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'[Report XL> 1986 Board of Governors of the Federal Reserve System Letter of Transmittal BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM Washington, D.C., May 18, 1987 THE SPEAKER OF THE HOUSE OF REPRESENTATIVES Pursuant to the requirements of section 10 of the Federal Reserve Act, I am pleased to submit the Seventy-Third Annual Report of the Board of Governors of the Federal Reserve System. This report covers operations of the Board during calendar year 1986. Sincerely, Paul A. Volcker, Chairman Contents Part 1 Monetary Policy and the U.S. Economy in 1986 3 INTRODUCTION 5 5 8 9 9 10 THE ECONOMY IN 1986 Prices Labor markets Household sector Business sector Government sector 13 MONETARY POLICY AND FINANCIAL MARKETS 15 Monetary aggregates 20 Aggregate credit flows 25 INTERNATIONAL DEVELOPMENTS 28 U.S. international transactions 31 Foreign exchange operations 33 MONETARY POLICY REPORTS TO THE CONGRESS 33 Report on February 19, 1986 53 Report on July 18, 1986 Part 2 Records, Operations, and Organization 75 RECORD OF POLICY ACTIONS OF THE BOARD OF GOVERNORS 75 Regulation D (Reserve Requirements of Depository Institutions) and Regulation Q (Interest on Deposits) 76 Regulation D (Reserve Requirements of Depository Institutions) 76 Regulation G (Securities Credit by Persons Other than Banks, Brokers, or Dealers) 77 Regulation J (Collection of Checks and Other Items and Wire Transfers of Funds) 77 Regulation K (International Banking Operations) 78 Regulation Y (Bank Holding Companies and Change in Bank Control) 78 Regulation Z (Truth in Lending) 79 Rules regarding delegation of authority 80 Policy statements 81 1986 discount rates 87 RECORD OF POLICY ACTIONS OF THE FEDERAL OPEN MARKET COMMITTEE 88 Authorization for domestic open market operations 89 Domestic policy directive 90 Authorization for foreign currency operations 92 Foreign currency directive 93 Meeting held on February 11-12, 1986 103 Meeting held on April 1, 1986 110 Meeting held on May 20, 1986 119 Meeting held on July 8-9, 1986 130 Meeting held on August 19, 1986 138 Meeting held on September 23, 1986 145 Meeting held on November 5, 1986 153 Meeting held on December 15-16, 1986 161 161 163 164 165 165 168 169 171 171 171 173 CONSUMER AND COMMUNITY AFFAIRS Regulatory and policy matters Community affairs Compliance examinations Survey on delayed availability of funds Compliance with consumer regulations Economic impact of Regulation E Complaints against state member banks Unregulated practices Community Reinvestment Act Consumer Advisory Council Legislative recommendations 177 177 178 179 179 179 180 LEGISLATIVE RECOMMENDATIONS Bank holding company legislation Emergency acquisition authority Increasing the number of Class C directors Funds for Reserve Bank Branches Interstate banking Improving check collection 181 181 181 183 LITIGATION Bank holding companies—antitrust action Bank Holding Company Act—review of Board actions Other litigation involving challenges to Board procedures and regulations 187 187 191 196 198 202 204 BANKING SUPERVISION AND REGULATION Supervision for safety and soundness Supervisory policy Regulation of the U.S. banking structure Board policy decisions and developments in bank-related activities Enforcement of other laws and regulations Federal Reserve membership 205 205 205 206 207 REGULATORY SIMPLIFICATION Regulation Q Policy regarding risk on large-dollar wire transfer systems Regulation Y Regulation K 209 FEDERAL RESERVE BANKS 209 Developments in the pricing of Federal Reserve services and in the payments mechanism 212 Examinations 212 Income and expenses 213 Federal Reserve Bank premises 213 Holdings of securities and loans 214 Volume of operations 215 BOARD OF GOVERNORS 215 Financial statements 221 222 STATISTIC"AL TABLES 1. Detailed statement of condition of all Federal Reserve Banks combined, December 31, 1986 224 2. Statement of condition of each Federal Reserve Bank, December 31, 1986 and 1985 228 3. Federal Reserve open market transactions, 1986 230 4. Federal Reserve Bank holdings of U.S. Treasury and federal agency securities, December 31, 1984-86 231 5. Number and salaries of officers and employees of Federal Reserve Banks, December 31, 1986 232 6. Acquisition costs and net book value of premises of Federal Reserve Banks and Branches, December 31, 1986 233 7. Income and Expenses of the Federal Reserve System, 1982-86 234 8. Income and expenses of Federal Reserve Banks, 1986 238 9. Income and expenses of Federal Reserve Banks, 1914-86 242 10. Priced services revenue and expenses at Federal Reserve Banks, 1986 and 1985 244 11. Operations in principal departments of Federal Reserve Banks, 1983-86 244 12. Federal Reserve Bank interest rates, December 31, 1986 245 13. Reserve requirements of depository institutions 246 14. Dates of removal of interest rate ceilings on deposits at federally insured institutions 246 15. Margin requirements for Regulations T, U, G, and X 247 16. Principal assets and liabilities, and number of insured commercial banks, by class of bank, June 30, 1986 and 1985 248 17. Reserves of depository institutions, Federal Reserve Bank credit, and related items—year-end, 1918-86, and month-end, 1986 252 18. Changes in number of banking offices in the United States, 1986 253 19. Mergers, consolidations, and acquisitions of assets or assumptions of liabilities approved by the Board of Governors, 1986 262 MAP OF FEDERAL RESERVE SYSTEM 263 264 266 267 268 270 271 FEDERAL RESERVE DIRECTORIES AND MEETINGS Board of Governors of the Federal Reserve System Federal Open Market Committee Federal Advisory Council Consumer Advisory Council Thrift Institutions Advisory Council Officers of Federal Reserve Banks, Branches, and Offices 293 INDEX DISTRICTS Parti Monetary Policy and the U.S. Economy in 1986 Introduction percent, a rate unprecedented during the postwar years. In part, this rapid money growth reflected the public's response to changes in interest rates that made holding NOW accounts and demand deposits more attractive. However, the growth in Ml was well in excess of what would be expected based on past relationships among money, interest rates, and income. Growth in the broader aggregates was more in line with past experience, taking account of interest rate movements. Both M2 and M3 expanded almost 9 percent and ended the year just within the upper bound of their annual target ranges. In the credit markets, short-term interest rates declined about 2 percentage points through the first three quarters of 1986, before backing up somewhat in response to pressure around the end of the year from a huge volume of tax-related financial transactions. Longer-term bond rates fell more than 2 percentage points in 1986; most of the decline occurred in the first four months of the year in response to an improved inflation outlook and sluggish growth in economic activity. After mid-April, Treasury bond rates fluctuated in a relatively narrow range, but corporate and municipal bond rates trended down and reached their lowest levels since the late 1970s. The declines in interest rates contributed to the vigorous pace of household spending last year by reNOTE. This discussion of economic and fi- ducing borrowing costs and boosting nancial developments in 1986 is adapted from asset values. Housing starts, which the Monetary Policy Report to the Congress Pursuant to the Full Employment and Balanced are particularly sensitive to interest Growth Act of 1978 (Board of Governors, Feb- rate developments, rose a bit despite the drag of a depressed economy in ruary 1987). Economic activity continued to expand moderately in 1986, at about the average pace prevailing since mid-1984. This growth was sufficient to create a substantial number of new jobs and to produce another small decline in the unemployment rate. Further progress also was made toward the objective of overall price stability. Wage and price behavior continued to be influenced by the anti-inflationary thrust of policies put in place earlier and by the adjustment of expectations to the new environment. Thus, while the plunge in world crude oil prices contributed importantly to the marked slowing in inflation in 1986, prices outside the energy area also decelerated on average. Labor cost pressures remained subdued, with nominal wage gains across a broad range of occupations and industries continuing to move toward rates more consistent with trends in labor productivity. The Federal Reserve encouraged continued economic expansion by supplying ample reserves for the banking system and reducing the discount rate four times, by a total of 2 percentage points. A large portion of the reserves provided were aimed at accommodating the strong demand for Ml-type deposits. Ml grew in excess of 15 percent in 1986, and its velocity declined more than 9 Introduction regions heavily dependent on oil and agriculture. In contrast, capital spending declined over the course of the year, largely because of the substantial cutback in oil drilling; more broadly, investment was restrained by an overhang of office and other commercial space and the weak pace of activity in major segments of the manufacturing sector. The disparity between household spending and business investment is indicative of the imbalances that characterized the U.S. economy in 1986. Indeed, economic performance throughout the expansion has varied considerably across industries and regions of the country. In some cases, such as agriculture, special circumstances have played a role. But more fundamentally, the imbalances are rooted in the enormous— and partly related—deficits in the country's external accounts and in the federal budget. Although the foreign exchange value of the dollar fell sharply through early 1987 from its peak in early 1985, the nation's trade deficit deepened. The increased price competitiveness of U.S. producers contributed to a sizable improvement in the growth of exports in 1986, but the pickup was limited by the sluggishness of economic activity in many other countries. At the same time, the volume of imports continued to rise rapidly through most of the year, in part because the pass-through into import prices of the dollar's depreciation against major foreign currencies was limited by the ability of foreign exporters and U.S. distributors to absorb much of the swing in exchange rates in their profit margins. Also, an increasing amount of imports was coming from the newly industrialized and developing countries whose currencies, as a group, did not appreciate against the dollar. With import penetration remaining on an uptrend, domestic production continued to expand less rapidly than domestic demand. The federal budget deficit also remained huge, despite substantial deficit-reducing actions taken by the administration and the Congress. Official estimates suggest a deficit for fiscal 1987 of around $175 billion, a good deal less than the record 1986 figure but still equal to a historically high 4 percent of the gross national product. Further cuts in the federal deficit are essential, in the context of movement toward better external balance, to ensure that an adequate flow of domestic saving is available to support needed domestic investment. The Economy in 1986 The economy completed a fourth consecutive year of expansion in 1986, with real gross national product increasing about 2 percent. The rise in overall activity resulted in 2V2 million new payroll jobs. The jobless rate for civilians continued to edge down and was 63A percent at yearend. Inflation slowed sharply in 1986: virtually all broad measures of price trends showed their smallest increases in many years. Although the sharpness of the deceleration owed much to specific developments in the markets for oil and other commodities, the favorable inflation performance also represented at a fundamental level the continuation of trends in wage and price behavior fostered by policies in place since the early part of the decade. While output continued to grow in 1986, the economy still was characterized by pronounced imbalances. These were reflected in marked disparities in economic performance across industries and geographic areas. In particular, domestic oil exploration and investment were cut back severely, and only massive federal subsidies sustained many farm enterprises faced with sharply lower crop prices. In addition, major segments of the industrial sector continued to struggle with intense foreign competition, and relatively low rates of capacity utilization, along with a glut of office space, depressed capital spending. The most serious imbalances continued to be in the external sector and in the federal budget. Despite the decline of roughly 40 percent after early 1985 in the foreign exchange value of the dollar against the other Group of Ten currencies, the country's trade balance continued to deteriorate. Growth in the volume of exports did pick up in 1986 in response to the enhanced international competitiveness of U.S. firms, but the rebound was damped by the relatively slow growth of the economies of U.S. major trading partners. Import volumes continued to expand rapidly through most of the year, in part because much of the swing in exchange rates apparently was absorbed in the profit margins of foreign exporters and U.S. distributors, and increases in the prices of imported goods were thereby limited. As a result, the current account deficit continued to widen, to about $150 billion in 1986. The federal budget deficit also increased, hitting $221 billion in fiscal 1986; the deficit vastly exceeded official targets, as underestimates of program costs and shortfalls in revenues offset the deficit-reducing actions taken by the administration and the Congress. The much smaller estimated deficit in the area of $175 billion for fiscal year 1987 is still considerably above the GrammRudman-Hollings target of $144 billion. Prices The GNP fixed-weight price index increased about 2V2 percent in 1986. This was the smallest yearly increase in more than two decades and followed a rise of 3V2 percent in 1985. Some other popular measures of 6 The Economy in 1986 c Performance Percent change, Q4 to Q4 Real GNP Percent change, Q4 to Q4 Real personal income and consumption 6 Consumption j expenditures u Millions of units Total private housing starts Percent of disposable income Personal saving rate 2 Percent change, Q4 to Q4 Billions of 1982 dollars Change in real business inventories Real business fixed investment 10 50 • 25 10 25 Percent Unemployment rate Percent change, Q4 to Q4 GNP fixed-weight price index 10 1982 1984 1986 All data are seasonally adjusted, and those that involve dollar amounts are in 1982 dollars. The unemployment data are from the U.S. Department of 1982 Jlli 1984 1986 Labor; the other data are from the U.S. Department of Commerce, The Economy in 1986 7 prices decelerated even more. The Consumer Prices Percent change, Dec. to Dec. consumer price index for goods and services rose only about 1 percent, Total 10 and the producer price index for finished goods actually fell 2V2 percent. The greater deceleration in the Energy consumer and producer price indexes than in the GNP price measure 10 reflects the greater importance of energy prices in those indexes. The movements in energy prices over the past year or so have been striking. World crude oil prices dropped from $26 per barrel in late 1985 to about $11 per barrel around midyear; they trended up over the second half of 1986 and rose to around $18 per barrel in early 1987 in the wake of 20 the agreement on production limits reached by the Organization of Pe15 troleum Exporting Countries in late December. The drop in crude oil 10 prices in the first half of 1986 was Goods less food and energy reflected promptly in prices of gasoline and home heating oil, which fell around 30 percent over the course of 1984 1986 1982 the year. Charges for electricity and The data are from the U.S. Department of Labor. natural gas also declined, but much less than those for refined petroleum products. On balance, retail energy prices declined 20 percent over the of home electronic and photographic year. equipment, and retail prices of such Price increases outside the energy goods accelerated. But there was area generally remained moderate in little evidence of any significant ag1986. Retail food prices rose 4 per- gregate impact on other consumer cent, a bit more than in 1985, reflect- goods. Prices for nonenergy services ing the effects of the summer's heat also slowed somewhat, but they still wave in the Southeast. However, rose around 5 percent, boosted by prices of retail goods excluding food continued large increases for medical and energy continued to slow and, services and higher premiums for on balance, were up only IV2 percent. various types of insurance. The influence of the depreciating Prices for many basic industrial dollar on consumer goods prices was commodities continued to decline highly variable across sectors and over most of the first three quarters relatively small overall. Sizable in- of 1986. Excess capacity in some creases occurred in dockside prices basic industries and the generally for foreign cars and for some types abundant world supplies of many I 1• • • I IIII lib 1.1. 8 The Economy in 1986 primary commodities contributed significantly to the weakness in these prices. Sluggish industrial activity in the United States and other large economies also was a factor. Prices in a number of these markets turned up late in the summer, possibly in response to the firming in U.S. industrial activity. Nonetheless, industrial commodity prices at yearend were well below the peaks reached in mid-1984. Labor Markets The increase of 2V2 million in nonfarm payroll employment in 1986 was about the same as the robust 1985 pace. Hiring in trade and services again was quite vigorous, with especially large increases for business and health services. In contrast, manufacturing employment contracted over the first three quarters of 1986. However, it picked up in the autumn in response to an apparent firming in industrial activity; in nondurable goods industries, where output had risen steadily, employment gains were widespread, but hiring at firms producing durable goods remained spotty. The growth in the number of jobs in 1986 slightly exceeded the rise in the labor force. As a result, the civilian unemployment rate edged down, to 63/4 percent at year-end. Labor force participation maintained its upward trend: women continued to enter the workforce in large numbers, in part responding to expanding job opportunities; and participation rates for adult men held steady. Overall, the number of persons employed relative to the working-age civilian population reached 61 percent, a new high. Wages continued on a path of moderation in 1986. Hourly compensation in the nonfarm private sector, Labor Market Conditions Millions of persons Payroll employment 100 Total 90 Nonmanufacturing 80 70 Percent change, Q4 to Q4 Compensation per hour 10 Output per hour 1982 1984 1986 Payroll employment covers the total nonfarm sector; hourly compensation and output cover the nonfarm business sector. All data are from the U.S. Department of Labor. as measured by the employment cost index, rose about 3XA percent, 3A percentage point less than in 1985. The deceleration in wages reflected the continued slack in labor markets as well as the reduction in price inflation, and was widespread across industries and occupations. In the unionized sector, wage increases were especially small, and a number of alternative, more flexible compensa- The Economy in 1986 tion arrangements were adopted, including the substitution of lump-sum payments for general wage increases. The advance in compensation for white-collar workers also moderated, although it remained more rapid than that for other groups. Unit labor costs in the nonfarm business sector were well contained in 1986, because of the relatively moderate increase in wages. Gains in output per hour, however, have averaged less than 1 percent per year since 1984; through 1986 the underlying trend in productivity for the business sector as a whole improved only slightly from the very low pace of the 1970s, and it remains well below the pace of earlier years in the postwar period. In contrast, productivity in manufacturing has increased about 3V2 percent a year over the past three years, in part because intense foreign competition has induced many producers to modernize their factories and streamline their operations. Household Sector The household sector was the major contributor to overall growth again in 1986. Consumer spending increased a robust 4 percent in real terms, even though income growth was only moderate on average for the second year in a row. Real disposable income soared in the first half of the year because of the plunge in energy prices, but it dropped after midyear as wage and salary gains remained sluggish and farm and interest income declined. Consequently, the personal saving rate fell to around 4 percent, the lowest annual average in nearly 40 years. The growth in consumption last year was paced by strong gains in purchases of durable goods, while 9 spending on nondurable goods and services increased at about the same rate as in the preceding few years. Among durable goods, sales of new cars rose to around IIV2 million units. Effective prices of new cars were held down by incentive programs of below-market financing for domestic makes and by the introduction of low-priced imports from Korea and Yugoslavia. At the same time, sales of Japanese and European models remained brisk, despite sizable increases in their sticker prices. Total outlays for other durable goods also rose substantially, as consumers greatly increased their purchases of home electronics products, and sales of furniture and appliances were supported in part by the robust pace of home sales in recent years. Housing activity continued to expand in 1986. Total housing starts edged up to 1.8 million units for the year as a whole, their highest level since the late 1970s. Single-family homebuilding increased about 10 percent, bolstered not only by a sizable decline in mortgage rates— which brought rates on fixed-rate loans back to single digits for the first time since 1978—but also by continuing favorable demographic trends. In contrast, multifamily activity dropped off considerably over the course of the year; an important factor in the decline was the restraining influence of record-high vacancy rates on rental units, especially in key markets in the South. In addition, several provisions of 1986 tax legislation have reduced the profitability of building rental housing. Business Sector Business spending on plant and equipment declined 4V2 percent in 10 The Economy in 1986 real terms in 1986. Much of the drop was attributable to the sharp cutback in oil and gas well drilling, which fell almost 50 percent over the year. But investment outside of the energy sector also was generally lackluster as many firms, especially in the tradable goods sector, trimmed expansion plans in light of relatively low rates of capacity utilization and continuing uncertainty about future sales trends. Investment in computers and other office machines remained on the path of reduced growth evident since the fading of the high-tech spending boom in 1985, in part because of concerns about the productivity-enhancing potential of some of these products. More generally, the widely anticipated elimination of the investment tax credit prompted many firms to accelerate spending in late 1985; despite another tax-related speedup late last year, the net effect of tax changes in 1986 appears to have been to depress equipment spending. Outlays for nonresidential structures outside of the energy area, which had risen exceptionally fast over the first few years of the expansion, fell in 1986. The decline in office construction, where vacancy rates reached extraordinarily high levels, was especially sharp. Inventory investment generally remained subdued in 1986. Faced with sluggish orders and stable or falling prices, manufacturers continued to trim their stocks. In the retail and wholesale trade sector, inventories of goods other than automobiles increased moderately for the second year in a row; however, at year-end such stocks appeared to be roughly in line with near-term sales prospects. At auto dealers, stocks fluctuated widely but showed little net change over the course of the year; drops in inventories coincided mainly with the special incentive programs that pushed sales to record levels, and also with a burst in sales in December in anticipation of tax changes in 1987. After-tax economic profits in the nonfinancial corporate sector, although at fairly high levels relative to GNP, were essentially unchanged overall from 1985. There was considerable diversity in the performance of individual industries: the petroleum industry experienced a marked decline in profits associated with the fall in oil prices, while petroleumusing industries such as chemicals and plastics fared relatively well. Government Sector Even though the administration and the Congress have taken significant action in the past few years to reduce it, the federal budget deficit has remained huge. In fiscal year 1986 the imbalance hit a record $221 billion, exceeding the previous year's deficit by more than $8 billion. Revenue growth in 1986 was restrained by the relatively moderate rise in nominal income, while demands on some programs were strong, especially in the areas of agriculture and health. Although the budgetary program put in place for fiscal year 1987 was nominally consistent with the Gramm - Rudman - Hollings deficit target of $144 billion by January 1987, the published estimates of the administration and the Congressional Budget Office were around $175 billion, equal to about 4 percent of GNP—still a high ratio historically. Excluding changes in farm inventories held by the Commodity Credit The Economy in 1986 Billions of dollars Federal government ;- 0 100 200 State and local government 20 10 1982 1984 1986 The data on the federal government deficit are for fiscal years and are on a budget basis; they are from the U.S. Department of the Treasury. The data on state and local governments are for operating budgets. They are on a national income accounts basis, and they come from the U.S. Department of Commerce. The total 1986 surplus of $5.0 billion for state and local governments contained about $4.7 billion of nonrecurring inflows from settlements involving oil company overcharges, Outer Continental Shelf rents, and stripper-well charges, as well as shifting of some revenue-sharing payments to fiscal 1986. 11 Corporation (CCC), federal purchases of goods and services rose appreciably in 1986. Over the course of the year defense purchases in real terms grew about 7 percent, similar to the increases recorded since the early 1980s. Excluding CCC purchases, real nondefense outlays, which have shown little net change in recent years, were essentially flat. Purchases of goods and services by state and local governments rose briskly in 1986, mainly because of a surge in construction activity. An upswing in the school-age population in recent years has led to a step-up in school building, and numerous programs are under way to expand and improve the infrastructure. The growth in overall outlays has been sustained despite concerns about the financial condition of the sector. Excluding some special one-time inflows, such as previously escrowed oil-lease payments, the combined surplus of operating and capital accounts for the sector as a whole fell to near zero in 1986. Many states, including most of those in the energy and agricultural regions, responded to budgetary pressures by raising taxes and cutting spending. 13 Monetary Policy and Financial Markets The Federal Reserve faced continuing challenges in 1986, not only in discerning the underlying trends in a complex domestic and international economic setting, but also in specifying appropriate policy actions in a financial environment marked by rapid structural change. As in previous years, and in keeping with the Full Employment and Balanced Growth Act, the Federal Reserve used money and credit aggregates as a means of assessing and characterizing policy. At the same time, in targeting these aggregates and in reaching operational decisions with respect to the degree of reserve pressures and the discount rate, the evaluation of signals provided by a broad range of economic and financial indicators played a large role. At its meeting in February 1986, the Federal Open Market Committee established target growth ranges, measured from the fourth quarter of 1985 to the fourth quarter of 1986, of 3 to 8 percent for Ml and 6 to 9 percent for both M2 and M3. The associated monitoring range for growth of domestic nonfinancial debt was set at 8 to 11 percent. In light of the experience of recent years, the Committee recognized that the relationship between Ml and economic activity was subject to especially great uncertainty. Accordingly, the FOMC agreed to evaluate movements in Ml in light of their consistency with the patterns in other monetary aggregates, developments in the economy and financial markets, and potential inflationary pressures. Ml was well above its annual target range when the FOMC met in July. The available evidence suggested that the rapid growth of Ml reflected shifts in portfolios toward liquid assets in the context of declining market interest rates, rather than excessive money growth with potential inflationary consequence. Against this background, the Committee concluded that Ml growth above the existing range would be acceptable, provided the broader aggregates expanded within their target ranges, price pressures remained in check, and the economy continued to expand at a moderate pace. The Committee reaffirmed the target ranges for M2 and M3 at its July meeting. According to data at that time, both of these aggregates had expanded at rates near the midpoints of their ranges, and Committee members believed that growth within those ranges for the year was still consistent with the overall policy objectives of reducing inflation further, promoting sustainable growth in output, and contributing to an improved pattern of international transactions. In the first half of the year, the growth of domestic nonfinancial debt exceeded both its monitoring range and the growth of nominal GNP, as it had in previous years. The Committee was concerned about the burdens and potential instabilities associated with the persistence of rapid debt growth, and it felt that raising the monitoring range for debt would create an inappropriate benchmark for evaluating long-term trends. The existing range was maintained, but the FOMC 14 Monetary Policy and Financial Markets Monetar Sect* Billions of dollars Ml M2 3400 3200 Total domestic nonfinancial debt = 'ii 7300 6900 Reserves 55 Total 45 1985 1986 The ranges adopted by the FOMC for the monetary aggregates and for total debt of the domestic nonfinancial sector were for the period from 1985:4 to 1986:4. The reserve aggregates have been adjusted to remove discontinuities associated with changes in reserve requirements. Nonborrowed reserves include extended credit. The shaded area is adjustment and seasonal borrowing. thought that debt growth could well exceed its upper bound. The growth of M2 quickened in the second half of the year, and M3 expanded at a somewhat faster pace as well. Nevertheless, both of the broader aggregates ended the year within their target ranges, although near the upper bounds. Ml accelerated further in the second half of the year, resulting in a record postwar decline in velocity for 1986. The growth of nonfinancial debt slowed slightly in the second half of the year, but still exceeded its monitoring range by nearly 2 percentage points. Pressure on reserve positions of depository institutions changed little over the course of 1986, as evidenced by a relatively low volume of borrowing at Federal Reserve Banks. The broadly accommodative thrust of policy also was manifest in the four reductions in the discount rate between March and August. In part, these cuts were intended to keep this rate in line with the yields on shortterm market instruments, but they also were taken in the context of hesitant worldwide economic growth, an improved inflation outlook, and growth of the broader monetary aggregates within their annual target ranges. In setting monetary policy the FOMC paid considerable attention to the country's trade deficit and the foreign exchange value of the dollar. The Committee members generally viewed the narrowing in the trade deficit as a key to achieving a sustainable and smooth expansion of activity across the economy. At the same time, the Committee was concerned that an unduly precipitous decline of the dollar against the currencies of the country's major trading partners could contribute to Monetary Policy and Financial Markets inflationary pressures here. To help limit the effect on the value of the dollar, the first reduction in the discount rate was coordinated with action by other major central banks; similarly, the reduction in April was accompanied by a cut in the Bank of Japan's discount rate. Monetary Aggregates M2 expanded almost 9 percent in 1986, placing this aggregate near the upper bound of its annual growth target. Although in recent years M2 has exhibited a tighter relationship with nominal GNP than Ml has, the velocity of M2 still registered a decline of 4 percent last year and reached its lowest level in decades. The buildup of M2 balances relative to income probably reflected incentives to place savings in various components of the aggregate whose offering rates were falling more slowly than market interest rates were. Among rates on retail deposits, the slowest to adjust in 1986 were those on short-term accounts. Depository institutions were reluctant to reduce rates on savings deposits because many of these accounts had represented a stable, profitable source of funds for many years. Rates on NOW accounts also fell only slightly. Much larger declines were registered on time deposits, reflecting not only quicker adjustment to market rates but also the pattern of rate movements in the credit markets, where long-term rates fell much more than short-term rates in late 1985 and early 1986. The changing structure of deposit rates at banks and thrift institutions led to a pronounced shift in the composition of M2: inflows to transaction deposits, savings deposits, money market deposit accounts, and money market mutual fund shares 15 were very strong while small time deposits ran off, marking the second consecutive year of zero or negative growth. The weakness in small time deposits in 1985 and 1986 also could have reflected "rate shock." As existing time deposits matured, savers with high-yielding deposits acquired several years earlier were unable to reinvest the funds at comparable returns. A sizable portion of maturing deposits evidently was placed in liquid instruments in M2 while savers searched for other investment opportunities. Yield-conscious investors also may have been lured from time deposits by attractive returns on some nondeposit instruments. For example, stock and bond mutual funds grew rapidly in 1985 and 1986 after stagnating during most of the 1970s and early 1980s, and the issuance of savings bonds was strong in the summer and fall before their minimum yield was lowered from lxh to 6 percent. M3 also ended 1986 near the upper bound of its annual target range, increasing 8% percent over the year. Growth of M3 close to that of M2 is not surprising, inasmuch as M2 constitutes four-fifths of the larger aggregate. (The remaining share is dominated by large time deposits and certain other managed liabilities of depository institutions.) Credit growth at banks and thrift institutions remained quite strong last year; but, with the exception of the first quarter, the use of managed liabilities in M3 was light as growth of core deposits was largely sufficient to fund asset expansion. Large certificates of deposit expanded only 3 percent on balance, with commercial banks paying down their outstanding CDs during much of the year and thrift institutions also doing so in the 16 Monetary Policy and Financial Markets Reserves, Money Stock, and Debt Aggregates Annual rate of change based on seasonally adjusted data unless otherwise noted, in percent1 1986 1985 Item 1984 1985 1986 Q4 Ql 02 Q3 Q4 2 Depository institution reserves Total Nonborrowed Required Monetary base3 Concepts of money4 Ml Currency and travelers checks Demand deposits Other checkable deposits M2 Non-Mi component MMDAs (n.s.a.), savings, and small-denomination time deposits General-purpose and broker/dealer money market mutual fund assets (n.s.a.) Overnight RPs and Eurodollars (n.s.a.) M3 Non-M2 component Large-denomination time deposits Institution-only money market mutual fund assets (n.s.a.) Large-denomination term RPs (n.s.a.) Term Eurodollars (n.s.a.) Domestic nonfinancial sector debt Federal Nonfederal 76 . -2.9 73 . 73 . 15.2 26.6 15.1 88 . 20.4 22.5 20.3 97 . 12.4 10.3 11.5 82 . 13.1 19.1 12.3 83 . 18.1 17.9 19.8 9.0 23.5 23.8 23.9 10.1 21.5 22.4 19.9 10.3 54 . 71 . 16 . 10.5 12.1 80 . 89 . 22.2 15.3 75 . 11.6 28.6 10.9 72 . 85 . 18.1 88 . 73 . 46 . 16.8 15.5 16.5 6.7 7.5 14.6 12.6 25.5 30.6 17.0 78 . 12.8 31.1 79 . 86 . 88 . 78 . 89 . 68 . 66 . 53 . 53 . 42 . 9.4 10.6 74 . 86 . 91 . 64 . 8.0 7.3 5.5 4.5 5.2 5.7 6.1 4.7 17.0 9.2 17.3 0.5 11.3 27.3 14.0 12.7 4.7 20.0 13.4 27.3 5.3 -2.3 30.7 18.1 10.7 23.3 7.7 3.4 8.8 8.5 7.1 8.9 7.7 17.3 8.7 6.1 9.7 6.4 7.9 3.4 29.2 4.8 3.0 10.0 12.6 1.6 -0.1 -2.2 33.6 12.1 30.3 3.1 22.9 39.2 30.9 16.8 36.7 -8.5 -4.0 -5.0 27.3 4.9 40.6 -3.1 47.0 8.2 18.8 6.1 13.6 -4.5 21.0 9.6 13.9 16.0 13.3 13.5 15.2 12.9 12.9 14.6 12.3 13.6 13.7 13.5 15.4 17.0 15.0 10.3 11.6 9.8 12.0 14.5 11.2 11.5 12.6 11.1 1. Changes are calculated from the average amounts outstanding in each quarter. Annual changes are measured from 0 4 to 04. 2. Data on reserves and the monetary base incorporate adjustments for discontinuities associated with the implementation of the Monetary Control Act and other regulatory changes to reserve requirements. 3. The monetary base consists of total reserves plus the currency component of the money stock (less the amount of vault cash holdings of thrift institutions that is included in the currency component of the money stock) plus, for institutions not having required reserve balances, the excess of current vault cash over the amount applied to satisfy current reserve requirements. 4. Ml consists of currency in circulation; travelers checks of nonbank issuers; demand deposits at all commercial banks other than those due to domestic banks, the U.S. government, and foreign banks and official institutions, less cash items in the process of collection and Federal Reserve float; and other checkable deposits, which consist of negotiable orders of withdrawal and automatic transfer service accounts at depository institutions, credit union share draft accounts, and demand deposits at thrift institutions. M2 is Ml plus money market deposit accounts (MMDAs); savings and small-denomination time deposits at all depository institutions (including retail repurchase agreements), from which have been subtracted all individual retirement accounts (IRAs) and Keogh accounts at commercial banks and thrift institutions; taxable and tax-exempt general-purpose and broker/ dealer money market mutual funds, excluding IRAs and Keogh accounts; overnight and continuingcontract RPs issued by commercial banks; and overnight Eurodollars issued to U.S. residents by foreign branches of U.S. banks worldwide. M3 is M2 plus large-denomination time deposits at all depository institutions; assets of institution-only money market mutual funds; large-denomination term RPs issued by commercial banks and thrift institutions; and term Eurodollars held by U.S. residents in Canada and the United Kingdom and at foreign branches of U.S. banks elsewhere. Monetary Policy and Financial Markets fourth quarter. The weakness in CDs was widespread as institutions relied more on other managed liabilities, such as term repurchase agreements (included in M3) and advances from Federal Home Loan Banks (not included in M3). The broad shift to liquid assets greatly affected the behavior of Ml. The narrow monetary aggregate expanded more than 15 percent in 1986, marking the second consecutive year of double-digit growth. Its velocity fell 9V2 percent compared with a decline of 5% percent in 1985. Since 1981, the velocity of Ml has declined 16 percent, a remarkable development in view of its tendency to climb about 3 percent a year in the previous two decades. Much of the rapid growth in narrow money over the past two years appears to have been related to the way the sharp decline in market interest rates affected incentives to hold NOW accounts and demand deposits. Short-term market interest rates fell about 5 percentage points from their peak in the latter part of 1984 to their lowest levels since 1977, while NOW account rates changed much less. Although more rapid money growth generally would be expected in an environment of declining rates, the expansion of Ml in 1985 and 1986 was in excess of that implied by the historical relationships among money, interest rates, and income. About half of the growth of Ml in both years occurred in interest-bearing checkable deposits. Because depository institutions were slow in adjusting the rates paid on NOW accounts, the spreads between those rates and rates on substitutes narrowed substantially. For example, 17 between the first quarter of 1986, when interest rates on NOW accounts were fully deregulated, and the fourth quarter of the year, the spread between the rate on threemonth Treasury bills and the average rate on NOW accounts at commercial banks shrank from 135 basis points to 53 basis points. Similarly, the average rate on NOW accounts in late 1986 was not far below that on six-month small time deposits. Demand deposits also accelerated; they grew nearly 12 percent from the fourth quarter of 1985 to the fourth quarter of 1986. As with other checkable deposits, lower short-term interest rates are an important influence on the growth of demand deposits because they reduce incentives to economize on transaction balances. Also, some demand deposits are held by business firms in exchange for services provided by banks, and these compensating-balance requirements typically are enlarged as market rates decline. Although these effects were important to the expansion of demand deposits throughout 1986, the apparent response to declining interest rates was much larger than would be expected from historical experience. Another element in the growth of demand deposits apparently was the large volume of financial transactions in 1986. For example, because of certain payment procedures—such as transferring funds held in escrow accounts by officer's check rather than by wire—the massive volume of mortgage originations and prepayments could have influenced the movement of demand deposits. In addition, a flurry of financial transactions around year-end induced in part by impending changes in the tax 18 Monetary Policy and Financial Markets law temporarily boosted demand deposits sharply. In implementing monetary policy in 1986, the FOMC generally accommodated through open market operations the strong demand for reserves associated with the rapid growth of transaction balances. In the context of prospects for slow growth of real economic activity, disinflationary trends in wages and prices, and growth of the broader monetary aggregates within their target ranges, four reductions in the discount rate were implemented between March and August. Early in the year, all the monetary aggregates slowed sharply, with M2 dropping below its annual target range. Also, evidence suggested that the economy was growing sluggishly, and the outlook for inflation improved as oil prices fell. In this environment, market interest rates began to decline in mid-February, and the Federal Reserve reduced the discount rate l/i percentage point to 7 percent in early March. At the Interest Rates Percent per year Short-term 20 U.S. government bonds State and local government bonds 1982 All the data are monthly averages. Their descriptions and sources are as follows: Federal funds, from the Federal Reserve; three-month Treasury bills, market rate on three-month issues, on a discounted basis, from the U.S. Department of the Treasury; conventional mortgages, weighted averages of 30-year, fixed-rate, level-payment mortgages at savings and loan associations, from the Federal Home Loan Mort- 1984 1986 gage Corporation; A-rated utility bonds, weighted averages of recently offered, 30-year investment-grade bonds adjusted to an A-rated basis by the Federal Reserve; U.S. government bonds, market yields adjusted to 30-year constant maturity by the U.S. Treasury; state and local government bonds, index based on 25 issues of 30-year revenue bonds of mixed quality, from the Bond Buyer. Monetary Policy and Financial Markets time, there was concern that unilateral action to lower interest rates might cause an excessive reaction in the foreign exchange market, where the dollar had been under downward pressure. Accordingly, the reduction was timed to correspond with similar actions by the central banks of West Germany, Japan, and several other industrialized nations. With the economy expanding slowly and underlying price pressures continuing to moderate, interest rates fell further throughout March and into April. By mid-April, most market interest rates had reached their lowest levels since the late 1970s, and the Federal Reserve instituted another reduction in the discount rate to catch up with and to ratify the declines in market rates. After mid-April, interest rates rose for a short time as market participants focused on an upturn in oil prices, an acceleration in the growth of the monetary aggregates, and a further decline in the foreign exchange value of the dollar. By the end of June, however, a steady flow of weak statistics began to reveal anemic growth in real economic activity in the second quarter. The FOMC had expected an improvement in activity in the second half of the year, but the rebound now appeared likely to be less vigorous than previously anticipated and perhaps delayed because of continued disappointing movements in the U.S. trade position and the effects of pending tax reform legislation on business investment. Accordingly, shortly after the July FOMC meeting, the Board approved another cut of a half point in the discount rate to 6 percent. The final reduction in the discount rate last year took place after the August FOMC meeting. The last two reductions in 1986 were adopted 19 without similar action by foreign central banks. Unilateral action to lower interest rates carried the risk of adding to the downward pressure on the dollar and possibly feeding a source of inflationary pressure. However, the Federal Reserve thought that prevailing economic and financial conditions warranted taking such a risk, realizing that the provision of reserves could be tightened through open market operations if adverse developments were to arise. Although the value of the dollar fluctuated considerably after the reduction in the discount rate in August, it showed no distinct downward movement until around year-end. Short-term interest rates declined about 1 percentage point over the summer months, moving either in anticipation of, or in response to, the reductions in the discount rate. Long-term rates were about unchanged on balance over the summer, but more concern about interest rate prospects developed in early fall. Economic indicators began signaling a pickup in the pace of economic activity, and rising prices of oil and precious metals, along with the potential effects of the cumulative decline in the value of the dollar, seemed to raise concerns about the outlook for inflation. Through the remainder of the year, the FOMC attempted to keep a steady degree of reserve pressure, and market interest rates fluctuated within a fairly narrow range. Even so, short-term interest rates moved higher as the end of the year approached, in part because of the exceptional volume of tax-related transactions. As firms rushed to complete mergers and buyouts, and households stepped up their sales of assets to realize capital gains, the demand for business loans and trans- 20 Monetary Policy and Financial Markets action balances surged. This heavy volume of financing also was reflected in unusually strong demand for reserves by depository institutions. The System added reserves freely to accommodate this demand, but the pressure nevertheless showed through short-term rates. Shortly after the turn of the year, short-term rates moved down toward their earlier levels. The dollar, however, was under substantial downward pressure in early 1987; disappointing figures on the U.S. trade deficit prompted selling of the dollar on exchange markets, and this pressure intensified with reported suggestions by some U.S. policymakers that, particularly in the absence of more growthoriented policies abroad, the dollar might need to depreciate further to correct the nation's external imbalance. Aggregate Credit Flows Domestic nonfinancial debt expanded almost 13 percent in 1986, a slightly slower pace than that in the two previous years but still above both the Committee's monitoring range and the growth of nominal GNP.1 Debt issuance by the state and local sector dropped off substantially from the pace set in 1985, when it was boosted by borrowing in anticipation of tax reform restrictions. In the household sector, mortgage borrowing strengthened, but a marked decrease in the expansion of consumer installment credit contributed 1. When measured from the end of December to the end of December, domestic nonfinancial debt expanded IIV2 percent. The growth from fourth quarter to fourth quarter cited in the text is higher because of the surge in debt at the end of 1985 and the arithmetical effects ofFRASER averaging. Digitized for quarterly to a slowing in the overall growth of household indebtedness. A continuation of corporate financial restructurings buoyed expansion of business debt, despite the maintenance of a moderate gap between capital spending and internal funds. Growth of federal sector debt remained strong. Growth of consumer installment credit receded last year to about 12 percent from the 15 to 20 percent pace of recent years. Nevertheless, installment debt continued to grow faster than income, and the ratio of such debt to income established another record. With mortgage debt expanding rapidly, the ratio of overall household debt to income also reached a new high. Assets of the household sector have increased sharply in recent years; rising stock prices alone added several hundred billions of dollars to household wealth in 1986. At the same time, many families, especially in parts of the country hard hit by economic adversities, have experienced difficulty in meeting their financial commitments. The number of personal bankruptcies accelerated dramatically in 1985 and 1986, surg- Consumer Installment Debt Percent of disposable income 20 1970 1975 1980 1986 Based on data from the Federal Reserve and from the U.S. Department of Commerce. Monetary Policy and Financial Markets ing last year well beyond the historical experience. Strains in managing credit card debt were particularly evident as delinquency rates on revolving-balance accounts increased appreciably. Delinquency rates on other categories of installment debt and on mortgage loans fell some last year, although they were much higher than in previous expansions. For some households, debt-servicing burdens were reduced by the refinancing of high-rate mortgages or the decline in interest payments on their adjustable-rate mortgages. Internal funds in the aggregate were nearly sufficient to meet the basic financing needs of nonfinancial corporations in 1986. However, some firms continued to borrow heavily to fund massive retirements of equity in association with mergers, buyouts, and share repurchases. At the same time, the drop in long-term interest rates afforded businesses the opportunity to improve their financial positions. As long-term interest rates declined in the spring of 1986 to their lowest levels in eight years, corporate bond issuance surged to record levels. Indeed, the volume of domestic corporate bonds sold last year was nearly twice the previous record set in 1985. Much of the proceeds from bond issuance in 1986 was used to refund higher-cost long-term debt or to pay down short-term debt. As the stock market continued to register impressive gains, new equity issuance also reached record levels; of the gross proceeds from issues sold last year, about 30 percent was raised by firms issuing stock in the public market for the first time. The retirement of high-coupon bonds, the reduced dependence on short-term credit, and the issuance equity shares tended to imof new 21 prove conventional measures of corporate balance-sheet strength. However, massive volumes of outstanding equity were retired through mergers, acquisitions, buyouts, and other restructurings, resulting in the third consecutive year of large net equity retirements. Reflecting the financing patterns in these years, the aggregate debt-equity ratio of nonfinancial corporations swelled to a record level on a "book" basis. But when stated at market values, the robust gains in share prices kept debt-equity ratios well below levels that generally prevailed during the 1970s. As interest rates trended down after 1981, interest-coverage ratios crept up, suggesting that the ability of firms in the aggregate to service their debt did not deteriorate. These modest gains, however, were achieved in relatively benign market and economic circumstances. The large paydown of equity reduced the ability of some corporations to weather economic shocks. The weak financial structures of some firms, along with strains in certain industries, led to more than $3 billion of corporate bond defaults in 1986, an amount that dwarfs experience in nearly every other year of the postwar period. Concern that other firms also might have problems in meeting their financial obligations was reflected in the pace of bond downgradings, which in 1986 were more than three times as numerous as in the late 1970s. Firms with downgraded debt typically find their securities trading at higher interest rates in the market. In general, however, quality spreads between private debt securities of different grades have been relatively stable in recent years, suggesting that investors have not been alarmed about the credit quality of corpora- 22 Monetary Policy and Financial Markets Ratio of Debt to Equity for Nonfinancial Corporations Percent 75 Debt (par) Equity (book) 50 A 1961 1966 1971 1976 1981 1986 Federal Reserve flow of funds accounts. The market value of debt is based on market prices of bonds traded on the New York Stock Exchange and par values of loans and short-term paper; the market value of equity is based on market prices of outstanding shares. tions in the aggregate and have not attempted to limit their portfolios to higher-rated issues.2 During the first half of 1986, spreads between the yields on corporate bonds and Treasury securities widened considerably, but this widening appeared to be related to the heavy volume of corporate issues and to a revaluation of call and refunding provisions on long- term obligations. A narrowing of these spreads early in 1987 reversed much of the earlier increase. While the economy had grown continuously for more than four years by the end of 1986, the expansion was uneven and it left certain sectors under severe strains. The well-known problems faced by firms in the mining, energy, agricultural, and many manufacturing industries, and by a number of heavily indebted developing countries, were feeding through to the financial intermediaries supplying them credit. For example, 136 commercial banks failed in 1986, compared with only 7 in 1981. Many of these institutions had heavy credit exposures to the oil industry, while more than 40 percent of them held relatively large amounts of agricultural loans. 2. The interest rate spreads between investment-grade and speculative issues widened about 50 basis points for a short time after the bankruptcy filing by LTV Corporation in July 1986. Low-rated or unrated bonds also experienced substantial yield increases for a time later in the year, further widening the spread, when concerns about the liquidity of that market segment surfaced in connection with the insider-trading scandal. That widening was reversed in early 1987. Monetary Policy and Financial Markets The impact of the distress in the farm sector also has been severe for the Farm Credit System, the government-sponsored agency that holds about 25 percent of outstanding farm debt in the United States. The losses of the banks in the System totaled nearly $2 billion in 1986, largely reflecting provisions for loan losses, and the System's capital surplus soon will be exhausted if losses do not abate. The Congress approved regulatory accounting procedures for the Farm Credit System in the fall of 1986 that will allow the banks to report higher net income than generally accepted accounting principles would permit. The higher reported income may ease some of the problems within the System relating to the preservation of capital and help to justify charging borrowers more competitive rates. By themselves, however, the accounting procedures do not provide substantive relief. The financial condition of the thrift industry as a whole has improved markedly since the early part of the decade, but the difficulties of many institutions have intensified. As interest rates fell from the elevated levels of 1981 and 1982, the average cost of funds at thrift institutions declined much more rapidly than the average yield on their assets. The industry as a whole returned to profitability in 1983, and aggregate earnings jumped thereafter. Net income for the industry in 1986 probably was strong again, but lower than in 1985. At the same time, problems of 23 asset quality have become increasingly important for a sizable number of these institutions. While some of these problems are associated with the economic distress in some regions of the country, overly aggressive investment strategies of some institutions certainly have contributed heavily. For 1986, about one-quarter of the thrift industry will report negative net income, and the longterm prospects for many of these institutions are unfavorable. Moreover, the resources of the Federal Savings and Loan Insurance Corporation are inadequate to manage these problems effectively. While the many stresses and financial vulnerabilities are not amenable to correction through general monetary policy, they do influence the economic environment and represent a potentially disruptive and destabilizing element in financial markets. The Federal Reserve has been called upon to play a positive role through its regulatory and supervisory functions. For example, steps have been taken to reduce the risks associated with large payments made by wire transfer, and several proposals have been made to ensure the capital adequacy of commercial banks. Many of the financial and sectoral stresses will take considerable time to alleviate, and will require a stable monetary environment, redress of the imbalances in the nation's federal budget and international trade positions, and prudent private behavior, encouraged as necessary by sound regulation. 25 International Developments The international scene in 1986 brought a further substantial decline in the dollar against the currencies of major foreign industrial countries, and some evidence emerged that the process of adjustment of external balances among major industrial countries may be under way. Although domestic demand abroad accelerated, exceeding for the first time since 1982 the rate of growth of real domestic demand in the United States, growth in real GNP in nearly all industrial countries remained sluggish and turned out to be below official forecasts at the start of the year. The United States again posted record trade and current account deficits for the year as a whole; but accelerating import prices during the course of the year and an upturn in real net exports in the fourth quarter suggested that the effects of the dollar's decline since February 1985 were beginning to show through. The sharp drop in oil prices through the first three quarters of 1986 were a factor in the low rates of increase in general price levels in major industrial countries. Although economic growth varied widely among nonOPEC developing countries, it continued at a moderate pace for the group as a whole. The dollar's foreign exchange value dropped another \5l/i percent against a weighted average of 10 currencies of major foreign industrial countries, bringing its decline between February 1985 and December 1986 to 33 percent. (Over this period the German mark appreciated 66 percent and the Japanese yen 61 percent Exchange Value of the Dollar and Interest Rate Differential Percentage points Ratio scale. March 1973 = 100 160 4 - Long-term real interest rate differential (U.S. minus foreign) 2 - 2 120 - 4 140 - 1975 1980 1986 Exchange value of the U.S. dollar is its weighted average exchange value against currencies of the other G-10 countries using 1972-76 total trade weights adjusted by relative consumer prices. Differential is rate on long-term U.S. government bonds minus rate on comparable foreign securities, both adjusted for expected inflation estimated by a 36-month centered moving average of actual inflation or staff forecasts where needed. against the dollar.) The dollar's decline was associated with a further drop in the long-term real interest rate differential, as U.S. rates fell more than foreign rates. Indeed, one measure of this differential showed that it became negative during 1986, after having been as high as around 4 percentage points in favor of the dollar in mid-1984. Major foreign central banks purchased a total of $11V2 billion in exchange market intervention in 1986, as contrasted with sales of %\11A billion in 1985. U.S. monetary authorities did not intervene in foreign exchange markets at all in 1986. After a further drop of 6lA percent in the dollar in early 1987, monetary authorities of the United States and 26 International Developments five other major countries met in Paris on February 22 to conduct multilateral surveillance of their economies in the framework of the May 1986 Tokyo summit. In their communique, they stated that the exchange rate changes over the past two years "have now brought their currencies within ranges broadly consistent with underlying economic fundamentals" and that further substantial exchange rate changes "could damage growth and adjustment prospects." Therefore, they "agreed to co-operate closely to foster stability of exchange rates around current levels." Real economic growth in the major foreign industrial countries was somewhat disappointing in 1986. In the first quarter, real GNP declined in several European economies and in Japan, partly as a result of unusually severe weather. A strong rebound of activity in the second quarter was followed by substantially slower growth during the remainder of the year. Weakness was particularly evident in the manufacturing sector. In the final quarter of 1986, industrial production in Germany was only slightly above its level at the end of 1985; Japan's industrial production declined during the second half of 1986 to an average level in the fourth quarter below that of a year earlier. In contrast to the slowing in real GNP, domestic demand expanded somewhat faster abroad in 1986 than had been the case in 1985. In the European economies especially, demand strength shifted to the domestic sectors of the economy from the export sector. The pace of growth abroad was generally insufficient to lower unemployment rates. In both Japan and France the unemployment rate atFRASER of the year was somewhat Digitized for the end GNP. Demand, and Prices Percent change from previous year Gross national product (Constant prices) Total domestic demand (Constant prices) Consumer price index United States 1982 1984 1986 Foreign data are multilaterally wieghted averages for the Group of Ten (G-10) industrial countries, using 1972-76 total trade weights, and are from foreign official sources. Data for the United States are from the U.S. Departments of Commerce and Labor. above its level at the beginning of 1986; in Germany the rate was slightly lower, and in the United Kingdom it was about the same. The rate of inflation in the major foreign industrial countries dropped sharply in 1986, on average, from its already low 1985 level. In Japan consumer prices were essentially unchanged during 1986, while in Germany consumer prices fell slightly. Wholesale prices declined significantly in most foreign industrial countries. Weakness in world oil prices early in the year and further appreciation relative to the dollar in the currencies of most of these countries were the principal factors working to lower inflation rates abroad. In several major foreign countries, rates of money growth rose in 1986. Target ranges announced for the growth of specific aggregates were exceeded in Germany and the United Kingdom. In Japan, money growth remained fairly rapid, whereas growth of the monetary aggregates in France slowed from its 1985 pace. Fiscal policy abroad was again generally restrained, and government deficits as a fraction of GNP were either about the same or down further in most of the foreign industrial countries. The aggregate current account surplus of the major foreign industrial countries rose more than $60 billion in 1986. The largest gains were experienced by Japan, whose surplus rose more than $35 billion to reach $86 billion, and by Germany, where the gain of about $22 billion brought the total surplus to $36 billion. In contrast, in both the United Kingdom and Canada the current account declined in 1986, to near balance and a significant deficit, respectively. Increases in the dollar value of these current account surpluses masked the adjustment of trade volumes that did occur in 1986 in several of the major foreign economies. In Japan the volume of exports declined more than 4 percent from the fourth quarter of 1985 to the fourth quarter of 1986, while the volume of imports rose more than 14 percent. German export volume in the final quarter of 1986 was about unchanged from its level one year earlier, while import volume was more than 6 percent higher than at the end of 1985. Declining oil revenues induced a further $10 billion contraction of International Developments 27 imports by OPEC countries, whose merchandise imports have now declined about $60 billion (or 40 percent) since 1981. However, the even sharper decline in the oil export revenue of OPEC countries resulted in a net $30 billion increase in the aggregate current account deficit of those countries during 1986. The exchange rate competitiveness on world markets of most non-OPEC developing countries continued to improve during 1986. The value of their currencies again declined significantly in real terms, reflecting the large declines against the Japanese and European currencies and only little change against the U.S. dollar. In most East Asian developing countries, the continuing rapid growth of manufactured exports combined with declining costs of oil imports to produce strong increases in trade surpluses. In the case of the highly indebted countries of Latin America, external interest payments continued to fall in 1986, reflecting the downward trend of world interest rates. However, declining oil and commodity prices along with domestic developments led to reemergence in 1986 of an overall current account deficit which, for Latin America, had almost been eliminated in 1984-85. Nevertheless, in some of these countries, particularly Mexico, Colombia, and Ecuador, the shifts toward markedly more competitive exchange rates in 1985 and 1986 aided a strong expansion of nontraditional exports during 1986. Efforts to provide additional financing for the heavily indebted developing countries faced growing difficulties during 1986. The World Bank helped several of these countries devise programs of structural reform. In doing so, it contributed significantly both to the resolution of 28 International Developments economic distortions affecting those U.S. International Trade countries and to sustainable ecoBillions of dollars Balances nomic growth. World Bank financial commitments for sectoral-adjustment programs also rose sharply. For Mexico and Nigeria, the interna100 tional bank creditors assembled parMerchandise trade allel new-money packages that were linked to the borrowing countries' performance under World Bank and Ratio scale, billions of 1982 dollars IMF-approved adjustment programs. Merchandise trade However, by the end of 1986, ^ : ^ ^ " 400 bank creditors collectively were unable to complete action on the pro300 posed new loans for Mexico—a failure representative of the tendency of the banks to act less rapidly and Total exports uniformly than during 1983-85 in the provision of new resources to Ratio scale, 1982=100 heavily indebted countries. On a net G N P fixed-weight price index basis, banks based in the industrial 105 countries appear to have provided Total exports no new lending in 1986 to the 15 heavily indebted countries that were identified in connection with the Program for Sustained Growth put forth by the U.S. Secretary of the 1982 1984 1986 Treasury in late 1985. U.S. International Transactions The U.S. merchandise trade and current account deficits widened further in 1986. A $7 billion increase in exports and a $31 billion increase in imports yielded a trade deficit of $148 billion; the deficit was $124 billion in 1985. The current account deficit was $141 billion in 1986, compared with $118 billion in 1985. The rise in the value of exports in 1986 reflected a strong increase in the volume of nonagricultural exports, which rose 14 percent from the fourth quarter to the fourth quarter, after having been flat in 1985. This strong recovery of exports came despite a slowing of economic growth in the rest of the world. The Data are seasonally adjusted at annual rates and are from the U.S. Department of Commerce. improvement in the price competitiveness of U.S. products resulting from the decline in the dollar appears to have contributed heavily to this rise in export volume. The growth, spread over most major categories of trade, was concentrated in sales of industrial supplies and capital goods, primarily to other industrial countries but also to developing countries in Asia. The value of agricultural exports fell by $3 billion in 1986, a drop due almost entirely to falling prices. Lower support prices introduced during the year for major crops resulted in some increase in price competitiveness. International Developments While ample foreign supplies have made marketing abroad increasingly difficult for many commodities, fourth-quarter demand for U.S. exports of soybeans was augmented as the result of a drought in Brazil, a major world supplier. The increase in the value of imports for 1986 as a whole reflected mainly a rise in volume that covered most trade categories. Increases were particularly pronounced in consumer goods and business machines. The 29 continued strength in imports of consumer goods reflected in part the strength of competition from abroad as import prices were slow to adjust, and in part the relative strength of U.S. domestic consumption over this period. Forty-five percent of U.S. consumer goods imports come from developing countries in Asia whose currencies have not appreciated against the dollar in real terms. Nonetheless, the average price of non-oil imports turned up during U.S. International Transactions1 Billions of dollars, seasonally adjusted Quarter Year Transaction 1985 1986 1985 1986 Q4 Ql Q2 Current account Merchandise trade balance Exports Imports Investment income (net) Direct investment, net Portfolio investment, net Other services (including military transactions) Unilateral transfers, private and government -118 -124 214 -339 25 26 -1 -141 -148 222 -369 23 33 -10 -34 -37 53 -90 9 10 -1 -34 -36 54 -90 7 8 -34 -36 55 -91 5 8 -2 Private capital flows Bank-reported capital, net (outflows, —) U.S. net purchases (—) of foreign securities Foreign net purchases ( + ) of U.S. Treasury securities Foreign net purchases of U.S. corporate bonds Foreign net purchases of U.S. corporate stocks U.S. direct investment abroad Foreign direct investment in United States Other corporate capital flows, net -3 -1 -15 -15 -4 103 82 34 40 20 12 U.S. official reserve assets, net (increase, - ) U.S. government foreign credits and other claims, net 21 9 6 46 53 18 5 -19 17 -32 4 -10 33 15 -6 8 13 6 -10 7 27 -11 11 _2 -4 * -2 26 5 3 1 16 13 7 4 -3 12 -6 14 n.a. -1 15 -3 -3 -4 * 4 15 -1 -1 4 23 *Less than ± $500 million. 1. Details may not add to totals because of round ing. 1 -4 -3 22 -37 -38 57 -96 5 8 -3 1 -5 26 -7 Seasonal adjustment discrepancy Statistical discrepancy -35 -37 56 -93 6 -1 -1 Foreign official assets in United States (increase, + ) -2 Q4 Q3 27 1 -1 -4 4 5 10 13 -6 10 SOURCE. U.S. Department of Commerce, Bureau of Economic Analysis. 30 International Developments 1986 after nearly five years of de- Taiwan, also added substantially to cline. Prices of most major import their official holdings in the United categories showed a significant accel- States, while the OPEC countries eration during 1986. This general continued to draw down their assets. trend suggests that in aggregate terms Private capital flows were again the price competitiveness of domest- dominated by securities transactions. ically produced products has im- Attracted by expected gains in U.S. proved somewhat. stock prices, foreigners purchased, The value of oil imports dropped net, a record $17 billion of U.S. sharply in 1986. A nearly 50 percent stocks. Foreign purchases of corpodrop in price (year over year) was rate bonds remained strong, as U.S. only partly offset by a 25 percent corporations continued to take adincrease in volume. The volume rose vantage of relatively low long-term sharply, if irregularly, during much interest rates to restructure their of 1986, partly to rebuild stocks and balance sheets, issuing a large volpartly in response to the break in oil ume of bonds in both the domestic prices as OPEC oil production in- and Eurobond markets. However, creased during the year. In anticipa- the share of Eurobonds in new pubtion of the announcement in Decem- licly offered bond issues by U.S. ber of an agreement by OPEC to corporations fell sharply in 1986. limit production, oil prices re- Recorded net purchases of U.S. bounded and the volume of oil im- Treasury securities by private foreigners declined as well, but purports fell in the fourth quarter. Among nontrade components of chases of Treasuries by foreign offithe current account, net payments cial reserve holders increased as on foreign portfolio holdings in the foreign monetary authorities inUnited States increased noticeably, vested the bulk of their intervention reflecting the growing stock of U.S. purchases of dollars in these instruportfolio liabilities to foreigners. This ments. Foreign direct investment in the increase was partly offset by higher net income receipts on U.S. direct United States reached record levels in 1986, swelled by mergers and investments abroad. The recorded $141 billion current takeovers bunched at the end of the account deficit for 1986 was balanced year, before the effective dates of by recorded net capital inflows of the new tax law. Direct investment $114 billion and a statistical discrep- abroad by U.S. residents was up ancy of $27 billion. Unlike the case sharply in 1986, largely because of in earlier years of current account the accounting effects of the sharp deficits, official reserve holders ac- depreciation of the dollar. Inflows reported by banks were counted for a significant part of the recorded capital inflow in 1986 (al- moderate in 1986, down substantially most $32 billion). A large part of the from 1985. Growth of liabilities to official inflow was associated with Latin American institutions other foreign exchange market interven- than banks dropped sharply from the tion by the G-10 countries, especially high 1984 and 1985 rates, and the Japan, to slow the depreciation of large 1985 decline in bankers acceptthe dollar. Several newly industrial- ances was followed by only a small ized countries in Asia, particularly decline in 1986. International Developments Foreign Exchange Operations 31 The only activity on the Federal Reserve swap network involved a U.S. monetary authorities did not $210 million drawing by the Bank of intervene in foreign exchange mar- Mexico in August. This was part of kets in 1986. Because of the substan- an official bridge-financing package tial further appreciations of major provided by the monetary authorities foreign currencies against the dollar of the United States and 14 other in 1986, the Federal Reserve System countries, pending drawings by Mexexperienced valuation gains of $1,971 ico on more permanent financing million on its holdings of foreign facilities provided by the Internacurrency reserve assets. At year-end, tional Monetary Fund and the World System holdings of foreign currencies Bank. This drawing on the Federal were valued at $9,475 million. Essen- Reserve was completely repaid by tially all of these holdings consisted February 1987. of marks, yen, and Swiss francs. 33 Monetary Policy Reports to the Congress Given below are reports submitted to the Congress by the Federal Reserve on February 19 and July 18, 1986, pursuant to the Full Employment and Balanced Growth Act of1978. Report, on February 19, 1986 Monetary Policy and the Economic Outlook for 1986 While there are unusual uncertainties surrounding prospects for prices and economic activity in 1986—stemming in part from questions about the timing and dimension of domestic adjustments to the weaker dollar on exchange markets, about oil price declines, and about the process of fiscal restraint—the overall economic outlook for the year appears generally favorable. Real economic growth probably will pick up somewhat from last year's pace, and inflationary pressures should remain contained. The recent weakness in oil prices, though it has the potential for causing dislocations in energy markets and adding to the strains on some heavily indebted oil-producing countries, should enhance real growth and work to offset the upward impact on the price level this year from the drop of the dollar on exchange markets. Over the course of the year, the prospective movement toward fiscal restraint, and also the more competitive exchange rate, should help correct imbalances that in recent years have threatened the sustainability of economic expansion and affected domestic and international financial markets. Economic and Financial Background The past year was one of further progress in the national economy. Although growth in economic activity was slower than that in the earlier phase of the expansion, increases in output were great enough to reduce the unemployment rate to its lowest level since 1980. Moreover, even as the economic upswing moved into its fourth year, inflationary pressures remained in check. In 1985, prices generally rose less than they had the year before and wage gains were restrained. Continued economic growth last year was supported by a generally accommodative monetary policy. The demand for narrow money was strong, partly in lagged response to earlier interest rate declines and partly perhaps in response to more conservative cash management practices. Ml expanded relatively rapidly throughout the year, growing about 12 percent, and its velocity exhibited an unusual and large drop of 5V2 percent; growth exceeded both the original target range set in February and the wider, rebased range for the second half set in July. However, the broader monetary aggregates behaved more normally and ended the year within their target ranges. M2 expanded about 8V2 percent as compared with its range of 6 to 9 percent, and M3 grew around 7V2 percent compared with its range of 6 to 9V2 percent. In credit markets, most short-term interest rates declined about a percentage point over last year, while 34 Monetary Policy Reports longer-term rates dropped approximately 2 percentage points, partly reflecting an improved outlook for inflation and expectations of greater fiscal restraint. Stock prices also rose substantially during the year. Meanwhile, debt growth was strong, with expansion of domestic nonfinancial debt for the year of 13V2 percent, above the monitoring range of 9 to 12 percent set by the Committee. The rapidity of debt creation reflected, in part, borrowings to finance retirements of corporate stock associated with mergers, buy-outs, and share repurchases and the acceleration of state and local debt issues in response to proposed tax law changes. While output of the U.S. economy, measured by real gross national product, expanded moderately in 1985, domestic sectors increased their purchases of goods and services more rapidly. The difference was reflected in an increasing volume of imports as the volume of exports declined. Thus, all segments of the economy did not share equally in the expansion. Key sectors such as manufacturing, mining, and agriculture continued to face strong competition from foreign producers. Sluggish growth abroad also limited export markets for U.S. producers. In financial markets, a number of institutions had to cope with loan problems associated with the economic pressures and large debt burdens of certain borrowers, including less developed countries and energy and agricultural borrowers in the United States. Adjustments are in process that should help correct the imbalances that have emerged in recent years. The resolve demonstrated by the Congress and the administration in passing the Balanced Budget and Emergency Deficit Control Act of 1985 has had salutary effects on expectation in financial markets. As budgetary deficits are reduced, more and more domestic saving can be channeled into investment in the plant and equipment needed to improve productivity and sustain economic growth over the long term. The decline in the dollar should help bring about an environment in which U.S. producers will be able to compete more effectively in world markets. The efforts of many banks and other financial intermediaries to bolster capital and reserves, together with lower interest rates, should help financial institutions to strengthen their ability to cope with financial strain. Questions remain, however, about other factors affecting the U.S. economy—including the strength of economic expansion abroad, the impact of a declining dollar on inflation here, and the effect of reduced oil prices on the financial health of domestic energy producers and of a number of oil-exporting developing countries. Monetary Policy for 1986 The Federal Open Market Committee framed its monetary policy plans for 1986 in light of the fundamental objectives of maintaining sustainable growth of economic activity, making continued progress over time toward price stability, and working toward better balance in the nation's external transactions. As shown in the accompanying table, the Committee set ranges for the monetary aggregates for the period from the fourth quarter of 1985 to the fourth quarter of 1986 of 3 to 8 percent for Ml and 6 to 9 percent for both M2 and M3; Monetary Policy Reports Ranges of Growth for Monetary and Credit Aggregates Percent change, fourth quarter to fourth quarter Money or credit aggregate Ml M2 M3 Debt 1986 3 to 8 6 to 9 6 to 9 8 to 11 1 1985 3to82 6 to 9 6 to 9Vi 9 to 12 1. Annual rate, applied to period from second to fourth quarter. it established a monitoring range of 8 to 11 percent for debt. These are the same ranges that had been tentatively set for 1986 in July of last year, except that the Ml range has been widened to reflect the uncertainties about the behavior of that aggregate, as noted below. Compared with ranges that had most recently been in effect for 1985, the new ranges involve a reduced upper limit for M3 and a generally lower range for debt. The ranges for Ml and M2 are unchanged. The width of the Ml range reflects continuing uncertainties about the behavior of Ml under varying economic and financial circumstances, given recent experience and the changed composition of the aggregate over the past few years. In particular, the availability of interest-bearing checking accounts that serve both transaction and savings functions may have increased the sensitivity of this aggregate to changes in market rates as well as to other factors influencing the public's allocation of its savings among various financial assets. While the range for Ml is wide enough to allow for some variation in behavior of the aggregate's income velocity in response to changing conditions, the range was set on the assumption that there would not be a large drop in velocity, such as occurred in 1985. In that connection, the Committee 35 will evaluate behavior of Ml in light of its consistency with the other monetary aggregates, economic and financial developments, and the potential for inflationary pressures. In sum, policy implementation will involve continuing appraisal of the relationships among the various measures of money and credit, their velocity trends, and indicators of economic activity and prices, as well as conditions in domestic credit and foreign exchange markets. The growth of the broader aggregates in 1986 is not expected to be far different from last year, when their velocities declined somewhat. Last year's velocity experience was closer to the norm for these aggregates than was the case for Ml. The final phase of deposit deregulation this year—the removal of minimum balance requirements on money market deposit accounts at the beginning of the year and the elimination of ceiling rates on savings and regular NOW accounts at the end of March— is expected to have only minimal effects on the broad aggregates as well as on Ml. Other ceiling-free accounts have been widely available for a number of years, and minimum balance requirements already have been reduced to a relatively low level. The Committee for some years has had a monitoring range for the total debt of domestic nonfinancial sectors. Historically, debt has expanded about as rapidly as GNP, but in recent years debt has grown more rapidly than the economy, raising some concern about the increasing debt burden. The growth of debt is expected to moderate somewhat in 1986. A diminution of debt financing for purposes of stock retirement is anticipated, and growth of state and 36 Monetary Policy Reports local government debt is expected to slow from last year's exceptional pace, absent further changes in the proposed tax law that might prompt a renewed acceleration in borrowing. While the federal deficit is expected to remain at a high level for much of 1986, it should begin declining in the course of the year as greater fiscal restraint takes hold and helps to curb the rate of increase in U.S. government debt. Economic Projections The Committee felt that its monetary objectives were consistent with expectations for continued growth in output, further reductions in unemployment, and muted inflation in 1986. While there clearly are a good many uncertainties and risks in the present environment—for instance, the actual outcome for the budget, behavior of the dollar, and oil prices— the Committee members and nonvoting Reserve Bank Presidents generally believe that prospects for the economy in the year ahead are reasonably favorable. As indicated in the table, their expectations center on real GNP growth of 3 to 3Vi percent and on inflation in the range of 3 to 4 percent. The expanding job opportunities associated with the in- crease in output are expected to lower the unemployment rate gradually, although sluggish productivity performance, if it should continue, would limit the nation's growth potential. Two key factors in the positive economic outlook are the recent developments in energy and financial markets. The decline in energy prices can be expected to raise the growth of real disposable income and to bolster consumer spending in the months ahead. The marked increase in household financial wealth associated with the rise in stock and bond prices also should provide the basis for continued gains in consumer outlays. This should work to offset the restraint in spending that could be exerted by the runup in household indebtedness and the associated decline in the personal saving rate during the past year. Nevertheless, the high level of debt remains a risk in the outlook for consumer spending. The rise in stock prices and the decline in interest rates have improved prospects for domestic investment in plant, equipment, and housing. Moreover, while the federal deficit is not likely to drop significantly for some months, as noted earlier, greater fiscal restraint, as it Economic Projections for 1986 Percent Measure FOMC Members and other FRB Presidents Administration Congressional Budget Office Range Change, fourth quarter to fourth quarter Nominal GNP Real GNP GNP implicit deflator Average unemployment rate in the fourth quarter unemployment rate. 1. Civilian Central tendency 5to8V2 23/4to41/4 2VztoAVi 61/2to71/4 3to3V£ 3 to 4 8.0 4.0 3.8 7.6 3.6 3.9 6y4to63/4 About 6I/2 6.7 6.71 develops, should enhance the availability of domestic saving for private investment and reduce the need to rely on foreign saving. Mortgage rates are at their lowest levels since 1979, and the greater affordability of housing can be expected to buoy residential construction even in the face of some evident overbuilding in the multifamily sector. Similarly, lower costs of capital should—along with some improvement in the competitiveness of U.S. industry owing to the dollar's decline—help to support business investment despite likely weakness in the energy and office building sectors. In the near term, the leanness of manufacturers' stocks suggests the likelihood of some pickup in the rate of inventory accumulation. The outlook for the external sector is quite uncertain. The response of U.S. industry, as well as of foreign producers, to the decline of the dollar will take place only over time and will depend on a number of factors, such as the extent to which it is believed the exchange rate change is "permanent" and the strategies firms pursue with respect to the potential trade-off between profit margin and market share. Perhaps more important in the short run, our trade and current account position also will depend on the pace of economic growth abroad: if growth in other countries is relatively slow, that would tend to limit near-term improvement. With regard to the outlook for inflation, wages in the aggregate have shown no tendency toward acceleration, and recent settlements in major collective bargaining agreements indicate wage gains in manufacturing, construction, and transportation are likely to continue at the moderate pace registered in re Monetary Policy Reports 37 cent years, even though the unemployment rate is declining. Disappointing productivity performance does raise questions about pressures from the labor cost side, although some pickup in productivity improvement is assumed this year. A decline in oil prices also should be a constructive influence. Nevertheless, it was recognized that a weaker dollar poses a clear risk of greater inflationary pressures. The projections by FOMC members and nonvoting Reserve Bank Presidents of real GNP and prices over 1986 generally are somewhat lower than the administration's projections, although the full range of expectations does encompass the latter. In any event, differences are not large and economic growth at the pace the administration anticipates can be accommodated by the FOMC's targets. The Performance of the Economy during the Past Year The economy completed a third successive year of expansion in 1985, with real gross national product increasing 2V2 percent over the year. The rise in economic activity was sufficient to create 3 million new payroll jobs and the unemployment rate edged down; with a further strong increase in employment in January of this year, the jobless rate for civilians reached a six-year low of 6.7 percent. Meanwhile, most broad measures of price increase indicate that inflation slowed to about a 3V2 to 33/4 percent rate in 1985, somewhat less than the pace registered over the previous two years. Though output and employment continued to grow in 1985, the rate of expansion was slower than some had anticipated, raising some con- 38 Monetary Policy Reports cerns about the sustainability of the recovery. Furthermore, the pattern of developments in the past year had some disturbing aspects: domestic and foreign demands continued to be diverted away from goods and services produced in the United States, draining income from our households and businesses and exacerbating an inventory correction by U.S. firms as their sales lagged; meanwhile, consumers continued to increase their spending at a substantial clip, but only by borrowing at a pace that pushed household debt burdens to still higher levels. Although the nation as a whole experienced continued growth, the serious sectoral imbalances that had emerged earlier during the recovery became more apparent when gains in activity moderated. Industrial output grew slowly in 1985, and manufacturing and mining employment posted outright declines during much of the year. The agricultural sector remained under acute pressure, as shrinking export markets and abundant harvests pushed prices sharply lower. As a result, farmers continued to face mounting difficulties in servicing the large volume of debt that had accumulated in the 1970s. To a considerable extent, these imbalances and stresses are related to fundamental disequilibria in the nation's finances: the continuing huge federal budget deficit and the growing deterioration in the U.S. current account. During the past year, however, policymakers took important steps to address these problems. The Balanced Budget and Emergency Deficit Control Act was passed, establishing a mechanism for deficit reduction and signaling the resolve of the Congress and the administration to achieve meaningful progress Digitized foron this front. And the financial FRASER authorities of the G-5 nations agreed that exchange rates should better reflect underlying economic relationships, which would enhance the prospects for some improvement in our external balance. The federal budget deficit was of record magnitude in fiscal year 1985. The large federal deficit not only absorbed a significant portion of the saving available to the domestic economy, but also continued to be a source of concern to investors with respect to longer-range potential for inflationary pressures. Not surprisingly, the prospect for some reduction in the deficit contributed to the downward trend in interest rates late last year. The importance of international economic developments for the performance of the U.S. economy has become increasingly apparent during the current economic expansion. Although the foreign exchange value of the dollar declined over most of the year—encouraged at times by coordinated official intervention activity—changes in spending patterns, which typically lag movements in exchange rates, were not yet evident and imports made further inroads into domestic markets. Meanwhile, slow growth, on average, in much of the rest of the world has failed to provide strong markets for U.S. exports. The net result has been that domestic demands have increased more rapidly than domestic production throughout the course of the expansion. An important achievement of the current recovery has been the sustained expansion of economic activity without any relinquishing of progress toward the goal of price stability. The containment of inflation has been aided by the high exchange value of the dollar and excess world Monetary Policy Reports supplies of many basic materials, which have left prices unchanged or lower for a wide range of imported goods, industrial commodities, agricultural products, and petroleum. More fundamentally, wage increases in the aggregate have been restrained, limiting upward pressure on costs. The Household Sector Spending in the household sector remained strong in 1985, despite a sharp slowing in income growth. Growth in real disposable income rose about IV2 percent, much less than the increase of 4 percent of the previous year. Income growth was limited as wage and salary gains decelerated, interest income weakened, and farm income plummeted. Meanwhile, real personal consumption expenditures advanced 3 percent last year—only a little less than in 1984—buoyed by continued high levels of borrowing. As a result, the personal saving rate fell to an average of about 4V2 percent last year, well below historical norms. The strength in household spending last year reflected further gains in outlays for consumer durables, especially purchases of new automobiles. Sales of new cars totaled more than 11 million units, the strongest selling pace since 1978. Sales of domestic autos picked up to 8V4 million units in response to the general downtrend in interest rates, several rounds of price and financing concessions offered by manufacturers, and increased availability of some models that had been in short supply in 1984. Sales of foreign cars climbed to a record level of more than 2% million units for the year; a greater volume of exports to the United States was permitted under the Japanese voluntary restraint pro 39 gram for 1985-86, and this accounted for most of the pickup. Activity in the housing sector was flat in 1985. The number of new homes started last year remained at about the same rate of 1% million units posted in the preceding two years. Construction of single-family housing showed no new strength, despite a decline in mortgage rates to their lowest level in six years and favorable demographic trends. In part, some of the effect of lower mortgage rates may have been offset by a tightening of qualification standards by lenders and mortgage insurers and higher mortgage insurance premiums. Construction of multifamily housing remained at the relatively high level of the two previous years, notwithstanding high and rising vacancy rates for rental units. Rental housing construction was supported by heavy issuance of debt by state and local authorities, partly in anticipation of constraints imposed by tax reform legislation. Recent trends in consumer balance sheets continued last year. Consumer installment debt, which had climbed sharply in 1984, did so again in 1985, and the ratio of debt to disposable income reached a record high. Growth in financial assets of households has, however, more than kept pace with the rapid rise in debt over the past two years. In particular, the strong gains posted by the stock and bond markets in 1985 provided a substantial boost to household wealth. Indications of debt-servicing difficulties in the household sector have mounted. Delinquency rates on consumer installment loans have been on the rise since mid-1984, and for some categories—such as bank credit cards—have reached relatively high levels. Moreover, mortgage loan delinquencies persist at the historically 40 Monetary Policy Reports high levels that have prevailed since the 1981-82 recession, associated with the influence of lingering high rates of unemployment in some communities, slow income growth, and weak housing prices in certain areas of the country. However, surveys of households continue to show favorable readings on attitudes concerning financial positions, suggesting that these financial strains are currently limited to a small part of the population. The Business Sector Economic conditions in the business sector also were mixed last year. After-tax economic profits of nonfinancial corporations as a group increased sharply for a third consecutive year and as a percent of GNP stood at their highest level since the late 1960s. Many firms in manufacturing and mining industries, however, have encountered significant difficulties brought about by the high value of the dollar. In addition to the influence of the exchange rate, downward pressures on prices and profits in the agricultural and energy sectors have been exacerbated by ample supplies in world markets. Business spending for equipment and structures advanced 6 percent in real terms in 1985, supported by falling interest rates, declining relative prices for capital equipment, and continued efforts to modernize facilities in order to meet intensified competition. Nevertheless, the growth in business fixed investment was well below the extraordinary pace of the preceding two years. Furthermore, the slowdown in capital outlays was widespread, including many categories of high technology equipment, heavy industrial machinery, and structures. Some deceleration of investment spending may be expected as an expansion progresses and the growth of sales subsides to more sustainable levels. However, the reduced pace of investment last year was reinforced by declining capacity utilization rates in the industrial sector. Moreover, rising vacancy rates for office buildings contributed to slower growth in expenditures for nonresidential structures. Businesses accumulated inventories at a much reduced pace in 1985, particularly in the manufacturing sector. In real terms, nonfarm business inventories rose $10 billion last year, after the sharp $56 billion investment that occurred in 1984. In the manufacturing sector, sluggish orders and stable or falling prices have induced businesses to adopt a cautious approach to inventory accumulation; factory inventories declined over the second half of 1985 and were little changed on net for the year as a whole. In the trade sector, stocks increased over the year, boosted by a large rise in auto inventories in the fourth quarter. Excluding autos, inventories at retail establishments increased about in line with the moderate rise in sales over 1985. Financial strains have remained evident in several important sectors of the economy. The decline in the exchange value of the dollar has yet to ease significantly the international trading problems of many industrial firms. Moreover, the activity and earnings of the domestic energy sector have been affected adversely by the weakening of petroleum prices on world markets. The financial condition of U.S. agriculture worsened further in 1985. A large portion of the agricultural sector has continued to struggle with sharply lower prices, diminished export markets, and depressed land values. With farm incomes plunging, debt-servicing prob- Monetary Policy Reports lems have created serious strains on both farmers and farm lenders. The Government Sector The federal budget deficit rose to $212 billion in fiscal year 1985. Although the expanding economy continued to boost receipts, outlays rose even faster, with large increases registered for agricultural support payments, interest outlays, and defense purchases. As a percent of GNP, the deficit remained at a historically high level of 5 percent, absorbing a large share of the net saving available to the domestic economy. Federal government purchases of goods and services, which add directly to GNP and constitute a third of total federal expenditures, posted another strong advance last year. Federal purchases, excluding changes in farm inventories held by the Commodity Credit Corporation (CCC), were up more than 3% percent over the year, after adjustment for inflation. Defense outlays continued to provide a major boost to federal purchases, rising 6V2 percent over the year. Purchases by the CCC rose sharply, as low market prices encouraged farmers to shift massive inventories of grain to the federal government. State and local governments increased purchases of goods and services about 3 percent in 1985, after a similar increase in the preceding year. Most of the growth in expenditures last year reflected strong increases in construction outlays as states and localities continued efforts to improve and expand basic infrastructure. With the rise in expenditures exceeding the growth in receipts, the fiscal position of state and local governments weakened throughout the year; aggregate operating and capital account surpluses, which had 41 risen to substantial levels in 1984, were virtually eliminated by the end of last year. The Foreign Sector After registering particularly sharp gains toward the end of 1984 and in the first two months of 1985, the dollar generally fell in international currency trading throughout the remainder of last year. By the end of 1985, the trade-weighted foreign exchange value of the dollar had fallen nearly 25 percent from its peak in February. This decline occurred against the backdrop of a narrowing of the differential between inflationadjusted, long-term interest rates in the United States and other industrial countries, which at least in part reflected the slowing of economic growth in the United States relative to growth abroad. It will take some time before the effects of the dollar's depreciation manifest themselves in the external position of the United States, which continued to deteriorate last year. The widening gap between imports and exports boosted the current account deficit to about $120 billion, up from $107 billion in 1984. Merchandise imports continued to rise in 1985, increasing about 3V2 percent in real terms over the year. Consumer goods, capital equipment, and industrial materials posted moderate increases. Although prices of imported goods fell for the year as a whole, some firming in the prices of manufactured imports became apparent toward the end of the year, in part attributable to the decline in the value of the dollar. The volume of merchandise exports declined in 1985; agricultural exports fell abruptly, while exports of nonagricultural goods were essentially unchanged. The failure of 42 Monetary Policy Reports growth in other industrial countries, on average, to pick up has limited the expansion of markets for U.S. products. Furthermore, economic growth in developing nations slowed a bit in 1985, as many countries continued to face difficult debt-servicing problems externally and strong inflationary pressures at home. In this context, the Secretary of the Treasury in October addressed the economic and financial problems confronted by many of these countries. He urged the borrowing countries to undertake comprehensive programs of economic adjustment designed to promote efficiency and economic growth. At the same time, he called upon the international banking community, the World Bank, and the other multilateral development banks, working with the International Monetary Fund, to provide the assurance that adequate external financing would be available to support such programs during the next several years. The initial response to these proposals has been positive; all parties generally accept that the proposals represent a constructive framework for dealing with the international debt problems of individual countries and for promoting the growth and stability of the world economy. Labor Markets With the economy continuing to expand, developments in labor markets remained generally favorable in 1985. The unemployment rate drifted down over the year, as gains in employment exceeded the growth of the labor force. Labor force participation has maintained its upward trend; women continued to enter the workforce in large numbers, in part responding to expanding job opportunities. Overall, the number of per sons employed relative to the population rose to a record level. Nonfarm payrolls expanded 3 million in 1985, somewhat below the unprecedented hiring rate posted during the first two years of the recovery. Although growth in employment in the aggregate continued, the composition of the gains reflected the unevenness of current expansion. Employment in the trade and service sectors accounted for more than twothirds of the growth in payrolls last year. Government employment rose nearly one-half million, reflecting primarily increased payrolls of state and local governments. In contrast, the weak expansion of output in the manufacturing sector resulted in some trimming of employment over the first three quarters of the year. Although an upturn in manufacturing jobs begain in the fall, employment was down about 170,000 over the year. Wage increases remained restrained in most segments of the labor market last year, despite a further reduction in the unemployment rate. Hourly compensation in the private sector, as measured by the employment cost index, rose about 4 percent in 1985,1 percentage point less than in the preceding year. Nearly all of the deceleration of compensation per hour last year reflected a slowing in the growth of fringe benefits; wage rates increased at about the same pace posted in 1984. To a large extent, the recent slowing in the growth of benefits has resulted from lower health care expenses for employers, as cost-sharing arrangements shifted greater responsibilities to employees and programs for hospital cost containment became more widespread. Meanwhile, labor productivity was nearly unchanged in 1985, after in- Monetary Policy Reports 43 energy markets continued to restrain the overall rate of inflation in 1985. Energy prices showed little change last year; however, a substantial margin of unutilized productive capacity, continued conservation efforts, and the debt-servicing problems of several important oil producers have all contributed to a situation of surplus availability of oil and to a sharp break in oil prices on world markets at the end of the year. Crop prices at the farm have remained depressed by diminished export demand and high levels of production. Lower prices for crude foods and small increases in processing costs held food prices at the retail level to an increase of 2% percent last year. Price Developments Most broad measures of prices indiPrices for many basic industrial cate that inflation was unchanged or commodities fell during 1985. Weak perhaps moved a bit lower in 1985, expansion of industrial production in even as the economy was passing the United States and in other major through a third year of expanding industrial countries has limited the activity. The consumer price index growth in demand for raw and semiadvanced 3% percent over 1985, processed materials. Furthermore, the somewhat less than the 4 percent high prices for many raw commodiincrease posted the previous year. ties that prevailed over the 1970s and The GNP fixed-weight price index, early 1980s induced a rapid expanwhich includes production for busi- sion of capacity, particularly in denesses, government, and export, as veloping countries. With productive well as for consumers, increased 3V2 capacity in place and with many of percent, about V percentage point these countries facing massive debt2 less than the average increase over servicing requirements, supplies of the preceding two years. Producer commodities on world markets have prices of finished goods advanced 13A remained plentiful. percent last year, and prices of interOn balance, price increases outmediate materials were essentially side the food and energy area held flat. steady last year. Consumer prices Progress toward price stability has other than food and energy increased been sustained by several factors, the about 4V2 percent, a bit less than in most important of which have been 1984. The prices of retail goods subdued inflation expectations, mod- excluding food and energy were held erate wage increases, and the influ- to a gain of 2 percent in 1985, at ence of the high value of the dollar least in part by small increases or on the prices of imports and goods declines in the prices of products in that compete with imports. In addi- markets in which import competition tion, developments in the food and is substantial. Price increases for creasing substantially earlier in the recovery. When viewed over a longer period, the underlying trend in productivity in recent years appears to have improved a little from the very low pace of the 1970s, but remains well below the pace earlier in the postwar period. Management and workers have responded to a more competitive environment by modernizing plant and equipment, improving operational efficiency, and making work rules more flexible. Unit labor costs in the nonfarm business sector rose 3% percent in 1985, higher than the increase during the previous two years but well under the pace registered in the early 1980s. 44 Monetary Policy Reports nonenergy services remained at an annual rate of about 5% percent last year. Capital equipment prices rose 23A percent in 1985, somewhat more than in 1984. Monetary Policy and Financial Markets in 1985 At its meeting in February 1985, the Federal Open Market Committee established ranges for money and credit growth during the year, measured from the fourth quarter of 1984 to the fourth quarter of 1985, of 4 to 7 percent for Ml, 6 to 9 percent for M2, and 6 to 9/2 percent for M3. The associated monitoring range for the debt of domestic nonfinancial sectors was set at 9 to 12 percent. In July, the Committee reaffirmed the ranges for M2, M3, and debt, but established a new Ml growth range of 3 to 8 percent, measured at an annual rate, from the second to the fourth quarter of the year. Over the first half of the year, Ml had grown well above the upper end of its range and velocity had registered an unusually steep decline, apparently reflecting substantial additions to money balances, especially interest-earning transaction balances, spurred by the sharp drop in interest rates since mid-1984. The Ml objective for the second half of the year anticipated a considerable slowing of growth, on the assumption that historically more normal behavior in the velocity of Ml would reemerge. Continued uncertainty about the behavior of the aggregate, however, was signaled in widening the Ml range 2 percentage points. The unusual pattern of Ml behavior in fact persisted over the second half of the year; growth in the aggregate did not slow, and its velocity registered an even steeper decline. At the same time, the broader monetary aggregates were growing generally within their ranges, while economic growth had slowed to well below the pace of the year before and upward price pressures remained muted. In the fall, the FOMC determined that, under these circumstances, growth in Ml above its range for the second half of the year would be acceptable. In general, the FOMC last year emphasized the need to evaluate growth in all the aggregates in light of developments in the economy and prices, as well as conditions in financial and foreign exchange markets. Throughout the year, monetary policy remained generally accommodative to emerging demands for money. Pressures on bank reserve positions were varied in a narrow range over the year, and the discount rate was reduced once, by Vi percentage point. Money, Credit, and Monetary Policy Ml increased at an annual rate of 12.7 percent from the second to the fourth quarter of the year, compared with its range of 3 to 8 percent for this period; growth for the year as a whole came to 11.9 percent. Much of the unusually strong growth in Ml in 1985 and the accompanying decline in velocity seemed to be attributable to lower interest rates, though expansion in the aggregate was stronger, particularly in the second half of the year, than historical evidence on its relationship to income and interest rates would have suggested.1 The behavior of this aggre1. Appendix A reviews the behavior of velocity in recent years. Monetary Policy Reports 45 gate may have become more sensitive to changes in market rates in recent years owing to the deregulation of certain transaction accounts. By reducing the opportunity cost of holding transaction balances, the creation of NOW and Super NOW accounts has made Ml a much more attractive savings vehicle for households. Moreover, with the rates on NOW accounts fixed and those on Super NOWs being adjusted sluggishly to changing conditions, falling interest rates have led to relatively substantial reductions in incentives to economize on Ml balances, with accompanying declines in velocity. However, considerable uncertainty about the response of Ml to variations in interest rates or income unavoidably persists, as both money holders and depository institutions adapt to the elimination of important regulatory constraints.2 In 1985, the interaction of lower market interest rates with deregulated transaction deposit rates seemed to induce especially heavy inflows to interest-bearing checkable accounts. Spreads between offering rates on these deposits and interest rates on time deposits and market instruments, low by the standards of recent decades, apparently diminished the incentives to keep savings in longerterm instruments, as well as to separate savings from transaction balances. Demand deposits also contributed to the increase in Ml last year, registering unusually rapid growth, especially in the second half. Business demand balances paced the rise, likely reflecting the cumulative effect of lower interest rates on incentives to economize on demand deposits and on compensating balance requirements, as well as generally more cautious cash management practices, possibly in part because banks and corporations sought to reduce risk in response to financial problems that had developed in certain areas of the market. M2 recorded growth of 8.6 percent in 1985, in the upper part of its range, as its nontransaction component increased 7.6 percent. The shift toward more liquid assets evident in the rapid rise of Ml also affected the distribution of deposits within the nontransaction portion of M2. Small time deposits declined last year, while some very liquid components, such as money market deposit accounts, posted very large increases, and even 2. Experimental alternative measures of money, which attempt to allow for the varying degree of "moneyness" in components of the monetary aggregates, are discussed in appendix B. 1. Ml, M2, and M3 incorporate eftects of benchmark and seasonal adjustments made in February 1986. 2. Ml figure in parentheses is adjusted for shifts to NOW accounts in 1981. 3. Mlfigurein parentheses is the annualized growth rate from the second to the fourth quarter of 1985. Growth of Money and Credit1 Percentage change Period Fourth quarter to fourth quarter 1979 1980 1981 1982 1983 1984 1985 Quarterly growth rates 1985 1 2 3 4 Ml 7.5 7.3 5.2 (2-5)2 8.7 10.4 5.4 11.9 (12.7)3 M2 Domestic nonM3 financial sector debt 8.1 10.3 9.0 9.6 9.3 12.3 12.4 9.6 9.8 9.1 10.0 12.2 9.9 8.0 10.5 8.6 7.4 9.1 11.2 14.1 13.5 10.1 11.7 10.1 10.5 6.3 5.6 14.5 9.5 7.6 10.6 5.9 5.7 13.5 11.9 12.2 13.7 46 Monetary Policy Reports savings deposits rose 4 percent after several years of declines. However, growth of M2 appears to have been restrained to an extent by some redirection of household portfolios toward such non-M2 instruments as shares in stock and bond mutual funds. M3 growth slowed to 7.4 percent last year—close to the midpoint of its range—reflecting in part a slower pace of credit expansion at depository institutions and consequently a reduced need to raise funds through managed liability issuance. Thrift institutions, in particular, greatly reduced their net acquisition of assets, partly in response to new Federal Home Loan Bank Board regulations that raised capital requirements for rapidly growing thrifts. The growth of large time deposits issued by thrift institutions slowed to less than 7 percent in 1985, down sharply from the pace of nearly 50 percent recorded in the preceding year. Expansion in debt of domestic nonfinancial sectors moderated only a little from its elevated 1984 pace and, at 13.5 percent, exceeded its monitoring range of 9 to 12 percent. Last year was the fourth consecutive year in which debt expanded more rapidly than GNP, after more than 20 years in which the ratio of debt to GNP had been generally stable. One factor boosting debt growth relative to spending has been the extraordinary pace of corporate borrowing to retire equity in mergers, buyouts, and stock repurchases. The volume of such borrowing appears to have been as large in 1985 as in 1984. In addition, borrowing surged late last year in the tax-exempt market, when issuance was accelerated in anticipation of possible tax law changes. Even after allowance for these two factors, which together may have accounted for roughly 2 percentage points of debt growth in 1985, the expansion of the debt of domestic nonfinancial sectors remained very strong. An important element in the continued rapid growth of debt and the rise in its ratio to GNP has been the huge size of federal deficits. Although federal debt growth has slowed since 1982, it continued to run at more than 15 percent last year. • In implementing policy during 1985, the Federal Reserve basically accommodated the strong demands for reserves by depository institutions. In the early part of the year—when Ml expansion was very rapid, and M2 and M3 growth was also strong— interest rates backed up somewhat. However, these increases were more than reversed later in the first half, influenced in part by a cut of xh percentage point in the discount rate from 8 to IV2 percent in May, as economic activity appeared more sluggish, partly reflecting the drag from the relatively high value of the dollar on exchange markets. Growth of the broader aggregates had slowed appreciably after the early part of the year, though Ml remained well above its range. On balance over the first six months of the year, most market interest rates fell about 1 percentage point, leaving them about 3 to 4 percentage points below their mid-1984 levels. On exchange markets, the dollar, which had risen sharply through February, declined thereafter and by midyear was 9 percent below its February peak on a trade-weighted basis, leaving it just under its level at the end of 1984. When, at its July meeting, the FOMC reaffirmed its ranges for M2, M3, and debt, and widened and Monetary Policy Reports rebased the Ml range, the members anticipated that these ranges would be consistent with continued subdued inflation and some pickup in economic growth from the sluggish firsthalf pace. As the summer progressed, however, it became clear that the demand for Ml remained strong. After slowing somewhat in July, Ml spurted again in August and continued to rise at a doubledigit annual rate in September. M2 growth also picked up during the summer, climbing above its range in this period. In the summer, market interest rates reversed a portion of their earlier declines. With both Ml and M2 growing relatively rapidly, economic activity apparently picking up, and the dollar having declined further, the Federal Reserve provided reserves a bit more cautiously for a time. But beginning around midautumn, the Federal Reserve was seeking a slight easing in bank reserve conditions, as incoming data suggested that relatively moderate increases in economic activity continued to be in prospect and upward price pressures remained subdued. Meanwhile, Ml growth was continuing strong on balance, but growth in the broader aggregates was slowing. On balance over the second half of the year, most short-term rates were little changed, ending the year just slightly above their midyear lows and about a percentage point below their levels when 1985 began. However, on exchange markets, the dollar declined more than 15 percent over the second half, impelled in large part by the G-5 announcement in September indicating the desirability of some appreciation of other currencies relative to the dollar and 47 by the ensuing coordinated intervention by the United States and other key industrial countries. In long-term debt markets, interest rates generally fell a percentage point or more on balance over the second half, with most of the decline occurring during a fourth-quarter rally that accelerated as the year drew to a close. The downward movement in long-term rates and simultaneous surge in stock market prices were fueled in part by legislative initiatives to mandate reductions in the federal deficit and to pare the government's demands on credit markets. Declining world oil prices and the continued softness in markets for other commodities promoted expectations of lower inflation among market participants, also contributing to the rally. Other Developments in Financial Markets Corporations were able to reduce their demands on credit markets in 1985 as strengthening profits and weaker capital expenditures narrowed the sector's financing gap. Nevertheless, business borrowing to finance stock retirements remained high—perhaps $70 billion in each of the past two years. Spurred by the drop in long-term rates, to six-year lows, corporate credit demands focused on the bond markets. Record amounts of securities were offered publicly by nonfinancial firms in both the domestic and the Eurobond markets last year. On the other hand, short-term borrowing slowed, with bank lending to businesses relatively weak. Tax-exempt borrowing was extraordinarily strong last year; a surge in bond offerings late in the year lifted 1985 volume to a record high. While more favorable interest rates 48 Monetary Policy Reports stimulated borrowing generally, efforts to finance in advance of possible restrictions under a proposed tax law scheduled to take effect after yearend boosted advance refunding and private purpose issues in particular. Households continued to borrow heavily in 1985. Their debt-servicing burden rose sharply as they continued to add to debt at a double-digit rate at the same time that growth of disposable income slowed. Signs of potential strain appeared, as the delinquency rate for consumer installment loans rose, although most measures of debt quality remained well within past experience. Consumer credit remained especially strong, growing at nearly the 20 percent rate recorded in 1984. But the growth of home mortgage borrowing, while near its 1983-84 average, was probably restrained somewhat by the tightening of lending standards that accompanied the rise of mortgage loan delinquency rates to record levels. Strains were evident in financial markets at times in 1985 but did not cause major disruptions in overall market conditions. Financial market concern over credit-quality issues was not severe enough to be reflected in a broad-based widening of yield spreads between corporate and Treasury debt or between privatesector securities of different risk classes. Nevertheless, the agricultural sector of the economy continued to experience serious financial distress and there were pressures on some segments of the financial community at times last year. Early in the year, privately insured savings and loans in Ohio and, then, in Maryland were closed or limited to small withdrawals after depositor runs in both states. The problem in Ohio was triggered by news of losses at one large thrift institution. Problems developed in Maryland when heightened depositor anxiety in the aftermath of the Ohio crisis combined with news of difficulties at a savings and loan in Maryland. As the difficulties emerged, the Federal Reserve advanced funds at the discount window to the affected institutions to bolster their liquidity. Such lending—whose expansive reserve effect was offset through open market operations—has been repaid in Ohio, where the troubled institutions have been restructured and reopened, but remains outstanding at a number of Maryland thrift institutions. The thrift industry as a whole showed some improvement in earnings and capital positions last year, although many institutions remained heavily burdened with low-quality or low-yielding assets. Lower interest rates lifted profits from their depressed 1984 levels by reducing the cost of funds and generating capital gains on asset sales. The profitability of commercial banks also appears to have increased in 1985, breaking the downtrend of recent years. Asset quality remained a concern for some institutions, however, and was a major factor in the sharp increase in the number of bank failures. Banks apparently again increased the rates at which they charged off bad loans and added to loan-loss reserves, reflecting continued financial strains in such industries as agriculture, energy, and real estate. Higher profits along with the rallies in stock and bond markets helped many banks improve their capital positions in 1985, facilitating efforts to comply with more stringent capital adequacy guidelines. As part of its efforts to ensure the continued safety and soundness of the financial system, the Federal Reserve also initiated a program to strengthen supervision of commercial banking operations. Agricultural finances drew special attention last year. Farm income remained depressed, and falling prices for agricultural products left many farmers unable to meet their debtservicing requirements. Moreover, declining land prices eroded the value of collateral behind many agricultural loans. Consequently, failures of banks with relatively high proportions of agricultural loans in their portfolios rose to 68 in 1985, from 32 in 1984 and an average of just 6 in each of the preceding three years. The Farm Credit System, which holds about one-third of U.S. agriculture's debt, experienced mounting losses and requested federal aid. Farm Credit securities, which had been priced very close to Treasury issues of comparable maturity, yielded as much as 100 basic points more than Treasury debt at one point in the fall. Rate spreads narrowed in December, after passage of legislation enabling the Farm Credit System to mobilize its resources more readily and providing for the possibility of a backup source of assistance once internal sources of funds are exhausted. To ease possible constraints on the availability of credit at agricultural banks over the 1985 growing season, the Federal Reserve in March liberalized its regular seasonal borrowing program and initiated a temporary special seasonal program aimed at making liquidity available to agricultural banks that might experience strong loan demand. Although total seasonal borrowing fell short of the unusually high level in 1984, evidence suggests that these actions increased access to seasonal credit, boosting borrowing somewhat above Monetary Policy Reports 49 what would otherwise have been expected, given money market conditions and overall slack loan demand by farmers. In early 1986, the Federal Reserve renewed the temporary seasonal program to assure that agricultural banks would not face liquidity constraints in accommodating the needs of their farm borrowers this year. Appendix A: Velocities of the Monetary Aggregates in the 1980s In 1985, the relationship between Ml and nominal GNP diverged substantially from historical patterns as Ml velocity registered a sharp drop of 5V2 percent. In contrast to the increases that had doubled velocity over the course of the 1960s and 1970s, last year's decrease left Ml velocity about 8 percent below its 1981 peak level. Velocities of the broader monetary aggregates also declined in 1985, but these declines were not so far off their historical norms. The downward trend of Ml velocity so far in the 1980s differs markedly from the annual rate of increase of 3V4 percent averaged during the preceding two decades. Two developments in recent years appear especially pertinent to explaining the changed relationship between Ml and income. First, interest rates at the end of last year were substantially below their peak levels in 1981. With such a decline, the earnings forgone in holding money, with its liquidity advantage, were considerably reduced, and preferences for money relative to other financial assets would be expected to increase in response. As this occurred, the velocity of Ml would be expected to decline. Second, deposit rate deregulation 50 Monetary Policy Reports has changed the pricing behavior and yield comparisons between some Ml deposits and other deposits and financial instruments. Whereas earlier only non-interest-bearing assets— demand deposits and currency—directly served transaction needs, in the 1980s individuals have had available for transaction purposes first NOW accounts with a 5V4 percent ceiling and subsequently Super NOW accounts with higher, competitively set rates. These institutional changes have reduced pressures for innovations that would enable depositors to conserve on Ml holdings or use them more intensively to support spending. Such innovations had contributed to the previous uptrend in Ml velocity. But also, the proliferation of interest-bearing checkable deposits for individuals, nonprofit organizations, and governmental units has altered the balance of motives for holding Ml deposits, making them more attractive repositories for savings as well as transaction funds and probably increasing the sensitivity of Ml demand to changes in market interest rates. This effect has grown in importance as interest-bearing checkable deposits have grown. Such accounts have proven enormously popular; at the end of last year, almost $180 billion in interest-bearing checkable accounts was outstanding, including more than $60 billion in Super NOWs, which have been available for only three years. The total figure compares with outstanding balances of less than $30 billion when NOW accounts were first authorized on a nationwide basis at the end of 1980. By the end of 1985 interest-bearing checkable deposits had grown to about 30 percent of Ml and 40 percent of the deposit component of that aggregate. The resulting higher interest rate sensitivity of the public's demand for Ml relates to the fact that when market rates decline, the opportunity cost—the gap between those rates and the fixed ceiling on NOWs— declines in percentage terms much more than do market rates themselves. And the tendency of offering rates on Super NOWs to lag changes in market rates has made their opportunity costs also move like those on fixed-rate accounts in the short run. Recent trends at depository institutions toward applying higher interest rates or lower fees to transaction accounts with higher balances have probably further changed opportunity cost calculations. This "tiering" can have the effect of providing a very high rate of return—and thus a low opportunity cost—on funds added to an account because, for example, per-check charges or other fees may cease to apply at the new larger balance. Not only does the responsiveness of Ml to interest rates and income seem to have changed in the 1980s, but the behavior of Ml also appears to have become less predictable on other grounds. In part, the increased unpredictability of Ml demand is due to the larger share of savings balances in Ml, which has made general portfolio-balance considerations a more important influence. Over the past several years, deposit rate deregulation has given institutions vastly increased freedom to set deposit rates and has provided their customers with a larger menu of assets paying market-related rates. With regulations progressively changing and depositors and depository institutions continually adapting to the changes, uncertainty has increased concerning the impact on money demand of variations in eco- Monetary Policy Reports nomic and financial conditions, including changes in wealth of money holders. Moreover, since the process of deposit rate deregulation has occurred alongside a general decline in inflation and market interest rates, the reasons for permanence of apparent shifts in Ml behavior often have been obscured. The declines in the velocities of M2 and M3 last year were neither as large as in that of Ml, nor as far from their longer-term trends. The velocity of M2 has declined in recent years, but on balance has shown little change over recent decades. While last year's drop in the velocity of M2 was about twice the average of the past several years, its size was within historical experience. The decline of M3 velocity was somewhat smaller than in recent years and continued a long-term downtrend in that measure. Nevertheless, the behavior of the broader aggregates probably has been altered by developments in the 1980s. For example, the interest rate responsiveness of M2 probably has declined with deregulation, which has permitted the yields on many of its components to vary with market rates. While this aggregate continues to show strong responses to rates over short periods, over intervals of a half year or more it has been far less affected than Ml. Appendix B: Experimental Money Stock Indexes Financial deregulation and innovation since the mid-1970s have blurred distinctions between transaction and nontransaction balances. As businesses and consumers have changed their payment practices and portfolios of financial assets, uncertainty about the behavior of conventional monetary aggregates and their ability 51 to foreshadow movements in GNP has intensified. The narrow aggregate Ml has been affected most noticeably. This aggregate consists of currency, demand deposits, and checkable deposits paying interest, mainly NOW accounts. The share of Ml balances paying interest has grown substantially and is held partly for savings purposes. In 1982-83 and again in 1985, growth of Ml was unusually strong relative to GNP. Old Ml-A, which includes only currency and demand deposits, was less affected in those years, but because it excludes NOWs, it understates transaction money. In 1981, Ml-A was considerably distorted as demand deposits were shifted into NOWs, which had been newly authorized nationwide. In light of these developments, the Board's staff has investigated several alternative measures of money. This appendix focuses mainly on the transaction money stock measure, MQ. Its components encompass currency and all checkable instruments that serve as means of payment, including money market deposit accounts (MMDAs) and certain money market funds, both of which have limited check-writing features. In contrast to the conventional aggregates, though, MQ is an index number. In general, index numbers are used to combine items that have dissimilar characteristics; an example would be the differing economic values of the various items in the industrial production index. In MQ, components are treated conceptually as differing in the volume of "GNP transactions" each finances per dollar, notwithstanding their common unit of account of one dollar. MQ and conventional narrow monetary aggregates are alike in that the growth rate of either can be 52 Monetary Policy Reports thought of as a weighted average of the growth rates of its components. But the weights applied to the growth rates of components are not equal for these different monetary aggregates. In conventional Ml and Ml-A, the implied weights are simply dollar shares of each component in the total. In MQ, the weights on the growth rates of components reflect not only differences in dollar amounts among components but also differences in the estimated intensity with which the various components are used in carrying out GNP transactions. Thus, instead of dollar quantity shares, MQ uses as weights the estimated share of GNP spending financed by each component. The implied quantity-share weight on the growth rate of other checkable deposits in Ml growth was about 26 percent in 1985, meaning that the 22 percent growth in this component last year contributed about 53A percentage points (26 percent x 22 percent = 53A percent) to the growth rate of Ml. Because they are excluded from Ml-A, these deposits receive a zero weight in Ml-A growth. The weight on the growth of other checkable deposits in MQ growth was about I2V2 percent in 1985, so the rapid growth in this component contributed only about 2% percentage points to MQ's growth rate over last year. When applied to the component growth rates, these weights produce the growth rates for MQ and the conventional narrow aggregates. MQ grew somewhat faster in the mid1970s than Ml. Over that period, demand deposit growth, which was relatively weak, received a lower weight in MQ, and currency growth a higher weight, than in Ml. Since then, MQ growth has been between growth of Ml-A and Ml. Although, in principle, MQ tends to adjust automatically for changes in payments practices, the experience in 1981 with major shifts from demand deposits to nationwide NOWs exemplifies the practical difficulties in developing appropriate weighting procedures. Still, Ml-A was even more distorted than MQ in 1981. Over 1985, MQ growth was about l3/4 percentage points slower than conventional Ml growth but around 2 percentage points faster than Ml-A growth. In 1983, M2 growth was distorted upward by the introduction of MMDAs, but otherwise it has been rather steady since the late 1970s. Annual velocity growth for MQ, has been between the growth rates of VI and Vl-A since the late 1970s. Over 1985, as over 1982, all three velocities fell, with VI registering the steepest declines in both years. Velocities of the broader conventional aggregates declined at about the same rate as VI in 1982 but by less than VI in 1985. The predictability of MQ's demand, given interest rate spreads and GNP, has been roughly comparable with that of Ml and Ml-A demand on average over the 1980s, with all three narrow aggregates exhibiting unexpectedly large increases in 1985 relative to econometric predictions. In 1982-83, however, MQ's demand was more predictable than either Ml or Ml-A. None of the three has been appreciably superior in its ability to presage movements in nominal GNP so far in the 1980s, on the basis of statistical relations that held on average over the 1970s; each signaled considerably more nominal GNP growth than actually occurred in 1982-83 and Monetary Policy Reports again in 1985. The broader conventional measures performed better than MQ, as well as conventional narrow measures, in these relatively simple tests of their demand and indicator properties for the 1980s, but they were less reliable indicators of GNP in the previous decade. Research is continuing on the development of MQ and the assessment of its demand and indicator properties. Efforts are under way to refine the procedures used to estimate MQ's weights, as well as to improve the basic method of weighting major outflows from particular accounts, such as those distorting MQ in 1981. At this time, however, understanding the significance of movements in MQ is hampered not only by limited experience with the aggregate but also by unresolved conceptual and measurement questions. In addition to MQ, several other monetary indexes have been constructed experimentally. The transaction money stock index, MT, is similar in concept to MQ but focuses on the way money is used for all transactions, including payments associated with financial trading, intermediate output, and so forth, instead of just GNP spending. In a different approach to monetary indexes, these monetary services indexes have been constructed to reflect a broader view of money as providing a range of services, such as liquidity, that goes beyond the means of payment, and these indexes correspondingly encompass broader collections of component assets; such indexes distinguish components by the estimated opportunity cost of holding each monetary asset rather than investing in the highest-yielding alternative financial asset. As with MQ, conceptual and measurement problems re 53 main to be solved for these other experimental indexes, which thus far do not appear to perform as well as conventional aggregates. Report on July 18, 1986 Monetary Policy and the Economic Outlook for 1986 and 1987 Sharp contrasts among sectors and regions of the economy characterized economic developments during the first half of 1986. Reflecting in substantial part continuing strong competitive pressures from abroad and large spending cutbacks in the oil industry in response to sharply declining prices, industrial and investment activity were restrained. In contrast, activity continued to expand rather strongly in housing, the financial sector, and the broad service area of the economy. On balance, real gross national product remained on a rather sluggish growth path. Although there are substantial uncertainties about the degree and timing of a pickup in economic activity, a number of positive economic and financial developments have occurred that should provide the basis for somewhat faster economic growth and some reduction in unemployment over the year ahead. Interest rates have moved lower, and, reflecting the decline of the dollar on foreign exchange markets, U.S. industry is in a stronger competitive position internationally. Also, inflation has remained subdued, reflecting not only declines in the prices of energy and other basic commodities but also continued restraint on wages in many sectors. Much of the uncertainty about a pickup in growth turns 54 Monetary Policy Reports on the strength of economic performance in other industrialized countries, and there is also some concern over the transitional effects of tax reform legislation. What monetary policy has been able to do, during a period of greater overall price stability and adequate capacity relative to the demands actually placed upon it, is to accommodate demands for money and credit, helping to facilitate further declines in interest rates. Monetary policy by itself cannot eliminate or deal with the sectoral imbalances that are still troubling the economy. A reduction of the large deficit in the nation's external accounts is of critical importance over time, and this reduction will be difficult to achieve in an orderly way without faster growth in key foreign economies. Agreement on tax reform also would remove a major source of uncertainty that probably has inhibited growth in the first half of the year; over time, substantial progress toward eliminating federal budget deficits is essential to achieving better balance in the U.S. and world economies. Overall, prospects for the economy appear to be favorable, but much will depend on the evolution of policy, both in this country and abroad. Economic and Financial Background The first half of this year saw a continuation of the reduced pace of economic growth that has prevailed since the middle of 1984. Although the service industries have been strong, manufacturing activity has been relatively sluggish in the face of strong foreign competition, and some sectors, such as energy and agriculture, are under strong pressure. The economy has generated a substantial number of new jobs this year, but the labor force also has grown rapidly and the unemployment rate has remained around 7 percent. Perhaps the most significant economic event in the first half of 1986 was the plunge in world crude oil prices. Despite the potential longerterm benefits from this development, the initial impact on the U.S. economy was negative as, with less of an incentive to search for new sources of supply, oil exploration activity was cut back sharply. However, falling crude oil prices have been translated quickly into lower rates of inflation for a time, and in addition, they have damped expectations about future price increases. Consumer confidence has been high, and with purchasing power boosted by the decline in energy prices, consumer spending has been strong. By damping inflation expectations, the drop in world oil prices also spurred a rally in credit markets, further extending the decline in interest rates that began in mid-1984. Against the background of relatively slow economic growth and little overall price pressure, monetary policy basically has accommodated strong demands for reserves to back deposits thus far in 1986, while responding to and facilitating the drop in market interest rates with three half-point cuts in the discount rate. At the same time, with the dollar under downward pressure in foreign exchange markets during most of the period and the economies of other key industrial countries somewhat weak early in the year, international economic and financial developments remained an important consideration in the conduct of monetary policy. Similar official changes in interest rates in several major foreign countries, where growth also has been slower than expected, took place around the time of the first two discount rate reductions by the Federal Reserve this spring. The coordinated cuts helped avoid the potential for disturbing exchange market conditions. Reductions in other short-term rates were generally in line with the total decline of IV2 percentage points in the discount rate since the end of last year. Yields on long-term credit market instruments fell as much as 2Vi percentage points, encouraged not only by the revision of inflation expectations that seemed to be keyed to falling energy prices but also by the sluggish performance of the economy and, early in the year, by the restraining effect of the GrammRudman-Hollings legislation on expected federal budget deficits. These and earlier declines in market rates had a particularly strong effect on the narrow monetary aggregate. By June, Ml had grown at an annual rate of 12% percent from its fourth-quarter 1985 level, well in excess both of its target range of 3 to 8 percent and of the growth in the economy. Over the first half of the year, the velocity of the aggregate appears to have declined at a faster rate than the postwar record decline in 1985. The interaction of lower interst rates with the changed composition of Ml since deposit deregulation explains a good portion of this rapid decline of velocity. The public apparently has been shifting a considerable amount of its savings into the negotiable order of withdrawal (NOW) account component of the aggregate in response to relatively large declines in rates on competitive outlets for liquid funds. Growth in demand deposits also has been quite strong, likely related to the effect of Monetary Policy Reports 55 lower interest rates on the balances that businesses must hold to compensate for banking services, as well as to a surge in financial market activity. Even after taking account of these factors, however, the strength of Ml appeared extraordinary in the first half. The broader aggregates grew more moderately, ending the first half near the middle of their respective target growth ranges of 6 to 9 percent. Nevertheless, the strong demand for liquid assets, generated by the relatively large declines in long-term rates, was evident not only in soaring Ml balances but also in the composition of the broader aggregates. For example, the more liquid components of M2 grew rapidly, while its time-deposit component increased only marginally. Over the same period, the debt of domestic nonfinancial sectors is estimated to have remained somewhat above its monitoring range, growing well in excess of GNP. The substantial decline in longterm interest rates since the middle of last year has helped buoy interestsensitive sectors of the economy. Activity in the housing market was quite strong in the first half of 1986, supported by the lowest level of mortgage rates in more than seven years. The reduction in interest rates also was a factor in the strength of consumer spending, both by reducing the overall cost of credit and by raising the value of the household sector's security holdings. Although the foreign exchange value of the dollar has fallen a third from its 1985 peak, the depreciation apparently has not yet produced a substantial increase in the volume of exports or a reduction in the volume of imports. Adjustments of trading patterns to exchange rate movements 56 Monetary Policy Reports quarter of 1987. Those ranges were felt to be consistent with a pickup in economic growth. The rapid rise in Ml over the first half of the year underscored the degree of uncertainty surrounding the behavior of the aggregate and, in particular, about its behavior relative to GNP. The nature of the relationship among Ml, income, and interest rates appears to have been significantly altered by the changed composition of the aggregate in recent years, as well as by the prospects for greater price stability. The precise implications of these developments for the future are not yet clear, given the limited experience to date. In these circumstances, the Committee decided that growth of Ml in excess of the previously established range of 3 to 8 percent for 1986 would be acceptable and growth in that aggregate over the balance of the year would continue to be evaluated in light of the behavior of the other monetary aggregates. Developments in all the aggregates will be judged against the background of Ranges for Money and Debt Growth developments in the economy and financial markets and potential price in 1986 and 1987 The FOMC reaffirmed the 1986 pressures. With respect to 1987, the Commitranges of 6 to 9 percent that had been established in February for M2 tee expressed the preliminary view and M3; as noted above, the broader that the current range for Ml—3 to monetary aggregates ended the first 8 percent—should provide for adehalf of the year near the middle of quate money growth to support conthose target ranges. For 1987, the tinued economic expansion, assumCommittee tentatively decided that, ing that a greater stability reemerges consistent with its intention to achieve in the link between Ml and income money growth at a rate consistent in a more stable economic, price, with maintaining reasonable price and interest rate environment than stability and sustainable economic has existed in recent years. However, expansion, the target growth ranges in the context of the experience of for both M2 and M3 would be the past several years and keeping in lowered Vi percentage point, to 5V2 mind the exceptiona uncertainties in to 8V2 percent, measured from the predicting the behavior of Ml, the fourth quarter of 1986 to the fourth Committee at the end of this year take place over a number of years, and it is not surprising that a dramatic improvement in our large merchandise trade deficit has yet to occur. However, progress has been somewhat slower than might have been expected, partly because of the slow growth in other major industrialized countries. The continuing appreciation of the dollar against the currencies of many developing nations also has been a factor. The influence of strong foreign competition remains pervasive. Agricultural products are in ample supply worldwide, reducing the export opportunities of our producers. In manufacturing, many industries continue to face weak foreign orders, while an increasing portion of domestic demand has been met from abroad in spite of price increases on some competing foreign products. With little observed pickup in demand, many firms have scaled back their expenditure plans, and capital spending remains weak as a result. Monetary Policy Reports Ranges of Growth for Monetary and Debt Aggregates Percent change, fourth quarter to fourth quarter Aggregate Ml M2 M3 Debt 1986 [3 6 6 8 to to to to 8]1 9 9 11 Tentative for 1987 [3 to 8]2 5Vi to 8V2 5Vi to 8!/2 8 to 11 1. While no new range was specified for 1986, growth in excess of the established range would be acceptable. 2. Indicative of likely range if more stable velocity behavior shows signs of reemerging. will review with particular care the appropriate range and weight to be placed on Ml in 1987. As shown in the accompanying table, the FOMC did not change the 1986 "monitoring" range for the credit market debt of domestic nonfinancial sectors and tentatively retained the same range for next year. It was anticipated that the debt aggregate might exceed the monitoring range of 8 to 11 percent for 1986 as a whole, given its rapid growth around the beginning of the year, but as in the past, the Committee felt that raising the target would create an inappropriate benchmark for evaluating longer-term trends in debt growth. Economic Projections The Committee believes that the monetary objectives it has set are supportive of a strengthening of economic activity in the second half of the year. However, the uncertainties associated with the economic outlook appear to be quite large, and continued vigilance and flexibility in the conduct of policy clearly are needed. As summarized in the table on economic projections, the central-tendency forecast of Committee members and nonvoting Reserve Bank Presi 57 dents is for growth of 2l/i to 3 percent in real GNP this year. Such an increase in output would be expected to generate appreciable further gains in employment, but the unemployment rate might not drop below 7 percent before year-end. With the decline in energy prices more than offsetting effects from the depreciation of the dollar and with pressure from domestic labor and product markets restrained, the inflation rate for the year is generally projected at between 2lA and 23A percent, as measured by the implicit deflator for GNP. In 1987, which would be the fifth year of the current expansion, real Economic Projections for 1986 and 19871 Percent FOMC Members and other FRB Presidents Central tendency Range 1986 Change, fourth quarter to fourth quarter 33/4 tO 6V2 Nominal GNP 2]/4 tO 3!/2 Real GNP GNP implicit deflator ... V/i t o 32/4 Average level in the fourth quarter Civilian unemployment rate 4 3 /4 tO 5 3 /4 2Vi to 3 3 2VA to 2 /4 7 6.9 to 7.2 1987 Change, fourth quarter to fourth quarter 5 to SVA Nominal GNP Real GNP 2 to 4V4 GNP implicit deflator ... IV2 to 4V4 Average level in the fourth quarter Civilian unemployment 6V1 to 7 rate 6 to IVi 3 to 31/2 3 to 4 Around 63/4 1. The administration has yet to publish its midsession budget review document, but spokesmen have indicated that there will be revisions to earlier forecasts. As a consequence, the customary comparison of FOMC forecasts and administration economic goals has not been included in this report. 58 Monetary Policy Reports GNP is projected by most participants to increase 3 to 3V2 percent, and unemployment is expected to decline moderately. A significant portion of the increase in production next year is expected to come from the external sector, with the lower value of the dollar expected to restrain the growth of imports and to stimulate exports. However, with energy prices leveling off, exchangerate-related increases in import prices are expected to cause an acceleration in inflation to a range of 3 to 4 percent next year. The forecasts of the Committee members and nonvoting Reserve Bank Presidents assume that the Congress will seek to achieve the Gr amm - Rudman - Hollings deficit reduction targets. Progress in reducing the federal deficit is seen as crucial in maintaining financial conditions conducive to balanced growth and to an improved pattern of international transactions. A number of factors point toward a reacceleration in growth, although the exact degree and timing remain uncertain. Despite their initial effects on investment, lower energy prices should help support economic activity, primarily by bolstering real consumer income. The lower level of interest rates also is expected to give some impetus to consumption while, at the same time, maintaining the strength in the housing market. Business spending on new plant and equipment is projected to pick up somewhat over time, but the degree of improvement will depend in part on the character of tax reform legislation. A critical element in the expected improvement in economic performance is progress toward reducing the size of the merchandise trade deficit. As previously noted, with import prices rising as a result of the depreciation of the dollar, the growth in imports is expected to slow, and the increased price competitiveness of U.S. goods should bolster export growth. However, a substantial improvement in our trade performance will require satisfactory growth of demand in other countries. Moreover, such an improvement will require open access to foreign markets, which underscores the critical importance of avoiding protectionist measures here and abroad. The Performance of the Economy During the First Half of 1986 The economy continued to expand in the first half of 1986, but apparently no more rapidly than in 1985. The overall increase in output during the first six months of the year generated slightly more than 1 million new jobs, and the civilian unemployment rate held near 7 percent. At the same time, the dramatic decline in world crude oil prices caused a substantial slowing in inflation. The combination of the lingering effects of the high foreign exchange value of the dollar during 1984 and 1985, the slow growth abroad, and the initial impact of lower crude oil prices played a key role in inhibiting any acceleration in overall economic activity. Industrial output declined noticeably over the first half, with activity reflecting the continuing intense competition from foreign producers in the manufacturing sector and also the sharp cutbacks in energy-related investment. U.S. agriculture confronts growing world supplies of many farm products, and many farmers continue to be squeezed by a heavy debt-servicing burden and falling land values. The drop in oil prices has caused substantial adjustment problems in the short run. Oil drilling has been reduced drastically, and a number of high-cost wells have been capped. More than 100,000 jobs have been lost in the oil industry since the beginning of the year. At the same time, however, some of the benefits from the drop in oil prices did begin to emerge in the first half. The lower price of crude oil was reflected fairly quickly in the prices of finished energy products, which caused consumer prices to register their largest three-month decline since the beginning of 1949. This lower price level has given a substantial boost to the purchasing power of consumers and has helped to support higher levels of spending. Although the volume of oil imports will rise, the sharper decline in price is an aid in reducing the large deficit in our trade account. A potentially more significant longer-term influence on our balance of trade is the lower value of the dollar. The prices of foreign goods are rising in dollar terms and should begin to shift expenditures from imports to domestic products. At the same time, U.S. goods are more competitive on world markets, although we have yet to experience a sustained improvement in exports. The rather moderate improvement in export volume to date reflects, in part, the effects of the dollar's earlier rise and the slow pace of economic activity abroad. Growth in the major industrialized nations was particularly weak in the first quarter of 1986, although there appears to have been some rebound in the second quarter. Meanwhile, the drop in oil revenues reduced import demand in some developing countries, most importantly Mexico. Monetary Policy Reports 59 Another factor affecting the economy this year has been the changing fiscal-policy environment. It now appears that the deficit in the current fiscal year may exceed earlier plans, but the Congress has moved to implement the spirit of the deficit targets contained in the GrammRudman-Hollings legislation in acting on its fiscal 1987 budget. The prospect of lower federal budget deficits in the years ahead, coupled with the drop in oil prices, encouraged sizable reductions in long-term interest rates at the beginning of 1986, which have begun to stimulate the interest-sensitive sectors of the economy. The most notable result has been in the housing sector in which lower mortgage rates have led to substantial gains in building activity. Investment in new plant and equipment has not shown a similarly positive response to lower interest rates, however; apart from the negative effects of the oil drilling decline, business spending has been damped by the existence of a sizable overhang of office and factory space and by continuing uncertainties about sales trends and tax reform. With the decline in energy prices, further progress has been made in reducing the inflation rate. Continued moderation in wage increases and abundant supplies of agriculture commodities and industrial raw materials also were important factors in restraining price increases in the first half of 1986. These favorable developments worked to offset the inflationary tendencies associated with the depreciation of the dollar and the continued rapid rise in the prices of services. The Household Sector Consumer expenditures were quite strong in the first half of 1986, 60 Monetary Policy Reports supported in part by rapid income growth. Real disposable income increased at about 5Vi percent at an annual rate, boosted by high levels of farm subsidy payments and the energy-related slowdown in inflation. In addition, survey information indicates that consumer confidence remains high, and many households consider it to be a good time to purchase big-ticket items such as a car or a new home. Under these circumstances, consumers have been willing to spend the bulk of their income gains, and the personal saving rate has remained at a historically low level. The increase in consumer spending was widespread. Purchases of nondurable goods, such as apparel, were particularly strong in the first quarter, while outlays for services also grew briskly. The demand for new automobiles also remained quite high after the large sales increase in 1985. New cars sold at an annual rate of 11 million units in the first six months of this year, with important support coming from a series of below-market finance incentive programs for many domestic models. Foreign automobiles continued to sell at a fast pace even though sticker prices generally have increased more than 10 percent in response to the exchange rate changes. Activity in the housing sector also has been strong this year. Stimulated by the decline in mortgage rates, sales of new single-family homes hit a record high in March and remained generally strong throughout the second quarter. Production responded to this increase in demand, and during the first half, single-family units were begun at a rate of 1% million units, the highest since 1979. Despite elevated rental vacancy rates, construction apparently was main tained in the multifamily sector by the large volume of mortgage revenue bonds issued by many state and local governments at the end of last year. However, as these tax-exempt funds were depleted, activity in the multifamily market began to taper off in the spring. In addition, concerns about the treatment of income properties under tax reform may have begun to restrain the construction of multifamily dwellings. Indicators of the financial position of the household sector were mixed in the first half of the year. Although the growth in consumer credit slowed from its rapid pace in 1985, the ratio of consumer installment debt to disposable income edged up to a new high. The rallies in the stock and bond markets strengthened the asset side of the household sector balance sheet, and many homeowners took the opportunity presented by the decline in interest rates to ease their debt-servicing burdens by refinancing mortgage loans. However, increased strains also were evident, as personal bankruptcies rose to record levels and mortgage delinquency rates remained historically high. The Business Sector The financial position of the business sector improved a bit in the aggregate during the early part of 1986, albeit with considerable diversity across industries. Economic profits in the corporate sector rose at an $11 billion annual rate in the first quarter, and the share of after-tax economic profits in GNP remained at the highest level since the late1960s. Financial conditions in agriculture and manufacturing remained weak, however. Agriculture continued to be hurt by excess supply conditions worldwide, and farm loan delinquencies rose to a postwar high. In manufacturing, intense price competition from foreign sources squeezed profit margins, and with little growth in demand, capacity utilization moved lower. Business spending on plant and equipment was weak in the first half of the year. This poor performance partly reflected a ''payback" after very strong capital spending in the fourth quarter of 1985. Firms apparently accelerated their spending at the end of last year to take advantage of investment incentives that were targeted for scaling back or elimination under proposed tax reform legislation; expenditures then dropped off in the first quarter of 1986. In addition to these tax-anticipation effects, the demand for computers and other high-technology equipment remained subdued, after increasing rapidly in the first two years of the recovery. Spending on nonresidential structures was down substantially, partly as a result of the cutback in oil and gas well drilling, which was large enough to reduce real GNP growth V percentage point in the 2 first quarter and perhaps more in the second quarter. However, a correction also began in the construction of office buildings in response to past overbuilding and high vacancy rates. Much of the change in business inventories in the first half of this year was associated with fluctuations in automobile dealers' stocks. Domestic car production outpaced sales in the first quarter, and this resulted in a substantial buildup of auto inventories. Assembly schedules were scaled back in the spring, which helped dealers reduce their excess inventories, although stocks remained high. Outside the auto area, inventory investment remained moderate overall, but the pattern differed markedly between manufacturing and Monetary Policy Reports 61 trade. Manufacturers continued to trim their stocks, preferring to keep inventories lean until there was firm evidence of a resurgence in demand. In contrast, inventory investment picked up at trade establishments, even though merchants continued to hold a historically high level of stocks relative to sales. With the declines in capital spending and the slow pace of inventory investment, internal funds in the aggregate were adequate to meet almost all of the basic financing needs of nonfinancial corporations. However, the drop in long-term interest rates to the lowest levels since 1978 prompted businesses to issue massive amounts of bonds; the proceeds were used not only to finance new investment but also to retire outstanding bonds and stocks and to pay down short-term debt. The Government Sector Despite congressional action to slow the growth of spending, the size of the federal budget deficit in fiscal 1986 may match or exceed the record $212 billion of fiscal 1985. Revenue growth has slackened in association with the slower pace of nominal income growth. Expansion of corporate tax receipts has slowed significantly, while excise tax revenues also are down as lower oil prices virtually have eliminated the receipts from the "windfall profits" tax. Federal purchases of goods and services fluctuated widely in the first half of 1986. They dropped substantially in the first quarter, in part reflecting a slowing in the purchases of farm products by the Commodity Credit Corporation (CCC), after a record increase in the fourth quarter of 1985. Excluding CCC purchases, real federal outlays were down 62 Monetary Policy Reports slightly, as a result of lower defense spending. Purchases of goods and services by state and local governments in real terms increased at an annual rate of 2.8 percent in the first quarter of 1986, about the same pace as in 1985. After a large increase in the first quarter, construction spending remained strong in the spring, while employment rose further. However, a number of states, particularly those dependent on agriculture and the oil industry, continued to experience a substantial deterioration in their financial condition. A significant portion of tax revenues in many oilproducing states are tied directly to the value of oil output, and the drop in oil prices has induced a concomitant decline in receipts. In addition, the secondary effects on energyrelated businesses are tending to reduce revenues further. To restore fiscal balance, many states have announced expenditure cuts or tax increases. The External Sector Continuing the decline that began early last year, the dollar depreciated further against the currencies of foreign industrial countries during the first half of 1986. On balance, the trade-weighted value of the dollar has fallen more than 30 percent from its February 1985 peak, about onethird of which has occurred this year. Associated with the depreciation was a narrowing in inflation-adjusted interest rate differentials between the United States and the other major industrialized countries, as interest rates declined both here and abroad. Although a substantial correction has occurred in the dollar's value, at least against the currencies of the major industrialized countries, the nation's current account deficit was unchanged in the first quarter from the high rate of $135 billion in the fourth quarter of 1985. This lack of improvement was the result of large increases in nonpetroleum imports while exports grew more slowly. The failure to date of the dollar's decline to slow import growth reflects, in part, the relatively slow pass-through of the depreciation into import prices. Because profit margins of foreign exporters expanded during the period of dollar appreciation, they are able, for a time, to absorb the reduced receipts without raising prices; slack markets at home also have held down price increases. In addition, the dollar has continued to rise against the currencies of many developing countries, which account for about one-quarter of U.S. nonpetroleum imports. However, nonpetroleum import prices now are increasing, led by large increases for automobiles, other consumer items, and capital equipment. The decline in the dollar also improved the price competitiveness of U.S. goods in foreign markets. However, exports have been slow to pick up, in important part because of the sluggish pace of foreign economic activity. Real gross national product declined in both Japan and West Germany in the first quarter, but economic growth appears to have been somewhat stronger in the spring. Economic growth also has been sluggish among many of our major trading partners in the developing world. Like other oil-producing countries, Mexico is adjusting its spending to lower oil revenues, and this adjustment has reduced the demand for U.S. products. Falling world commodity prices also have aggravated the financial difficulties of other developing nations, including Monetary Policy Reports members of the Organization of Petroleum Exporting Countries. Reflecting these influences, the volume of U.S. merchandise imports rose IV2 percent in the first quarter of 1986, as nonpetroleum imports continued to grow rapidly while oil imports declined. The largest increases were in machinery, with smaller advances registered for some consumer goods. The volume of merchandise exports was up somewhat in the first quarter, with a decline of 3V2 percent in exports of agricultural products offset by increased U.S. nonagricultural exports. Labor Markets Nonfarm payroll employment expanded in the first half at an average pace of roughly 175,000 per month on a strike-adjusted basis, down from 230,000 in 1985. Continuing the trend of the past few years, gains at trade and service establishments were quite strong and accounted for most of the overall employment increase. Hiring also was brisk at construction sites through much of the period, buoyed by the strength in homebuilding. However, manufacturing payrolls contracted somewhat, with weakness in the motor vehicle, metals, and machinery industries. The civilian unemployment rate averaged somewhat higher over the first half of the year than at the end of 1985. The continued expansion of job opportunities about matched the rise in the number of individuals entering or reentering the workforce, and labor force participation reached a new high by midyear. However, the weakness in the industrial sector was reflected in a rise in the number of workers separated from their last job. 63 In view of the continued slack in labor markets as well as lower price inflation, wage growth remained moderate. The employment cost index, a broad measure of overall compensation trends, rose 33A percent in the 12 months ending in March, down from 4V2 percent over the year ended in March 1985. Most of the slowing was the result of smaller increases in the cost of employee benefit programs, reflecting in part efforts to contain medical insurance expenses, while wages and salaries rose at about the rate of 4 percent experienced in 1985. Continued moderation in union wage gains also was evident in the collective bargaining agreements reached in the first half of 1986. After declining at the end of 1985, labor productivity in the nonfarm business sector rebounded in the first quarter of 1986. However, the gain largely reflected erratic movements in hours worked by self-employed workers, and productivity has been essentially flat over the past year after rising substantially early in the recovery. Productivity in manufacturing has increased somewhat faster during this expansion, as intense import competition has forced many producers to modernize their factories and streamline work rules. As a result of the first-quarter bounce back in productivity, unit labor costs in the nonfarm business sector fell during that period, but they were still up about 3 percent from a year earlier. Price Developments Falling energy prices were largely responsible for a significant slowing in measures of aggregate inflation during the first half of 1986. A broad measure of prices—the fixed-weighted 64 Monetary Policy Reports price index for GNP—increased at a 2V2 percent annual rate in the first quarter, down from a rise of 3V2 percent in 1985. Consumer prices actually declined over the Februaryto-April period, but they still were up IV2 percent over the 12-month period ended in May. The drop in prices was greater at the wholesale level, where weakness in the industrial sector added to the downward pressure from energy prices. The speed and magnitude of the decline in world crude oil prices this winter were dramatic. Over the January-to-April period, crude oil prices fell more than $15 per barrel to their lowest level since 1978. Prices of refined petroleum products responded quickly to the drop in crude oil prices, and retail gasoline prices fell 25 percent, or about 28 cents a gallon, over the January-to-May period. Charges for electricity and natural gas, which compete with fuel oil as a power source, responded more slowly to the lower crude oil prices but by the end of May had fallen about 1 percent. The prices of industrial raw materials continued to decline in the first half. Prices were depressed by abundant world supplies of many primary commodities; debt-servicing obligations led many developing countries to maintain or expand their output. Sluggish industrial activity in the United States and other large economies contributed to the softness of commodity markets. Outside the energy area, further progress was made in reducing the inflation rate during the first half of the year. Retail food prices rose at an annual pace of only 1 percent through May, held down by falling meat prices. A small decline in the prices of consumer goods was responsible for the slowdown in the consumer price index (CPI), excluding food and energy, to an annual rate of increase of 3V2 percent from its 4V2 percent rise during 1985. In contrast, the prices of nonenergy services continued to increase at an annual rate of 6 percent, boosted by rising housing costs and by higher premiums for most types of insurance. Monetary Policy and Financial Markets in the First Half of 1986 The Federal Open Market Committee at its meeting in February of this year established target growth ranges, measured from the fourth quarter of 1985 to the fourth quarter of 1986, of 3 to 8 percent for Ml and 6 to 9 percent for both M2 and M3. The associated monitoring range for growth of the debt of domestic nonfinancial sectors was set at 8 to 11 percent. As compared with the ranges for 1985, the M2 target was unchanged, the upper limit for M3 was reduced V percentage point, and the 2 debt range was lowered 1 full percentage point; the Ml target remained the same as that set last July for the second half of 1985. It was expected that growth of money and credit within these ranges would be adequate to encourage sustainable economic expansion consistent with progress over time toward reasonable price stability and an improved pattern of international transactions. In retaining the comparatively wide target range for Ml, the FOMC recognized continuing uncertainties about the behavior of that aggregate. Moreover, the Committee agreed that, in view of these uncertainties and the unexpectedly rapid growth of Ml relative to GNP in recent years, the behavior of the narrow money stock would be evaluated in Monetary Policy Reports light of growth in the broader monetary aggregates, developments in the economy and financial markets, and the potential for inflationary pressures. In the event, rapid Ml growth reemerged early this spring, and by June the aggregate was far above its range. M2 and M3, however, ended the first half near the middle of their 1986 target ranges. This disparate pattern of money growth, as well as the modest expansion in economic output, ebbing inflation, and continuing downward pressure on the dollar in foreign exchange markets, provided the setting for policy during the first six months of this year. In general, monetary policy was accommodative. As an operational matter, the degree of pressure on reserve positions of depository institutions remained limited, and the discount rate was lowered twice in the first half of the year, V percentage point 2 each time, in the context of sizable declines in market interest rates and similar actions by some other industrial countries. In early July, the discount rate was cut another V 2 point, to 6 percent. Money, Credit, and Monetary Policy In 1985, Ml grew at a rate substantially above its target growth range in the first half, and it continued to do so over the remainder of the year, even after the range had been rebased and widened in July. Instead of the return to more normal behavior that the FOMC had looked for, Ml velocity—the ratio of nominal GNP to Ml balances—fell even more rapidly in the second half of the year than it had in the first. Taking the prevailing economic and financial conditions into account, the Committee decided in the latter part 65 of 1985 that above-target Ml growth would be acceptable. In light of the uncertainties surrounding the behavior of Ml, in February of this year the FOMC set a 1986 target range for the aggregate that, while not providing for a drop in velocity as large as the 6 percent decline posted in 1985, was wide enough to allow for appreciable variation in velocity relative to historical trends. Nevertheless, the Committee recognized that the relationship of Ml to income had become increasingly difficult to predict, owing importantly to the changing composition of Ml. An important share of the aggregate now consists of interest-bearing deposits, which are potentially an attractive repository for savings as well as transaction balances, introducing an additional source of sensitivity to changes in Growth of Money and Credit Percentage change at annual rate Ml M2 M3 Domestic nonfinancial sector debt 11.9 7.3 7.9 13.0e 12.8 7.8 7.8 12.7e 12.3 9.6 9.8 1982 .. 1983 1984 1985 7.5 8.1 10.3 7.3 9.0 9.6 5.2 9.3 12.3 (2.5)1 8.7 9.1 10.0 10.4 12.2 9.9 5.4 8.0 10.5 11.9 8.6 7.6 9.0 11.2 14.3 14.0 Quarterly average 1985.1 2 3 4 1986:1 2 10.1 10.5 14.5 10.7 7.7 15.8 13.6 12.0 12.9 14.6 16.1 9.6e Period 1985:4 to 1986:2 1985:4 to June 1986 Fourth quarter to fourth quarter 1979 1980 1981 11.7 10.2 6.3 5.5 9.5 7.6 6.0 6.5 4.3 7.4 10.3 8.3 1. Ml figure in parentheses is adjusted for shifts to NOW accounts in 1981. e Estimated. 66 Monetary Policy Reports interest rates and other economic variables. In these circumstances, the Committee emphasized that policy implementation would involve a continuing appraisal of trends in all of the money and credit measures, as well as of indicators of economic activity and prices, and conditions in credit and foreign exchange markets. Within this framework for policy and against a background of incoming data indicating moderation of inflationary pressures and a relatively slow pace of economic expansion— including weakness in some important goods-producing sectors—the Federal Reserve basically accommodated the demands for reserves associated with strong Ml growth over the first half of 1986. Early in the year, reserves were provided slightly more freely, continuing the trend toward easier reserve conditions that had developed late last year. In the initial months of 1986, growth of Ml dropped off sharply from its rapid 1985 pace, and growth of M2 also slowed substantially, to a rate below its annual target range. There were signs of some sluggishness in economic activity, and steep declines in oil prices, which were improving the outlook for inflation, contributed importantly to a rally in long-term credit markets that picked up momentum in midFebruary. At the same time, shortterm interest rates edged a little lower, but the federal funds rate remained significantly above the Federal Reserve's discount rate. In this context, a cut in the discount rate would complement the thrust of open-market operations and would accommodate the market tendency toward lower interest rates. However, an important consideration in the timing and extent of any rate cut was the risk posed by an excessive reaction in the foreign exchange markets, when the dollar remained under downward pressure during much of the period. Ultimately, on March 7, the Federal Reserve cut the interest rate charged for discount window borrowings l/i percentage point to 7 percent, and the central banks of Japan, Germany, and several other industrial nations took similar actions around that time. Short-term rates in U.S. markets fell throughout March and much of April. Interest rates in long-term markets continued to benefit from the favorable effect of slumping oil prices on inflation expectations, as well as improvements in the federal budget outlook, with the GrammRudman-Hollings legislation beginning to bite and official projections of the deficit being revised sharply downward. To an extent, declining rates also reflected the optimism present in the markets that, with economic growth remaining moderate, there was potential for a further easing of monetary policy. Ml accelerated markedly—moving above its target range in March—apparently in response to lower interest rates, but M2 and M3 growth were rather restrained, with M2 remaining below the lower end of its range throughout the first quarter. On April 18, the Federal Reserve announced another reduction in the discount rate, to 6V2 percent. This change served primarily to catch up with and validate declines that already had taken place in market rates. Exchange rates and international interest rate considerations again played a role, and our discount rate cut coincided with a rate cut by the Bank of Japan. By this time, market interest rates in the United States had fallen 1 to 2 percentage points since December, to their lowest levels in eight or nine years. Both short- and long-term rates then turned higher for a time, as some indications of stronger economic growth seemed to be developing and prospects for a further easing of monetary policy receded. Supporting the market's changed outlook were an acceleration in the monetary aggregates, strength in some incoming economic indicators, and the dollar's slide on foreign exchange markets, which continued through mid-May. The dollar subsequently recovered a bit, but most of the increase both in the exchange rate and in U.S. market interest rates was reversed before the first half ended, as indications of an expected strengthening of economic activity failed to materialize. With market interest rates falling, price pressures remaining subdued, and the economies of the United States and other industrial countries growing relatively slowly, the Federal Reserve again reduced the discount rate V 2 percentage point, to 6 percent, effective July 11. On balance since the end of 1985, the dollar has declined more than 10 percent, and short-term rates, about IV2 percentage points. Long-term Treasury yields fell as much as 2V4 percentage points, but yields on other long-term securities fell less; corporate and tax-exempt bond yields dropped about 1 point, and fixedrate mortgages fell just V percentage 2 point. The smaller declines in these other markets were due in part to the massive issuance of these obligations (including a large volume of refinancings) elicited by the drop in rates over recent quarters, to investor desires for call protection, and in the case of tax-exempt securities, to concerns about tax reform. Monetary Policy Reports 67 Lower market interest rates have been an important factor in the rapid growth of Ml this year. The strong response of Ml to the decline in rates has reflected in part the cumulative effect of the deposit deregulation of recent years. In the first half of 1986, the final two installments of deregulation—the removal of minimum balance requirements on money market deposit accounts and Super NOWs on January 1 and the lifting of the ceiling on passbook savings rates on April 1—appear to have had little immediate effect on the growth of Ml or the other aggregates because relatively few institutions actually changed their deposit pricing practices. But the advent and expansion of interest-bearing checking accounts over the years have attracted more savings-type balances and have increased the responsiveness of Ml to interest rate changes. Since rates on the interest-bearing Ml accounts have adjusted sluggishly to changes in market rates, relatively wide swings in the incentives to hold these deposits have resulted. Growth in NOW accounts surged in the first half of 1986, reaching an annual rate of around 25 percent in the second quarter, as it responded to the lower overall level of market interest rates and the narrower spread between long- and short-term rates. The latter development seemed to spur shifts of funds from time deposits into shorter-term accounts, including NOW accounts. Demand deposit growth also strengthened as interest rates declined. In part, lower rates prompted increases in the compensating balances that businesses needed to hold in the form of demand deposits to pay for bank services. In addition, deposit levels may have been boosted to an extent by a sizable increase in financial transac- 68 Monetary Policy Reports tions in the first half of the year, especially soaring mortgage prepayments and originations, which was stimulated by lower rates. The velocity of Ml fell only moderately in the first quarter, but as money growth picked up and nominal GNP apparently failed to accelerate, velocity dropped at an extraordinary pace in the second quarter, resulting in a first-half rate of decline in Ml velocity that probably was somewhat faster than the average over 1985. Although the rapid Ml growth and falling velocity stemmed in large measure from interest rate declines, the size of the Ml increase was distinctly larger than what would have been expected based on historical relationships among money, income, and interest rates. In contrast to Ml, which grew at an annual rate of 12% percent through June and exceeded its target by a large margin, both M2 and M3 grew moderately in the first half of the year and in June were near the middle of their respective ranges. Some of the more liquid components of the broader monetary aggregates, however, increased very rapidly, as part of the larger shift in investor portfolios toward short-term assets. This shift had much less effect on M2 or M3 than on Ml, because the reallocation of funds took place largely within these broader aggregates. In addition to transaction deposits, money market deposit accounts, money market mutual funds, and ordinary savings deposits all expanded strongly during the first half of the year, while small time deposits grew only slightly. Investors looked not only to the shorter-term components of the monetary aggregates, but also to stock and bond mutual funds (not included in the aggregates), which posted very attractive returns as a result of ongoing market rallies. Flows into such funds probably depressed M2 growth somewhat in the first half of this year, as they had in 1985. Even so, lower market interest rates and strong demands for short-term assets lifted M2 in excess of income, leading to an appreciable further decline in M2 velocity over the first two quarters of 1986. While M2 showed a fair amount of volatility in the first half, growth of M3 was comparatively steady from month to month, as banks varied their issuance of managed liabilities to compensate for fluctuations in core deposit inflows. The debt of domestic nonfinancial sectors is estimated to have expanded at a more moderate rate over the first six months of 1986 than it had in some time, although still well in excess of the growth in income.1 Bond issuance had surged in December in advance of the possible effective date of some provisions of tax-reform legislation, lifting the first-quarter level of the debt aggregate. Hence, when measured from its fourthquarter-average base, the growth of domestic nonfinancial sector debt has remained above its monitoring range, coming in at an annual rate of 123/4 percent through June. Measured from its level at the end of December, however, debt grew at an annual rate of 10V4 percent through the end of June. To an extent, the lower rate of debt growth since the end of December represented a reaction to the inflated borrowing just before the end of last year, when special factors applying to particular sectors com1. The appendix reviews some aspects of the recent behavior of the debt aggregate. bined to boost debt issuance tremendously, far in excess of normal credit needs. For example, the pronounced slowdown of federal borrowing in the first quarter reflected the drawdown of substantial cash balances built up by the government before year-end. Indeed, federal borrowing picked up again in the second quarter, and, for the year as a whole, the huge federal deficit is likely to make a strong contribution to aggregate debt growth, as it has for the past several years. Following the surge in their borrowing late last year, state and local governments showed a sharp drop in debt growth. This earlier borrowing and continued uncertainty about tax reform restrained tax-exempt debt growth in early 1986. Beginning in March, however, public-purpose and refunding issues increased again as rates declined further and views changed about the likely form and effective date of restrictions proposed in tax-reform legislation. Borrowing by the household sector also eased somewhat from the heavy pace of recent years. After a surprising slowdown early in the year, net residential mortgage borrowing apparently expanded rapidly in the second quarter. Over the entire period, lower mortgage rates spurred a substantial pickup in total mortgage originations, but the high volume of refinancings reportedly strained the ability of lenders to process real estate transactions. Consumer credit growth rates this year have been substantially below those of last year, though still outpacing the growth of income. An increasing number of consumers seem to be experiencing difficulty in making timely payments on outstanding credit; delinquencies on consumer loans other than credit cards have risen moderately, but Monetary Policy Reports 69 those on bank credit cards have surged in the past two years, and personal bankruptcy rates have soared. The smallest degree of deceleration occurred in the debt of the nonfinancial business sector, which continued to be boosted by the wave of corporate mergers, acquisitions, and share repurchases. While the stock market rally helped spur a substantial rise in gross equity issuance, net stock issuance remained decidedly negative because of the mergers and restructurings. Most notable so far this year, however, was the strength of long-term debt issuance by businesses in response to steeply falling long-term rates; gross issuance of corporate bonds, especially strong in March and April, ran far in excess of previous records. Nonfinancial firms increased their short-term debt only slightly, however, and this was reflected in a decline in their commerical paper outstanding, as well as in slow business loan growth at banks. The stresses evident in many parts of the economy left their mark on the books of banks and other financial institutions. Asset quality deteriorated as a consequence of the sharp drop in oil prices and associated dislocations in the energy sector, overbuilding in commercial real estate, and the continuing distress in agriculture. Banks with relatively large amounts of farm loans outstanding, as well as other agricultural lenders, have been particularly hard hit recently; loan losses at these institutions have soared and their profitability has continued to slide. While banks in regions with economies heavily dependent on energy production were among the most strongly capitalized and profitable earlier, their financial position has eroded under 70 Monetary Policy Reports pressure of surrounding economic difficulties. Bank failures in the first half of this year continued to run at about the rapid pace of 1985, with agricultural banks again accounting for a disproportionate share. Overall bank earnings began to improve in 1985, and the industry has added significantly to its capital and loss reserves, although the explosion in off-balance-sheet commitments and the clouded outlook surrounding the repayment of many bank loans may have made it more difficult to assess the level of risk in the banking industry. At savings and loan associations, overall profitability appears to be improving as interest rates have declined and mortgage origination activity has surged. However, a substantial number of these institutions continue to have severe problems owing primarily to losses on weak assets, prompting proposals to add to the financial resources of the Federal Savings and Loan Insurance Corporation. Concerns over loans to certain developing countries came to the forefront again this year as Mexico began to grapple with the additional economic and financial problems brought on in large part by dramatically lower oil prices. Banks have remained cautious lenders in the face of ongoing concerns about the economic and financial prospects of these countries. However, despite the weakness of global demand, some progress has been made in implementing appropriate macroeconomic policies and policies of internal structural reform. Financial support for such policies both from multilateral lending institutions and private creditors has been provided or is being negotiated along the lines proposed by Secretary of the Treasury Baker in Seoul last fall. Appendix: Some Aspects of the Behavior of Domestic Nonfinancial Sector Debt After moving in rather close alignment for about a quarter of a century, debt growth in recent years has far outpaced expansion of nominal GNP. The ratio of debt outstanding to GNP began climbing late in 1981 and subsequently soared well above the range that had prevailed since the early 1950s, a development that extended through the first half of 1986. The debt aggregate is derived from the Federal Reserve's Flow of Funds accounts. It contains the credit market debt of domestic nonfinancial sectors—households, nonfinancial businesses, state and local governments, and the federal government—whose spending accounts for the vast bulk of income and production. It excludes debt of the financial sector because funds raised by financial intermediaries are already counted in the debt aggregate at the point they are channeled to nonfinancial sectors. To include financial sector debt would lead to double counting. Nonfinancial sectors also behave to a degree as financial intermediaries, raising funds in credit markets and using the proceeds, at least for a while, to acquire credit market claims on other nonfinancial units. In such cases, "double counting" may be said to exist, because the initial borrowing appears as debt of a domestic nonfinancial unit, and the financial asset acquired has as its counterpart, either directly or indirectly, debt of another nonfinancial Monetary Policy Reports unit. For example, a substantial portion of the funds raised by state and local governments in 1985 was used to acquire claims on the federal government or mortgage claims on households. The federal government also issues debt and uses the proceeds to extend loans to private borrowers—obligations that appear elsewhere in the debt aggregate. While nonfinancial sectors engage to some degree in these intermediary functions on a regular basis, a marked increase in such activity can act to boost measured growth in the debt aggregate. This was the case last year, when the proceeds of a large volume of debt issued by state and local governments with the intention of retiring outstanding obligations at a later time were placed largely in special nonmarketable securities of the federal government. In addition, debt growth has been lifted in recent years by a wave of corporate mergers, acquisitions, and share repurchases that has resulted in a massive retirement of equity, financed with credit. To assess the degree to which this double counting and corporate substitution of debt for equity have acted to boost debt growth, the behavior of an adjusted debt measure and of an equity-augmented measure was examined. The adjusted debt measure excludes readily identifiable double counting—in particular, that associated with the aforementioned state and local and federal government borrowing as well as with credit extended by nonfinancial businesses to the household sector. The resulting measure of adjusted debt is noticeably smaller in relation to GNP, but it has behaved quite similarly to the regular debt measure, rising 71 sharply relative to GNP in recent years to well above the range prevailing since the 1950s. The adjusted debt measure can be augmented by the accumulated net issuance of equity so that it encompasses funds raised in all markets. Although increasing less rapidly than debt or adjusted debt—for example, it rose I2V2 percent in 1985 on an end-of-period basis, as compared with I4V2 percent for adjusted debt and 15 percent for debt—the augmented measure also has risen rapidly in recent years in relation to GNP, indicating that borrowing to retire equity explains only a small portion of the increase in the debt-GNP ratio. From a longer perspective, this measure has remained within its historical range, and its recent rise returns it, in relation to GNP, to the levels prevailing in the 1950s and early 1960s. The evidence thus suggests that unusual behavior of the debt aggregate relative to GNP in recent years is related more to changes in underlying behavior than to the special factors just discussed. The unusual rise in debt relative to GNP in recent years has been in both the federal and nonfederal components of the aggregate. Growth in federal debt strengthened in the early 1980s and soared in 1982 with the widening of the budget deficit. After 1982, growth of federal debt slowed a bit in percentage terms while continuing to increase in dollar amounts and relative to GNP. Rising federal budget deficits have been associated with rising current account deficits and a growing gap between domestic purchases and output as net exports have contracted sharply. From one perspective, the growing federal def- 72 Monetary Policy Reports icit can be viewed as being financed by an inflow of funds from abroad— the counterpart to our current account deficit—which has enabled the federal government to increase its borrowing without curbing private spending and credit use to the extent that would be necessary in the absence of those external funds.2 However, the erosion of our international competitive position, which is reflected in the current account deficit, certainly has greatly affected individual industries. Debt of each of the nonfederal sectors—households, nonfinancial businesses, and state and local governments—also has increased relative to economic activity, even after removing the types of double counting mentioned above. In the case of households, the exceptional growth of debt has been evident in both mortgage and consumer debt and has been accompanied by a spectacular buildup of financial assets and a low personal saving rate. In other words, the household sector has been "grossing up" its balance sheet in recent years by heavy financial asset accumulation and borrowing. Financial deregulation and competition for household assets likely have contributed to this process by expanding access to market-related yields on deposits and other financial assets, while growing competition among lenders for market share and the trend toward securitization have added to sources of credit and put downward pressure on household 2. Not shown in the charts to the appendix is the relation between debt measures and domestic spending (GNP less net exports). In recent years, debt growth has been somewhat more in line with growth in domestic purchases than output, but this ratio, too, hasrisensharply. borrowing costs. The corresponding narrowing of the spread between borrowing and deposit rates adds to the willingness of households to borrow rather than draw down liquid assets when spending rises relative to income. Demographic factors also appear to have contributed to household debt growth as the baby boom generation has moved further into the age bracket in which spending on housing and durables and borrowing tend to be high. In addition, households have benefited from the runup in stock market prices in recent years, and this boost to their net worth may have encouraged more borrowing. Even so, household debt growth has outstripped increases in net worth. For nonfinancial corporations, most of the advance in indebtedness relative to output in recent years stems from the substitution of debt for equity, previously discussed. The unevenness of the current economic expansion also appears to have boosted corporate borrowing because some industries—especially those dependent on export markets and those competing with imports— have experienced protracted weakness, even though overall cash flows have been strong; thus, working capital and investment needs have been less closely matched with cash flows among firms than is typical, contributing to more rechanneling of funds through credit markets and more corporate borrowing. Finally, state and local government borrowing was especially heavy in 1985, even after removing the doublecounting factors already mentioned, as lower interest rates and the anticipation of tax reform also fueled a surge in tax-exempt bond issuance for purposes other than advance refunding and mortgage acquisitions. Part 2 Records, Operations, and Organization 75 Record of Policy Actions of the Board of Governors Regulation D (Reserve Requirements of Depository Institutions) and Regulation Q (Interest on Deposits) March 12, 1986—Amendments The Board amended Regulations D and Q in connection with the expiration of its authority to set interest rate ceilings and reserve requirements for deposit instruments. Votes for these actions: Messrs. Volcker, Martin, Wallich, Rice, Ms. Seger, Messrs. Angell, and Johnson. Governor Seger dissented from the Board's decision to establish early withdrawal penalties for small institutions. The Depository Institutions Deregulation Act of 1980 called for phasing out over a six-year period interest rate ceilings on all deposit accounts except demand deposits. The Board's authority under the act to set interest rate ceilings expires March 31, 1986, leaving only the prohibition on the payment of interest on demand deposits as a constraint on deposit interest rates. Statutory authority for money market deposit accounts (MMDAs) also expires on that date, as does the Board's authority to set penalties for early withdrawal of time deposits. The Board amended Regulations D and Q to continue the existing exemptions of savings deposits and MMDAs from reserve requirements and from the prohibition against the payment of interest on demand deposits. Thus savings accounts con tinue to qualify for the zero or 3 percent reserve requirement if no more than three transfers are allowed each month; MMDAs qualify if no more than six transfers are allowed each month. Previously, businesses had been permitted to hold savings accounts up to a maximum of $150,000. The amendments remove the $150,000 limitation on business savings accounts, making their treatment similar to that of MMDAs. Any business account from which more than three telephone transfers are permitted per month, however, is considered a demand deposit and is subject to the interest rate limitation and reserve requirement appropriate for demand deposits. The Board also decided to continue some early withdrawal penalties to help preserve for reserve requirement purposes the distinctions between transaction accounts and time deposits and among nonpersonal time deposits of differing maturities. In addition, the Board decided to extend the applicability of early withdrawal penalties to certain small institutions—primarily credit unions—that had not had such penalties under the 1980 act. The Board agreed to allow these institutions a longer period for compliance with this provision. Governor Seger dissented from the Board's decision to apply early withdrawal penalties to small institutions. Most of the amendments are effective April 1, 1986. Credit unions and other small institutions that had not 76 Board Policy Actions been subject to the early withdrawal penalties have until January 1, 1987, to begin imposing penalties on time deposits opened, added to, or renewed after that date. Regulation D (Reserve Requirements of Depository Institutions) the lower reserve requirement applies. The Garn-St Germain Depository Institutions Act of 1982 established a zero percent reserve requirement on the first $2 million of an institution's reservable liabilities. It also provided for annual adjustments to that exemption based on deposit growth nationwide. Recent growth in deposits indicated that the amount subject to a zero percent reserve requirement should be increased from $2.6 million to $2.9 million, and the Board amended Regulation D accordingly. November 24, 1986— Amendment The Board amended Regulation D, effective December 31, 1986 (1) to increase the amount of transaction account balances to which the lower reserve requirement applies; and (2) to increase the amount of reservable Regulation G (Securities Credit liabilities subject to a zero percent by Persons Other than Banks, Brokers, or Dealers) reserve requirement. Votes for these actions: Messrs. Volcker, Johnson, Ms. Seger, Messrs. Angell, and Heller. Absent and not voting: Messrs. Wallich and Rice. Under the Monetary Control Act of 1980, depository institutions, Edge and agreement corporations, and U.S. agencies and branches of foreign banks are subject to reserve requirements set by the Board. Initially, reserve requirements were set at 3 percent of an institution's first $25 million in transaction balances and 12 percent on balances above that level. The act directs the Board to adjust the amount subject to the lower reserve requirement to reflect changes in the amount of transaction balances nationwide. By the beginning of 1986, this amount had been raised to $31.7 million. Recent growth in such balances indicated that a further increase of $5 million was warranted. The Board, therefore, amended Regulation D to increase to $36.7 million the amount to which January 8, 1986—Interpretation The Board issued an interpretation of Regulation G, effective January 10, 1986, that clarifies the need for margin requirements for certain debt securities issued by a company seeking to acquire another. Votes for this action: Messrs. Volcker, Partee, and Rice. Votes against this action: Mr. Martin and Ms. Seger. 1 Absent and not voting: Mr. Wallich. The interpretation addresses debt securities issued by a shell corporation in a takeover attempt. (A shell corporation is a firm that has no significant business operations, functions primarily as a vehicle for acquiring the stock of the target company, and has virtually no assets other than the margin stock.) The 1. On this and subsequent pages, footnote 1 indicates that there was a vacancy on the Board when this action was taken. Board Policy Actions interpretation states that debt securities issued by such a shell company are presumed to be indirectly secured by the stock of the company being acquired and, therefore, are subject to the margin requirements of Regulation G. If specific evidence exists of collateral other than the margin stock or of a guarantee by the parent of the shell company, then the securities are not covered by the interpretation. Governors Martin and Seger believed that adoption of the interpretation was unnecessary. They noted that a process already exists whereby the staff provides advice on margin stock matters, and they saw no reason for the Board to be involved in such determinations. In addition, they preferred a longer comment period. Regulation J (Collection of Checks and Other Items and 77 nonstandard holiday must pay for checks made available to it on that day or reimburse the Reserve Bank for the value of the resultant float. The Board also modified its ACH procedures, effective April 1, 1987, to reduce and reallocate float that results from nonstandard holidays. In addition, the Board adopted a schedule for Reserve Bank observance of the 10 national holidays, effective January 1, 1987. In other amendments, the Board established two-year limits for bringing actions against a Reserve Bank for mishandling a payment item (beginning January 1, 1990) and for bringing action against a paying bank for failing to comply with the regulation's notification requirements (beginning August 1, 1986). The Board also authorized the Reserve Banks to collect instruments drawn on payors in foreign countries. Wire Transfers of Funds) May 28, 1986—Amendments The Board amended Regulation J, effective January 1, 1987, to reduce and reallocate check float, to permit Reserve Banks to collect checks drawn on banks in foreign countries, and to make other technical changes. The Board also modified its automated clearinghouse (ACH) procedures and adopted a standard holiday schedule for the Reserve Banks. Regulation K (International Banking Operations) June 23, 1986—Amendment Effective July 8, 1986, the Board revised the procedures governing international investments by U.S. banking organizations. Votes for this action: Messrs. Volcker, Wallich, Rice, Ms.1 Seger, Messrs. Angell and Johnson. Previously, the regulation's proviVotes for these actions: Messrs. Volcker, Wallich, Rice, Ms.1 Seger, Messrs. sions on foreign investment had reAngell and Johnson. quired a banking organization to obtain the Board's consent to invest The Board changed the procedures more than 10 percent of its capital for recovering check float arising and surplus in a foreign company. from the local or regional observance The amendment removes that reof a holiday not observed nationally. quirement and permits such an inEffective January 1, 1987, a paying vestment with written notice to the bank that closes voluntarily on a Federal Reserve 45 days in advance. 78 Board Policy Actions Regulation Y (Bank Holding Companies and Change in Bank Control) June 25, 1986—Amendments The Board amended Regulation Y, effective December 15, 1986, to add six activities to the list of nonbanking activities permissible for bank holding companies. Votes for this action: Messrs. Volcker, Wallich, Rice, Ms.1 Seger, Messrs. Angell and Johnson. The Board also revised the portion of the regulation governing insurance activities. Votes for this action: Messrs. Volcker, Rice, Ms. Seger, Messrs. Angell, and Johnson. Abstaining: Mr. Wallich.1 The amendments to Regulation Y permit bank holding companies to engage in the following nonbanking activities: consumer financial counseling; tax preparation and planning; commodity trading and futures commission merchant advisory services; check guarantee services; credit bureau and collection agency services; and personal property appraisal. The regulation stipulates the conditions under which holding companies may engage in these activities. The Board eliminated a requirement that holding companies that underwrite credit-related insurance provide rate reductions or other policy benefits to customers. The requirement had stipulated that holding companies must charge premiums lower than the maximum established by state rules. The Board found that this requirement put holding companies at a competitive disadvantage and that other safeguards exist to address the possibility of adverse effects on the public. The Board also redefined the scope of insurance activities permitted under the Garn-St Germain Depository Institutions Act of 1982. The act prohibited some insurance activities that had been permissible under Regulation Y and permitted expansion of other activities. The act generally prohibited agency and underwriting activities, except as specifically exempted. The Board revised Regulation Y to incorporate exemptions that permit the following activities: (1) selling credit-related life, accident, and health insurance and insurance for involuntary unemployment; (2) selling, through finance-company subsidiaries, property insurance on collateral of $10,000 or less (or $25,000 for manufactured homes); (3) continuing and expanding certain agency activities authorized before specified grandfather dates; (4) acting as a managing general agent for group insurance for the holding company; (5) acting as a general insurance agent if the holding company has $50 million in assets or less; and (6) acting as a general insurance agent in towns with inadequate insurance agency facilities or with fewer than 5,000 residents. The Board determined that a bank holding company's authority to operate a general insurance agency in small towns should be confined to those towns in which the company has lending offices. Regulation Z (Truth in Lending) December 10, 1986— Amendment The Board amended Regulation Z, effective December 16, 1986, to redefine what constitutes an advance of new money in a refinancing and, Board Policy Actions thereby, to expand the exemptions from the right of rescission. Votes for this action: Messrs. Volcker, Johnson, Ms. Seger, Messrs. Angell and Heller. Absent and not voting: Messrs. Wallich and Rice. Under the Truth in Lending Act, consumers who use their homes as collateral for a loan have three days within which to rescind the transaction. Creditors are required to provide borrowers with a written notice of their right to rescind such a transaction, and creditors cannot disburse funds or otherwise perform services until the three-day rescission period has expired. Regulation Z exempts refinancings from the right of rescission if the new credit is extended by the same creditor who made the original loan and if the transaction does not involve an advance of new money. Regulation Z had defined new money as the difference between the new "amount being financed" and the outstanding balance plus any earned unpaid finance charges. The Board amended the regulation to redefine what constitutes a new advance of money so that the right of rescission would not be triggered if a consumer finances charges such as attorney's fees, title search fees, and insurance premiums. The Board found that these charges generally are not substantial relative to the principal amount refinanced and do not put the borrower's home at a significantly higher risk of loss. The Board decided to withdraw one other proposed amendment to the right of rescission that had been published for comment. The amendment had pertained to refinancings by creditors other than those who made the original mortgage loans. The Board's decision reflected the limited nature of the exemption pro 79 posed, the complexity of an implementing rule, and several adverse comments received on the proposal. Rules Regarding Delegation of Authority December 15, 1986— Amendment The Board amended its rules, effective immediately, to permit certain System officials to waive the requirements to publish notice and seek public comment on a proposed change in the control of a bank, if such disclosures would seriously threaten the bank. Votes for this action: Messrs. Volcker, Johnson, Ms. Seger, Messrs. Angell, and Heller. Absent and not voting: Messrs. Wallich and Rice. Recent legislation amended the Change in Bank Control Act to require that public comment be sought on any proposed change in bank ownership. That legislation, however, permits a federal bank regulator to dispense with the publication and comment requirements if the regulator determines that such disclosure would seriously threaten the safety or soundness of the bank being acquired. The amendment to the Board's rules delegates authority to determine whether to waive the notice requirements either to the Board's Director of the Division of Banking Supervision and Regulation, with the concurrence of the General Counsel, or to the appropriate Reserve Bank, with the concurrence of the Board's Director of Banking Supervision and the General Counsel. A waiver of these requirements would be appropriate, for instance, when prompt action is necessary to prevent the bank's failure. These System officials 80 Board Policy Actions already have comparable delegated authority for applications filed under the Bank Holding Company Act. Policy Statements July 11, 1986—Revisions to Capital Adequacy Guidelines The Board revised its guidelines for capital adequacy to permit bank holding companies to count perpetual debt as primary capital and to limit the inclusion of certain sources of equity as primary capital. Votes for this action: Messrs. Volcker, Wallich, Rice, Ms.1 Seger, Messrs. Angell and Johnson. The revised guidelines establish criteria for determining whether a perpetual debt instrument qualifies as primary capital. The guidelines now permit qualifying perpetual debt, perpetual preferred stock, and mandatory convertible stock to compose up to one-third of an institution's primary capital. Also, 20 percent of an institution's primary capital may be in the form of mandatory convertible securities and perpetual debt. Perpetual debt securities issued or in the process of being issued on November 20, 1985, when the proposed revisions were published for comment, are grandfathered and excluded from the limitations. November 3, 1986—Basic Financial Services The Board authorized issuance of a policy statement on the types of basic services that financial institutions should be encouraged to offer. Votes for this action: Messrs. Volcker, Johnson, Angell and Heller. Vote against: Ms. Seger. Absent and not voting: Messrs. Wallich and Rice. The Board's Consumer Advisory Council had become concerned that changes in the financial services market might have an adverse effect on lower-income households. After careful study, the Council recommended that the Board issue a policy statement encouraging state member banks to offer the types of services most needed by low- and moderate-income households. The Board agreed with the need for such a statement but believed that the policy should have broader applicability. The Board recommended that the Federal Financial Institutions Examination Council propose such a statement for all financial institutions. After review, the council approved a joint policy statement to be issued by its member agencies that encourages efforts by trade associations and individual financial institutions to make basic banking services available to all customers. Rather than identify particular accounts or services that should be offered, the statement broadly defines the types of services that institutions should endeavor to provide and encourages trade associations and financial institutions to ensure availability of certain basic services, such as a safe and accessible place to keep money; a way to obtain cash, including the cashing of government checks; and a means for making third-party payments. The Board adopted the policy statement. Ms. Seger objected to issuance of the policy statement because she believed that actions by certain trade associations adequately addressed the concerns in the statement and that Board action, therefore, was not necessary. Board Policy Actions 81 By the latter part of February a majority of the Board Members believed that, on balance, the latest available information pointed to a more sluggish expansion of business activity than they had anticipated earlier in the year. They also called attention to the disinflationary effects of falling oil prices, to declining interest rates, and to recent evidence of slower monetary growth. Other Members observed that the weakening in some business indicators was relatively recent and did not necessarily portend a slower economic expansion. Moreover, the recent moderation in monetary growth came after an extended period of generally rapid expansion. These Members also expressed concern about the potentially adverse influence that a reduction in the discount rate might have on the foreign exchange value of the dollar unless it was associated with Actions on the Basic movements toward ease by at least Discount Rate some of the leading industrial countries abroad. January-February: No Change At a meeting held on February 24, During the early weeks of the year, the Board discussed but took no the Board by a vote of 4 to 3 2 action on a number of requests by approved a reduction of V percentindividual Federal Reserve Banks to age point in the basic discount rate reduce the basic discount rate by Vi to 7 percent. On the same day, the or V2 percentage point. A rate of IV2 Board rescinded that action by unanpercent had been in effect since mid- imous vote following a review of May 1985. The Board's ongoing re- prospective actions by key central view of economic and financial de- banks abroad to reduce their lending velopments, including the behavior rates. Members who favored a reof the monetary aggregates, resulted duction in the discount rate on doin decisions to defer action rather mestic grounds decided that a delay than to approve or deny the pending of limited duration would be acceptrate cuts. The Board also took ac- able, given the outlook for easing count of developments in foreign actions by at least some other major exchange markets and noted the risks central banks during the next couple to the dollar of a reduction under of weeks, if not within the next few the prevailing circumstances, partic- days. ularly if a lower discount rate were not accompanied by cuts in the lending rates of key central banks March-August: Basic Rate Reduced abroad. On March 6, by unanimous vote, the 1986 Discount Rates The Board approved four reductions of V percentage point in the basic 2 discount rate during 1986. Those reductions served to lower the rate from 7V2 percent in early March to 5V2 percent in the latter half of August. There were no increases in the discount rate during the year. The reasons for the Board's decisions are reviewed below. Those decisions were made in the context of the policy actions of the Federal Open Market Committee and of general economic and financial developments that are covered in more detail elsewhere in this REPORT. A listing of the Board's actions on the discount rate during 1986, including the votes on those actions, follows this review. 82 Board Policy Actions Board approved a reduction from 7V2 to 7 percent in the basic discount rate. This action was taken in the context of similar actions announced or expected by central banks in a number of other major industrial countries and in light of sizable further declines in most domestic interest rates in recent weeks. The Members also noted that the expansion of the monetary aggregates had been more limited thus far in 1986 than earlier, and the latest business information tended to confirm previous indications of more sluggish economic growth. In addition, a relatively favorable outlook for prices had been enhanced by the continuing decline in oil prices. On April 18, the Board approved another reduction of V percentage 2 point in the basic discount rate. Most of the members believed that such an action was desirable to bring the rate into better alignment with shortterm market rates, which had continued to decline since March 6. A reduction was also thought to be consistent with prospective policy easing in one or more of the major industrial nations abroad. Members noted that the latest indicators of business activity suggested on balance that economic growth would be relatively sluggish in the second quarter, especially reflecting weakness in business investment. Among other factors an important influence on such investment was the adverse effect of lower oil prices on the energy industry. Governor Rice dissented from this action. In his view the economic outlook remained favorable despite indications of slower expansion in the current quarter. He stressed that consumer spending was being well maintained, and he believed that some turnaround in business spend ing was likely and would contribute to faster economic growth during the second half of the year. The outlook for net exports also appeared to be more positive. He concluded that a further cut in the discount rate was not warranted in these circumstances. On July 10, the Board unanimously approved another reduction in the basic discount rate to 6 percent. Such an action was judged to be consistent with the accommodative monetary policy that had been implemented for some time through open market operations, and it took account of recent declines in a number of market interest rates. A lower discount rate also was deemed appropriate in the context of relatively slow growth in overall business activity, relatively low prices for a number of important commodities, and reduced pressures on the prices of goods fostered by an economy that was operating comfortably within capacity limits and subject to strong competition from abroad. Members noted that while Ml had been growing rapidly in recent months, the broader aggregates, M2 and M3, were currently near the midpoints of their target ranges for 1986. The Federal Open Market Committee had established those ranges in February and had reaffirmed them at its meeting on July 8-9. Some Members commented on the risks to the dollar of reducing the discount rate when few, if any, of the major central banks abroad were likely to ease their policies, at least over the near term. In this situation the dollar might remain under downward pressure in the foreign exchange market. But it was noted that a reduction in the System's rate might encourage easing measures abroad later, if not immediately. Board Policy Actions The last reduction in the discount rate during 1986, to 5V2 percent, was approved by unanimous vote on August 20. The Members agreed that such an action was consistent with the policy decision reached by the Federal Open Market Committee at its meeting on August 19 and with the System's broad objective of sustaining orderly economic growth within a framework of progress toward price stability. The Members recognized that there were risks of downward pressures on the dollar in the foreign exchange market, given the prospect that key industrial nations abroad were not likely to lower their discount rates in the near future. However, those risks were felt to be manageable and to be acceptable in light of prevailing and prospective economic and financial conditions. September-December: No Change During the closing months of the year, the Board made no further changes in the discount rate. The Members took account of a pickup in the growth of economic activity from the very sluggish pace in the second quarter. Prices tended to rise somewhat faster during the summer and fall months, reflecting developments in food and energy markets, but overall pressures on prices remained limited during this period. Renewal of Temporary Seasonal Credit Program On February 14, 1986, the Board approved the renewal for 1986 of its temporary, simplified seasonal credit program. This program was originally approved and implemented in 1985 as a means of making funds available at the discount window to agricultural banks experiencing unu 83 sually strong loan demands. The program was intended to complement the longstanding regular seasonal credit program and thereby to help assure that small- and mediumsized banks did not face liquidity constraints in accommodating their farm borrowers over the 1986 planting and production cycle. Under this temporary program, eligible banks could borrow at the discount window to fund one-half of their loan growth in excess of 2 percent over a base level; such borrowing could not exceed 5 percent of their deposits. For 1986, the Board modified the temporary program slightly to enhance the program's usefulness to potential borrowers. The modifications (1) gave banks the option of borrowing at a fixed rate of V2 percentage point over the basic discount rate or at a variable rate that is the basic discount rate itself, and (2) permitted banks added flexibility in determining the base from which loan growth would be measured. Banks were allowed to borrow under either the regular or the temporary seasonal programs, but not under both at the same time. New Policy on Large Borrowings from the Discount Window On May 19, 1986, the Board approved a new policy to deal with exceptionally large borrowings from the discount window that arise from computer breakdowns or other operating problems. Under the new policy, a rate higher than the basic discount rate is applied to loans of unusual size that result from a major operating problem at the borrower's facility unless the problem clearly is beyond the reasonable control of the borrowing institution. The rate to be charged is the highest rate estab- 84 Board Policy Actions lished for loans to depository institutions. The Board's objective was to ensure that, in such circumstances, credit extended by the Federal Reserve would be at rates as high as or higher than those for short-term accommodation in the open market. The Board also wanted to encourage institutions to maintain or install appropriate measures and precautions to reduce the chances that major problems might develop. Structure of Discount Rates The basic discount rate noted in this report is the rate charged on loans to depository institutions for shortterm adjustment credit. The basic rate also applies to most seasonal credit, including the regular seasonal program; under that program, credit may be provided for periods longer than those permitted under adjustment credit to assist smaller institutions in meeting regular needs for funds arising from certain expected seasonal movements in their deposits and loans. As noted above, credit is also provided at the basic discount rate under the variable-rate option of the temporary seasonal program and at a rate h percentage point above the basic rate under the fixedrate option of the temporary seasonal program. Another category of discount-window credit relates to loans made over extended periods to depository institutions that are under sustained liquidity pressure. Such extended credit may also be provided when exceptional circumstances or practices adversely affect a particular depository institution. The interest rate on extended credit rises relative to the basic rate as the period of borrowing lengthens. For loans that have been outstanding for more than 150 days, or for a shorter period if they are expected to be outstanding for an unusually long time and in relatively large amounts, the Reserve Banks may charge a flexible rate. The flexible rate, which has a floor that is 1 percentage point above the basic discount rate, takes account of the rates on market sources of funds. The Board approved reductions in the flexible rate periodically during the year, from 8V2 percent in midMarch to 6V2 percent in early September. As of December 31, 1986, the structure of discount rates was as follows: a basic rate of 5V2 percent for short-term adjustment credit and for credit under the regular seasonal program. No loans were outstanding under the temporary seasonal program at year-end. Rates on extended credit ranged from the basic rate of 5V2 percent for the first 60 days of borrowing, to 6V2 percent for the next 90 days of borrowing, and to 7V2 percent after 150 days. The flexible rate on extended credit was 6V2 percent at year-end and was authorized for the Federal Reserve Banks of Richmond, Atlanta, Chicago, Kansas City, Dallas, and San Francisco. Votes on Reserve Bank Requests to Change the Discount Rate Under the provisions of the Federal Reserve Act, the boards of directors of the Federal Reserve Banks are required to establish rates on loans to depository institutions at least every 14 days and to submit such rates to the Board of Governors for review and determination. The Board votes listed below are those that involved changes in the basic discount rate. Votes involving the re- Board Policy Actions establishment of existing rates are not shown. All of the latter were unanimous. February 24, 1986 Effective February 25, 1986, the Board approved actions taken by the directors of the Federal Reserve Banks of Dallas and San Francisco to reduce the basic discount rate from 7V2 percent to 7 percent. Votes for this action: Mr. Martin, Ms. Seger, and Messrs. Angell and Johnson. Votes against this action: Messrs. Volcker, Wallich, and Rice. February 24, 1986 The Board rescinded its approval of a reduction in the basic discount rate from 7V2 percent to 7 percent at the Federal Reserve Banks of Dallas and San Francisco. Votes for this action: Messrs. Volcker, Martin, Wallich, Rice, Ms. Seger, and Messrs. Angell and Johnson. Votes against this action: None. March 6, 1986 Effective March 7, 1986, the Board approved actions taken by the directors of the Federal Reserve Banks of Boston, New York, Philadelphia, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco to reduce the basic discount rate to 7 percent. Votes for this action: Messrs. Volcker, Martin, Wallich, Rice, Angell, and Johnson. Votes against this action: None. Absent and not voting: Ms. Seger. The Board subsequently approved a similar action taken by the directors of the Federal Reserve Bank of Cleveland, effective March 10, 1986. April 18, 1986 Effective April 21, 1986, the Board 85 approved actions taken by the directors of the Federal Reserve Banks of Boston, New York, Cleveland, Richmond, Chicago, Minneapolis, Kansas City, Dallas, and San Francisco to reduce the basic discount rate to 6V2 percent. Votes for this action: Messrs. Volcker, Martin, Wallich, Ms. Seger, and Messrs. Angell and Johnson. Vote against this action: Mr. Rice. The Board subsequently approved similar actions taken by the directors of the Federal Reserve Banks of Atlanta and St. Louis, effective April 22, and Philadelphia, effective April 23, 1986. July 10, 1986 Effective July 11, 1986, the Board approved actions taken by the directors of the 12 Federal Reserve Banks to reduce the basic discount rate to 6 percent. Votes for this action: Messrs. Volcker, Wallich, Rice, Ms. Seger, Messrs. Angell and Johnson. Votes against this action: None.1 August 20, 1986 Effective August 21, 1986, the Board approved actions taken by the directors of the Federal Reserve Banks of Boston, New York, Cleveland, Richmond, Atlanta, Chicago, Minneapolis, Kansas City, Dallas, and San Francisco to reduce the basic discount rate to 5V2 percent. Votes for this action: Messrs. Volcker, Wallich, Rice, Ms. Seger, and Messrs. Angell, Johnson, and Heller. Votes against this action: None. The Board subsequently approved similar actions taken by the directors of the Federal Reserve Banks of Philadelphia and St. Louis, effective August 22, 1986. 87 Record of Policy Actions of the Federal Open Market Committee The record of policy actions of the Federal Open Market Committee is presented in the ANNUAL REPORT of the Board of Governors pursuant to the requirements of section 10 of the Federal Reserve Act. That section provides that the Board shall keep a complete record of the actions taken by the Board and by the Federal Open Market Committee on all questions of policy relating to open market operations, that it shall record therein the votes taken in connection with the determination of open market policies and the reasons underlying each such action, and that it shall include in its ANNUAL REPORT to the Congress a full account of such actions. In the pages that follow, there are entries with respect to the policy actions taken at the meetings of the Federal Open Market Committee held during the calendar year 1986, including the votes on the policy decisions made at those meetings as well as a resume of the basis for the decisions. The summary descriptions of economic and financial conditions are based on the information that was available to the Committee at the time of the meetings, rather than on data as they may have been revised later. It will be noted from the record of policy actions that in some cases the decisions were made by unanimous vote and that in other cases dissents were recorded. The fact that a decision in favor of a general policy was by a large majority, or even that it was by unanimous vote, does not necessarily mean that all members of the Committee were equally agreed as to the reasons for the particular decision or as to the precise operations in the open market that were called for to implement the general policy. During 1986 the policy record for each meeting was released a few days after the next regularly scheduled meeting and was subsequently published in the Federal Reserve Bulletin. Policy directives of the Federal Open Market Committee are issued to the Federal Reserve Bank of New York as the Bank selected by the Committee to execute transactions for the System Open Market Account. In the area of domestic open market activities, the Federal Reserve Bank of New York operates under two separate directives from the Open Market Committee: an Authorization for Domestic Open Market Operations and a Domestic Policy Directive. (A new Domestic Policy Directive is adopted at each regularly scheduled meeting.) In the foreign currency area, it operates under an Authorization for Foreign Currency Operations and a Foreign Currency Directive. These four instruments are shown below in the form in which they were in effect at the beginning of 1986. Changes in the instruments during the year are reported in the records for the individual meetings. 88 FOMC Policy Actions Authorization for Domestic Open Market Operations In Effect January 1, 1986 1. The Federal Open Market Committee authorizes and directs the Federal Reserve Bank of New York, to the extent necessary to carry out the most recent domestic policy directive adopted at a meeting of the Committee: (a) To buy or sell U.S. Government securities, including securities of the Federal Financing Bank, and securities that are direct obligations of, or fully guaranteed as to principal and interest by, any agency of the United States in the open market, from or to securities dealers and foreign and international accounts maintained at the Federal Reserve Bank of New York, on a cash, regular, or deferred delivery basis, for the System Open Market Account at market prices, and, for such Account, to exchange maturing U.S. Government and Federal agency securities with the Treasury or the individual agencies or to allow them to mature without replacement; provided that the aggregate amount of U.S. Government and Federal agency securities held in such Account (including forward commitments) at the close of business on the day of a meeting of the Committee at which action is taken with respect to a domestic policy directive shall not be increased or decreased by more than $6.0 billion during the period commencing with the opening of business on the day following such meeting and ending with the close of business on the day of the next such meeting; (b) When appropriate, to buy or sell in the open market, from or to acceptance dealers and foreign accounts maintained at the Federal Reserve Bank of New York, on a cash, regular, or deferred delivery basis, for the account of the Federal Reserve Bank of New York at market discount rates, prime bankers acceptances with maturities of up to nine months at the time of acceptance that (1) arise out of the current shipment of goods between countries or within the United States, or (2) arise out of the storage within the United States of goods under contract of sale or expected to move into the channels of trade within a reasonable time and that are secured throughout their life by a warehouse receipt or similar document conveying title to the underlying goods; provided that the aggregate amount of bankers acceptances held at any one time shall not exceed $100 million; (c) To buy U.S. Government securities, obligations that are direct obligations of, or fully guaranteed as to principal and interest by, any agency of the United States, and prime bankers acceptances of the types authorized for purchase under l(b) above, from dealers for the account of the Federal Reserve Bank of New York under agreements for repurchase of such securities, obligations, or acceptances in 15 calendar days or less, at rates that, unless otherwise expressly authorized by the Committee, shall be determined by competitive bidding, after applying reasonable limitations on the volume of agreements with individual dealers; provided that in the event Government securities or agency issues covered by any such agreement are not repurchased by the dealer pursuant to the agreement or a renewal thereof, they shall be sold in the market or transferred to the System Open Market Account; and provided further that in the event bankers acceptances covered by any such agreement are not repurchased by the seller, they shall continue to be held by the Federal Reserve Bank or shall be sold in the open market. 2. In order to ensure the effective conduct of open market operations, the Federal Open Market Committee authorizes and directs the Federal Reserve Banks to lend U.S. Government securities held in the System Open Market Account to Government securities dealers and to banks participating in Government securities clearing arrangements conducted through a Federal Reserve Bank, under such instructions as the Committee may specify from time to time. 3. In order to ensure the effective conduct of open market operations, while assisting in the provision of short-term investments for foreign and international accounts maintained at the Federal Reserve Bank of New York, the Federal Open Market Committee authorizes and directs the Federal Reserve Bank of New York (a) for System Open Market Account, to sell U.S. Government securities to such foreign and international accounts on the bases set forth in paragraph l(a) under agreements providing for the resale by such FOMC Policy Actions accounts of those securities within 15 calendar days on terms comparable to those available on such transactions in the market; and (b) for New York Bank account, when appropriate, to undertake with dealers, subject to the conditions imposed on purchases and sales of securities in paragraph l(c), repurchase agreements in U.S. Government and agency securities, and to arrange corresponding sale and repurchase agreements between its own account and foreign and international accounts maintained at the Bank. Transactions undertaken with such accounts under the provisions of this paragraph may provide for a service fee when appropriate. Domestic Policy Directive In Effect January 1, 19861 The information reviewed at this meeting suggests that economic activity is expanding at a relatively modest pace in the current quarter. Total nonfarm payroll employment increased further in November, though less than in October, and the civilian unemployment rate edged down to 7.0 percent. Retail sales and industrial production picked up in November after declining in October. After strengthening in October, housing starts fell appreciably in November. Incoming information generally suggests relatively sluggish business capital spending. Revised merchandise trade data for the third quarter confirm that the deficit widened further, as nonoil imports continued to increase and exports fell somewhat. Broad measures of prices and wages appear to be rising at rates close to those recorded earlier in the year. After declining in October, Ml grew substantially in November while growth in M2 and M3 continued quite moderate. Expansion in total domestic nonfinancial debt has remained rapid. Through November, Ml expanded at a rate well above the long-run range set by the Committee, M2 grew at a rate a bit below the upper 1. Adopted by the Committee at its meeting on Dec. 16-17, 1985. end of its range for the year, and M3 expanded at a rate near the mid-point of its range for 1985. Treasury bill rates have fallen somewhat while other short-term market interest rates have changed little on balance since the November meeting of the Committee; long-term rates have moved appreciably lower over the period. The trade-weighted value of the dollar against major foreign currencies has declined on balance since the Committee's meeting in early November, though the dollar has tended to stabilize more recently. The Federal Open Market Committee seeks to foster monetary and financial conditions that will help to reduce inflation further, promote growth in output on a sustainable basis, and contribute to an improved pattern of international transactions. In furtherance of these objectives the Committee at the July meeting reaffirmed ranges for the year of 6 to 9 percent for M2 and 6 to 9Vi percent for M3. The associated range for total domestic nonfinancial debt was reaffirmed at 9 to 12 percent. With respect to Ml, the base was moved forward to the second quarter of 1985 and a range was established at an annual growth rate of 3 to 8 percent. The range takes account of expectations of a return of velocity growth toward more usual patterns, following the sharp decline in velocity during the first half of the year, while also recognizing a higher degree of uncertainty regarding that behavior. The appropriateness of the new range will continue to be reexamined in the light of evidence with respect to economic and financial developments including developments in foreign exchange markets. More generally, the Committee agreed that growth in the aggregates may be in the upper parts of their ranges, depending on continuing developments with respect to velocity and provided that inflationary pressures remain subdued. For 1986 the Committee agreed on tentative ranges of monetary growth, measured from the fourth quarter of 1985 to the fourth quarter of 1986, of 4 to 7 percent for Ml, 6 to 9 percent for M2, and 6 to 9 percent for M3. The associated range for growth in total domestic nonfinancial debt was provisionally set at 8 to 11 percent for 1986. With respect to Ml particularly, the Committee recognized that uncertainties surrounding recent behavior of 90 FOMC Policy Actions velocity would require careful reappraisal of the target range at the beginning of 1986. Moreover, in establishing ranges for next year, the Committee also recognized that account would need to be taken of experience with institutional and depository behavior in response to the completion of deposit rate deregulation early in the year. In the implementation of policy for the immediate future, the Committee seeks to decrease somewhat the existing degree of pressure on reserve positions. This action is expected to be consistent with growth in M2 and M3 over the period from November to March at annual rates of about 6 to 8 percent; while the behavior of Ml continues to be subject to unusual uncertainty, growth at an annual rate of 7 to 9 percent over the period is anticipated. Somewhat greater reserve restraint might, and somewhat lesser reserve restraint would, be acceptable depending on behavior of the aggregates, the strength of the business expansion, developments in foreign exchange markets, progress against inflation, and conditions in domestic and international credit markets. The Chairman may call for Committee consultation if it appears to the Manager for Domestic Operations that reserve conditions during the period before the next meeting are likely to be associated with a federal funds rate persistently outside a range of 6 to 10 percent. actions on the open market at home and abroad, including transactions with the U.S. Treasury, with the U.S. Exchange Stabilization Fund established by Section 10 of the Gold Reserve Act of 1934, with foreign monetary authorities, with the Bank for International Settlements, and with other international financial institutions: 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 B. To hold balances of, and to have outstanding forward contracts to receive or to deliver, the foreign currencies listed in paragraph A above. C. To draw foreign currencies and to permit foreign banks to draw dollars under the reciprocal currency arrangements listed in paragraph 2 below, provided that drawings by either party to any such arrangement shall be fully liquidated within 12 months after any amount outstanding at that time was first drawn, unless the Committee, because of exceptional circumstances, specifically authorizes a delay. D. To maintain an overall open position in all foreign currencies not exceeding $10.0 billion. For this purpose, the overall open position in all foreign currencies is defined as the sum (disregarding signs) of net positions in individual currencies. The net position in a single Authorization for Foreign foreign currency is defined as holdings of Currency Operations balances in that currency, plus outstanding contracts for future receipt, minus In Effect January 1, 1986 outstanding contracts for future delivery of that currency, i.e., as the sum of these 1. The Federal Open Market Committee elements with due regard to sign. 2. The Federal Open Market Commitauthorizes and directs the Federal Reserve Bank of New York, for System Open tee directs the Federal Reserve Bank of Market Account, to the extent necessary New York to maintain reciprocal curto carry out the Committee's foreign cur- rency arrangements ("swap" arrangerency directive and express authorizations ments) for the System Open Market Acby the Committee pursuant thereto, and count for periods up to a maximum of 12 in conformity with such procedural in- months with the following foreign banks, structions as the Committee may issue from which are among those designated by the Board of Governors of the Federal Retime to time: A. To purchase and sell the follow- serve System under Section 214.5 of Reging foreign currencies in the form of cable ulation N, Relations with Foreign Banks transfers through spot or forward trans- and Bankers, and with the approval of the FOMC Policy Actions Committee to renew such arrangements on maturity: Foreign bank Amount (millions of dollars equivalent) Austrian National Bank National Bank of Belgium Bank of Canada National Bank of Denmark Bank of England Bank of France German Federal Bank Bank of Italy Bank of Japan Bank of Mexico Netherlands Bank Bank of Norway Bank of Sweden Swiss National Bank Bank for International Settlements Dollars against Swiss francs Dollars against authorized European currencies other than Swiss francs 250 1,000 2,000 250 3,000 2,000 6,000 3,000 5,000 700 500 250 300 4,000 600 1,250 Any changes in the terms of existing swap arrangements, and the proposed terms of any new arrangements that may be authorized, shall be referred for review and approval to the Committee. 3. All transactions in foreign currencies undertaken under paragraph 1(A) above shall, unless otherwise expressly authorized by the Committee, be at prevailing market rates. For the purpose of providing an investment return on System holdings of foreign currencies, or for the purpose of adjusting interest rates paid or received in connection with swap drawings, transactions with foreign central banks may be undertaken at non-market exchange rates. 4. It shall be the normal practice to arrange with foreign central banks for the coordination of foreign currency transactions. In making operating arrangements with foreign central banks on System holdings of foreign currencies, the Federal Reserve Bank of New York shall not commit itself to maintain any specific balance, unless authorized by the Federal Open Market Committee. Any agreements or understandings concerning the administration of the accounts maintained by the Federal Reserve Bank of New York with the foreign banks designated by the Board of Governors under Section 214.5 of Regulation N shall be referred for review and approval to the Committee. 91 5. Foreign currency holdings shall be invested insofar as practicable, considering needs for minimum working balances. Such investments shall be in liquid form, and generally have no more than 12 months remaining to maturity. When appropriate in connection with arrangements to provide investment facilities for foreign currency holdings, U.S. Government securities may be purchased from foreign central banks under agreements for repurchase of such securities within 30 calendar days. 6. All operations undertaken pursuant to the preceding paragraphs shall be reported promptly to the Foreign Currency Subcommittee and the Committee. The Foreign Currency Subcommittee consists of the Chairman and Vice Chairman of the Committee, the Vice Chairman of the Board of Governors, and such other member of the Board as the Chairman may designate (or in the absence of members of the Board serving on the Subcommittee, other Board Members designated by the Chairman as alternates, and in the absence of the Vice Chairman of the Committee, his alternate). Meetings of the Subcommittee shall be called at the request of any member, or at the request of the Manager for Foreign Operations, for the purposes of reviewing recent or contemplated operations and of consulting with the Manager on other matters relating to his responsibilities. At the request of any member of the Subcommittee, questions arising from such reviews and consultations shall be referred for determination to the Federal Open Market Committee. 7. The Chairman is authorized: A. With the approval of the Committee, to enter into any needed agreement or understanding with the Secretary of the Treasury about the division of responsibility for foreign currency operations between the System and the Treasury; B. To keep the Secretary of the Treasury fully advised concerning System foreign currency operations, and to consult with the Secretary on policy matters relating to foreign currency operations; C. From time to time, to transmit appropriate reports and information to the National Advisory Council on International Monetary and Financial Policies. 92 FOMC Policy Actions 8. Staff officers of the Committee are authorized to transmit pertinent information on System foreign currency operations to appropriate officials of the Treasury Department. 9. All Federal Reserve Banks shall participate in the foreign currency operations for System Account in accordance with paragraph 3 G(l) of the Board of Governors' Statement of Procedure with Respect to Foreign Relationships of Federal Reserve Banks dated January 1,1944. B. Maintain reciprocal currency ("swap") arrangements with selected foreign central banks and with the Bank for International Settlements. C. Cooperate in other respects with central banks of other countries and with international monetary institutions. 3. Transactions may also be undertaken: A. To adjust System balances in light of probable future needs for currencies. B. To provide means for meeting System and Treasury commitments in particular currencies, and to facilitate operations of the Exchange Stabilization Fund. C. For such other purposes as may Foreign Currency Directive be expressly authorized by the Committee. In Effect January 1, 1986 4. System foreign currency operations shall be conducted: 1. System operations in foreign currenA. In close and continuous consulcies shall generally be directed at count- tation and cooperation with the United ering disorderly market conditions, pro- States Treasury; vided that market exchange rates for the B. In cooperation, as appropriate, U.S. dollar reflect actions and behavior with foreign monetary authorities; and consistent with the IMF Article IV, SecC. In a manner consistent with the tion 1. obligations of the United States in the In2. To achieve this end the System shall: ternational Monetary Fund regarding exA. Undertake spot and forward pur- change arrangements under the IMF Archases and sales of foreign exchange. ticle IV. FOMC Policy Actions Meeting Held on February 11-12, 1986 Domestic Policy Directive The information reviewed at this meeting suggested that economic activity was expanding at a moderate pace. A number of major indicators of production and spending had shown improvement in late 1985 and early 1986. Underlying inflationary pressures appeared to be generally well contained. Prices in the latter part of the year were boosted by developments in markets for food and energy, but oil prices declined substantially in early 1986. The labor market, one of the few areas for which data for early 1986 were available at the time of this meeting, showed exceptional strength in January. Total nonfarm payroll employment rose 566,000—about twice the average monthly increase in the fourth quarter of 1985—and the unemployment rate declined to 6.7 percent, its lowest rate in six years. Hiring remained brisk at trade establishments and in finance and service industries, with those sectors accounting for about two-thirds of the rise. Employment gains in the construction industry were also strong, apparently due in part to unusually good weather throughout most of the country during the month. In the manufacturing sector, employment increased for the fourth consecutive month, and the average number of hours in the factory workweek remained at a high level. The index of industrial production rose an estimated 0.7 percent further in December, after no change on balance over the preceding two months. Available information for January suggested some additional that month. The index of rise in 93 capacity utilization for total industry rose in December for the second consecutive month, increasing 0.4 percentage point to 80.5 percent. Nevertheless, the year-end rate remained below the most recent peak of 82.0 percent recorded in the summer of 1984. Total retail sales rose 1.9 percent in December, after having declined on balance over the previous two months. Sales increased for all major categories, but most of the rise was attributable to sizable gains in outlays for durable goods. Boosted by an expanded round of financing incentive programs, sales of domestic automobiles registered a strong rebound toward the end of December and were at an annual rate of 7.9 million units for the month as a whole—about 1V2 million units above the rate in each of the preceding two months. Sales advanced further in January to a rate of 8.6 million units. Total private housing starts rose sharply in December, more than offsetting the appreciable decline in the previous month, and newly issued permits for residential building also increased substantially. The strength in housing activity during the month was apparent in both the single-family and the multifamily sectors. For the fourth quarter as a whole, both housing starts and permits were at annual rates of nearly l3/4 million units—close to the pace recorded in earlier quarters and for the year 1985. Sales of new homes improved a bit around year-end, and sales of existing homes in the final quarter of 1985 registered their fifth consecutive quarterly increase. Business capital spending strengthened somewhat in the fourth quarter. Growth in expenditures for producers' durable equipment was especially rapid, possibly reflecting firms' 94 FOMC Policy Actions attempts to realize tax benefits that might be eliminated for equipment installed after 1985. New orders for nondefense capital goods grew appreciably in December but were essentially flat over the fourth quarter as a whole. Shipments of such goods, however, rose about 3V2 percent in the quarter. Outlays for nonresidential construction rose about 5 percent in December after having changed little on balance since August. In the final months of 1985, the rates of increase in consumer and producer prices were somewhat higher than in the spring and summer, reflecting mainly what appeared to be a temporary spurt in prices for food and energy-related items. In the agricultural component, prices of domestically produced crude foods had leveled off in December and apparently fell in January. In the energy sector, prices of crude oil and other petroleum products tumbled dramatically in early 1986, and the effects of these declines were likely to show through at the consumer level in coming months. Excluding the food and energy sectors, consumer prices rose in November and December at a pace close to that for the year as a whole, and producer prices changed little on balance over the two-month period. For the year 1985 consumer prices rose about 3% percent, compared with 4 percent in 1984; producer prices rose about 1% percent in both years. The index of average hourly earnings of nonfarm production workers increased 3 percent last year, about the same as in 1984. The trade-weighted value of the dollar against major foreign currencies had declined about 4 percent further since the Committee's meeting in mid-December. Throughout the period, and particularly around of the January meeting of the time the G-5 countries, exchange market movements reflected varying assessments of official attitudes toward the dollar and differing views about the likely effects of sharply declining oil prices on various industrial and developing countries. Preliminary data on merchandise trade for the fourth quarter suggested that the deficit widened further from the already high third-quarter level. Both oil and non-oil imports rose, and exports were little changed. For the year 1985 the deficit was estimated at about $120 billion, up from $107 billion in 1984. At its meeting on December 1617, 1985, the Committee had adopted a directive that called for some limited decrease in the degree of pressure on reserve positions. The members expected such an approach to policy implementation to be consistent with growth of M2 and M3 at annual rates of about 6 to 8 percent over the period from November to March. Although the behavior of Ml continued to be subject to unusual uncertainty, the members expected expansion of that aggregate to slow to an annual rate of 7 to 9 percent over the four-month period.1 It was agreed that somewhat greater restraint might, and somewhat lesser restraint would, be acceptable over 1. These growth rates and all subsequent data on the monetary aggregates reflect annual benchmarks and seasonal factors as published on February 13, 1986. The monetary aggregates are defined as follows: Ml comprises demand deposits at commercial banks and thrift institutions, currency in circulation, travelers checks of nonbank issuers, negotiable order of withdrawal (NOW) and automatic transfer service (ATS) accounts at banks and thrift institutions, and credit union share draft accounts. M2 contains Ml and savings and small-denomination time deposits (including money market deposit accounts FOMC Policy Actions the intermeeting period, depending on the growth of the monetary aggregates, the strength of the business expansion, the performance of the dollar on foreign exchange markets, progress against inflation, and conditions in domestic and international credit markets. The intermeeting range for the federal funds rate was retained at 6 to 10 percent. With respect to the Committee's longer-run ranges for monetary growth during 1985, Ml expanded at a rate well above the range of 3 to 8 percent, at an annual rate, set for the second half of the year; M2 grew at a rate somewhat below the upper end of its range of 6 to 9 percent for the year; and M3 expanded at a rate near the midpoint of its range of 6 to 9V2 percent for 1985. Expansion in total domestic nonfinancial debt was above the upper end of its monitoring range of 9 to 12 percent for the year. In early 1986, there was evidence of a marked overall slowing in the monetary aggregates. Ml, which had increased at an annual rate of about 12V2 percent in December, grew only a little in January; on average over the two months, expansion in Ml was running near the lower end of the short-run range anticipated by the Committee at its previous meeting. M2, which had (MMDAs) at all depository institutions, overnight repurchase agreements (RPs) at commercial banks, overnight Eurodollars held at foreign branches of U.S. banks by U.S. residents other than banks, and money market mutual fund shares other than those restricted to institutions). M3 is M2 plus large-denomination time deposits at all depository institutions, large-denomination term RPs at commercial banks and savings and loan associations, institution-only money market mutual funds, and term Eurodollars held by U.S. residents in Canada and the United Kingdom and at foreign branches of U.S. banks elsewhere. 95 expanded moderately in December, decelerated markedly in January, reflecting both the slowdown in Ml and quite low growth in its nontransaction component. Expansion in M3 picked up somewhat in January as banks issued a substantial volume of large time deposits to support a further robust increase in bank credit; its growth over the two-month period was in line with the Committee's expectations. Open market operations during the intermeeting period were directed toward achieving a slight decrease in pressures on reserve positions. Seasonal plus adjustment borrowing from the discount window, while rising sharply around year-end when excess reserves were particularly large, averaged only about $260 million during the two full maintenance periods ending in January. Open market operations were undertaken in an environment of large seasonal fluctuations in reserve needs, unusually high Treasury balances, a weakening tendency for the dollar in foreign exchange markets, incoming economic data that were somewhat stronger than had generally been anticipated and, as the period progressed, sharp further declines in oil prices. Under these conditions the federal funds rate generally hovered around the 8 percent level during much of the intermeeting interval and was considerably above that level for a few days around year-end. More recently, the rate moved down to a range of 73A to 7% percent. Other short-term rates rose a little over the period, and intermediate- and long-term rates were unchanged to somewhat lower. The staff projections presented at this meeting suggested that economic activity and employment would be somewhat stronger over the near 96 FOMC Policy Actions term than had been anticipated at the time of the previous meeting. For the year 1985, the third successive year of economic expansion, real GNP was estimated to have increased about 2V2 percent, and broad measures of inflation generally had risen at rates of around 3V2 to 33/4 percent—close to, or somewhat below, those recorded in the preceding two years. Real GNP was expected to grow a little more this year than in 1985 and the average unemployment rate was projected to decline somewhat from the rate recorded last year. The rate of increase in prices over the coming year was expected to be little changed from that experienced in 1985. It was noted, however, that the sharp further declines in oil prices in the days before this meeting had not been incorporated in the projections. In the Committee's discussion of the economic situation and outlook the members differed somewhat in their assessments of the prospects for business activity, but they generally agreed that further expansion at a somewhat faster pace than in 1985 was a reasonable expectation for 1986. At the same time, several members commented that the outlook remained subject to substantial uncertainties. Changes in the international prices of crude oil were so large and so recent that they were particularly difficult to evaluate. Members also referred to uncertainties surrounding prospects for fiscal policy stemming from the legal challenge to the Gramm-Rudman-Hollings legislation, the problems for business investors associated with pending tax reform legislation, and the difficulties of predicting and assessing changes in the foreign exchange value of#the dollar. While they recognized the limitations of any forecasts under present circumstances, the members of the Committee and the Federal Reserve Bank presidents not currently serving as members presented at this meeting specific projections of economic activity, average prices, and the rate of unemployment. For the period from the fourth quarter of 1985 to the fourth quarter of 1986, forecasts for growth of real GNP centered on a range of 3 to 3Vi percent, with a full range of 23A to 41/* percent. Forecasts of growth in nominal GNP had a central tendency of 6V2 to 7V4 percent and an overall range of 5 to 8V2 percent. With regard to the rate of inflation, as indexed by the GNP deflator, the projections centered on rates of 3 to 4 percent and the range was 2V2 to 4V2 percent. Estimates of the rate of unemployment in the fourth quarter of 1986 varied from about 6V4 to 63/4 percent, with several in the area of 6V2 percent. These forecasts were based on the Committee's objectives for growth in money and credit that were established at this meeting. It was also assumed that federal budget deficits would be on a declining trend and that the foreign exchange value of the dollar would not change enough after its substantial fall during 1985 to exert a significant further impact on economic activity and prices during 1986. In the course of the Committee's discussion, members referred to the recent improvement in several key indicators of business activity. In themselves these indicators augured well for continuing economic growth over the year ahead. On the other hand some members commented that the current and prospective performance of several important sectors of the economy—such as agriculture FOMC Policy Actions 97 and business fixed investment—did The fiscal policy outlook, despite not suggest a strengthening expan- current legal complications, was seen sion. However, the actual perfor- as pointing to declining budgetary mance of those sectors among others deficits. Members commented that would be influenced to an important the better prospects for action on the extent by a number of broad, over- federal budget had already helped to riding factors. reduce inflationary expectations and Among the positive factors cited had exerted a quite favorable impact by the members were the recent on domestic financial markets. The decline in oil prices, lower interest actual implementation of deficit-rerates, and higher stock prices. These ducing measures—in terms of their developments generally had favora- direct effects on government spendble implications for consumer spend- ing—would tend to restrain the ing, housing, and many types of growth of income and economic acbusiness investment. Some members tivity. However, those effects might also referred to the rapid growth in well be offset, at least in part, by Ml and to the ample availability of increased private spending that would liquidity as factors that would tend tend to be stimulated by downward to support the expansion over the adjustments in interest rates as maryear ahead. The decline in the for- kets anticipated or responded to eign exchange value of the dollar, reduced federal credit demands. while exerting upward pressures on In their discussion of the outlook prices, was seen as another positive for inflation, the members expressed development in terms of its impact somewhat differing views. These on economic activity, although views ranged from expectations of little differed considerably with regard to change, or perhaps some improvethe timing and extent of that impact. ment, from the recent trend to the On the negative side, members anticipation of some deterioration. mentioned the downside risks inher- In the context of the sizable decline ent in the debt problems faced by in unemployment and poor producmany consumers and a number of tivity performance, some members industries, including agriculture, and commented that the economy's the associated financial strains on growth potential might be more limsome of their institutional lenders. ited than they had thought earlier The recent decline in oil prices, while and that relatively rapid business a favorable development in terms of expansion might at some point, though its overall impact on the economy, not over the quarters immediately nonetheless had negative conse- ahead, be associated with increasing quences for energy producers and inflationary pressures. Other memtherefore for important parts of the bers, while also troubled by produccountry. Several members also tivity trends, nonetheless felt that the stressed the adverse repercussions of rate of unemployment was still suflower oil prices on a number of ficiently high and capacity utilization developing countries that were heav- rates sufficiently low to rule out such ily dependent on oil exports to ser- a concern for the conduct of policy vice their large debts to international for the time being. Views also diflending institutions, including major fered in emphasis with regard to the inflationary impact of the decline in U.S. banks. 98 FOMC Policy Actions the foreign exchange value of the dollar. The depreciation of the dollar, especially if it were to continue substantially further, could involve significant upward pressures on import prices at some point. Some members emphasized their view that the inflationary impact of the dollar decline would be greatly dampened by efforts of foreign business firms to retain market shares. Others, while recognizing that the effects of the dollar's decline could be delayed and in the short run offset by reduced oil prices, felt that the inflationary potential would be significant over time, depending in part on other economic policy developments. The members generally agreed that, in addition to oil price and federal budgetary developments, the strong price competition in many markets and restrained labor settlements were factors currently tending to curb inflationary pressures. At this meeting the Committee reviewed the 1986 growth ranges for the monetary and credit aggregates that it had tentatively set in July 1985 within the framework of the Full Employment and Balanced Growth Act of 1978 (the HumphreyHawkins Act). Those tentative ranges included growth, measured from the fourth quarter of 1985 to the fourth quarter of 1986, of 4 to 7 percent for Ml and 6 to 9 percent for both M2 and M3. The associated range for total domestic nonfinancial debt had been provisionally set at 8 to 11 percent for 1986. Discussion of the tentative range for Ml focused on its appropriate width and level in light of the economic and financial circumstances that appeared to be in prospect for the year ahead and on its unusual behavior in recent years. While the expressed some differing members preferences regarding an appropriate range for Ml, the differences were not very large. All of the members contemplated a marked slowing in Ml growth from that experienced in 1985 as a likely development despite their expectations of some pickup in the expansion of nominal GNP. Nonetheless, the members gave considerable emphasis to the uncertainties that continued to surround the outlook for the velocity of Ml—the relationship between Ml and GNP. The sharp decline in Ml velocity during 1985 was unexpected although after the fact it could be explained to a considerable extent, though not entirely, by historical relationships of money to income and interest rates. Still, the changing composition of Ml, involving a growing share of interest-bearing components, had increased the proportion of Ml that served both a transaction and a savings function and appeared to have made the behavior of this aggregate less predictable in comparison to earlier experience. Moreover, demand deposits had grown much more in 1985 than might have been anticipated and it was not clear whether that growth reflected more cautious cash management practices on the part of businesses or other perhaps transitory factors. In the view of most, but not all, of the members it was desirable to widen the tentative Ml range in order to take account of the uncertainty in the relationship between Ml and economic activity and prices, but in general the suggested ranges involved approximately the same midpoints. The upper limits that were proposed generally assumed there would not be as large a drop in velocity this year as had occurred in 1985. But it was noted that in the absence of some reversal in the sharp 1985 drop in Ml velocity, growth toward the upper end of the range might well prove to be consistent with satisfactory economic performance. It might even be appropriate for Ml to run above the upper bound of its range should recent velocity trends persist. On the other hand, more moderate growth in Ml could be indicated to the extent that its velocity proved to be stronger than expected. In general, there was agreement that the behavior of Ml should be evaluated in light of its consistency with M2 and M3 and also in the context of broader economic and financial developments and the potential for inflationary pressures. With regard to the broader monetary aggregates, the members indicated that the tentative ranges established in July for 1986 were still appropriate. Growth last year was generally in line with expectations, and on balance over the past few years, the behavior of M2 and M3 seemed to have been less affected than Ml by institutional and interest rate changes. In part that development reflected the fact that the broader aggregates include an array of deposit and money market instruments that often exhibit offsetting movements. In the course of the Committee's discussion, consideration was given to the appropriate degree of emphasis to be given to Ml in policy implementation, at least until there was more evidence that the behavior of Ml velocity could be anticipated with a greater degree of confidence. Most of the members felt that the Committee's current procedures remained appropriate, taking account of the considerations underlying the range adopted and its interpretation. Digitized forSome emphasized that Ml was likely FRASER FOMC Policy Actions 99 to prove again to be a more useful guide for policy implementation in a variety of potential economic settings. One member commented that over time Ml would probably serve as a better indicator of future GNP than the broader measures of money. Alternatively, it was suggested that while Ml might have become a less reliable guide, at least under recently prevailing circumstances, it continued to have significant value as a policy indicator when considered in the context of the behavior of the broader aggregates. Collectively, the aggregates used by the Committee appeared to have more significance than any one of them viewed separately. With respect to the monitoring range for total domestic nonfinancial debt, a majority of the members favored adopting the range of 8 to 11 percent for 1986 that had been tentatively established in July. A number of other members preferred somewhat higher ranges in the expectation that debt expansion, while decreasing from its actual pace in 1985, might still be around—or perhaps a bit above—the upper limit of the tentative range. In the course of the discussion, it was suggested that the Committee drop its monitoring range for debt, perhaps substituting another measure such as total liquid assets. It was pointed out, among other things, that the debt aggregate was subject to serious measurement problems, including a large amount of double counting—related for example to financial activities such as advance refundings and mortgage financing by state and local governments—and distortions arising from an extraordinary pace of share retirements financed by borrowing. It was also noted that the debt measure had been deviating substantially in recent 100 FOMC Policy Actions years from past historical relationships to GNP. A majority of the members, while acknowledging the difficulties with this aggregate and agreeing that further study was needed, continued to feel that it served as a useful benchmark for evaluating the growth of debt in the economy and that its behavior should continue to be monitored, particularly in light of the Committee's concern about the increasing debt burden in the economy. At the conclusion of the Committee's consideration of the long-run ranges, all of the members indicated that they favored or found acceptable monetary growth ranges for 1986 of 3 to 8 percent for Ml and 6 to 9 percent for both M2 and M3. A monitoring range of 8 to 11 percent was also accepted for total domestic nonfinancial debt. In keeping with the Committee's usual procedures under the Humphrey-Hawkins Act, the ranges would be reviewed at midyear, or sooner if deemed necessary, in the light of their behavior in relation to economic and financial developments. The following paragraph relating to the long-run ranges was approved for the domestic policy directive: The Federal Open Market Committee seeks to foster monetary and financial conditions that will help to reduce inflation further, promote growth in output on a sustainable basis, and contribute to an improved pattern of international transactions. In furtherance of these objectives the Committee agreed to establish the following ranges for monetary growth, measured from the fourth quarter of 1985 to the fourth quarter of 1986. With respect to Ml, the Committee recognized that, based on the experience of recent years, the behavior of that aggregate was subject to substantial uncertainties in relationship to economic activity and prices, depending among other things on its re sponsiveness to changes in interest rates. It agreed that an appropriate target range under existing circumstances would be 3 to 8 percent, but it intends to evaluate movements in Ml in the light of its consistency with the other monetary aggregates, developments in the economy and financial markets, and potential inflationary pressures. It adopted a range of 6 to 9 percent for M2 and 6 to 9 percent for M3. The associated range for growth in total domestic nonfinancial debt was set at 8 to 11 percent for the year 1986. Votes for this action: Messrs. Volcker, Corrigan, Angell, Black, Forrestal, Johnson, Keehn, Martin, Parry, Rice, Ms. Seger, and Mr. Wallich. Votes against this action: None. In the Committee's discussion of policy implementation for the weeks immediately ahead, a number of members referred to the difficulty of clearly appraising the significance of the most recent economic and financial developments. While monetary expansion had slowed in recent weeks, the period of reduced growth was brief and it followed a period of substantial expansion. Strong employment growth did not appear to be fully matched by other current economic indicators. The needed correction of the value of the dollar entailed risks of a more fundamental change in market attitudes and a cumulating decline in the exchange rate that might discourage willingness to hold dollars at declining interest rates. In these circumstances, nearly all participants agreed that little or no change in reserve availability was warranted. In that connection, members also noted that the recent slowing of the monetary aggregates was reasonably in line with the Committee's expectations at the time of the December meeting for the November-to-March period. In the course of the Committee's FOMC Policy Actions discussion it was noted that while monetary policy had been relatively accommodative for some time, shortterm rates had shown little tendency to decline and the Federal funds rate remained significantly above the discount rate even though borrowing at the discount window had dropped to rather low levels last month. Moreover, long-term rates had declined substantially since early fall. In that context, and against the already accommodative mode of open market operations, the point was made that the discount rate might need to be reduced to permit or accommodate a market tendency toward lower rates and that such a move would be a desirable complement to open market operations in the light of the risks of a slower rate of business expansion. More generally, in prevailing circumstances, the members wished to conduct open market operations in a manner that would not in itself signal or encourage higher interest rates or impede the tendency for some market rates to decline. At the same time, there was concern that policy implementation be sensitive to a situation in which a decline in the dollar might tend to feed upon itself, leading to an exaggerated fall with disturbing implications for inflation, financial markets, and the economy over time. In that connection it was noted that the desirability of a discount rate action would depend on evolving economic and financial circumstances; among other factors, in the light of the risks for the dollar in foreign exchange markets, such action would need to take account of the willingness of major central banks abroad to take broadly similar actions. In the Committee's discussion of possible intermeeting adjustments in 101 policy implementation, the members agreed that the appropriate degree of pressure on reserve positions should continue to be determined in light of the growth of the monetary aggregates judged in the context of incoming information about the economy, the outlook for prices, and conditions in domestic and international financial markets, including the value of the dollar in the foreign exchange markets. A majority of the members agreed with the suggestion that there should be no presumptions about the likely direction of any intermeeting adjustments, given the many uncertainties about prospective economic and financial developments and the behavior of the monetary aggregates. However, some members believed that policy implementation should remain especially alert to developments that might call for some easing of reserve conditions in light of the considerable risks that they saw of some weakening in the economic expansion. At the conclusion of the Committee's discussion a majority of the members indicated their acceptance of a directive that called for maintaining unchanged conditions of reserve availability. The members expected such an approach to policy implementation to be consistent with growth in M2 and M3 at annual rates of about 6 percent and 7 percent respectively for the period from November to March. Over the same period they expected Ml to expand at an annual rate of around 7 percent, although the behavior of Ml was seen as still subject to unusual uncertainty. The Committee indicated that it might find somewhat greater or somewhat lesser reserve restraint acceptable over the intermeeting period depending on the 102 FOMC Policy Actions growth of the monetary aggregates, the strength of the business expansion, the performance of the dollar on foreign exchange markets, progress against inflation, and conditions in domestic and international credit markets. The members agreed that the intermeeting range for the federal funds rate, which provides a mechanism for initiating consultation of the Committee when its boundaries are persistently exceeded, should be left unchanged at 6 to 10 percent. A t the conclusion of the meeting, the following domestic policy directive, embodying the Committee's long-run ranges and its short-run operating instructions, was issued to the Federal Reserve Bank of N e w York: The information reviewed at this meeting suggests that economic activity is currently expanding at a moderate pace. Total nonfarm payroll employment increased substantially further in January, and the civilian unemployment rate declined to 6.7 percent. In December industrial production rose further, and available information suggests some additional rise in January. Retail sales increased considerably in December after declining on balance over the previous two months, and housing starts rebounded from their OctoberNovember pace. Business capital spending strengthened somewhat in the fourth quarter. Merchandise trade data for the fourth quarter suggest that the deficit widened further from the very high thirdquarter level. In late 1985 consumer and producer prices rose somewhat more than earlier, but for the year as a whole broad measures of prices and wages increased at rates close to those recorded in 1984. With respect to the Committee's ranges for longer-term monetary growth, Ml expanded at a rate well above the range set for the second half of 1985; M2 grew at a rate somewhat below the upper end of its range for the year; and M3 expanded at a rate near the midpoint of its range for 1985. Expansion in total domestic nonfinancial debt was above the upper end of its monitoring range for the year. growth in Ml and M2 slowed In January markedly, while growth in M3 picked up as banks issued a substantial volume of large time deposits to support further robust growth in bank credit. Interest rates have fluctuated considerably since the December meeting of the Committee; on balance, short-term interest rates have risen a little while longer-term rates are unchanged to somewhat lower. The tradeweighted value of the dollar against major foreign currencies has declined further. The Federal Open Market Committee seeks to foster monetary and financial conditions that will help to reduce inflation further, promote growth in output on a sustainable basis, and contribute to an improved pattern of international transactions. In furtherance of these objectives the Committee agreed to establish the following ranges for monetary growth, measured from the fourth quarter of 1985 to the fourth quarter of 1986. With respect to Ml, the Committee recognized that, based on the experience of recent years, the behavior of that aggregate was subject to substantial uncertainties in relationship to economic activity and prices, depending among other things on its responsiveness to changes in interest rates. It agreed that an appropriate target range under existing circumstances would be 3 to 8 percent, but it intends to evaluate movements in Ml in the light of its consistency with the other monetary aggregates, developments in the economy and financial markets, and potential inflationary pressures. It adopted a range of 6 to 9 percent for M2 and 6 to 9 percent for M3. The associated range for growth in total domestic nonfinancial debt was set at 8 to 11 percent for the year 1986. In the implementation of policy for the immediate future, the Committee seeks to maintain the existing degree of pressure on reserve positions. This action is expected to be consistent with growth in M2 and M3 over the period from November to March at annual rates of about 6 percent and 7 percent, respectively; while the behavior of Ml continues to be subject to unusual uncertainty, growth at an annual rate of about 7 percent over the period is anticipated. Somewhat greater reserve restraint or somewhat lesser reserve restraint might be acceptable depending on behavior of the aggregates, the strength of the business expansion, developments in foreign exchange markets, progress against inflation, and conditions in domestic and international credit FOMC Policy Actions 103 tially in January, rose further in February, but employment in manufacturing fell after four months of gains. The average monthly rise in employment for the two months was about 325,000, somewhat higher than the average in the fourth quarter of Votes for the short-run operational paragraph: Messrs. Volcker, Corrigan, 1985. Hiring was exceptionally brisk Angell, Black, Forrestal, Johnson, at retail trade and service establishKeehn, Parry, Rice, and Wallich. Votes ments in both months. In contrast to against this action: Mr. Martin and Ms. the employment gains reported in Seger. the payroll survey, employment as measured by the household survey Mr. Martin and Ms. Seger dis- fell almost 400,000 in February, about sented because they preferred some offsetting the increase in January, easing of reserve conditions given and the civilian unemployment rate the risks they saw of unacceptably rose 0.6 percentage point to 7.3 sluggish economic expansion. Such percent. A sharp drop in agricultural risks would be reduced in their view employment, not measured by the by lower short-term interest rates, payroll survey, accounted for about which had not declined in line with half of the decline; job losses in recent reductions in long-term inter- energy-related industries apparently est rates and in inflation expecta- also contributed to the decline. tions. They also believed some modThe index of industrial production est easing could lead to market fell an estimated 0.6 percent in Febconditions that would facilitate a ruary after edging up only slightly in reduction in the discount rate. January. Although output of automotive goods was higher in February, production cutbacks were wideMeeting Held on April 1, 1986 spread for most other categories of goods. In particular, petroleum drillDomestic Policy Directive ing activity was curtailed sharply in The information reviewed at this response to the dramatic declines in meeting indicated a mixed pattern of oil prices. Limited information availdevelopments. On balance it ap- able for March, including reported peared that economic activity had cutbacks in motor vehicle assemblies picked up from the reduced fourth- and steel production and a further quarter pace, although spending re- decline in drilling activity, suggested mained sluggish in some key sectors. continued sluggishness in producPrice developments thus far in 1986 tion. The index of capacity utilization had been dominated by sharp de- for total industry declined 0.6 perclines in oil prices. Energy prices fell cent to 80.0 percent; over the past substantially over the first two months year the index generally had flucof the year and food prices also tuated in a range of 80 to 81 percent. declined somewhat, while prices of Although retail sales changed little most other goods and services rose in January and February, they reat a moderate pace. mained about 1.0 percent above the Total nonfarm payroll employ- average in the fourth quarter, owing ment, which had increased substan- to a spurt in December. The rise markets. The Chairman may call for Committee consultation if it appears to the Manager for Domestic Operations that reserve conditions during the period before the next meeting are likely to be associated with a federal funds rate persistently outside a range of 6 to 10 percent. 104 FOMC Policy Actions relative to the level of the fourth quarter was attributable to gains in outlays for durable goods, particularly automobiles and furniture and appliances. Sales of domestic automobiles, boosted by additional financing incentive programs, rose to an average annual rate of 8.3 million units over the January-February period, about IV2 million units above the depressed fourth-quarter rate. However, sales slipped during the first 20 days of March to a rate of 7 million units. Total private housing starts surged in the January-February period to an annual rate of more than 2 million units, compared with an average of about l3/4 million units for the fourth quarter and for the year 1985. The increase was concentrated in the single-family sector, though construction of multifamily structures remained at a relatively brisk pace despite continued high rental vacancy rates. Sales of new homes declined somewhat in February to a level about equal to the fourthquarter average, while sales of existing homes remained at about their January pace and a little lower than in the fourth quarter. Over the period since the FOMC meeting in February, the average rate on commitments at savings and loan associations for conventional fixed-rate home mortgage loans had declined nearly 1 percentage point to about 10 percent, the lowest level since 1978. Business capital spending apparently weakened somewhat in early 1986 after a surge around the end of last year. Shipments of nondefense capital goods from domestic producers rose 5 percent in February but remained well below the average in the fourth quarter. New orders for nondefense capital goods, after hav ing been essentially flat in the fourth quarter, declined sharply in January but turned up in February. Outlays for nonresidential structures probably fell in early 1986, as spending on petroleum drilling activity reportedly plummeted. Largely reflecting declines in energy prices, the producer price index for finished goods fell substantially in January and February, dropping 0.7 percent and 1.6 percent respectively. Producer prices for consumer foods and for crude food materials also declined appreciably over the two months. The consumer price index declined 0.4 percent in February—its first decline in more than three years—more than offsetting a rise in January. A sharp drop in prices for gasoline and fuel oil accounted for most of the February decline, but food prices also fell. Prices of other goods and services generally rose moderately. The index of average hourly earnings edged up on balance over the first two months of the year. The trade-weighted value of the dollar against major foreign currencies continued to fall through about mid-March but recently rose somewhat; on balance the dollar had declined about 1% percent over the period since the February meeting. Disappointment among market participants about data released on U.S. economic activity and concerns about potential adverse effects of the sharp declines in oil prices on U.S. banks holding sizable loans to energy-related businesses and to oil-producing developing countries exerted downward pressure on the dollar, offset to some extent by views that foreign authorities, especially the Japanese, were reluctant to see further appreciation of their currencies. The merchandise trade deficit in January appeared to have been only slightly smaller than in December; preliminary data for February suggested that exports increased and that the price and quantity of oil imports declined. At its meeting on February 11-12, 1986, the Committee had adopted a directive that called for maintaining unchanged conditions of reserve availability. The members expected such an approach to policy implementation to be consistent with growth in M2 and M3 at annual rates of about 6 percent and 7 percent respectively for the period from November to March. Over the same period they expected Ml to expand at an annual rate of around 7 percent, though the behavior of Ml was viewed as still subject to unusual uncertainty. The Committee agreed that somewhat greater or somewhat lesser reserve restraint might be acceptable over the intermeeting period, depending on the behavior of the aggregates, the strength of the business expansion, developments in foreign exchange markets, progress against inflation, and conditions in domestic and international credit markets. The intermeeting range for the federal funds rate was retained at 6 to 10 percent. After growing little in January, Ml expanded at an annual rate of about 1XA percent in February and was expected to grow at a rate of about 14 percent in March—leaving this aggregate at a level somewhat above the upper end of the Committee's range for the year. On the other hand, growth of M2 was generally sluggish over the first three months of the year, and expansion in M3 remained moderate. As a result, M2 was running below its long-run range while M3 was near the midpoint of its range for 1986. The expansion in total domestic nonfinancial debt appeared to FOMC Policy Actions 105 have slowed appreciably over the first quarter, after extraordinarily rapid growth around the end of last year. Open market operations during the intermeeting period were directed at maintaining about the prevailing degree of pressure on reserve positions. Seasonal plus adjustment borrowing from the discount window averaged about $350 million during the three full reserve maintenance periods after the February FOMC meeting. That level was inflated a bit by technical problems associated with wire transfers early in the interval; more recently, borrowing was running in the area of $225 million to $250 million. Federal funds generally traded in the 7% to 8 percent area during the first half of the intermeeting period. After the announcement by the Federal Reserve on March 7 of a reduction in the discount rate from iVi to 7 percent, the federal funds rate fell to around 7% percent and generally fluctuated around that level throughout the remainder of the period. Other short-term interest rates declined about V2 to % percentage point over the intermeeting interval. Long-term rates dropped more sharply, falling by 1 to nearly 13A percentage points, against a background of further weakness in oil prices, mixed economic news, and declines in some aggregate measures of prices. During the Committee's discussion of the economic situation and outlook, several members commented on the contrast between current indications of some sluggishness in economic activity and a number of underlying developments that pointed to stronger expansion later in the year and perhaps in 1987 as well. The incoming information on business activity was mixed, but it was thought that on balance such information suggested a pickup in eco- 106 FOMC Policy Actions nomic growth in the first half of this year from the very slow pace in the fourth quarter. Several members observed, though, that the near-term outlook remained relatively weak, particularly taking account of substantial cutbacks in oil company investments associated with declining oil prices. At the same time a combination of developments—including reduced interest rates, higher stock prices, lower oil prices, and a decline in the dollar on exchange markets—was likely to exert an increasingly stimulative impact on the economy as the year progressed. The staff projection presented at this meeting had suggested that the expansion in real GNP would strengthen by the second half of the year, after relatively modest growth in the first half. In evaluating the economic outlook, some members referred to the apparent improvement in business confidence over the course of recent weeks as the cost of capital declined and international competitiveness improved. It was thought that substantial declines in interest rates would have a stimulative impact on interestsensitive sectors of the economy; indeed, that impact was already being felt in the housing sector. Members also reported that lower interest rates were leading to a large volume of mortgage debt refinancings. The latter would reduce monthly servicing costs and would therefore tend to support consumer spending over time. The rise in stock market prices and the decline in oil prices also were viewed as favorable for consumer spending. Taking account of these various factors, a few members commented that potential deviations from the staff projection were likely to be in the direction of more rapid growth. Other members, while seeing some improvement as a likely prospect for the second half of the year, nonetheless emphasized the uncertainties— both domestic and international— that continued to trouble the business outlook and that could portend more restrained expansion than was currently anticipated. Consumer debt burdens remained large and one member observed that sales of new automobiles currently appeared to be inhibited to some extent by a reduced willingness or capacity of some consumers to borrow. In the business sector, while investment spending was likely to benefit considerably from the reduced cost of capital, its overall growth might well be restrained by weak demands for business equipment in important sectors of the economy such as agriculture and energy, and by the impact over time of apparent overbuilding, notably of office structures, in some parts of the country. One member also noted that uncertainties relating to tax reform legislation were continuing to inhibit business investment spending. Members also indicated that the improved conditions in financial markets stemmed to a large extent from expectations of future reductions in federal budget deficits and a failure to implement such reductions could have highly adverse consequences for financial markets and the economy. With respect to exchange market developments, the decline in the dollar was viewed as implying upward pressures on domestic prices over time, but also as likely to stimulate business activity. While there were few actual indications to date of directly induced increases in export sales, contacts with business suggested that export markets were FOMC Policy Actions 107 improving. The members continued to differ in their assessment of when and to what extent a lower dollar would exert its favorable effects on overall domestic economic activity or begin to show through significantly in prices. One emphasized that efforts by foreign firms to retain market shares, especially in the absence of strong economic growth abroad, would tend to reduce the expansionary and price effects of the dollar's depreciation. Some members commented that the strength of the expansion in the U.S. economy over the next few quarters would depend to an important extent on the rate of economic growth in key industrial nations abroad and the resulting increase in their demands for U.S. exports. It was noted, however, that stronger expansion in some major foreign countries might well be contingent on their pursuit of more stimulative economic policies, and there was question about the willingness of some key countries to undertake such policies at this time. A member also commented on the importance of world commodity prices in maintaining the international purchasing power of many developing countries, in addition to those that exported oil, and the potentially adverse repercussions of lower commodity prices on world trade and U.S. export industries. In their comments about the outlook for inflation the members gave considerable emphasis to the favorable impact of declining oil prices, but it was also noted that those prices remained vulnerable to a reversal. In the staffs economic projections, the rate of increase in prices was projected to slow over the near term, largely because of the favora ble, one-time effects of lower oil prices. Members noted that the current downward pressures on prices provided an opportunity for the more effective pursuit of policies designed to foster a continuing reduction in the rate of inflation. It was observed in this connection that while considerable progress had been made in curbing inflation in key industries such as manufacturing and construction, the services industries appeared to be particularly resistant to further anti-inflationary progress. Partly for that reason but also in light of the recent weakness in productivity, the depreciation of the dollar, federal budget uncertainties, and the possibility of a reversal in oil prices, some members expressed concern about the underlying inflationary potential in the economy. They also cited recent price increases by a major automobile manufacturer as a worrisome development in terms of its broader implications for inflationary attitudes and future inflation. At its meeting in February the Committee had agreed on policy objectives for monetary growth for the period from the fourth quarter of 1985 to the fourth quarter of 1986 that included ranges of 3 to 8 percent for Ml and 6 to 9 percent for both M2 and M3. The associated range for total domestic nonfinancial debt was set at 8 to 11 percent. In keeping with the Committee's usual procedures under the Humphrey-Hawkins Act, these ranges would be reviewed at the July meeting or sooner if warranted by unanticipated developments. In the Committee's discussion of policy implementation for the weeks immediately ahead, all of the members favored directing open market operations at least initially toward 108 FOMC Policy Actions maintaining essentially unchanged conditions of reserve availability. However, some shadings of opinion were expressed. A few preferred to tilt the provision of reserves toward slightly easier reserve conditions or at least to retain flexibility in that direction, depending on emerging market conditions. Others expressed the view that current reserve pressures should be well maintained, recognizing the possibility that such an approach to policy implementation might involve some little tightening of market conditions since market participants might be anticipating some easing. More generally, a number of members commented that policy implementation needed to take account of the already accommodative posture of monetary policy and the favorable, though somewhat uncertain, prospects for stronger expansion over the intermediate term, if not in the period immediately ahead. The members anticipated that, with little or no change in reserve conditions, the monetary aggregates would tend to grow at rates that were broadly consistent with the Committee's target ranges for the year. Ml might remain on the high side in the weeks ahead, but it was emphasized that the behavior of Ml remained subject to considerable uncertainty. According to an analysis prepared for this meeting, Ml growth over the next three months might be close to that experienced over the Decemberto-March period, assuming unchanged conditions of reserve availability, somewhat slower expansion in nominal GNP, and no further declines in short-term market rates. However, demands for Ml balances were likely to be boosted, possibly substantially, if interest rates should decline further during the period ahead. Some members also stressed the desirability of focusing on the tendency for the velocity of Ml to remain relatively weak and the associated possibility that relatively rapid growth in Ml and in reserves might be needed to help sustain the expansion. In general, the members agreed that the behavior of Ml should continue to be evaluated in light of its consistency with M2 and M3 and also in the context of broader economic and financial developments, the potential for inflationary pressures, and exchange market conditions. Over the next three months M2 was expected to strengthen from its reduced pace in the first quarter, while M3 was likely to continue to expand at a moderate rate. With regard to possible intermeeting adjustments in policy implementation, the members could foresee potential developments that might call for either some easing or some tightening, given the uncertainties about prospective economic and financial developments and the behavior of the monetary aggregates. In these circumstances, most of the members felt that there should be no presumptions about the likely direction of any intermeeting adjustments. However, some members believed that policy implementation should remain especially alert to developments that might call for some easing of reserve conditions, given the risks that the expansion might prove to be significantly weaker than expected over the period immediately ahead. It was noted that a further reduction in the discount rate, should market conditions here and policy developments abroad make such an action desirable, could have implications for monetary policy implementation and, depending on the circumstances, might require a con- FOMC Policy Actions 109 sultation of the Committee prior to the next scheduled meeting on May 20. At the conclusion of the Committee's discussion, all of the members indicated their acceptance of a directive that called for maintaining about the existing degree of pressure on reserve conditions. The members expected such an approach to policy implementation to be consistent with growth of both M2 and M3 at an annual rate of about 7 percent for the period from March to June. Over the same period, Ml was expected to expand at an annual rate of about 7 to 8 percent, but the members recognized that the behavior of Ml remained subject to unusual uncertainty. The Committee indicated that it might find somewhat lesser or somewhat greater reserve availability acceptable over the intermeeting period depending on the growth of the monetary aggregates, the strength of the business expansion, the performance of the dollar on foreign exchange markets, progress against inflation, and conditions in domestic and international credit markets. The Committee agreed that the current intermeeting range of 6 to 10 percent for the federal funds rate should be retained, although some members suggested that the current range might be lowered as a technical adjustment that would bring the present trading level of the federal funds rate closer to the midpoint of the range. At the conclusion of the meeting the following domestic policy directive was issued to the Federal Reserve Bank of New York: The information reviewed at this meeting indicates a mixed pattern of developments with evidence of a pickup in eco nomic activity from the reduced fourth quarter pace but with spending sluggish in some key sectors. Total nonfarm payroll employment increased appreciably further in February following a large rise in January, but employment in manufacturing fell after four months of gains and industrial production declined. The civilian unemployment rate rose sharply to 7.3 percent. Retail sales were little changed in January and February after rising over the previous two months, while housing starts were well above their pace in late 1985. Business capital spending apparently weakened somewhat in early 1986. The merchandise trade deficit for January appears to have been only slightly smaller than in December; preliminary data for February suggest that exports increased and that the price and quantity of oil imports declined. Largely reflecting declines in energy prices, consumer prices edged down on balance over the first two months of 1986 and producer prices fell substantially. Growth in Ml picked up considerably over the course of the first quarter, leaving this aggregate by March somewhat above the upper end of its range for the year. On the other hand, growth of M2 was generally sluggish over the past 3 months and was running below its longrun range. Expansion of M3 was moderate during the winter months, with growth around the midpoint of its range for 1986. Interest rates have declined considerably since the February meeting of the Committee. On March 6, the Federal Reserve Board approved a reduction in the discount rate from TA to 7 percent. The trade-weighted value of the dollar against major foreign currencies continued to decline through mid-March but has risen somewhat more recently; on balance the dollar has declined slightly since the February meeting. The Federal Open Market Committee seeks monetary and financial conditions that will foster reasonable price stability over time, promote growth in output on a sustainable basis, and contribute to an improved pattern of international transactions. In furtherance of these objectives the Committee agreed at its February meeting to establish the following ranges for monetary growth, measured from the fourth quarter of 1985 to the fourth quarter of 1986. With respect to Ml, the Committee recognized that, based on the experience of recent years, the behavior of that aggregate was subject to substantial 110 FOMC Policy Actions uncertainties in relationship to economic activity and prices, depending among other things on its responsiveness to changes in interest rates. It agreed that an appropriate target range under existing circumstances would be 3 to 8 percent, but it intends to evaluate movements in Ml in the light of its consistency with the other monetary aggregates, developments in the economy and financial markets, and potential inflationary pressures. It adopted a range of 6 to 9 percent for M2 and 6 to 9 percent for M3. The associated range for growth in total domestic nonfinancial debt was set at 8 to 11 percent for the year 1986. In the implementation of policy for the immediate future, the Committee seeks to maintain the existing degree of pressure on reserve positions. This action is expected to be consistent with growth in M2 and M3 over the period from March to June at annual rates of about 7 percent; while the behavior of Ml continues to be subject to unusual uncertainty, growth at an annual rate of about 7 to 8 percent over the period is anticipated. Somewhat lesser reserve restraint or somewhat greater reserve restraint might be acceptable depending on behavior of the aggregates, the strength of the business expansion, developments in foreign exchange markets, progress against inflation, and conditions in domestic and international credit markets. The Chairman may call for Committee consultation if it appears to the Manager for Domestic Operations that reserve conditions during the period before the next meeting are likely to be associated with a federal funds rate persistently outside a range of 6 to 10 percent. Votes for this action: Messrs. Volcker, Corrigan, Angell, Guffey, Horn, Johnson, Melzer, Morris, Rice, Ms. Seger, and Mr. Wallich. Votes against this action: None. Absent and not voting: Mr. Martin. On April 21, the Committee held a conference by telephone after the announcement of a reduction in the discount rate from 7 to 6V2 percent effective on that date. The members reviewed recent economic and financial developments, including the behavior of the monetary aggregates and technical factors affecting the provision of reserves. At the conclusion of the discussion the members agreed that no changes were needed in the current directive adopted at the meeting on April 1. It was understood that in carrying out open market operations within the framework of that directive, and recognizing that partial data suggested a strengthening in all the monetary aggregates in recent weeks, a degree of caution should be exercised to avoid an impression that a further change in the discount rate was sought over the period immediately ahead. Meeting Held on May 20, 1986 1. Domestic Policy Directive The information reviewed at this meeting indicated a mixed pattern of economic developments. On balance, growth in real GNP, estimated by the Commerce Department to have picked up in the first quarter to an annual rate of 3.7 percent, appeared to be expanding at a relatively modest pace in the current quarter. Thus far in 1986, broad measures of prices, heavily influenced by sharp reductions in petroleum prices, had shown declines in energy and food prices and moderate increases in prices of most other goods and services. Total nonfarm payroll employment rose 200,000 further in April, after increasing about 3A million in the first quarter, but employment trends continued to be unbalanced across industries. Employment in finance and service industries remained strong, and hiring at construction sites picked up substantially after changing little in the first quarter. In manufacturing, however, job losses were recorded for the third consecutive month, and the length of the average factory workweek slipped from the high levels registered at the end of last year. Employment in the oil and gas industry plummeted during the first four months of the year, as firms curtailed drilling activity in response to lower oil prices. The civilian unemployment rate edged down to 7.1 percent in April, close to the level that had prevailed throughout 1985. The index of industrial production rose an estimated 0.2 percent in April after steep declines in the preceding two months. The increase was attributable mainly to a rebound in motor vehicle assemblies, but there were also some gains in steel output and in production of equipment for business and for defense and space; these developments offset a further plunge in oil and gas well drilling. The index of capacity utilization for total industry dropped 0.7 percent further in March to 79.3 percent, its lowest level since December 1983, and apparently changed little in April. Total retail sales rose Vi percent in April, primarily reflecting a substantial increase in spending for automotive products and continued gains in outlays for general merchandise. Sales of domestic automobiles, sparked by a new series of sales and financing incentives, strengthened to an annual rate of 8.0 million units from their sluggish pace of 6.9 million units in March. Sales rose even further in early May to a rate of 8.8 million units. Total private housing starts increased about 4 percent in April from a relatively high level. During the first four months of 1986, starts averaged nearly 2 million units at an Digitized forannual rate, well above levels of FRASER FOMC Policy Actions 111 about l3/4 million units in each of the previous three years. Issuance of residential building permits also rose somewhat in April, with the increase concentrated in the single-family sector. Permits for multifamily structures fell, apparently in response to high rental vacancy rates, particularly in the South, and perhaps to heightened uncertainties about the prospects for changes in tax legislation relating to certain types of real estate investment. Weakness in the energy sector has contributed to a slowing in business capital spending in recent months. Outlays for nonresidential structures fell sharply as spending on petroleum drilling activity plummeted. Expenditures for capital equipment dropped substantially, about reversing the rise in the previous quarter that was attributed to purchases of equipment in advance of potentially adverse tax law changes. New orders for nondefense capital goods, which had been flat in the fourth quarter, remained lackluster through March. Recent surveys of capital spending plans point to no more than modest growth in outlays for the year as a whole. Largely reflecting declines in energy prices, the producer price index fell 0.6 percent in April, its fourth consecutive monthly decline, and over the first four months of the year the index was down about 11 percent at an annual rate. The consumer price index had fallen 0.4 percent in March for the second month in a row, and had declined at an annual rate of about 2 percent over the first three months of the year. Though movements in these indexes were dominated by the sharp drop in prices of petroleum products, declines in food prices at both the producer and consumer levels also helped to hold down inflation in the first quarter. 112 FOMC Policy Actions On the other hand, prices of goods other than food and energy items generally have been rising in recent months at about the same pace that prevailed last year, while prices of services have been increasing a little faster than in 1985. The trade-weighted value of the dollar against major foreign currencies rose somewhat in the week before this meeting but on balance it had declined about 43A percent further over the period since the Committee's meeting on April 1; the largest decline was against the Japanese yen. There was little net change over the period in the differential between U.S. and a weighted average of foreign interest rates. Throughout the period, but especially around the time of the Tokyo Summit in early May, statements of U.S. and foreign officials appeared to influence trading behavior. The U.S. merchandise trade deficit appeared to have decreased somewhat in the first quarter, as both the volume and average price of oil imports fell and nonagricultural exports picked up. At its meeting on April 1, 1986, the Committee had adopted a directive that called for maintaining about the existing degree of pressure on reserve positions. The members expected such an approach to policy implementation to be consistent with growth of both M2 and M3 at an annual rate of about 7 percent for the period from March to June. Over the same period, Ml was expected to expand at an annual rate of about 7 to 8 percent, but the members recognized that the behavior of Ml remained subject to unusual uncertainty. The Committee agreed that somewhat lesser or somewhat greater reserve restraint might be acceptable over the intermeeting period depending on the behavior of the aggregates, the strength of the business expansion, developments in foreign exchange markets, progress against inflation, and conditions in domestic and international credit markets. The intermeeting range for the federal funds rate was retained at 6 to 10 percent. Ml grew at an annual rate of 14V2 percent in April, close to its rapid pace in March, and data available thus far for early May indicated further strong expansion. Ml has expanded more rapidly than the Committee expected at the time of its April 1 meeting, and for the year to date has grown at a rate well above the 8 percent upper limit of the Committee's range for 1986. M2 and M3 expanded in April at annual rates of about 133A percent and IOV2 percent respectively, also outpacing the growth paths previously expected for the second quarter. However, given its earlier weakness, M2 moved only into the lower part of its longrun range in April, while M3 rose to a level slightly above the midpoint of its range for 1986. Expansion of total domestic nonfinancial debt, which had slowed appreciably over the first quarter, appeared to be continuing at a relatively moderate pace. Open market operations during the intermeeting period were directed at maintaining about the prevailing degree of pressure on reserve positions. During the three full reserve maintenance periods after the April 1 meeting, seasonal plus adjustment borrowing from the discount window averaged about $275 million. Borrowing was exceptionally light in the days immediately preceding the announcement on April 18 FOMC Policy Actions 113 of a reduction in the discount rate from 7 to 6V2 percent, but has averaged a little more than $300 million since then. Federal funds generally traded in the 63/4 to 7 percent area over most of the intermeeting period, down about xh percentage point from the rate prevailing around the time of the previous meeting. Most other short-term rates also declined on balance, though by less than the federal funds and discount rates, while long-term rates moved somewhat higher. After declining early in the intermeeting period, interest rates subsequently rose against the background of an upturn in oil prices, strong money supply growth, further depreciation of the dollar, and emerging views among market participants that the scope for further easing in monetary policy was reduced. The staff projections presented at this meeting suggested that expansion in real GNP, though relatively modest in the current quarter, would likely strengthen over the second half of 1986 and would be at a moderate pace in 1987. The rate of unemployment was expected to decline marginally over the projection horizon. The general level of prices, as measured by the GNP implicit deflator, was projected to rise relatively slowly in the near term, but to pick up later as the favorable effects of declining oil prices dissipated and upward pressures on prices from the dollar's depreciation tended to intensify. In the Committee's discussion of the economic situation and outlook, members commented that stronger economic expansion in line with the staff forecast was a reasonable expectation for the second half of the year, but several members also stressed the risks of a different outcome. It was generally noted that there was no firm evidence to date of a pickup from the currently sluggish rate of expansion in overall economic activity and that weaknesses remained in key sectors of the economy such as energy and agriculture. However, a number of fundamental factors pointed to faster growth later, though there was considerable uncertainty about both the timing and the magnitude of the prospective strengthening. These factors included substantially reduced interest rates, higher prices in equity markets, lower oil prices, and the favorable effects of the dollar's depreciation on the international competitiveness of U.S. products. At the same time, some members observed that inflationary pressures could increase over the next several quarters, particularly if domestic demands for goods and services proved to be quite strong at a time when the lagged price effects of the dollar's depreciation were being felt. It was noted in this connection that progress toward reducing federal budget deficits was urgently needed to improve prospects for balanced economic growth and help protect against renewed inflation. With regard to specific indications of prospective strengthening in economic activity, members referred among other developments to the apparent improvement in business confidence in many parts of the country. Housing activity was described as strong in most areas, and some members cited evidence of a pickup in sales of consumer durables related to housing. And although activity in manufacturing industries tended to remain sluggish, the service industries generally were experiencing considerable growth, includ- 114 FOMC Policy Actions ing notably the financial services and tourism. While the staff forecast had indicated continuing growth of consumer spending and modest expansion in business fixed investment and inventories, one member referred to the possibility that expansion in these key sectors might gather momentum as uncertainties about the actual strength of business were resolved favorably, contributing to a greater acceleration in real economic growth. Another member commented that the buildup of liquidity was seen by many observers as a positive factor for the expansion, especially in the context of what was viewed as an accommodative monetary policy. While broad measures of liquidity had not shown particular strength in recent quarters, holdings of cash balances had been expanding rapidly and were available to support a considerable pickup in spending at some point in the future. On the other hand, several members indicated that the possibility of the expansion remaining weak could not be ruled out. In this regard, a number of members indicated that they viewed business fixed investment as a major uncertainty in the overall economic outlook, noting that current indicators of future investment remained weak and that there was considerable reluctance to undertake some investment activities pending the passage of tax reform legislation. Moreover, the apparent overbuilding of commercial and other facilities in some parts of the country and weak investment demand in depressed sectors of the economy would tend to inhibit investment spending over the quarters ahead. Members also referred to shortfalls in revenues of state and local governments in depressed areas of the country as a negative factor. Finally, one member referred to the possibility of an inventory correction should the currently positive business mood begin to deteriorate. A number of members expressed the view that the performance of the economy during the second half of the year would hinge to a considerable extent on foreign developments. Some felt that the main downside risks in the nearer-term business outlook were on the foreign trade side. To an important degree, rising demands for U.S. exports would depend on faster growth in key foreign industrial nations, and it was observed that such growth had been disappointing and a pickup might not occur in the absence of more stimulative economic policies in at least some of those countries. And while a depreciated dollar could be expected to have a favorable impact on U.S. foreign trade over time, that impact might well be delayed and muted in an environment of slow growth abroad and of highly competitive markets for internationally traded goods. Further growth in protectionism in the United States might likewise have a strongly inhibiting effect on U.S. export markets as foreign nations retaliated. A number of members raised questions about the outlook for inflation. It was pointed out that the recently favorable behavior of overall prices was the result of price declines in the energy and food sectors. Those declines would soon be in the past, and upward pressures on overall prices would reemerge, stimulated in part by the lagged inflationary effects of the dollar's depreciation. Indeed, prices of nonfuel imports were already indicated to have turned up. Even if oil prices were to stabilize near current levels, their favorable impact on overall prices would tend to wane over the quarters ahead, and the possibility of a reversal in oil prices could not be dismissed. Agricultural prices also could not be expected to continue trending downward, and indeed some firming had occurred recently. On the more favorable side, members referred to the intense competition in many markets and to restrained wage settlements in a number of industries. Basic cost pressures appeared to be well contained so far in manufacturing industries although price and wage pressures in the service industries remained disturbing. In one view any intensification of inflationary pressures might well be delayed until well into 1987. At its meeting in February the Committee had agreed on policy objectives for monetary growth for the period from the fourth quarter of 1985 to the fourth quarter of 1986 that included ranges of 3 to 8 percent for Ml and 6 to 9 percent for both M2 and M3. The associated range for total domestic nonfinancial debt was set at 8 to 11 percent. In keeping with the Committee's usual procedures under the Humphrey-Hawkins Act, these ranges would be reviewed at the July meeting when provisional ranges would also be established for 1987. The Committee's policy discussion focused to a considerable extent on the members' evaluation of the recent behavior of the monetary aggregates, particularly Ml. With varying degrees of emphasis, members questioned the reliability of Ml developments as a guide for the conduct of monetary policy under prevailing circumstances. It was noted in this connection that the rapid growth in Ml and the associated weakness in its velocity appeared to reflect to a considerable but nonetheless uncer FOMC Policy Actions 115 tain extent the earlier declines that had occurred in market interest rates in the context of subsiding inflationary expectations and softness in final demands. From this viewpoint, the relatively rapid growth in the demand for money balances needed to be accommodated in order to assure a satisfactory performance of the economy. On the other hand, rapid monetary growth also might imply an excessive buildup in liquidity, with inflationary implications for the future. In that context, several members emphasized the need to gauge the performance of Ml in light of whether behavior of other, broader, monetary aggregates provided confirming evidence of a rapid growth in liquid assets. Members noted that expansion of the broader aggregates, despite the more rapid growth in recent weeks, was well within the Committee's ranges for 1986, and indeed near the lower end of the range in the case of M2. The more moderate growth of the broader aggregates this year, along with relatively moderate growth of L, an even more encompassing measure of the public's liquid asset holdings, raised questions as to whether the growth of Ml really represented a potentially excessive buildup in liquidity or was more of a shift in the composition of liquid holdings in response to relative movements in interest rates. However, continuing growth in M2 and M3 at the relatively rapid rates experienced recently could be a matter of increasing concern. One member expressed a somewhat differing assessment of the behavior of the broader aggregates this year in that the contingent liabilities of banks, most of which back instruments that are not included in M2 and M3, also seemed to have grown rapidly. More- 116 FOMC Policy Actions over, growth of M2 and M3 appeared to have been held back by investor portfolio shifts into bonds and equities, including mutual funds, and the unwinding of such shifts could result in faster growth later. In this view, therefore, less comfort could be taken from the relatively restrained growth of the broader aggregates for the year to date. According to an analysis prepared for this meeting, the maintenance of the current degree of pressure on reserve positions could be expected to be associated with slower monetary growth over the balance of the quarter. Even so, because of the substantial expansion in April and early May, growth for the quarter as a whole would be considerably faster than was expected at the time of the previous meeting, notably in the case of Ml. According to this analysis, the unusual surge in demand deposits was likely to subside over the course of coming weeks, while some moderation could also be expected in the growth of NOW accounts as both depositors and depository institutions completed their adjustments to the lower market interest rates that had emerged. Members indicated broad agreement with this analysis, but they questioned the timing and extent of the slower growth. In light of the uncertainties that were involved, some proposed omitting numerical references in the directive to the Committee's expectations for monetary growth in the second quarter. However, despite the greater than usual uncertainties, a majority of the members preferred to retain the customary procedure of specifying numerical growth expectations in the directive. In the Committee's discussion of policy implementation for the period immediately ahead, most of the members indicated that they were in favor of continuing to direct open market operations at least initially toward maintaining the existing degree of reserve availability. In support of this view, members commented that the rapid growth of the monetary aggregates and the favorable conditions for a pickup in business activity had to be weighed against the currently sluggish growth in overall business activity and the consequent uncertainties surrounding the economic outlook. One member felt, however, that the rapid growth in Ml and the potential for increased inflationary pressures later in the year and in 1987 argued for some firming. With regard to possible adjustments during the intermeeting period, a majority of the members felt that policy implementation should be alert to the potential need for some firming of reserve conditions, especially if business indicators gave a clear signal of a pickup in the rate of economic expansion and monetary growth did not slow in line with expectations. Generally, these members did not want to rule out the possibility of some easing in the weeks immediately ahead, but they foresaw the potential desirability of such a course only in the context of appreciably more sluggish economic performance than was now expected. In this connection, one member emphasized that continuing declines in the velocity of money in combination with a sluggish economic performance might warrant some easing of reserve conditions. Other members believed that there should be no presumptions about the likely direction of any intermeeting adjustments, given the prevailing uncertainties about the performance of the economy, possible developments in domestic and international financial markets, and the behavior of the monetary aggregates. Some members also expressed the view that the Committee should be tolerant of a shortfall of Ml growth below current expectations in light of the rapid expansion of Ml recently and for the year-to-date. It was noted that account needed to be taken of the behavior of the dollar on foreign exchange markets in any intermeeting adjustments. At the conclusion of the Committee's discussion, all but one member indicated their acceptance of a directive that called for no change in the existing degree of pressure on reserve positions. The members expected such an action to be associated with a deceleration in monetary growth over the balance of the second quarter. Because such growth had been rapid thus far in the quarter, the members anticipated faster growth of the monetary aggregates, especially Ml, than was expected at the time of the April 1 meeting. The members recognized that the behavior of Ml remained subject to unusual uncertainty, but they agreed that its growth might be in the area of 12 to 14 percent for the period from March to June, assuming some decline over the balance of the quarter. For the same period, M2 and M3 were now expected to expand at annual rates of around 8 to 10 percent. The members agreed that if the anticipated slowing in monetary growth did not occur, somewhat greater reserve pressure would be acceptable in the context of a pickup in the expansion of economic activity, with account being taken of conditions in domestic and international financial markets and the behavior of the dollar on foreign exchange markets. On the other hand, FOMC Policy Actions 117 somewhat lesser reserve restraint might be acceptable in the event of pronounced sluggishness in the performance of the economy in association with a marked slowing in monetary growth. The Committee agreed that the current intermeeting range for the federal funds rate should be reduced by 1 percentage point to 5 to 9 percent. The reduction was intended as a purely technical adjustment in the context of an unchanged degree of reserve availability and its purpose was to provide a more symmetrical range around the lower federal funds rate that had prevailed for some time. The members regard the federal funds range as a mechanism for initiating Committee consultation when its boundaries are persistently exceeded. At the conclusion of the meeting the following domestic policy directive was issued to the Federal Reserve Bank of New York: The information reviewed at this meeting indicates a mixed pattern of developments but suggests on balance that economic activity is expanding at a relatively modest pace in the current quarter. Total nonfarm payroll employment increased moderately further in April following a considerable rise in the first quarter, but employment in manufacturing fell for the third consecutive month. The civilian unemployment rate edged down to 7.1 percent. Industrial production and total retail sales turned up in April following earlier declines, while housing starts rose somewhat further from a relatively high level. Weakness in the energy sector has contributed to a slowing of business capital spending. The merchandise trade deficit appears to have decreased somewhat in the first quarter, as the volume and average price of oil imports fell. Largely reflecting declines in energy prices, consumer prices have declined somewhat since late 1985 and producer prices have fallen substantially. In April Ml continued to grow at a rapid pace, leaving this aggregate above the up- 118 FOMC Policy Actions per end of its range for the year. Growth of the broader aggregates, especially of M2, strengthened considerably in April, bringing M2 into the lower part of its longrun range and M3 slightly above the midpoint of its range for 1986. Most shortterm interest rates have declined on balance since the April 1 meeting of the Committee, while long-term rates are somewhat higher. On April 18, the Federal Reserve Board approved a reduction in the discount rate from 7 to 6!/2 percent. The trade-weighted value of the dollar against major foreign currencies has risen somewhat recently but on balance the dollar has declined further since the April meeting, particularly against the Japanese yen. The Federal Open Market Committee seeks monetary and financial conditions that will foster reasonable price stability over time, promote growth in output on a sustainable basis, and contribute to an improved pattern of international transactions. In furtherance of these objectives the Committee agreed at its February meeting to establish the following ranges for monetary growth, measured from the fourth quarter of 1985 to the fourth quarter of 1986. With respect to Ml, the Committee recognized that, based on the experience of recent years, the behavior of that aggregate was subject to substantial uncertainties in relationship to economic activity and prices, depending among other things on its responsiveness to changes in interest rates. It agreed that an appropriate target range under existing circumstances would be 3 to 8 percent, but it intends to evaluate movements in Ml in the light of its consistency with the other monetary aggregates, developments in the economy and financial markets, and potential inflationary pressures. It adopted a range of 6 to 9 percent for M2 and 6 to 9 percent for M3. The associated range for growth in total domestic nonfinancial debt was set at 8 to 11 percent for the year 1986. In the implementation of policy for the immediate future, the Committee seeks to maintain the existing degree of pressure on reserve positions. This action is expected to be consistent with a deceleration in money growth over the balance of the quarter. However, in view of the rapid money growth thus far in the quarter and the apparent weakness in velocity, the Committee anticipates faster growth for the monetary aggregates, particularly Ml, than expected at the last meeting. M2 and M3 are expected to expand over the period from March to June at annual rates of about 8 to 10 percent. While the behavior of Ml continues to be subject to unusual uncertainty, growth at an annual rate of about 12 to 14 percent over the period is now anticipated. If the anticipated slowing in monetary growth does not develop, somewhat greater reserve restraint would be acceptable in the context of a pickup in growth of the economy, taking account of conditions in domestic and international financial markets and the behavior of the dollar in foreign exchange markets. Somewhat lesser reserve restraint might be acceptable in the context of a marked slowing in money growth anid pronounced sluggishness in economic rformance. The Chairman may call for per Committee consultation if it appears to the Manager for Domestic Operations that reserve conditions during the period before the next meeting are likely to be associated with a federal funds rate persistently outside a range of 5 to 9 percent. Votes for this action: Messrs. Volcker, Corrigan, Angell, Guffey, Mrs. Horn, Messrs. Johnson, Melzer, Morris, Rice, and Ms. Seger. Vote against this action: Mr. Wallich. Absent and not voting: None. Mr. Wallich dissented because he preferred to direct open market operations toward somewhat greater restraint. He was concerned about the implications of rapid monetary expansion for inflation and wanted to take action promptly to help assure slower monetary growth. 2. Authorization for Domestic Open Market Operations On June 18, 1986, the Committee approved a temporary increase of $3 billion, to $9 billion, in the limit between Committee meetings on changes in System Account holdings of U.S. government and federal agency securities specified in paragraph l(a) of the authorization for FOMC Policy Actions 119 domestic open market operations. The increase was effective immediately for the intermeeting period ending with the close of business on July 9, 1986. Votes for this action: Messrs. Volcker, Corrigan, Angell, Guffey, Mrs. Horn, Messrs. Johnson, Morris, Rice, and Boykin. Votes against this action: None. Absent and not voting: Mr. Melzer, Ms. Seger and Mr. Wallich. (Mr. Boykin voted as alternate for Mr. Melzer.) This action was taken on the recommendation of the Manager for Domestic Operations. The Manager had advised that through June 17, outright purchases of securities thus far in the intermeeting interval had reduced the leeway under the usual $6 billion limit to about %2lA billion. It was anticipated that substantial additional purchases of securities in excess of that leeway would be necessary over the remainder of the intermeeting period. Currency in circulation was expanding rapidly, as expected, while required reserves were growing considerably faster than had been anticipated earlier. Meeting Held on July 8-9, 1986 Domestic Policy Directive The information reviewed at this meeting indicates that economic activity has expanded at a relatively slow pace recently. Consumer spending and housing activity have been strong, reflecting large gains in real income and lower interest rates. However, business investment has remained sluggish, and the trade balance has continued to deteriorate. At the same time, wage and price increases have been moderate. Total nonfarm payroll employ ment grew slowly again in June, rising about 80,000 after adjusting for strike activity. Employment continued falling in manufacturing, particularly in the metals and machinery industries, and more jobs were lost in oil and gas extraction. Hiring in construction, which had surged in April, levelled off in May and fell in June. Service industries continued to post large gains in employment in June; however, hiring at retail establishments was markedly slower than earlier in the year. The civilian unemployment rate declined to 7.1 percent from 7.3 percent in May. The index of industrial production fell 0.6 percent in May and has declined 1% percent since December, erasing the gains that occurred at the end of 1985. The decrease in output in May was related in part to a further contraction in oil and gas drilling and to a decline in auto assemblies. Output elsewhere generally was lower with notable weakness in the production of business equipment and selected materials for durable goods. Available indicators of industrial activity in June are mixed; auto assemblies are expected to have increased, but the output of steel decreased and strike activity hampered production in the lumber, aluminum, and communication equipment industries. Capacity utilization in manufacturing was 78.6 percent in May, off 0.6 percentage point from April and more than 2 percentage points from January. Total retail sales were about unchanged in May; however, sales at the retail control group of stores, which excludes outlets for autos, gasoline, and building materials, rose somewhat and were stronger in the previous two months than originally reported. Total car sales in May were at an annual rate of llVi million units, up from the 10% million unit 120 FOMC Policy Actions pace registered in the first quarter. Sales of domestic automobiles have held at around a rate of 8V4 million units since the expansion of incentive financing programs in late April, up from the 73A million unit pace earlier in the year. Housing activity generally has been brisk. Starts fell a little in May but still were at a 1.9 million unit annual rate. Single-family starts held steady at a level that was fractionally above the first-quarter average, while the pace of house sales, although down in May, has remained relatively robust. At the same time, home prices have risen sharply. Multifamily starts fell sharply in May, owing in part to the depletion of tax-exempt funds raised by huge issues of mortgage revenue bonds in late 1985 and to overbuilding in a number of major markets. Business investment probably declined again in the second quarter, reflecting weakness in the energy sector, the availability of unutilized capacity, and concerns about tax reform. Shipments of nondefense capital goods have been sluggish in recent months. In the construction area, drilling activity has fallen sharply further, and spending for office and other commercial projects also has weakened. Moreover, advance indicators of investment spending have been weak. New commitments for nonresidential building have fallen since late last year, and new orders for nondefense capital goods were flat in May after two months of declines. In addition, according to the latest surveys, businesses are planning little, if any, increase in nominal spending for 1986 as a whole. The producer and consumer price indexes turned up in May, as the steep decline in energy prices ended. Producer prices rose 0.6 percent, after declining in the previous four months. Consumer prices were up 0.2 percent; retail gasoline prices rose 2l/i percent, after falling around 25 percent from January to April. Excluding food and energy, the CPI has risen at an annual rate of about 3V2 percent so far this year, somewhat less than in 1985. Prices of goods have been essentially flat, while some types of services have registered large increases. The trade-weighted value of the dollar against major foreign currencies has declined almost T}h percent on balance since the FOMC meeting on May 20; the largest decline was registered against the yen. In the first two weeks of the intermeeting period, the dollar appreciated somewhat in response to data indicating a possible strengthening of U.S. economic activity. This rise was subsequently reversed when additional information on the economic performance in the United States disappointed market expectations. The differential between U.S. interest rates and a weighted average of foreign short-term interest rates changed little on balance over the period. Preliminary data for the U.S. merchandise trade deficit showed a somewhat larger deficit in April than the average for the first quarter, because a decline in the value of oil imports was more than offset by an increase in imports of other goods; exports in April-May combined seem to have been no higher than the firstquarter rate. At its meeting on May 20, 1986, the Committee had adopted a directive that called for maintaining the existing degree of pressure on reserve positions. The members expected such an approach to policy to be consistent with a deceleration in money growth over the balance of FOMC Policy Actions 121 the quarter. However, because such the midpoint of its range for the growth had been rapid in April and year. M3 continued to increase at early May, the Committee antici- rates around the middle of its longpated faster growth for the quarter run range in May and June. as a whole, particularly for Ml, than However, in the light of the clear was expected at the time of the April indications that business activity, meeting. M2 and M3 were expected rather than picking up momentum, to expand over the period from was growing at a slower pace, open March to June at annual rates of 8 market operations during the interto 10 percent. Over the same period, meeting period continued to be diMl was anticipated to grow at an rected at maintaining the prevailing annual rate of 12 to 14 percent, degree of pressure on reserve posialthough the members acknowledged tions. In the three complete maintethat the behavior of Ml continues to nance periods since the May meetbe subject to unusual uncertainty. ing, adjustment plus seasonal The Committee agreed that if money borrowing at the discount window growth did not slow as anticipated, averaged $285 million. Excess resomewhat greater reserve restraint serves averaged around $830 million would be acceptable in the context in the first two maintenance periods of a pickup in the economic expan- after the meeting, but then rose to sion, while also taking account of $1.3 billion in the most recent period, conditions in domestic and interna- which included the quarter-end statetional financial markets and the be- ment date. havior of the dollar on foreign exFederal funds generally traded in change markets. On the other hand, a narrow range around 67/s percent they agreed that somewhat lesser over the intermeeting period, aside restraint might be acceptable if the from somefirmingaround the quarter expansion weakened noticeably in end. Other interest rates rose early conjunction with a marked slowing in the period but then retreated amid in monetary growth. The intermeet- signs of weakness in the economies ing range for the federal funds rate of the United States and some of its was reduced to 5 to 9 percent. major trading partners, renewing exIn the circumstances, Ml contin- pectations of a discount rate cut in ued to expand rapidly over the past the near future. Since the May meettwo months, with growth surging to ing short-term market rates had dean annual rate of around 23 percent clined 10 to 40 basis points on in May before decelerating to a rate balance. In long-term markets, yields of about 15 percent in June. Conse- on Treasury securities were down quently, growth in Ml from March about 35 to 45 basis points, while to June, at an annual rate of almost rates on corporate and municipal 18 percent, substantially exceeded bonds were about unchanged and the Committee's short-run expecta- those on fixed-rate mortgages were tions and so far this year has been up around V of a percentage point. 2 well above the Committee's 3 to 8 The widening spread between rates percent range for 1986. Growth in on long-term private securities and M2 slowed in both May and June Treasury issues appeared to reflect but was still somewhat above earlier strong foreign demand for recently expectations for the quarter and issued long-term Treasuries, large this aggregate up to around brought supplies of private securities, and 122 FOMC Policy Actions increased focus on the value of the greater call protection for Treasury issues. The staff projections presented at this meeting continued to suggest that growth in real GNP, though relatively slow in the second quarter, was likely to strengthen somewhat in the second half of the year. However, growth over the next two quarters probably would be at a slower pace than had been expected earlier in part because news on business investment and foreign trade was disappointing. Growth was projected to continue at a moderate pace in 1987. The civilian unemployment rate was forecast to decline somewhat over the projection horizon. Inflation was expected to pick up a bit over the next six quarters, as the favorable effects of declining energy prices diminished while upward pressure on prices from the effects of the dollar's depreciation tended to intensify. In their discussion of the economic situation and outlook, Committee members generally agreed that some strengthening in the economic expansion was a reasonable expectation for the second half of the year and that, on the whole, the prospects were favorable for continuing growth at a moderate pace in 1987. At the same time, members emphasized the uncertainties that surrounded the economic outlook and a number commented that the improvement in economic activity might well be more delayed or less pronounced than they had anticipated earlier. In this connection, some members expressed concern about the lack of firm evidence to date of a prospective pickup in the rate of economic growth and, in particular, the absence thus far of any apparent improvement in the balance of trade, which many mem- bers saw as the key to stronger economic expansion. The members continued to view the outlook for inflation as relatively favorable, although they anticipated that, in the context of a growing economy, the lagged impact of the dollar's depreciation was likely to boost prices somewhat. In keeping with the usual practice at meetings when the Committee considers its long-run objectives for monetary growth, the members of the Committee and the Federal Reserve Bank presidents not currently serving as members prepared specific projections of economic growth, the rate of unemployment, and changes in the overall price level. With regard to the rate of expansion in real GNP, the projections had a central tendency of 2V2 to 3 percent for 1986 as a whole and 3 to 3V2 percent for 1987. Forecasts of growth in nominal GNP centered on ranges of 43A to 53/4 percent for 1986 and 6 to IV2 percent for 1987. The central tendency for the rate of unemployment was an average of 7 percent in the fourth quarter of 1986 and around 63/4 percent in the fourth quarter of 1987. With respect to the rate of inflation, as indexed by the GNP deflator, the projections centered on rates of 2lA to 2% percent for 1986 and 3 to 4 percent for 1987. In making these forecasts, the members took account of the Committee's objectives for monetary growth that were established at this meeting. The projections were based on the assumption that fluctuations over the projection period in the foreign exchange value of the dollar would not be of sufficient magnitude to have a significant effect on economic activity or prices during the period. The members also assumed that the Con- FOMC Policy Actions 123 gress would seek to achieve the deficit reductions contemplated by the Gramm-Rudman-Hollings legislation. In the members' views, significant progress in reducing the federal deficit was essential in order to maintain financial conditions that were conducive to sustained economic expansion and an improved pattern of international transactions. In their assessment of the factors pointing to somewhat faster economic growth over the balance of the year and in 1987, members referred as they had at earlier meetings to a number of favorable underlying developments including reduced interest rates, higher stock market prices, lower energy costs, and the positive impact of the dollar's depreciation on the competitive position of U.S. businesses. Members also made reference to the stimulative impact of a broadly accommodative monetary policy, as evidenced by rapid growth in money and credit and several decreases in the discount rate. One member suggested that stimulative financial conditions probably helped to account for the relative longevity of the current business expansion in the face of a variety of unfavorable factors. The latter included the negative impact that the decline in oil prices and the uncertainties associated with pending tax reform legislation were currently exerting on investment activity; some members commented that both of these factors were likely to have a less inhibiting impact on the economy over the course of the next several quarters. On the other hand, the overbuilding of various commercial facilities, notably of office structures, in several parts of the country and severe problems in agriculture were deemed likely to have retarding influences on economic activity that could persist. Such developments were reflected in sharp contrasts in the economic performance of different sectors and regions of the country and in strains on financial institutions that serviced the depressed industries. Moreover, members expressed concern about the continuing rapid growth in total debt and its negative implications for sustained business expansion. The members gave particular emphasis during the discussion to the key role of foreign trade developments, which were seen as a major source of uncertainty in shaping the economic outlook. The substantial depreciation of the dollar against the currencies of several large industrial countries had strengthened the international competitiveness of U.S. businesses, notably in the industrial sector, and pointed to eventual improvement in the U.S. trade balance. Unfortunately, evidence of such improvement had proved elusive to date and several members commented that significant progress in reducing the nation's trade deficit was unlikely in the absence of faster economic growth in key industrial nations abroad. Indications of such growth were mixed, with several countries having experienced relative weakness earlier in the year. The absence of more robust growth abroad—and an improvement in the U.S. trade balance—would constitute a major risk to the realization of stronger domestic economic expansion. At this meeting the Committee reviewed its ranges for growth of the monetary and debt aggregates in 1986 and established tentative ranges for 1987 within the framework of the Full Employment and Balanced 124 FOMC Policy Actions Growth Act of 1978 (the HumphreyHawkins Act). 1 At its meeting on February 11-12, 1986, the Committee had adopted monetary growth ranges of 3 to 8 percent for Ml and 6 to 9 percent for both M2 and M3 for the period from the fourth quarter of 1985 to the fourth quarter of 1986. The associated range for growth in total domestic nonfinancial debt was set at 8 to 11 percent. With respect to Ml the Committee had recognized that, based on the experience of recent years, the behavior of that aggregate was subject to substantial uncertainties in relation to economic activity and prices. The Committee had indicated its intention to evaluate Ml behavior in the light of its consistency with the other monetary aggregates, developments in the economy and financial markets, and potential inflationary pressures. In the Committee's discussion of its long-run ranges at this meeting, all of the members supported a proposal to retain the range of 6 to 9 percent for growth in M2 and in M3 for the year 1986. Both aggregates had expanded at rates that left them close to the midpoint of their ranges at midyear. Growth within these ranges for the year as a whole was still deemed to be consistent with the Committee's overall policy objectives. A majority of the members preferred a slightly lower range for 1987. In their view, a modest reduction would be consistent with the Committee's long-term objective of achieving a rate of monetary growth compatible with price stability. They also believed that the lower range was likely to prove fully con- 1. The midyear Monetary Policy Report prepared pursuant to this legislation was transDigitized formitted to the Congress on July 18, 1986. FRASER sistent with somewhat faster economic growth in 1987 and, in that context, with some decline in velocity should that develop. Some members suggested maintaining the 6 to 9 percent range for 1987 because it would provide a little extra leeway that might prove useful in support of continuing growth in nominal GNP, given the possibility of some further decline in the velocity of the broader aggregates. However, the slightly lower range favored by the majority was considered acceptable by most members. In the discussion of appropriate ranges for Ml growth in 1986 and 1987, the members gave considerable emphasis to the exceptional uncertainties that continued to affect Ml velocity. Over the course of recent years, the relationship of Ml to income appeared to have been significantly altered by changes in the composition of the aggregate, resulting in part from the deregulation of interest rate ceilings and the relatively rapid growth of its interestbearing components. In the process, the demand for Ml balances has become much more sensitive to movements in interest rates. Given the evolving nature of that demand, it had become very difficult to assess or predict the implications of Ml growth for the future course of economic activity and the rate of inflation. As a consequence, a number of members questioned the usefulness of Ml as a guide for the conduct of monetary policy under present circumstances. A few proposed dropping the Ml range, at least pending the reestablishment of a more predictable relationship with overall measures of economic performance. A majority, however, preferred to retain an Ml range even though they believed its operational significance could only be judged in the perspective of concurrent economic and financial developments, including the behavior of M2 and M3. It was noted in this discussion that even under current circumstances Ml continued to have some information value for policy and that retention of some range for Ml, even if used only as a benchmark for measuring deviations, might well assist judgments about monetary policy. Moreover, the importance of Ml could again become greater in the future. After reviewing the available evidence, the members concluded that much of the rapid growth of Ml in recent months probably reflected shifts in holdings of liquid assets in response to declining interest rates and subsiding inflationary expectations rather than excessive money creation with potentially inflationary consequences. Tending to reinforce that judgment was the moderate growth in overall economic activity, the behavior of broad measures of inflation, and the expansion of M2 and M3 at rates well within their ranges for the year. As events unfolded, relatively rapid growth in Ml had been needed to accommodate continuing economic expansion. Given developments for the year to date, growth in excess of the 3 to 8 percent range established in February appeared likely for 1986 as a whole, but most of the members did not want to raise or to rebase the existing range; such an adjustment might imply greater certainty about future performance than in fact existed. Since they believed that the significance of changes in Ml could only be evaluated in the context of the behavior of the broader aggregates and against the background of economic and financial developments, includ ing trends in interest rates, they FOMC Policy Actions 125 agreed that after taking account of those factors Ml growth above the existing range would be acceptable for the year. With regard to 1987, some members argued that the uncertainties precluded setting a meaningful range for Ml so far in advance, but a majority preferred to retain this year's range of 3 to 8 percent. The members noted that this range should be considered even more tentative than usual. Such a range assumed that the velocity of Ml would not change as much as in the recent period under conditions of greater economic, price, and interest rate stability. In any event the members agreed that developments over the balance of this year would provide a better basis for judging the prospects for Ml behavior in 1987 and that careful appraisal of the range—including the weight that Ml should receive as a guide to policy—would be required at the start of next year. Turning to the Committee's monitoring range for total domestic nonfinancial debt, most of the members indicated that they were in favor of retaining the 8 to 11 percent range adopted in February for 1986 even though growth in excess of that range now appeared likely for the year. Members expressed concern about the persistence of rapid growth of total debt in the context of already large debt burdens. As in the past, they felt that raising the Committee's range for debt would create an inappropriate benchmark for evaluating long-term trends in debt expansion. One member proposed dropping the range for total debt and substituting a measure for total liquid assets, which, at least in the past year or two, had had a closer relationship to developments in nominal GNP. Other members preferred to 126 FOMC Policy Actions continue to monitor debt trends explicitly in light of their concerns about the implications of overall debt levels. For 1987, the members generally felt that a range of 8 to 11 percent for total debt growth would remain appropriate, though that range would need to be reviewed early next year. At the conclusion of the Committee's review, all of the members indicated that they favored, or could accept, a proposal to reaffirm the ranges for monetary and debt growth that had been established in February for the year 1986. The behavior of all of the monetary aggregates would continue to be judged against the background of developments in the economy and financial markets and potential price pressures. Growth of Ml in excess of its range would be acceptable and would be evaluated in the light of the behavior of the broader aggregates. The Committee recognized that expansion in total debt also might exceed its range for the year. The following paragraph relating to the long-run ranges for 1986 was approved for the domestic policy directive: The Committee agreed at this meeting to reaffirm the ranges established in February for growth of 6 to 9 percent for both M2 and M3, measured from the fourth quarter of 1985 to the fourth quarter of 1986. With respect to Ml, the Committee recognized that, based on the experience of recent years, the behavior of that aggregate is subject to substantial uncertainties in relation to economic activity and prices, depending among other things on the responsiveness of Ml growth to changes in interest rates. In light of these uncertainties and of the substantial decline in velocity in the first half of the year, the Committee decided that growth of Ml in excess of the previously established 3 to 8 percent range for 1986 would be acceptable. Acceptable growth of Ml over the remainder of the year will depend on the behavior of velocity, growth in the other monetary aggregates, developments in the economy and financial markets, and price pressures. Given its rapid growth in the early part of the year, the Committee recognized that the increase in total domestic nonfinancial debt in 1986 may exceed its monitoring range of 8 to 11 percent, but felt an increase in that range would provide an inappropriate benchmark for evaluating longerterm trends in that aggregate. Votes for this action: Messrs. Volcker, Corrigan, Angell, Guffey, Mrs. Horn, Messrs. Johnson, Melzer, Morris, Rice, Ms. Seger, and Mr. Wallich. Votes against this action: None. Absent and not voting: None. With respect to the tentative ranges for 1987, most of the Committee members supported a reduction of xh percentage point in the ranges for M2 and M3. For Ml and total debt the members agreed that with the reservations noted above, the 1986 ranges should be retained for 1987; those ranges implied considerable reductions from the rates of growth that now seemed likely for 1986. It was understood that all the ranges were provisional and that, notably in the case of Ml, they would be reviewed in early 1987 in the light of intervening developments. The following paragraph relating to the ranges for 1987 was approved for inclusion in the domestic policy directive: For 1987 the Committee agreed on tentative ranges of monetary growth, measured from the fourth quarter of 1986 to the fourth quarter of 1987, of 5^2 to 8V2 percent for M2 and M3. While a range of 3 to 8 percent for Ml in 1987 would appear appropriate in the light of most historical experience, the Committee recognized that the exceptional uncertainties surrounding the behavior of Ml velocity over the more recent period would require careful appraisal of the target range at the beginning of 1987. The associated FOMC Policy Actions 127 range for growth in total domestic nonfinancial debt was provisionally set at 8 to 11 percent for 1987. Votes for this action: Messrs. Volcker, Corrigan, Angell, Guffey, Mrs. Horn, Messrs. Johnson, Melzer, Morris, Rice, and Wallich. Vote against this action: Ms. Seger. Absent and not voting: None. Ms. Seger dissented because she preferred to retain—at least for now—this year's range of 6 to 9 percent for growth in both M2 and M3 in 1987. In her view, the higher range might be needed to accommodate an acceptable rate of economic expansion, especially in light of the possibility that the velocity of these aggregates might remain weak next year. At the same time she did not want to rule out the possibility that interim developments might justify reductions in the M2 and M3 ranges when the latter were reconsidered early next year. She also preferred not to specify a tentative range for Ml at this time because of the substantial uncertainties currently surrounding the relationship between Ml growth and broad measures of economic activity. In their discussion of policy implementation for the weeks immediately ahead, Committee members took account of the likelihood that the discount rate would be reduced within a few days after the meeting. Against the background of sluggish expansion in economic activity and a subdued rate of inflation, most of the members believed that some easing was desirable and they indicated a preference for implementing the easing, at least initially, through a lower discount rate rather than through open market operations. Some members commented that further easing could have a favorable impact on interest-sensitive sectors of the econ omy, particularly in light of what could be viewed as still relatively high real interest rates. It was also suggested that a reduction in the discount rate might encourage over time similar actions by a number of major countries abroad, although such actions were not expected over the near term, at least in the case of some of the key industrial nations. While nearly all the members indicated their acceptance of the policy approach in question, a few referred to the risks of easing under present circumstances, particularly the risk under current conditions of sharp further depreciation of the dollar in foreign exchange markets. Concern also was expressed about the absence of clearer indications of a reduction in federal budgetary deficits. In one view, a cut in the discount rate might need to be accompanied by some increase in the degree of pressure on reserve positions, pending evaluation of further economic and financial developments. With respect to the outlook for monetary growth, the members expected that M2 and M3 might continue to expand at rates around their 1986 ranges over coming months, even assuming some pickup in the rate of business activity and some easing in overall conditions of reserve availability. In their evaluation of the outlook for growth in Ml, the members took account of an analysis that indicated that appreciably slower growth might be expected over the months ahead even if interest rates were to fall somewhat further. However, the members recognized that the timing and extent of any slowing in Ml growth continued to be subject to unusual uncertainty. In the circumstances and taking account of their willingness to accept Ml growth 128 FOMC Policy Actions in excess of the 3 to 8 percent range, especially if growth of the broader aggregates remained within their ranges, a majority of the members expressed a preference for not indicating a specific rate of expected growth for Ml in the short-run operational paragraph of the Committee's directive. In the Committee's discussion of possible intermeeting adjustments in policy implementation, the members generally agreed that there should be no presumptions about the likely direction of any such adjustments, given the current uncertainties about prospective economic and financial developments and the behavior of the monetary aggregates. A majority of the members also indicated a preference for reducing the existing intermeeting range for the federal funds rate by 1 percentage point to 4 to 8 percent. The reduction was viewed as a technical adjustment that would provide a more symmetrical range around a lower federal funds rate that could be expected to emerge following the anticipated reduction in the discount rate. The Committee regards the federal funds range as a mechanism for initiating Committee consultation when its boundaries are persistently exceeded. At the conclusion of the Committee's discussion, all but one member indicated their acceptance of an operational paragraph for the directive that called for some decrease in the existing degree of reserve pressure, recognizing that that relaxation could be accomplished in the first instance by a reduction in the discount rate. The members expected such an approach to policy implementation to be consistent with growth in M2 and M3 at annual rates of about 7 to 9 percent over the three-month period from June to September. Over the same period growth in Ml was expected to moderate from the exceptionally large increase during the second quarter. The specific rate of Ml growth remained subject to unusual uncertainty and the Committee agreed that this aggregate should continue to be judged in the light of the behavior of the broader aggregates and other factors. The Committee indicated that it might find somewhat greater or somewhat lesser reserve restraint acceptable over the intermeeting period depending on the growth of the monetary aggregates, the strength of the business expansion, the performance of the dollar on foreign exchange markets, progress against inflation, and conditions in domestic and international credit markets. At the conclusion of the meeting, the following domestic policy directive, embodying the Committee's long-run ranges and its short-run operating instructions, was issued to the Federal Reserve Bank of New York: The information reviewed at this meeting indicates a mixed pattern of developments but suggests on balance that economic activity expanded slowly in the second quarter. In June total nonfarm payroll employment grew little after accounting for striking workers, with continued weakness in the industrial sector reflected in further declines in employment in manufacturing and mining. The civilian unemployment rate moved down to 7.1 percent from 7.3 percent in May. Industrial production declined in May. Total retail sales were about unchanged during the month, although consumer spending rose considerably for the second quarter as a whole. Housing starts fell somewhat in May from a relatively high level. Weakness in the energy sector has contributed to a slowing of business capital spending. Preliminary data for the U.S. merchandise trade balance in April show a somewhat larger deficit than the rate recorded in the first quarter. Both con- sumer and producer prices turned up in May but have fallen on balance since late 1985, largely reflecting declines in energy prices. Ml growth in June, though less than in May, was still rapid; through June, Ml grew at a rate well above the Committee's range for 1986. Growth of M2 slowed somewhat and expansion of M3 remained relatively moderate in June, keeping these two aggregates close to the middle of their respective ranges for the year. Expansion in total domestic nonfinancial debt remains appreciably above the monitoring range for 1986. Most short-term interest rates have declined on balance since the May 20 meeting of the Committee. Rates on Treasury bonds also have moved lower while rates on private long-term obligations are about unchanged to somewhat higher. The trade-weighted value of the dollar against major foreign currencies has declined somewhat on balance since the May meeting. The Federal Open Market Committee seeks monetary and financial conditions that will foster reasonable price stability over time, promote growth in output on a sustainable basis, and contribute to an improved pattern of international transactions. In furtherance of these objectives the Committee agreed at this meeting to reaffirm the ranges established in February for growth of 6 to 9 percent for both M2 and M3, measured from the fourth quarter of 1985 to the fourth quarter of 1986.With respect to Ml, the Committee recognized that, based on the experience of recent years, the behavior of that aggregate is subject to substantial uncertainties in relation to economic activity and prices, depending among other things on the responsiveness of Ml growth to changes in interest rates. In light of these uncertainties and of the substantial decline in velocity in the first half of the year, the Committee decided that growth of Ml in excess of the previously established 3 to 8 percent range for 1986 would be acceptable. Acceptable growth of Ml over the remainder of the year will depend on the behavior of velocity, growth in the other monetary aggregates, developments in the economy and financial markets, and price pressures. Given its rapid growth in the early part of the year, the Committee recognized that the increase in total domestic nonfinancial debt in 1986 may exceed its monitoring range Digitized forof 8 to 11 percent, but felt an increase in FRASER FOMC Policy Actions 129 that range would provide an inappropriate benchmark for evaluating longerterm trends in that aggregate. For 1987 the Committee agreed on tentative ranges of monetary growth, measured from the fourth quarter of 1986 to the fourth quarter of 1987, of 5Vi to $V2 percent for M2 and M3. While a range of 3 to 8 percent for Ml in 1987 would appear appropriate in the light of most historical experience, the Committee recognized that the exceptional uncertainties surrounding the behavior of Ml velocity over the more recent period would require careful appraisal of the target range at the beginning of 1987. The associated range for growth in total domestic nonfinancial debt was provisionally set at 8 to 11 percent for 1987. In the implementation of policy for the immediate future, the Committee seeks to decrease somewhat the existing degree of pressure on reserve positions, taking account of the possibility of a change in the discount rate. This action is expected to be consistent with growth in M2 and M3 over the period from June to September at annual rates of about 7 to 9 percent. While growth in Ml is expected to moderate from the exceptionally large increase during the second (quarter, that growth will continue to be judged in the light of the behavior of M2 and M3 and other factors. Somewhat greater or lesser reserve restraint might be acceptable depending on the behavior of the aggregates, the strength of the business expansion, developments in foreign exchange markets, progress against inflation, and conditions in domestic and international credit markets. The Chairman may call for Committee consultation if it appears to the Manager for Domestic Operations that reserve conditions during the period before the next meeting are likely to be associated with a federal funds rate persistently outside a range of 4 to 8 percent. Votes for the short-run operational paragraph: Messrs. Volcker, Corrigan, Angell, Guffey, Mrs. Horn, Messrs. Johnson, Morris, Rice, Ms. Seger, and Mr. Wallich. Vote against this action: Mr. Melzer. Absent and not voting: None. Mr. Melzer preferred to direct open market operations toward maintaining the existing degree of 130 FOMC Policy Actions pressure on reserve conditions. He was concerned that easing under current circumstances could foster inflationary expectations, especially in light of the uncertain outlook for reductions in the federal deficit, and have adverse repercussions on the dollar in foreign exchange markets. In addition, he noted that the outlook for the balance of 1986 and 1987 appeared to be in line with the economy's long-run potential and, in any event, he believed that further accommodation would have little positive impact on real output in the short run and would be accompanied by greater price pressures in the long run. ufacturing employment registered another drop, bringing the cumulative decline since January to 175,000. The civilian unemployment rate declined 0.2 percentage point to 6.9 percent, toward the lower end of the range that has prevailed over the past year. The index of industrial production edged down 0.1 percent in July after declining 0.3 percent in June. Since reaching its most recent peak in January, the index has dropped about 2 percent. Despite increased production in July in industries affected by the settlement of strikes, particularly the communication equipment industry, output has remained generally sluggish. Weakness has persisted in the output of business equipment and consumer goods, although the Meeting Held on August 19, 1986 direct effects of declines in petroleum drilling are beginning to wane; auDomestic Policy Directive tomobile assemblies were down The information reviewed at this 400,000 in July, but the decline was meeting indicated an uneven pattern largely offset by gains in the producof developments in different sectors tion of light trucks. Capacity utilizaof the economy but suggested on tion in manufacturing, mining, and balance that economic activity was utilities decreased 0.2 percentage point expanding at a moderate pace in the further in July to 78.2 percent; during current quarter. Consumer spending the past six months the overall rate and housing activity have been rela- of capacity utilization has fallen 2.6 tively robust, while business invest- percentage points. Total retail sales were about unment has remained sluggish and the trade balance does not appear to changed in June and July; however, have improved. On average, prices excluding automobiles, gasoline, and and wages have risen more slowly nonconsumption items, retail sales this year than in 1985, although increased 0.7 percent in July after an fluctuations in energy costs have upward-revised increase of 0.4 perresulted in some month-to-month cent in June. Sales remained particularly strong at furniture and applivolatility. Total nonfarm payroll employ- ance stores. Total car sales slipped ment grew strongly in July, rising to a 10.9 million unit annual rate in nearly VA million after adjustment for July, as a drop in sales of domestic strikes, well above the average models more than offset an increase monthly gains during the first half of in foreign car sales. the year. Hiring was up in construcResidential construction activity has tion and remained robust in the trade continued to expand, reflecting the and service sectors. However, man- rise in housing starts earlier in the year. However, the level of starts has tapered off recently from the exceptional pace of the early spring, reflecting in part high vacancy rates and tax law changes that have damped multifamily construction. In June, total private starts were at an annual rate of 13A million units. Sales of single-family homes also weakened in May and June, but from a very high April peak. Business fixed investment apparently remained sluggish with the weakness concentrated in nonresidential structures. The sharp curtailment of petroleum drilling contributed to a further decline in the nonresidential structures component, although commercial and industrial construction also fell. Moreover, new commitments for nonresidential construction have fallen sharply since late last year, suggesting that outlays may retreat further during the third quarter. In contrast to structures, outlays for equipment rose markedly in the second quarter, led by a rebound in office and computer equipment; however, this gain only partly reversed a sharp decline in the first quarter. New orders for nondefense capital goods fell for three consecutive months before posting a small gain in June. Inventory data for the second quarter, though incomplete, suggested a marked slowdown in the rate of accumulation, as auto dealers pared stocks slightly after two quarters of rapid accumulation. Wage increases appear to have slowed further this year, and, except for *a June rebound in consumer energy prices, recent price data have reflected continued restraint through midyear. The producer price index fell 0.4 percent in July, and the consumer price index excluding energy was up 0.2 percent in June. For FOMC Policy Actions 131 the second quarter as a whole, the CPI excluding energy rose at an annual rate of about 3 percent, down almost a full percentage point from the first quarter. In the commodity markets, the price of crude oil on spot markets fell through much of July, but then rose sharply following an accord by OPEC to restrain production. At the same time, livestock and poultry prices have moved higher while gold and platinum prices have soared, apparently largely reflecting expectations of reduced supplies. Since the July FOMC meeting, the weighted-average foreign exchange value of the dollar declined a further 3V2 percent on balance; the dollar depreciated almost 5V2 percent against the mark and somwhat less against the yen. The reduction in the discount rate by the Federal Reserve announced on July 10 and the failure of other central banks to follow apparently contributed to the dollar's weakness. Short-term interest rates abroad were little changed during the intermeeting period while comparable U.S. rates declined about xh of 1 percentage point. The differentials between long-term interest rates in the United States and comparable rates in Germany and Japan were about unchanged on balance. The U.S. merchandise trade deficit in the second quarter appeared unchanged from the first quarter. The value of oil imports continued to fall, while that of non-oil imports rose further. About one-half of the increase in the value of non-oil imports apparently reflected rising import prices. At its meeting on July 8-9, the Committee adopted a directive that called for decreasing somewhat the existing degree of pressure on reserve positions, taking account of the possibility of a change in the discount rate. The members expected such an 132 FOMC Policy Actions approach to policy to be consistent with growth in M2 and M3 over the period from June to September at annual rates of 7 to 9 percent. Over the same period growth in Ml was expected to moderate from the rapid pace in the second quarter. The Committee agreed that it would continue to evaluate Ml in light of the broader aggregates and other factors. The members also acknowledged that somewhat greater or lesser reserve restraint might be acceptable depending on the behavior of the aggregates, the strength of the business expansion, developments in foreign exchange markets, progress against inflation, and conditions in domestic and international credit markets. The intermeeting range for the federal funds rate was reduced 1 percentage point to 4 to 8 percent. An easing in reserve conditions was implemented shortly after the July meeting through a V2 point reduction in the discount rate to 6 percent. In the two complete reserve maintenance periods since the meeting, adjustment plus seasonal borrowing at the discount window averaged just under $400 million, somewhat higher than in the previous intermeeting period. A portion of this borrowing, however, reflected adjustment credit to depository institutions facing special situations. Incoming data during the intermeeting period indicated that growth of all of the monetary aggregates accelerated in July. M2 and M3 were estimated to have expanded at annual rates of 123/4 and 13 percent respectively. The rapid growth in the broader aggregates pushed them into the upper portions of their ranges for 1986. At the same time growth in Ml in July was close to the extraordinary pace of the second quarter. Federal funds generally traded in the 6V4 to 63/s percent area after the l /i percentage point cut in the discount rate announced on July 10, down from the 6% percent rate prevailing at the time of the July meeting. With the reduction in the discount rate widely anticipated, however, other interest rates generally did not post comparable declines. While rates on short-term securities have fallen 25 to 50 basis points over the intermeeting period, yields in the longer-term markets have been about unchanged to only slightly lower on balance. The recent behavior of longer-term interest rates has reflected in part uncertainty about the prospects for further rate declines in light of the absence of policy actions abroad to reduce interest rates as well as a cautious interpretation of incoming economic and price news, including the possibility of some increase in inflationary pressures over time. The staff projections presented at this meeting suggested that growth in real GNP likely would pick up somewhat in coming months. Growth was forecast to continue at a moderate pace in 1987. A projected improvement in the U.S. trade position was anticipated to be a key element supporting growth in domestic production over the next year and a half. Over the same time period, growth in domestic demand was expected to be relatively sluggish. The rate of inflation was anticipated to edge up in coming quarters, partly reflecting upward pressure on prices from the effects of the dollar's depreciation as well as the diminishing impact of oil price declines, which had served to hold down price indexes thus far in 1986. The civilian unemployment rate was forecast to FOMC Policy Actions 133 drop somewhat over the projection horizon. In the Committee's discussion of the economic situation and outlook, members focused considerable attention on the uncertain prospects for the nation's foreign trade deficit. They saw trade developments as a key element in the outlook for domestic business activity, and several commented that the business expansion might well remain relatively weak if the trade balance did not show significant improvement over the quarters ahead. The substantial depreciation of the dollar against major foreign currencies was still expected to foster a turnaround in net exports at some point, but the absence of progress to date could be read as auguring a muted as well as a further delayed response to the dollar's depreciation. During the discussion, a number of members emphasized that improvement in the trade balance was being inhibited by relatively sluggish economic activity in several key industrial nations abroad. Other developments working in the same direction included the lack of dollar depreciation against the currencies of a number of developing countries that had important trading relationships with the United States, the severe debt problems of several less developed nations, and the competition in agricultural export markets stemming from large grain harvests in many parts of the world. On the more positive side, members referred to the apparently more favorable prospects for economic expansion in a major European country. Some members also commented that while improvement in the trade balance had been more delayed than many had expected, some historical expe rience in combination with current circumstances provided reasons for remaining optimistic that a substantial turnaround in trade would occur later, perhaps toward the end of this year or in early 1987. The members differed to some extent in their assessment of domestic developments bearing on the economic outlook. While economic performance remained uneven in different sectors of the economy and parts of the country, overall consumer spending and the demand for housing were being well maintained in association with continuing gains in employment and incomes and reduced interest rates. One member observed that, given generally lean inventories outside the automobile industry, further gains in consumer spending were likely to stimulate increasing domestic production at some point. A number of members also referred to the relatively rapid growth in money balances as a factor that would tend to support business activity over the quarters ahead. On the negative side, rising consumer debt burdens were likely to restrain the expansion in consumer spending and business investment showed no evidence of an appreciable pickup. The members recognized that a number of developments, in addition to the uncertainties surrounding the outlook for trade, were currently clouding economic prospects. These included the tax reform legislation whose overall impact was very difficult to predict, especially for the next several quarters, because of the very comprehensive and complex changes incorporated in the legislation. In the consumption area, for example, the loss of deductibility for sales taxes starting in 1987 and the phase-out of interest deductions on consumer debt 134 FOMC Policy Actions might tend to restrain spending on consumer durables over time, but some members noted that it might also stimulate such spending over the balance of the year. The impact of the new legislation on business investment was especially hard to assess. It was suggested that on balance the impact might tend to be negative for some time, but many businessmen apparently saw the removal of uncertainties about the legislation as a positive development for the nearer term. Members also commented that the outlook for the federal budget deficit and its consequent impact on the economy remained unclear. With regard to the prospects for inflation, the members generally were not concerned about a resurgence in the nearer term, but several expressed uneasiness about the longerrun outlook. Members referred to the inflationary implications of relatively rapid monetary growth, especially if it continued, and to the further impact of the dollar's depreciation on prices of imports and competing domestic products. In the latter connection one member observed that, despite relatively large inventories, domestic producers of automobiles were raising their prices in response to increases in the prices of competing imports. One member also expressed concern that the new tax reform legislation, to the extent that it shifted tax burdens to businesses, could put upward pressures on prices, at least initially. The favorable direct effects of large declines in oil prices now appeared to be in the past, and one member observed that commodity prices more generally might be poised for an upturn. Some members saw indications that inflationary expectations were starting to intensify, even though actual prices and wages generally were rising less rapidly this year than in 1985. At its meeting in July the Committee had reviewed the basic policy objectives that it had established in February for growth of the monetary and credit aggregates in 1986 and had set tentative objectives for expansion in 1987. For the period from the fourth quarter of 1985 to the fourth quarter of 1986, the Committee had reaffirmed the ranges established in February for growth of 6 to 9 percent for both M2 and M3. The associated range for expansion in total domestic nonfinancial debt also was reaffirmed at 8 to 11 percent for 1986. With respect to Ml, the Committee decided that growth in excess of the 3 to 8 percent range set in February would be acceptable and would be evaluated in the light of the behavior of Ml velocity, the expansion of the broader aggregates, developments in the economy and financial markets, and price pressures. For 1987 the Committee agreed on tentative monetary growth objectives that included a reduction of V2 percentage point to a range of 5V2 to 8V2 percent for both M2 and M3. In the case of Ml the Committee expressed the preliminary view that retention of the 1986 range of 3 to 8 percent, which implied a considerable reduction from the actual rate of growth that now seemed likely for 1986, appeared appropriate for 1987 in the light of most historical experience. The Committee also retained the range of 8 to 11 percent for growth in total domestic nonfinancial debt in 1987. It was understood that all the ranges were provisional and that, notably in the case of Ml, they would be reviewed in early 1987 in the light of intervening developments. In the Committee's discussion of policy implementation for the weeks immediately ahead, a number of members suggested that any further easing might be accomplished through a further xh percentage point reduction in the discount rate, while open market operations would be directed toward maintaining an essentially unchanged degree of reserve availability. Some members expressed reservations about such a reduction, especially in the absence of indications that it would be followed fairly promptly by policy easing actions in major industrial nations abroad. In this view a unilateral decrease in the discount rate might foster substantial additional depreciation in the dollar, with adverse repercussions on investor willingness to hold dollars. Several members, however, saw a lesser risk to the dollar or one that needed to be accepted. Some wanted to reduce the risks of rapid dollar depreciation by a small increase in the degree of reserve pressure in the event of a reduction in the discount rate. Several other members indicated that they did not agree. While some firming should not be ruled out in their view, it should be made contingent on an adverse move in the exchange rate and other potential developments such as evidence of greater inflationary danger and stronger business activity. One member also commented that any increase in the degree of reserve pressure had to be weighed against the risk of triggering a rise in long-term interest rates; such a rise, if it occurred, would weaken the prospects for a pickup in the rate of economic expansion. In further discussion, Committee members expressed some concern about the continuation of rapid growth in the monetary aggregates and the implications of such growth for po FOMC Policy Actions 135 tential inflation later. The members recognized that much of the rapid growth, especially in Ml, probably reflected increasing demands for liquid assets in response to declining interest rates and subsiding inflation rather than excessive money creation with potentially inflationary consequences. They also felt that Ml growth should continue to be evaluated in the context of a relatively sluggish economy and in light of the expansion in the broader aggregates. While a sluggish economic performance would dampen inflationary risks, continuing growth in M2 and M3 at the relatively rapid rates experienced recently might be a matter of growing concern, especially if such expansion tended to coincide with indications of stronger business activity. In their evaluation of the outlook for monetary growth, the members took into account an analysis which indicated that much slower expansion, especially in the broader aggregates, was likely to develop over the next few months if short-term interest rates stayed around their current levels. On the other hand, monetary growth might remain relatively rapid over the period ahead if short-term rates were to drop somewhat further. The members recognized that the timing and extent of any slowing in monetary growth remained subject to a great deal of uncertainty. In the discussion of possible intermeeting adjustments in the degree of reserve pressure, the members agreed that a degree of flexibility would be useful, taking into consideration whether or not the discount rate was reduced and subsequent developments in domestic financial markets and especially in foreign exchange markets. If the discount rate were not reduced, a slight easing in pressure on reserve positions might 136 FOMC Policy Actions be appropriate. Alternatively, if the discount rate were reduced and the reduction was followed by a substantial weakening of the dollar in foreign exchange markets, a little greater caution in the provision of reserves through open market operations would be appropriate. In keeping with the Committee's usual practice, consideration also would need to be given to ongoing economic and financial developments and the growth of the monetary aggregates. Such developments might warrant an adjustment in either direction. At the conclusion of the Committee's discussion, all but two members indicated that they favored or could accept a directive that called for some slight easing in the degree of reserve pressure, taking account of the possibility that such easing might be accomplished through a reduction in the discount rate. The members expected this approach to policy implementation to be consistent with growth in M2 and M3 at annual rates of about 7 to 9 percent over the June-to-September period. Over the same interval, growth in Ml was expected to moderate from the exceptionally large increase during the second quarter. With the prospective behavior of Ml remaining subject to unusual uncertainty, the Committee again decided not to specify a rate of expected growth in the operational paragraph of the directive but to continue to evaluate this aggregate in the light of the performance of the broader aggregates and other factors. The Committee indicated that it might find somewhat greater or somewhat lesser reserve restraint acceptable over the intermeeting period depending on the decision with respect to the discount rate and on such other factors as the behavior of the monetary aggregates, the strength of the business expansion, the performance of the dollar in foreign exchange markets, progress against inflation, and conditions in domestic and international credit markets. The members agreed that the intermeeting range for the federal funds rate, which provides a mechanism for initiating consultation of the Committee when its boundaries are persistently exceeded, should be left unchanged at 4 to 8 percent. At the conclusion of the meeting, the following domestic policy directive was issued to the Federal Reserve Bank of New York: The information reviewed at this meeting indicates a mixed pattern of developments but suggests on balance that economic activity is expanding moderately in the current quarter. In July total nonfarm payroll employment grew strongly, boosted in part by the return of striking workers. However, continued weakness in the industrial sector was reflected in further declines in employment in manufacturing and mining. The civilian unemployment rate moved down to 6.9 percent from 7.1 percent in June. Industrial production declined slightly further in July. The nominal value of total retail sales was about unchanged during the month, as sales of new autos declined somewhat but spending on other consumer goods remained strong. Housing starts fell somewhat in May and June from a relatively high level earlier in the year. Business capital spending appears to have remained weak, partly reflecting continuing declines in the energy sector. While fluctuations in energy prices have caused some month-to-month volatility, on average prices and wages are rising more slowly this year than in 1985. The trade-weighted value of the dollai against major foreign currencies has continued to decline since the July 8-9 meeting of the Committee. The U.S. merchandise trade deficit in the second quarter appears to have been about unchanged from the first quarter. The value of total exports and of total imports remained about the same in the two quarters, although the value of oil imports continued to fall in the second quarter while that of non-oil imports rose further. Growth of M2 and especially of M3 picked up in July, lifting expansion of these two aggregates for the year through July well into the upper portion of their respective ranges established by the Committee for 1986. In July Ml continued to grow at a rate close to the very rapid pace of the second quarter. Expansion in total domestic nonfinancial debt remains appreciably above the Committee's monitoring range for 1986. Short-term interest rates have declined somewhat since the July meeting of the Committee, while most long-term interest rates are about unchanged to slightly lower on balance. On July 10, the Federal Reserve Board approved a reduction in the discount rate from 6V2 to 6 percent. The Federal Open Market Committee seeks monetary and financial conditions that will foster reasonable price stability over time, promote growth in output on a sustainable basis, and contribute to an improved pattern of international transactions. In furtherance of these objectives the Committee agreed at the July meeting to reaffirm the ranges established in February for growth of 6 to 9 percent for both M2 and M3, measured from the fourth quarter of 1985 to the fourth quarter of 1986. With respect to Ml, the Committee recognized that, based on the experience of recent years, the behavior of that aggregate is subject to substantial uncertainties in relation to economic activity and prices, depending among other things on the responsiveness of Ml growth to changes in interest rates. In light of these uncertainties and of the substantial decline in velocity in the first half of the year, the Committee decided that growth of Ml in excess of the previously established 3 to 8 percent range for 1986 would be acceptable. Acceptable growth of Ml over the remainder of the year will depend on the behavior of velocity, growth in the other monetary aggregates, developments in the economy and financial markets, and price pressures. Given its rapid growth in the early part of the year, the Committee recognized that the increase in total domestic nonfinancial debt in 1986 may exceed its monitoring range of 8 to 11 percent, but felt an increase in that range would provide an inappropriate benchmark for evaluating longerterm trends in that aggregate. For 1987 the Committee agreed on tentative ranges of monetary growth, measured from the fourth quarter of 1986 to quarter of 1987, of 5Vi to SVi the fourth FOMC Policy Actions 137 percent for M2 and M3. While a range of 3 to 8 percent for Ml in 1987 would appear appropriate in the light of most historical experience, the Committee recognized that the exceptional uncertainties surrounding the behavior of Ml velocity over the more recent period would require careful appraisal of the target range at the beginning of 1987. The associated range for growth in total domestic nonfinancial debt was provisionally set at 8 to 11 percent for 1987. In the implementation of policy for the immediate future, the Committee seeks to decrease slightly the existing degree of pressure on reserve positions, taking account of the possibility of a change in the discount rate. This action is expected to be consistent with growth in M2 and M3 over the period from June to September at annual rates of about 7 to 9 percent. While growth in Ml is expected to moderate from the exceptionally large increase during the second quarter, that growth will continue to be judged in the light of the behavior of M2 and M3 and other factors. Somewhat greater or lesser reserve restraint might be acceptable depending on the behavior of the aggregates, the strength of the business expansion, developments in foreign exchange markets, progress against inflation, and conditions in domestic and international credit markets. The Chairman may call for Committee consultation if it appears to the Manager for Domestic Operations that reserve conditions during the period before the next meeting are likely to be associated with a federal funds rate persistently outside a range of 4 to 8 percent. Votes for this action: Messrs. Volcker, Corrigan, Angell, Guffey, Heller, Mrs. Horn, Messrs. Johnson, Morris, Rice, and Ms. Seger. Votes against this action: Messrs. Melzer and Wallich. Absent and not voting: None. Messrs. Melzer and Wallich were in favor of maintaining the existing degree of reserve pressure. Mr. Melzer continued to be concerned about the impact of further easing on inflationary expectations and the value of the dollar in foreign exchange markets. In addition, he noted that during the intermeeting period the 138 FOMC Policy Actions outlook for real economic activity in the second half of 1986 and in 1987 had not deteriorated and perhaps even had improved slightly. Mr. Wallich emphasized that the implementation of unchanged reserve conditions would improve the prospects for significant slowing in monetary growth, thereby reducing the potential for inflation. Meeting Held on September 23, 1986 Domestic Policy Directive The information reviewed at this meeting suggested a moderate pickup in economic growth from the slow pace in the second quarter. Payroll employment expanded further in August with gains widespread by industry. Consumer spending has continued to increase at a relatively rapid pace, and construction of singlefamily homes has remained at a high level. Business capital spending, however, has been sluggish, particularly for new structures. Wage rates have continued to increase slowly in recent months, while producer and consumer prices have tended to firm reflecting developments in food and energy markets. Total nonfarm payroll employment continued to expand in August, rising about XA million further after adjusting for strike activity, somewhat faster than the average gain so far this year. Hiring at service establishments accounted for two-thirds of the increase, but construction employment also was up substantially, and manufacturing employment rose for the first time since January. The civilian unemployment rate edged down again in August to 6.8 percent, nearly xh percentage point below the second-quarter average. After declining on balance over the first half of the year, industrial production has picked up recently. According to revised data, output was flat in June and rose 0.3 percent in July, rather than declining in both months as previously reported. In August industrial production edged up 0.1 percent. Gains in output in July and August were particularly large for defense and space equipment. Production of business equipment, consumer goods, and construction supplies also registered strong increases. Capacity utilization in manufacturing, mining, and utilities fell 0.1 percentage point in August to 79 percent, about the same as the rate in the preceding three months but 1.6 percentage points below a year ago. Retail sales rose 0.8 percent in August, after a July increase of 0.3 percent. Sales in the automotive group strengthened noticeably in response to incentive plans offered at the end of the month by domestic auto producers. Total car sales rose to an annual rate of 12.2 million units in August, compared with 10.9 million units in July. In the early part of September, sales of domestically produced autos soared to an annual rate of 17 million units. Outlays for durable goods other than autos, which were strong earlier in the year, dropped back in August, but sales at general merchandisers posted another large gain. Residential construction activity remained relatively high through the summer. Housing starts totaled 1.8 million units at an annual rate in July and August. Single-family starts remained close to the vigorous pace of the first half of the year, while FOMC Policy Actions 139 multifamily starts were appreciably index had risen on balance in other below their average level in that recent months after falling somewhat period. In July sales of new homes during the first four months of the dropped below the extraordinary lev- year. In the commodity markets, els recorded earlier in the year, but spot prices for precious metals rose sales of existing homes remained at sharply during August, reflecting about the advanced pace of the supply disruptions and, perhaps, renewed inflationary expectations. The second quarter. Business capital spending has re- latter appeared to be associated in mained sluggish, reflecting continued part with oil price developments and weakness in nonresidential construc- the lower foreign exchange value of tion. Although the contraction in oil the dollar. Lumber prices also rose and gas-well drilling appears to be significantly during August. subsiding, the downtrend in commerThe trade-weighted value of the cial and industrial building has con- dollar against major foreign currentinued partly because of high vacancy cies had changed very little on balrates and the impact of the tax ance since the August 19 meeting of reform legislation. The value of non- the Committee, although it flucresidential construction put in place tuated over a fairly wide range. fell in July for the fifth time in six Exchange rates appeared to be afmonths. Business outlays for equip- fected mainly by news about prosment, however, have expanded pects for economic activity in the somewhat in recent months; ship- United States and abroad. Germany ments of nondefense capital goods in and Japan did not follow the Federal August were lVi percent above the Reserve's reduction in the discount second-quarter average. New orders rate, and short-term interest rates fell in August, partially reversing abroad were little changed while gains in the previous two months, money market rates in the United largely because orders for aircraft States were somewhat lower. At the and parts dropped. Bookings for same time, long-term rates in the office and computing equipment, United States moved up sharply relhowever, have rebounded from their ative to comparable foreign interest level earlier this year. rates. Preliminary data for the U.S. Wage rates have continued to rise merchandise trade deficit in July moderately over the past few months, indicated a substantially larger deficit while producer and consumer prices than on average in the first half of have firmed somewhat on balance the year as non-oil imports surged. due to developments in food and Real economic growth appeared to energy markets. Prices other than have picked up on balance in the those for food and energy, however, foreign industrial countries during have risen at about the same pace as the second quarter after a weak earlier in the year. In August, the performance in the first quarter. producer price index advanced 0.3 At its meeting in August, the percent, after changing little on bal- Committee adopted a directive that ance over the previous three months called for decreasing slightly the and declining sharply earlier in the existing degree of pressure on reyear. The consumer price index in- serve positions, taking account of the creased 0.2 percent in August. The possibility of a change in the discount 140 FOMC Policy Actions rate. The members expected such an approach to policy to be consistent with growth in M2 and M3 over the period from June to September at annual rates of about 7 to 9 percent. Over the same period growth in Ml was expected to moderate from the rapid pace during the second quarter. The Committee agreed that it would continue to evaluate growth of Ml in light of the expansion of the broader aggregates and other factors. The members also decided that somewhat greater or lesser reserve restraint might be acceptable depending on the behavior of the aggregates, the strength of the business expansion, developments in foreign exchange markets, progress against inflation, and conditions in domestic and international credit markets. The intermeeting range for the federal funds rate was maintained at 4 to 8 percent. The discount rate was reduced V2 percentage point shortly after the August meeting. In the two complete reserve maintenance periods ending after the meeting, adjustment plus seasonal borrowing at the discount window averaged close to $460 million, somewhat higher than in the previous intermeeting period. In the first week of the current maintenance period, borrowing dropped back to about $280 million. Growth in the broader monetary aggregates slowed in August; M2 and M3 grew at annual rates of about 103/4 percent and 8V2 percent, respectively. In August, both aggregates were close to the upper limits of their longer-run ranges. In contrast to the broader aggregates, growth in Ml accelerated, but it appeared to have slowed considerably in the early weeks of September. Federal funds generally have traded around 57/s percent since the reduction in the discount rate shortly after the August 19 meeting of the Committee. Other short-term interest rates fell about 30 basis points following the discount rate cut. Longer-term bond yields changed little immediately after the discount rate action but have increased noticeably in recent weeks, with rates on Treasury securities rising as much as 60 basis points. The recent behavior of longterm rates apparently has reflected, at least in part, some concerns by market participants about whether inflationary pressures could develop in the context of some strengthening in economic activity, the declining dollar, firmer oil prices, and rapid monetary growth in the United States and abroad. The staff projections presented at this meeting suggested that growth in real GNP likely would pick up a bit further in coming months. Growth was forecast to continue at a moderate pace in 1987. Through 1987, the key element supporting expansion in domestic production was a projected improvement in the U.S. trade position. Growth in domestic spending was forecast to slow over the next several quarters. The staff outlook for inflation indicated a limited increase from the current pace due to some firming in world oil prices and the effects of the dollar's depreciation. The civilian unemployment rate was expected to decline slightly over the projection horizon. In the Committee's discussion of the economic situation and outlook, the members expressed general agreement with the staff projection that moderate growth through the forecast horizon was the most likely outcome. However, the outlook remained subject to substantial uncer- FOMC Policy Actions 141 tainties relating to both domestic and international factors. On the favorable side, consumer spending and construction of single-family housing remained elements of strength in the domestic economy, and members reported that business sentiment appeared to have improved recently in several, but not all, parts of the country. One member noted that reduced personal income taxes could help to sustain consumer expenditures next year. Another commented that the emergence of apparently more stable conditions in agriculture and energy would tend to remove the retarding influences that those key sectors had been exerting on overall economic activity. On the negative side, the demand for automobiles undoubtedly would weaken after the currently attractive incentive programs expired, and the apparent overbuilding of multifamily housing in many areas would tend to restrain overall residential construction. Business fixed investment was not expected to provide much, if any, impetus to the expansion despite indications of improvement recently in the demand for equipment. Adverse factors bearing on the investment outlook included the current oversupply of office buildings and other commercial facilities in many parts of the country and the negative effects of the tax reform legislation on investment incentives that many businessmen were reporting. The outlook for fiscal policy remained uncertain; several members noted that some of the proposed measures for reducing the deficit in 1987 did not deal with underlying imbalances and that the prospects beyond 1987 were especially unclear. However, one member observed that a reduction in government borrow ing, if achieved, would tend to have a favorable impact on financial markets and thus on the economy generally. On balance, while a few members supported the view that some pickup in domestic demand was a reasonable expectation, most believed that growth in domestic demand would probably taper off over the next several quarters. In their view, therefore, the prospects for sustained economic growth depended on an improvement in the foreign trade balance. The members generally agreed that the substantial depreciation of the dollar against several major foreign currencies provided a basis for anticipating a reduction in the trade deficit in real terms, but the timing of such a reduction still was subject to a great deal of uncertainty. Moreover, several expressed concern that the improvement might well be relatively modest, especially in the absence of stronger economic growth in key industrial nations abroad; and some members also commented on the inertia on both the import and export sides associated with long-term contracts and established marketing relationships. It also was noted that the currencies of a number of developing countries had changed relatively little vis-a-vis the dollar over the past year or so, raising a question as to the speed of adjustment in the trade balance. With regard to currently available information on trade developments, a few members referred to limited indications in reports from firms in their Districts that tended to suggest some gains in the international competitive position of U.S. firms and better prospects for greater stability, if not some improvement, in the overall trade balance. However, 142 FOMC Policy Actions broadly confirming evidence of such a development had not materialized thus far. Against the background of the dollar's depreciation, the members agreed that some upward pressure on prices could be expected over the next several quarters, a tendency that would be reinforced if world oil prices continued to rise. Moreover, most commodity prices appeared to have stabilized recently, after declining earlier, while prices of precious metals had increased considerably and these developments along with conditions in financial markets suggested increased concern about the possibility of a pickup in inflation. On the other hand, a number of members observed that wages generally were rising somewhat less this year than in 1985 and some members also commented on the continuing efforts of many business firms to hold down their costs. And while productivity gains had been relatively limited in recent quarters, many labor contracts incorporated provisions on work rules that should help to improve efficiency and moderate pressures on costs. At its meeting in July the Committee reviewed the basic policy objectives that it had established in February for growth of the monetary and credit aggregates in 1986 and set tentative objectives for expansion in 1987. For the period from the fourth quarter of 1985 to the fourth quarter of 1986, the Committee reaffirmed the ranges established in February for growth of 6 to 9 percent for both M2 and M3. The associated range for expansion in total domestic nonfinancial debt also was reaffirmed at 8 to 11 percent for 1986. With respect to Ml, the Committee decided that growth in excess of the 3 to 8 percent range set in February would be acceptable and that such growth would be evaluated in the context of the velocity of Ml, the expansion of the broader aggregates, developments in the economy and financial markets, and price pressures. For 1987 the Committee agreed on tentative monetary growth objectives that included a reduction of Vi percentage point to a range of 5V2 to 8^2 percent for both M2 and M3. In the case of Ml the Committee expressed the preliminary view that retention of the 1986 range of 3 to 8 percent, which implied a considerable reduction from the likely rate of growth in 1986, appeared appropriate for 1987 in the light of most historical experience. The Committee also retained the range of 8 to 11 percent for growth of total domestic nonfinancial debt in 1987. It was understood that all the ranges were provisional and that, notably in the case of Ml, they would be reviewed in early 1987 against the background of intervening developments. In the Committee's discussion of policy implementation for the weeks immediately ahead, nearly all the members were in favor of directing open market operations, at least initially, toward maintaining unchanged conditions of reserve availability. Several emphasized that monetary policy had moved toward an increasingly accommodative posture over the course of recent months and that it was now time to pause and observe developments, given the rapid growth in the broad as well as the narrow monetary aggregates, a few indications of more strength in the economy, and some signs of increasing inflationary expectations. One member expressed the view, however, that some tightening of reserve conditions was desirable at this time against the background of recent economic and financial developments, notably the persistence of rapid growth in the monetary aggregates. In their discussion of policy implementation over the near term, the members took into account an analysis that suggested that if current conditions of reserve availability were maintained and if short-term interest rates did not deviate significantly from their existing levels, the growth of the monetary aggregates could be expected to slow over the months ahead, relative to the very rapid pace over the summer months, even assuming somewhat stronger expansion in economic activity. The most recent behavior of the monetary aggregates lent some weight to such an expectation. However, the anticipated slowing still would result in growth of the broad aggregates around the upper bound of their long-term ranges. Also, the members recognized that the extent of any slowing in monetary growth was subject to perhaps more than the usual uncertainties, reflecting for example questions about the pace of further adjustments in offering rates on various types of interest-bearing deposits as depository institutions continued to respond to earlier declines in shortterm market rates. The members also noted that the monetary aggregates might well continue to grow very rapidly if short-term interest rates were to decline appreciably further. In the course of the discussion, a number of members expressed concern about the potential for the broad monetary aggregates to exceed their longer-term ranges. While recognizing the need to evaluate the aggregates in the context of economic and financial developments more generally, these members em FOMC Policy Actions 143 phasized the potential for inflation stemming from the buildup in money balances, and in liquid assets more generally, and these members attached considerable importance to constraining the growth of the broader monetary aggregates to within the Committee's ranges for the year, A slightly different view acknowledged that the Committee's objectives for M2 and M3 appeared to remain appropriate for the year, but in this view actual growth marginally in excess of those ranges should be tolerated—and the added risks of some future inflation accepted—if such growth occurred in the context of continuing sluggish economic expansion. One member stressed that if the velocity of money continued to decline, further rapid expansion might indeed be needed to sustain an acceptable rate of economic growth. Turning to the question of possible adjustments in the degree of reserve pressure during the intermeeting period, the members did not foresee as likely any developments that might call for more than a slight change, if any, in the availability of reserves during the weeks ahead. In this context, however, a number believed that policy implementation should be especially alert to the potential need for some slight firming of reserve conditions, particularly if monetary growth did not slow in line with expectations, though this growth would continue to be viewed in the context of other economic and financial developments. Most of these members did not want to rule out the possibility of some easing in the weeks immediately ahead, but they saw the prospects for such a move as less likely, and two favored a directive that would not contemplate any easing. Other members felt that there should be no presumptions about the 144 FOMC Policy Actions likely direction of any intermeeting adjustments, given the many uncertainties that existed about the behavior of the monetary aggregates and about prospective economic and financial developments. The members agreed that the behavior of the dollar on foreign exchange markets could be an important factor influencing any small intermeeting adjustments. At the conclusion of the Committee's discussion, all but one member indicated that they favored a directive that called for no change in the current degree of pressure on reserve positions. The members expected this approach to policy implementation to be consistent with some reduction in the growth of M2 and M3 to annual rates of 7 to 9 percent over the four-month period from August to December. Over the same interval, growth in Ml was expected to moderate from the exceptionally large increase during the past several months. Because the prospective behavior of Ml remained subject to unusual uncertainty, the Committee again decided not to specify a rate of expected growth for this aggregate in the operational paragraph of the directive but to continue to evaluate Ml in the light of the performance of the broader aggregates and other factors. The members indicated that slightly greater reserve restraint would, or slightly lesser restraint might, be acceptable over the intermeeting period depending on the behavior of the monetary aggregates, taking into account the strength of the business expansion, the performance of the dollar in foreign exchange markets, progress against inflation, and conditions in domestic and international credit markets. The members agreed that the intermeeting range for the federal funds rate, which provides a mechanism for initiating consultation of the Committee when its boundaries are persistently exceeded, should be left unchanged at 4 to 8 percent. A t the conclusion of the meeting, the following domestic policy directive was issued to the Federal R e serve Bank of N e w York: The information reviewed at this meeting suggests some pickup in the growth of economic activity from the slow pace in the second quarter. In August total nonfarm payroll employment grew considerably further, with employment in manufacturing rising for the first time since January. The civilian unemployment rate edged down further to 6.8 percent. Industrial production rose slightly in July and August after declining on balance during the first half of the year. Consumer spending has remained relatively strong in recent months, with gains in retail sales in August paced by a sharp rise in auto sales. Housing starts in July and August stayed at a relatively high level. Business capital spending appears to have remained sluggish, reflecting weakness in nonresidential construction. A more moderate rate of wage increases has been sustained in recent months, while broad measures of prices have firmed somewhat due to developments in food and energy markets. The trade-weighted value of the dollar against major foreign currencies is essentially unchanged on balance since the August 19 meeting of the Committee. Preliminary data for the U.S. merchandise trade deficit in July indicate a larger deficit than in previous months. Growth of M2 and especially of M3 moderated in August, but expansion of these two aggregates for the year through August has been at the upper end of their respective ranges established by the Committee for 1986. In August Ml continued to grow very rapidly. Expansion in total domestic nonfinancial debt remains appreciably above the Committee's monitoring range for 1986. Short-term interest rates have declined further since the August meeting of the Committee while longterm market rates have risen on balance. On August 20, the Federal Reserve Board approved a reduction in the discount rate from 6 to 5V2 percent. The Federal Open Market Committee seeks monetary and financial conditions that will foster reasonable price stability over time, promote growth in output on a sustainable basis, and contribute to an improved pattern of international transactions. In furtherance of these objectives the Committee agreed at the July meeting to reaffirm the ranges established in February for growth of 6 to 9 percent for both M2 and M3, measured from the fourth quarter of 1985 to the fourth quarter of 1986. With respect to Ml, the Committee recognized that, based on the experience of recent years, the behavior of that aggregate is subject to substantial uncertainties in relation to economic activity and prices, depending among other things on the responsiveness of Ml growth to changes in interest rates. In light of these uncertainties and of the substantial decline in velocity in the first half of the year, the Committee decided that growth of Ml in excess of the previously established 3 to 8 percent range for 1986 would be acceptable. Acceptable growth of Ml over the remainder of the year will depend on the behavior of velocity, growth in the other monetary aggregates, developments in the economy and financial markets, and price pressures. Given its rapid growth in the early part of the year, the Committee recognized that the increase in total domestic nonfinancial debt in 1986 may exceed its monitoring range of 8 to 11 percent, but felt an increase in that range would provide an inappropriate benchmark for evaluating longerterm trends in that aggregate. For 1987 the Committee agreed on tentative ranges of monetary growth, measured from the fourth quarter of 1986 to the fourth quarter of 1987, of 5Vi to SVi percent for M2 and M3. While a range of 3 to 8 percent for Ml in 1987 would appear appropriate in the light of most historical experience, the Committee recognized that the exceptional uncertainties surrounding the behavior of Ml velocity over the more recent period would require careful appraisal of the target range at the beginning of 1987. The associated range for growth in total domestic nonfinancial debt was provisionally set at 8 to 11 percent for 1987. In the implementation of policy for the immediate future, the Committee seeks to maintain the existing degree of pressure on reserve positions. This action is expected to be consistent with growth in M2 and M3 over the period from August FOMC Policy Actions 145 to December at annual rates of 7 to 9 percent. While growth in Ml is expected to moderate from the exceptionally large increase during the past several months, that growth will continue to be judged in the light of the behavior of M2 and M3 and other factors. Slightly greater reserve restaint would, or slightly lesser reserve restraint might, be acceptable depending on the behavior of the aggregates, taking into account the strength of the business expansion, development in foreign exchange markets, progress against inflation, and conditions in domestic and international credit markets. The Chairman may call for Committee consultation if it appears to the Manager for Domestic Operations that reserve conditions during the period before the next meeting are likely to be associated with a federal funds rate persistently outside a range of 4 to 8 percent. Votes for this action: Messrs. Volcker, Corrigan, Angell, Guffey, Heller, Mrs. Horn, Messrs. Johnson, Melzer, Morris, Rice, and Ms. Seger. Vote againstthis action: Mr. Wallich. Mr. Wallich dissented because he preferred a slight tightening of reserve conditions. He was concerned about the persistence of rapid monetary expansion and the associated potential for inflation. In his view some reduction in the availability of reserves was needed to increase the likelihood of significant slowing in monetary growth over the months ahead. Meeting Held on November 5, 1986 1. Domestic Policy Directive The information reviewed at this meeting suggested that economic activity grew at a moderate rate in the third quarter, after rising only slightly in the previous quarter. Payroll employment expanded somewhat fur- 146 FOMC Policy Actions ther in September, although manufacturing jobs declined following little change in August. Consumer spending, which had been quite robust in the first half of the year, strengthened further in the third quarter. Business capital spending, however, remained sluggish, reflecting declines in outlays for nonresidential construction; new orders rose in September and equipment spending picked up. Residential constuction expenditures advanced further in the third quarter, but housing starts fell in September. Wage increases have continued to moderate, while prices have increased a bit because of developments in food and energy markets. Industrial production rose another 0.1 percent in September. The gain partly reflected a surge in the production of cars and light trucks. Other production was unchanged on balance; production of defense equipment rose, but output of nondefense goods edged down and materials production remained sluggish. Domestic automakers apparently cut back assemblies during October, but still were planning relatively large production for the fourth quarter as a whole. Capacity utilization in manufacturing, mining, and utilities was unchanged in September at 79.2 percent. The utilization rate in mining continued to decline, while the rate in manufacturing edged up, reflecting the pickup in motor vehicle production. Total nonfarm payroll employment grew somewhat further in September. The sluggish pace of industrial production was reflected in a decline in manufacturing jobs that more than offset the increase reported for August. Employment in trade, finance, and services advanced further in September, but at a less rapid rate than in earlier months of the year. The civilian unemployment rate moved back up to 7 percent in September, close to its average level earlier in the year. Total retail sales increased 4.6 percent in September because of a substantial jump in auto sales following the expansion of sales incentive programs by domestic automakers in late August. During September, domestic cars sold at a record 11% million unit annual rate, compared with an average 8% million unit pace in the preceding five months. Light trucks and foreign cars also sold at record monthly rates in September. Outside of the auto group, sales were virtually unchanged from August levels. In the business sector, spending has remained sluggish. Business purchases of motor vehicles were up sharply in the third quarter, but spending for other equipment declined, and outlays for nonresidential structures dropped substantially further. However, new orders for nondefense capital goods rose sharply in September; although aircraft orders accounted for half of the increase, bookings for many other types of equipment also posted sizable gains. For structures, data on new commitments have continued to point to further declines in office building, but the drop in oil- and gas-well drilling appears to have ended. Housing starts have declined since earlier in the year but residential construction expenditures rose through the summer. Total private housing starts dropped in September to an annual rate of 1.68 million units from a rate of about 1.8 million units during July and August. Single family starts fell somewhat in September, registering the lowest monthly reading since December, but sales of new and existing homes increased during the month. Multifamily housing starts declined further apparently reflecting in part record high vacancy rates and prospectively diminished rates of return on rental properties as a result of tax reform. Labor cost increases have moderated further over the past year, but price increases have been a bit higher in recent months than earlier in the year due mainly to developments in food and energy markets. Consumer food prices rose sharply during the summer, reflecting in part weatherrelated disruptions in some supplies. By September conditions had improved, and increases in retail food prices slowed noticeably. In the energy sector, petroleum prices moved up at the wellhead and refinery levels in the September PPI, reflecting the OPEC agreement in early August to curtail production. This increase in crude oil costs apparently has already reached the retail level as gasoline and heating oil prices turned up in the September CPI, after steep declines throughout much of the year. Excluding food and energy, consumer prices have risen recently at about the same pace as earlier in the year. The trade-weighted value of the dollar against major foreign currencies continued to decline for several weeks after the September 23 FOMC meeting, but it subsequently recovered and has risen somewhat on balance. Short-term and long-term interest rate differentials increased a bit during the intermeeting period; foreign rates moved up, particularly at the short end, while rates in the United States eased slightly. Real net exports of goods and services dropped further in the third quarter, mainly reflecting a surge in the volume of oil imports. After the recov FOMC Policy Actions 147 ery in real economic activity in most major foreign industrial countries in the second quarter, available data for the third quarter indicate further moderate expansion in Germany, France, the United Kingdom and to a lesser extent in Japan. At its meeting in September, the Committee adopted a directive that called for maintaining the existing degree of pressure on reserve positions. The members expected such an approach to policy to be consistent with growth in M2 and M3 from August to December at annual rates of 7 to 9 percent. Growth in Ml over the same period was expected to moderate from the exceptionally large increase during the previous several months. The Committee agreed that the growth in Ml would continue to be evaluated in view of the behavior of the broader aggregates and other factors. The members also decided that slightly greater reserve restraint would, or slightly lesser reserve restraint might, be acceptable depending on the behavior of the monetary aggregates, taking into account the strength of the business expansion, developments in foreign exchange markets, progress against inflation, and conditions in domestic and international credit markets. The intermeeting range for the federal funds rate was maintained at 4 to 8 percent. M2 and M3 increased at annual rates of 83A and 7V2 percent respectively, on average over September and October, well below their rates of growth since early spring. Through October, both aggregates were very close to the upper ends of their 6 to 9 percent annual growth ranges established by the Committee for 1986. Growth in Ml still was quite strong over September and October, but down substantially from its average over the previous several months. 148 FOMC Policy Actions Adjustment plus seasonal borrowing at the discount window averaged about $325 million in the two complete maintenance periods after the September meeting. Federal funds generally continued to trade close to 5% percent over the intermeeting period. Most other interest rates eased somewhat on balance, with short-term rates about unchanged to down 15 basis points and long-term rates off as much as 35 basis points. Bond prices increased in the days just before the meeting in part reflecting perceptions of stronger foreign demand for dollar assets, prompted to some extent by the cut in the Japanese discount rate on October 31. In addition, market participants reportedly interpreted the cut in the Japanese rate as giving the Federal Reserve more leeway to ease domestic monetary policy. The staff projections presented at this meeting suggested that real GNP would continue to grow at a moderate rate through the end of 1987. Anticipations of sustained growth in real exports, reflecting the improvement in the price competitiveness of U.S. goods, continued to be a key element supporting the expected expansion in domestic production. Growth in domestic spending was projected to be relatively sluggish over the forecast horizon. The staffs projection for inflation continued to show some step-up early next year associated with the effects of rapidly rising import prices on the prices of U.S. goods and with the turnaround in energy prices. In the Committee's discussion of the economic situation and outlook, the members agreed that incoming data on business activity and reports on specific conditions in many indus tries were broadly consistent with the staff forecast of continuing expansion at a moderate pace. There were uncertainties nonetheless about the prospective performance of individual sectors of the economy and thus of the economy generally. In the view of most members the risks of a deviation from the staff projection appeared to be evenly balanced, but a few felt the risks were greater in the direction of less growth. As they had at several previous meetings, the members focused on the performance of net exports as a key factor in the outlook for economic activity. The most recent data could be interpreted as suggesting that the trade balance was no longer worsening. However, clear evidence of an actual turnaround in the trade balance had not yet emerged and it was far from certain that there would be significant improvement during the months ahead. Some members reported that a growing number of firms were experiencing increases in orders from abroad, a development that lent support to expectations of a significant pickup in export sales over the next few quarters. To an important degree, the outlook for U.S. exports remained contingent on growing demands from major industrial nations. In that regard it was noted that the evidence was mixed. Domestic expansion—and also the demand for foreign goods—appeared to be strengthening in some major countries, but the outlook was less promising in others. On the import side, members observed that foreign competition remained intense, notably from countries whose exchange rates had not appreciated against the dollar. Nonetheless, there were reports that rising import prices FOMC Policy Actions 149 were improving the competitive position of at least some domestic producers. In the Committee's review of the outlook for spending by domestic sectors of the economy, the members generally expected demand to continue to increase, but at a slower pace than in recent quarters. Individual members again highlighted the uneven conditions in different industries and parts of the country. One member commented that the complex tax reform legislation constituted a major source of uncertainty. The members agreed that total consumer spending would tend to be held down in the current quarter by reduced purchases of automobiles following the bulge associated with attractive incentive programs. One member observed, however, that some offsetting expenditures on highpriced items might be induced before year-end because the deductibility of sales taxes in computing personal income taxes would be terminated starting in 1987. On the negative side, one member suggested that the adjustment in automobile sales might take longer than many observers currently expected and also stressed that consumer debt burdens were an important inhibiting factor on spending. In the area of business investment, members noted that construction activity would probably be held down by relatively high vacancy rates in office buildings, multifamily housing, and other commercial facilities such as hotels, especially in the context of the reportedly adverse impact of the tax reform legislation on such investments. Members also referred to a number of plant closings in the manufacturing sector. On the other hand, some current economic indicators pointed to a strengthening in the demand for business equipment. One member also commented that the prospects for improvement in the nation's balance of trade, if realized, would require more investment in domestic productive facilities over time. In regard to agriculture current conditions were mixed, but one member indicated that the overall situation in that industry and also in energy no longer appeared to be worsening and accordingly those key sectors of the economy had probably ceased to exert a negative influence on general economic activity. Likewise, the outlook for reduced government deficits, including surpluses for state and local governments, and the apparently favorable prospects for foreign trade implied a reduction in major structural imbalances and an improved basis for sustained economic expansion. With regard to the outlook for inflation, the members agreed that the lagged impacts of the dollar's depreciation along with developments in energy markets were likely to contribute to somewhat faster price increases during the year ahead. Many domestic businesses reportedly continued to look for competitive opportunities to raise prices and widen profit margins. One member observed that a potential inflation risk, and one for business activity generally, would be the emergence of new protectionist measures in response to unsatisfactory progress in reducing the nation's trade deficit. On the favorable side, wages generally appeared to be continuing to rise more slowly than earlier and businesses were continuing to devote considerable attention to paring costs and improving their productivity. 150 FOMC Policy Actions Some food prices might also tend to nonfinancial debt in 1987. It was decline following increases in recent understood that all the ranges were months. More generally, the pros- provisional and that, notably in the pect that capacity utilization rates case of Ml, they would be reviewed were likely to remain relatively low in early 1987 against the background in most industries over the year of intervening developments. ahead implied that inflationary presThe Committee's discussion of polsures would be muted during that icy implementation for the weeks period. immediately ahead reflected the sense At its meeting in July the Com- that the economy was continuing to mittee reviewed the basic policy ob- expand at a moderate rate and that, jectives that it had established in while price pressures could be February for growth of the monetary strengthening somewhat in response and credit aggregates in 1986 and it to higher import prices, those price set tentative objectives for expansion increases should be well contained. in 1987. For the period from the Externally, some signs of greater fourth quarter of 1985 to the fourth stability seemed to be emerging in quarter of 1986, the Committee re- exchange markets. In those circumaffirmed the ranges established in stances, all of the members indicated February for growth of 6 to 9 percent that they were in favor of continuing for both M2 and M3. The associated to direct open market operations range for expansion in total domestic toward maintaining unchanged connonfinancial debt also was reaffirmed ditions of reserve availability. That at 8 to 11 percent for the current conclusion was also warranted by year. With respect to Ml, the Com- indications that monetary growth had mittee decided that growth in excess moderated somewhat over Septemof the 3 to 8 percent range set in ber and October, and an expectation February would be acceptable and that the broad aggregates might stay that such growth would be evaluated close to the Committee's earlier exin relation to the velocity of Ml, the pectations for growth near the upper expansion of the broader aggregates, ends of their long-term ranges in the developments in the economy and closing months of the year, assuming financial markets, and price pres- no significant changes in reserve sures. For 1987 the Committee agreed conditions and in short-term interest on tentative monetary growth objec- rates. tives that included reductions of xh In the Committee's discussion of percentage point to ranges of 5V2 to possible intermeeting adjustments in 8^2 percent for both M2 and M3. In the degree of reserve pressure, the the case of Ml the Committee ex- members suggested that developpressed the preliminary view that ments calling for more than a slight retaining the 1986 range of 3 to 8 change in reserve conditions would percent, which implied a considera- be unlikely during the weeks ahead. ble reduction from the likely rate of Although a few members felt that growth in 1986, appeared appropri- policy implementation should remain ate for 1987 in the light of most especially alert to the potential need historical experience. The Commit- for some easing of reserve conditee also retained the range of 8 to 11 tions, notably the need to respond percent for growth of total domestic to emerging indications, if any, of FOMC Policy Actions 151 relatively weak business activity, most felt that there should be no presumptions about the likely direction of any small intermeeting adjustments, should they be desirable. With respect to the monetary aggregates, some members commented that a shortfall from current expectations would be a welcome development, given the rapid growth earlier in the year, and within limits a shortfall should be tolerated provided it occurred in the context of satisfactory economic performance and did not appear to be associated with upward pressures on market interest rates. One member commented, however, that a sharp and abrupt slowdown in Ml growth might well signal a weaker economy and, depending on the circumstances, might require more than a slight adjustment in policy implementation. At the conclusion of the Committee's discussion, all of the members indicated that they favored a directive that called for no change in the current degree of pressure on reserve positions. The members expected this approach to policy implementation to be consistent with growth of M2 and M3 at annual rates of 7 to 9 percent over the fourth quarter from a September base. Over the same period, growth in Ml was expected to moderate from its exceptional pace during most of the period since early spring. Because the behavior of Ml remained subject to unusual uncertainty, the Committee decided to continue its recent practice of not specifying a rate of expected growth for purposes of short-run policy implementation but to evaluate this aggregate in the light of the performance of the broader monetary aggregates and other factors. The members indicated that slightly greater or slightly lesser reserve pressures might be acceptable over the intermeeting period depending on the behavior of the monetary aggregates, taking into account the strength of the business expansion, the performance of the dollar in foreign exchange markets, progress against inflation, and conditions in domestic and international credit markets. The members agreed that the intermeeting range for the federal funds rate, which provides a mechanism for initiating consultation of the Committee when its boundaries are persistently exceeded, should be left unchanged at 4 to 8 percent. At the conclusion of the meeting, the following domestic policy directive was issued to the Federal Reserve Bank of New York: The information reviewed at this meeting indicates that economic activity grew at a moderate pace in the third quarter. In September total nonfarm payroll employment grew somewhat further, although employment in manufacturing fell after changing little in August. The civilian unemployment rate moved back up to 7.0 percent in September, close to its average level earlier in the year. Industrial production rose slightly further in September and posted a moderate gain over the third quarter. Consumer spending has remained strong in recent months, with gains in retail sales in August and especially in September paced by a sharp rise in auto sales. Housing starts fell in September, but residential investment increased further in the third quarter as a whole. Business capital spending appears to have remained sluggish; equipment spending picked up in the third quarter and new orders were strong in September, but outlays for nonresidential construction continued to decline. Real net exports of goods and services dropped further in the third quarter, reflecting in large part a surge in the volume of oil imports. Increases in labor compensation have slowed over the course of the year, while broad measures of prices have firmed somewhat recently due to developments in food and energy markets. 152 FOMC Policy Actions Growth of M2 moderated further in September, but appears to have picked up in October, while growth of M3 has tended to slow. Expansion of these two aggregates for the year through September has been at the upper end of their respective ranges established by the Committee for 1986. Growth of Ml slowed in the September-October period from the very rapid pace experienced since early spring. Expansion in total domestic nonfinancial debt remains appreciably above the Committee's monitoring range for 1986. Most interest rates have declined somewhat since the September 23 meeting of the Committee. Although the tradeweighted value of the dollar against major foreign currencies continued to decline for several weeks after the September meeting, it subsequently recovered and has risen somewhat on balance. The Federal Open Market Committee seeks monetary and financial conditions that will foster reasonable price stability over time, promote growth in output on a sustainable basis, and contribute to an improved pattern of international transactions. In furtherance of these objectives the Committee agreed at the July meeting to reaffirm the ranges established in February for growth of 6 to 9 percent for both M2 and M3, measured from the fourth quarter of 1985 to the fourth quarter of 1986. With respect to Ml, the Committee recognized that, based on the experience of recent years, the behavior of that aggregate is subject to substantial uncertainties in relation to economic activity and prices, depending among other things on the responsiveness of Ml growth to changes in interest rates. In light of these uncertainties and of the substantial decline in velocity in the first half of the year, the Committee decided that growth of Ml in excess of the previously established 3 to 8 percent range for 1986 would be acceptable. Acceptable growth of Ml over the remainder of the year will depend on the behavior of velocity, growth in the other monetary aggregates, developments in the economy and financial markets, and price pressures. Given its rapid growth in the early part of the year, the Committee recognized that the increase in total domestic nonfinancial debt in 1986 may exceed its monitoring range of 8 to 11 percent, but felt an increase in that range would provide an inappropriate benchmark for evaluating longerDigitized forterm trends in that aggregate. FRASER For 1987 the Committee agreed on tentative ranges of monetary growth, measured from the fourth quarter of 1986 to the fourth quarter of 1987, of 5Vi to %Vi percent for M2 and M3. While a range of 3 to 8 percent for Ml in 1987 would appear appropriate in the light of most historical experience, the Committee recognized that the exceptional uncertainties surrounding the behavior of Ml velocity over the more recent period would require careful appraisal of the target range at the beginning of 1987. The associated range for growth in total domestic nonfinanical debt was provisionally set at 8 to 11 percent for 1987. In the implementation of policy for the immediate future, the Committee seeks to maintain the existing degree of pressure on reserve positions. This action is expected to be consistent with growth in M2 and M3over the period from September to December at annual rates of 7 to 9 percent. While growth in Ml over the same period is expected to moderate from its exceptional pace during the previous several months, growth in this aggregate will continue to be judged in the light of the behavior of M2 and M3 and other factors. Slightly greater reserve restraint or slightly lesser reserve restraint might be acceptable depending on the behavior of the aggregates, taking into account the strength of the business expansion, developments in foreign exchange markets, progress against inflation, and conditions in domestic and international credit markets. The Chairman may call for Committee consultation if it appears to the Manager for Domestic Operations that reserve conditions during the period before the next meeting are likely to be associated with a federal funds rate persistently outside a range of 4 to 8 percent. Votes for this action: Messrs. Volcker, Corrigan, Angell, Guffey, Heller, Mrs. Horn, Messrs. Johnson, Melzer, Morris, Rice, and Ms. Seger. Votes against this action: None. Absent and not voting: Mr. Wallich. 2. Authorization lor Domestic Open Market Operations Effective December 3, 1986, the Committee approved a temporary FOMC Policy Actions 153 increase of $1 billion, to $7 billion, vehicles, which dropped off with the in the limit between Committee end of financing incentive programs, meetings on changes in System Ac- consumer spending has posted sizacount holdings of U.S. government ble gains in recent months. Business and federal agency securities speci- investment spending, however, has fied in paragraph l(a) of the author- remained sluggish, while housing starts ization for domestic open market have weakened. At the same time, operations. The increase was effec- the trade balance has shown only tive for the intermeeting period end- limited indications of improvement. ing with the close of business on Increases in labor costs still were moderate, but price increases have December 16, 1986. been somewhat higher than earlier Votes for this action: Messrs. Volcker, in the year because of developments Corrigan, Angell, Guffey, Heller, Mrs. Horn, Messrs. Johnson, Melzer, in food and energy markets. Morris, Rice, and Ms. Seger. Votes Total nonfarm payroll employagainst this action: None. Absent and ment rose about Vi million in both not voting: Mr. Wallich. October and November. Much of the This action was taken on the rec- gain was in the private service-proommendation of the Manager for ducing sector, but factory employDomestic Operations. The Manager ment also rose moderately, and the had advised that outright purchases workweek lengthened. Aggregate of securities in the intermeeting in- hours for production and nonsuperterval through December 1, 1986, visory workers in November were a had reduced the leeway under the full percentage point above the thirdusual $6 billion limit to about $3.5 quarter average. The civilian unembillion. Additional purchases of se- ployment rate stayed at 7 percent in curities in excess of that leeway likely November for the third consecutive would be necessary over the remain- month. Gains in employment and hours der of the intermeeting period, chiefly reflecting seasonal increases in cur- worked were associated with a sizarency in circulation and required ble pickup in industrial production in November. The industrial producreserves. tion index rose 0.6 percent last month, after essentially no change over the previous three months. Increases in Meeting Held on output were evident in most major December 15-16, 1986 marketing groups, with only energy materials showing a marked decline, Domestic Policy Directive although auto assemblies were about The information reviewed at this unchanged from October. Capacity meeting suggested that economic ac- utilization in manufacturing, mining, tivity was continuing to expand at a and utilities rose 0.3 percentage point moderate pace in the current quarter. in November to 79.3 percent. NonePayroll employment increased con- theless, utilization has changed little siderably in October and November; on balance since March and is 2*/2 hiring in manufacturing rose some- points below its most recent peak in what in both months after declining the summer of 1984. on balance since the beginning of the Sales of domestic cars fell sharply year. Apart from sales of motor after the expiration of cut-rate fi 154 FOMC Policy Actions nancing incentive programs in early October. These sales averaged less than 7 million units at an annual rate over the October-November period, compared with the strong 9*/2 million unit pace for the third quarter as a whole. Excluding autos, gasoline, and nonconsumer items, retail sales in November rose 0.9 percent paced by continued strength in purchases of furniture and appliances and in other nonauto durables. In addition, data for earlier months were revised upward slightly. Business investment appears to have remained sluggish. Shipments of nondefense capital goods increased in October, and construction spending has firmed in recent months but prospects for such spending have continued to be affected adversely by high vacancy rates and reactions to tax reform. In contrast, sales of heavy-weight trucks fell markedly in October, and business purchases of cars and light trucks also probably declined sharply after the sales incentive programs ended. At the same time, new orders for nondefense capital goods fell 5 percent. Initial surveys of capital spending plans for 1987 suggested that overall nominal spending on plant and equipment is likely to change little from the 1986 level. Housing starts continued to decline in November. During the month total private housing starts, at 1.6 million units, were a bit below the reduced pace of September and October. Single-family starts were virtually unchanged from their rate during the preceding two months, but were below their level earlier in the year; new home sales also have remained below their previous pace in recent months. Multifamily starts declined further in November in response to high vacancy rates and adverse changes in tax laws. Price increases, although still moderate, have been somewhat higher than earlier in the year partly because of developments in food and energy markets. The consumer price index rose 0.2 percent in October and the producer price index was up 0.2 percent in November. In the food sector, some upward price pressure continued to be evident, although increases in food prices slowed from the rapid pace during the summer. In addition, energy prices turned down a bit at both the retail and refinery levels, despite the firming of crude oil prices in spot markets since midsummer. Excluding food and energy, the CPI rose 0.4 percent in October, somewhat faster than earlier in the year as new car prices increased sharply. Wage inflation has picked up a bit recently, but has continued at a moderate pace. The trade-weighted value of the dollar against other G-10 currencies has declined somewhat on balance since the November 5 meeting of the Committee. Exchange rates have been affected by news about the pace of economic activity, developments in the U.S. trade balance, and prospects for monetary actions in the United States and in key industrial nations abroad. Short-term interest rates rose moderately abroad, about in line with movements in U.S. rates, while differentials in long-term interest rates moved slightly against dollar assets. Over the period, the dollar declined about 2 percent against the mark and was essentially unchanged against the yen, but the dollar's depreciation had been somewhat larger in early December. As of midDecember, the value of the dollar in relation to other major currencies FOMC Policy Actions 155 was little changed on balance from the level prevailing in August. Economic activity in major foreign industrial countries was mixed in the third quarter. The U.S. merchandise trade deficit was estimated to be about the same in the third quarter as in the previous three quarters. Exports were flat in the quarter, while the value of oil imports was close to that in the second quarter as price declines about offset volume increases. Very preliminary data indicated that the deficit in October was the smallest in recent months as exports of agricultural products rose somewhat and imports declined moderately. At its meeting on November 5, the Committee adopted a directive that called for maintaining the existing degree of pressure on reserve positions. This action was expected to be consistent with growth in both M2 and M3 at annual rates of 7 to 9 percent from September to December. Growth in Ml over the same period was expected to moderate from its exceptional pace during the previous several months. The Committee agreed that the growth in Ml would continue to be evaluated in light of the behavior of the broader monetary aggregates and other factors. The members also decided that slightly greater or slightly lesser reserve restraint might be acceptable depending on the behavior of the monetary aggregates, taking into account the strength of the business expansion, developments in foreign exchange markets, progress against inflation, and conditions in domestic and international credit markets. The intermeeting range for federal funds was maintained at 4 to 8 percent. M2 growth slowed substantially in November to a 6V2 percent annual rate, and M3 growth moderated further to a 5V2 percent annual rate; through November both M2 and M3 were just inside the upper bounds of their 6 to 9 percent growth ranges established by the Committee for 1986. Ml accelerated again in November, reaching a rate of 21 percent, as growth in demand deposits surged. Ml growth has remained far in excess of GNP growth so far this year and its velocity is expected to fall at a historically high rate. Growth of total reserves picked up sharply over the intermeeting period largely because of a surge in required reserves against transaction deposits. In addition, excess reserves increased from almost $750 million in the previous three months to around $1 billion on average in November, reflecting mainly the usual patterns around holidays and social security payment dates. Adjustment plus seasonal borrowing in the two complete maintenance periods since the November FOMC meeting averaged about $300 million, down somewhat from the average over the previous intermeeting period. Even so, the funds rate firmed from around 57/s percent at the time of the last meeting to well above 6 percent in early December. More recently, the federal funds rate has averaged close to 6 percent. With the federal funds rate firmer through much of the intermeeting period, other short-term market rates rose 15 to 50 basis points. However, bond yields generally were about unchanged to down 25 basis points. Rates on commitments for fixed-rate home mortgages dropped about V2 percentage point, moving toward a more normal alignment with Treasury bond yields. Although stock prices fell initially on the announce- 156 FOMC Policy Actions ment of insider trading violations related to takeover activity, on balance they showed little change over the period. The staff projections presented at this meeting suggested that real GNP would continue to grow at a moderate rate through the end of 1987. Prospects for an improvement in real net exports of goods and services continued to be a key element shaping the 1987 forecast; export growth was expected to accelerate next year and import growth to moderate as world trade flows adjusted to increased U.S. competitiveness. Gross domestic purchases were projected to be relatively sluggish through the end of 1987, reflecting mainly a shift toward fiscal restraint, the likely weakness in multifamily housing and nonresidential construction, and the damping influence of higher import prices on the growth of real income and consumption. Inflation was expected to pick up a bit in early 1987 as a consequence of the dollar's depreciation and higher energy prices. In the Committee's discussion of current and prospective economic developments, members generally agreed that continuing expansion at a moderate pace remained a reasonable expectation for the year ahead, but a number of members emphasized the risks of a shortfall from current projections, especially in the early part of 1987. In particular, members mentioned the risks that the expected improvement in the nation's foreign trade might be relatively disappointing next year and that overall business spending might remain sluggish. A few members also referred to the possibility of slower growth in consumer spending. On balance, however, while no important sector of the domestic economy seemed likely to be a source of substantial strength in 1987, the members read current economic indicators and other business information as pointing to a fifth year of moderate expansion. Such expansion might be accompanied by some rise in the rate of inflation, primarily reflecting the effects of the dollar's depreciation and energy-sector developments. The members again gave considerable attention to the outlook for foreign trade. An improvement in trade generally was viewed as an essential factor in sustaining a moderate rate of business expansion in the context of perhaps diminishing growth in overall domestic demands. Unfortunately, there was no convincing evidence thus far of a turnaround in the trade balance, and a number of members commented that the expected improvement could be relatively limited next year. On the favorable side, the depreciation of the dollar evidently had enhanced the competitive position of U.S. firms, and individual reports of expanding export opportunities appeared to be multiplying as well as indications of an improved ability of many U.S. firms to compete domestically with imports. As they had at earlier meetings, the members referred to a number of factors that were inhibiting an overall improvement in net exports, including limited expansion in many industrial nations abroad and strong competition from a number of countries whose currencies had not appreciated against the dollar. One member also stressed that persisting debt problems in several developing countries constituted an element of vulnerability for international financial markets and international trade and also for the U.S. economy. With regard to the domestic econ- omy, a number of members commented that consumer expenditures on durables, especially automobiles, and some business spending appeared to have been accelerated into 1986 in reaction to provisions of the tax reform legislation. Compensating adjustments in such spending later could have a restraining effect on economic growth, notably during the first part of 1987. Nonetheless, a few members referred to the possibility that consumer spending might be well maintained during 1987 as a whole. The latter acknowledged the inhibiting effects of the growth in consumer debt, but they stressed the favorable implications of cumulative increases in the total assets and net worth of consumers and the positive impact of reductions in personal income tax rates. The outlook for business spending continued to be uncertain and in some respects unpromising, especially with regard to multifamily housing and nonresidential construction; both areas would be adversely affected by high vacancy rates and negative reactions to the tax reform legislation. There were further reports of plant closings, notably in the Midwest. However, one member observed that business spending for plant and equipment might well hold up in response to continuing growth in overall economic activity. As usual, the prospects for inventory accumulation were uncertain and would be affected by the outlook for prices. With regard to the outlook for prices and wages, members generally agreed that increases might be somewhat larger in 1987, reflecting the impact of rising import prices and indications of a turnaround in oil prices. However, the prospect of only moderate economic growth and Digitized forcontinued margins of slack in labor FRASER FOMC Policy Actions 157 and product markets suggested that strong wage pressures were not likely over the year ahead. One member observed that agricultural conditions worldwide suggested an absence of pressure on food prices. Moreover, generally limited growth in key industrial nations together with an ample availability of productive resources abroad implied continuing strong competitive pressures and restrained advances in prices of U.S. imports. Even so, a somewhat higher rate of inflation appeared to be in prospect for next year. At its meeting in July, the Committee had agreed on tentative ranges of 5V2 to 8V2 percent for growth in both M2 and M3 during the period from the fourth quarter of 1986 to the fourth quarter of 1987. The associated range for growth in total domestic nonfinancial debt was set at 8 to 11 percent for 1987. In the case of Ml the Committee had indicated on a more tentative basis than usual that it might retain the 1986 range of 3 to 8 percent for 1987. Such a range implied a marked reduction from the Ml growth experienced in 1986 and provisionally assumed that the relationship of Ml to income, interest rates, and other economic variables next year would be broadly consistent with earlier historical experience. At this meeting the Committee held a preliminary discussion of the factors bearing on appropriate ranges for the various monetary aggregates in 1987. Most of the attention was devoted to the issue of whether a range should be established for Ml, given the uncertainty surrounding behavior of that aggregate and its velocity in recent years. While most members currently did not favor establishing a formal target range for Ml growth in 1987, many of them 158 FOMC Policy Actions believed that this aggregate should continue to be monitored or evaluated in light of information about the economy, prices, and the broad monetary aggregates and other financial variables. The Committee will complete its review of the role of Ml and the ranges for the broad aggregates for 1987 at its February meeting. In the Committee's discussion of policy implementation for the period immediately ahead, all of the members indicated that they were in favor of directing open market operations, at least initially, toward maintaining unchanged conditions of reserve availability. For now, monetary policy was deemed to be exerting an appropriate degree of pressure on reserve positions in light of the growth of the broader monetary aggregates within—though at the upper ends of—their longer-run ranges, and the generally favorable prospects for sustained, albeit moderate, economic growth. The members recognized that the outlook for the monetary aggregates remained uncertain, notably in the case of Ml. According to an analysis presented at this meeting, a moderate trend in the growth of M2 and M3 might be anticipated, given the outlook for fairly limited growth in economic activity and an abatement of the effects of earlier interest rate declines. For the months ahead, growth in the broader aggregates might be well within the Committee's tentative ranges for 1987 on the assumption that there would be no significant changes in market interest rates. The outlook for Ml growth remained highly uncertain, although underlying forces seemed consistent with a considerable slowing over time from the extraordinary expansion experienced during 1986. Some concern was expressed that the failure of such a slowing to occur and the associated large provision of reserves could eventually have inflationary consequences. Even with some moderation over coming months, Ml might continue to expand at rates markedly in excess of the growth in nominal GNP. In view of the uncertainties that were involved and in keeping with the Committee's practice since mid-1986, the members did not want to indicate specific expectations with regard to Ml growth in the operational paragraph of the Committee's directive. Nonetheless, it was understood that growth of this aggregate would continue to be evaluated in light of the behavior of the broader monetary aggregates and other economic and financial developments. In their discussion of possible intermeeting adjustments in the degree of reserve pressure, the members thought it unlikely that developments would warrant more than a minor, if any, change in reserve conditions during the weeks ahead. All of the members understood that some small adjustment in either direction might be appropriate under certain circumstances. However, in the context of what they perceived as greater downside risks in the outlook for economic activity, several believed that policy implementation should remain especially alert to developments that might call for somewhat easier reserve conditions. It was noted in this connection that the relative stability of the dollar in foreign exchange markets over the past few months provided greater flexibility for potential easing actions. At the conclusion of the Committee's discussion, all of the members indicated that they favored a directive that called for no change in the degree of pressure on reserve posi- FOMC Policy Actions 159 tions. The members expected this approach to policy implementation generally appears to have remained sluggish. Preliminary data for the U.S. merOctober suggest to be consistent with growth of both chandise trade deficit in Broad measures a moderate narrowing. M2 and M3 at an annual rate of of prices havefirmedsomewhat in recent about 7 percent over the four-month months due to developments in food and period from November to March. energy markets. Labor cost increases this Because the behavior of Ml re- year have remained moderate compared with other recent years. mained subject to unusual uncerGrowth of M2 slowed substantially in tainty, the members decided they November, while growth of M3 remained would continue to evaluate this ag- moderate. Expansion of these two aggregregate in the light of the perform- gates for the year through November has below the upper of their ance of the broader monetary aggre- been just ranges established endthe Comrespective by gates and other factors. The members mittee for 1986. In November growth of indicated that slightly greater reserve Ml accelerated to a very rapid rate. Exrestraint or somewhat lesser reserve pansion in total domestic nonfinancial debt restraint would be acceptable over remains appreciably above the Committee's monitoring range for 1986. Shortthe intermeeting period depending term interest rates have risen somewhat on the behavior of the monetary since the November 5 meeting of the aggregates, taking into account the Committee, while long-term rates have strength of the business expansion, declined on balance. In foreign exchange markets the trade-weighted value of the the performance of the dollar in dollar against other G-10 currencies has foreign exchange markets, progress declined moderately on balance since the against inflation, and conditions in November meeting. The Federal Open Market Committee domestic and international credit markets. The members agreed that seeks monetary and financial conditions the intermeeting range for the fed- that will foster reasonable price stability over time, promote growth in output on eral funds rate, which provides a a sustainable basis, and contribute to an mechanism for initiating consultation improved pattern of international transof the Committee when its bounda- actions. In furtherance of these objectives ries are persistently exceeded, should the Committee agreed at the July meeting to reaffirm the ranges established in Febbe left unchanged at 4 to 8 percent. ruary for growth of 6 to 9 percent for both At the conclusion of the meeting, M2 and M3, measured from the fourth the following domestic policy direc- quarter of 1985 to the fourth quarter of tive was issued to the Federal Re- 1986. With respect to Ml, the Committee recognized that, based on the experience serve Bank of New York: of recent years, the behavior of that aggregate is subject to substantial uncerThe information reviewed at this meet- tainties in relation to economic activity ing suggests that economic activity con- and prices, depending among other things tinues to grow at a moderate pace in the on the responsiveness of Ml growth to current quarter. Total nonfarm payroll changes in interest rates. In light of these employment grew appreciably further in uncertainties and of the substantial deOctober and November, and employment cline in velocity in the first half of the in manufacturing also rose after declining year, the Committee decided that growth on balance in previous months. The ci- of Ml in excess of the previously estabvilian unemployment rate remained at 7.0 lished 3 to 8 percent range for 1986 would percent in November for the third con- be acceptable. Acceptable growth of Ml secutive month. Industrial production over the remainder of the year would depicked up considerably in November. To- pend on the behavior of velocity, growth tal retail sales rose moderately last month in the other monetary aggregates, develafter changing little on balance over Sep- opments in the economy and financial tember and October. Housing starts have markets, and price pressures. Given its and business capital spending rapid growth in the early part of the year, weakened 160 FOMC Policy Actions the Committee recognized that the increase in total domestic nonfinancial debt in 1986 may exceed its monitoring range of 8 to 11 percent, but felt an increase in that range would provide an inappropriate benchmark for evaluating longerterm trends in that aggregate. For 1987 the Committee agreed on tentative ranges of monetary growth, measured from the fourth quarter of 1986 to the fourth quarter of 1987, of 5Yi to 8x/2 percent for M2 and M3. While a range of 3 to 8 percent for Ml in 1987 would appear appropriate in the light of most historical experience, the Committee recognized that the exceptional uncertainties surrounding the behavior of Ml velocity over the more recent period would require careful appraisal of the target range at the beginning of 1987. The associated range for growth in total domestic nonfinancial debt was provisionally set at 8 to 11 percent for 1987. In the implementation of policy for the immediate future, the Committee seeks to maintain the existing degree of pressure on reserve positions. This action is expected to be consistent with growth in M2 and M3 over the period from November to March at an annual rate of about 7 percent. Growth in Ml will continue to be appraised in the light of the behavior of M2 and M3 and the other factors cited below. Slightly greater reserve restraint or somewhat lesser reserve restraint would be acceptable depending on the behavior of the aggregates, taking into account the strength of the business expansion, developments in foreign exchange markets, progress against inflation, and conditions in domestic and international credit markets. The Chairman may call for Committee consultation if it appears to the Manager for Domestic Operations that reserve conditions during the period before the next meeting are likely to be associated with a federal funds rate persistently outside a range of 4 to 8 percent. Votes for this action: Messrs. Volcker, Corrigan, Angell, Guffey, Heller, Mrs. Horn, Messrs. Johnson, Melzer, Morris, and Ms. Seger. Votes against this action: None. Absent and not voting: Mr. Rice. 161 Consumer and Community Affairs In 1986 the Federal Reserve Board used its rulewriting and enforcement authority to maintain statutory protections for consumers while easing regulatory burdens on institutions. This report examines in detail the activities of the Federal Reserve System in support of those goals. and promote widespread use of EFTs (electronic fund transfers). Regulation Z (Truth in Lending): Adjustable-Rate Mortgages In November 1986 the Board issued for public comment proposed amendments to Regulation Z (Truth in Lending) on disclosure of inforRegulatory and Policy Matters mation about adjustable-rate mortgages (ARMs). Under the proposal, The Board issued and proposed revisions to regulations and adopted a creditors would be required to give policy statement encouraging depos- consumers general information about itory institutions to provide basic ARMs; the Consumer Handbook on services to low- and moderate-income Adjustable Rate Mortgages, by the consumers. Also, the Board pub- Federal Reserve Board and the Fedlished a pamphlet, A Guide to Busi- eral Home Loan Bank Board, could ness Credit and the Equal Credit Op- fulfill this requirement. In addition, portunity Act, to advise applicants for creditors would give a more detailed business credit of their rights under description of the variable-rate feathe act and help them prepare an ef- ture, along with an example of the way changes in the index rate affect fective loan presentation. payments, with the application form or before the consumer pays a nonRegulation E refundable fee. These revisions would (Electronic Fund Transfers) permit consumers to shop for credit In July the Board proposed revisions and would conform the Board's disto Regulation E (Electronic Fund closure rules with those of several Transfers) to eliminate the require- other federal agencies. The Board ment that service providers, such as developed this proposal after reviewretailers, that offer electronic fund ing the comments on a proposal transfer services but do not hold published in May 1985 and after consumers' accounts send periodic consulting with these other agencies. statements to their customers. Instead, those providers would be required to furnish information for Regulation Z: inclusion on the periodic statements Refinancings and Rescission of the account-holding institutions. In December the Board issued reviThe changes were intended to elimi- sions to Regulation Z that exempted nate duplication of information, re- certain refinancings by> original credduce the risk of confusion to con- itors from the right of rescission. The sumers from duplicative statements, rule, which was effective immedi 162 Consumer and Community Affairs ately, provides that the right of rescission will not apply if the only items included in the refinancing, other than the unpaid principal, are closing costs such as attorney's fees, title examination fees, and insurance premiums. At the same time, the Board withdrew a proposal that would have excluded from the right of rescission certain refinancings by a creditor other than the original creditor. Consumer groups had opposed any expansion of the exemption from the right of rescission, and creditors were dissatisfied with the limited nature of the proposed exemption. The Board withdrew the proposal because a rule that might accommodate both those concerns would be complex and perhaps beyond the Board's statutory authority. Regulation A A (Credit Practices Rule) In November the Board granted a request from the state of Wisconsin for an exemption from the Credit Practices Rule (Regulation AA). That rule prohibits banks and their subsidiaries from using certain remedies to enforce consumer credit obligations and from "pyramiding" late charges; it also provides protections for cosigners. It covers all consumer credit transactions except those for the purchase of real property. To qualify for an exemption, a state must have a requirement or a prohibition that protects consumers at least as well as the corresponding federal provision does. Because the Wisconsin law covers only transactions up to $25,000, transactions above that amount remain subject to the federal rule; however, compliance with Wisconsin law for such transactions will constitute compliance with the federal requirements. The exemption does not apply to transactions in which the creditor is a federally chartered institution. The Board also received applications from California and New York for exemptions from the Credit Practices Rule. It will take final action on these requests in early 1987. Interpretations In 1986 the Board continued to provide legal interpretations through the official staff commentaries on Regulation B (Equal Credit Opportunity), Regulation E (Electronic Fund Transfers), and Regulation Z (Truth in Lending). These commentaries help financial institutions and others apply the regulations to specific situations; updates generally are published by April 1 each year. In November the Board also issued an update to its staff guidelines on the Credit Practices Rule. Business Credit Pamphlet In July the Board published A Guide to Business Credit and the Equal Credit Opportunity Act for distribution through government agencies, women's groups, and other organizations. It describes the credit application process from the lender's perspective, offers guidance on the preparation of effective loan proposals, and discusses protections the act affords as they apply to business credit. The pamphlet is designed to increase public awareness, particularly among women and minority entrepreneurs, of the rights of business credit applicants and the responsibilities of business credit lenders. Consumer and Community Affairs 163 Cited as a goal in the joint policy statement, a free or low-cost method In September the Board approved a to cash government checks is fredraft policy statement on the need quently mentioned in discussions of to make basic financial services ac- basic financial services. The Board cessible to low- and moderate-in- has been exploring this issue and in come consumers. The Board for- December held a conference with warded the statement to the Federal representatives from government, inFinancial Institutions Examination dustry, and consumer groups to disCouncil (FFIEC) with the recom- cuss alternatives to government checks mendation that the council's constit- and to address other concerns about uent agencies—the Board, the Office the present system. One alternative of the Comptroller of the Currency is direct delivery of payments, such (OCC), the Federal Deposit Insur- as welfare or social security, through ance Corporation (FDIC), the Fed- electronic terminals or special distrieral Home Loan Bank Board bution outlets, involving neither pa(FHLBB), and the National Credit per instruments nor accounts at fiUnion Administration (NCUA)— nancial institutions. The conferees consider issuing it jointly. The policy believed that direct delivery might statement encourages voluntary ef- work for state and local benefits but forts by industry groups and individ- were less certain that it would be ual depository institutions to offer economic for federal payments. Some basic services. The statement gives conferees supported testing the idea institutions maximum flexibility, con- by adding federal payments to a local sistent with safe and sound business direct-delivery system already in place. practices, in designing the services. It asks that institutions consider providing a safe place to keep money, a way to get cash (including the cashing of government checks), and a way to Community Affairs make payments to third parties. In During 1986 the Federal Reserve October the FFIEC approved the System continued to encourage comdraft statement for submission to munity and economic development, member agencies, and by year-end it in keeping with its responsibilities had been adopted by the Board, the under the Community Reinvestment OCC, the FDIC, and the NCUA. Act (CRA). At the Reserve Banks, The policy statement recognizes the Community Affairs Officers the role of trade groups in this effort (CAOs) and their staffs carry out and recommends that they encourage educational activities to further pubmember institutions to offer and lic-private partnerships and private publicize low-cost basic financial sector initiatives for community deservices, survey the availability of velopment. The aim is to gather and such services among member insti- disseminate information and to foster tutions, and make available to their communication among those inmembers material on the successful volved in community development, experiences of institutions with basic including banks and bank holding financial services. companies, borrowers, local govern- Basic Financial Services 164 Consumer and Community Affairs ments, and development organizations. The CAOs increased their activities in 1986 toward these ends. As federal funding decreased, community organizations relied less on federal programs to support community development and more on those at the local level. In pursuing its educational goal, the community affairs program helped banks and other organizations involved in community development to learn about successful programs and strategies they might duplicate. The community affairs program also brought these groups together to help them take full advantage of available resources and opportunities in devising development strategies. In other cases, the program enabled the parties to improve communication and to identify common purposes, sometimes in connection with protests of applications under the Community Reinvestment Act. These meetings often helped promote understanding between applicants and community representatives and avoid protests of applications altogether. The staff members of the Board and of the Reserve Banks developed and participated in more than 50 presentations on economic and housing development topics such as cooperative housing, commercial revitalization, investment in black-owned businesses, employee ownership of businesses, and community development corporations. Presentations focused on the formation of bankcommunity and bank-public sector partnerships that would foster private sector initiatives. To facilitate the exchange of information among community development participants, the Federal Reserve Banks of Minneapolis, Dallas, Philadelphia, Richmond, and At lanta publish community affairs newsletters that feature development activities in their districts. Other Reserve Banks publish lists of successful strategies and programs to help bankers extend their involvement in community development. During the year, the Federal Reserve held approximately 100 meetings on community development issues with bankers, holding company officers, and community groups. At these meetings the System's staff learned about developments in banking and in local communities, and bankers and community developers learned about the services available through Reserve Banks. Another result was that some banks have combined their efforts to address specific credit needs. The Board continued to support the Reserve Banks' community affairs activities with its quarterly newsletter, Communique, with lists of knowledgeable individuals and organizations, and with presentations. It also gave information to national community organizations, bankers' associations, and individuals about the community affairs program, the community development corporations that are subsidiaries of bank holding companies, community economic development programs, and community reinvestment. A member of the Board also continued to serve on the board of directors of the Neighborhood Reinvestment Corporation. Compliance Examinations State member banks are examined regularly by the consumer affairs examiners of the Reserve Banks for compliance with the consumer credit Consumer and Community Affairs 165 protection laws and the Community Reinvestment Act. In 1986 the Board lengthened the examination cycle for some institutions. Effective January 1, 1987, a small percentage of the banks with highly satisfactory records of compliance with consumer protection and CRA laws will be examined only every 24 months, instead of the 18 months specified for banks with ratings of satisfactory or better. Banks that perform poorly will continue to receive closer supervisory attention and be examined at least every 12 months. Survey on Delayed Availability of Funds In March 1984 the Board joined the Comptroller of the Currency, the Federal Deposit Insurance Corporation, and the Federal Home Loan Bank Board in adopting an interagency policy statement on delayed availability of funds. The statement asked financial institutions that delay availability on paper-check deposits to review their policies and consider reducing the delays, consistent with prudent business practices; to disclose their policies to depositors at the time an account is opened and, when practical, at the time a deposit is made; and to refrain from imposing unnecessary delays on all checks, particularly social security and other government checks. Between 1984 and mid-1986 the System surveyed the policies and practices on delayed availability of all state member banks. The findings suggest that state member banks are addressing appropriately the provisions of the policy statement: • Most state member banks that placed holds on check deposits did so only in special cases. • Few state member banks placed automatic holds on all deposits or on particular types of deposits. • Most state member banks with hold policies disclosed those policies to depositors when an account was opened, the majority of them in writing. • Most state member banks did not hold funds beyond the provisional crediting period. Compliance with Consumer Regulations Data received from the five federal agencies that supervise financial institutions and from other federal supervisory agencies indicate that compliance with the Truth in Lending Act (implemented through Regulation Z), the Equal Credit Opportunity Act (Regulation B), and the Electronic Fund Transfer Act (Regulation E) remained substantially the same as in 1985. This section summarizes data covering the reporting period July 1, 1985, to June 30, 1986.x Truth in Lending Act (Regulation Z) The Board, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Federal Home Loan Bank Board, and the National Credit Union Administration reported that 62 percent of the institutions examined were in full compliance with the requirements of Regulation Z, compared with 63 percent in 1985. The agencies that provide data on the 1. Not all the federal agencies that regulate financial institutions use the same method to compile compliance data. However, the data support the general conclusions presented here. 166 Consumer and Community Affairs frequency of violations (the Board, the OCC, and the NCUA) reported that 48 percent of the institutions that were not in full compliance had no more than five violations. These data suggest that many institutions not in full compliance are making a satisfactory effort toward compliance. From the findings of the five financial regulatory agencies, the most frequent violations of Regulation Z appear to be the following: • Failure to disclose the annual percentage rate accurately. • Failure to disclose the number, amounts, and timing of payments scheduled to repay the obligation. • Failure to disclose the amount financed accurately. • Failure to disclose the finance charge accurately. • Failure to make the disclosures clearly and conspicuously in writing in a form that the consumer may keep. The OCC and the FHLBB issued five cease-and-desist orders for violations involving Regulation Z; the Board issued three formal enforcement actions that included provisions relating to Regulation Z. The Board, the OCC, the FDIC, and the FHLBB reported reimbursements of $1.3 million (involving 243 institutions and 12,252 customer accounts) under the Regulation Z Interagency Enforcement Policy Guide. These numbers compare with a total of $2 million in 1985 that involved 235 institutions and 29,823 customer accounts. The Federal Trade Commission (FTC) continued its special efforts to enforce the credit-advertising provisions of the Truth in Lending Act, with particular attention to the sale of homes and automobiles. The FTC reported that 90 percent of the ad vertisers in its real estate credit program were in compliance, the same as in 1985. This program has enabled the FTC to monitor companies nationwide and, in most cases, has resulted in voluntary compliance with the law. The FTC follows up on its monitoring program through enforcement action against companies that continue to violate the law. During this reporting period, four real estate companies agreed to pay $375,000 in civil money penalties for advertising violations, such as advertising only a reduced, first-year rate of interest for a mortgage without disclosing the much higher annual percentage rate, and advertising specific credit terms without providing all the required disclosures. Since it began in 1983, the FTC's compliance program aimed at automobile credit advertising has brought numerous automobile dealers into voluntary compliance. In the past year, enforcement efforts were concentrated on the relatively small number of dealers that continued to violate the law. The FTC filed four complaints. Three of these cases currently are in litigation; in the fourth, the dealer agreed to pay $70,000 in civil money penalties. The other agencies that enforce the Truth in Lending Act—the Packers and Stockyards Administration of the Department of Agriculture, the Farm Credit Administration, and the Department of Transportation— reported satisfactory levels of compliance. The Department of Transportation concluded an enforcement action against an air carrier for violations of the rules governing credit refunds. To heighten consumer and creditor awareness of the rights and responsibilities established by the act, the Consumer and Community Affairs 167 • Failure to provide the specific Board, the FTC, and the FHLBB issued or distributed several publi- reasons for adverse action. • Failure to request information cations. The FTC issued new brochures entitled "Second Mortgage for monitoring purposes as part of Financing," "Refinancing Your an application for credit primarily Home," "Escrow Accounts," and for the purchase or refinancing of a "A Consumer Guide to Vehicle dwelling. • Illegally inquiring about the sex Leasing," and revised editions of its "Money Mortgage Guide" and "Hol- of an applicant. The OCC and the FHLBB, in iday Shopping Tips." The Board issued four compliance brochures conjunction with the Department of entitled "Construction Loan Disclo- Justice, issued two cease-and-desist sures and Regulation Z," "Com- orders involving violations of Regubined Construction/Permanent Loan lation B. The Board issued five Disclosures and Regulation Z," formal enforcement actions that in"Regulation Z: The Right of Rescis- cluded provisions relating to Regusion," and "Regulation Z: Under- lation B. standing Prepaid Finance Charges." Most creditors that were subject As of August 1, 1985, the FHLBB to the FTC testing program, in which required all institutions insured by auditors pose as credit applicants, the Federal Savings and Loan Insur- appeared to be complying with the ance Corporation to distribute the nondiscrimination provisions of the Consumer Handbook on Adjustable act. However, some creditors conRate Mortgages, as a way of giving tinue to discourage or disfavor credit early and uniform information about applicants because of their age or these mortgages. because they rely on alimony or other protected income. During this reporting period, the FTC took enEqual Credit Opportunity Act forcement action against three cred(Regulation B) itors, two of which were found through The five federal agencies that super- the FTC's testing program. The FTC vise financial institutions reported is conducting several other investithat 79 percent of the institutions gations to identify illegal discriminaexamined were in full compliance tion. Other agencies responsible for enwith the Equal Credit Opportunity Act (ECOA), compared with 81 forcing the ECOA—the Department percent in 1985. These are the most of Transportation, the Interstate frequent violations of Regulation B: Commerce Commission, and the • Failure to provide a written no- Packers and Stockyards Administratice of adverse action that includes a tion—reported satisfactory levels of statement of the action taken, the compliance. The Farm Credit name and address of the creditor, Administration, the Securities and the ECO A notice, and the name and Exchange Commission, and the Small address of the federal agency that Business Administration reported violations, but none required formal enforces compliance. • Failure to notify the applicant of enforcement action. the action taken within 30 days after The FTC prepared a film for receiving a completed application. distribution to credit unions on the 168 Consumer and Community Affairs requirements of the act and issued a brochure entitled "Scoring for Credit." As noted earlier, the Board distributed "A Guide to Business Credit and the Equal Credit Opportunity Act." Electronic Fund Transfer Act (Regulation E) The federal regulatory agencies responsible for enforcing the Electronic Fund Transfer Act reported that 91 percent of the institutions examined were in full compliance, compared with 93 percent in 1985. The most frequent violations of Regulation E were the following: • Failure to provide, in a timely manner, a written statement outlining the terms and conditions of the EFT service. • Failure to provide a periodic notice on procedures for resolving disputes. • Failure to provide a written receipt at the time of an electronic fund transfer. • Failure to provide a statement of the consumer's liability for unauthorized transfers. According to the FTC, the fact that complaints regarding Regulation E were so few suggests that there is no special compliance problem. The other agencies responsible for enforcing the EFT act, the Department of Transportation and the Securities and Exchange Commission, reported a satisfactory level of compliance. Economic Impact of Regulation E In accordance with statutory requirements, the Board monitors the effects of the Electronic Fund Transfer Act on the costs and benefits of EFT service to financial institutions and consumers. The economic effects of the act spread during 1986 as more financial institutions offered EFTs and more consumers used them. Approximately two-thirds of the nation's depository financial institutions, representing every class size, now provide EFT services that are covered by the requirements of the act and Regulation E. These services include direct deposits, preauthorized electronic transfers, and access to automated teller machines (ATMs). Although the number of ATMs remained about the same in 1986 as in 1985, the use of the machines continued to increase. Moreover, consumers gained wider access to EFT services through the expansion of shared ATM networks. The volume of fund transfers made at electronic point-of-sale terminals grew, and point-of-sale transactions appeared poised for rapid expansion in coming years. Consumer demand for EFT services has continued to grow. The evidence indicates that at least 70 percent of households have a savings or transaction account with an EFT feature that they use at least occasionally. The number of transactions conducted through ATMs has increased, and the number of consumers electing to receive payroll or government transfer payments by electronic direct deposit has also risen. The benefits to consumers from the EFT act are difficult to measure because they cannot be isolated from consumer protections that would have been provided in any case. Statistics from examination reports do not suggest widespread problems or violations of the consumer rights established by the act. The federal agencies that regulate financial institutions Consumer and Community Affairs 169 reported little change from 1985 in the percentage of institutions not in full compliance. The most frequent violation was failure to provide one or more disclosures to consumers. The majority of institutions cited for noncompliance had one to five violations, a small number in light of the volume of consumer EFT transactions. Data from the Board's Consumer Complaint Control System confirm that consumers have no serious problems with EFT. Of the 2,400 complaints processed in 1986,94 involved EFTs. The Federal Reserve System forwarded 32, which did not pertain to state member banks, to other agencies for resolution. Of the remaining 62 complaints, only 2 involved a possible violation of the regulation. The costs of industry practices that would have evolved in the absence of statutory requirements are unknown. Consequently, the incremental costs associated with the act, as in the case of consumer benefits, are difficult to quantify. But the compliance cost of an EFT transaction is probably not high enough to compromise the cost advantage such transactions have over check-based transactions. As EFT systems mature, as transaction volume builds, and as start-up costs for compliance are amortized, compliance costs per EFT transaction and per dollar of transferred funds are likely to decline. As noted earlier, the Board has proposed to amend Regulation E to eliminate the statement requirement for providers of point-of-sale services. The Board expects this proposal, if adopted, to lower costs substantially for these EFT transactions and promote wider use of the system. Complaints against State Member Banks In 1986 the Federal Reserve System received a total of 2,400 complaints (see the accompanying table). Within this total, 930 were complaints against state member banks, which the Federal Reserve investigates and resolves. The System referred the remaining 1,470 complaints, involving other creditors or businesses, to the appropriate enforcement agencies. Most of the complaints (1,909) were made in letters; 478 came by telephone, and 13 were made in person. The Board also received 181 written inquiries concerning consumer credit laws and regulations, and banking policies and practices. In responding, the Board's staff gave consumers brochures on the general issues plus explanations of laws, regulations, Consumer Complaints Received by the Federal Reserve System, by Subject, 19861 Subject Regulation B (Equal Credit Opportunity) Regulation C (Home Mortgage Disclosure) Regulation E (Electronic Fund Transfers) Regulation M (Consumer Leasing) Regulation Q (Interest on Deposits) Regulation Z (Truth in Lending) Regulation BB (Community Reinvestment) Fair Credit Reporting Act Fair Debt Collection Practices Act Holder in due course Real Estate Settlement Procedures Act Transfer agents Number 144 9 94 8 100 494 2 118 34 1 1 3 Unregulated bank practices Other 2 . . . . . . 1,329 63 Total 2,400 1. Includes 930 complaints about state member banks, over which the Federal Reserve has jurisdiction, and 1,470 complaints about other lenders, which the Federal Reserve referred to the appropriate agencies. 2. Primarily miscellaneous complaints against business entities. 170 Consumer and Community Affairs and banking practices specific to their complaints or inquiries. The Board's staff continues regularly to review and assess the System's handling of complaints. The staff reviews a sample of complaints about state member banks for adherence to System policies; and, through follow-up questionnaires, it attempts to gauge complainants' perceptions of the System's handling of complaints. Approximately 66 percent of the respondents found the System's explanations clear and understandable; 79 percent were satisfied with the speed in handling their com- plaints; 97 percent felt that the Federal Reserve staff treated them courteously; 92 percent said they would contact the Federal Reserve again if they had another problem with a bank; and 55 percent found the resolutions of their complaints acceptable. The proportion of those satisfied with the System's handling of their complaints is higher than the proportion of those satisfied with the outcome because some complaints involved banking practices that are permissible and that cannot be changed unless the bank does so voluntarily or the law is changed. Consumer Complaints about State Member Banks Received by the Federal Reserve System, by Function and Resolution, 1986 Type of complaint Type of resolution Total complaints about state member banks Number Percent By type Insufficient information1 Information furnished to complainant2 Bank legally correct No accommodation 3 Accommodation made Clerical error, corrected Factual dispute4 Bank violation, resolved5 Possible bank violation, unresolved6 ... Customer error Pending, December 31 Complaints referred to other agencies Total, all complaints Total complaints Loan function Discrimination Deposit Other function Electronic fund transfers Trust Other 930 100 72 8 432 46 216 23 57 6 34 117 4 15 10 50 7 26 0 2 0 0 355 90 164 40 15 3 21 9 5 1 3 1 0 173 43 76 21 4 2 77 18 52 10 4 0 34 1 10 2 2 0 0 7 1 0 0 1 0 0 6 0 37 3 9 103 1,470 2,400 1. The staff has been unable, after follow-up correspondence with the consumer, to obtain sufficient information to process the complaint. 2. When it appears that the complainant does not understand the law and that there has been no violation on the part of the bank, the Federal Reserve System explains the law in question and provides the complainant with other pertinent information. 3. In these cases the bank appears to be legally correct but has chosen to make an accommodation. 4. These cases involve factual disputes not resolvable by the Federal Reserve System and contractual disputes that can be resolved only by the courts. Con 13 72 4 5 49 17 741 1,173 360 144 15 13 24 43 18 21 6 1 0 0 18 257 94 12 576 401 sumers wishing to pursue the matter may be advised to seek legal counsel or legal aid or to use small claims court. 5. In these cases a bank appears to have violated a law or regulation and has taken corrective measures voluntarily or as indicated by the Federal Reserve System. 6. When a bank appears to have violated a law or regulation, customers are advised to seek civil remedy through the courts. Cases that appear to involve criminal irregularity are referred to the appropriate law enforcement agency. 144 Consumer and Community Affairs 171 The accompanying table summa- denials based on credit history indirizes the nature and resolution of cated that the applicant did not complaints filed against state mem- realize the implications of a poor ber banks in 1986, classified accord- credit history or of a lack of borrowing to bank functions: loans, depos- ing experience on the decision about its, electronic fund transfers, trust creditworthiness. services, and others. Of the 930 complaints received about state member banks, just over half concern loan functions, including alleged Community Reinvestment Act discrimination on a prohibited basis, The Board is required by the Comdisclosure of credit costs, and credit munity Reinvestment Act to encourdenial on a nonprohibited basis; age institutions under its jurisdiction another quarter involved practices to help meet the credit needs of their concerning deposit accounts, includ- communities—including low- and ing disputes about interest. moderate-income neighborhoods—in a manner consistent with the safety and soundness of the institutions. Unregulated Practices The Board assesses the record of Under section 18(f) of the Federal state member banks in meeting these Trade Commission Act, the Federal needs as part of its examinations and Reserve Board is authorized to iden- takes an institution's CRA perfortify unfair or deceptive banking prac- mance into account when acting on tices and adopt regulations that pro- certain applications filed by banks hibit them. The Board has a system and bank holding companies. to monitor complaints about banking During the 1986 reporting period practices that are not subject to (July 1, 1985, through June 30, existing regulation but that may be 1986), Federal Reserve personnel unfair or deceptive. The Board iden- examined 761 state member banks tifies unregulated practices that are for compliance with the CRA. The the subject of 15 or more complaints records of almost all of these banks per quarter, or 50 or more for the were deemed satisfactory or better. year. Of the 1,329 complaints about During calendar year 1986, 20 unregulated practices received in 1986, applications filed by banks or bank the 398 identified by this system fell holding companies with the Federal into the following categories: credit Reserve System were protested under denial based on credit history (109); the CRA; 13 were decided by yearother unregulated lending practices end. Seven of these protests were (96); credit denial based on other withdrawn after the applicants and nonprohibited factors, such as the protestants reached agreement, often lack of sufficient assets (77); exces- as a result of meetings facilitated by sive time taken to clear checks, the Federal Reserve Banks. including delayed availability of funds (60); and crediting of deposits to accounts (56). Each of these categories accounts for less than 5 per- Consumer Advisory Council cent of all consumer complaints re- November 1986 marked the tenth ceived. Many of the complaints about anniversary of the Federal Reserve's 172 Consumer and Community Affairs Consumer Advisory Council (CAC). Created by the Congress and representing a wide spectrum of interests, the 30-member CAC advises the Board on the implementation of federal laws governing consumers' rights and responsibilities in their dealings with the financial services industry. In 1986 the council met in March, June, and October. Throughout 1986 a study group of the CAC focused on reduced-rate financing offered by automakers. The CAC was concerned that these programs, which offer rates far below the market, might undermine the usefulness of the annual percentage rate (APR) for comparing the cost of credit offered by different credit providers. In some reduced-rate programs, a purchaser has the choice of financing the vehicle through the automaker's subsidiary at a reduced rate of interest or receiving a cash rebate from the manufacturer. Some critics believe that the rebate should be treated as part of the financing cost and taken into account in computing the APR, a required disclosure under truth in lending. The act, however, does not require such adjustments. The CAC was unable to reach consensus on appropriate disclosures for reduced-rate financing; it will continue to study the issue. In June 1986 the CAC unanimously reiterated its support, first voiced in October 1985, for the Board's issuing a policy statement that would encourage state member banks to offer basic financial services for low- and moderate-income consumers. It also asked the Board to encourage other financial regulatory agencies to join in a statement. After considering the council's strong views, the Board approved a policy statement on basic financial services, which it sent to the FFIEC in October (described above). The council expressed views on disclosures about funds availability and on the general improvement of the check-clearing process. It adopted resolutions recommending the mandatory disclosure of hold periods by all financial institutions, the adoption of a uniform system for counting the days that checks are held, and the continuation of industry efforts to streamline check-clearing. Uniformity in the required disclosures for adjustable-rate mortgages was another issue the CAC addressed in 1986. In March and October the council urged the federal agencies to adopt uniform disclosure requirements, supported the use of an ARMs brochure, and encouraged early disclosures. It also adopted a resolution calling for the Board's approval of consumer financial counseling as an activity of bank holding companies. In 1986 the council also considered the following issues: • A Board proposal for amending Regulation E that would eliminate the periodic statement requirements for institutions that issue debit cards but do not hold accounts. • Protests by community groups in connection with holding company applications under the Community Reinvestment Act. • Projected increases in secondmortgage debt. • The effect that proposed ceilings on credit card interest rates might have on creditors and consumers. • The effect of interstate banking on consumers, small businesses, and the financial industry. Consumer and Community Affairs 173 Legislative Recommendations tutions and Consumer Affairs of the In 1986 the Board testified before Senate Committee on Banking, various subcommittees of the Senate Housing, and Urban Affairs on sevand the House on legislation dealing eral bills dealing with credit card with credit card interest rates and disclosures. The proposed legislation disclosures, truth in savings, and covered issues such as early disclosures of the cost of a credit card business credit. plan, additional disclosures of the conditions under which a finance charge may be imposed, a mandated Credit Card Interest Rates method for computing balances, and In January the Board testified before quarterly reports to the Board by the Subcommittee on Financial Insti- credit card issuers about costs. The tutions and Consumer Affairs of the Board endorsed full disclosure both Senate Committee on Banking, as the fair way to deal with customers Housing, and Urban Affairs on leg- and as an aid in the competitive islation that would establish a federal process. At the same time, the Board ceiling on the interest rates that could pointed out that the costs of requirbe charged on credit card debt. The ing additional disclosures in all apBoard opposed the legislation in the plications (rather than only in mail belief that credit is most efficiently solicitations, as one of the bills proand productively distributed when vided) may not be justified. The Board believed that a maninterest rates are determined in markets free from artificial restraints. dated method for computing balThe Board noted that on average, ances would depart from the apfor the period 1972 through 1984, proach of the Truth in Lending Act, the rate of return earned on credit which is to leave the regulation of card operations was below that earned substantive terms to the states. The on other types of lending. While the Board acknowledged that a uniform Board noted that returns on credit method might eliminate the consumcards had increased in recent years, er's need to understand how one it also pointed out that credit card creditor's method differs from anothfinance rates had tended to decline er's, but it noted that this approach in the months before the hearing. had several drawbacks. Often the The Board stated that efforts to timing of a consumer's purchases and constrain rates through federal reg- payments determines which method ulation are likely to reduce credit yields the lowest finance charge. In availability, particularly for less afflu- addition, if regulating the method ent borrowers, or encourage less causes an increase in operating costs efficient means of recapturing credit or a reduction in revenues, creditors might seek to make up the difference costs. by restricting credit availability, eliminating grace periods, or imposing annual fees or higher interest rates. Credit Card Disclosures The Board also believed that states, In May the Board testified before with their experience in regulating the Subcommittee on Financial Insti- yield-producing terms of accounts, 174 Consumer and Community Affairs were in a better position to regulate this area. In addition, the Board pointed to ongoing efforts by the Federal Reserve System and others to increase consumer awareness of this and other aspects of credit card transactions. The Board suggested postponing action on requiring creditors to report information on credit card costs until it had evaluated an APR demonstration project then under way. This study was conducted at the request of the Congress in three test cities to measure the benefits of providing consumers with comparative information, through newspaper charts, about the closed-end credit charges of lenders. deposit accounts evolve while minimizing the burden on depository institutions. The Board noted its proposal to amend Regulation Q to update and clarify its rules on advertising of accounts and its work toward a policy statement on disclosures of terms on deposit accounts. As these measures would be limited to member banks, the Board is consulting with the other regulatory agencies so that these requirements would be applied uniformly to all depository institutions. Regulation B and Business Credit In August the Board testified before the Subcommittee on Consumer Affairs and Coinage of the House Truth in Savings Committee on Banking, Finance and In June the Board testified before Urban Affairs on proposed changes the Subcommittee on Financial Insti- to the Equal Credit Opportunity Act tutions Supervision, Regulation and with respect to business credit transInsurance of the House Committee actions. The proposal would extend on Banking, Finance and Urban to business transactions certain techAffairs on proposed truth-in-savings nical requirements of Regulation B legislation. This legislation would that currently relate only to conestablish uniform requirements for sumer transactions, would require all depository institutions regarding public hearings on any exemptions, advertisements of interest rates and and would put a five-year limit on disclosures. Among other things, it exemptions. The Board believed that would require the disclosure of an the ECOA and Regulation B in their annual percentage yield, an annual present form provide adequate legal rate of simple interest, and a sched- protection against discrimination. The ule of fees and charges. The Board exceptions established for business supported providing bank customers credit are narrowly drawn and rewith clear and complete information spond directly to the distinctions when they open accounts, but ques- between consumer and business tioned whether legislation is neces- credit. The Board stated that the sary. Should the Congress decide it legislation would not significantly is necessary, the Board believed, the improve the Board's rulewriting legislation should provide for a flex- processes. Although a public hearing ible structuring of rules to enhance before granting or continuing any consumer benefits as new types of exception for business credit would Consumer and Community Affairs afford an extra oppprtunity to gather information, the Board has found written public comment to be adequate. And the Board already periodically evaluates regulatory provisions under its Regulatory Improvement Project, a program calling for the review of regulations every five years or so. Finally, the Board expects that the business credit pamphlet developed with industry and minority group organizations will inform business credit applicants of their rights under the ECOA, besides 175 giving them practical assistance in obtaining credit. Recommendations of Other Agencies Each year the Board asks the agencies with enforcement responsibilities under Regulations B, E, and Z for recommendations concerning changes to the regulations or the underlying acts. In 1986 the agencies submitted no suggestions or recommendations for changes. 177 Legislative Recommendations The Board of Governors has made the following recommendations for legislation to the Congress of the United States. The Federal Reserve recommends that the Congress recognize the competitive, technological, and international forces operating in the banking and financial marketplace and expand the authorized role for bank holding Bank Holding Company companies. Legislation Plainly, the time has arrived to The Federal Reserve believes that clarify and expand certain securities reform of the existing statutory powers of bank holding companies, framework is urgently needed to a matter that cannot be dealt with maintain a strong, stable, and com- reasonably and rationally without petitive banking system. The forces congressional action. of change—technological, ecoThe Board believes that it would nomic, and competitive—at work on be appropriate, as a matter of good an international scale need to be public policy, to permit bank holding channeled constructively if the broader companies to underwrite municipal public interests are to be served. revenue bonds, mortgage-backed seClearly, areas exist in which market curities, commercial paper, and mucompetition should be freed and tual funds. The Board would also efficiency promoted. At the same encourage the Congress to consider time, there are areas in which insti- other financial areas appropriate for tutional stability and public policy bank holding companies, including objectives need to be protected by insurance and real estate brokerage, maintaining an appropriate legisla- and insurance underwriting. tive and regulatory framework. The Federal Reserve would also To these ends, the Federal Re- urge the Congress to undertake hearserve has recommended that the ings of other studies in the area of Congress include in any legislative corporate underwriting—a process reform these features: that the Board would be pleased to • Expansion of the powers of bank support. The issues in this area are holding companies. more complicated because of the • Clarification of the definition of greater potential for conflict of inter"bank" to resolve the "nonbank est. However, a substantial amount of bank" issue and clarification of the such activity is already conducted by proper scope of powers for state- bank holding companies abroad, and chartered institutions. the increased securitization of financial • Streamlining of the procedures assets by banks and others requires of the Bank Holding Company Act. fresh consideration of how banks may participate in that process. Powers The legitimate boundaries of activities Definitions permitted to banking organizations New definitions of the terms "bank" be reviewed and enlarged. and "thrift institution" are necessary need to 178 Legislative Recommendations to assure an orderly framework for the development of the financial system, to promote competitive equity, and to maintain the basic separation of banking and commerce. The Board believes that banks continue to perform a unique and critical role in the financial system and the economy—as operators of the payments system, as custodians of liquid savings, as key and impartial suppliers of short-term credit, and as the link between monetary policy and the economy. The Board believes that all institutions having the unique character of banks should be subject to the rules applicable to banking institutions—that is, the limitations on the range of activities and ownership, as well as the protections against conflict of interest, concentration of resources, and excessive risk. To achieve that end and to close the socalled "nonbank bank" loophole, the Board has recommended clarifying the definition of "bank" in the Bank Holding Company Act by, among other changes, extending the definition to cover all institutions that are insured by the Federal Deposit Insurance Corporation. The Board has also recommended that thrift institutions meet a minimum residential mortgage test to remain eligible for the special benefits provided by law for such institutions. The holding companies of thrift institutions not meeting the test would be limited so that the scope of their permissible nonbanking activities would be similar to those of bank holding companies. The Board has recommended that the Congress establish limits with respect to the ability of states to authorize state-chartered institutions to engage in certain activities that may affect the safety and soundness of the financial system with adverse consequences for the federal insurance funds. Procedures The Board favors streamlining the procedures for dealing with bank holding company applications. By recent changes in the regulation governing holding company activities, the Board has gone as far as it believes it can, consistent with present law, to speed up procedures and lessen regulatory burdens. The Board has recommended legislation eliminating the "benefits and burdens" test of present law, providing for expedited notice procedures for approval of new activities, and setting out new and simplified criteria for determining the permissibility of new activities generally. Emergency Acquisition Authority The Board favors an extension and modification of the provisions contained in title I of the Garn-St Germain Depository Institutions Act that permit the FDIC and the FSLIC to arrange for emergency interstate mergers and acquisitions of financially troubled thrift institutions and failed insured commercial banks with assets of $500 million or more. In light of the continuing strains evident in some sectors of the thrift and banking industries, including difficulties experienced by some banks engaged in lending to the agricultural and energy sectors, the Board has recommended that the emergency arrangements for failing institutions in the Garn-St Germain Act be extended and liberalized in the following ways: (1) reduce the threshold Legislative Recommendations 179 amount for interstate emergency acquisitions from $500 million to $250 million; (2) permit interstate acquisition of banks in danger of closing as well as of closed banks; and (3) allow for acquisition of a holding company and its affiliated banks if the holding company has a bank or banks in danger of closing with total assets of $250 million or more and which represent at least 33 percent of its banking assets. Increasing the Number of Class C Directors The Board has recommended that the Federal Reserve Act be amended to increase the number of Class C directors at each Federal Reserve Bank from three to five. The proposal aims to diversify further the backgrounds and interests represented on the boards of directors of the Reserve Banks as a way of accomplishing one of the objectives of the Federal Reserve Reform Act of 1977. That act provides for the representation of the interests of consumers, labor, and services, in addition to agriculture, commerce, and industry, on the boards of the Reserve Banks. The Board also has recommended that thrift institutions be added to the groups that should be considered in selecting Class C directors in view of the changes made by the Monetary Control Act of 1980. That act applied reserve requirements to such institutions and made Federal Reserve credit and services available to them. Funds for Reserve Bank Branches The Board has recommended that the Federal Reserve Act be amended with respect to the limit on the cumulative dollar amount that may be spent on construction of Federal Reserve Bank branch buildings. The System incurs expenses for branch construction principally for additions to, or replacements for, existing branch facilities. The current limitation, set in 1974, will be exhausted by projects that are under way or that are currently at an advanced planning stage. Branches of Federal Reserve Banks provide important services to the financial system and the public, including the distribution of coin and currency, the clearing of checks, and the processing of electronic payments. The current statutory limitation will prevent needed renovation and new construction at branch buildings. Interstate Banking The Board believes that the Congress should review and clarify national policy toward interstate banking. It recognizes that regional arrangements provide a possible transitional approach to full interstate banking. Viewed as a permanent solution, however, regional compacts would tend to balkanize banking, with a tendency toward regional concentrations. The potential weaknesses of regional compacts could be substantially ameliorated if states entering into such regional arrangements were also required after a few years to permit reciprocal entry by banks in any state that has enacted a regional arrangement or otherwise provides for entry of banks of any other states. To forestall large concentrations of domestic banking resources, the Board has recommended that certain safeguards be included in liberalizing 180 Legislative Recommendations interstate banking. The Board has suggested the following approaches: the very largest holding companies might be prohibited from merging with one another; institutions could be prohibited from obtaining by acquisition more than some fixed share of banking assets, although de novo or small acquisitions could still be permitted; and states could set limits on the percentage of banking assets within their own boarders that could be acquired through acquisitions or mergers. The Board has also recommended that Congress authorize interstate branching within metropolitan areas and within neighboring areas of contiguous states. depository institutions of making funds available more promptly. The Board has felt primary emphasis should be placed on efforts to alleviate the problem of funds availability through disclosure and improvements to the check collection and return process. However, the Board is aware that some states have enacted mandatory schedules that appear to be operating reasonably well. The Board believes that mandatory schedules could be workable provided the Federal Reserve is given authority to determine those schedules in the light of anticipated improvements to the check system. Such schedules should be based on the times in which most checks can reasonably be expected to be collected and returned to the depository institution in which they were first Improving Check Collection deposited in the event of dishonor. The Board believes that depository The Board believes that, after a institutions should clearly disclose to relatively short transition period, customers their policies with respect schedules of from two to six business to the availability of deposited funds days or even less are feasible deat the time an account is opened and pending on where the check is drawn. when such policies are changed. The Board also believes that manMoreover, authority to override in- datory schedules should contain exdividual state statutes is necessary if ceptions to permit depository instithe process of collection and return tutions to place holds on deposits of of checks is to be speeded, thus accounts presenting unusually high reducing or eliminating the risk to risks. 181 Litigation During 1986 the Board of Governors was named in 47 pending lawsuits, compared with 55 in 1985. Of the 12 new lawsuits filed in 1986, 9 raised questions under the Bank Holding Company Act, compared with 4 in 1985. As of December 31, 1986, 29 cases were pending, 14 of which involve questions under the Bank Holding Company Act. The sections below briefly describe each of these cases. Bank Holding Companies— Antitrust Action In 1986 no bank holding company acquisitions or mergers that had been approved by the Board were challenged by the U.S. Department of Justice under antitrust laws, and no such cases were pending from previous years. Bank Holding Company Act— Review of Board Actions In Dimension Financial Corporation etal. v. Board of Governors, No. 832696 (10th Circuit, filed December 30, 1983); First Bancorporation v. Board of Governors, No. 84-1011 (10th Circuit, filed January 5, 1984); and Colorado Industrial Bankers Association et al. v. Board of Governors, No. 84-1122 (10th Circuit, filed January 27, 1984), petitioners challenged the definition of "commercial loan" and "demand deposit" in a revision of the Board's Regulation Y that was approved by the Board on December 14, 1983 (Federal Reserve Bulletin, vol. 70, February 1984, p. 121). The court of appeals set aside the definitions challenged in Regulation Y on September 24, 1984 (744 F.2d 1402). A petition for writ of certiorari (No. 84-1274, filed February 6, 1985) was granted by the Supreme Court on April 29, 1985 (105 S. Ct. 2137). By decision dated January 22,1986, the Court affirmed the court of appeals decision (106 S. Ct. 681). In Florida Bankers Association et al. v. Board of Governors, Nos. 843269 and 84-3270 (11th Circuit, filed on April 20, 1984), petitioners seek review of a Board order dated March 23, 1984, approving an application by U.S. Trust Corporation, New York, New York, to expand the activities of its subsidiary, U.S. Trust Company of Florida, N.A., Palm Beach, Florida, to include the acceptance of time and demand deposits and the making of consumer loans (Federal Reserve Bulletin, vol. 70, April 1984, p. 371). On May 20, 1985, the court reversed the Board's order of approval (760 F.2d 1135). By order dated January 27,1986, the Supreme Court granted intervenor U.S. Trust Company's petition for certiorari (No. 85-193), vacated the court of appeals judgment, and remanded the case back to the court of appeals (106 S. Ct. 875). In an opinion dated October 6, 1986, that court upheld the Board's order (800 F.2d 1534). A petition for certiorari filed December 23,1986, by petitioners is pending (No. 86-1023). In Florida Department of Banking v. Board of Governors, Nos. 84-3831 and 84-3832 (11th Circuit, filed November 30, 1984), and Florida Bankers Association v. Board of Gover- 182 Litigation nors, Nos. 84-3883 and 84-3884 (11th Circuit, filed December 21, 1984), petitioners seek review of Board orders dated November 1, 1984, approving the applications by Bank of Boston Corporation, Boston, Massachusetts, and Bankers Trust New York Corporation, New York, New York, to expand the activities of their subsidiaries—Bank of Boston Trust Company of Southeast Florida, N.A., Dearfield Beach, Florida; Bank of Boston Trust Company of Southwest Florida, N.A., Sarasota, Florida; and Bankers Trust Company of Florida, N.A., Palm Beach, Florida—to include the acceptance of time and demand deposits and the making of consumer loans (Federal Reserve Bulletin, vol. 71, January 1985, pp. 55 and 51, respectively). Proceedings in the cases have been stayed pending a final disposition by the Supreme Court in Florida Bankers Association v. Board of Governors. In Independent Community Bankers Association of South Dakota v. Board of Governors, No. 85-1496 (D.C. Circuit, filed August 7, 1985), petitioner seeks review of the Board's order dated July 12, 1985, approving the application of First City Bancorporation of Texas, Inc., Houston, Texas, to acquire First City BankSioux Falls, N.A., Sioux Falls, South Dakota (Federal Reserve Bulletin, vol. 71, September 1985, p. 716). The case is pending. In First National Bancshares Corp. II v. Board of Governors, No. 853702 (6th Circuit, filed September 4, 1985), petitioner sought review of the Board's order dated August 5, 1985, denying the application of First National Bancshares Corporation II, Lexington, Tennessee, to become a bank holding company by acquiring First National Bancshares Corpora tion, Lexington, Tennessee, and, indirectly, its subsidiary, First National Bank of Lexington, Lexington, Tennessee (Federal Reserve Bulletin, vol. 71, October 1985, p. 793). By order dated October 28, 1986, the court affirmed the Board's order (804 F.2d 54). In First National Bank of Blue Island Employee Stock Ownership Plan v. Board of Governors, No. 852615 (7th Circuit, filed September 23, 1985), petitioner sought review of the Board's order dated August 22, 1985, denying the application of First National Bank of Blue Island Employee Stock Ownership Plan, Blue Island, Illinois, to become a bank holding company by acquiring Great Lakes Financial Resources, Inc., Blue Island, Illinois (Federal Reserve Bulletin, vol. 71, October 1985, p. 804). By order dated October 1, 1986, the court affirmed the Board's order (802 F.2d 291). In CBC, Inc. v. Board of Governors, No. 86-1001 (10th Circuit, filed January 2, 1986), petitioner seeks review of the Board's order dated December 15, 1985, requiring that bank holding companies with assets of $150 million or more must file certified financial statements with their annual reports. The case is pending. In St. James Bancorp v. Board of Governors, No. 86-1224 (8th Circuit, filed February 19, 1986), petitioner sought review of the Board's order dated January 21, 1986, denying the application of St. James Bancorp, Inc., St. James, Minnesota, to become a bank holding company by acquiring Roseville Bancorp, Inc., Minneapolis, Minnesota, and thereby to indirectly acquire Mid America National Bank of Roseville, Roseville, Minnesota (Federal Reserve Bulletin, vol. 72, March 1986, p. Litigation 183 199). On April 15, 1986, petitioner's fering of securities in violation of the motion for dismissal of the case was Bank Holding Company Act. On October 27, 1986, the court disgranted by the court. In Securities Industry Association missed the case for lack of jurisdicv. Board of Governors, No. 86-1412 tion, and on October 30, 1986, peti(D.C. Circuit, filed July 14, 1986), tioner appealed. The case is pending petitioner seeks review of the Board's (No. 86-5667). order dated June 13,1986, approving In Independent Insurance Agents the application of National West- of America, Inc., et al. v. Board of minster Bank PLC, London, Eng- Governors, Nos. 86-1572, 86-1573 land, and its U.S. subsidiary, NatWest and 86-1576 (D.C. Circuit, filed OcHoldings, Inc., New York, New tober 24, 1986), petitioners seek York, to offer investment advice and review of the Board's order dated securities brokerage services to insti- October 3, 1986, amending the protutional customers through a single visions of Regulation Y that deal subsidiary (Federal Reserve Bulletin, with permissible insurance activities vol. 72, August 1986, p. 584). The for bank holding companies. The case is pending. case is pending. In Jenkins v. Board of Governors et al, No. 86-1419 (D.C. Circuit, filed July 18, 1986), petitioner seeks Other Litigation Involving review of the Board's action of May Challenges to Board Procedures 21, 1986, approving the application and Regulations of First Security Financial, Salt Lake City, Utah, for membership in the In 1986 actions were taken or were Federal Reserve System. The Board pending, including those under the filed a motion to dismiss on August Financial Institutions Supervisory Act, the Glass-Steagall Act, and the Farm 14, 1986. The case is pending. In Independent Community Bank- Credit Act. ers Association of South Dakota v. Board of Governors, No. 86-5373 Financial Institutions (8th Circuit, filed October 3, 1986), Supervisory Act petitioner seeks review of the Board's In Carter v. Board of Governors et order dated September 15, 1986, al, No. 85-4021 (6th Circuit, filed approving the application of Michi- December 9, 1985), plaintiff sought gan National Corporation, Bloom- review of the Board's order dated field Hills, Michigan, to acquire In- November 18, 1985, removing him dependence One Bank, N.A., Rapid as an officer of First National Bank City, South Dakota (Federal Reserve of Clinton, Clinton, Kentucky. On Bulletin, vol. 72, November 1986, p. February 13, 1986, the case was voluntarily dismissed by the peti792). The case is pending. In Securities Industry Association tioner. v. Board of Governors, No. 86-2768 In Adkins v. Board of Governors, (D.C. Circuit, filed October 7,1986), No. 86-3853 (4th Circuit, filed May petitioner seeks a declaration from 8, 1986), petitioner seeks review of the court that Charles Schwab & the Board's order dated April 24, Co., Inc., a discount broker that is a 1986, assessing civil money penalties subsidiary of a bank holding com- against him. The case is pending. pany, participated in the public of In a case filed in the U.S. District 184 Litigation Court for the District of Minnesota, No. 4-83-995 (filed November 16, 1983), which was placed under seal by court order, plaintiff alleges that the Board reviewed and copied his records at a national bank in violation of the Right to Financial Privacy Act. The case is pending. In a case filed in the U.S. District Court for the District of Columbia, No. 86-2868 (filed October 20,1986), which was placed under seal by court order, plaintiff seeks injunctive relief from a Temporary Order of Cease and Desist issued against him by the Board. The case is pending. The Glass-Steagall Act In Securities Industry Association v. Board of Governors, Nos. 80-2614 and 80-2730 (D.D.C., filed October 24, 1980), plaintiffs sought review of a Board statement dated September 26, 1980, denying in part plaintiff's petition that the Board prohibit Bankers Trust Company, a state member bank, from selling thirdparty commercial paper as an agent of the issuer, pursuant to the GlassSteagall Act. On June 28, 1984, the Supreme Court overruled the Board's decision and remanded the case to the court of appeals (104 S. Ct. 2979), which remanded it to the district court. On October 19, 1984, the district court remanded the case to the Board to determine whether the methods that Bankers Trust uses to place commercial paper constitute underwriting or similar activities within the meaning of the Act. On June 4, 1985, the Board determined that the current placement methods of Bankers Trust are consistent with the Act. By memorandum orders dated February 4 and 18, 1986, the district court invalidated the Board's decision and permanently enjoined Bankers Trust from their current placement methods (627 F.Supp. 695, 628 F.Supp. 1438). The injunction was subsequently stayed by the court of appeals. By order dated December 23, 1986, the court of appeals reversed the district court and reinstated the Board's decision (Nos. 865089, 86-5090, 86-5091, 86-5139). Farm Credit Act Several cases have been filed in various district courts seeking injunctive relief and damages relating to loans made to plaintiff farmers by commercial banks and the Farm Credit System. Populist Party of Iowa v. Federal Reserve Board, No. 85-626-B (S.D. Iowa, filed August 2, 1985), was dismissed on December 11, 1985, for lack of jurisdiction. Alfson v. Wilkinson et al., No. A l 85-267 (D.N.D., filed October 8, 1985), was dismissed by court order on November 17, 1986. Jensen v. Wilkinson et al, No. 85-4436-S (D. Kan., filed October 10, 1985), and related cases, were dismissed by court order on October 7, 1986. Souser et al. v. Volcker et al., No. 85-C-2370 (D. Colo., filed November 1, 1985), and related cases, were dismissed by court order on December 4, 1985. Kurkowski v. Wilkinson et al., No. CV-85-0-916 (D. Neb., filed October 16, 1985) was dismissed on April 22, 1986, and plaintiff appealed to the eighth circuit. The case is pending. Podolak v. Volcker et al., No. C850456 (D. Wyo., filed October 28, 1985), and related cases were dismissed on February 24, 1986, and plaintiffs appealed to the tenth circuit. The cases are pending. A motion by the federal defend- Litigation 185 federal monetary credit and bankruptcy statutes by the Board and BancOhio National Bank. On November 20,1985, the U.S. magistrate recommended dismissal of the action. Plaintiff filed a notice of appeal on March 5, 1986, No. 86-3210 (6th Circuit). The case is pending. In Cook v. Spillman et al., No. CIV-S-85-0953 EJG (E.D. Cal., filed July 10,1985); Wight etal. v. Internal Other Actions Revenue Service et al., No. CIV-SIn Melcher v. Federal Open Market 85-0012 MLS (E.D. Cal., filed July Committee, No. 84-1335 (D.D.C., 12, 1985); and Urwyler et al. v. filed April 30, 1984), plaintiff chal- Internal Revenue Service et al, No. lenges the constitutionality of the CV-F-85-402 REC (E.D. Cal., filed Federal Open Market Committee. July 18, 1985), plaintiffs allege that On June 5, 1986, the court denied the sixteenth amendment to the Conthe defendant's motion to dismiss stitution was not properly ratified (644 F.2d 510). By order dated and that the use of Federal Reserve September 26,1986, the court upheld notes constitutes illegal gambling. the constitutionality of the Federal The Board's motions to dismiss the Open Market Committee and dis- cases were granted by the district missed the case (Id.). The court court. The plaintiff in Cook filed a denied plaintiffs motion to alter or notice of appeal on January 10,1986, amend judgment on November 18, No. 86-1642 (9th Circuit), and by 1986, and plaintiff filed a notice of order dated December 22, 1986, the court dismissed the appeal. The appeal. The case is pending. In Brown v. United States Congress plaintiffs in Wight and Urwyler filed etal,No. 84-2887-6 (IG) (S.D. Cal., notices of appeal on December 22, filed December 7, 1984), plaintiff 1985, No. 85-2826, and December 3, seeks damages resulting from alleged 1985, No. 85-2877, respectively (9th discrimination in home financing and Circuit). These cases are pending. In Johnson v. Federal Reserve mandatory injunctions regarding the Board's monetary policy. The court System et al., Nos. S85-0958(R) and dismissed the case on September 17, S85-1269(N) (S.D. Miss., filed July 1985. Plaintiff filed a notice of appeal 16 and October 21, 1985), plaintiff on September 20, 1985, No. 85-6313 sought injunctive relief and damages (9th Circuit), then voluntarily dis- against defendants relating to foremissed the appeal on November 12, closures on plaintiffs property. By 1985. On September 27, 1985, plain- order dated June 23, 1986, the court tiff filed a motion for reconsideration dismissed the complaint. Plaintiff filed with the district court. The case is a notice of appeal on July 23, 1986, No. 86-4536 (5th Circuit). On Seppending. In Lewis v. Volcker et al., No. C- tember 29, 1986, the court dismissed 1-85-0099 (S.D. Ohio, filed January the appeal for failure to prosecute. 14, 1985), plaintiff seeks damages In McHuin v. Volcker et al., No. resulting from alleged violations of 85-2170 WARB (W.D. Okla., filed ants to dismiss has been filed in each of the following cases: Farmer v. Wilkinson et al., No. 4-85-CIVIL1448 (D. Minn., filed October 21, 1985); Kolb v. Wilkinson et al, No. C85-4184 (N.D. Iowa, filed October 22, 1985); Myers et al. v. Federal Reserve Board, No. 85-1427 (D. Ida., filed November 18, 1985). 186 Litigaton August 29, 1985), plaintiff sought reinstatement as an employee at the Federal Reserve Bank of Kansas City. By order dated December 9, 1986, the complaint was dismissed by the court. In Howe v. United States et ai, No. 85-4504-C (D. Mass., filed December 6, 1985), plaintiff challenges the constitutionality of the current monetary system. By order dated April 18, 1986, the court dismissed the complaint. Plaintiff filed a notice of appeal on April 28, 1986, No. 861430 (1st Circuit). By order dated July 30, 1986, the court affirmed the district court's dismissal of the action, and plaintiff filed a petition for rehearing. By order dated August 29, 1986, the court denied the petition. Appellant filed a petition for writ of certiorari on November 26, 1986 (No. 86-889). The case is pending. In Optical Coating Laboratory, Inc. v. United States, No. 288-86C (Ct. Cl., filed May 6, 1986), plaintiff seeks damages based upon the expiration of its contract with the Federal Reserve Board. The case is pending. 187 Banking Supervision and Regulation In 1986 the Board of Governors continued its program to strengthen the supervision and regulation of the banking organizations under its jurisdiction. The Board initiated the program in the fall of 1985 in light of developments within the banking system over the past several years, and it is aimed at three broad areas of supervision: (1) preventing the emergence of problems in banking organizations through strengthened policies designed to encourage sound banking practices, (2) the early identification of problems that do emerge through more frequent and thorough on-site examinations and inspections, and (3) improved communication of findings to bank management and boards of directors so that they will move quickly to correct problems. The new program resulted in a 21 percent increase over 1985 in on-site examinations and inspections and a substantial expansion in the number of meetings with boards of directors. The Board took several steps in 1986 to further strengthen its supervisory program. The principal step was its proposal in early 1986 for a risk-adjusted measure of capital adequacy. The plan has been revised and issued jointly for public comment with the other federal banking regulators and the Bank of England. The Board also revised its guidelines on capital adequacy, specifying that perpetual debt, properly structured, could qualify as a noncommon equity form of primary capital and respecifying the percentages of these forms of capital that can qualify as primary capital. In recognition of the unique problems currently facing banks with substantial exposure to the agricultural and energy sectors of the economy, the Board in 1986 adopted policies to assist these banks. The policy allows such banks to operate with reduced levels of capital if they have the ability to improve their capital position over a reasonable period of time and if they have instituted reasonable plans to correct their financial or operating deficiencies. In addition, the policy makes clear that problem loans need not necessarily be written down if they are restructured in line with Financial Accounting Standard 15 so that the sum of future interest and principal payments equals at least the face amount of the loan. Supervision for Safety and Soundness The Federal Reserve conducts the following activities to ensure the safety and soundness of financial institutions: on-site examinations and inspections, surveillance and monitoring, and enforcement and other supervisory actions. Examinations and Inspections The on-site review of operations is an integral part of ensuring the safety and soundness of financial institutions. Examinations of state member banks and Edge corporations and inspections of bank holding companies and their subsidiaries entail (1) 188 Banking Supervision and Regulation an appraisal of the quality of the institution's assets; (2) an evaluation of management, including internal policies, operations, and procedures; (3) an assessment of the key financial factors of capital, earnings, asset and liability management, and liquidity; and (4) a review for compliance with applicable laws and regulations.1 ments. System examiners conducted 811 examinations, many jointly or concurrently with examiners from state regulatory agencies. Bank Holding Companies In 1986 the number of bank holding companies increased by 12 to a total of 6,465. These organizations control 9,409 commercial banks, which hold about 92 percent of the total assets State Member Banks The Federal Reserve is the primary of insured commercial banks in the federal supervisor and regulator of United States. state-chartered commercial banks that Most large bank holding compaare members of the Federal Reserve nies, as well as small companies with System. At the end of 1986 there significant nonbank assets, are inwere 1,110 state member banks, spected annually under the new polaccounting for about 8 percent of all icy. Others are inspected at least insured commercial banks. These every three years or, in the case of banks held about 18 percent of total the smallest companies that do not assets of insured commercial banks. have nonbank assets, on a sample As stated above, the Federal Re- basis. The inspection focuses on the serve in 1986 increased the frequency operations of the parent holding of scheduled examinations and in- company and its nonbank subsidispections of state member banks and aries; the subsidiary banks are exbank holding companies. In general, amined by the appropriate federal the new guidelines, established by banking regulatory agencies. In 1986, the Board in the fall of 1985, call for System examiners made 2,242 onstate member banks to be examined site inspections of bank holding comat least annually. Except for large or panies. An additional 96 off-site troubled banks, examination by either inspections were conducted, and state a Reserve Bank or a state banking examiners made 87 inspections. agency will meet that requirement. In 1986, 1,016 state member banks were examined, 298 of which were Enforcement Actions examined by state banking depart- and Civil Money Penalties Under the Financial Institutions Supervisory Act of 1966, the Board of 1. The Board's Division of Consumer and Community Affairs is responsible for review- Governors has the authority to enter ing compliance with consumer and civil rights into written agreements with, or laws. The responsibility is accomplished mainly issue cease and desist orders against, through examinations by specially trained Re- state member banks and bank holdserve Bank examiners. These regulatory responsibilities are described in the section of this ing companies, and persons associREPORT covering consumer and community af- ated with such organizations that fairs. Compliance with other statutes and reg- engage in unsafe or unsound praculations, which is treated in this section, is the tices or that violate applicable laws responsibility of the Board's Division of Banking Supervision and Regulation and of the Re- or regulations. The Board may also serve Banks, whose examiners check for safety assess civil money penalties for vioand soundness. lations of a cease-and-desist order, Banking Supervision and Regulation 189 of the Bank Holding Company Act, or of certain provisions of the Federal Reserve Act. In 1986 the Reserve Banks recommended and the Board's staff initiated and worked on 260 enforcement cases that involved 481 separate actions, such as cease and desist orders, removals, and civil money penalties, most dealing with unsafe or unsound banking practices; 125 cases involving 178 actions were completed by year-end. Also, the Board assessed or collected 12 civil money penalties, totaling $625,000, paid by 1 state member bank, 1 bank holding company, and 10 individuals. A description of all formal supervisory actions during the year and the reasons for them were made available to the public in the Board's twice-yearly "Report on Formal Enforcement Actions." International Activities The Federal Reserve is responsible for supervising several international banking activities. Edge and Agreement Corporations Edge corporations are international banking organizations chartered by the Board to provide all segments of the U.S. economy with a means of financing international trade, especially exports. An agreement corporation is a company that enters into an agreement with the Board not to exercise any power that is impermissible for an Edge corporation. In 1986 the Federal Reserve conducted examinations of 124 Edge and agreement corporations. Foreign-Office Operations of U.S. Banking Organizations Examinations of the international operations of state member banks, Edge corporations, and bank holding companies are conducted principally at the banking organizations' head offices in the United States, where the ultimate responsibility for foreign offices lies. To verify and supplement the results of the head-office examinations, on-site reviews of important foreign offices are performed at least every three years. In 1986 the Federal Reserve examined 16 foreign branches of state member banks and 15 foreign subsidiaries of Edge corporations and bank holding companies. All the examinations abroad were coordinated with the supervisory authorities of the countries in which the examinations took place. U.S. Activities of Foreign Banks Foreign banks continue to expand their operations in the United States and are significant participants in the U.S. banking system. As of December 31, 1986, 259 foreign banks operated 398 state-licensed branches and agencies, of which 32 are insured by the Federal Deposit Insurance Corporation; at year-end these foreign banks also operated 89 branches and agencies licensed by the Office of the Comptroller of the Currency, of which 3 have FDIC insurance. Foreign banks also directly owned 19 Edge corporations and 11 commercial lending companies. In addition, foreign banks held a majority interest in 72 U.S. commercial banks. Together, these foreign banks at yearend controlled approximately 12 percent of U.S. banking assets. The Federal Reserve has broad authority to supervise and regulate foreign banks that engage in banking in the United States through branches, agencies, commercial lending companies, Edge corporations, or banks. In exercising this authority, the Fed- 190 Banking Supervision and Regulation eral Reserve relies on examinations conducted by the appropriate federal or state regulatory agency. Although states have primary authority for examining state-licensed, uninsured branches and agencies, the Federal Reserve participated in the examination of 98 such offices during the past year. Specialized Examinations The Federal Reserve conducts specialized examinations in the following areas of bank activity: electronic data processing, trust activities, municipal securities dealing and clearing, and securities transferring. In 1986, guidelines for the frequency of specialized examinations were adopted, and in conformance with the System's program for strengthening Reserve Bank supervision, the frequency of specialized examinations for problem institutions was increased. Electronic Data Processing Under the Interagency EDP Examination Program, the Federal Reserve examines the electronic data processing (EDP) activities of state member banks, Edge and agreement corporations, and independent centers that provide EDP services to these institutions. In 1986, System examiners conducted 334 on-site EDP reviews. In addition, the Federal Reserve reviews reports of EDP examinations issued by other bank regulatory agencies on organizations that provide data processing services to state member banks. Trust Activities The Federal Reserve examines trust departments of state member banks, trust companies that are members of the Federal Reserve System, and certain foreign and domestic trust company subsidiaries of bank holding companies. These examinations review the trust functions to ensure that they are conducted in accordance with laws, regulations, and applicable fiduciary principles. During the year, the Federal Reserve conducted 250 such examinations. Municipal Securities Dealers and Clearing Agents The Securities Act Amendments of 1975 made the Board responsible for supervising state member banks and bank holding companies that act as municipal securities dealers or as clearing agencies. In 1986 the Board examined 32 of the 50 state member banks registered with the Board that deal in municipal securities. A clearing agency acts as a custodian of securities involved in transactions settled by bookkeeping entries. The four agencies registered with the Board were examined in 1986. Transfer Agents System examiners conduct separate reviews of state member banks and bank holding companies that act as transfer agents. Transfer agents countersign and monitor the issuance of securities, register the transfer of securities, and exchange or convert securities. During 1986 the Board examined 91 such banks and bank holding companies. Surveillance and Monitoring In line with the overall supervisory objective of maintaining a safe and sound banking system, the Federal Reserve monitors quarterly the financial condition of member banks and bank holding companies. The surveillance program supplements the Banking Supervision and Regulation 191 examination process through computerized screening systems that identify institutions with poor or deteriorating financial profiles. It further aids in the allocation of the System's examination resources by focusing on banking institutions that have serious financial problems and that may be subject to accelerated examinations or may warrant closer supervision. In 1986 the System strengthened its surveillance program by revising its screening program while continuing the electronic transmission of surveillance results between the Reserve Banks and the Board of Governors. The Board revised the reporting requirements for large and small bank holding companies and introduced new requirements for reporting of data on nonbank subsidiaries. These changes enhanced the Federal Reserve System's ability to evaluate the financial condition of these institutions. Also, the performance report for bank holding companies has been revised and now includes information on nonbank activities. Supervisory Reporting Requirements In 1986 the Federal Reserve completely revised the Bank Holding Company Supervision Manual to incorporate amendments to Regulation Y and the programs to strengthen the overall supervision of bank holding companies. The Commercial Bank Examination Manual, which covers state member banks, was similarly updated to incorporate the strengthened program of supervision and regulation. In 1986 the Federal Reserve made major revisions to the following reports required of bank holding comthe financial statements for panies: bank holding companies with consolidated assets of $150 million or more or with more than one subsidiary bank (FR Y-9C) and the parentcompany-only financial statements for these bank holding companies (FR Y-9LP), both filed quarterly; the parent-company financial statements for one-bank holding companies with less than $150 million (FR Y-9SP), filed semiannually; and the combined financial statements for nonbank subsidiaries (FR Y-11Q), filed quarterly, with a supplement (FR Y11AS) filed annually by type of nonbank subsidiary. Under these revisions, the Federal Reserve significantly improved the overall quality of the financial data needed for the timely supervision and monitoring of bank holding companies. Supervisory Policy In 1986 the Board of Governors made or initiated major changes in its supervisory guidelines. The following sections summarize these changes and review other activities during the year to strengthen the supervisory program. Capital Adequacy In November 1986 the Board of Governors issued revisions to its capital adequacy guidelines for bank holding companies. These revisions (1) allowed certain perpetual debt securities to be treated as primary capital and (2) placed a combined limit on the amount of perpetual debt, perpetual preferred stock, and mandatory convertible debt securities that may qualify as primary capital. The combined amount of such securities that may qualify as primary capital was limited to onethird of total primary capital. In addition, the revisions limited the 192 Banking Supervision and Regulation amount of mandatory convertible securities and perpetual debt that may qualify as primary capital to 20 percent of total primary capital. of capital adequacy. In January 1987 the Board of Governors issued the risk-based measure for public comment. Supplemental Measure of Adjusted Capital Problem Loans in Agriculture and Energy In January 1986 the Federal Reserve issued for public comment a proposal to supplement its capital adequacy guidelines for state member banks and bank holding companies. The supplemental adjusted capital measure was designed to relate capital requirements more closely to the risk profiles of banking organizations. The goals of the proposal are to (1) address off-balance-sheet exposures, which have expanded rapidly at many large banking organizations for the past several years; (2) temper the disincentives, inherent in the existing guidelines, to hold low-risk, relatively liquid assets; and (3) move capital requirements of state member banks and bank holding companies into closer alignment with capital adequacy policies in use or under development in other major industrial countries. Similar proposals were issued by the Office of the Comptroller of the Currency (for national banks) and by the Federal Deposit Insurance Corporation (for federally insured nonmember banks). After most of the public comments that were to be received were in hand, the three U.S. bank regulatory authorities discussed with representatives of the Bank of England ways to bring into closer alignment the capital requirements of regulators in their respective countries. Those discussions produced a risk-based measure of capital that would create for the two countries a single definition of primary capital and a single set of standards In 1986 the three federal bank regulatory agencies agreed to employ a common general supervisory policy to assist banks that are essentially sound and well-managed yet are experiencing difficulty with their capital ratios because of problems with their loans in the agriculture and energy sectors. The policy calls for the Reserve Banks to exercise appropriate forbearance in applying capital adequacy guidelines for such banks if they demonstrate a clear potential for restoring their capital position over a reasonable period of time. Banks seeking such "capital forbearance" are required to notify their Reserve Bank immediately when loan losses have caused their capital ratios to fall to levels materially below the minimum regulatory standards. Notification is to be followed by a comprehensive operating plan for restoring capital to normal levels. This policy does not discourage banks from forbearance on agricultural and energy loans in instances where it will work to the benefit of the bank as well as the borrower. Restructured loans do not require an automatic charge-off when future payments of principal and interest will at least equal the face amount of the loan under the criteria of Financial Accounting Standard 15 (Accounting by Debtors and Creditors for Troubled Debt Restructurings). In a related action effective June 30, 1986, the Federal Financial Institutions Examination Council amended the regulatory reports for Banking Supervision and Regulation 193 banks. These revised reports permit such restructured, performing loans to be reported separately from restructured but troubled loans. Fees for Processing Applications and for Examining Edge Corporations In 1986 the Board's staff studied the various methods the Federal Reserve System might use to recover some or all of the expenses involved in examining Edge corporations and in processing various types of applications. The Board has received, and at year-end was analyzing, public comments on its proposal to charge fees for these activities. Relations with the States The Board approved a policy, adopted by the Federal Financial Institutions Examination Council, to share confidential information with state agencies regulating banks and thrift institutions. This policy was adopted to better supervise the growing interstate activities of financial institutions. The Board in 1986 provided $100,000 to the Education Foundation of State Bank Supervisors. Established by the Conference of State Bank Supervisors, the foundation offers technical courses to state bank examiners. The Board also authorized the Federal Reserve Banks to provide scholarships to examiners employed by state banking agencies to help them cover expenses in attending training courses offered by the Federal Reserve and by the Federal Financial Institutions Examination Council. Work on Accounting Standards The Board and its staff are working Digitized forto eliminate, to the greatest extent FRASER possible, differences between regulatory reporting requirements and generally accepted accounting principles. Board staff members have served on various advisory committees of the Financial Accounting Standards Board (FASB) and are participating in that group's project on financial instruments. Staff members also provide commentary on proposals affecting banking organizations that are issued by FASB and by the American Institute of Certified Public Accountants. Reducing Risks in Large-Dollar Electronic Payment Systems In March 1986 the Board implemented a policy to reduce the risks associated with large-dollar payment systems. The Board strongly encouraged depository institutions using Fedwire or one of the private, largedollar wire networks to adopt voluntary limits on their own overdrafts. The Board announced that institutions not complying with the policy would not be permitted to incur daylight overdrafts on Fedwire. The program has reduced the risk associated with daylight overdrafts in several ways. First, the number of depository institutions incurring overdrafts during a typical monitoring period decreased from about 4,000 to about 3,200 between 1985 and 1986. Second, average cross-system funds overdrafts (to be distinguished from book-entry security overdrafts) remained approximately constant during this period, at about $80 billion, while the dollar volume of wire funds transfers increased more than 30 percent. Thus, overdrafts as a portion of gross payments volume declined markedly. Finally, virtually no institutions exceeded their over- 194 Banking Supervision and Regulation draft caps. Together, these facts indicate that the program has contained the growth of overdrafts without disrupting the payments systems and thereby has lowered the risks to the Federal Reserve, to the depository institutions, and to the wider economy. In December 1986 the Board issued for comment a series of proposals to further reduce payments system risk. The most significant of these would include in the total overdraft subject to voluntary ceilings those overdrafts due to bookentry security transactions. Depository institutions would have two options for including book-entry overdrafts in their total net debits subject to a cap: (1) depository institutions could include all of these overdrafts in their current net debit cap, or (2) institutions could collateralize the overdrafts caused by the book-entry transfers with book-entry securities that are eligible for pledging. Under the second option, only the uncollateralized portion of bookentry overdrafts would be added to the net debit subject to the cap. The Board is also seeking comment on whether there should be a book-entry transfer limit and whether that limit should be $25 million or $50 million per transaction. Such a limit would induce market participants to deliver securities earlier in the day rather than "building" positions of securities until late in the day. Position-building by securities dealers is a major source of bookentry overdrafts. The Board proposed the following additional changes: • Reduce the levels for the sender net debit cap in the present policy by 25 percent. • Establish a new de minimis cap category for institutions that do not incur large or frequent daylight overdrafts. This cap would be the lesser of 10 percent of capital or $500,000 and would be available to institutions that do not wish to undergo the selfassessment currently required for establishing a regular cap. • Amend its policy statement regarding consolidation of payments activities by affiliated institutions. Under one option, holding companies might consolidate payment activities at one subsidiary through affiliate transfers over Fedwire, provided that the board of directors of the sending institution approved such transfers periodically. Under the second approach, transfers that create a pattern of overdrafts at the sending institution would be prohibited. In addition, the Board proposed several changes affecting automated clearinghouse (ACH) procedures: (1) for purposes of calculating daylight overdraft levels only, post all entries for ACH debit payments and checks as of 1:00 p.m. Eastern time; (2) grant finality for ACH credit payments of $5,000 or less at 1:00 p.m. local time; (3) treat as provisional credit all ACH debit items and those ACH credit items greater than $5,000 until the Reserve Banks have received the funds; (4) accelerate the deadline for the return of debit transactions larger than $2,500 to the nighttime deposit deadline on the banking day following settlement or receipt; and (5) require notification of returns of $100,000 or more by 3:00 p.m. Eastern time on the banking day following settlement of receipt. The Board will review the public comments on these proposals in the spring and summer of 1987. Final actions that may be taken are likely to have effective dates in both 1987 and 1988. Banking Supervision and Regulation 195 Staff Training System staff training emphasizes analytical and supervisory themes common to the four areas of supervision and regulation—examinations, inspections, applications, and surveillance—and stresses the interdependence among these areas. In 1986 the Federal Reserve conducted forty-two school sessions covering a wide variety of topics. Programs included twelve banking sessions split into three levels—core, intermediate, and advanced—plus a seminar for senior examiners on energy lending, six sessions of a credit analysis course, two sessions of a bank holding company applications school, and three consumer compliance schools. New courses were held on bank holding company inspections, parent cash flow and liquidity analysis, and effective writing for banking supervision staff. In addition, some staff members attended two schools conducted jointly with the Federal Bureau of Investigation on white-collar crime and bank failures. The Federal Financial Institutions Examination Council (FFIEC), of which the System is a member, conducted approximately 78 courses covering off-balance sheet risks, international banking, income property lending, securities dealers, whitecollar crime, management, conducting meetings with management, and instructor training. Overall, the Federal Reserve and the FFIEC in 1986 trained 1,433 persons: 830, including 33 from foreign central banks, in System schools; and 603 in FFIEC schools. In addition, 122 state examiners received training under the scholarship program for states provided by the Federal Reserve Banks—84 in Fed- eral Reserve courses and 38 in FFIEC courses. Federal Financial Institutions Examination Council In 1986 the Federal Financial Institutions Examination Council made several policy recommendations to its constituent agencies; all the recommendations were adopted by the Federal Reserve's Board of Governors.2 The Federal Reserve endorsed guidelines on uniform disclosure for adjustable-rate mortgages; and it endorsed a policy statement dealing with the provision of basic financial services, both of which are discussed in detail in the chapter on consumer and community affairs. The Federal Reserve also endorsed the sharing of confidential supervisory information with state banking agencies, thereby formally adopting a policy in place at the Federal Reserve since the advent of regional interstate compacts. The new policy calls for the signing of formal agreements between federal and state regulatory agencies to assure uniform treatment of the information among the sharing agencies and to provide increased security. The council also approved new and revised reporting requirements: • The Reports of Condition and Income (Call Reports) were modified to reflect adoption of new regulatory policies toward agricultural lenders, which were announced by 2. The Federal Financial Institutions Examination Council consists of representatives of the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Federal Home Loan Bank Board, the National Credit Union Administration, and the Office of the Comptroller of the Currency. 196 Banking Supervision and Regulation the banking constituency of the council. • New reporting requirements for the sale of assets permit banks to treat loans transferred "without recourse" as sales in certain situations where banks retain residual interests in related escrow accounts. The new rule provides guidance for banks desiring to transfer assets and have the transactions qualify as sales rather than as borrowings. • The Uniform Bank Performance Report was revised in several respects to make the presentation in it identical to that in the Call Report. structure of U.S. banking at the local, regional, and national levels. The Board also has primary responsibility for regulating the international operations of domestic banking organizations and the U.S. banking operations of foreign banks, whether conducted directly through a branch or agency or indirectly through a subsidiary commercial lending company. In addition, the Board has established regulations for the interstate banking activities of these foreign banks and for foreign banks that control a U.S. subsidiary commercial bank. Regulation of the U.S. Banking Structure The Board of Governors administers the Bank Holding Company Act, the Bank Merger Act, and^ the Change in Bank Control Act for state member banks and bank holding companies. In doing so, the Federal Reserve acts on a variety of proposals that directly or indirectly affect the Bank Holding Company Act By law, a company must obtain the Board's approval if it is to form a bank holding company by acquiring control of one or more banks. Moreover, once formed, a bank holding company must receive the Board's approval before acquiring additional banks or nonbanking companies. In reviewing an application filed Bank Holding Company Decisions by the Federal Reserve, Domestic Applications, 1986 Proposal Direct action by the Board of Governors Action under authority delegated by Board of Governors Director of Division of Banking Office of the Supervision and Secretary1 Regulation1 Federal Reserve Banks Total Approved Denied Approved Denied Approved Approved Permitted Formation of holding company ... Merger of holding company Acquisition Bank Nonbank Acquisition of bank service corporation2 ... Other Total 274 57 3 0 0 3 457 0 520 23 0 0 0 6 71 0 100 76 117 2 0 0 0 0 0 28 14 405 171 0 240 511 542 0 3 0 0 5 3 53 1,107 240 1,681 0 1 0 1 6 0 1 0 1 1. Official staff of the Board of Governors. 2. Approved under the Bank Service Corporation 0 2 0 0 Act, which contains standards patterned after those of the Bank Holding Company Act. Banking Supervision and Regulation 197 by a bank holding company, the Board considers factors relating to the convenience and needs of the community to be served, the applicant's financial and managerial resources, the prospects of both the applicant and the firm to be acquired, and the competitive effects of the proposal. In 1986 the Federal Reserve System acted on 1,681 bank holding company and related applications. The System approved 517 proposals to organize bank holding companies and denied 3; approved 509 bank acquisitions by existing bank holding companies and denied 2; and approved 542 requests to acquire nonbank companies that are engaged in activities closely related to banking and denied none. Data on these and related bank holding company decisions are shown in the accompanying table. Bank Merger Act The Bank Merger Act requires that all proposed bank mergers be acted upon by the appropriate federal bank regulatory agency. If the bank surviving the merger is a state member bank, the Federal Reserve has primary jurisdiction. Before acting on a proposed bank merger, the Federal Reserve considers factors relating to the community's convenience and needs, the financial and managerial resources and prospects of the existing and proposed institutions, and the competitive effects of the proposal. The Board must also consider the views of certain other agencies on the competitive factors involved in the transaction. During 1986, the Federal Reserve approved 61 merger applications: 1 was approved by the Board; under authority delegated by the Board, its Office of the Secretary approved 4 and the Reserve Banks approved 56. As required by law, each merger is described in this REPORT, in table 19 of the Statistical Tables section. When the Office of the Comptroller of the Currency or the Federal Deposit Insurance Corporation has jurisdiction over a merger, the Board is asked to comment on the competitive factors to assure comparable enforcement of the antitrust provisions of the act. The Board and those agencies have adopted standard terminology for assessing competitive factors in bank merger cases to assure consistency in administering the act. On behalf of the Board, the Reserve Banks submitted 722 reports on competitive factors to the OCC and the FDIC in 1986. Change in Bank Control Act The Change in Bank Control Act of 1978 requires persons seeking control of a bank or bank holding company to obtain approval from the appropriate federal banking agency before the transaction occurs. The Board is responsible for reviewing changes in the control of state member banks and of bank holding companies. In evaluating a transfer of control under the Change in Bank Control Act, the Board must review the financial condition, competence, experience, and integrity of the acquiring person; it must consider the effect on the financial condition of the bank or bank holding company to be acquired; and it must determine the effect on competition in any relevant market. In October 1986 the Congress amended the act, requiring the federal banking agencies to publish notice of each proposed change in control and to invite public com- 198 Banking Supervision and Regulation ment, particularly from persons located in the markets served by the institution to be acquired. The amendments also require the federal banking agencies to investigate the qualifications of each person seeking control; the Board routinely conducts such an investigation under the Change in Bank Control Act. In 1986, the Federal Reserve System acted on 217 proposed changes in control of state member banks and bank holding companies. The Reserve Banks processed 208 cases, and the Board processed 9; the Board disapproved 1 proposal. Delegation of Applications The Board has delegated certain regulatory functions—including the authority to approve, but not the authority to deny, certain types of applications—to the Reserve Banks, to the Director of the Board's Division of Banking Supervision and Regulation, and to the Secretary of the Board. The delegation of responsibility for applications permits staff members to work more efficiently at both the Board and the Reserve Banks by removing routine cases from the Board's agenda. During 1986, 85 percent of the applications were acted upon under delegated authority. Timely Processing of Applications The System maintains target dates and procedures for the processing of applications. These target dates promote efficiency at the Board and the Reserve Banks and reduce the burden on applicants. The time allowed for a decision is 60 days; during 1986, 93 percent of the applications met Digitized forthis standard. FRASER In 1986, all of the 61 applications for bank mergers were processed within 60 days. The System also prepared 722 reports on the competitive factors of proposed mergers for the other two banking agencies; nearly all of these reports were processed within 30 days. Of the 217 changeof-control notices involving state member banks or bank holding companies, 201 were handled within 60 days. The System measures its performance in processing international applications against a 60-day standard. In 1986 the Federal Reserve acted on 119 international applications, 87 percent of which the System handled within the time allowed. Board Policy Decisions and Developments in Bank-Related Activities In 1986 the Board approved a number of new nonbanking activities, including several for individual bank holding companies. It also had under consideration other proposed nonbanking activities, including those involving securities underwriting and real estate investment. In addition, the Board approved several acquisitions involving interstate banking. Approval of Permissible Nonbanking Activities In 1986 the Board for the first time approved the following activities for individual bank holding companies: (1) printing and selling checks and related documents that carry coded information for depository institutions; (2) providing investment advice in connection with securities brokerage, subject to certain conditions; and (3) placement of commercial paper to a limited extent. In addition, the Board permitted Banking Supervision and Regulation 199 the formation of limited-purpose insurance companies, owned cooperatively by bank holding companies; the insurance firms would underwrite directors' and officers' blanket bond insurance for the shareholder bank holding companies. The Board approved the addition to Regulation Y of six nonbanking activities for bank holding companies; the action means that applications for these activities, some of which had been approved previously in individual cases, are simplified and action on them is quickened. The new activities are: consumer financial counseling; tax planning and tax preparation; futures and options advisory services; check guaranty services; collection and credit bureau services; and appraisals of personal property. The Board also revised the portion of Regulation Y dealing with permissible insurance activities for bank holding companies. The Board approved the application of a bank holding company to acquire a firm that electronically processes and transmits banking and economic data, a service permitted in Regulation Y. The Board determined, however, that the portion of the firm that designs and assembles the hardware for the data services was not incidental to the provision of those services. Therefore the Board disapproved the acquisition of the hardware portion of the firm. Applications to Engage in New Nonbanking Activities At year-end the Board also had under consideration applications to engage in two new nonbank activities: providing advisory services with respect to futures contracts on stock indexes; and acting as drawee for variably denominated payment in struments without a limit on face value when such instruments are sold or issued by nonaffiliated third parties. At year-end, applications were also pending that would allow affiliates that already underwrite U.S. government securities to underwrite and deal in commercial paper, mortgagebacked securities, municipal revenue bonds and consumer-related receivables. The Board held a hearing in February 1987 on the complex factual and legal issues involved in these applications. In 1986 the Board solicited public comment on whether to permit bank holding companies to engage in real estate investment activities under specific conditions. The conditions are designed to ensure that the conduct of the activity does not result in unsafe or unsound banking practices, unfair competition, conflicts of interest, or other adverse effects. Interstate Banking The Federal Reserve during 1986 approved applications by out-of-state banking organizations to acquire financially troubled thrift institutions. In one case the institution was uninsured; in two others the institutions were federally insured. These acquisitions helped restore financial stability to the affected communities and provided depositors with better access to their funds. Because of the significant public benefits resulting from the proposed transactions, the Board approved the acquisitions despite its general prohibition on affiliations between bank holding companies and thrift institutions. In other matters, the Board continued to approve interstate bank holding company applications based on state laws that permit regional interstate banking. The U.S. Supreme 200 Banking Supervision and Regulation Court has upheld the constitutionality of such laws, and the Board has found in individual instances that these laws satisfy the requirement of the Bank Holding Company Act that each state's laws must allow the acquisition. Applications by State Member Banks State member banks must obtain the permission of the Board to open new domestic branches, to make investments in bank premises that exceed 100 percent of capital stock, and to add to the capital base from sales of subordinated debt. State member banks must also give six months' notice of their intention to withdraw from membership in the System, although the Board may shorten or eliminate the notice period in specific cases. These matters are normally handled under delegated authority by the Federal Reserve Banks or, in the case of bank premises or proposed sales of subordinated debt, by the Director of the Board's Division of Banking Supervision and Regulation. Stock Repurchases by Bank Holding Companies A bank holding company sometimes purchases its own shares from its shareholders. When the company borrows the money to buy the shares, the transaction increases the debt of the bank holding company and simultaneously decreases its equity. Relatively large repurchases may undermine the financial condition of a bank holding company and its bank subsidiaries. The Board's regulations require holding companies to give advance notice of repurchases that retire 10 percent or more of their consolidated equity capital. The Board may object to stock repurchases by holding companies that fail to meet certain standards, including the Board's capital guidelines. During 1986 the Federal Reserve reviewed 142 proposed stock repurchases by bank holding companies, 139 of which were acted on by the Reserve Banks on behalf of the Board. Public Notice of Board Decisions Each action by the Board that involves a bank holding company, bank merger, change in control, or international banking proposal is effected by an order or announcement. Orders state the decision along with the essential facts of the application and the basis for the decision; announcements state only the decision. All orders and announcements are released immediately to the public; they are also reported in the Board's weekly H.2 statistical release and in the monthly Federal Reserve Bulletin. Actions taken by the Reserve Banks are also reported in the H.2 statistical release and in the Bulletin. Announcements of applications and notices received by the System but not yet acted on are made in the H.2 release. International Activities of U.S. Banking Organizations The Board has four principal statutory responsibilities in supervising the international operations of U.S. banking organizations: it must provide authorization and regulation of foreign branches of member banks; of overseas investments by member banks, Edge corporations, and bank holding companies; and of investments by bank holding companies in Banking Supervision and Regulation 201 export trading companies; and it must charter and regulate Edge corporations and their investments. branches and agencies of foreign banks. By the end of 1986, 540 IBFs had been established. Foreign Branches of Member Banks Edge and Agreement Corporations Under sections 25 and 25 (a) of the Federal Reserve Act, Edge and agreement corporations may engage in international banking and foreign financial transactions. These corporations, which are usually subsidiaries of member banks, provide their owner organizations with the following powers: (1) they may conduct a deposit and loan business in states other than that of the parent, provided that the business is strictly related to international transactions; and (2) their powers to make foreign investments are broader than those of member banks because they can invest in foreign financial organizations, such as finance companies and leasing companies, as well as in foreign banks. By the end of 1986 there were 137 Edge corporations, which had 104 branches. The Board requires each Edge corporation that is engaged in banking to maintain a ratio of equity to risk-assets of at least 7 percent. Under provisions of the Federal Reserve Act and of Regulation K, member banks in most cases must seek Board approval to establish branches in foreign countries. In reviewing proposed foreign branches, the Board considers the requirements of the law, the condition of the bank, and the bank's experience in international business. In 1986 the Board approved the opening of three foreign branches. By the end of 1986, 158 member banks were operating 952 branches in foreign countries and overseas areas of the United States; 131 national banks were operating 822 of these branches, and 27 state member banks were operating the remaining 130 branches. International Banking Facilities The Board amended its Regulations D and Q to permit the establishment of international banking facilities (IBFs) in the United States as of December 3, 1981. An IBF is essentially a set of asset and liability accounts that is segregated from the other accounts of the office establishing the IBF. Deposits from, and credit extended to, foreign residents or other IBFs generally can be booked at these facilities free from domestic reserve requirements and interest rate limitations. Subject to conditions specified by the Board, IBFs may be established by U.S. depository institutions, by Edge and agreement corporations, and by U.S. Foreign Investments Under authority of the Federal Reserve Act and the Bank Holding Company Act, U. S. banking organizations may engage in activities overseas with the authorization of the Board. To a significant extent, the Board's Regulation K permits such investments without prior Board review. In 1986 the Board reviewed and permitted 64 foreign investments by member banks, Edge and agreement corporations, and bank holding 202 Banking Supervision and Regulation companies. In most cases, the applicant requested permission to increase an existing investment. Export Trading Companies In 1982 the Bank Export Services Act amended section 4 of the Bank Holding Company Act to permit bank holding companies, their subsidiary Edge or agreement corporations, and bankers' banks to invest in export trading companies, subject to certain limitations and after Board review. The purpose was to allow effective participation by bank holding companies in the financing and development of export trading companies. On June 2, 1983, the Board adopted regulations to achieve the objectives set forth in the law: to facilitate the export of goods and services produced in the United States and to minimize potential adverse effects on the subsidiary banks of the bank holding companies involved. In 1986 the Board acted affirmatively on the 2 notifications received for the establishment of export trading companies. At year-end, 33 bank holding companies had investments in export trading companies. Enforcement of Other Laws and Regulations The preceding sections have discussed the Board's activities in carrying out its statutory responsibilities for the supervision of bank safety and soundness and the regulation of the banking structure. This section describes the enforcement of other laws, rules, and regulations. Bank Secrecy Act Through the examination process, the Federal Reserve monitors whether the institutions it supervises are complying with the recordkeeping and reporting requirements of the Currency and Foreign Transactions Reporting Act (the Bank Secrecy Act). Among the stipulations in the act to combat unlawful currency transactions is the requirement that financial institutions and selected other businesses report to the Internal Revenue Service certain cash transactions and shipments of more than $10,000. As mandated by the passage of the Anti-Drug Abuse Act of 1986, Board staff members worked with the other federal financial institutions to develop regulations to ensure compliance with the Bank Secrecy Act. The regulations took effect January 27, 1987. In 1986 the Board also strengthened its examination procedures to emphasize the provisions of the Bank Secrecy Act that federal law enforcement authorities consider to be critical. Board staff members continue to serve as active participants on the Bank Secrecy Act interagency working group headed by the Department of the Treasury. Securities Regulation Under the Securities Exchange Act of 1934, the Board is responsible for regulating credit in certain transactions involving the purchase or carrying of securities. In fulfilling its responsibility under the act, the Board limits the amount of credit that may be provided by securities brokers and dealers (Regulation T), by banks (Regulation U), and by other lenders (Regulation G). Regulation X extends these credit limitations, or margin requirements, to certain borrowers and to certain credit extensions, such as credit obtained from foreign lenders by U.S. citizens. Banking Supervision and Regulation 203 Brokers and dealers are examined for compliance with Regulation T by the Securities and Exchange Commission, the National Association of Securities Dealers, and the national securities exchanges. The three federal bank supervisory agencies examine banks under their respective jursidictions for compliance with Regulation U. Other lenders are examined for compliance with Regulation G by the Board, the National Credit Union Administration, the Farm Credit Administration, or the Federal Home Loan Bank Board according to the jurisdiction involved. At the end of 1986 there were 533 "G-lenders," of which 297 were subject to the Board's supervision. Of these 297, 180 are subject to regular inspection by the Federal Reserve System. During the year, Federal Reserve examiners inspected 52 G-lenders for compliance with the Federal Reserve's margin requirements (these lenders are inspected on either a biennial or triennial basis, according to the type of credit extended). Regulations U and G in general impose credit limits on loans whose purpose is the purchasing or carrying of publicly held equity securities and that are secured by such securities. Regulation T limits the amount of credit that brokers and dealers may extend when securities serve as collateral for credit that is used to purchase or carry securities. This collateral must consist of stocks and bonds traded on national securities exchanges, of certain over-the-counter (OTC) stocks that the Board designates as having characteristics similar to those of stocks listed on national exchanges, or of bonds meeting certain requirements. The Board's Division of Banking Supervision and Regulation monitors the market activity of all over-thecounter stocks to determine what stocks are subject to the Board's margin regulations. In 1986 the Board published the resulting "List of Marginable OTC Stocks" in February, May, August, and November. The November list consisted of 2,887 stocks. In January 1986 the Board adopted an interpretive rule regarding the margin requirements under Regulation G. The interpretation declares that debt securities issued by a shell corporation set up to acquire and hold the stock of a target company in a takeover attempt are presumed to be secured indirectly by the target stock and thus subject to the margin restrictions of Regulation G. The interpretation indicates that the presumption would not apply to certain transactions if the lenders could rely on assets other than the target stock as collateral or look to a guaranty of the parent of the shell corporation for repayment. Under section 8 of the Securities Exchange Act, a nonmember domestic or foreign bank may lend to brokers or dealers posting registered securities as collateral only if the bank has filed an agreement with the Board that it will comply with all the statutes, rules, and regulations applicable to member banks regarding credit on securities. During the year, the Board processed 17 such agreements. In 1986 the Securities Regulation Section of the Board's Division of Banking Supervision and Regulation issued 43 interpretations of the margin regulations. Those that presented sufficiently important or novel issues were published in the "Securities Credit Transactions Handbook," which is part of the Federal Reserve Regulatory Service. These interpre- 204 Banking Supervision and Regulation Loans by State Member Banks to their Executive Officers, 1985-86 Period October 1-December 31, 1985 January 1-March 31, 1986 April 1-June 30, 1986 July 1-September 30, 1986 tations serve as a guide to the margin regulations. Financial Disclosure by State Member Banks Under the Board's Regulation F, state member banks must disclose certain information of interest to investors, including financial reports and proxy statements, if they issue securities registered under the Securities Exchange Act of 1934. Board staff members review the information for compliance with the regulation. At the end of 1986, 31 state member banks, most of which are of small or medium size, were registered with the Board under Regulation F. The disclosure rules of Regulation F are required by statute to be substantially similar to those issued by the Securities and Exchange Commission. In 1986 a comprehensive revision of Regulation F was under consideration by the Board's staff. That revision would require banks subject to Regulation F to use the forms prescribed by the Securities and Exchange Commission. Small banks would have the option of filing Number Amount (dollars) Range of interest rates charged (percent) 1,111 1,199 1,356 1,410 23,869,607 21,566,130 23,509,393 26,715,716 6.25-21 1.0-21 6.0-21 6.5-30.53 simplified quarterly reports. The proposal would ease compliance with the regulation. Loans to Executive Officers Under section 22(g) of the Federal Reserve Act, each state member bank must include with each quarterly report of condition a report of all extensions of credit made by the bank to its executive officers since the date of the bank's previous report of condition. The accompanying table summarizes these data for the last quarter of 1985 and the first three quarters of 1986. Federal Reserve Membership At the end of 1986, 5,995 banks were members of the Federal Reserve System, a decrease of 55 from the previous year. Member banks operated 28,456 branches on December 31, 1986, a net increase of 861 for the year. Member banks accounted for 40 percent of all commercial banks in the United States and for 64 percent of all commercial banking offices. 205 Regulatory Simplification The Board of Governors established the Regulatory Improvement Project in 1978 and reaffirmed its commitment to regulatory improvement by creating a Regulatory Policy and Planning Committee in 1986. The program was established to minimize the burdens imposed by regulation; to ensure that consideration is given to minimizing the economic impact of regulation on small business; to see that interested parties have the opportunity to participate in the design of proposed regulations and to comment on them; and to ensure that regulations are written in simple and clear language. In addition to monitoring the creation of new regulations, the program periodically reviews all existing regulations for adherence to these objectives. Regulation Q The statutory authority to set interest rate ceilings on time and savings deposits and to prescribe rules regarding early withdrawals from time deposits expired on March 31, 1986. In anticipation of that date, the Board of Governors in early 1986 revised and simplified its Regulation Q, which governed the payment of interest on deposits. Following that action, the major substantive provision of Regulation Q that remains, as authorized by section 19(i) of the Federal Reserve Act, prohibits a member bank from paying interest on a demand deposit. As part of the revision, the definition of "savings deposit" was deleted from Regulation Q, and an amended definition of the term was incorporated in Regulation D. Together, these changes removed the $150,000 limitation on business savings accounts. The provisions of Regulation Q dealing with the advertising of interest on deposits were not amended in final form in March; however, the Board has issued for comment in a separate rulemaking a consolidation of the various provisions regarding advertising that will be included in the final version of Regulation Q. To promote equity of treatment among financial institutions and to promote consumer understanding, the Board is attempting to develop advertising provisions that will be adopted by all the financial regulatory agencies. Published interpretations of Regulation Q that are obsolete will be rescinded; viable interpretations of it will be revised in line with the simplification of that regulation. Policy Regarding Risk on Large-Dollar Wire Transfer Systems In December 1986 the Board issued for comment several refinements to its policy regarding large-dollar transfers. One of the proposals would establish a de minimus cap for institutions that do not incur large or frequent daylight overdrafts. This cap would be the lesser of 10 percent of capital or $500,000 and would be available to institutions that do not undergo the self-assessment required for establishing a positive limit or 206 Regulatory Simplification cap on the amount of daylight overdrafts that can be accumulated on Fedwire. Under the Board's current policy, a bank must submit a formal cap to the Federal Reserve for incurring daylight overdrafts or else the Federal Reserve imposes a limit of zero. This part of the policy has proved difficult to administer. In any twoweek period, almost half of the 3,400 institutions incurring an overdraft have either not filed a cap or have filed a cap of zero. These 1,600 institutions are mainly small and account for about 0.4 percent of all overdrafts. The managements of these institutions find either the self-evaluation or the absolute avoidance of overdrafts excessively burdensome, and many Reserve Banks have found the resources required to monitor and counsel these institutions to be unusually high relative to the risks involved. The proposed de minimus cap is intended to alleviate these burdens and costs. In order to further reduce the burden on participating institutions, the Board amended its policy statement in December to provide that depository institutions that perform a self-assessment need do so only once each year rather than every six months as provided in the original policy statement. Regulation Y In May 1986 the Board requested comment on whether it should ease the conditions it imposes through Regulation Y on the acquisition of thrift institutions by bank holding companies. Currently, under regulations implementing the Bank Holding Company Act and the Garn-St Germain Depository Institutions Act of 1982, bank holding companies are prohibited from allowing their thrift subsidiaries and other affiliates to conduct joint marketing and sales operations; from cross-advertising through thrift subsidiaries the services and products offered by other affiliates; and from engaging in certain transactions, such as the transfer, purchase, sale, or loan of any assets or liabilities between the thrift institution and other affiliates of the bank holding company. These limitations were developed in the context of specific applications pending before the Board and after informal public hearings and public comment. The conditions were designed to assure that the thrift institution continued to be operated as a separate and independent institution engaged primarily in mortgage lending activities and did not operate in fact as a bank in violation of the interstate banking prohibitions of the Bank Holding Company Act. The conditions were also designed to prevent the acquiring bank holding company from obtaining an unfair competitive advantage over other banks and thrift institutions. In light of the deregulation of interest rate differentials, the increasing similarity in the powers of banks and thrift institutions, and the spread of interstate deposit-taking in both the thrift and banking industries, the Board believes that the recent requests for relief from the restrictions in Regulation Y present an appropriate framework for reevaluating them. In October 1986 the Federal Reserve Board expanded the list of permissable nonbanking activities for bank holding companies; it also elim7 inated a 1972 limit on the premiums Regulatory Simplification 207 that could be charged by bank holding companies engaging in credit life insurance underwriting. The requirement had stipulated that premiums must be set on a sliding scale 2 to 5 percent lower than the maximum allowed by the state where the company is located. In its decision, the Board determined that this requirement put bank holding companies at an unfair disadvantage with respect to competing insurance providers. During the past 14 years the underwriting of credit life insurance has remained the only permissible nonbanking activity for which the Board has imposed a requirement or condition that effectively determines the fee structure for the activity. This is a matter of concern to the Board because, under authorization of a federal statute, credit insurance rate ceilings are set by the individual states. Moreover, the rate reduction requirement can give the appearance that only lower rates than those permitted by the states are in the public interest or create a public benefit. This may be inappropriate at a time when the states have become increasingly active in reviewing and setting credit life insurance rate ceilings. Regulation K In July the Board amended the portion of Regulation K (International Banking Activities) requiring that a banking organization apply to the Board when it proposes to invest more than 10 percent of its capital and surplus in a foreign organization. After several years' experience with these procedures, the Board has found that the investments do not always raise issues that require Board consideration. The July amendment permits the bank to make an additional investment after giving 45 days' notice to the Board, a change that will shorten the time that banking organizations must wait before making additional foreign investments. 209 Federal Reserve Banks Developments in the Pricing of Federal Reserve Services and in the Payments Mechanism In 1986 the Federal Reserve Banks fully recovered their costs of providing priced services, as required by the Monetary Control Act of 1980. The System as a whole recovered 104.3 percent of its operating expenses and imputed costs, compared with 105.6 percent in 1985. Table 10, in the Statistical Tables section of this REPORT, presents revenue and expenses by major category of service for 1986 and 1985. Revenue at the Reserve Banks from all priced services totaled $742.0 million and costs were $711.7 million. These figures include the income and expenses related to clearing balances, the value of priced float, and the PSAF (the private sector adjustment factor—the taxes and costs of capital that the System would have incurred if it were a private firm). The Federal Reserve System had a net revenue of $30.3 million from priced services. In March 1986 the Board implemented a policy to reduce risk on networks used to transfer large-dollar payments. Proposals to further reduce risk on funds transfer systems, on the book-entry securities system, and on automated clearinghouse systems, were published in December. See the chapter in this REPORT on banking supervision and regulation for a discussion of the Board's policy and proposals on reducing and controlling risks in the payments system. Check Collection Check operations of the Federal Reserve Banks cost the System $547.9 million in 1986, including the cost of float and the PSAF. Check operations generated $572.5 million in revenue, for a surplus of $24.6 million. The number of checks processed by Federal Reserve Banks rose 5 percent in 1986, to 16.2 billion. In May the Board adopted amendments to Regulation J, which governs check collection and wire transfers. One change permits the Reserve Banks to collect checks drawn on banks located in foreign countries. This service will be limited, and the checks will be collected through correspondent banks. The other amendments relate primarily to a Reserve Bank's liabilities regarding check collection and funds transfers. In July the Board requested public comment on proposals to make permanent the two-tiered pricing structure being tested at the head offices of the Federal Reserve Banks of Minneapolis and Kansas City and to establish criteria for determining the conditions under which a tiered fee structure would be extended to other Federal Reserve offices. A tiered pricing structure can reflect the costs of check processing more accurately because it permits setting fees for sending institutions according to the costs associated with the presentment point. The Board approved the proposals in November. The Federal Reserve System in 1986 continued its efforts to improve the handling of return items (checks 210 Federal Reserve Banks not honored by the institution on tablish a float factor that would be which they were drawn). In one applied to the value of ACH debit initiative, the Federal Reserve and transactions processed at night. No the financial industry conducted a final action was taken in 1986 on this test in which they learned that the proposal. forward collection process had the potential to speed the return of many items to the institution of first de- Wire Transfer of Funds posit. The Federal Reserve and the and Net Settlement Service financial industry will continue to The number of funds transfers over pursue this initiative. Fedwire grew 10.6 percent in 1986, In November the Board issued for for a total of 49.9 million transacpublic comment a proposal to pro- tions. This service and the net settlevide a redeposit service for low- ment service incurred costs of $79.6 dollar checks that are returned be- million and earned $82.7 million, for cause of insufficient or uncollected a net surplus of $3.1 million. funds. Under this service, which is In June the Board published for being tested in the St. Louis, Atpublic comment a proposal to require lanta, and Cleveland Districts, Reserve Banks would intercept dis- that information in third-party Fedhonored checks and redeposit them wire messages be in a standard foron behalf of the collecting institution. mat to facilitate the automated hanThis practice would speed processing dling of transfers. In November, the times and reduce costs. No final Board approved a 25-cent surcharge action was taken in 1986 on this to be imposed beginning April 1, 1988, for Fedwire funds transfers not proposal. conforming to the format; it set April 3, 1989, as the date on which use of Automated Clearinghouse the standard format will be mandaIn 1986, for the first time, the prices tory. of automated clearinghouse (ACH) In March the Board approved a services were established to recover modification to the interim terms for 100 percent of costs. Previously, an treating ACH net settlement entries incentive pricing program had been for credit transactions. Pending in effect. The cost of providing com- adoption of policies to address the mercial ACH services in 1986 was risk involved in these transactions, $35.3 million; revenue was $36.5 net settlement entries for ACH credit million. The System processed 363 transactions will be treated as final million commercial transactions, 28 at 6:00 p.m. Eastern time on the percent more than in 1985. settlement date. Net settlement enIn September the Board issued for tries for ACH debit transactions are public comment a proposal for re- treated as provisional until the busicovering the cost of float generated ness day following the settlement by ACH transactions processed dur- date. ing the night cycle and for a correNet settlement services based on sponding reduction of the per-item next-day finality were approved for surcharge on such transactions. Spe- one network of automated teller cifically, the Board proposed to es- machines in 1986. Federal Reserve Banks 211 Coin and Currency Services In its coin and currency operations the Federal Reserve continued to focus on controls, on efficiency in processing currency, and on the maintenance of high quality in circulating currency. Four Federal Reserve Districts provided transportation of cash in 1986, and five Districts provided wrapped coins for depository institutions. Two other priced services— special packaging and more frequent access—were approved by the Board in December. These services are now covered by the uniform standards for cash services. In addition, the System tested and evaluated prototype second-generation equipment intended to improve the processing of currency. The Federal Reserve continued to work with the Treasury to develop measures to deter the counterfeiting of U.S. currency. Definitive Securities and Noncash Collection Services The System received $24 million in revenue for definitive safekeeping and noncash collection services in 1986; the total cost of these services, including the PSAF, was $24.4 million. The number of definitive securities issues and deposits increased 4 percent in 1986 to 165,000. The number of items for noncash collection decreased 7 percent to 4.3 million. In November the Board approved the consolidation at the Federal Reserve Bank of Minneapolis of the collections involving municipal bonds and coupons that were being carried out by the Federal Reserve Bank of San Francisco. It also published for public comment a list of factors to be considered when the Reserve Banks propose to consolidate in one District the priced services offered by one or more other Districts. No action was taken on this proposal in 1986. Book-Entry Securities The Federal Reserve provides bookentry securities services for the Treasury and for certain federally sponsored agencies, such as the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation. Since October 1985 the Treasury has established the fees, and the Reserve Banks have charged institutions for these transfers. The Treasury component of the bookentry service incurred costs, excluding the PSAF, of $11.9 million in 1986. For the year, the Federal Reserve processed 6.0 million transfers of Treasury securities, 98 percent of which were on line. Book-entry services for federal agency securities incurred costs, including the PSAF, of $7.9 million and earned revenue of $9.4 million in 1986. The Federal Reserve processed 1.8 million such transfers during the year, 98 percent of which were on line. In July 1986 the Federal Reserve implemented the Treasury Direct book-entry securities system. This system, which was developed on behalf of the Treasury, is used primarily by individual investors. Treasury bonds and notes were converted to Treasury Direct in 1986; Treasury bills will be phased into the system in 1987. Book-entry safekeeping and transfer of mortgage-backed securities issued by federal agencies were ex- 212 Federal Reserve Banks panded from the Federal Reserve Bank of New York to all Districts during 1986. Float Federal Reserve float increased to a daily average of $446 million in 1986, compared with $440 million in 1985. The costs of all Federal Reserve float associated with priced services are recovered each year. In May the Board approved a standard holiday schedule to be followed by the Federal Reserve Banks, effective January 1, 1987. At that time, it also adopted proposals to modify the procedures that the Federal Reserve Banks use to recover the cost of float generated by ACH debit and check transactions associated with nonstandard holiday and midweek closings. The allocation of check float, which was adopted as an amendment to Regulation J, is effective January 1, 1987. The modifications to the procedures for recovering the cost of ACH float take effect on April 1, 1987. In conjunction with proposals issued in December to reduce risk in the ACH system, the Board proposed procedures to recover the cost of float generated by ACH credit transactions. No final action was taken in 1986 on this proposal. assess conformance with the policies issued by the Federal Open Market Committee, the Division annually audits the accounts and holdings of the Federal Reserve System Open Market Account at the Federal Reserve Bank of New York and the foreign currency operations conducted by that Bank. The Division furnishes copies of these reports to the Committee. The examination procedures used by the Division are reviewed each year by a private firm of certified public accountants. Income and Expenses The accompanying table summarizes the income, expenses, and distribution of net earnings of the Federal Reserve Banks for 1986 and 1985. Income was $17,465 million in 1986, $667 million less than in 1985, reflecting the decrease in interest rates on securities. Total expenses were $1,254 million ($1,049 million in operating expenses, $108 million in earnings credits granted to depository institutions, and $97 million in assessment for expenditures by the Board of Governors). The cost of currency was $181 million. Income from financial services was $628 million. The profit-and-loss account showed a net addition of $1,976 million, due primarily to a $1,971 million increase in the value of assets denominated Examinations in foreign currencies and revalued at The Board's Division of Federal market exchange rates. Statutory Reserve Bank Operations examines dividends to member banks totaled the 12 Reserve Banks and their 25 $110 million, $7 million more than branches each year, as required by in 1985. The rise reflected an insection 21 of the Federal Reserve crease in the capital and surplus of Act. The results of the audits are member banks and a consequent given to the management and direc- increase in the paid-in capital stock tors of the respective Banks and to of the Reserve Banks. the Board of Governors. Also, to Payments to the U.S. Treasury in Federal Reserve Banks 213 Income. Expenses, and Distribution of Net Earnings of Federal Re* rve Banks. 1986 and 1985 Thousands of dollars Item 1986 1985 Current income Current expenses Operating expenses Earnings credits granted Current net income Net addition to (deduction from) current net income Assessments by the Board of Governors For expenditures of Board For cost of currency Net income before payments to U.S. Treasury Dividends paid Payments to U.S. Treasury (interest on Federal Reserve notes) Transferred to surplus 17,464,528 1,156,868 1,049,159 107,709 16,307,661 1,975,893 278,118 97,338 180,780 18,005,437 109,588 17,803,895 91,954 18,131,983 1,127,744 1,022,527 105,217 17,004,238 1,301,624 251,116 77,378 173,739 18,054,746 103,029 17,796,464 155,253 Details may not add to totals because of rounding. the form of interest on Federal Reserve notes totaled $17,804 million, compared with $17,796 million in 1985. This sum consists of all net income after dividends and the amount necessary to bring the surplus of the Banks to the level of their paid-in capital. In the Statistical Tables section of this REPORT, table 7 provides a summary statement of the income and expenses of the Federal Reserve System for 1982-86; table 8 details income and expenses of each Federal Reserve Bank for 1986, and table 9 shows a condensed statement for each Bank for 1914-86. A detailed account of the assessments and expenditures of the Board of Governors appears in the next section, Financial Statements. In early 1986 the Board produced a new document, Annual Report: Budget Review, which consolidated public information available from other sources in order to provide a single, comprehensive view of the System's 1986 calendar year budgets and its budgetary processes. That publication has been produced again to cover the budgets of the Board and the Banks for 1987. Federal Reserve Bank Premises During 1986 the Board of Governors authorized the construction of an addition to the Federal Reserve Bank of Atlanta and a new building for the Charlotte Branch in North Carolina. With Board approval the Helena Branch acquired two properties adjacent to the existing building for future expansion. Table 6, in the Statistical Tables section of this REPORT, shows the cost and book values of premises owned or occupied by the Federal Reserve Banks and Branches and of real estate acquired for future banking-house purposes. Holdings of Securities and Loans The accompanying table presents holdings, earnings, and average interest rates on securities and loans of the Federal Reserve Banks for the years 1984-86. Average daily holdings of securities and loans during 1986 were $193,354 million, an increase of $16,666 million over 1985. Holdings of U.S. government securities in- 214 Federal Reserve Banks Securities and Loans of Federal Reserve Banks, 1984-86 Millions of dollars, except as noted Item and year Average daily holdings2 1984 1985 1986 Earnings 1984 1985 1986 Average interest rate (percent) 1984 1985 1986 1. Includes acceptances. 2. U.S. Treasury securities and obligations of federal agencies. creased $17,155 million, and holdings of loans decreased $489 million. From 1985 to 1986 the average rate of interest on all types of holdings decreased—from 9.60 percent to 8.38 percent on U.S. government securities and from 8.38 percent to 6.84 percent on loans. Total 1 U.S. government securities2 Loans 165 002 176,688 193,354 161 247 175,359 192,514 3 726 1,329 840 17,080 16,954 16 199 16,688 16,843 16 142 389 111 57 10.35 9.60 8.38 10.35 9.60 8.38 10.44 8.38 6.84 3. Based on holdings at opening of business. Volume of Operations Table 11, in the Statistical Tables section of this REPORT, shows the volume of operations in the principal departments of the Federal Reserve Banks for the years 1983-86. 215 Board of Governors Financial Statements The financial statements of the Board for the years 1986 and 1985 were examined by Price Waterhouse, independent public accountants. R E P O R T OF INDEPENDENT ACCOUNTANTS To the Board of Governors of the Federal Reserve System In our opinion, the accompanying balance sheets and the related statements of revenues and expenses and fund balance and of changes in financial position present fairly the financial position of the Board of Governors of the Federal Reserve System at December 31, 1986 and 1985, and the results of its operations and the changes in its financial position for the years then ended, in conformity with generally accepted accounting principles consistently applied. Our examinations of these statements were made in accordance with generally accepted auditing standards and accordingly included such tests of the accounting records and such other auditing procedures as we considered necessary in the circumstances. ' Washington, D.C. February 18, 1987 216 Financial Statements BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM BALANCE SHEETS As of December 31 1986 1985 ASSETS CURRENT ASSETS Cash Accounts receivable Stockroom and cafeteria inventories, at cost Prepaid expenses and other assets Total current assets PROPERTY, BUILDINGS AND EQUIPMENT, Net (Note 3) OTHER ASSETS $ 8,646,210 2,045,873 285,843 627,054 $ 8,144,767 1,542,680 290,475 151,851 11,604,980 10,129,773 64,827,375 56,176,157 1,708,506 Total assets — $78,140,861 $66,305,930 $ 4,655,794 2,861,053 3,896,398 478,716 11,891,961 $ 6,508,435 2,611,001 3,807,048 440,831 13,367,315 66,248,900 $78,140,861 52,938,615 $66,305,930 LIABILITIES AND FUND BALANCE CURRENT LIABILITIES Accounts payable Accrued payroll and related taxes Accrued annual leave Other liabilities Total current liabilities COMMITMENTS AND CONTINGENCIES (Note 6) FUND BALANCE Total liabilities and fund balance The accompanying notes are an integral part of these statements. Financial Statements 217 BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM STATEMENTS OF REVENUES AND EXPENSES AND FUND BALANCE For the years ended December 31 1986 1985 $ 97,337,500 3,169,567 100,507,067 $ 77,377,700 2,531,681 79,909,381 53,259,376 5,401,797 6,156,450 4,085,161 3,490,423 2,970,714 2,598,055 2,537,670 2,083,894 2,022,535 2,150,807 86,756,882 53,179,014 6,052,103 4,954,614 2,722,449 3,341,459 2,874,688 2,943,864 2,230,242 1,928,506 2,000,230 2,044,414 84,271,583 13,750,185 (4,362,202) BOARD OPERATING REVENUES Assessments levied on Federal Reserve Banks for Board operating expenses and capital expenditures Other revenues (Note 4) Total operating revenues BOARD OPERATING EXPENSES Salaries Retirement and insurance contributions Depreciation and losses (gains) on disposals Contractual services and professional fees Postage and supplies Utilities Equipment and facility rentals Travel Repairs and maintenance Printing and binding Other (Note 4) Total operating expenses BOARD OPERATING REVENUES OVER (UNDER) EXPENSES ISSUANCE AND REDEMPTION OF FEDERAL RESERVE NOTES Assessments levied on Federal Reserve Banks for currency costs Expenses for currency printing, issuance, retirement, shipping and research costs (Note 5) CURRENCY ASSESSMENTS (UNDER) OVER EXPENSES 180,779,673 173,738,745 181,219,573 173,298,845 (439,900) 439,900 TOTAL REVENUES OVER (UNDER) EXPENSES 13,310,285 (3,922,302) FUND BALANCE, Beginning of year 52,938,615 56,860,917 $ 66,248,900 $ 52,938,615 FUND BALANCE, End of year The accompanying notes are an integral part of these statements. 218 Financial Statements B O A R D OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM STATEMENTS OF CHANGES IN FINANCIAL POSITION For the years ended December 31 1986 1985 SOURCES OF CASH Board operations Net revenues over (under) expenses Add (deduct) items not affecting cash Depreciation and losses (gains) on disposals Accrued annual leave (Increase) decrease in accounts receivable, inventories, and prepaid expenses and other assets (Decrease) increase in accounts payable, accrued payroll and related taxes, and other liabilities Funds provided by operations Proceeds from disposals of furniture and equipment Total sources $13,310,285 6,156,450 89,350 $(3,922,302) 4,954,614 142,740 (973,764) 77,752 (1,564,704) 17,017,617 2,277,264 19,294,881 1,058,996 2,311,800 3,628 2,315,428 303,557 16,781,375 1,708,506 399,094 4,069,299 — 18,793,438 4,468,393 USES OF CASH Capital expenditures for Buildings Furniture and equipment Increase in other non-current assets Total uses INCREASE (DECREASE) IN CASH CASH BALANCE, Beginning of year CASH BALANCE, End of year : 501,443 10,297,732 $ 8,646,210 $ 8,144,767 The accompanying notes are an integral part of these statements. (2,152,965) 8,144,767 Financial Statements 219 BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1986 AND 1985 plan benefits for the Federal Reserve Board Plan, including those arising from COLA supplements, were as follows: As of January 1 (1) SIGNIFICANT ACCOUNTING POLICIES Board Operating Revenues and Expenses—Assessments made on the Federal Reserve Banks for Board operating expenses are calculated based on expected cash needs. These assessments, other operating revenues, and operating expenses are recorded on the accrual basis of accounting. Issuance and Redemption of Federal Reserve Notes— The Board incurs expenses and assesses the Federal Reserve Banks for the cost of printing, issuing, shipping and retiring Federal Reserve Notes. These assessments and expenses are separately reported in the statements of revenues and expenses because they are not Board operating transactions. Property, Buildings and Equipment—The Board's property, buildings and equipment are stated at cost less accumulated depreciation. Depreciation is calculated on a straight-line basis over the estimated useful lives of the assets, which range from 3 to 10 years for furniture and equipment and from 10 to 50 years for building equipment and structures. Other Assets—The Board has made prepayments for computer equipment to be received over the next two years. In addition, maintenance on this and other computer equipment received during 1986 has been prepaid through January 1989. Other Assets includes the equipment prepayments and the portion of the prepaid maintenance services which will be received during 1988 and 1989. As the equipment is received and maintenance service provided the furniture and equipment account and the appropriate expense account will be charged accordingly. Contingency Processing Center—The Board operates on behalf of the Federal Reserve System a contingency processing center to handle data processing requirements during emergency situations. The Board recovers from the Federal Reserve Banks a proportionate amount of the operating expenses of the center in the form of fees. 1986 Actuarial present value of accumulated plan benefits Vested Nonvested 1985 $65,003,000 4,625,000 $69,628,000 $57,167,000 3,691,000 $60,858,000 The assumed rate of return used in determining the present value of accumulated plan benefits was 8.5% in 1986 and 9.5% in 1985. As of January 1,1986 and 1985, net assets available for plan benefits were approximately $165 million and $135 million, respectively. As of January 1, 1987, the Board will implement Statement of Financial Accounting Standards No. 87, Employers Pension Accounting. This implementation will require changes in the accounting principles for the Board Plan and the Bank Plan. Because of the overfunded status of the plans, it is presently estimated that implementation of FAS 87 will result in a reduction of operating expense (pension income) and the recording of prepaid pension cost. Employees of the Board may also participate in the Federal Reserve System's Thrift Plan. Under the Thrift Plan, members may contribute up to a fixed percentage of their salary. Board contributions are based upon a fixed percentage of each member's basic contribution and were $1,337,000 in 1986 and $877,000 in 1985. The Board also provides certain health care benefits for retired employees. The cost of providing the benefits is recognized by expensing the insurance premiums which were $98,300 in 1986 and $54,200 in 1985. (3) PROPERTY, BUILDINGS AND EQUIPMENT (2) RETIREMENT BENEFITS Substantially all employees of the Board participate in either the Retirement Plan for Employees of the Federal Reserve Board (Board Plan), the Retirement Plan for Employees of the Federal Reserve System (Bank Plan) or the Civil Service Plan. The Board Plan, the Bank Plan and the Civil Service Plan are a contributory defined benefit plan, a non-contributory defined benefit plan, and a defined contribution plan, respectively. Board contributions to the Board Plan and the Bank Plan are actuarially determined and funded in the current period. Board contributions to the Civil Service Plan directly match employee contributions. The Board contributions to the retirement plans totaled $719,000 in 1986 and $1,960,000 in 1985. As of January 1, 1986 and 1985 (the dates of the most recent actuarial valuations), the accumulated The following is a summary of the components of the Board's fixed assets, at cost, net of accumulated depreciation. As of December 31 1986 Land and improvements Buildings Furniture and equipment Less accumulated depreciation Total property, buildings and equipment . . . 1985 $ 1,301,314 62,062,311 $ 1,301,314 61,851,962 31,955,505 95,319,130 24,799,885 87,953,161 30,491,755 31,777,004 $64,827,375 220 Financial Statements (4) OTHER REVENUES AND OTHER EXPENSES The following are summaries of the components of Other Revenues and Other Expenses. As of December 31 1985 1986 Other Revenues Contingency Processing Center fees Sale of publications Miscellaneous Total other revenues Other Expenses Subsidies and contributions .. Tuition, registrations and membership fees Cafeteria operations, net Miscellaneous Total other expenses The Board's programs were research and development efforts and, accordingly, all costs were expensed as incurred. Board costs associated with this program were $728,964 and $6,734,590 for 1986 and 1985, respectively, and are included in currency expenses. Certain equipment was sold for $750,000 in 1986 and $451,400 in 1985. The sale proceeds were credited to currency costs. (6) CONTINGENCIES $1,543,761 $ 981,573 1,124,482 501,324 1,104,154 445,954 $3,169,567 $2^531,681 $ 703,213 $ 794,611 587,670 495,694 520,450 339,474 531,411 222,698 $2^150,807 The major research contract associated with the counterfeit deterrence program discussed in Note 5 expired on January 31,1985. The contractor has filed a lawsuit for contract termination costs of approximately $4 million. Board counsel believes that the contract properly expired, the claim for termination costs is without merit, and additional costs, if any, to the Board will not be material. The Board has been named as a defendant in various litigation involving challenges to, or appeals from, actions or proposed actions of the Board pursuant to statutory requirement or authorization. Such lawsuits generally seek injunctive or declaratory relief against the Board rather than monetary awards. It is the opinion of Board counsel that such lawsuits involving monetary awards do not represent a material liability to the Board. $2,044,414 (7) FEDERAL FINANCIAL INSTITUTIONS EXAMINATION COUNCIL (5) ADVANCED COUNTERFEIT DETERRENCE RESEARCH During the period 1983 through 1986, the Board sponsored programs to develop technology to deter counterfeiting of U.S. currency and to detect counterfeit currency in circulation. In connection with this program, the Board: 1) sponsored basic research into applying a deterrent device to currency; 2) sponsored the prototyping of production equipment and processes; 3) purchased certain equipment required for a contractor to make test production runs; 4) purchased application machines for use in the production of currency; and 5) sponsored research into methods for detecting counterfeit currency during sorting processes by the Federal Reserve Banks. The Board's participation in this program was substantially complete by the end of 1985. The Board is one of the five member agencies of the Federal Financial Institutions Examination Council (the "Council"). During 1986 and 1985, the Board paid $137,000 and $131,000, respectively, in assessments for operating expenses of the Council. These amounts are included in subsidies and contributions for 1986 and 1985. The Board serves as custodian for the Council's cash account. This cash is not reflected in the accompanying financial statements. It also processes accounting transactions, including payroll for most of the Council employees, and performs other administrative services for which the Board is reimbursed by the Council. The Board is not reimbursed for the costs of personnel who serve on the Council and on the various task forces and committees of the Council. Statistical Tables 222 Tables 1. Detailed Statement of Condition of All Federal Reserve Banks Combined, December 31,1986l Thousands of dollars ASSETS Gold certificate account Special drawing rights certificate account Coin Loans and securities Loans to depository institutions Federal agency obligations Bought outright Held under repurchase agreement U.S. Treasury securities Bought outright Bills Notes Bonds 11,083,947 5,018,000 485,827 1,564,797 7,829,312 2,313,535 103,774,920 68,125,600 25,723,814 Total bought outright 197,624,334 Held under repurchase agreement 13,691,465 Total securities 211,315,799 Total loans and securities 223,023,443 Items in process of collection Transit items 8,063,084 Other items in process of collection 2,211,741 Total items in process of collection 10,274,825 Bank premises Land Buildings (including vaults) Building machinery and equipment Construction account Total bank premises 105,638 452,363 157,448 127,236 737,047 Less depreciation allowance Bank premises, net Other assets Furniture and equipment Less depreciation Total furniture and equipment, net Denominated in foreign currencies2 Interest accrued Premium on securities Due from Federal Deposit Insurance Corporation Overdrafts Prepaid expenses Suspense account Real estate acquired for banking-house purposes Other Total other assets Total assets 182,516 554,531 ' 660,169 515,885 249,460 266,425 9,474,797 2,601,442 1,206,675 2,904,299 190,096 26,159 17,483 6,368 126,488 16,820,232 267,366,443 Tables 223 — Continued LIABILITIES Federal Reserve notes Outstanding (issued to Federal Reserve Banks) Less held by Federal Reserve Banks 231,612,805 36,252,042 Total Federal Reserve notes, net 195,360,763 Deposits Depository institutions U.S. Treasury, general account Foreign, official accounts 48,107,361 7,587,759 286,709 Other deposits Officers' and certified checks International organizations Other3 54,673 198,757 669,890 Total other deposits Deferred credit items 923,320 9,012,278 Other liabilities Discount on securities Sundry items payable Suspense account All other 2,247,837 49,437 30,228 14,121 Total other liabilities 2,341,623 Total liabilities 263,619,813 CAPITAL ACCOUNTS Capital paid in Surplus Other capital accounts4 Total liabilities and capital accounts 1. Amounts in boldface type indicate items in the Board's weekly statement of condition of the Federal Reserve Banks. 2. Of this amount $3,028.1 million was invested in securities issued by foreign governments, and the balance was invested with foreign central banks and the Bank for International Settlements. 1,873,315 1,873,315 0 267,366,443 3. In closing out the other capital accounts at yearend, the Reserve Bank earnings that are payable to the Treasury are included in this account pending payment. 4. During the year, includes undistributed net income, which is closed out on Dec. 31; see table 8. 224 Tables 2. Statement of Condition of Each Federal Reserve Bank, December 31,1986 and 1985 Millions of dollars Total Boston Item 1986 1985 11,084 5,018 485 11,090 4,718 487 703 314 26 658 281 26 1,565 0 3,060 0 43 0 24 0 Federal agency obligations Bought outright Held under repurchase agreements 7,829 2,314 8,227 1,694 464 0 481 0 U.S. Treasury securities Bought outright 1 Held under repurchase agreements Total loans and securities 197,625 13,691 223,024 177,798 3,529 194,308 11,702 0 12,209 10,386 0 10,891 10,273 661 11,667 607 621 92 529 93 9,475 7,345 7,016 7,679 284 209 196 201 1986 1985 ASSETS Gold certificate account Special drawing rights certificate account Coin Loans To depository institutions Other Acceptances held under repurchase agreements .. Items in process of collection Bank premises Other assets Denominated in foreign currencies2 All other 0 0 +1,444 + 449 267,365 237,572 15,902 13,324 195,360 181,450 12,260 11,349 48,107 7,588 287 923 56,905 28,631 9,351 480 1,041 39,503 2,870 0 5 21 2,896 1,178 0 4 36 1,218 9,012 2,342 10,679 2,378 497 127 521 130 63,619 234,010 15,780 13,218 1,873 1,873 0 1,781 1,781 0 61 61 0 53 53 0 267,365 237,572 15,902 13,324 Federal Reserve notes outstanding (issued to Bank) LESS: HeldbyBank 231,603 36,243 208,427 26,977 14,393 2,133 13,504 2,155 Federal Reserve notes, net 195,360 181,450 12,260 11,349 Collateral for Federal Reserve notes Gold certificate account Special drawing rights certificate account Other eligible assets U.S. Treasury and federal agency securities 11,084 5,018 0 179,258 11,090 4,718 0 165,642 195,360 181,450 Interdistrict Settlement Account Total assets LIABILITIES Federal Reserve notes Deposits Depository institutions U.S. Treasury, general account Foreign, official accounts Other Total deposits Deferred credit items Other liabilities and accrued dividends3 Total liabilities CAPITAL ACCOUNTS Capital paid in Surplus Other capital accounts Total liabilities and capital accounts FEDERAL RESERVE N O T E STATEMENT Total collateral http://fraser.stlouisfed.org/ For notes see end of table. Federal Reserve Bank of St. Louis Tables 225 2.- ('ontinued Philadelphia N e w York Cleveland 1986 1985 3,277 1,354 16 431 162 20 483 195 23 650 314 33 1986 1985 3,146 1,489 14 1986 Richmond 1985 1986 1985 635 270 33 959 461 81 969 426 88 2,060 178 155 206 153 231 312 134 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 2,539 2,314 2,744 1,694 251 0 288 0 460 0 481 0 673 0 726 0 64,079 13,691 82,757 59,305 3,529 69,332 6,328 0 6,757 6,226 0 6,669 11,605 0 12,271 10,394 0 11,028 16,985 0 17,889 15,682 0 16,720 1,311 32 1,338 31 595 47 533 48 375 32 432 28 701 100 682 101 2,341 2,038 1,712 1,521 436 115 344 128 569 203 449 212 483 280 344 365 -5,576 -3,210 -466 -651 + 247 + 215 -158 -All 87,552 75,371 8,097 7,772 14,694 13,302 20,796 19,278 61,693 53,848 5,513 5,870 12,482 11,341 17,150 16,656 14,639 7,588 174 516 22,917 8,153 9,351 367 495 18,366 1,945 0 7 8 1,960 1,136 0 7 28 1,171 1,528 0 9 27 1,564 1,126 0 10 43 1,179 2,645 0 8 45 2,698 1,584 0 7 69 1,660 1,158 852 1,486 793 381 71 485 80 298 128 434 134 564 182 584 196 86,620 74,493 7,925 7,606 14,472 13,088 20,594 19,096 466 466 0 439 439 0 86 86 0 83 83 0 112 112 0 107 107 0 101 101 0 91 91 0 87,552 75,371 8,097 7,772 14,694 13,302 20,796 19,278 65,671 4,068 57,138 3,290 7,908 2,395 7,999 2,129 13,896 1,414 12,543 1,202 19,955 2,805 18,176 1,520 61,693 53,848 5,513 5,870 12,482 11,341 17,150 16,656 226 Tables 2. Statement of Condition of Each Federal Reserve Bank, December 31,1986 and 1985—Continued Millions of dollars Atlanta Chicago Item 1986 1986 1985 1985 1,394 656 29 1,451 620 29 ASSETS Gold certificate account Special drawing rights certificate account Coin Loans To depository institutions Other 507 203 47 413 192 53 73 0 38 0 89 0 32 0 • 0 0 ,0 0 Federal agency obligations Bought outright Hela under repurchase agreements 312 0 252 0 873 0 906 0 U.S. Treasury securities Bought outright 1 Held under repurchase agreements Total loans and securities 7,885 0 8,270 5,446 0 5,736 22,040 0 23,002 19,588 0 20,526 Items in process of collection Bank premises 815 51 909 48 1,013 43 958 22 Other assets Denominated in foreign currencies2 Allother 777 158 582 220 1,279 3,319 982 3,659 +1,489 + 3,476 + 2,975 -263 12,317 11,629 33,710 27,984 Federal Reserve notes 7,557 7,341 27,064 23,724 Deposits Depository institutions U.S. Treasury, general account Foreign, official accounts Other Total deposits 3,430 0 12 28 3,470 2,893 0 12 31 2,936 5,008 0 20 103 5,131 2,545 0 21 109 2,675 867 87 914 144 752 261 849 254 11,981 11,335 33,208 27,502 168 168 0 147 147 0 251 251 0 241 241 0 12,317 11,629 33,710 27,984 12,545 4,988 10,558 3,217 29,158 2,094 25,553 1,829 7,557 7,341 27,064 23,724 Acceptances held under repurchase agreements Interdistrict Settlement Account Total assets LIABILITIES Deferred credit items Other liabilities and accrued dividends3 Total liabilities CAPITAL ACCOUNTS Capital paid in Surplus Other capital accounts Total liabilities and capital accounts FEDERAL RESERVE N O T E STATEMENT Federal Reserve notes outstanding (issued to Bank) LESS: Held by Bank Federal Reserve notes, net 1. Includes securities loaned—fully guaranteed by U.S. Treasury securities pledged with Federal Reserve Banks—and excludes securities sold and scheduled to be bought back under matched sale-purchase transactions. 2. Valued monthly at market exchange rates. 3. Includes exchange-translation account reflecting the monthly revaluation at market exchange rates of foreign-exchange commitments. 4. Includes special investment account at the Federal Reserve Bank of Chicago in Treasury bills maturing within 90 days. Tables 227 2.--•("• onli;Hied St . Lou i s Kansas City Minneapolis San Francisco Dallas 1986 1985 1986 1985 1986 1985 1986 1985 1986 1985 366 160 26 357 157 26 168 66 20 156 63 22 598 216 43 617 263 48 692 307 40 713 307 39 1,470 670 106 1,361 590 84 37 0 15 0 206 0 3 0 152 0 207 0 195 0 19 0 21 0 42 0 230 0 239 0 113 0 108 0 321 0 367 0 501 0 532 0 1,092 0 1,103 0 5,816 0 6,083 5,162 0 5,416 2,856 0 3,175 2,343 0 2,454 8,118 0 8,591 7,930 0 8,504 12,655 0 13,351 11,492 0 12,043 27,556 0 28,669 23,844 568 20 828 18 492 24 654 25 1,527 46 1,840 46 710 20 1,358 19 1,545 154 1,606 128 284 104 197 114 313 60 232 92 426 162 316 156 786 214 561 540 1,497 483 24,989 -1 + 487 + 78 -39 -106 -769 -80 -612 + 154 1,101 471 + 1,334 7,610 7,600 4,396 3,659 11,503 11,021 16,040 14,968 34,748 31,664 5,889 5,796 2,838 2,391 8,293 7,823 11,250 11,100 23,371 24,211 1,021 0 4 12 1,037 896 0 4 21 921 884 0 5 12 901 471 0 5 13 489 1,425 0 7 28 1,460 1,055 0 7 37 1,099 3,675 0 12 41 3,728 2,615 0 12 51 2,678 9,037 0 24 82 9,143 4,979 0 24 108 5,111 504 64 709 66 495 40 630 33 1,495 93 1,837 102 610 136 751 143 1,391 301 1,479 303 7,494 7,492 4,274 3,543 11,341 10,861 15,724 14,672 34,206 31,104 58 58 0 54 54 0 61 61 0 58 58 0 81 81 0 ooo oooo 158 158 0 148 148 0 271 271 0 280 280 0 7,610 7,600 4,396 3,659 11,503 11,021 16,040 14,968 34,748 31,664 7,467 1,578 7,091 1,295 3,383 545 2,999 608 11,665 3,372 11,100 3,277 14,236 2,986 13,043 1,943 31,236 7,865 28,723 4,512 5,889 5,796 2,838 2,391 8,293 7,823 11,250 11,100 23,371 24,211 228 Tables 3. Federal Reserve Open Market Transactions. 1986' Millions of dollars Type of transaction Jan. Feb. I Mar. Apr. U.S. TREASURY SECURITIES Outright transactions (excluding matched transactions) Treasury bills Gross purchases Gross sales Exchange Redemptions 286 225 0 0 0 2,277 0 1,000 396 0 0 0 2,988 0 0 0 Others within 1 year Gross, purchases Gross sales Maturity shift Exchange Redemptions 0 0 725 -596 0 0 0 4,776 -2,148 0 0 0 1,152 -1,458 0 0 0 447 -1,129 0 1 to 5 years Gross purchases Gross sales Maturity shift Exchange 0 0 -703 596 0 0 -4,776 1,548 0 0 -1,152 1,458 0 0 -447 1,134 5 to 10 years Gross purchases Gross sales Maturity shift Exchange 0 0 -22 0 0 0 0 350 More than 10 years Gross purchases Gross sales Maturity shift Exchange All maturities Gross purchases Gross sales Redemptions 0 0 -5 0 0 0 0 250 286 225 0 0 2,277 1,000 396 0 0 2,988 0 0 Matched transations Gross sales Gross purchases 63,109 61,156 90,459 94,368 88,917 88,604 109,253 103,957 Repurchase agreements1 Gross purchases Gross sales 24,257 24,699 0 3,087 6,748 6,748 21,156 13,634 -2,335 -2,456 83 5,214 Net change in U.S. Treasury securities *Less than $500,000 in absolute value. 1. Sales, redemptions, and negative figures reduce holdings of the System Open Market Account; all other figures increase such holdings. Details may not add to totals because of rounding. ooo Total net change in System Open Market Account ... ooo Net change in agency obligations ooo Repurchase agreements2 Gross purchases Gross sales ooo FEDERAL AGENCY OBLIGATIONS Outright transactions Gross purchases Gross sales Redemptions 5,384 6,454 0 623 1,821 1,821 3,387 1,955 1,070 -663 0 1,432 3,405 -3,119 83 6,647 2. In July 1984 the Open Market Trading Desk discontinued accepting bankers acceptances in repurchase agreements. Tables 229 3. -Continued June July Aug. Sept. Nov. Oct. Dec. Total ooooo May 3,318 0 0 0 5,422 0 0 0 22,602 2,502 0 1,000 0 0 974 -529 0 190 0 2,974 -1,810 0 0 0 1,280 -1,502 0 190 0 18,673 -20,179 0 0 0 -1,053 1,892 0 0 -969 529 893 0 -2,414 1,510 0 0 -1,280 1,502 893 0 -17,058 16,984 1,402 0 0 0 867 0 0 0 2,940 0 0 0 861 0 0 0 0 0 1,847 -1,819 0 0 0 1,152 -1,957 0 0 0 579 -1,253 0 0 0 1,715 -4,087 0 0 0 1,053 -1,892 0 0 0 -1,532 1,019 * 0 0 -1,152 1,957 0 0 -386 1,253 0 0 -1,194 2,587 0 0 -193 0 0 0 -520 1,000 0 0 0 0 0 0 -5 0 236 0 -560 200 0 0 0 0 236 0 -1,620 2,050 0 0 0 0 0 0 0 0 0 0 0 500 0 0 0 0 0 0 0 0 158 0 0 100 0 0 0 0 158 0 0 1,150 3,196 0 0 1,402 0 0 867 0 0 2,940 0 0 861 0 0 928 0 0 4,795 0 0 5,422 0 0 24,078 2,502 1,000 62,663 67,147 80,219 80,674 70,928 69,659 60,460 60,011 73,179 70,817 77,262 81,892 60,146 60,232 91,404 88,730 927,997 927,247 12,395 19,917 5,640 5,640 18,657 18,657 0 0 14,717 8,403 5,670 11,984 16,888 15,471 44,303 32,028 170,431 160,268 158 1,857 -403 2,491 4,814 -756 6,298 15,023 29,989 0 0 125 0 0 2,678 869 952 2,761 1,622 1,274 5,488 3,522 31,142 30,522 0 4,984 4,984 * -90 1,809 -1,902 223 1,965 222 1,857 -403 2,401 6,623 -2,658 6,522 16,988 30,211 3,135 4,567 1,691 1,691 -1,482 -1,324 0 0 ooo 0 0 398 0 0 50 ooo 0 0 93 ooo 0 0 0 0 oo* 0 0 -315 500 oooo 3,196 0 0 0 230 Tables 4. Federal Reserve Bank Holdings of U.S. Treasury and Federal Agency Securities, December 31, 1984-861 Millions of dollars Increase or decrease (-) December 31 Description 1986 U.S. Treasury securities, total By term 2 1-15 days 16-90 days 91 days to 1 year 1-5 years 5-10 years More than 10 years By type of holding Held outright3 Treasury bills Treasury notes Treasury bonds Held under RPs Federal agency obligations, total By term 2 1-15 days 16-90 days 91 days to 1 year 1-5 years 5-10 years More than 10 years By type of holding Held outright Banks for Cooperatives Federal Farm Credit Banks Federal Home Loan Banks Federal Home Loan Mortgage Corporation Federal Intermediate Credit Banks Federal Land Banks Farmers Home Administration Federal National Mortgage Association Government National Mortgage Association participation certificates U.S. Postal Service Washington Metropolitan Area Transit Authority General Services Administration Held under RPs 1. Details may not add to totals because of rounding. 2. Includes the effects of temporary transactions (repurchase agreements and matched sale-purchase agreements). 1985 1984 1986 1985 206,520 177,281 157,010 29,239 20,271 15,684 53,611 62,239 36,469 15,451 23,066 5,261 43,462 56,364 35,650 14,785 21,759 415 37,396 47,795 37,072 14,100 20,233 10,423 10,148 5,875 4,846 6,067 8,568 -1,421 103,775 68,126 25,724 13,691 85,425 67,647 24,726 3,529 10,143 9,921 2,704 1,836 818 666 685 1,308 1,526 71,035 65,237 22,951 1,627 18,350 10,163 14,390 2,410 1,775 1,902 8,777 222 1,144 808 961 575 521 1,224 3,854 1,178 1,471 4,056 1,187 1,665 4,350 1,267 374 409 399 0 2,486 2,252 21 2,477 2,260 21 2,363 2,260 0 30 236 101 0 50 236 101 2,490 479 997 868 1,261 -153 -247 -202 -193 -294 -9 -35 -80 10 440 -21 0 0 50 350 147 8 -8 0 -21 0 0 114 0 0 0 2,847 2,962 -357 -115 67 37 67 37 67 37 0 0 0 0 117 14 117 14 1,693 0 0 620 0 0 2,314 117 14 388 -115 -46 1,306 3. Excludes the effects of temporary transactions (repurchase agreements and matched sale-purchase agreements). Tables 231 Number and Salaries of Officers and Employees of Federal Reserve Banks, December 3), 1986 President Federal Reserve Bank (including Branches) Boston New York Philadelphia Cleveland Richmond Atlanta Chicago St. Louis Minneapolis Kansas City Dallas San Francisco ... Total Other officers Employees Number Number Annual salaries (dollars) 150,300 170,800 131,200 135,300 131,300 141,600 155,900 128,500 110,000 130,000 127,700 146,500 53 161 52 57 79 66 80 57 43 60 60 98 3,410,600 11,949,050 3,473,550 3,529,300 4,798,000 4,098,650 4,974,300 3,246,600 2,550,600 4,333,600 3,627,403 6,146,314 1,267 3,695 1,096 1,263 1,744 2,037 2,589 1,204 942 1,512 1,457 2,239 1,659,100 866 56,137,967 21,045 Annual salary (dollars) Fulltime Total Annual salaries (dollars) Number Annual salaries (dollars) 242 57 81 62 153 81 32 86 152 61 47 82 33,767,315 98,737,087 26,130,930 28,421,330 37,015,168 44,564,265 63,141,844 26,000,824 22,400,458 33,762,405 32,746,058 55,969,264 1,563 3,914 1,230 1,383 1,977 2,185 2,702 1,348 1,138 1,634 1,565 2,420 37,328,215 110,856,937 29,735,680 32,085,930 41,944,468 48,804,515 68,272,044 29,375,924 25,061,058 38,226,005 36,501,161 62,262,078 1,136 502,656,948 23,059 560,454,015 Parttime 232 Tables 6. Acquisition Costs and Net Book Value of Premises of Federal Reserve Banks and Branches, December 31, 19861 Dollars Federal Reserve Bank or Branch BOSTON Annex . Acquisition costs Land Buildings (including vaults)2 22,036,681 27,840 3,436,277 477,863 887,844 80,543,612 89,202 21,160,038 1,136,219 2,693,864 PHILADELPHIA 1,876,601 CLEVELAND Cincinnati Pittsburgh 1,074,281 2,246,599 1,658,376 RICHMOND Annex Baltimore .... Charlotte .... ATLANTA .. Birmingham . Jacksonville .. Annex Miami Nashville New Orleans . NEW YORK Annex Buffalo Building machinery and equipment Total3 5,360,169 107,940,462 44,538 161,580 Net book value Other real estate4 92,447,624 125,652 21,735,584 745,855 2,258,313 46,331,899 2,359,936 5,840,022 28,217,354 788,472 3,241,643 52,413,293 5,903,704 60,193,598 46,842,992 7,409,713 13,537,723 7,717,686 4,697,832 7,528,477 3,287,248 13,181,825 23,312,798 12,663,310 7,564,641 14,177,766 9,798,480 3,912,575 522,733 6,472,984 347,071 55,727,664 3,725,466 26,826,903 2,758,209 14,314,313 3,924,584 3,842,189 946,943 73,954,552 8,172,784 37,142,076 4,052,223 58,785,695 4,041,391 34,045,323 2,767,990 1,202,255 2,363,463 1,066,862 107,925 3,607,531 592,342 3,087,693 6,375,901 1,905,770 19,192,963 76,236 11,965,974 1,474,678 2,782,464 3,558,580 1,046,244 778,381 15,843 2,107,796 1,252,346 1,477,946 11,136,737 5,315,476 21,038,206 200,003 17,681,302 3,319,367 7,348,103 5,874,793 3,588,824 19,106,106 149,727 15,587,112 1,488,340 4,843,229 38,036,406 762,364 4,366,443 1,224,363 1,675,934 608,243 48,365 283,753 CHICAGO .. Annex Detroit 4,511,942 53,066 797,734 38,084,306 548,119 3,154,226 12,203,707 215,796 2,798,874 54,799,956 816,981 6,750,834 ST. LOUIS Little Rock Louisville .. Memphis ... 700,378 1,148,492 700,075 1,135,623 10,601,614 2,082,669 3,182,471 4,216,382 4,634,979 1,010,869 1,131,238 2,126,755 15,936,971 4,242,031 5,013,784 7,478,760 9,320,327 2,689,032 2,574,551 5,015,257 MINNEAPOLIS . Helena KANSAS CITY Denver Oklahoma City . Omaha 1,394,384 289,619 1,798,804 2,997,746 646,386 6,534,083 26,681,737 106,380 11,609,885 4,321,485 3,245,825 12,382,609 7,692,189 66,777 35,768,310 462,775 23,533,226 342,040 157,115 8,450,928 2,610,017 1,672,442 0 21,859,617 9,929,248 5,564,653 18,916,692 16,646,625 7,203,281 3,892,965 18,675,728 149,948 DALLAS ... El Paso Houston San Antonio 3,738,290 262,477 2,049,064 459,635 5,137,194 1,348,665 2,722,066 2,293,818 3,738,335 393,301 898,037 574,346 12,613,819 2,004,443 5,669,167 3,327,799 9,816,367 1,692,162 5,153,564 2,699,718 SAN FRANCISCO . Los Angeles Portland Salt Lake City Seattle Total 15,541,937 117,592,789 4,353,961 2,910,659 1,683,361 207,381 1,972,068 480,222 2,184,342 274,772 16,434,132 149,568,859 140,287,078 9,758,695 6,030,890 2,494,074 2,540,173 2,116,864 649,432 3,590,213 2,779,171 1,137,923 4,145,847 2,567,210 1,686,734 105,638,563 579,019,548 157,447,772 842,105,883 659,684,425 1. Details may not add to totals because of rounding. 2. Includes expenditures for construction at some offices, pending allocation to appropriate accounts. 2,220,765 6,368,485 3. Excludes charge-offs of $17,698,968 before 1952. 4. Covers acquisitions for banking-house purposes and Bank premises formerly occupied and being held pending sale. Tables 233 Millions of dollars Item 1982 1983 1984 1985 1986 CURRENT INCOME Loans Acceptances U.S. Treasury and federal agency securities Foreign currencies Other 174.6 18.3 132.9 6.0 569.5 3.2 427.9 0 279.2 0 15,492.9 432.5 12.3 15,150.2 273.8 9.3 16,687.5 217.1 16.9 16,843.1 228.7 17.3 16,141.5 393.9 22.1 Total current income 16,130.7 15,572.1 17,494.2 17,517.1 16,836.8 138.4 140.3 148.3 155.0 152.0 163.3 148.3 175.7 145.8 189.1 648.8 678.4 704.6 746.2 773.2 115.1 1,042.6 120.3 1,102.1 126.3 1,146.1 131.5 1,201.6 136.8 1,244.9 77.3 386.7 78.1 496.2 85.8 574.7 97.4 614.9 112.1 627.7 578.6 527.7 485.6 489.4 505.0 98.4 152.1 162.6 173.3 181.2 677.0 679.8 648.2 662.7 686.2 28.3 71.8 118.7 105.2 107.7 15,425.4 14,820.5 16,727.2 16,749.2 16,042.9 -149.6 -456.3 -454.8 1,210.0 1,970.6 85.2 -4.5 -68.8 21.0 34.9 -400.4 48.6 -6.7 -412.9 99.4 -7.9 1 ,301.6 66.8 -61.6 1,975.9 15,356.6 14,420.2 16,314.3 18,050.8 18,018.7 CURRENT EXPENSES Monetary and economic policy Supervision and regulation Services to financial institutions and the public Services to the U.S. Treasury and other government agencies Total current expenses LESS Reimbursements Revenue from priced services EQUALS Net expenses PLUS Currency costs . EQUALS Net expenses including currency costs PLUS Earnings-credit costs1 Current net income ADDITIONS TO AND DEDUCTIONS FROM CURRENT NET INCOME Unrealized gains or losses ( - ) on the revaluation of foreign currency assets Gains or losses ( - ) on sales of U.S. Treasury and federal agency securities Other Total Net income before distributions DISTRIBUTIONS Dividends paid Transfers to surplus Net transfers to or deductions from ( - ) Board account Interest on Federal Reserve notes 79.4 78.3 85.2 106.7 92.6 162.0 103.0 155.3 109.6 92.0 -5.7 15,204.6 -.5 14,228.8 5.5 16,054.1 -3.9 17,796.5 13.3 17,803.9 Total distributions 15,356.6 14,420.2 16,314.3 18,050.8 18,018.7 1. The amount of the credits granted to depository institutions on clearing balances maintained with the Reserve Banks. These earnings credits may be used to offset charges for Federal Reserve priced services. The clearing balances are invested in U.S. Treasury securities, the earnings on which are reflected in the current-income section of this table. 234 Tables 8. Income and Expenses of Federal Reserve Banks, 1986 Dollars Item1 Total Boston New York Philadelphia Cleveland CURRENT INCOME Loans U.S. Treasury and federal agency securities Foreign currencies Priced services Other 279,190,611 1,120,763 4,896,983 2,018,391 674,180 16,141,544,144 393,563,826 627,736,431 22,116,636 945,814,646 11,816,759 40,112,790 718,137 5,349,330,871 97,225,032 91,705,355 12,202,190 532,591,184 18,089,170 27,488,236 416,697 941,194,643 23,594,141 38,173,956 415,209 Total 17,464,151,647 999,583,095 5,555,360,431 580,603,678 1,004,052,128 596,170,328 37,836,420 121,402,742 31,833,173 33,961,449 133,360,309 11,206,609 19,775,226 8,309,368 3,115,473 895,990 24,926,134 1,410,355 2,608,710 7,455,196 544,866 781,103 8,233,284 1,586,532 1,642,322 81,879,848 15,254,693 46,004,715 3,689,087 1,032,847 2,647,573 9,081,204 3,485,763 8,607,238 4,700,356 659,592 2,702,203 5,996,838 734,643 2,958,404 22,213,256 23,549,010 22,809,177 14,975,977 14,217,178 4,049,382 2,451,201 2,024,412 491,003 831,804 3,942,496 2,266,744 3,473,847 9,019,992 3,097,100 1,484,083 1,699,042 2,339,572 44,964 1,121,352 1,032,263 1,336,295 1,572,713 238,568 683,830 3,095,811 40,665,348 68,000,516 38,997,781 107,709,013 42,977,117 (0) 144,496 1,575,224 4,122,377 2,310,667 6,285,764 2,709,019 (3,026,998 (6,460,239 (107,054 0 6,911,418 11,178,992 6,299,082 13,328,823 7,104,336 1,492,712 (3,283,543) (5,734) 181,191 905,877 4,085,222 2,199,042 8,790,331 1,962,449 2,519,609 (2,165,453) (55,564) 124,568 4,298,098 3,887,739 1,348,496 9,581,389 3,274,418 (1,148,176) (3,014,681) (234,019) 74,927,816 (5,318,162) 69,609,654 236,348,411 (23,720,410) 212,628,001 73,788,206 (13,028,800) 60,759,406 78,094,973 (7,215,209) 70,879,764 CURRENT EXPENSES Salaries and other personnel expenses Retirement and other benefits Fees Travel Postage and other shipping costs Communications Materials and supplies Building expenses Taxes on real estate Property depreciation Utilities Rent Other Equipment Purchases Rentals Depreciation Repairs and maintenance Earnings-credit costs Other Shared costs, net2 Recoveries Expenses capitalized3 Total Reimbursements Net expenses For notes see end of table (31,379,530) (2,484,527) 1,268,997,855 (112,130,141) 1,156,867,714 Tables 235 8.—Continued Richmond 8,683,419 Atlanta 1,758,728 Chicago St. Louis Minneapolis 206,123,740 1,553,429 1,155,916 1,393,795,932 20,081,599 52,082,123 795,769 583,449,314 1,782,213,012 32,267,312 53,106,506 69,092,954 84,722,988 470,078,035 11,816,759 28,079,122 224,144,963 12,987,606 35,415,830 " 1,712,351 370,493 390,753 1,475,438,842 688,218,943 2,127,878,597 511,897,838 274,095,068 1,650,635 Kansas City 19,203,921 Dallas 29,553,875 San Francisco 2,447,266 681,240,909 1,031,823,291 2,205,867,344 17,710,372 32,680,564 62,188,006 41,805,226 351,111 46,291,219 1,096,215 72,766,632 1,997,076 760,311,539 1,141,445,164 2,345,266,324 44,080,072 10,038,418 349,272 1,665,257 51,549,126 11,539,975 513,462 1,619,936 72,064,506 16,365,777 1,137,153 3,242,904 30,525,105 7,139,832 482,665 1,009,051 26,434,759 5,724,870 472,366 787,209 39,562,626 9,171,739 526,234 1,469,358 38,673,184 8,274,539 341,835 1,352,176 68,247,166 16,181,177 726,396 2,701,210 6,576,593 999,950 4,117,490 8,825,877 2,004,836 4,500,592 8,763,448 1,560,278 5,348,490 4,514,170 553,216 3,017,772 5,681,792 524,644 1,864,426 6,398,070 1,110,055 3,075,365 4,643,382 911,626 2,912,327 13,009,031 1,677,243 4,252,835 1,798,916 3,584,287 1,990,046 471,346 1,505,402 1,192,616 1,221,876 1,901,214 331,446 840,507 2,467,453 1,253,534 2,582,728 2,344,884 2,503,667 439,828 807,715 1,275,662 374,633 658,529 2,499,795 1,049,995 842,796 120,392 579,423 822,327 1,807,786 1,378,799 57,265 635,011 576,649 1,239,587 1,097,629 1,090,216 679,652 1,907,448 4,830,948 2,329,759 391,268 1,080,901 398,444 2,236,631 6,502,505 3,660,276 7,809,201 4,538,660 (167,450 (4,092,201 (201,859 267,476 4,460,076 6,457,395 3,871,991 11,555,130 3,642,064 2,295,570 (1,408,749) (228,960) 508,815 6,340,781 7,860,609 6,331,553 21,705,770 5,992,257 (5,718,346) (2,438,685) (546,832) 488,684 914,504 3,150,813 1,891,150 4,423,451 1,718,082 1,016,171 (1,224,932) (29,033) 340,332 1,014,199 3,955,537 1,914,523 5,576,544 2,098,738 1,889,536 (635,004) (58,479) 62,221 1,551,465 3,756,425 2,410,548 6,387,245 2,087,056 739,942 (1,061,559) (482,825) 185,795 4,706,426 5,857,989 2,247,760 4,412,349 2,462,461 605,203 (2,281,496) (423,006) 393,789 5,750,649 7,184,913 4,512,693 7,853,016 5,387,577 (497,773) (3,312,988) (111,162) 97,861,256 116,953,456 159,670,744 (7,619,873^ (8,052,423) (12,795,133) 90,241,383 108,901,033 146,875,611 63,147,068 (7,293,892) 55,853,176 62,678,393 (3,587,127) 59,091,266 81,465,153 (5,751,432) 75,713,721 79,566,283 144,496,096 (5,433,355) (12,314,325) 74,132,928 132,181,771 236 Tables 8. Income and Expenses of Federal Reserve Banks. 1986—Continued Dollars Item1 Total Boston New York 16,307,283,932 929,973,442 5,342,732,429 519,844,271 933,172,362 66,836,210 2,015,616,683 2,082,452,893 3,938,872 59,127,102 63,065,974 21,891,327 486,783,891 508,675,217 2,210,987 90,652,224 92,863,212 3,918,560 118,246,959 122,165,518 106,559,537 3,070,996 12,535,159 5,913,742 5,032,520 1,975,893,356 59,994,978 496,140,058 86,949,469 117,132,998 97,337,500 180,779,673 2,912,600 11,306,558 24,112,100 53,649,878 4,522,900 5,848,170 5,865,800 11,299,418 18,005,060,114 975,749,262 5,761,110,509 596,422,670 1,033,140,142 109,587,968 3,346,081 27,204,022 4,964,655 6,590,413 17,803,517,996 964,288,881 5,707,345,837 587,538,416 1,022,235,729 Philadelphia Cleveland PROFIT A N D LOSS Current net income Additions to and deductions from current net income Profits on sales of U.S. Treasury and federal agency securities Other additions Total additions . . . . Deductions from current net income Net additions to or deductions ( - ) from current net income Assessments by Board Board expenditures4 Cost of currency Net income before payment to U.S. Treasury Dividends paid Payments to U.S. Treasury (interest on Federal Reserve notes) Transferred to surplus 91,954,150 8,114,300 26,560,650 3,919,600 4,314,000 Surplus, January 1 Surplus, December 31 1,781,361,150 1,873,315,300 52,798,900 60,913,200 439,440,700 466,001,350 82,545,900 86,465,500 107,000,300 111,314,300 1. Details may not add to totals because of rounding. 2. Includes distribution of costs for projects performed by one Bank for the benefit of one or more other Banks. 3. Includes expenses for labor and materials tem- porarily capitalized and charged to activities when the products are consumed. 4. For additional details, see the last four pages of the preceding section: Board of Governors, Financial Statements. Tables 237 8, Continued Richmond 1,385,197,458 Atlanta Chicago 579,317,913 1,981,002,986 St. Louis Minneapolis 456,044,663 215,003,799 Kansas City Dallas San Francisco 684,597,818 1,067,312,237 2,213,084,554 5,797,536 100,693,533 106,491,069 2,447,617 161,618,945 164,066,562 7,421,767 266,049,513 273,471,280 1,957,658 59,122,161 61,079,819 935,655 65,044,501 65,980,156 2,828,720 88,680,559 91,509,279 4,294,070 206,670,303 210,964,372 9,193,441 312,926,994 322,120,434 4,346,605 5,232,023 7,555,952 3,699,975 1,975,070 3,419,573 46,518,066 7,259,856 102,144,465 158,834,539 265,915,328 57,379,844 64,005,086 88,089,706 164,446,306 314,860,578 5,019,100 16,595,018 8,066,900 7,312,579 13,217,900 23,637,227 2,959,100 5,774,394 3,191,300 2,381,509 4,395,000 7,794,959 8,137,900 11,059,110 14,936,900 24,120,852 722,772,973 2,210,063,188 504,691,013 273,436,076 14,838,725 3,373,526 3,554,079 691,586,059 2,185,033,713 497,265,437 267,240,546 1,465,727,805 5,798,975 1,449,589,630 9,472,564 760,497,564 1,212,561,533 2,488,887,379 4,878,187 9,223,358 755,101,827 1,194,015,275 2,482,276,645 10,339,200 21,714,350 10,190,750 4,052,050 2,641,450 517,550 9,322,900 90,812,250 101,151,450 146,545,500 168,259,850 241,181,250 251,372,000 53,722,900 57,774,950 58,493,400 61,134,850 80,135,800 80,653,350 148,211,250 157,534,150 16,343,385 (9,732,650) 280,473,000 270,740,350 238 Tables 9. Income and Expenses of Federal Reserve Banks, 1914-861 Dollars Period, or Federal Reserve Bank Current income Net expenses Net additions or deductions ( - ) Assessments by Board of Governors Board expenditures Costs of currency All Banks 1914-15 . 1916 1917 1918 1919 2,173,252 5,217,998 16,128,339 67,584,417 102,380,583 2,018,282 2,081,722 4,921,932 10,576,892 18,744,815 5,875 -193,001 -1,386,545 -3,908,574 -4,673,446 302,304 192,277 237,795 382,641 594,818 1920 1921 1922 1923 1924 1925 1926 1927 1928 1929 181,296,711 122,865,866 50,498,699 50,708,566 38,340,449 41,800,706 47,599,595 43,024,484 64,052,860 70,955,496 27,548,505 33,722,409 28,836,504 29,061,539 27,767,886 26,818,664 24,914,037 24,894,487 25,401,233 25,810,067 -3,743,907 -6,314,796 -4,441,914 -8,233,107 -6,191,143 -4,823,477 -3,637,668 -2,457,792 -5,026,029 -4,861,642 709,525 741,436 722,545 702,634 663,240 709,499 721,724 779,116 697,677 781,644 1,714,421 1,844,840 805,900 3,099,402 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 36,424,044 29,701,279 50,018,817 49,487,318 48,902,813 42,751,959 37,900,639 41,233,135 36,261,428 38,500,665 25,357,611 24,842,964 24,456,755 25,917,847 26,843,653 28,694,965 26,016,338 25,294,835 25,556,949 25,668,907 -93,136 311,451 -1,413,192 -12,307,074 -4,430,008 -1,736,758 485,817 -1,631,274 2,232,134 2,389,555 809,585 718,554 728,810 800,160 1,372,022 1,405,898 1,679,566 1,748,380 1,724,924 1,621,464 2,175,530 1,479,146 1,105,816 2,504,830 1,025,721 1,476,580 2,178,119 1,757,399 1,629,735 1,356,484 1940 1941 1942 1943 1944 1945 1946 1947 1948 1949 43,537,805 41,380,095 52,662,704 69,305,715 104,391,829 142,209,546 150,385,033 158,655,566 304,160,818 316,536,930 25,950,946 28,535,547 32,051,226 35,793,816 39,659,496 41,666,453 50,493,246 58,191,428 64,280,271 67,930,860 11,487,697 720,636 -1,568,208 23,768,282 3,221,880 -830,007 -625,991 1,973,001 -34,317,947 -12,122,274 1,704,011 1,839,541 1,746,326 2,415,630 2,296,357 2,340,509 2,259,784 2,639,667 3,243,670 3,242,500 1,510,520 2,588,062 4,826,492 5,336,118 7,220,068 4,710,309 4,482,077 4,561,880 5,186,247 6,304,316 1950 1951 1952 1953 1954 1955 1956 1957 1958 1959 275,838,994 394,656,072 456,060,260 513,037,237 438,486,040 412,487,931 595,649,092 763,347,530 742,068,150 886,226,116 69,822,227 83,792,676 92,051,063 98,493,153 99,068,436 101,158,921 110,239,520 117,931,908 125,831,215 131,848,023 36,294, 117 -2,12?,! 1,583,988 -1,058,993 -133,641 -265,456 -23,436 -7,140,914 124,175 98,247,253 3,433,700 4,095,497 4,121,602 4,099,800 4,174,600 4,194,100 5,339,800 7,507,900 5,917,200 6,470,600 7,315,844 7,580,913 8,521,426 10,922,067 6,489,895 4,707,002 5,603,176 6,374,195 5,973,240 6,384,083 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1,103,385,257 941,648,170 1,048,508,335 1,151,120,060 1,343,747,303 1,559,484,027 1,908,499,896 2,190,403,752 2,764,445,943 3,373,360,559 139,893,564 148,253,719 161,451,206 169,637,656 171,511,018 172,110,934 178,212,045 190,561,166 207,677,768 237,827,579 13,874,702 3,481,628 -55,779 614,835 725,948 1,021,614 996,230 2,093,876 8,519,996 -557,553 6,533,700 6,265,100 6,654,900 7,572,800 8,655,200 8,576,396 9,021,600 10,769,596 14,198,198 15,020,084 7,455,011 6,755,756 8,030,028 10,062,901 17,229,671 23,602,856 20,167,481 18,790,084 20,474,404 22,125,657 For notes see end of table. Tables 239 9.—Continued Payments to U.S. Treasury jjiviaenus paid Franchise tax Under section 13b Interest on Federal Reserve notes Transferred to surplus (section 13b) Transferred to surplus (section 7) 217,463 1,742,775 6,804,186 5,540,684 5,011,832 2,703,894 1,134^234 48,334,341 70,651,778 5,654,018 6,119,673 6,307,035 6,552,717 6,682,496 6,915,958 7,329,169 7,754,539 8,458,463 9,583,911 60,724,742 59,974,466 10,850,605 3,613,056 • 113,646 59,300 818,150 249,591 2,584,659 4,283,231 82,916,014 15,993,086 -659,904 2,545,513 -3,077,962 2,473,808 8,464,426 5,044,119 21,078,899 22,535,597 10,268,598 10,029,760 9,282,244 8,874,262 8,781,661 8,504,974 7,829,581 7,940,966 8,019,137 8,110,462 17,308 -2,297,724 -7,057,694 11,020,582 -916,855 6,510,071 607,422 352,524 2,616,352 1,862,433 4,533,977 1,134,234 2,bil,418 8,214,971 8,429,936 8,669,076 8,911,342 9,500,126 10,182,851 10,962,160 11,523,047 11,919,809 12,329,373 297,667 227,448 176,625 119,524 24,579 -60,323 27,695 102,880 67,304 -419,140 -425,653 82,152 141,465 197,672 244,726 326,717 247,659 67,054 35,605 -54,456 -4,333 49,602 135,003 201,150 262,133 27,708 86,772 75,233,818 166,690,356 193,145,837 17,617,358 570,513 3,554,101 40,327,362 48,409,795 81,969,625 81,467,013 8,366,350 18,522,518 21,461,770 13,082,992 13,864,750 14,681,788 15,558,377 16,442,236 17,711,937 18,904,897 20,080,527 21,197,452 22,721,687 196,628,858 254,873,588 291,934,634 342,567,985 276,289,457 251,740,721 401,555,581 542,708,405 524,058,650 910,649,768 21,849,490 28,320,759 46,333,735 40,336,862 35,887,775 32,709,794 53,982,682 • 61,603,682 59,214,569 -93,600,791 23,948,225 25,569,541 27,412,241 28,912,019 30,781,548 32,351,602 33,696,336 35,027,312 36,959,336 39,236,599 896,816,359 687,393,382 799,365,981 879,685,219 1,582,118,614 1,296,810,053 1,649,455,164 1,907,498,270 2,463,628,983 3,019,160,638 42,613,100 70,892,300 45,538,200 55,864,300 -465,822,800 27,053,800 18,943,500 29,851,200 30,027,250 39,432,450 240 Tables 9. Income and Expenses of Federal Reserve Banks, 1914-861—Continued Dollars Period, or Federal Reserve Bank Current income Net expenses Net additions or deductions ( - ) Assessments by Board of Governors Board expenditures Costs of currency 1970 1971 , 1972 1973 1974 1975 1976 1977 1978 1979 3,877,218,444 3,723,369,921 3,792,334,523 5,016,769,328 6,280,090,965 6,257,936,784 6,623,220,383 6,891,317,498 8,455,390,401 10,310,148,406 276,571,876 319,608,270 347,917,112 416,879,377 476,234,586 514,358,633 558,128,811 568,851,419 592,557,841 625,168,261 11,441,829 94,266,075 49,615,790 80,653,488 78,487,237 (202,369,615 7,310,500 (177,033,463 (633,123,486" (151,148,220; 21,227,800 32,634,002 35,234,499 44,411,700 41,116,600 33,577,201 41,827,700 47,366,100 53,321,700 50,529,700 23,573,710 24,942,528 31,454,740 33,826,299 30,190,288 37,130,081 48,819,453 55,008,163 60,059,365 68,391,270 1980 1981 1982 1983 1984 1985 1986 12,802,319,335 15,508,349,653 16,517,385,129 16,068,362,117 18,068,820,742 18,131,982,786 17,464,528,361 718,032,836 814,190,392 926,033,957 1,023,678,474 1,102,444,454 1,127,744,490 1,156,867,714 (115,385,855 (372,879,185 (68,833,150 (400,365,922 (412,943,156 1,301,624,294 1,975,893,356 62,230,800 63,162,700 61,813,400 71,551,000 82,115,700 77,377,700 97,337,500 73,124,423 82,924,013 98,441,027 152,135,488 162,606,410 173,738,745 180,779,673 201,351,041,661 15,388,965,389 719,539,608 1,104,734,408 1,632,591,378 9,803,200,724 57,385,270,437 8,717,528,786 14,139,606,581 15,827,364,278 8,156,237,834 30,096,109,587 7,099,272,065 3,701,637,078 8,886,354,267 11,432,350,490 26,106,109,536 1,017,553,501 3,137,962,811 813,507,271 1,048,066,501 1,199,898,709 1,290,631,358 2,023,093,302 832,610,270 688,831,380 960,456,350 853,164,594 1,523,189,340 12,451,897 226,300,627 34,022,670 (11,731,536) 23,752,524 65,940,608 47,687,622 6,419,380 24,764,072 32,041,055 100,690,486 157,200,201 40,245,686 285,823,686 54,357,018 88,679,690 57,039,076 80,003,260 158,691,072 34,805,272 32,581,415 47,391,509 68,658,773 156,457,951 94,541,879 384,580,071 81,336,705 103,387,314 157,346,619 107,259,873 228,273,239 64,705,904 29,477,129 81,238,328 97,291,884 203,152,433 201,351,041,661 15,388,965,389 1,104,734,408 1,632,591,378 Total, 1914-86 ... Aggregate for each Bank, 1914-86 Boston New York Philadelphia Cleveland Richmond Atlanta Chicago St. Louis Minneapolis Kansas City Dallas San Francisco Total 1. Details may not add to totals because of rounding. 2. The $2,001,987,499 transferred to surplus was reduced by direct charges of $500,000 for charge-off on Bank premises (1927), $139,299,557 for contributions to capital of the Federal Deposit Insurance 719,539,608 Corporation (1934), and $3,657 net upon elimination of sec. 13b surplus (1958); and was increased by transfer of $11,131,013 from reserves for contingencies (1945), leaving a balance of $1,873,315,298 on Dec. 31, 1986. Tables 241 .—Continued Payments to U.S. Treasury Dividends paid Franchise tax Under section 13b Interest on Federal Reserve notes Transferred to surplus (section 13b) Transferred to surplus (section 7) 41,136,551 43,488,074 46,183,719 49,139,682 52,579,643 54,609,555 57,351,487 60,182,278 63,280,312 67,193,615 3,493,570,636 3,356,559,873 3,231,267,663 4,340,680,482 5,549,999,411 5,382,064,098 5,870,463,382 5,937,148,425 7,005,779,497 9,278,576,140 32,579,700 40,403,250 50,661,000 51,178,300 51,483,200 33,827,600 53,940,050 45,727,650 47,268,200 69,141,200 70,354,516 74,573,806 79,352,304 85,151,835 92,620,451 103,028,905 109,587,968 11,706,369,955 14,023,722,907 15,204,590,947 14,228,816,297 16,054,094,674 17,796,464,292 17,803,894,710 56,820,950 76,896,650 78,320,350 106,663,100 161,995,900 155,252,950 91,954,150 2,001,987,4992 1,916,915,357 149,138,300 2,188,893 179,874,063,709 (3,657) 80,693,766 522,528,517 105,358,897 162,246,232 95,361,774 125,692,661 266,882,194 61,775,316 53,126,165 79,977,326 111,616,868 251,655,641 7,111,395 68,006,262 5,558,901 4,842,447 6,200,189 8,950,561 25,313,526 2,755,629 5,202,900 6,939,100 560,049 7,697,341 280,843 369,116 722,406 82,930 172,493 79,264 151,045 7,464 55,615 64,213 102,083 101,421 8,504,082,114 52,709,476,089 7,589,623,877 12,596,031,746 14,228,138,199 6,436,029,586 27,174,680,395 6,046,163,532 2,852,049,609 7,657,543,870 10,239,779,757 23,840,464,936 135,411 (433,412) 290,661 (9,906) (71,517) 5,491 11,682 (26,515) 64,874 (8,674) 55,337 (17,089) 71,008,025 503,257,921 100,795,722 124,548,093 107,031,258 173,526,390 266,700,754 62,894,578 65,012,063 84,793,300 161,811,628 280,607,767 1,916,915,357 149,138,300 2,188,893 179,874,063,709 (3,657) 2,001,987,499 242 Tables 10. Priced Services Revenue and Expenses 1 at Federal Reserve Banks, 1986 and 1985 Millions of dollars Service Commercial check collection Total Item Wire transfer and net settlement 1986 Net revenue Private sector adjustment 3 Net revenue after private sector adjustment 1986 1985 1986 1985 733.0 617.2 572.5 481.3 555.8 464.6 82.7 68.8 77.4 62.4 116.2 Expenses 1985 742.0 625.8 Revenue22 115.7 91.2 91.2 13.9 14.9 85.9 82.2 66.6 61.6 10.8 10.6 30.3 33.6 24.6 29.6 3.1 4.3 MEMO Net revenue after private sector adjustment, with allowance for ACH program4 1. Derived from the income and expense data shown in table 8. Expenses for priced services are based primarily on the Federal Reserve Planning and Control System, which provides for the allocation of expenses to the principal areas of activity of the Banks. 2. Total System revenue for 1986 and 1985 respectively comprises $627.7 million and $613.8 million 38.6 of income from fees for services, and $114.2 million and $119.1 million of income related to clearing balances established by depository institutions. Total System expenses for 1986 and 1985 respectively include $106.3 million and $105.6 million of earnings credits granted to depository institutions on clearing balances. Tables 243 10.—-Continued Service Definitive safekeeping and noncash collection Commercial ACH 4 Bookentry securities Cash services 1986 1985 1986 1985 1986 1985 1986 1985 36.5 31.2 27.5 29.1 24.0 21.9 25.0 23.0 9.4 6.3 28.8 20.1 16.8 16.3 18.5 18.0 5.4 (16) 2.1 2.0 3.1 8.7 .5 .5 4.1 2.5 2.5 2.3 1.6 4.8 .4 .3 1.3 (4.1) (.4) (.3) 1.5 3.9 Expenses for commercial check collection, wire transfer and net settlement, commercial ACH, bookentry securities, and definitive safekeeping and noncash collection include costs of float. 3. An imputed cost intended to reflect the taxes that would have been paid and the return on capital that would have been provided had a private firm furnished the services. 4. The Board established an incentive pricing program for the commercial ACH service that provided for fee structures designed to recover an increasing share of expenses over a period of several years. Revenue for the commercial ACtl service was expected to represent approximately 80 percent of expenses plus the private sector adjustment in 1985 and 100 percent of expenses plus the private sector adjustment in 1986. 244 Tables 11. Operations in Prmeipal Departments of Federal Reserve Banks, 1983-86 Operation 1986 Millions of pieces (except as noted) Loans (thousands) Currency received and counted Currency verified and destroyed Coin received and counted Checks handled U.S. government checks Postal money orders All other1 Issues, redemptions, and exchanges of U.S. Treasury and federal agency securities Transfer of funds2 Food stamps redeemed Millions of dollars Loans Currency received and counted Currency verified and destroyed Coin received and counted Checks handled U.S. government checks Postal money orders All otheri Issues, redemptions, and exchanges of U.S. Treasury and federal agency securities Transfer of funds2 Food stamps redeemed 1. In the REPORT for 1983 and for 1984, data in- cluded checks handled by more than one Federal Rer serve office. 1985 1984 1983 19 15,408 5,584 20,461 24 14,655 5,744 19,691 33 13,422 5,329 19,201 22 11,464 4,403 17,712 584 140 16,226 592 130 15,965 598 135 15,178 612 115 14,650 204 50 2,216 171 45 2,322 168 42 2,536 168 38 2,684 193,424 195,515 47,842 3,088 307,856 182,095 51,081 3,226 852,777 183,419 50,164 3,624 214,190 141,684 36,224 2,795 606,029 11,103 11,137,202 538,261 9,486 9,557,753 529,895 9,085 9,553,515 552,493 7,854 9,854,112 75,447,899 65,866,333 125,028,070 109,126,369 10,475 10,195 50,327,014 98,003,445 9,941 51,352,275 87,754,086 10,861 2. In the REPORT for 1983 and for 1984, data in- cluded transfers processed by both sending and receiving Federal Reserve offices. 12. Federal Reserve Bank Interest Rates, December 31, 1986 Percent per year Loans to depository institutions Bank All Federal Reserve Banks Short-term adjustment credit and seasonal credit2 51/2 1. Rates applied to short-term advances for the purpose of meeting temporary funding requirements and to longer-term advances made to smaller institutions for the purpose of meeting seasonally recurring needs for funds. A temporary simplified seasonal program was established on Mar. 8, 1985, and the interest rate was a fixed rate Yi percent above the rate on adjustment credit. The program was reestablished on Feb. 18, 1986; the rate may be either the same as that for adjustment credit or a fixed rate V2 percent higher. See sections 201.3(a) and 201.3(b)(l) of Regulation A. 2. Applicable to advances when exceptional circumstances or practices involve only a particular de- Extended credit2 First 60 days of borrowing Next 90 days of borrowing After 150 days 51/2 61/2 71/2 pository institution and to advances when an institution is under sustained liquidity pressures. As an alternative, for loans outstanding for more than 150 days, a Federal Reserve Bank may charge a flexible rate that takes into account rates on market sources of funds, but in no case will the rate charged be less than the basic rate plus one percentage point. Where credit provided to a particular depository institution is anticipated to be outstanding for an unusually prolonged period and in relatively large amounts, the time period in which each rate under this structure is applied may be shortened. See section 201.3(b)(2) of Regulation A. Tables 245 13, Reserve Requirements of Depository Institutions1 Type of deposit, and deposit interval2 Depository institution requirements after implementation of the Monetary Control Act Percent of deposits Effective date 3 12 12/30/86 12/30/86 3 0 10/6/83 10/6/83 3 11/13/80 34 Net transaction accounts $0 million-$36.7 million More than $36.7 million Nonpersonal time deposits5 By original maturity Less than IV2 years Vh years or more Eurocurrency liabilities All types 1. Reserve requirements in effect on Dec. 31,1986. Required reserves must be held in the form of deposits with Federal Reserve Banks or vault cash. Nonmembers may maintain reserve balances with a Federal Reserve Bank indirectly on a pass-through basis with certain approved institutions. For previous reserve requirements, see earlier editions of the ANNUAL REPORT and of the Federal Re- serve Bulletin. Under provisions of the Monetary Control Act, depository institutions include commercial banks, mutual savings banks, savings and loan associations, credit unions, agencies and branches of foreign banks, and Edge corporations. 2. The Garn-St Germain Depository Institutions Act of 1982 (Public Law 97-320) requires that $2 million of reservable liabilities (transaction accounts, nonpersonal time deposits, and Eurocurrency liabilities) of each depository institution be subject to a zero percent reserve requirement. The Board is to adjust the amount of reservable liabilities subject to this zero percent reserve requirement each year for the succeeding calendar year by 80 percent of the percentage increase in the total reservable liabilities of all depository institutions, measured on an annual basis as of June 30. No corresponding adjustment is to be made in the event of a decrease. On Dec. 30, 1986, the exemption was raised from $2.6 million to $2.9 million. In determining the reserve requirements of depository institutions, the exemption shall apply in the following order: (1) net NOW accounts (NOW accounts less allowable deductions); (2) net other transaction accounts; and (3) nonpersonal time deposits or Eurocurrency liabilities starting with those with the highest reserve ratio. With respect to NOW accounts and other transaction accounts, the exemption applies only to such accounts that would be subject to a 3 percent reserve requirement. 3. Transaction accounts include all deposits on which the account holder is permitted to make withdrawals by negotiable or transferable instruments, payment orders of withdrawal, and telephone and preauthorized transfers in excess of three per month for the purpose of making payments to third persons or others. However, MMDAs and similar accounts subject to the rules that permit no more than six preauthorized, automatic, or other transfers per month, of which no more than three can be checks, are not transaction accounts (such accounts are savings deposits subject to time deposit reserve requirements). 4. The Monetary Control Act of 1980 requires that the amount of transaction accounts against which the 3 percent reserve requirement applies be modified annually by 80 percent of the percentage increase in transaction accounts held by all depository institutions, determined as of June 30 each year. Effective Dec. 30, 1986, the amount was increased from $31.7 million to $36.7 million. 5. In general, nonpersonal time deposits are time deposits, including savings deposits, that are not transaction accounts and in which a beneficial interest is held by a depositor that is not a natural person. Also included are certain transferable time deposits held by natural persons and certain obligations issued to depository institution offices located outside the United States. For details, see section 204.2 of Regulation D. 246 Tables 14. Dates of Removal of Interest Rate Ceilings on Deposits at Federally Insured Institutions1 Type of deposit Effective date Savings Negotiable order of withdrawal Money market deposit account 4/1/86 1/1/86 1/1/86 Time accounts 7-31 days More than 31 days 1/1/86 10/1/83 1. All restrictions on the maximum rates of interest payable on various categories of deposits were removed over a period beginning on Dec. 14,1982, and ending on Apr. 1, 1986. For information on the maximum rates payable on specific types of accounts at various times, see the Federal Reserve Bulletin, the Federal Home Loan Bank Board Journal, and the Annual Report of the Federal Deposit Insurance Corporation. 15. Initial Margin Requirements under Regulations T, U, G, and X 1 Percent of market value Short sales, T only 2 Effective date 1934, Oct. 1 .. 1936, Feb. 1 . Apr. 1 . 1937, Nov. 1 . 1945, Feb. 5 , July 5 .. 1946, Jan. 21 . 1947, Feb. 21 1949, Mar. 3 1951, Jan. 17 1953, Feb. 20 1955, Jan. 4 ., Apr. 23 1958, Jan. 16 Aug. 5 Oct. 16 1960, July 28 1962, July 10 1963, Nov. 6 1968, Mar. 11 June 8 1970, May 6 . 1971, Dec. 6 1972, Nov. 24 1974, Jan. 3 . 25-45 25-55 55 40 50 75 100 75 50 75 50 60 70 50 70 90 70 50 70 70 80 65 55 65 50 1. These regulations, adopted by the Board of Governors pursuant to the Securities Exchange Act of 1934, limit the amount of credit to purchase and carry "margin securities" (as defined in the regulations) when such credit is collateralized by securities. Margin requirements on securities other than options are the difference between the market value (100 percent) and the maximum loan value of collateral as prescribed by the Board. Regulation T was adopted effective Oct. 15, 1934; Regulation U, effective May 1, 1936; Regulation G, effective Mar. 11, 1968; and Regulation X, effective Nov. 1, 1971. On Jan. 1, 1977, the Board of Governors for the first time established in Regulation T the initial margin required for writing options on securities, setting 50 60 50 50 50 50 50 50 75 100 75 50 75 50 60 70 50 70 90 70 50 70 70 80 65 55 65 50 it at 30 percent of the current market value of the stock underlying the option. On Sept. 30, 1985, the Board changed the required initial margin, allowing it to be the same as the option maintenance margin required by the appropriate exchange or self-regulatory organization; such maintenance margin rules must be approved by the Securities and Exchange Commission. Effective Jan. 31, 1986, the SEC approved new maintenance margin rules, permitting margins to be the price of the option plus 15 percent of the market value of the stock underlying the option. 2. From Oct. 1, 1934, to Oct. 31, 1937, the requirement was the margin "customarily required" by the brokers and dealers. Tables 247 16. Principal Assets and Liabilities and Number of Insured Commercial Banks, by Class of Bank, June 30, 1986 and 19851 Asset and liability items shown in millions of dollars Item Member banks Total Total National State Nonmember banks June 30, 1986 Loans and investments Gross loans Net loans Investments U.S. Treasury and federal agency securities Other Cash assets Deposits, total Interbank Other transaction Other nontransaction Equity capital 1,847,784 1,429,545 1,415,173 418,239 1,362,285 1,086,417 1,076,351 275,868 1,088,052 869,696 861,926 218,356 274,233 216,721 214,426 57,512 485,499 343,128 338,822 142,371 253,205 165,034 220,219 1,805,885 63,279 539,334 1,343,692 173,666 161,648 114,220 170,583 1,298,430 56,234 402,206 934,080 127,109 131,632 86,724 134,379 1,048,265 39,356 318,165 770,128 98,472 30,016 27,496 36,205 250,166 16,878 84,041 163,952 28,637 91,557 50,814 49,636 507,454 7,045 137,127 409,611 46,557 14,186 5,954 4,866 1,088 8,232 Loans and investments Gross loans Net loans Investments U.S. Treasury and federal agency securities Other Cash assets, total 1,698,882 1,313,609 1,296,823 385,273 1,237,788 990,950 979,587 246,837 987,793 791,578 782,744 196,215 249,995 199,373 196,843 50,622 461,094 322,659 317,236 138,436 252,375 132,899 203,479 158,099 88,738 158,215 127,427 68,788 121,805 30,672 19,950 36,409 94,276 44,160 45,264 Deposits Interbank Other demand Other time and savings Equity capital 1,656,573 56,252 463,744 1,252,395 160,101 1,179,123 50,598 340,487 864,651 117,454 954,143 35,210 268,786 715,332 91,721 224,980 15,388 71,701 149,319 25,733 477,450 5,654 123,257 387,744 42,648 14,367 5,979 4,910 1,069 8,388 Number of banks June 30, 1985 Number of banks 1. All insured commercial banks in the United States. Details may not add to totals because of rounding. 248 Tables Reserves of Depository Institutions, Federal Reserve Bank Credit, and Related Items—Year-End 1918-X6, and Month-End I9861 Millions of dollars Period Factors supplying reserve tunas Federal Reserve Bank credit outstanding U.S. Treasury and federal agency securities Other Held 2 Federal All under Bought repur- Loans Float other3 Reserve outTotal assets4 chase right agreement Total Gold stock5 Special drawing rights certificate account Treasury currency outstanding6 1918 1919 239 300 239 300 0 1,766 0 2,215 199 201 294 575 2,498 3,292 2,873 2,707 1,795 1,707 1920 1921 , 1922 1923 1924 287 234 436 134 540 287 234 436 80 536 0 2,687 0 1,144 0 618 14 723 4 320 119 40 78 27 52 262 146 273 355 390 3,355 1,563 1,405 1,238 1,302 2,639 3,373 3,642 3,957 4,212 1,709 1,842 1,958 2,009 2,025 1925 1926 1927 1928 1929 375 315 617 228 511 367 312 560 197 488 3 57 31 23 643 637 582 1,056 632 63 45 63 24 34 378 384 393 500 405 1,459 1,381 1,655 1,809 1,583 4,112 4,205 4,092 3,854 3,997 1,977 1,991 2,006 2,012 2,022 1930 1931 1932 1933 1934 739 817 1,855 2,437 2,430 686 775 1,851 2,435 2,430 43 42 4 2 0 251 638 235 98 7 21 20 14 15 5 372 378 41 137 21 1,373 1,853 2,145 2,688 2,463 4,306 4,173 4,226 4,036 8,238 2,027 2,035 2,204 2,303 2,511 1935 1936 1937 1938 1939 2,431 2,430 2,564 2,564 2,484 2,430 2,430 2,564 2,564 2,484 1 0 0 0 0 5 3 10 4 7 12 39 19 17 91 38 28 19 16 11 2,486 2,500 2,612 2,601 2,593 10,125 11,258 12,760 14,512 17,644 2,476 2,532 2,637 2,798 2,963 1940 1941 1942 1943 1944 2,184 2,184 2,254 2,254 6,189 6,189 11,543 11,543 18,846 18,846 0 0 0 0 0 3 3 6 5 80 94 471 681 815 10 14 10 4 2,274 2,361 6,679 12,239 19,745 21,995 22,737 22,726 21,938 20,619 3,087 3,247 3,648 4,094 4,131 1945 1946 1947 1948 1949 24,252 23,350 22,559 23,333 18,885 24,262 23,350 22,559 23,333 18,885 0 0 0 0 0 249 163 85 223 78 578 580 535 541 534 2 1 1 1 2 15,091 24,093 23,181 24,097 19,499 20,065 20,529 22,754 24,244 24,427 4,339 4,562 4,562 4,589 4,598 1950 1951 1952 1953 1954 20,778 23,801 24,697 25,916 24,932 20,725 23,605 24,034 25,318 24,888 53 196 663 598 44 67 19 156 28 143 1,368 1,184 967 935 3 5 4 2 1 22,216 25,009 25,825 26,880 25,885 22,706 22,695 23,187 22,030 21,713 4,636 4,709 4,812 4,894 4,985 1955 1956 1957 1958 1959 24,785 24,915 24,238 26,347 26,648 24,391 24,610 23,719 26,252 26,607 394 305 519 95 41 108 50 55 64 458 1,585 1,665 1,424 1,296 1,590 29 70 66 49 75 26,507 26,699 25,784 27,755 28,771 21,690 21,949 22,781 20,534 19,456 5,008 5,066 5,146 5,234 5,311 1960 1961 1962 1963 1964 27,384 28,881 30,820 33,593 37,044 26,984 30,478 28,722 33,582 36,506 400 159 342 11 538 33 130 38 63 186 1,847 2,300 2,903 2,600 2,606 74 51 110 162 94 29,338 31,362 33,871 36,418 39,930 17,767 16,889 L 978 15,513 15,388 5,398 5,585 5,567 5,578 5,405 For notes see last two pages of table. Tables 249 17.—Continued Factors absorbing reserve funds Currency in circulation Treasury cash holdings7 Deposits, other than reserves, with Federal Reserve Banks Treasury Foreign utner Other Federal Reserve accounts 4 Required clearing balances Other Federal Reserve liaWith bilities Federal and Reserve capital4 Banks Member bank reserves 8 Currency and coin9 Required10 Excess10 4,951 5,091 288 385 51 31 96 73 25 28 118 208 0 0 0 0 1,636 1,890 0 0 1,585 1,822 51 68 5,325 4,403 4,530 4,757 4,760 218 214 225 213 211 57 96 11 38 51 5 12 3 4 19 18 15 26 19 20 298 285 276 275 258 0 0 0 0 0 0 0 0 0 0 1,781 1,753 1,934 1,898 2,220 0 0 0 0 0 0 1,654 0 1,884 2,161 0 99 0 14 59 4,817 4,808 4,716 4,686 4,578 203 201 208 202 216 16 17 18 23 29 8 46 5 6 6 21 19 21 21 24 272 293 301 348 393 0 0 0 0 0 0 0 0 0 0 2,212 2,194 2,487 2,389 2,355 0 0 0 0 0 2,256 2,250 2,424 2,430 2,428 -44 -56 63 -41 -73 4,603 5,360 5,388 5,519 5,536 211 222 272 284 3,029 19 54 8 3 121 6 79 19 4 20 22 31 24 128 169 375 354 355 360 241 0 0 0 0 0 0 0 0 0 0 2,471 1,961 2,509 2,729 4,096 0 0 0 0 0 2,375 1,994 1,933 1,870 2,282 96 -33 576 859 1,814 5,882 6,543 6,550 6,856 7,598 2,566 2,376 3,619 2,706 2,409 544 244 142 923 634 29 99 172 199 397 226 160 235 242 256 253 261 263 260 251 0 0 0 0 0 0 0 0 0 0 5,587 6,606 7,027 8,724 11,653 0 0 0 0 0 2,743 4,622 5,815 5,519 6,444 2,844 1,984 1,212 3,205 5,209 8,732 11,160 15,410 20,499 25,307 2,213 2,215 2,193 2,303 2,375 368 867 799 579 440 1,133 774 793 1,360 1,204 599 586 485 356 394 284 291 256 339 402 0 0 0 0 0 0 0 0 0 0 4,026 12,450 13,117 12,886 14,373 0 0 0 0 0 7,411 9,365 11,129 11,650 12,748 6,615 3,085 1,988 1,236 1,625 28,515 28,952 28,868 28,224 27,600 2,287 2,272 1,336 1,325 1,312 977 393 870 1,123 821 862 508 392 642 767 446 314 569 547 750 495 607 563 590 106 0 0 0 0 0 0 0 0 0 0 15,915 16,139 17,899 20,479 16,568 0 0 0 0 0 14,457 15,577 16,400 19,277 15,550 1,458 562 1,499 1,202 1,018 27,741 29,206 30,433 30,781 30,509 1,293 1,270 1,270 761 796 668 247 389 346 563 895 526 550 423 490 565 363 455 493 441 714 746 111 839 907 0 0 0 0 0 0 0 0 0 0 17,681 20,056 19,950 20,160 18,876 0 0 0 0 0 16,509 19,667 20,520 19,397 18,618 1,172 389 -570 763 258 31,158 31,790 31,834 32,193 32,591 767 775 761 683 391 394 441 481 358 504 402 322 356 272 345 554 426 246 391 694 925 901 998 1,122 841 0 0 0 0 0 0 0 0 0 0 19,005 19,059 19,034 18,504 18,174 0 0 0 0 310 18,903 19,089 19,091 18,574 18,619 102 -30 -57 -70 -135 32,869 33,918 35,338 37,692 39,619 377 422 380 361 612 485 465 597 880 820 217 279 247 171 229 533 320 393 291 321 941 1,044 1,007 1,065 1,036 0 0 0 0 0 0 0 0 0 0 17,081 17,387 17,454 17,049 18,086 2,544 2,544 3,262 4,099 4,151 18,988 18,988 20,071 20,677 21,663 637 96 645 471 574 250 Tables 17. Reserves of Depository Institutions, Federal Reserve Bank Credit, and Related Items—Year-End 1918-86, and Month-End 1986'—Continued Millions of dollars Factors supplying reserve funds Period Federal Reserve Bank credit outstanding U.S. Treasury and federal agency securities11 Other Held All Federal 2 under Bought repur- Loans Float other3 Reserve outTotal assets4 chase right12 agreement Total Gold stock5 SpeTreacial sury drawcurig n rights rency certif- outicate standing6 account 5,575 6,317 6,784 6 795 6,852 1965 1966 1967 1968 1969 40,768 44,316 49,150 52,937 57,154 40,478 43,655 48,980 52,9373 57,154 290 661 170 0 0 137 173 141 186 183 2,248 2,495 2,576 3,443 3,440 187 193 164 58 64 0 43,340 13,733 0 47,177 13,159 o 52,031 11,982 0 56 624 10 367 2,743 64,584 10,367 1970 1971 1972 1973 1974 62,142 70,804 71,230 80,495 85,714 62,142 69,481 71,119 80,395 84,760 o 1,323 111 100 954 335 39 1,981 1,258 299 4,261 4,343 3,974 3,099 2,001 57 261 106 68 999 1,123 1,068 1,260 1,152 3,195 67,918 76,515 78,551 86,072 92,208 10,732 10 132 10,410 11,567 11,652 400 400 400 400 400 7,147 7710 8,313 8,716 9,253 1975 1976 1977 1978 1979 94,124 104,093 111,274 118,591 126,167 92,789 100,062 108,922 117,374 124,507 1,335 4,031 2,352 1,217 1,660 211 25 265 1,174 1,454 3,688 2,601 3,810 6,432 6,767 1,126 991 954 587 704 3,312 3,182 2,442 4,543 5,613 102,461 110,892 118,745 131,327 140,705 11,599 11,598 11,718 11,671 11,172 500 1,200 1,250 1 300 1,800 10,218 10,810 11,331 11 831 13,083 1980 1981 1982 1983 1984 1985 1986 130,592 140 348 148,837 160,795 169,627 191,248 221,459 128,038 2,554 136,863 3,485 144,544 4,293 159,203 1,592 167,612 2 015 186,025 5,223 205,454 16,005 1,809 1,601 717 918 3,577 3,060 1,565 4,467 1,762 2,735 1,605 833 988 1,261 776 195 1,480 418 0 0 0 8,739 9,230 9,890 8,728 12,347 15,302 17,475 146,383 153,136 63,659 172,464 186,384 210,598 241,760 11,160 11,151 11,148 11,121 11,096 11,090 11,084 2,518 3 318 4,618 4,618 4 618 4,718 5,018 13,427 13 687 13,786 15,732 16 418 17,075 17,567 1986 187,842 Jan 184,723 Feb Mar. . . 184,807 . Apr. . . 191,454 . 190,129 May 191,986 June July . . 191,583 .. Aug. . . 193,984 . Sept. . . 200,607 . 197,949 Oct Nov. . . 204,470 . Dec. . . 221,459 . 184,132 3,710 0 184,723 0 184,807 182,499 8,955 0 190,129 0 191,986 0 191,583 0 193,984 192,484 8,123 0 197,949 202,705 1,765 205,454 16,005 827 661 818 954 850 952 737 913 879 806 557 1,565 663 -212 560 851 132 283 831 261 849 441 748 1,261 0 0 0 0 0 0 0 0 0 0 0 0 15,814 15,301 15,635 17,235 15,326 15,800 16,515 16,547 17,023 16,797 15,898 17,475 205,146 200,473 201,820 210,494 206,437 209,021 209,666 211,705 219,358 215,993 221,673 241,760 11,090 11,090 11,090 11,090 11,085 11,084 11,084 11,084 11,084 11,084 11,084 11,084 4,718 4,718 4,718 4,718 4,818 4,818 4,818 5,018 5,018 5,018 5,018 5,018 17,103 17,154 17,207 17,252 17,296 17,330 17,353 17,394 17,438 17,477 17,517 17,567 1. For a description of figures and discussion of their significance, see Banking and Monetary Statistics, 1941-1970 (Board of Governors of the Federal Reserve System, 1976), pp. 507-23. 2. Beginning with 1960, figures reflect a minor change in concept; see Federal Reserve Bulletin, vol. 47 (February 1961), p. 164. 3. Principally acceptances and, until Aug. 21, 1959, industrial loans, authority for which expired on that date. 4. For the period before Apr. 16, 1969, includes the total of Federal Reserve capital paid in, surplus, other capital accounts, and other liabilities and accrued dividends, less the sum of bank premises and other assets, and was reported as "Other Federal Reserve accounts"; thereafter, "Other Federal Reserve assets" and "Other Federal Reserve liabilities and capital" are shown separately. 5. For the period before Jan. 30, 1934, includes gold held in Federal Reserve Banks and in circulation. 6. Includes currency and coin (other than gold) issued directly by the Treasury. The largest components are fractional and dollar coins. For details see "Currency and Coin in Circulation," Treasury Bulletin. 7. Coin and paper currency held by the Treasury, as well as any gold in excess of the gold certificates issued to the Reserve Bank. 8. Beginning in November 1979, includes reserves of member banks, Edge corporations, and U.S. agencies and branches of foreign banks. Beginning on Nov. 13, 1980, includes reserves of all depository institutions. 9. Between Dec. 1, 1959, and Nov. 23, 1960, part was allowed as reserves; thereafter all was allowed. 10. Estimated through 1958. Before 1929 data were available only on call dates (in 1920 and 1922 the call dates were Dec. 29). Beginning on Sept. 12, 1968, the amount is based on close-of-business figures for Tables 251 Factors absorbing reserve funds Currency in culation Treasury cash holdings7 Deposits, other than reserves, with Federa Reserve Banks Treasury Foreign Other Federal Reserve liaWith bilities Federal and Reserve capital 5 Banks Member bank reserves 8 Other Other Federal Reserve accounts 4 Required clearing balances 211 -147 -773 -1,353 0 0 0 0 0 0 0 0 0 0 0 18,447 19,779 21,092 21,818 22,085 4,163 4,310 4,631 4,921 5,187 22,848 24,321 25,905 27,439 28,173 30,033 -460 32,496 1,035 32,044 98 13 35,268 - 1 , 3 6 0 37,011 - 3 , 7 9 8 Currency and coin 9 ExRequired 10 cess 10 ' 13 42,056 44,663 47,226 50,961 53,950 760 1,176 1,344 695 596 668 416 1,123 703 1,312 150 174 135 216 134 355 588 563 747 807 57,903 61,068 66,516 72,497 79,743 431 460 345 317 185 1,156 2,020 1,855 2,542 2,113 148 294 325 251 418 1,233 999 840 1,41914 1,27514 0 0 0 0 0 0 0 0 0 0 1,986 2,131 2,143 2,669 2,935 24,150 27,788 25,647 27,060 25,843 5,423 5,743 6,216 6,781 7,370 86,547 93,717 103,811 114,645 125,600 483 460 392 240 494 7,285 10,393 7,114 4,196 4,075 353 352 379 368 429 1,090 1,357 1,187 1,256 1,412 0 0 0 0 0 0 0 0 0 0 2,968 3,063 3,292 4,275 4,957 26,052 25,158 26,870 31,152 29,792 8,036 8,628 9,421 10,538 11,429 35,197 35,461 37,615 42,694 44,217 136,829 144,774 154,908 171,935 183,796 197,488 211,995 441 443 429 479 513 550 447 3,062 4,301 5,033 3,661 5,316 9,351 7,588 411 505 328 191 253 480 287 617 781 1,033 851 867 1,041 917 0 0 0 0 0 0 0 0 111 436 1,013 1,126 1,490 1,812 4,671 5,261 4,990 5,392 5,952 5,940 6,088 27,456 25,111 26,053 20,413 20,693 27,141 46,295 13,654 15,576 16,666 17,821 n.a. n.a. n.a. 675 40,558 42,145 - 1 , 4 4 2 41,391 1,328 39,179 -945 n.a. n.a. n.a. n.a. n.a. n.a. 190,430 191,033 193,209 194,503 197,812 199,281 200,552 201,778 200,630 202,506 206,878 211,995 565 604 617 638 631 601 532 497 492 485 459 447 16,228 5,026 3,280 11,550 3,083 3,143 3,983 1,106 7,514 2,491 2,529 7,588 256 277 274 326 254 354 233 227 342 303 225 287 477 436 511 441 417 450 688 461 663 479 425 917 0 0 0 0 0 0 0 0 0 0 0 0 1,164 1,226 1,542 1,590 1,582 1,593 1,631 1,169 1,681 1,744 1,802 1,812 6,622 6,735 6,162 6,680 6,110 6,484 6,658 6,652 6,463 6,342 6,480 6,088 22,316 28,098 29,240 27,826 29,747 30,347 28,644 32,901 35,113 35,222 36,494 46,295 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. the reserve period two weeks before the report date. 11. Beginning on Dec. 1, 1966, includes federal agency obligations held under repurchase agreements and beginning on Sept. 29,1971, federal agency issues bought outright. 12. Includes, beginning in 1969, securities loaned— fully guaranteed by U.S. government securities pledged with Federal Reserve Banks—and excludes securities sold and scheduled to be bought back under matched sale-purchase transactions. 13. Beginning with week ending Nov. 15, 1972, includes $450 million of reserve deficiencies on which Federal Reserve Banks are allowed to waive penalties for a transition period in connection with bank adaptation to Regulation J as amended, effective Nov. 9, 1972. Allowable deficiencies are as follows (beginning with first statement week of quarter, in millions): 1973—Ql, $279; Q2, $172; Q3, $112; Q4, $84; 1974— Q l , $67; Q2, $58. The transition period ended with n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. -238 -232 -182 -700 -901 -l,10315 -1,535 -1,265 -893 -2,835 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. the second quarter of 1974. 14. For the period before July 1973, includes certain deposits of domestic nonmember banks and foreign-owned banking institutions held with member banks and redeposited in full with Federal Reserve Banks in connection with voluntary participation by nonmember institutions in the Federal Reserve System program of credit restraint. As of Dec. 12, 1974, the amount of voluntary nonmember bank and foreign-agency and branch deposits at Federal Reserve Banks that are associated with marginal reserves are no longer reported. However, two amounts are reported: (1) deposits voluntarily held as reserves by agencies and branches of foreign banks operating in the United States and (2) Eurodollar liabilities. 15. Adjusted to include waivers of penalties for reserve deficiencies, in accordance with change in Board policy effective Nov. 19, 1975. 252 Tables 18. Changes in N u m b e r of Banking Offices in the United States, 19861 Commercial banks (including stock savings banks and nondeposit trust companies) Type of office and change All banks Member Total Banks, Dec. 31, 1985. Changes during 1986 New banks Ceased banking operation Banks converted into branches Other 3 Net change Banks, Dec. 31, 1986 . Total National State Insured 15,068 6,050 4,967 1,083 8,392 6262 358 16 307 -148 304 -148 154 -56 105 -46 49 -10 90 -78 60 -14 3 0 0 0 -305 -300 -133 -111 -88 -76 -23 -33 -22 10 -167 -4 0 -49 -3 1 -2 -13 -234 -220 -58 -85 15,208 14,848 5,992 4,882 43,092 27,595 22,661 27 -159 -3 1 -15 1,110 8,233 623 359 1 88 2,219 41 4,934 15,409 1,226 305 -615 0 4 1,098 300 -601 19 9 646 133 -411 16 419 490 111 -342 -8 307 156 22 -69 24 112 448 167 -190 3 -405 920 825 803 558 245 Branches and additional offices, Dec. 31, 1986 4 .... 46,272 43,917 28,398 23,219 5,179 Other3 Net change 1. Preliminary. Final data will be available in the Annual Statistical Digest, 1986, forthcoming. 2. As of Dec. 31, 1986, includes 14 noninsured state member banks and 2 noninsured national trust companies. NonNoninsured Insured insured 15,442 Branches and additional offices, Dec. 31, 1985 4 ... 45,352 Changes during 1986 De novo Banks converted Discontinued Sale of branch Nonmember Mutual savings banks 4 0 0 0 -5 128 3 -14 -19 33 0 2 0 0 -38 23 -1 131 -36 15,432 87 2,350 3. Includes interclass changes. 4. Excludes banking facilities. Tables 253 19. Mergers, Consolidations, and Acquisitions of Assets or Assumptions of Liabilities Approved by the Board of Governors, 1986 Colonial Bank, Montgomery, Alabama, to merge with Luverne Bank and Trust Company, Luverne, Alabama SUMMARY REPORT BY THE ATTORNEY GENERAL The banking factors and considerations relating to the convenience and needs of the community are consistent with approval. (12/6/85) The proposed transaction would not be significantly adverse to competition. Norstar Bank of Upstate New York, Albany, New York, to acquire six branches of The Bank of New York, New York, New York BASIS FOR APPROVAL BY THE FEDERAL RESERVE BANK (1/8/86) SUMMARY REPORT BY THE ATTORNEY GENERAL Colonial Bank (Applicant) has assets of $102 million, and Luverne Bank and Trust Company (Bank) has assets of $31 million. Applicant and Bank are not located in the same market, and the proposal would have no significant effect on competition. The banking factors and considerations relating to the convenience and needs of the community are consistent with approval. The Suburban Bank, Richmond, Virginia, to merge with Virginia Capital Bank, Richmond, Virginia SUMMARY REPORT BY THE ATTORNEY GENERAL (2/6/86) The proposed transaction would not have a significantly adverse effect on competition. BASIS FOR APPROVAL BY THE FEDERAL RESERVE BANK (2/5/86) The Suburban Bank (Applicant) has assets of $13.2 million, and Virginia Capital Bank has assets of $23.4 million. Although Applicant and Bank compete in the Richmond banking market, the proposal would have no significant effect on competition. The resulting bank's pro forma market share would be only 0.5 percent. The banking factors and considerations relating to the convenience and needs of the community are consistent with approval. Shelby County State Bank, Shelbyville, Illinois, to merge with Windsor State Bank, Windsor, Illinois SUMMARY REPORT BY THE ATTORNEY GENERAL (10/10/86) The proposed transaction would not have a significantly adverse effect on competition. BASIS FOR APPROVAL BY THE FEDERAL RESERVE BANK (3/4/86) Shelby County State Bank (Applicant) has assets of $52.6 million, and Windsor State Bank (Bank) has assets of $11.5 million. Applicant and Bank are not in the same banking market. Thus, no adverse competitive factors exist. (1/24/86) The proposed transaction would not be significantly adverse to competition. BASIS FOR APPROVAL BY THE FEDERAL RESERVE BANK (3/18/86) Norstar Bank of Upstate New York (Applicant) has assets of $2.7 billion, and six branches of The Bank of New York (Branches) have assets of $220 million. Applicant and Branches are both located in the Syracuse market; however, the Herfindahl-Hirschman index will increase only 18 points to 1850, and thus no adverse competitive factors exist. The banking factors and considerations relating to the convenience and needs of the community are consistent with approval. City Bank and Trust Company, Moberly, Missouri, to acquire certain assets and insured deposits of Farmers and Merchants Bank of Huntsville, Huntsville, Missouri SUMMARY REPORT BY THE ATTORNEY GENERAL No report received. Request for report on the competitive factors was dispensed with, as authorized by the Bank Merger Act, to permit the Federal Reserve System to act immediately to safeguard depositors of Farmers and Merchants Bank. BASIS FOR APPROVAL BY THE FEDERAL RESERVE BANK (3/31/86) City Bank and Trust Company (Applicant) has assets of $108.2 million, and Farmers and Merchants Bank of Huntsville (Bank) has assets of $18.8 million. The FDIC has recommended immediate action by the Federal Reserve System to prevent the probable failure of Bank. American Trust and Savings Bank, Dubuque, Iowa, to acquire certain assets and liabilities of The National Bank, Dyers ville, Iowa SUMMARY REPORT BY THE ATTORNEY GENERAL No report received. Request for report on the competitive factors was dispensed with, as authorized by the Bank Merger Act, to per- 254 Tables 19. Mergers, Consolidations, and Acquisitions of Assets or Assumptions of Liabilities Approved by the Board of Governors, 1986—Continued mit the Federal Reserve System to act immediately to safeguard depositors of The National Bank. BASIS FOR APPROVAL BY THE FEDERAL RESERVE BANK (4/10/86) American Trust and Savings Bank (Applicant) has assets of $246 million, and The National Bank (Bank) has assets of $41.6 million. The Comptroller of the Currency has recommended immediate action by the Federal Reserve System to ensure continuation of Bank's services. Georgia Railroad Bank & Trust Company, Augusta, Georgia, to merge with Bank of Waynesboro, Waynesboro, Georgia SUMMARY REPORT BY THE ATTORNEY GENERAL (4/16/86) The proposed transaction would not be significantly adverse to competition. BASIS FOR APPROVAL BY THE FEDERAL RESERVE BANK (4/22/86) Georgia Railroad Bank & Trust Company (Applicant) has assets of $753.6 million, and Bank of Waynesboro (Bank) has assets of $43.4 million. Applicant and Bank operate in separate banking markets. The banking factors and considerations relating to the convenience and needs of the community are consistent with approval. Norstar Bank of Upstate New York, Albany, New York, to assume the assets and liabilities of the Greenwich branch of Chemical Bank, New York, New York SUMMARY REPORT BY THE ATTORNEY GENERAL (4/25/86) The proposed transaction would not be significantly adverse to competition. BASIS FOR APPROVAL BY THE FEDERAL RESERVE BANK (4/25/86) Norstar Bank of Upstate New York (Applicant), with assets of $2.7 billion, proposes to assume $11.7 million in assets and $11.6 million in liabilities of the Greenwich branch of Chemical Bank (Bank). Applicant and Bank operate in the Glen Falls banking market. On a pro forma basis, Applicant will control 12.3 percent of the commercial banking deposits in the market. The Herfindahl-Hirschman index will increase only 47 points. Consummation of the proposal would have no significant effect on competition. The banking factors and considerations relating to the convenience and needs of the community are consistent with approval. Manufacturers Hanover Trust Company, New York, New York to acquire certain assets and assume certain liabilities of six branches of Dollar Dry Dock Savings Bank, White Plains, New York SUMMARY REPORT BY THE ATTORNEY GENERAL (3/28/86) The proposed transaction would not be significantly adverse to competition. BASIS FOR APPROVAL BY THE FEDERAL RESERVE BANK (5/8/86) Manufacturers Hanover Trust Company (Applicant), with assets of $62.3 billion, proposes to acquire $333 million in assets and assume $354 million in liabilities of six branches of Dollar Dry Dock Savings Bank (Branches). Both Applicant and Branches are located in the metropolitan New York banking market. Applicant is ranked third in the market, with 8.1 percent of market deposits. On a pro forma basis, Applicant's market share will increase to 8.3 percent, and Applicant will remain the third largest banking organization in the market. The banking factors and considerations relating to the convenience and needs of the community are consistent with approval. First Community Bank, Inc., Princeton, West Virginia, to merge with First Community BankCastle Rock, Pineville, West Virginia SUMMARY REPORT BY THE ATTORNEY GENERAL (5/2/86) The proposed transaction would not be significantly adverse to competition. BASIS FOR APPROVAL BY THE FEDERAL RESERVE BANK (5/23/86) First Community Bank, Inc. (Applicant) has assets of $136 million, and First Community Bank-Castle Rock (Bank) has assets of $56 million. Applicant and Bank are not located in the same market, and the proposal would have no significant effect on competition. The banking factors and considerations relating to the convenience and needs of the community are consistent with approval. Tables 255 Indiana Southern Bank, Sellersburg, Indiana, to acquire United Bank of Indiana, N.A., Clarksville, Indiana Ireland Bank, Malad City, Idaho, to acquire all the assets and liabilities of Downey State Bank, Downey, Idaho SUMMARY REPORT BY THE ATTORNEY GENERAL SUMMARY REPORT BY THE ATTORNEY GENERAL (5/2/86) The proposed transaction would not be significantly adverse to competition. (7/7/86) No existing competition of significance will be eliminated by the proposed transaction. BASIS FOR APPROVAL BY THE FEDERAL RESERVE BANK (6/26/86) BASIS FOR APPROVAL BY THE FEDERAL RESERVE BANK (8/15/86) Indiana Southern Bank (Applicant) has assets of $82.4 million, and United Bank of Indiana, N.A. (Bank), has assets of $38 million. Applicant and Bank operate in the Louisville banking market, and each controls less than 2 percent of the commercial banking deposits in the market. Although Applicant, combined with other commercial banking deposits controlled by its parent holding company, would control slightly more than 30 percent of the market deposits, thrift institutions offer substantial competition to commercial banks. No significant adverse competitive effects arise from the transaction. The banking factors and considerations relating to the convenience and needs of the community are consistent with approval. Ireland Bank (Applicant) has assets of $25.2 million, and Downey State Bank (Bank) has assets of $18.1 million. The Director of the Idaho Department of Finance has recommended immediate action by the Federal Reserve System to prevent the probable failure of Bank. The banking factors and considerations relating to the convenience and needs of the community are consistent with approval. Norstar Bank of Upstate New York, Albany, New York, to purchase assets and assume liabilities of three branches of Citibank (New York State), N.A., Buffalo, New York SUMMARY REPORT BY THE ATTORNEY GENERAL (9/12/86) The proposed transaction would not have a significantly adverse effect on competition. The Bank of New York, New York, New York, to acquire certain assets and assume certain liabilities of three branches of The Home Savings Bank, Brooklyn, New York SUMMARY REPORT BY THE ATTORNEY GENERAL (5/2/86) The proposed transaction will not have a significantly adverse effect on competition. BASIS FOR APPROVAL BY THE FEDERAL RESERVE BANK (7/2/86) The Bank of New York (Applicant), with assets of $17.2 billion, proposes to acquire assets of $1.4 million and liabilities of $79 million of three branches of The Home Savings Bank (Branches). Applicant and Branches operate in the metropolitan New York-New Jersey banking market. The pro forma market share is 2.4 percent. The proposal would have no significant effect on competition. The banking factors and considerations relating to the convenience and needs of the community are consistent with approval. BASIS FOR APPROVAL BY THE FEDERAL RESERVE BANK (10/1/86) Norstar Bank of Upstate New York (Applicant), with assets of $2.7 billion, proposes to purchase assets of $1 million and assume liabilities of $42 million of three branches of Citibank (New York State), N.A., in the Albany banking market. Applicant's resulting increase in market share in the Albany area is well within Justice Department and Board guidelines. The banking factors and considerations relating to the convenience and needs of the community are consistent with approval. Security Savings Bank, Mars hall town, Iowa, to acquire certain assets and liabilities of The First National Bank of Prairie City, Prairie City, Iowa SUMMARY REPORT BY THE ATTORNEY GENERAL No report received. Request for report on the competitive factors was dispensed with, as authorized by the Bank Merger Act, to permit 256 Tables 19. Mergers, Consolidations, and Acquisitions of Assets or Assumptions of Liabilities Approved by the Board of Governors, 1986—Continued the Federal Reserve System to act immediately to safeguard depositors of The First National Bank of Prairie City. million in assets from the Hialeah branch of Popular Bank of Florida (Bank), with total banking assets of $71.2 million. Both Applicant BASIS FOR APPROVAL BY THE FEDERAL RESERVE and Bank are in the Miami-Fort Lauderdale banking market. As a result of this acquisition, BANK (7/24/86) Security Savings Bank (Applicant) has assets the Herfindahl-Hirschman index will remain of $163.3 million, and The First National Bank unchanged at 909. Thus, no significant adverse of Prairie City (Bank) has assets of $8.7 mil- competitive effects exist. The banking factors and considerations relion. The Comptroller of the Currency has re- lating to the convenience and needs of the comquested immediate action by the Federal Re- munity are consistent with approval. serve System to ensure continuation of Bank's Norstar Bank of Upstate New York, Albany, services. Banco de Ponce, Ponce, Puerto Rico, to acquire certain assets and assume certain liabilities of two branches of The East New York Savings Bank, New York, New York SUMMARY REPORT BY THE ATTORNEY GENERAL (9/26/86) The proposed transaction would not have a significantly adverse effect on competition. BASIS FOR APPROVAL BY THE FEDERAL RESERVE BANK (10/10/86) Banco de Ponce (Applicant), with assets of $2.3 billion, proposes to acquire certain assets and assume certain liabilities of two branches of The East New York Savings Bank (Bank), with assets of $1.4 billion. Both Applicant and Bank are in the metropolitan New York-New Jersey banking market. As a result of this acquisition, Applicant's market share of 0.1 percent will remain unchanged. Consummation would result in no significant adverse competitive effects. The banking factors and considerations relating to the convenience and needs of the community are consistent with approval. Imperial Bank of Florida, Coral Gables, Florida, to acquire certain assets and assume certain liabilities of the Hialeah branch of Popular Bank of Florida, Miami, Florida SUMMARY REPORT BY THE ATTORNEY GENERAL (7/25/86) The proposed transaction would not have a significantly adverse effect on competition. BASIS FOR APPROVAL BY THE FEDERAL RESERVE BANK (10/14/86) Imperial Bank of Florida (Applicant), with assets of $18.0 million, proposes to acquire $12.5 New York, to merge with Seaway National Bank, Watertown, New York SUMMARY REPORT BY THE ATTORNEY GENERAL (9/12/86) The proposed transaction would not have a significantly adverse effect on competition. BASIS FOR APPROVAL BY THE FEDERAL RESERVE BANK (11/14/86) Norstar Bank of Upstate New York (Applicant) has assets of $3.2 billion, and Seaway National Bank (Bank) has assets of $25.8 million. Applicant does not currently operate in Bank's market, and no issues are raised with respect to competition. Thus, the proposed transaction would have no adverse competitive effects. The banking factors and considerations relating to the convenience and needs of the community are consistent with approval. United Virginia Bank, Richmond, Virginia, to merge with People's Bank of Chesapeake, Chesapeake, Virginia SUMMARY REPORT BY THE ATTORNEY GENERAL (10/17/86) The proposed transaction would not have a significantly adverse effect on competition. BASIS FOR APPROVAL BY THE FEDERAL RESERVE BANK (11/3/86) United Virginia Bank (Applicant) has assets of $6.9 billion, and People's Bank of Chesapeake (Bank) has assets of $80 million. Applicant and Bank compete in the areas of Norfolk-Portsmouth, Virginia, and Currituck County, North Carolina, with Applicant ranked second and Bank ranked eighth among 16 banks in the market. Applicant would remain the second largest bank in the market with 16.7 percent of commercial banking deposits. Tables 257 The banking factors and considerations relating to the convenience and needs of the community are consistent with approval. First Interstate Bank of California, Los Angeles, California, to acquire the assets and assume the liabilities of First National Bank, Willows, California SUMMARY REPORT BY THE ATTORNEY GENERAL No report received. Request for report on the competitive factors was dispensed with, as authorized by the Bank Merger Act, to permit the Federal Reserve System to act immediately to safeguard depositors of First National Bank. BASIS FOR APPROVAL BY THE BOARD (11/21/86) First Interstate Bank of California (Applicant) has assets of $20.6 billion, and First National Bank (Bank) has assets of $65 million. The Comptroller of the Currency has recommended immediate action by the Federal Reserve System to ensure continuation of Bank's First Virginia Bank-Citizens, Clintwood, Virginia, to merge with Peoples Bank of Pound, Pound, Virginia SUMMARY REPORT BY THE ATTORNEY GENERAL (11/21/86) The proposed transaction would not be significantly adverse to competition. BASIS FOR APPROVAL BY THE FEDERAL RESERVE BANK (11/28/86) First Virginia Bank-Citizens (Applicant) has assets of $28.7 million, and Peoples Bank of Pound (Bank) has assets of $45.9 million. Applicant and Bank are not located in the same market, and the proposal would have no significant effect on competition. The banking factors and considerations relating to the convenience and needs of the community are consistent with approval. Security Bank, Marshalltown, Iowa, to purchase the assets and liabilities o/Hawkeye Bank & Trust, Eldora, Iowa SUMMARY REPORT BY THE ATTORNEY GENERAL (11/21/86) The proposed transaction would not be significantly adverse to competition. BASIS FOR APPROVAL BY THE FEDERAL RESERVE BANK (12/30/86) Security Bank (Applicant) has assets of $188 million, and Hawkeye Bank & Trust (Bank) has assets of $16.5 million. Applicant and Bank are not located in the same market, and the proposal would have no significant effect on competition. The banking factors and considerations relating to the convenience and needs of the community are consistent with approval. Mergers Approved Involving Wholly Owned Subsidiaries of the Same Bank Holding Company In each of the following cases, the summary report by the attorney general indicates that the transaction would not have a significantly adverse effect on competition because the proposed merger is essentially a corporate reorganization. The Board of Governors, the Federal Reserve Bank, or the Secretary of the Board of Governors, whichever approved the application, determined that the competitive effects of the proposed transaction, the financial and managerial resources and the prospects of the banks concerned, and the convenience and needs of the community to be served were consistent with approval. Institution1 Commerce Union Merger Commerce Union Tennessee Commerce Union Tennessee Commerce Union Tennessee Assets (millions of Bank, Nashville, Tennessee 1,956 dollars) Bank of Humphreys County, Waverly, 48 Bank of Rutherford County, Murfreesboro 118 Bank of Sumner County, Gallatin, 79 Date of approval 3/7/86 258 Tables 19. Mergers, Consolidations, and Acquisitions of Ass;^ts or Assumptions of Liabilities Approved by the Board of Governors. 1986—Continued Institution1 The Toledo Trust Company Three Sea Gate, Toledo, Ohio... Merger First Buckeye Bank, N.A., Mansfield, Ohio Assets (millions of dollars) Date of approval 2,184 3/25/86 833 The Merrill Trust Company, Bangor, Maine. Merger Merrill Bank, N.A., Farmington, Maine 665 The Central Trust Company, Newark, Ohio Merger The Clear Creek Valley Banking Company, Amanda, Ohio .. 367 Security Bank & Trust Company, Southgate, Michigan Merger Security Bank & Trust Company of Oakland County, Novi, Michigan State Bank of Carthage, Carthage, Indiana Merger The First National Bank of Mays, Mays, Indiana 108 5/27/86 15 1,100 6/19/86 50 11 6/23/86 9 Ohio Citizens Bank, Toledo, Ohio Merger The Citizens National Bank, Bryan, Ohio. 773 First Source Bank, South Bend, Indiana Merger Community State Bank, North Liberty, Indiana. 827 7/8/86 134 8/15/86 19.7 Rocky Mountain State Bank, Salt Lake City, Utah Merger Rocky Mountain State Bank of Bountiful, Bountiful, Utah .. 15 Mercantile Bank & Trust Company, Kansas City, Missouri.. Merger Noland Road Mercantile Bank, Independence, Missouri Mercantile Regional Bank, Kansas City, Missouri Mercantile National Bank of Clay County, Kansas City, Missouri 237 Old Kent Bank of Kalamazoo, Kalamazoo, Michigan Merger The American National Bank in Portage, Portage, Michigan The American National Bank & Trust Company of Michigan, Kalamazoo, Michigan 28 Old Kent Bank-Southwest, Niles, Michigan Merger The American Bank of Niles, N.A., Niles, Michigan. 3/31/86 8/29/86 13 9/25/86 138 164 31 10/1/86 33 420 258 25 10/2/86 Tables 259 Assets (millions of dollars) Institution1 Norstar Bank, Rochester, New York Merger Norstar Bank of Upstate New York, Albany, New York . Date of approval 1,682 10/10/86 1,043 Hawkeye-Capital Bank & Trust Company, Des Moines, Iowa. Merger Hawkeye Bank and Trust of Des Moines, Des Moines, Iowa... 107 Silicon Valley Bank, San Jose, California Merger National Intercity Bank, Santa Clara, California . 101 Commerce Union Bank, Nashville, Tennessee Merger Commerce Union Bank of Lawrence County, Lawrenceburg, Tennessee 61 10/31/86 54 1,956 11/18/86 64 Security Bank of Richmond, Richmond, Michigan. Merger Security Bank Imlay City, Imlay City, Michigan ... 83 First Virginia-Commonwealth, Grafton, Virginia. Merger First Virginia Bank-Surry, Surry, Virginia 37 The Merchants Bank, Kansas City, Missouri. Merger The Bank of Kansas City, Kansas City Westport Bank, Kansas City, Missouri 10/16/86 11/25/86 40 12/1/86 17 963 12/15/86 114 84 1. Each proposed transaction was to be effected under the charter of the first-named bank. The entries are in chronological order of approval, Mergers Approved Involving a Nonoperating Institution with an Existing Bank to the acquisition of the surviving bank by the holding company, the merger would have no effect on competition. The Board of Governors, the Federal Reserve Bank, or the Secretary of the Board of Governors, whichever approved the application, determined that the proposal would, in itself, have no adverse competitive effects, and that the financial factors and considerations relating to the convenience and needs of the community were consistent with approval. The following transactions have no significant effect on competition; they merely facilitate the acquisition of the voting shares of a bank or banks by a holding company. In such cases the summary report by the attorney general indicates that the transaction will merely combine an existing bank with a nonoperating institution; in consequence, and without regard Institution1 Shelbyville Interim Bank Merger Shelby County State Bank, Shelbyville, Illinois. Assets (millions 2 of dollars) Date of approval 3/4/86 50 260 Tables 19. Mergers, Consolidations, and Acquisitions of Assets or Assumptions of Liabilities Approved by the Board of Governors, 1986—Continued Institution1 B.N.S. Bank, Northbrook, Illinois Merger Bank of the North Shore, Northbrook, Illinois . The New Waterford Interim Bank, New Waterford, Ohio Merger The New Waterford Bank, New Waterford, Ohio The Bel Air Bank, Bel Air, Maryland . Merger Commercial Bank, Bel Air, Maryland . PCB Company, Hurricane, West Virginia Merger Putnam County Bank, Hurricane, West Virginia. New First Union Bank and Trust Company, Medaryville, Indiana Merger First Union Bank and Trust Company, Winamac, Indiana FIBC Service Bank III, Howe, Indiana. Merger State Bank of Lima, Howe, Indiana Central Virginia Bank, Powhatan, Virginia Merger Community Bank of Powhatan, Powhatan, Virginia. Barbour Interim Bank, Philippi, West Virginia. Merger Barbour County Bank, Philippi, West Virginia. Beach Bank, Seabrook, New Hampshire Merger Seabrook Bank & Trust Company, Seabrook, New Hampshire Lake view Interim Bank, Lake view, Michigan. Merger Bank of Lake view, Lake view, Michigan New Lowell State Bank, Lowell, Michigan. Merger State Savings Bank, Lowell, Michigan Traders Interim Bank, Spencer, West Virginia . Merger Trader Bank, Spencer, West Virginia Assets (millions 2 of dollars) Date of approval 3/11/86 32 3/27/86 46 4/21/86 122 6/5/86 128 6/19/86 476 8/5/86 31 8/28/86 31 9/15/86 36 9/26/86 44 10/29/86 50 11/25/86 67 11/26/86 63 Tables 261 19. — Continued Assets (millions 2 of dollars) Institution The Lunenburg County Bank, Kenbridge, Virginia Merger Community Bank of Lunenburg, Kenbridge, Virginia 1. Each proposed transaction was to be effected under the charter of the first-named bank. The entries are in chronological order of approval. Date of approval 12/1/86 24 2. In each case, the first-named bank is newly organized and not in operation. 262 The Federal Reserve System Boundaries of Federal Reserve Districts and their Branch Territories Q © Legend o ® • • Boundaries of Federal Reserve Districts Boundaries of Federal Reserve Branch Territories Board of Governors of the Federal Reserve System Federal Reserve Bank Cities Federal Reserve Branch Cities Federal Reserve Bank Facilities Federal Reserve Directories and Meetings 264 Directories and Meetings Board of Governors of the Federal Reserve System December 31, 1986 PAUL A. VOLCKER of MANUEL H. JOHNSON Term expires January 31, 1992 January 31, 2000 January 31, 1988 New Jersey, Chairman1 of Virginia, Vice Chairman1 Vacant WAYNE D. ANGELL of Kansas January 31, 1994 EMMETT J. RICE of New York MARTHA R. SEGER of Michigan H. ROBERT HELLER of California January 31, 1990 January 31, 1998 January 31, 1996 OFFICE OF BOARD MEMBERS JOSEPH R. COYNE, Assistant to the Board DONALD J. WINN, Assistant to the Board M. ROBERTS, Assistant to the Chairman BOB S. MOORE, Special Assistant to the Board STEVEN OFFICE OF EXECUTIVE DIRECTOR FOR INFORMATION RESOURCES MANAGEMENT ALLEN E. BEUTEL, Executive Director STEPHEN R. MALPHRUS, Assistant Director OFFICE OF THE SECRETARY WILLIAM W. WILES, Secretary BARBARA R. LOWREY, Associate OFFICE OF STAFF DIRECTOR FOR MONETARY AND FINANCIAL POLICY Secretary JAMES MCAFEE, Associate Secretary DONALD L. KOHN, Deputy Staff Director R. V. BERNARD, Special Assistant to the Board NORM AND LEGAL DIVISION MICHAEL BRADFIELD, General Counsel J. VIRGILMATTINGLY, JR., Deputy OFFICE OF STAFF DIRECTOR FOR MANAGEMENT S. DAVID FROST, Staff Director EDWARD T. MULRENIN, Assistant Director CHARLES L. HAMPTON, Senior Technical Adviser Staff PORTIA W. THOMPSON, Equal Employment Opportunity Programs Officer OFFICE OF STAFF DIRECTOR FOR FEDERAL RESERVE BANK ACTIVITIES THEODORE E. ALLISON, Staff Director 1. The designations as Chairman and Vice Chairman expire on August 6, 1987, and August 4, 1990, respectively, unless the services of these members of the Board shall have terminated General Counsel M. ASHTON, Associate General Counsel OLIVER IRELAND, Associate General Counsel RICKI R. TIGERT, Assistant General Counsel MARYELLEN A. BROWN, Assistant to the General Counsel RICHARD DIVISION OF RESEARCH AND STATISTICS JAMES L. KICHLINE, Director EDWARD C. ETTIN, Deputy Director MICHAEL J. PRELL, Deputy Director Directories and Meetings 265 DIVISION OF RESEARCH AND STATISTICS—Continued JARED J. ENZLER, Associate Director DAVID E. LINDSEY, Associate Director ELEANOR J. STOCKWELL, Associate Director MARTHA BETHEA, Deputy Associate Director THOMAS D. SIMPSON, Deputy Associate Director LAWRENCE SLIFMAN, Deputy Associate Director PETER A. TINSLEY, Deputy Associate Director SUSAN J. LEPPER, Assistant Director RICHARD D. PORTER, Assistant Director MARTHA S. SCANLON, Assistant Director JOYCE ZICKLER, Assistant Director LEVON H. GARABEDIAN, Assistant Director (Administration) DIVISION OF FEDERAL RESERVE BANK OPERATIONS—Continued CHARLES W. BENNETT, Assistant Director ANNE M. DEBEER, Assistant Director JACK DENNIS, JR., Assistant Director EARL G. HAMILTON, Assistant Director JOHN H. PARRISH, Assistant Director FLORENCE M. YOUNG, Adviser DIVISION OF BANKING SUPERVISION AND REGULATION WILLIAM TAYLOR, Director Director DON E. KLINE, Associate Director FREDERICK M. STRUBLE, Associate Director WILLIAM A. RYBACK, Deputy Associate Director STEPHEN C. SCHEMERING, Deputy DIVISION OF INTERNATIONAL FINANCE EDWIN M. TRUMAN, Director J. PROMISEL, Senior Associate Director CHARLES J. SIEGMAN, Senior Associate Director DAVID H. HOWARD, Deputy Associate Director ROBERT F. GEMMILL, Staff Adviser LARRY DONALD B. ADAMS, Assistant Director PETER HOOPER, III, Assistant Director KAREN H. JOHNSON, Assistant Director RALPH W. SMITH, JR., Assistant Director DIVISION OF FEDERAL RESERVE BANK OPERATIONS Associate Director RICHARD SPILLENKOTHEN, Deputy Associate Director HERBERT A. BIERN, Assistant Director JOE M. CLEAVER, Assistant Director ANTHONY CORNYN, Assistant Director JAMES I. GARNER, Assistant Director JAMES D. GOETZINGER, Assistant Director MICHAEL MARTINSON, Assistant Director ROBERT S. PLOTKIN, Assistant Director SIDNEY M. SUSSAN, Assistant Director LAURA M. HOMER, Securities Credit Officer DIVISION OF CONSUMER AND COMMUNITY AFFAIRS CLYDE H. FARNSWORTH, JR., Director GRIFFITH L. GARWOOD, Director C. MCENTEE, Associate Director DAVID L. ROBINSON, Associate Director C. WILLIAM SCHLEICHER, JR., Associate Director JERAULD ELLIOTT 2 WELFORD S. FARMER, Deputy Director FREDERICK R. DAHL, Associate C. Director KLUCKMAN, Associate GLENN E. LONEY, Assistant Director ELLEN MALAND, Assistant Director DOLORES S. SMITH, Assistant Director 2. On loan from the Federal Reserve Bank of Richmond. 266 Directories and Meetings Board of Governors of the Federal Reserve System — Continued DIVISION OF PERSONNEL DAVID L. SHANNON, Director JOHN R. WEIS, Assistant Director CHARLES W. WOOD, Assistant Director DIVISION OF HARDWARE AND SOFTWARE SYSTEMS BRUCE M. BEARDSLEY, Director THOMAS C. JUDD, Assistant Director ELIZABETH B. RIGGS, Assistant Director DIVISION OF SUPPORT SERVICES ROBERT E. FRAZIER, Director WALTER W. KREIMANN, Associate Director GEORGE M. LOPEZ, Assistant Director ROBERT J. ZEMEL, Assistant Director DIVISION OF APPLICATIONS DEVELOPMENT AND STATISTICAL SERVICES WILLIAM R. JONES, Director DAY RADEBAUGH, Assistant Director OFFICE OF THE CONTROLLER GEORGE E. LIVINGSTON, Controller BRENT L. BOWEN, Assistant Controller C. STEVENS, Assistant Director PATRICIA A. WELCH, Assistant Director RICHARD Federal Open Market Committee December 31, 1986 Members PAUL A. VOLCKER, Chairman, Board of Governors E. GERALD CORRIGAN, Vice Chairman, elected member by Federal Reserve Bank of New York WAYNE D. ANGELL, Board of Governors ROGER GUFFEY, elected by Federal Reserve Banks of Minneapolis, Kansas City, and San Francisco H. ROBERT HELLER, Board of Governors KAREN N. HORN, elected by Federal Reserve Banks of Cleveland and Chicago MANUEL H. JOHNSON, Board of Governors THOMAS C. MELZER, elected by Federal Reserve Banks of Atlanta, St. Louis, and Dallas FRANK E. MORRIS, elected by Federal Reserve Banks of Boston, Philadelphia, and Richmond EMMETT J. RICE, Board of Governors MARTHA R. SEGER, Board of Governors Alternate Members G. BOEHNE, elected by Federal Reserve Banks of Boston, Philadelphia, and Richmond ROBERT H. BOYKIN, elected by Federal Reserve Banks of Atlanta, St. Louis, and Dallas SILAS KEEHN, elected by Federal Reserve Banks of Cleveland and Chicago GARY H. STERN, elected by Federal Reserve Banks of Minneapolis, Kansas City, and San Francisco THOMAS M. TIMLEN, elected by Federal Reserve Bank of New York http://fraser.stlouisfed.org/ EDWARD Federal Reserve Bank of St. Louis Directories and Meetings 267 Federal Open Market Committee—Continued Officers NORMAND R. V. BERNARD, Assistant Secretary MICHAEL BRADFIELD, General Counsel JAMES H. OLTMAN, Deputy General Counsel JAMES L. KICHLINE, Economist RICHARD G. DAVIS, Associate Economist THOMAS E. DAVIS, Associate Economist DONALD L. KOHN, Associate Economist DAVID E. LINDSEY, Associate Economist EDWIN M. TRUMAN, Economist (International) ANATOL B. BALBACH, Associate Economist JOHN M. DAVIS, ALICIA H. MUNNELL, Associate Economist MICHAEL J. PRELL, Associate Economist CHARLES J. SIEGMAN, Associate Economist Associate Economist PETER D. STERNLIGHT, Manager for Domestic Operations, System Open Market Account SAM Y. CROSS, Manager for Foreign Operations, System Open Market Account During 1986, the Federal Open Market of the Federal Open Market Committee Committee held eight regularly scheduled in this REPORT.) meetings (See Record of Policy Actions b'cdcuil \iivisi>ry Council December 31, 1986 Members District 1—ROBERT L. NEWELL, Chairman and Chief Executive Officer, Connecticut National Bank, Hartford, Connecticut District 2—JOHN F. MCGILLICUDDY, Chairman of the Board and Chief Executive Officer, Manufacturers Hanover Trust Company, New York, New York District 3—GEORGE A. BUTLER, Chairman, First Pennsylvania Bank, N.A., Philadelphia, Pennsylvania District 4—JULIEN L. MCCALL, Chairman and Chief Executive Officer, National City Corporation, Cleveland, Ohio District 5—JOHN G. MEDLIN, JR., Chairman of the Board and Chief Executive Officer, Wachovia Bank and Trust Company, N.A., President and Chief Executive Officer, The First Wachovia Corporation, Winston-Salem, North Carolina District 6—BENNETT A. BROWN, Chairman and Chief Executive Officer, Citizens and Southern Georgia Corporation and The Citizens and Southern National Bank, Atlanta, Georgia District 7—HAL C. KUEHL, Chairman of the Board and Chief Executive Officer, First Wisconsin National Bank of Milwaukee, Milwaukee, Wisconsin District 8—WILLIAM H. BOWEN, Chairman of the Board and Chief Executive http://fraser.stlouisfed.org/ Officer, First Commercial Bank, N.A., Little Rock, Arkansas Federal Reserve Bank of St. Louis 268 Directories and Meetings Federal Advisory Council—Continued Members—Continued District 9—D. H. ANKENY, JR., Chairman and Chief Executive Officer, First Bank System, Minneapolis, Minnesota District 10—F. PHILLIPS GILTNER, President, First National Bank, Omaha, Nebraska District 11—NAT S. ROGERS, Consultant and Director, First City National Bancorporation of Texas, Inc., Houston, Texas District 12—G. ROBERT TRUEX, JR., Chairman, Rainier Bancorporation and Rainier National Bank, Seattle, Washington Officers ROBERT L. NEWELL, President WILLIAM H. BOWEN, HERBERT V. PROCHNOW, Secretary WILLIAM J. KORSVIK, Associate Secretary Vice President Directors GEORGE A. BUTLER JOHN G. MEDLIN, JR. Meetings of the Federal Advisory Council were held on February 6-7, May 1-2, September 11-12, and November 13-14, 1986. The Board of Governors met with the council on February 7, May 2, September 12, and November 14, 1986. The council, which is composed of 12 repre- HAL C. KUEHL sentatives of the banking industry, one from each Federal Reserve District, is required by law to meet in Washington at least four times per year and is authorized by the Federal Reserve Act to consult with and advise the Board on all matters within the jurisdiction of the Board. Consumer Advisory Council December 31, 1986 Members G. BRATT, Associate Professor, Department of Urban and Environmental Policy, Tufts University, Medford, Massachusetts EDWIN B. BROOKS, President, Security Federal Savings and Loan Association, Richmond, Virginia JONATHAN A. BROWN, Director, BankWatch, Washington, D.C. MICHAEL S. CASSIDY, Senior Vice President, Chase Manhattan Bank, New York, New York THERESA FAITH CUMMINGS, Social Services Consultant, Springfield, Illinois NEIL J. FOGARTY, Attorney, Hudson County Legal Services, Jersey City, New Jersey STEVEN M. GEARY, Associate General Counsel, Missouri Division of Finance, Jefferson City, Missouri KENNETH A. HALL, President, Great Southern National Bank of Jackson, Jackson, Mississippi STEVEN W. HAMM, Administrator, South Carolina Department of Consumer Affairs, Columbia, South Carolina ROBERT J. HOBBS, Senior Attorney, National Consumer Law Center, Boston, http://fraser.stlouisfed.org/ Massachusetts Federal Reserve Bank of St. Louis RACHEL Directories and Meetings 269 Consumer Advisory Council—Continued Members—Continued W. JOHNSON, Professor of Management and Director, Credit Research Center, Purdue University, West Lafayette, Indiana JOHN M. KOLESAR, President, Ameritrust Development Bank, Cleveland, Ohio EDWARD N. LANGE, Partner, Davis, Wright, Todd, Riese & Jones, Seattle, Washington ALAN B. LERNER, Senior Executive Vice President, Associates Corporation of North America, Dallas, Texas FRED S. MCCHESNEY, Visiting Fellow of Law and Economics, University of Chicago, Chicago, Illinois FRED H. MILLER, Professor of Law, University of Oklahoma, Norman, Oklahoma MARGARET M. MURPHY, Associate Professor and Director, Columbia Center, Johns Hopkins University, Columbia, Maryland ROBERT F. MURPHY, Chairman, General Motors Acceptance Corporation, Detroit, Michigan HELEN E. NELSON, President, Consumer Research Foundation, Mill Valley, California LAWRENCE S. OKINAGA, Partner, Carlsmith, Carlsmith, Wichman & Case, Honolulu, Hawaii SANDRA R. PARKER, Chairman, Banking Committee, Richmond United Neighborhoods, Richmond, Virginia JOSEPH L. PERKOWSKI, Chief Executive Officer, Minneapolis Federal Employees Credit Union, Minneapolis, Minnesota BRENDA L. SCHNEIDER, Director of Community Relations, Manufacturers National Bank, Detroit, Michigan JANE SHULL, Director, Institute for the Study of Civic Values, Philadelphia, Pennsylvania TED L. SPURLOCK, Vice President and Director of Credit and Consumer Banking Services, J.C. Penney Company, Inc., Dallas, Texas MEL STILLER, Executive Director, Consumer Credit Counseling Service of Eastern Massachusetts, Boston, Massachusetts CHRISTOPHER J. SUMNER, President and Chief Executive Officer, Western Savings & Loan Company, Salt Lake City, Utah EDWARD J. WILLIAMS, Senior Vice President, Consumer Banking Group, Harris Trust and Savings Bank, Chicago, Illinois MERVIN WINSTON, Vice President, First Bank System, Inc., Minneapolis, Minnesota MICHAEL ZOROYA, Retail Services Consultant, The May Department Stores, St. Louis, Missouri Officers MARGARET M. MURPHY, Chairman LAWRENCE S. OKINAGA, Vice Chairman The Consumer Advisory Council met with and representatives of consumer and members of the Board of Governors on community interests. It was established March 20-21, June 19-20, and October pursuant to the 1976 amendments to the 8-9, 1986. The council is composed of Equal Credit Opportunity Act to advise academics, state government officials, the Board on consumer financial services, representatives of the financial industry, ROBERT 270 Directories and Meetings Thrift Institutions Advisory Council December 31, 1986 Members G. CARR, President and Chief Executive Officer, The Cape Cod Five Cents Savings Bank, Orleans, Massachusetts M. TODD COOKE, Vice Chairman, Meritor Financial Group, Philadelphia, Pennsylvania RICHARD H. DEIHL, Chairman of the Board and Chief Executive Officer, Home Savings of America, Los Angeles, California JOHN C. DICUS, President, Capitol Federal Savings and Loan Association, Topeka, Kansas HAROLD W. GREENWOOD, JR., Chairman, President, and Chief Executive Officer, Midwest Federal Savings and Loan Association, Minneapolis, Minnesota JOHN A. HARDIN, Chairman and President, First Federal Savings Bank, Rock Hill, South Carolina JAMIE J. JACKSON, President, Commonwealth Financial Group, Houston, Texas FRANCES LESNIESKI, President, Michigan State University Federal Credit Union, East Lansing, Michigan DONALD F. MCCORMICK, Chairman of the Board, Howard Savings Bank, Livingston, New Jersey HERSCHEL ROSENTHAL, President, Flagler Federal Savings and Loan Association, Miami, Florida GARY L. SIRMON, President, First Federal Savings and Loan Association, Walla Walla, Washington MICHAEL R. WISE, Chairman and Chief Executive Officer, Silverado Banking, Denver, Colorado ELLIOTT Officers RICHARD H. DEIHL, President The members of the Thrift Institutions Advisory Council met with the Board of Governors on January 31, May 1, September 9, and November 6, 1986. The council, which is composed of representatives from credit unions, savings and loan MICHAEL R. WISE, Vice President associations, and savings banks, consults with and advises the Board on issues pertaining to the thrift industry and on various other matters within the Board's jurisdiction, Directories and Meetings 271 Officers nt Federal Reserve Banks, Branches, and Office* December 31, 19861 BANK, Branch, or facility BOSTON3 Chairman2 Deputy Chairman Joseph A. Baute George N. Hatsopoulos President First Vice President Frank E. Morris Robert W. Eisenmenger NEW YORK3 John Brademas Clifton R. Wharton, Jr. Mary Ann Lambertsen E. Gerald Corrigan Thomas M. Timlen PHILADELPHIA .. Robert M. Landis Nevius M. Curtis Edward G. Boehne Richard L. Smoot CLEVELAND3 W.H. Knoell E. Mandell de Windt Owen B. Butler James E. Haas Karen N. Horn William H. Hendricks Leroy T. Canoles, Jr. Robert A. Georgine Robert L. Tate Wallace J. Jorgenson Robert P. Black Jimmie R. Monhollon John H. Weitnauer, Jr. Bradley Currey, Jr. A.G. Trammell E. William Nash, Jr. Sue McCourt Cobb Patsy R. Williams Sharon A. Perlis Robert P. Forrestal Jack Guynn Robert J. Day Marcus Alexis Robert E. Brewer Silas Keehn Daniel M. Doyle W.L. Hadley Griffin Mary P. Holt Sheffield Nelson William C. Ballard, Jr. G. Rives Neblett Thomas C. Melzer Joseph P. Garbarini Buffalo Cincinnati Pittsburgh RICHMOND3 Baltimore Charlotte John T. Keane Birmingham Jacksonville Miami Nashville New Orleans CHICAGO3 Detroit ST. LOUIS Little Rock Louisville Memphis Charles A. Cerino4 Harold J. Swart4 Robert D. McTeer4 Albert D. Tinkelenberg4 John G. Stoides4 Culpeper ATLANTA Vice President in charge of Branch Delmar Harrison Fred R. Herr James D. Hawkins Patrick K. Barron Jeffrey J. Wells Henry H. Bourgaux, Jr. Roby L. Sloan4 John F. Breen James E. Conrad Paul I. Black, Jr. 272 Directories and Meetings BANK, Branch, or facility MINNEAPOLIS Helena KANSAS CITY Denver Oklahoma City Omaha DALLAS El Paso Houston San Antonio SAN FRANCISCO Los Angeles Portland Salt Lake City Seattle Chairman2 Deputy Chairman John B. Davis, Jr. Michael W. Wright Marcia S. Anderson President First Vice President Gary H. Stern Thomas E. Gainor Irvine O. Hockaday, Jr. Robert G. Lueder James E. Nielson Patience S. Latting Kenneth L. Morrison Roger Guffey Henry R. Czerwinski Robert D. Rogers Bobby R. Inman Peyton Yates Walter M. Mischer, Jr. Ruben M. Garcia Robert H. Boykin William H. Wallace Alan C. Furth Fred W. Andrew Richard C. Seaver Paul E. Bragdon Don M. Wheeler John W. Ellis Robert T. Parry Carl E. Powell Vice President in charge of Branch Robert F. McNellis Enis Alldredge, Jr. William G. Evans Robert D. Hamilton James L. Stull Joel L. Koonce, Jr. J.Z. Rowe4 Thomas H. Robertson Thomas C. Warren5 Angelo S. Carella4 E. Ronald Liggett4 Gerald R. Kelly4 1. A current list of these officers appears each month in the Federal Reserve Bulletin. 2. The Chairman of a Federal Reserve Bank, by statute, serves as Federal Reserve Agent. 3. Additional offices of these Banks are located at Lewistown, Maine; Windsor Locks, Connecticut; Cranford, New Jersey; Jericho, New York; Utica at Oriskany, New York; Columbus, Ohio; Columbia, South Carolina; Charleston, West Virginia; Des Moines, Iowa; Indianapolis, Indiana; and Milwaukee, Wisconsin. 4. Senior Vice President. 5. Executive Vice President. Conference of Chairmen Robert J. Day as Vice Chairman, and Leroy T. Canoles, Jr., as the other member. The chairmen of the Federal Reserve Banks are organized into the Conference of Chairmen that meets to consider matters of common interest and to consult with and advise the Board of Governors. Such meetings, attended also by the deputy chairmen, were held in Washington on June 4-5 and December 3-4, 1986. The Executive Committee of the Conference of Chairmen during 1986 comprised Robert D. Rogers, Chairman; John H. Weitnauer, Jr., Vice Chairman; and Joseph A. Baute, member. On December 4, 1986, the Conference elected its Executive Committee for 1987, naming Joseph A. Baute as Chairman, Conference of Presidents The presidents of the Federal Reserve Banks are organized into the Conference of Presidents, which meets periodically to consider matters of common interest and to consult with and advise the Board of Governors. On October 15, 1985, Edward G. Boehne, President of the Federal Reserve Bank of Philadelphia, was elected Chairman of the conference for 1986, and Silas Keehn, President of the Federal Reserve Bank of Chicago, was elected Vice Chairman. Joanna H. Frodin, of the Federal Reserve Bank of Philadelphia, was ap- Directories and Meetings 273 pointed Secretary, and Joan M. DeRycke, of the Federal Reserve Bank of Chicago, was appointed Assistant Secretary. Conference of First Vice Presidents The Conference of First Vice Presidents of the Federal Reserve Banks was organized in 1969 to meet periodically to consider operational issues and other matters. On October 21, 1985, Richard L. Smoot, First Vice President of the Federal Reserve Bank of Philadelphia, was elected Chairman of the conference for 1986, and Daniel M. Doyle, First Vice President of the Federal Reserve Bank of Chicago, was elected Vice Chairman. Joanna H. Frodin, of the Federal Reserve Bank of Philadelphia, was appointed Secretary, and Joan M. DeRycke, of the Federal Reserve Bank of Chicago, was appointed Assistant Secretary. Directors The following list of directors of Federal Reserve Banks and Branches shows for each director the class of directorship, the principal business affiliation, and the date the term expires. Each Federal Reserve Bank has nine members on its board of directors: three Class A and three Class B directors, who are elected by the stockholding member banks, and three Class C directors, who are appointed by the Board of Governors of the Federal Reserve System. Directors are chosen without discrimination as to race, creed, color, sex, or national origin. Class A directors represent the stockholding member banks in each Federal Reserve District. Class B and Class C directors represent the public and are chosen with due, but not exclusive, consideration to the interests of agriculture, commerce, industry, services, labor, and consumers; they may not be officers, directors, or employees of any bank. In addition, Class C directors may not be stockholders of any bank. For the election of Class A and Class B directors, the Board of Governors classifies the member banks of each Federal Reserve District into three groups. Each group, which comprises banks with similar capitalization, elects one Class A director and one Class B director. The Board of Governors designates one Class C director as chairman of the board of directors and Federal Reserve Agent of each District Bank and appoints another Class C director as deputy chairman. Federal Reserve Branches have either five or seven directors, a majority of whom are appointed by the parent Federal Reserve Bank; the others are appointed by the Board of Governors. One of the directors appointed by the Board is designated annually as chairman of the board of that Branch in a manner prescribed by the parent Federal Reserve Bank. For the name of the chairman and deputy chairman of the board of directors of each Reserve Bank and of the chairman of each Branch, see the preceding table, "Officers of Federal Reserve Banks, Branches, and Offices." 274 Directories and Meetings Term District 1—BOSTON Class A William S. Edgerly Homer B. Ellis, Jr Harry R. Mitiguy Dec'fl Chairman of the Board and President, State Street Bank and Trust Company, Boston, Massachusetts Chairman, Factory Point National Bank, Manchester Center, Vermont President, Howard Bancorp, Burlington, Vermont 1986 1987 1988 Class B Richard M. Oster Ralph Z. Sorenson Matina S. Horner President and Chief Executive Officer, Cookson America, Inc., Providence, Rhode Island Chairman, President and Chief Executive Officer, Barry Wright Corporation, Newton Lower Falls, Massachusetts President, Radcliffe College, Cambridge, Massachusetts 1986 1987 1988 Class C Michael J. Harrington Harrington Company, Peabody, Massachusetts Joseph A. Baute Chairman and Chief Executive Officer, Markem Corporation, Keene, New Hampshire George N. Hatsopoulos....Chairman of the Board and President, Thermo Electron Corporation, Waltham, Massachusetts 1986 1987 1988 District 2—NEW YORK Class A T. Joseph Semrod Robert W. Moyer Lewis T. Preston Chairman of the Board, United Jersey Bank, Hackensack, New Jersey President and Chief Executive Officer, Wilber National Bank, Oneonta, New York Chairman of the Board, Morgan Guaranty Trust Company of New York, New York, New York 1986 1987 1988 Class B John R. Opel John F. Welch, Jr Richard L. Gelb Chairman of the Board, International Business Machines Corp., Armonk, New York Chairman and Chief Executive Officer, General Electric Company, Fairfield, Connecticut Chairman and Chief Executive Officer, Bristol-Myers Company, New York, New York 1986 1987 1988 Directories and Meetings 275 Class C Clifton R. Wharton, Jr Virginia A. Dwyer John Brademas Term expires Dec. 31 Chancellor, State University of New York System, Albany, New York Senior Vice President—Finance (Retired), American Telephone and Telegraph Co., New York, New York. President, New York University, New York, New York 1986 1987 1988 BUFFALO BRANCH Appointed by the Federal Reserve Bank Herbert Fort President, The Bath National Bank, Bath, New York Ross B. Kenzie Chairman and Chief Executive Officer, Goldome FSB, Buffalo, New York R. Carlos Carballada President and Chief Executive Officer, Central Trust Company, Rochester, New York Donald I. Wickham President, Tri-Way Farms, Inc., Stanley, New York Appointed by the Board of Governors Matthew Augustine President and Chief Executive Officer, Eltrex Industries, Inc., Rochester, New York Joseph Yantomasi Consultant, United Auto Workers, Buffalo, New York Mary Ann Lambertsen Vice President, Human Resources, Fisher-Price, East Aurora, New York 1986 1987 1988 1988 1986 1987 1988 District 3—PHILADELPHIA Class A John H. Walther Chairman of the Board, New Jersey National Bank, Pennington, New Jersey Ronald H. Smith President and Chief Executive Officer, CCNB Bank, N.A., New Cumberland, Pennsylvania Clarence D. McCormick...President, The Farmers and Merchants National Bank, Bridgeton, New Jersey Class B Carl E. Singley Charles F. Seymour Dean and Professor of Law, Temple University Law School, Philadelphia, Pennsylvania Chairman and Chief Executive Officer, Jackson-Cross Company, Philadelphia, Pennsylvania 1986 1987 1988 1986 1987 276 Directories and Meetings Nicholas Riso President and Chief Executive Officer, Giant Food Stores, Inc., Carlisle, Pennsylvania Class C Robert M. Landis George E. Bartol III Nevius M. Curtis Partner, Dechert, Price, and Rhoads, Philadelphia, Pennsylvania Chairman of the Board, Hunt Manufacturing Company, Philadelphia, Pennsylvania Chairman and Chief Executive Officer, Delmarva Power & Light Company, Wilmington, Delaware Term expires Dec. 31 1988 1986 1987 1988 District 4—CLEVELAND Class A J. David Barnes Raymond D. Campbell William A. Stroud Class B John R. Hall Richard D. Hannan Daniel M. Galbreath Class C W.H. Knoell E. Mandell de Windt John R. Miller Chairman and Chief Executive Officer, Mellon Bank, Pittsburgh, Pennsylvania Chairman, President, and Chief Executive Officer, Independent State Bank of Ohio, Columbus, Ohio Chairman and President, First-Knox National Bank, Mount Vernon, Ohio Chairman of the Board and Chief Executive Officer, Ashland Oil, Inc., Ashland, Kentucky Chairman of the Board and President, Mercury Instruments, Inc., Cincinnati, Ohio President, John W. Galbreath & Co., Columbus, Ohio President and Chief Executive Officer, Cyclops Corporation, Pittsburgh, Pennsylvania Chairman of the Board (Retired), Eaton Corporation, Cleveland, Ohio Former President and CEO, The Standard Oil Company, Cleveland, Ohio 1986 1987 1988 1986 1987 1988 1986 1987 1988 CINCINNATI BRANCH Appointed by the Federal Reserve Bank Vernon J. Cole Executive Vice President and Chief Executive Officer, Harlan National Bank, Harlan, Kentucky Sherrill Cleland President, Marietta College, Marietta, Ohio 1986 1987 Directories and Meetings 277 Jerry L. Kirby Robert A. Hodson Chairman of the Board, President, and Chief Executive Officer, Citizens Federal Savings & Loan Association, Dayton, Ohio President and Chief Executive Officer, 1st Security Bank, Hillsboro, Ohio Appointed by the Board of Governors Owen B. Butler Chairman of the Board (Retired), The Procter & Gamble Company, Cincinnati, Ohio Don Ross Owner, Dunreath Farm, Lexington, Kentucky Kate Ireland National Chairman, Frontier Nursing Service, Wendover, Kentucky Term expires Dec. 31 1987 1988 1986 1987 1988 PITTSBURGH BRANCH Appointed by the Federal Reserve Bank G.R. Rendle President and Chief Executive Officer, Gallatin National Bank, Uniontown, Pennsylvania Charles L. Fuellgraf, Jr. ...Chief Executive Officer, Fuellgraf Electric Company, Butler, Pennsylvania James S. Pasman, Jr Former Vice Chairman, Aluminum Company of America, Pittsburgh, Pennsylvania Lawrence F. Klima President, The First National Bank of Pennsylvania, Erie, Pennsylvania Appointed by the Board of Governors Karl M. von der Heyden ..Senior Vice President-Finance and Chief Financial Officer, H. J. Heinz Company, Pittsburgh, Pennsylvania Milton A. Washington President and Chief Executive Officer, Allegheny Housing Rehabilitation Corporation, Pittsburgh, Pennsylvania James E. Haas President and Chief Operating Officer, National Intergroup, Inc., Pittsburgh, Pennsylvania 1986 1987 1987 1988 1986 1987 1988 District 5—RICHMOND Class A Robert S. Chiles, Sr Robert F. Baronner President and Chief Executive Officer, Greensboro National Bank, Greensboro, North Carolina Chairman of the Board and Chief Executive Officer, One Valley Bancorp of West Virginia, Inc. and Kanawha Valley Bank, N.A., Charleston, West Virginia 1986 1987 278 Directories and Meetings K. Donald Menefee Class B Thomas B. Cookerly Floyd D. Gottwald, Jr Edward H. Covell Class C Leroy T. Canoles, Jr Hanne Merriman Robert A. Georgine Chairman of the Board and Chief Executive Officer, Madison National Bank, Washington, D.C President, Broadcast Division, Allbritton Communications, Washington, D.C Chairman of the Board and Chief Executive Officer, Ethyl Corporation, Richmond, Virginia President, The Covell Company, Easton, Maryland President, Kaufman & Canoles, Norfolk, Virginia President, Garfinckel's, Washington, D.C. .. President, Building & Construction Trades Department, AFL-CIO, Washington, D.C Term expires Dec. 31 1988 1986 1987 1988 1986 1987 1988 BALTIMORE BRANCH Appointed by the Federal Reserve Bank Charles W. Hoff III President and Chief Executive Officer, Farmers and Mechanics National Bank, Frederick Maryland Raymond V. Haysbert, Sr President and Chief Executive Officer, Parks Sausage Company, Baltimore, Maryland... H. Grant Hathaway Chairman of the Board, Equitable Bank, N.A., Baltimore, Maryland Joseph W. Mosmiller Chairman of the Board, Loyola Federal Savings and Loan Association, Baltimore, Maryland Appointed by the Board of Governors Robert L. Tate Chairman, Tate Industries, Baltimore, Maryland Gloria L. Johnson President, Hutzler Brothers Company, Baltimore, Maryland Thomas R. Shelton President, Resource Management Group, Inc., Salisbury, Maryland 1986 1987 1988 1988 1986 1987 1988 CHARLOTTE BRANCH Appointed by the Federal Reserve Bank John A. Hardin Chairman of the Board and President, First Federal Savings Bank, Rock Hill, South Carolina 1986 Directories and Meetings 279 James M. Culberson, Jr. ..Chairman and President, The First National Bank of Randolph County, Asheboro, North Carolina J. Donald Collier Orangeburg, South Carolina James G. Lindley Chairman, South Carolina National Corporation, and Chairman and President, South Carolina National Bank, Columbia, South Carolina Appointed by the Board of Governors Wallace J. Jorgenson President, Jefferson-Pilot Communications Company, Charlotte, North Carolina James E. Bostic, Jr Division General Manager, Convenience Products Division, Georgia-Pacific Corporation, Aiken, South Carolina G. Alex Bernhardt President, Bernhardt Industries, Inc., Lenoir, North Carolina Term expires Dec. 31 1987 1988 1988 1986 1987 1988 District 6—ATLANTA Class A Mary W. Walker E. B. Robinson, Jr Virgil H. Moore, Jr Class B Harold B. Blach, Jr Horatio C. Thompson Bernard F. Sliger Class C Bradley Currey, Jr Jane C. Cousins John H. Weitnauer, Jr Vice Chairman, The National Bank of Walton County, Monroe, Georgia Chairman and Chief Executive Officer, Deposit Guaranty National Bank and Deposit Guaranty Corporation, Jacksonville, Mississippi Chairman and Chief Executive Officer, First Farmers and Merchants National Bank, Columbia, Tennessee President, Blach's Inc., Birmingham, Alabama President, Horatio Thompson Investments, Inc., Baton Rouge, Louisiana President, Florida State University, Tallahassee, Florida President, Rock-Tenn Company, Norcross, Georgia President and Chief Executive Officer, Merrill Lynch Realty/Cousins, Miami, Florida Chairman (Retired), Rich way, Atlanta, Georgia 1986 1987 1988 1986 1987 1988 1986 1987 1988 280 Directories and Meetings BIRMINGHAM BRANCH Appointed by the Federal Reserve Bank Charles L. Peery Chairman, The First National Bank of Florence, Florence, Alabama Willard L. Hurley Chairman and Chief Executive Officer, First Alabama Bancshares, Inc., Birmingham, Alabama Judith Thompson Vice Chairman, Thompson Tractor Company, Inc., Birmingham, Alabama .... Milton A. Wendland Owner-Operator, Autauga Farming Company, Autaugaville, Alabama Appointed by the Board of Governors Margaret E.M. Tolbert Associate Provost for Research and Development and Director, Carver Research Foundation, Tuskegee University, Tuskegee, Alabama A.G. Trammell President, Alabama Labor Council, AFL-CIO, Birmingham, Alabama Roy D. Terry President and Chief Executive Officer, Terry Manufacturing Company, Inc., Roanoke, Alabama Term expires Dec. 31 1986 1987 1988 1988 1986 1987 1988 JACKSONVILLE BRANCH Appointed by the Federal Reserve Bank John D. Uible Chairman and Chief Executive Officer, Florida National Banks of Florida, Inc., Jacksonville, Florida Buell G. Duncan, Jr Chairman, President, and Chief Executive Officer, Sun Bank, N.A., Orlando, Florida Robert R. Deison President and Chairman of the Board, Andrew Jackson State Savings and Loan Association, Tallahassee, Florida George W. Gibbs III President, Atlantic Dry Dock Corporation, Jacksonville, Florida Appointed by the Board of Governors Saundra H. Gray Owner, Gemini Springs Farm, DeBary, Florida Andrew A. Robinson Dean, College of Education and Human Services, University of North Florida, Jacksonville, Florida E. William Nash, Jr President, South-Central Operations, The Prudential Insurance Company of America, Jacksonville, Florida 1986 1987 1988 1988 1986 1987 1988 Directories and Meetings 281 MIAMI BRANCH Appointed by the Federal Reserve Bank Robert L. Kester Vice Chairman, Barnett Bank of South Florida, N.A., Pompano Beach, Florida... Robert D. Rapaport Chairman, Royal Palm Savings Association, Palm Beach, Florida Robert M. Taylor Chairman and Chief Executive Officer, The Mariner Group, Inc., Fort Myers, Florida William H. Losner President and Chief Executive Officer, The First National Bank of Homestead, Homestead, Florida Appointed by the Board of Governors Eugene E. Cohen Chief Financial Officer and Treasurer, Howard Hughes Medical Institute, Coconut Grove, Florida Robert D. Apelgren President, Apelgren Corporation, Pahokee, Florida Sue McCourt Cobb Attorney, Greenberg, Traurig, Askew, Hoffman, Lipoff, Rosen, and Quentel, P.A., Miami, Florida Term expires Dec. 31 1986 1987 1987 1988 1986 1987 1988 NASHVILLE BRANCH Appointed by the Federal Reserve Bank Robert W. Jones Chairman and President, First National Bank, McMinnville, Tennessee Will A. Hildreth President and Chief Executive Officer, First National Bank of Loudon County, Lenoir City, Tennessee Eugene C. Cheatham President, Advanced Integrated Technology, Inc., Nashville, Tennessee Shirley A. Zeitlin President, Shirley Zeitlin & Co. Realtors, Nashville, Tennessee Appointed by the Board of Governors Patsy R. Williams Partner, Rhyne Lumber Company, Newport, Tennessee C. Warren Neel Dean, College of Business Administration, The University of Tennessee, Knoxville, Tennessee Condon S. Bush President, Bush Brothers & Company, Dandridge, Tennessee 1986 1987 1988 1988 1986 1987 1988 282 Directories and Meetings NEW ORLEANS BRANCH Appointed by the Federal Reserve Bank Carl E. Jones, Jr Chairman, President, and Chief Executive Officer, First Alabama Bank of Mobile, N.A., Mobile, Alabama James G. Boyer Chairman, President, and Chief Executive Officer, Gulf National Bank at Lake Charles, Lake Charles, Louisiana Alan R. Barton President and Chief Executive Officer, Mississippi Power Company, Gulfport, Mississippi Robert M. Shofstahl President and Chief Executive Officer, Pelican Homestead and Savings Association, Metairie, Louisiana Appointed by the Board of Governors Leslie B. Lampton President, Ergon, Inc., Jackson, Mississippi Caroline K. Theus President, Ingle wood Land and Development Company, Alexandria, Louisiana Sharon A. Perlis President, Sharon A. Perlis (APLC), Metairie, Louisiana Term expires Dec. 31 1986 1987 1988 1988 1986 1987 1988 District 7—CHICAGO Class A O. Jay Tomson Barry F. Sullivan John W. Gabbert Class B Leon T. Kendall Edward D. Powers Max J. Naylor Class C Robert J. Day Chairman of the Board and Chief Executive Officer, Citizens National Bank of Charles City, Charles City, Iowa Chairman of the Board and Chief Executive Officer, First National Bank of Chicago, Chicago, Illinois , President and Chief Executive Officer, First National Bank and Trust Company, LaPorte, Indiana 1986 1987 1988 Chairman of the Board, Mortgage Guaranty Insurance Corporation, Milwaukee, Wisconsin President and Chief Executive Officer, Mueller Company, Decatur, Illinois Farmer, Jefferson, Iowa 1986 Chairman and Chief Executive Officer, USG Corporation, Chicago, Illinois 1986 1987 1988 Directories and Meetings 283 Marcus Alexis Charles S. McNeer Dean, College of Business Administration, University of Illinois at Chicago, Chicago, Illinois Chairman of the Board and Chief Executive Officer, Wisconsin Electric Power Company, Milwaukee, Wisconsin Term expires Dec. 31 1987 1988 DETROIT BRANCH Appointed by the Federal Reserve Bank Ronald D. Story Chairman and President, The Ionia County National Bank of Ionia, Ionia, Michigan... Richard M. Gillett Chairman of the Board, Old Kent Financial Corporation, Grand Rapids, Michigan Thomas R. Ricketts Chairman of the Board and President, Standard Federal Bank, Troy, Michigan ... Donald R. Mandich Chairman and Chief Executive Officer, Comerica Bank-Detroit, Detroit, Michigan Appointed by the Board of Governors Karl D. Gregory Professor of Economics and Management, School of Economics and Management, Oakland University, Rochester, Michigan.... Robert E. Brewer Senior Vice President, Accounting, Administration & Financial Services, K mart Corporation, Troy, Michigan Phyllis E. Peters Director, Professional Standards Review, Touche Ross & Company, Detroit, Michigan 1986 1987 1987 1988 1986 1987 1988 District 8—ST. LOUIS Class A Clarence C. Barksdale H.L. Hembree III Paul K. Reynolds Class B Frank A. Jones, Jr Jesse M. Shaver Chairman of the Board, Centerre Bancorporation, St. Louis, Missouri Chairman of the Board and Chief Executive Officer, Arkansas Best Corporation, Fort Smith, Arkansas President and Chief Executive Officer, The First National Bank of Pittsfield, Pittsfield, Illinois President, Dietz Forge Company, Memphis, Tennessee President, JMS Corporation, Louisville, Kentucky 1986 1987 1988 1986 1987 284 Directories and Meetings Robert J. Sweeney Class C Mary P. Holt W.L. Hadley Griffin Robert L. Virgil, Jr President and Chief Executive Officer, Murphy Oil Corporation, El Dorado, Arkansas President, Clothes Horse, Little Rock, Arkansas Chairman of the Executive Committee, Brown Group, Inc., St. Louis, Missouri.... Dean, School of Business, Washington University, St. Louis, Missouri Term expires Dec. 31 1988 1986 1987 1988 LITTLE ROCK BRANCH Appointed by the Federal Reserve Bank William H. Kennedy, Jr. ..Chairman of the Board (Retired), Worthen Banking Corporation, Little Rock, Arkansas Wilbur P. Gulley, Jr Chairman of the Board, Savers Federal Savings & Loan Association, Little Rock, Arkansas W. Wayne Hartsfield President and Chief Executive Officer, First National Bank, Searcy, Arkansas Robert C. Connor, Jr President, Union National Bank of Little Rock, Little Rock, Arkansas Appointed by the Board of Governors Richard V. Warner Group Vice President, Wood Products Group, Potlatch Corporation, Warren, Arkansas Sheffield Nelson Attorney, Little Rock, Arkansas James R. Rodgers Airport Manager, Little Rock Regional Airport, Little Rock, Arkansas 1986 1987 1987 1988 1986 1987 1988 LOUISVILLE BRANCH Appointed by the Federal Reserve Bank Frank B. Hower, Jr Chairman of the Board and Chief Executive Officer, Liberty National Bank and Trust Company of Louisville, Louisville, Kentucky John E. Darnell, Jr Chairman of the Board, The Owensboro National Bank, Owensboro, Kentucky R. I. Kerr, Jr Chairman of the Board, President, and Chief Executive Officer, Great Financial Federal, Louisville, Kentucky Allan S. Hanks President, The Anderson National Bank of Lawrenceburg, Lawrenceburg, Kentucky 1986 1987 1987 1988 Directories and Meetings 285 Appointed by the Board of Governors William C. Ballard, Jr Executive Vice President, Finance and Administration, Humana, Inc., Louisville, Kentucky Raymond M. Burse President, Kentucky State University, Frankfort, Kentucky Lois H. Gray Chairman of the Board, James N. Gray Construction Company, Inc., Glasgow, Kentucky Term expires Dec. 31 1986 1987 1988 MEMPHIS BRANCH Appointed by the Federal Reserve Bank Wayne W. Pyeatt President, Memphis Fire Insurance Company, Memphis, Tennessee Edgar H. Bailey Chairman and Chief Executive Officer, Leader Federal Savings and Loan Association, Memphis, Tennessee John P. Dulin President, First Tennessee Bank, N.A., Memphis, Tennessee William H. Brandon, Jr. ..President, First National Bank of Phillips County, Helena, Arkansas Appointed by the Board of Governors Donald B. Weis President, Tamak Transportation Corporation, West Memphis, Arkansas .... G. Rives Neblett Neblett and Havens, Attorneys at Law, Shelby, Mississippi Katherine Hinds Smythe...President, Memorial Park, Inc., Memphis, Tennessee 1986 1987 1987 1988 1986 1987 1988 District 9—MINNEAPOLIS Class A Burton P. Allen, Jr Thomas M. Strong Duane W. Ring President, First National Bank, Milaca, Minnesota President and Chief Executive Officer, Citizens State Bank, Ontonagon, Michigan President and Chief Executive Officer, Norwest Bank La Crosse, N.A., La Crosse, Wisconsin 1986 1987 1988 Class B Harold F. Zigmund William L. Mathers Richard L. Falconer Chairman (Retired), Blandin Paper Company, Grand Rapids, Minnesota President, Mathers Land Company, Miles City, Montana District Staff Manager, Northwestern Bell, Minneapolis, Minnesota 1986 1987 1988 286 Directories and Meetings Class C John B. Davis, Jr Michael W. Wright John A. Rollwagen Term expires Dec. 31 President Emeritus, Macalester College, St. Paul, Minnesota Chairman, President, and Chief Executive Officer, Super Valu Stores, Inc., Minneapolis, Minnesota Chairman and Chief Executive Officer, Cray Research Inc., Minneapolis, Minnesota .... 1986 1987 1988 HELENA BRANCH Appointed by the Federal Reserve Bank Dale W. Anderson President and Chief Executive Officer, Norwest Bank Great Falls, N.A., Great Falls, Montana Seabrook Pates President and General Manager, Midland Implement Company, Inc., Billings, Montana F. Charles Mercord President and Chief Executive Officer, First Federal Savings Bank of Montana, Kalispell, Montana Appointed by the Board of Governors Marcia S. Anderson President, Bridger Canyon Stallion Station, Inc., Bozeman, Montana Warren H. Ross President, Ross 87 Ranch, Inc., Chinook, Montana 1986 1986 1987 1986 1987 District 10—KANSAS CITY Class A Harold L. Gerhart, Jr Donald D. Hoffman Robert L. Hollis Class B Richard D. Harrison Vacancy Jerry D. Geist President and Chief Executive Officer, First National Bank of Newman Grove, Newman Grove, Nebraska Chairman of the Board, Central Bank of Denver, Denver, Colorado Chairman of the Board and Chief Executive Officer, First National Bank & Trust Co., Okmulgee, Oklahoma Chairman and Chief Executive Officer, Fleming Companies, Inc., Oklahoma City, Oklahoma Chairman and President, Public Service Company of New Mexico, Albuquerque, New Mexico 1986 1987 1988 1986 1987 1988 Directories and Meetings 287 Class C Fred W. Lyons, Jr President and Chief Executive Officer, Marion Laboratories, Inc., Kansas City, Missouri Robert G. Lueder Chairman of the Board, Lueder Construction Company, Omaha, Nebraska Irvine O. Hockaday, Jr. ...President and Chief Executive Officer, Hallmark Cards, Inc., Kansas City, Missouri Term expires Dec. 31 1986 1987 1988 DENVER BRANCH Appointed by the Federal Reserve Bank Roger L. Reisher Co-Chairman, FirstBank Holding Company of Colorado, Lakewood, Colorado Junius F. Baxter Chairman of the Board and Chief Executive Officer, Bank Western Federal Savings Bank, Denver, Colorado George S. Jenks President and Chief Executive Officer, Sunwest Financial Services, Inc., Albuquerque, New Mexico W. Richard Scarlett III Chairman and President, The Jackson State Bank, Jackson Hole, Wyoming Appointed by the Board of Governors James C. Wilson President and Chief Executive Officer, Rocky Mountain Energy, Broomfield, Colorado James E. Nielson President and Chief Executive Officer, JN Incorporated, Cody, Wyoming Anthony W. Williams Attorney, Williams, Turner, & Holmes, P.C., Grand Junction, Colorado 1986 1987 1988 1988 1986 1987 1988 OKLAHOMA CITY BRANCH Appointed by the Federal Reserve Bank William O. Alexander President and Chief Executive Officer, Continental Federal Savings & Loan Association, Oklahoma City, Oklahoma... Marcus R. Tower Tulsa, Oklahoma William H. Crawford Chairman and Chief Executive Officer, First National Bank and Trust Company, Frederick, Oklahoma 1987 Appointed by the Board of Governors John F. Snodgrass President and Trustee, The Samuel Roberts Noble Foundation, Inc., Ardmore, Oklahoma Patience S. Latting Oklahoma City, Oklahoma 1986 1987 1986 1986 288 Directories and Meetings OMAHA BRANCH Appointed by the Federal Reserve Bank Donald J. Murphy Director, Norwest Bank Nebraska, N.A., Omaha, Nebraska John T. Selzer President, Scottsbluff National Bank and Trust Company, Scottsbluff, Nebraska Charles H. Thorne Chairman of the Board and Chief Executive Officer, First Federal Savings and Loan Association of Lincoln, Lincoln, Nebraska Appointed by the Board of Governors Janice D. Stoney Executive Vice President and Chief Operating Officer, Northwestern Bell Telephone Company, Omaha, Nebraska... Kenneth L. Morrison President, Morrison-Quirk Grain Corporation, Hastings, Nebraska Term expires Dec. 31 1986 1987 1987 1986 1987 District 11—DALLAS Class A Miles D. Wilson Gene Edwards Charles T. Doyle Class B Kent Gilbreath Robert L. Pfluger Robert Ted Enloe III Class C Hugh G. Robinson Bobby R. Inman Robert D. Rogers Chairman of the Board and Chief Executive Officer, The First National Bank of Bellville, Bellville, Texas Chairman of the Board, First Amarillo Bancorporation, Inc., Amarillo, Texas Chairman and Chief Executive Officer, Gulf National Bank, Texas City, Texas Associate Dean, Hankamer School of Business, Baylor University, Waco, Texas Rancher, San Angelo, Texas President, Lomas & Nettleton Financial Corporation, Dallas, Texas President, Cityplace Development Corporation, Dallas, Texas Chairman of the Board, President, and Chief Executive Officer, Microelectronics and Computer Technology Corporation, Austin, Texas President and Chief Executive Officer, Texas Industries, Inc., Dallas, Texas 1986 1987 1988 1986 1987 1988 1986 1987 1988 EL PASO BRANCH Appointed by the Federal Reserve Bank David L. Stone President, The Portales National Bank, Portales, New Mexico 1986 Directories and Meetings 289 Tony A. Martin Gerald W. Thomas Chairman of the Board, First City National Bank of Midland, Midland, Texas President Emeritus and Professor of Animal Range Science, Center for International Programs, New Mexico State University, Las Cruces, New Mexico Vacancy Appointed by the Board of Governors John R. Sibley President, Delaware Mountain Enterprises, Carlsbad, New Mexico Mary Carmen Saucedo Associate Superintendent, Central Area Office, El Paso Independent School District, El Paso, Texas Peyton Yates President, Yates Drilling Company, Artesia, New Mexico Term expires Dec. 31 1987 1987 1988 1986 1987 1988 HOUSTON BRANCH Appointed by the Federal Reserve Bank Marcella D. Perry Port Commissioner, Port of Houston Authority of Harris County, Houston, Texas Thomas B. McDade Vice Chairman (Retired), Texas Commerce Bancshares, Inc., Houston, Texas David E. Sheffield Victoria, Texas Jeff Austin, Jr President, First National Bank of Jacksonville, Jacksonville, Texas Appointed by the Board of Governors Walter M. Mischer, Jr President, The Mischer Corporation, Houston, Texas Andrew L. Jefferson, Jr. ..Attorney, Jefferson, Mims, and Plummer, Houston, Texas Leo E. Linbeck, Jr Chairman and Chief Executive Officer, Linbeck Construction Corporation, Houston, Texas 1986 1987 1987 1988 1986 1987 1988 SAN ANTONIO BRANCH Appointed by the Federal Reserve Bank C. Ivan Wilson Chairman of the Board and Chief Executive Officer, First City Bank of Corpus Christi, Corpus Christi, Texas Joe D. Barbee President and Chief Executive Officer, Barbee-Neuhaus Implement Company, Weslaco, Texas Robert T. Rork Chairman of the Board and Chief Executive Officer, RepublicBank San Antonio, N.A., San Antonio, Texas Jane Flato Smith Rancher, San Antonio, Texas 1986 1987 1987 1988 290 Directories and Meetings Appointed by the Board of Governors Lawrence L. Crum Professor of Banking and Finance, The University of Texas at Austin, Austin, Texas Ruben M. Garcia Chief Executive Officer, Modern Machine Shop, Inc., Laredo, Texas Robert F. McDermott Chairman of the Board and President, United Services Automobile Association, San Antonio, Texas Term expires Dec. 31 1986 1987 1988 District 12—SAN FRANCISCO Class A Rayburn S. Dezember Donald J. Gehb Spencer F. Eccles Chairman, Central Pacific Corporation, and American National Bank, Bakersfield, California President and Chief Executive Officer, Alameda Bancorporation and Alameda First National Bank, Alameda, California Chairman, President and Chief Executive Officer, First Security Corporation, Salt Lake City, Utah 1986 1987 1988 Class B John C. Hampton George H. Weyerhaeuser Togo W. Tanaka President, Willamina Lumber Company, Portland, Oregon 1986 President and Chief Executive Officer, Weyerhaeuser Company, Tacoma, Washington Chairman, Gramercy Enterprises, Inc., Los Angeles, California 1987 1988 Class C Fred W. Andrew Alan C. Furth Carolyn S. Chambers President, Apex Orchards, Inc., Bakersfield, California Vice Chairman, Santa Fe Southern Pacific Corporation, and President, Southern Pacific Company, San Francisco, California President and Chief Executive Officer, Chambers Communications Corp., Eugene, Oregon 1986 1987 1988 LOS ANGELES BRANCH Appointed by the Federal Reserve Bank Harvey J. Mitchell President and Chief Executive Officer, Escondido National Bank, Escondido, California 1986 Directories and Meetings 291 Robert R. Dockson Howard C. McCrady William L. Tooley Chairman of the Board, CalFed, Inc., and California Federal Savings and Loan Association, Los Angeles, California Chairman of the Board, Valley National Bank, Phoenix, Arizona Chairman, Tooley & Company, Investment Builders, Los Angeles, California Appointed by the Board of Governors Lola M. McAlpin-Grant.. .Attorney, Inglewood, California Richard C. Seaver President, Hydril Company, Los Angeles, California Thomas R. Brown, Jr Chairman of the Board, Burr-Brown Corporation, Tucson, Arizona Term expires Dec. 31 1987 1988 1988 1986 1987 1988 PORTLAND BRANCH Appointed by the Federal Reserve Bank William S. Naito Vice President, Norcrest China Company, Portland, Oregon John A. Elorriaga Chairman of the Board and Chief Executive Officer, United States National Bank of Oregon, Portland, Oregon G. Dale Weight Chairman of the Board and Chief Executive Officer, Benjamin Franklin Savings and Loan Association, Portland, Oregon Herman C. Bradley, Jr President and Chief Executive Officer, Tri-County Banking Company, Junction City, Oregon Appointed by the Board of Governors Paul E. Bragdon President, Reed College, Portland, Oregon.. Sandra A. Suran Partner in Charge, Peat, Marwick, Mitchell and Co., Beaverton, Oregon G. Johnny Parks Former Northwest Regional Director, International Longshoremen's & Warehousemen's Union, Portland, Oregon 1986 1987 1987 1988 1986 1987 1988 SALT LAKE CITY BRANCH Appointed by the Federal Reserve Bank Albert C. Gianoli President and Chairman of the Board, First National Bank of Ely, Ely, Nevada Lela M. Ence , Executive Director, University of Utah Alumni Association, Salt Lake City, Utah Fred C. Humphreys Chairman and Chief Executive Officer, The Idaho First National Bank and Moore Financial Group, Boise, Idaho Gerald R. Christensen President, First Federal Savings and Loan Association, Salt Lake City, Utah 1986 1987 1987 1988 292 Directories and Meetings Appointed by the Board of Governors Robert N. Pratt President, Moriah Enterprises, Inc., Bountiful, Utah Don M. Wheeler President, Wheeler Machinery Company, Salt Lake City, Utah D. N. Rose President and Chief Executive Officer, Mountain Fuel Supply Company, Salt Lake City, Utah Term expires Dec. 31 1986 1987 1988 SEATTLE BRANCH Appointed by the Federal Reserve Bank H. H. Larison President, Columbia Paint Company, Spokane, Washington John N. Nordstrom Co-Chairman of the Board, Nordstrom, Inc., Seattle, Washington William S. Randall President and Chief Executive Officer, First Interstate Bank of Washington, N.A., Seattle, Washington William W. Philip Chairman of the Board and President, Puget Sound National Bank, Tacoma, Washington Appointed by the Board of Governors Carol A. Nygren Managing Partner, Laventhol & Horwath, Seattle, Washington John W. Ellis President and Chief Executive Officer, Puget Sound Power & Light Company, Bellevue, Washington Byron I. Mallott Chief Executive Officer, Sealaska Corporation, Juneau, Alaska 1986 1987 1987 1988 1986 1987 1988 Index 295 Index Acceptances, bankers (See Bankers acceptances) Adjustable-rate mortgages Amendment to Regulation Z, 161 Consumer Handbook on Adjustable Rate Mortgages, 161, 167, 172 Agriculture Farm Credit Act, 184 Problem loans, 192 Seasonal credit program, renewal, 83 American Institute of Certified Public Accountants, 193 Annual Report: Budget Review, 213 Anti-Drug Abuse Act of 1986, 202 Assets and liabilities Banks, by class, 247 Board of Governors, 215-20 Federal Reserve Banks, 224-27 Audits (See Examinations, inspections, regulation, and audits) Automated clearinghouse service, 77, 194, 210, 212 Automated teller machines, 168 Automobile credit, 166 Balance of payments (See U.S. international transactions) Bankers acceptances Authority to purchase and to enter into repurchase agreements, 87-89 Federal Reserve Banks Holdings, 213, 222, 224, 226 Income, 212, 234-37 Open market transactions, 228 Repurchase agreements, 87-89, 222, 224, 226, 228 Bank Export Services Act, 202 Bank holding companies (See also Regulations: Y) Activities approved, pending, and denied, 198-202 Amendment to Regulation Y, 78 Antitrust action, 181 Applications by, processing and notice of Board decisions, 193, 198-202 Bank holding companies — Continued Capital adequacy guidelines, 80, 191-92 Examination, inspection, and regulation, 187, 188-91, 206 International activities, 189, 200 Legislative recommendations, 177-78 Litigation, 181-86 Number and assets, 188 Stock repurchases by, 200 Surveillance and monitoring program, 190 Bank Holding Company Act (See also Regulations: Y) Amendment to Rules Regarding Delegation of Authority, 80 Legislative recommendations and litigation, 177-86, 200, 206-07 Provisions, 188, 196, 198, 201 Bank Holding Company Supervision Manual, 191 Banking offices, changes in number, 234 Banking supervision and regulation by Federal Reserve System, 187-204 Bank, new definitions, legislative recommendations, 177-78 Bank of England, 187, 192 Bank of Japan, 15 Bank Merger Act, 197 Bank mergers and consolidations, 253-61 Bank Secrecy Act, 202 Basic financial services, 80, 163, 172 Board of Governors (See also Federal Reserve System) Budget, 213 Cash, sources, uses, and balance at end of 1986, 215-20 Consumer Advisory Council, 171-72, 268 Delegated authority, 198 Expenses (See Income and expenses) Financial statements, 215-20 Income (See Income and expenses) Interpretations (See Interpretations of Regulations) 296 Index Board of Governors —Continued Legislative recommendations, 173-75, 177-80 Litigation, 181-86 Members and officers, 264 Policy actions (See Policy actions) Pricing of Federal Reserve services (See Fees) Publications (See Publications) Regulations (See Regulations) Regulatory simplification, 205-07 Salaries, 231 Branch banks Federal Reserve (See Federal Reserve Banks) Foreign branches of U.S. banking organizations, 189, 200-02 U.S. activities of foreign banks, 189-90 Budgets, Federal Reserve Board and Banks, 213 Business credit transactions, proposed legislation, 174 Call Reports, 195 Capital accounts Banks, by class, 232 Federal Reserve Banks, 222, 224, 226 Capital adequacy guidelines, 80, 191-92 Change in Bank Control Act of 1978, 78, 197-98 Check clearing and collection Availability of funds, speedup, 165, 172, 209 Fees for Federal Reserve services, 209-14 Float (See Float) Legislative recommendations, 180 Volume of operations, 244 Coin and currency services, 211 Combined Construction/Permanent Loan Disclosures and Regulation Z, brochure, 167 Commercial Bank Examination Manual, 191 Commercial banks (See also Insured commercial banks) Banking offices, changes in number, 252 Supervision and regulation by Federal Reserve System, 187-204 Transfers of funds (See Transfers of funds) Commodity Credit Corporation, 10-11, 61 Communique, newsletter, 164 Community Affairs Officers, 163-64 Community Affairs Program, 164 Community Reinvestment Act Examination under, 163, 164, 165, 171, 172 Comptroller of the Currency Conformity with, 192, 195 Jurisdiction, 189, 197 Reports, orders, and legislative recommendations by, 163, 165-66 Condition statements of Federal Reserve Banks, 222, 224-27 Congressional Budget Office, 10 Construction Loan Disclosures and Regulation Z, brochure, 167 Consumer Advisory Council, 171-72, 268 Consumer and community affairs, 161-75 Consumer Complaint Control System, 169 Consumer Handbook on Adjustable Rate Mortgages, 161, 167, 172 Credit (See also Loans) Equal Credit Opportunity (See Equal Credit Opportunity Act) Real estate, 9, 166 Seasonal credit program, renewal, 83 Securities, 76-77, 202 Truth in Lending (See Truth in Lending Act) Credit cards, 173-74 Credit Practices Rule (See also Regulations: A A) Update to staff guidelines, 162 Currency and coin services, 211 Currency and Foreign Transactions Reporting Act (Bank Secrecy Act), 202 Depository institutions Checks (See Check clearing and collection) Interest on deposits (See Interest on deposits) Reserve requirements (See Regulations: D) Reserves and related items, 248-51 Services to (See Fees) ' Index 297 Deposits Banks, by class, 247 Checks (See Check clearing and collection) Federal Reserve Banks, 222, 224, 226, 249, 253 Interest rates (See Interest on deposits) Reserve requirements (See Reserve requirements of depository institutions) Directors, Federal Reserve Banks and Branches Legislative recommendation, 179 List, 272 Discount rates at Federal Reserve Banks (See Interest rates) Dividends Federal Reserve Banks, 212-13, 234, 239, 240 Federal Reserve System, 233 Earnings of Federal Reserve Banks, 212, 234-37, 238-41 Economy in 1986, 5-11 Edge and agreement corporations, 187-88, 189, 190, 193, 201, 202 Educational activities, 193, 195 Education Foundation of State Bank Supervisors, 193 Electronic data processing activities, examination, 190 Electronic Fund Transfer Act Compliance with, 168 Economic impact, 168-69 Electronic fund transfers (See Transfers of funds and Regulations: E) Electronic fund transfer systems, policy of reducing risks on large-dollar transfers, 193 Equal Credit Opportunity Act Compliance with, 167-68 Regulation B (See Regulations) Examinations, inspections, regulation, and audits Bank holding companies, 187-91, 177-78, 188 Federal Reserve Banks, 212 International activities, 189 Large-dollar electronic fund transfers, 193, 205 Specialized, 190 State member banks, 164-65, 188 Examinations, inspections, regulation, and audits—Continued Surveillance and monitoring program, relation to, 190-91 System Open Market Account, 212 Expenses (See Income and expenses) Export trading companies, 189, 202 Farm Credit Act, 183, 184 Farm Credit Administration, 166, 167, 203 Farm Credit System, 22 Federal Advisory Council, 267 Federal agency securities Authority to purchase and to enter into repurchase agreements, 87-89, 118, 153 Federal Reserve Bank holdings, 214, 222, 224, 226, 230, 248 Federal Reserve open market transactions for 1986, 228 Repurchase agreements, 87-89, 222, 224, 226, 228, 230 Transfer, by Reserve Banks, 211 Federal Bureau of Investigation, training by, 195 Federal Deposit Insurance Corporation, 163, 165-66, 178, 189, 192, 195 Provisions involving, and jurisdiction, 197 Federal Financial Institutions Examination Council, 80, 163, 172, 193, 195 Federal Home Loan Bank Board Actions taken, 95, 163, 165-66, 167 Compliance with, 195, 203 Publication, 161 Federal Home Loan Banks, 17 Federal Home Loan Mortgage Corporation, 211 Federal National Mortgage Association, 211 Federal Open Market Committee Audit of System Open Market Account, 212 Litigation, 185 Meetings, 13, 87 Members and officers, 266 Policy actions, 81, 82, 83, 87-160 Federal Reserve Act Legislative recommendations, 179 Provisions, 189, 201, 204, 212 Federal Reserve Agents, 272 298 Index Federal Reserve Banks Assessments for expenses of Board of Governors, 217, 234, 238, 240 Atlanta Bank, 164 Bank premises, 179, 213, 222, 224, 226, 232 Branches Bank premises, 179, 213, 232 Directors, 273 Vice presidents in charge, 271 Budgets, 213 Capital accounts, 223, 224, 226 Chairmen and deputy chairmen, 271 Coin and currency service, 211 Condition statement, 222, 224 Dallas Bank, 164 Delegated authority, 197, 198 Deposits, 223, 224, 226, 249, 251 Directors Legislative recommendation, 179 List, 273 Dividends paid, 213, 234, 239, 241 Examination or audit, 212 Expenses (See Income and expenses) Income (See Income and expenses) Interest rates, 81-83, 244 Kansas City Bank, 186 Loans and securities, 213, 222, 224, 226, 230, 232, 248, 250 Minneapolis Bank, 164 New York Bank, 87, 160, 212 Officers and employees, number and salaries, 231 Operations, volume, 244 Philadelphia Bank, 164 Presidents and first vice presidents, 231, 271 Pricing of services, 209-12, 234, 242 Profit and loss, 236 Richmond Bank, 164 Seasonal credit program, renewal, 83 Training, 193, 195 Federal Reserve Board (See Board of Governors) Federal Reserve Bulletin, 200 Federal Reserve notes Condition statement data, 222-27 Cost of issuance and redemption, 213, 217 Interest paid to U.S. Treasury on, 213, 233 Litigation, 185 Federal Reserve Reform Act of 1977, Digitized for 298 FRASER Federal Reserve System (See also Board of Governors) Banking supervision and regulation by, 187-204 Budgets, 212-13, 233, 234 Consumer affairs (See Consumer and community affairs) Costs of certain services, 193 Expenses (See Income and expenses) Foreign currency operations (See Foreign currencies) Income (See Income and expenses) Map of Federal Reserve Districts, 262 Membership, 204 Pricing of services, 193, 209-12, 234, 242 Training, 193, 195 Federal Savings and Loan Insurance Corporation, 167, 297 Federal Trade Commission, 167, 168 Federal Trade Commission Improvement Act, unregulated practices, 171 Fedwire, 193, 206, 210 Fees Federal Reserve services to depository institutions Automated clearinghouse service, 210 Check clearing and collection, 209 Pricing of, 209-12, 234, 242 Proposal to charge for services, 193 Securities and noncash collection services, 211 U.S. Treasury securities, 211 Financial Accounting Standard 15, 187 Financial Accounting Standards Board, 193 Financial Institutions Supervisory Act of 1966, 183, 188 Financial markets and monetary policy, 13-23 Float (See also Check clearing and collection), 77, 209, 210, 212 Foreign banking and financing (See Regulations: K) Foreign banks, U.S. activities, 189-90 Foreign branches of U.S. banking organizations, 189, 200-02 Foreign currencies Authorization and directive for operations in, and review of documents, 87, 90, 92 Federal Reserve income on, 234 Index 299 Foreign exchange operations, 31 Full Employment and Balanced Growth Act of 1978, 3, 13, 33 Garn-St Germain Depository Institutions Act of 1982, 76, 78, 178, 206 Glass-Steagall Act, 183, 184 Gold certificate accounts of Reserve Banks and gold stock, 222, 224, 226, 248, 250 Gramm-Rudmann-Hollings legislation, 5, 10 Guide to Business Credit and the Equal Credit Opportunity Act, 161, 162 Income and expenses Board of Governors, 215-20 Federal Reserve Banks, 212-13, 234-37, 238-41 Federal Reserve System, 213, 233 Reports of Condition and Income, (Call Reports), 195 Insured commercial banks (See also Commercial banks) Acquisition authority in emergency, legislative recommendation, 178-79 Assets and liabilities, 247 Banking offices, changes in number, 252 Number, by class of bank, 247 Interest on deposits (See also Interest rates) Dates of removal of rate ceilings on time and savings deposits, 246 Regulation Q (See Regulations) Interest rates (See also Interest on deposits) Annual percentage rate, 172, 173-74 Credit cards, 173-74 Federal Reserve Banks Changes, 81-83, 84-85 Discount window, new policy, 83 Structure of discount rate, 84 Table, 244 Mortgage loans, 161 Internal Revenue Service, 185, 202 International banking activities, 189-90, 200-02, 207 International banking facilities, 201 International banking operations, 77, 207 201, International developments, review of 1986, 25-31 International Monetary Fund, 31 International transactions, U.S., 28-30 Interpretations of Regulations Margin regulations, 76, 202-04 Regulations B, E, and Z, 162 Regulation Q, 201, 205 Interstate banking, 179-80, 199 Interstate Commerce Commission, 167 Investments Banks, by class, 247 Federal Reserve Banks, 222, 224, 226 Foreign, by U.S. banking organizations, 201 State member banks, 201, 247 Labor market developments, 8 Legislative recommendations Board of Governors, 173-75, 177-80 Of other agencies with enforcement responsibilities, 175 Litigation Bank holding companies, 181-83 Board procedures and regulations, challenges to, 183-86 Loans (See also Credit) Agricultural (See Agriculture) Banks, by class, 247 Energy, 192 Executive officers of state member banks, 204 Federal Reserve Banks Holdings and income, 213-14, 222, 224, 226, 230, 234, 236, 248, 250 Interest rates, 81-85, 244 To depository institutions, 222, 224, 226, 234, 248, 250 Volume of operations, 244 Real estate, 9, 166 Margin credit regulation (See Regulations: G, T, U, and X) Margin requirements, 76, 202-04, 246 Member banks (See also Depository institutions and National banks) Assets, liabilities, and capital accounts, 247 Banking offices, changes in number, 252 Borrowings and loans (See Loans) Branches, 200, 201 300 Index Member banks —Continued Capital adequacy guidelines, 80, 191-92 Control of, changes in, 197 Membership in Federal Reserve System, 204 Number, 247 Reserve requirements, 245 Reserves and related items, 248-51 State member banks (See State member banks) Surveillance and monitoring program, 190 Transfers of funds (See Transfers of funds) Mergers and consolidations, 197, 198 Monetary Control Act of 1980, 179, 209 Monetary policy Financial markets relative to, 13-23 Reports to the Congress, 3, 33-72 Review of 1986, 3-12 Mortgage loans, 9, 166 Mutual savings banks, 244 National banks (See also Member banks) Assets, liabilities, and capital accounts, 247 Banking offices, changes in number, 244 Capital adequacy guidelines, 80, 191-92 Foreign branches, 189, 200, 201 Number, 247 National Credit Union Administration, 163, 165-66, 195, 203 Neighborhood Reinvestment Corporation, 164 Net Settlement Service, 210 Nonbanking activities, 199 Nonmember depository institutions Assets and liabilities, 247 Banking offices, changes in number, 244 Number, 247 Over-the-counter marginable stocks, 203 Payments mechanism (See also Fees), 209-12 Policy actions Board of Governors Discount rates at Federal Reserve Banks, 81-85 Regulations, 75-79 Statements and other actions, 80, 161-63, 165, 172 Federal Open Market Committee (See also System Open Market Account), 87-160 Presidents and vice presidents of Federal Reserve Banks Conferences, 272 List, 271-72 Salaries of presidents, 230 Prices, 5-8 Pricing of Federal Reserve services, 209-12, 234, 242 Profit and loss, Federal Reserve Banks, 234 Proposed revisions to Regulation Q, 205 Publications Annual Report: Budget Review, 213 Bank Holding Company Supervision Manual, 191 '' Combined Construction/Permanent Loan Disclosures and Regulation Z," 167 Commercial Bank Examination Manual, 191 Communique, newsletter, 164 "Construction Loan Disclosure and Regulation Z," 167 Consumer Handbook on Adjustable Rate Mortgages, by Federal Reserve Board and Federal Home Loan Bank Board, 161, 167, 172 Credit Practices Rule, staff guidelines, 162 Federal Reserve Bulletin, 200 Guide to Business Credit and the Equal Credit Opportunity Act, 161, 162 Marginable over-the-counter stocks, list, 203 Regulations B, E, and Z, official staff commentaries, 162 Regulation Z Interagency Enforcement Policy Guide, 166 "Regulation Z: The Right of Rescission," 167 Index 301 Publications —Continued "Regulation Z: Understanding Prepaid Finance Charges," 167 "Securities Credit Transactions Handbook," Federal Reserve Regulatory Service, 203 Real estate loans, 9, 166 Regulation of banking organizations (See Banking supervision and regulation by Federal Reserve System) Regulations (See also Regulatory Improvement Project and Rules Regarding Delegation of Authority) AA, Unfair or Deceptive Acts or Practices, 162 B, Equal Credit Opportunity, 162, 165, 167, 174, 175 D, Reserve Requirements of Depository Institutions, 75, 76, 201, 205 E, Electronic Fund Transfers, 161, 162, 165, 168-69, 172, 175 F, Securities of State Member Banks, 204 G, Securities Credit by Persons Other than Banks, Brokers, or Dealers, 76, 202-04 J, Collection of Checks and Other Items and Wire Transfers of Funds, 77, 212 K, International Banking Operations, 77, 201, 207 Q, Interest on Deposits, 75, 201, 205 T, Credit by Brokers and Dealers, 202-04 U, Credit by Banks for the Purpose of Purchasing or Carrying Margin Stocks, 202-04 X, Borrowers of Securities Credit, 202-04 Y, Bank Holding Companies and Change in Bank Control, 78, 181, 191, 199, 206 Z, Truth in Lending, 78, 161, 162, 165, 167, 175 Regulation Z: The Right of Rescission, brochure, 167 Regulation Z: Understanding Prepaid Finance Charges, 167 Regulatory Improvement Project, 175, 205 Regulatory Policy and Planning Committee, 205 Regulatory simplification, 205-07 Report on Formal Enforcement Actions, 189 Repurchase agreements Authority to purchase and to enter into, 87-89 Bankers acceptances (See Bankers acceptances) Federal agency securities (See Federal agency securities) U.S. Treasury securities (See U.S. Treasury securities) Reserve requirements of depository institutions Regulation D (See Regulations) Table, 245 Reserves and related items, 251 Right to Financial Privacy Act, 184 Rules Regarding Delegation of Authority, 79, 198 Salaries Board of Governors, 217 Federal Reserve Banks, 231 Schools, 193, 195 Seasonal Credit Program, renewal, 83 Securities (See also specific types) Credit, 76, 203, 246 Municipal securities dealers, clearing agents, and transfer agents, 190 Over-the-counter, 203 Regulation, 202-04 Services by Federal Reserve, 211 Securities Act Amendments of 1975, 190 "Securities Credit Transactions Handbook," Federal Reserve Regulatory Service, 203 Securities and Exchange Act of 1934, 202-04 Securities of state member banks, 204 Small Business Administration, 167 Special drawing rights, 222, 224, 226, 248, 250 302 Index State member banks (See also Member banks) Applications by, 200 Assets and liabilities, 188, 247 Banking offices, changes in number, 252 Basic financial services, recommendations, 172 Capital adequacy guidelines, 80, 191-92 Consumer complaints against, 169-71 Control of, changes, 197 Examinations and inspections, 164, 171, 187-91 Fees (See Fees) Financial disclosures, 204 Foreign branches, 201 Interest on deposits (See Interest on deposits) Loans to executive officers, 204 Membership in Federal Reserve System, 204 Mergers and consolidations (See Bank mergers and consolidations) Number, 188, 247 Reserve requirements (See Reserve requirements of depository institutions) Securities of, 204 Survey on delayed availability of funds, 165 Stock market credit (See Securities credit) Supervision of banking organizations (See Banking supervision and regulation by Federal Reserve System) System Open Market Account Audit, 212 Domestic Open Market Operations, Authorization for, 87, 88-89, 118-52 Domestic Policy Directive, 87, 89, 93, 103, 110, 119, 130, 138, 145, 153 Foreign Currency Directive, 92 Foreign Currency Operations, Authorization for, 87, 90-92 Thrift institutions, legislative recommendations and approval of acquisitions, 177-79, 198 Training, 193, 195 Transfer agents, 190 Transfers of funds (See also Fees) Check clearing and collection (See Check clearing and collection) Federal Reserve operations, volume, 244 Large-dollar transfers, policy on reducing risks, 193, 205 Pricing of Federal Reserve services, 209-12, 234, 242 Trust activities, examination, 190 Truth in Lending Act Annual percentage rate, 172, 173-74 Compliance with, 165, 173 Regulation Z (See Regulations) Truth in Savings, proposed legislation, 174 Thrift Institutions Advisory Council, 270 World Bank, 31 FRB l-ll,200-0587C Uniform Bank Performance Report, 196 U.S. Department of Agriculture, Packers and Stockyards Administration, 166, 167 U.S. Department of Justice, 181 U.S. Department of Transportation, 166, 167, 168 U.S. Department of the Treasury, 202, 212 U.S. international transactions, 28-30 U.S. Treasury securities Authority to buy, to enter into repurchase agreements, and to lend, 87-89, 118, 152 Bank holdings, by class of bank, 247 Federal Reserve Banks Holdings, 213-14, 222, 224, 226, 230, 248, 250 Income, 213, 234-37 Transfers by, 211 Open market transactions, 228 Repurchase agreements Authorization for, 87-89 Board policy statement, 80 Tables, 222, 224, 226, 228, 230, 248, 250