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MEMORANDUM OF DISCUSSION
A meeting of the Federal Open Market Committee was held in
the offices of the Board of Governors of the Federal Reserve
System in Washington, D.C. on Monday and Tuesday, April 15-16,
1974, beginning at 4:00 p.m. on Monday.
PRESENT:
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Burns, Chairman
Hayes, Vice Chairman
Black
Brimmer
Bucher
Clay
Holland
Kimbrel
Mitchell
Sheehan
Wallich
Winn
Messrs. Coldwell, MacLaury, Mayo, and Morris,
Alternate Members of the Federal Open
Market Committee
Mr. Eastburn, President of the Federal Reserve
Bank of Philadelphia
Mr. Broida, Secretary
Mr. Altmann, Deputy Secretary
Mr. Bernard, Assistant Secretary
Mr. O'Connell, General Counsel
Mr. Partee, Senior Economist
Mr. Axilrod, Economist (Domestic Finance)
Messrs. Brandt, Bryant, Davis, Doll, Hocter,
Parthemos, and Pierce, Associate Economists
Mr. Holmes, Manager, System Open Market
Account
4/15/74
Mr. Coyne, Assistant to the Board of
Governors
Mr. O'Brien, Special Assistant to the
Board of Governors
Mr. McWhirter1 /, Associate Director,
Division of Federal Reserve Bank
Operations, Board of Governors
Mr. Keir, Adviser, Division of Research
and Statistics, Board of Governors
Miss Pruitt, Economist, Open Market
Secretariat, Board of Governors
Mrs. Ferrell, Open Market Secretariat
Assistant, Board of Governors
Messrs. Leonard and Williams, First Vice
Presidents, Federal Reserve Banks of
St. Louis and San Francisco, respectively
Messrs. Boehne, Scheld, and Sims, Senior Vice
Presidents, Federal Reserve Banks of
Philadelphia, Chicago, and San Francisco,
respectively
Messrs. Willey, Jordan, and Green, Vice
Presidents, Federal Reserve Banks of
New York, St. Louis, and Dallas,
respectively
Mr. Poole, Adviser, Federal Reserve Bank
of Boston
Mr. Duprey, Senior Economist, Federal
Reserve Bank of Minneapolis
Mr. Gillum, Economist, Federal Reserve Bank
of Philadelphia
By unanimous vote, the minutes
of actions taken at the meeting of
the Federal Open Market Committee
held on March 18-19, 1974, were
approved.
The memorandum of discussion
for the meeting of the Federal Open
Market Committee held on March 18-19,
1974, was accepted.
1/ Entered meeting at point indicated.
4/15/74
Mr. McWhirter, Associate Director of the Board's Division
of Federal Reserve Bank Operations, entered the meeting.
Chairman Burns noted that a report of examination of the
System Open Market Account, dated April 10, 1974, had been dis
tributed to the Committee on April 11.
He asked Mr. McWhirter
to comment.
Mr. McWhirter observed that the examination of the System
Account, including foreign currency operations, had been made as
at the close of business March 8, 1974.
In contrast to the situa
tion at the time of the previous examination, in July 1973, no out
of-balance conditions were found.
No errors had been made in the
accounts since the first of the year; an error that had occurred
in December had been discovered and corrected by the Bank well
before the examination started.
In his opinion, the new computer
systems that had been installed, the new computer programs in use,
and the attention of management were entirely adequate.
The reports of audit of the
System Open Market Account and of
foreign currency operations, made
by the Board's Division of Federal
Reserve Bank Operations as at the
close of business March 8, 1974,
were accepted.
Mr. McWhirter left the meeting at this point.
4/15/74
Chairman
Burns noted that at its previous meeting the
Committee had considered a recommendation by the Manager, con
tained in his memorandum of March 15, 1974, that the System begin
submitting noncompetitive bids in rolling over official account
holdings of Treasury bills in regular bill auctions.
A decision
had been deferred pending the development of certain additional
information, and a new memorandum from the Manager had been dis
tributed on April 9, 1974.1 /
He asked Mr. Holmes to comment.
Mr. Holmes said he hoped the new memorandum circulated
last week answered the questions that had been raised by some
Committee members in the earlier discussion.
As reported in the
memorandum, an analysis of the bill auctions over a 3-month periodfrom December 1973 through February 1974--indicated that, on the
average, System bids for 3-month bills were priced at the equivalent
of .003 of a percentage point above the average bids of all other
competitive bidders; for
6-month bills the corresponding figure
was .001 of a percentage point.
It seemed to him that those results
indicated that a shift to a noncompetitive bidding basis, under
which official tenders in an auction would be awarded at the average
price, would have very little effect on the auctions.
1/ A copy of the new memorandum, dated April 8, 1974, and entitled
"Proposal to bid for Treasury bills on a noncompetitive basis," has been
placed in the Committee's files.
4/15/74
Mr. Holmes noted that the procedures he proposed also
would call for the Treasury to announce, in advance of each
bill auction, the total amount of official holdings of maturing
bills--by the System, Treasury investment accounts, and foreign
official accounts--that would be eligible for noncompetitive roll
over.
As he had mentioned at the previous meeting and in his latest
memorandum, it was possible that such announcements would have some
effect on the average prices received by the Treasury in individual
auctions; in particular, dealers might tend to bid more aggressively
for the remaining supply when official holdings were relatively
large and less aggressively when they were relatively small.
Over
time, however, such effects should balance out.
As indicated in his latest memorandum, Mr. Holmes continued,
he recommended that the Committee approve the proposals contained in
his memorandum of March 15.
The Treasury had agreed to those pro
posals and was prepared to make the change promptly if the Committee
approved them.
The Treasury presumably would publish an explana
tion of the new procedure in one of its regular bulletins; he would
expect to work with Treasury personnel and with Board staff on the
text of the explanation.
Mr. Brimmer observed that he had been among those at the
previous meeting who had raised questions about the likely effects
4/15/74
on prices of a shift to noncompetitive tenders for official
accounts.
He had expected the effects to be in the direction
reported in Mr. Holmes' memorandum but had thought they would
be larger.
In any case, he was now prepared to approve the
proposals.
Mr. Coldwell remarked that, despite the findings reported
by Mr. Holmes, he still had some concerns about the proposal.
If
the Committee were inclined to approve it he would suggest that it
do so for a trial period of, say, 6 months.
The Manager might then
report on how well the new bidding method was working and the
Committee could decide whether or not to continue it.
Mr. Hayes asked the Manager whether he considered 6 months
a desirable period for the purpose Mr. Coldwell had suggested.
Mr. Holmes replied that if there were problems with the
approach--and he was not aware of any at present--they were likely
to emerge long before 6 months had elapsed.
Mr. Brimmer expressed a similar view.
He added that, once
the new approach was announced, market participants would have a
right to expect that it would be continued unless serious problems
developed.
He favored proceeding on the assumption that the approach
would work rather than viewing it as experimental.
he was opposed to the suggestion of a trial period.
In particular,
4/15/74
Mr. Hayes proposed that the Manager simply be asked to
inform the Committee promptly if any problems arose.
Mr. Coldwell said he thought the Committee should review
the approach after some specific period--he had used 6 months only
as an example--on the basis of a report by the Manager on how
well it was working.
The Chairman suggested that if the Committee approved the
Manager's recommendations it should do so on the understanding that
Mr. Holmes would submit a formal report on how well the approach
was working at any time he felt able to do so but not later than
6 months from now.
There was general agreement with the Chairman's suggestion.
Mr. Mitchell asked whether it was likely, under the proposed
approach, that any one dealer would bid successfully for the bulk
of the bills available to the public in auctions when official hold
ings of maturing bills were very large.
Mr. Holmes said he thought that was quite unlikely.
In any
case, the Treasury had the right to reject any tenders, and it now
followed a rule of thumb under which no bidder would be awarded
more than 25 per cent of the issues offered in an auction.
Mr. Wallich referred to Mr. Holmes' comment that under the
new approach dealers might bid more or less aggressively, depending
4/15/74
on whether official holdings of maturing bills were relatively
large or small.
He agreed that the
effects should balance out
over time in terms of a simple average of the average prices in
successive auctions.
It might be worth noting, however, that the
prices would tend to be more favorable to the Treasury when the
volume of bills bid for by the public was small and less favorable
when that volume was large.
On a weighted average basis, therefore,
there would be a small net disadvantage to the Treasury.
After further discussion, the Committee agreed that the
recommendations set forth in the Manager's memorandum of March 15,
1974, should be approved, subject to the understanding suggested
by the Chairman that within 6 months Mr. Holmes would submit a
formal report on how well the approach was working.
By unanimous vote, the Committee
approved the recommendations contained
in a memorandum from the System Account
Manager dated March 15, 1974, entitled
"Proposal to bid for Treasury bills on
a noncompetitive basis."
The Chairman suggested that the Committee turn to the
question of the kinds of information on longer-run targets that
should be included in the policy records.
In the discussion last
December the Committee had agreed, after extensive debate, to
publish its short-run ranges of tolerance in quantitative form
and to describe its longer-run targets in qualitative terms.
The
4/15/74
first policy record prepared on the new basis--for the meeting
held in January--would be published in about a week.
It could
be argued that any further discussion of the matter today would
be premature, since it had been the sense of the December discus
sion that the Committee should proceed cautiously--taking an
initial step with respect to the short-run targets and then,
after some experience had been gained, considering whether to
take a further step with respect to the longer-run targets.
How
ever, the question had been raised in a proper manner and was now
before the Committee.
Chairman Burns noted that a staff memorandum containing
background material, including a listing of four alternative courses
that might be followed at this point, had been distributed.1/
While
1/ A copy of this memorandum, dated April 3, 1974, and entitled
"Background material for contemplated discussion of desirability of
publishing longer-run targets in policy record," has been placed in
the Committee's files. The four alternative courses suggested for
Committee consideration were as follows:
1. Holding to the decision taken in December, in the
expectation that the whole subject of publication of target
information will be reviewed after some experience is accu
mulated under the procedures agreed upon then, . . .It could
be argued in support of this alternative that there have been
no developments since December to cause the Committee to
reverse a considered decision.
2. Setting aside the December decision, and agreeing
that longer-run targets, as well as short-run ranges of
tolerance, shall be published in numerical form in policy
(Footnote continued on next page)
4/15/74
-10
the members were, of course, free to comment on any of the four possible
courses, he would suggest that they focus mainly on alternatives 1 and 3.
The Chairman then invited Mr. Eastburn to open the discussion.
Mr. Eastburn said he would speak to the two alternatives
the Chairman had mentioned.
While he personally would be inclined
to publish the longer-run targets in quantitative form, he was not
sure about the possible effects of such a course and accordingly
concurred in the view that the Committee should move cautiously.
Since the January policy record had not yet been published, the
records beginning, say, with that for the February meeting.
Adoption of this alternative presumably would be on the
grounds that the December decision was a mistaken one.
3. Holding to the December decision, but agreeing
not to exclude directives calling for growth in monetary
aggregates over the months ahead at "faster (slower)" or
"somewhat faster (slower)" rates than experienced in some
specified past period. . . .It could be argued that this
alternative would reduce the risks of undesirable market
effects to an acceptable level, since it would not involve
explicit or implicit disclosure of the precise numerical
targets or even the identity of the target measures, and
since the period to which the targets applied would be
stated in general terms ("over the months ahead"). At
the same time, the language would give at least some
general impression, albeit imprecise, of the direction
and broad thrust of monetary objectives.
4. Proceeding as in (3), but also agreeing not to
exclude directives calling for growth in monetary aggre
gates at rates "about the same as" those in some historical
period. This alternative would be somewhat more forthcom
ing about the nature of the longer-run targets. On the
other hand, the language could be interpreted more precisely
than that under (3), and therefore would involve greater
risks of undesirable market effects.
-11-
4/15/74
members had not had an opportunity to observe the reaction in
financial markets to the disclosure of the short-run ranges of
tolerance.
They had, however, had an opportunity to review a
draft of that policy record and to observe how the citation of
the short-run targets would appear in context.
In his judgment,
the public was likely to be confused by a series of records in
which varying--sometimes widely varying--short-run targets were
associated with directives calling for "moderate" growth in the
monetary aggregates.
He thought it would be appropriate for the
Committee to remedy that situation at an early point, rather than
let such confusion accumulate.
In sum, Mr. Eastburn continued, he favored alternative 3
over 1.
The analysis in the paper prepared at the Philadelphia
Bank,1/which the members had received, supported going at least
as far as alternative 3; as the paper indicated, that would repre
sent not a new step but rather a return to a trend that had been
interrupted last year.
The main point, in his view, was that the
Public Information Act required the Committee to make at least the
degree of disclosure that would be involved under 3.
He might note
that alternative 4, while somewhat more venturesome, also had
1/ This paper, prepared by Gary P. Gillum and entitled "The place
of the long-run targets in the policy record," was distributed on
April 9, 1974. A copy has been placed in the Committee's files.
4/15/74
-12-
precedents in drafts submitted by the staff.
If the Committee
pursued the alternative 3 course for, say, 3 months without
encountering difficulties, it could proceed to take another
cautious step toward further disclosure.
Chairman
Burns suggested that the Committee debate the
merits of publishing longer-run targets as a policy matter with
out raising the legal issue.
Few of the members were well
qualified to discuss that issue, and the Committee's attorneys
had concluded on the basis of extensive studies that the require
ments of the Public Information Act depended on determinations
that were within the province of the Committee.
Mr. Kimbrel observed that he was inclined toward alternative 3,
and would hope that the Committee could develop somewhat more precise
interpretations of the kinds of phrases it used in the directive.
He would be interested, however, in knowing whether the Chairman
thought that alternative would create any difficulties for him in
his capacity as System spokesman before Congressional committees
and elsewhere.
Chairman Burns replied that he would not anticipate any such
difficulties.
Mr. Brimmer remarked that alternative 3 did not go as far
toward disclosure as he had advocated late last year as a member
4/15/74
-13-
of the subcommittee on policy records.
It was a step in the right
direction, however, and he would favor it over alternative 1 if
the Committee were making its initial decision today.
He would
be concerned, however, about changing procedures only a short time
after those agreed upon in December had been implemented.
The Chairman observed that the question raised by Mr. Brimmer
was a troublesome one to which the Committee might want to return
later in its discussion.
Mr. Hayes said that among the several alternatives he pre
ferred 3 to 1 and 4 to 3.
His first choice, however would be alter
native 2--to publish the longer-run targets.
He was not particularly
concerned about the risk that the release of 6-month targets 3 months
after the meeting would have undesired market effects, since he
believed that market participants would readily understand that
the targets were subject to change at every meeting.
Moreover,
publishing the longer-run targets would have the advantage of pro
viding a much better perspective for the short-run ranges of tolerance.
In general, he believed the best course for the Committee was to pub
lish as much information as it could about its objectives, in an
effort to avoid biased interpretations.
He was not persuaded that
the decision taken in December--to provide quantitative information
only on the short-run targets--was really the more cautious approach;
4/15/74
-14-
caution might well call for releasing the longer-run targets in
quantitative form.
Mr. Mayo said he favored alternative 1, which called for
holding to the December decision at this time.
As the members
would recall, he had originally expressed a preference for pub
lishing the longer-run targets but not the short-run ranges of
tolerance.
The Committee had debated the subject at great length
in December; it had made a decision; and to his knowledge there
had been no developments since then to warrant reopening the issue.
He would see no advantages in incorporating in the policy records
for the January and February meetings quantitative information on
the longer-run targets adopted then, as if the Committee had known
in January and February that those figures would be published.
He
had no objections to alternative 4, and could accept it as a second
choice.
He preferred alternative 1, however, simply on the grounds
that it was not good management for the Committee to reopen a
settled matter in the absence of new developments.
Mr. MacLaury expressed the view that in attempting to
choose among the four alternatives listed in the staff's memorandum
the Committee was continuing to focus on the wrong issue.
In his
judgment, the issue of the public's right to know--and of the
benefits the Committee would derive from improved public knowledge--
-15-
4/15/74
arose primarily in connection with information on the Committee's
policy-making procedures rather than on the targets it happened
to adopt at particular meetings.
That was why he was inclined to
place great stress on what would be said at the time the January
policy record was published.
A full explanation should be made of
the Committee's procedures, including the role played by the longer
run targets, even if the Committee preferred not to reveal the
specific targets during the period to which they applied.
Mr. MacLaury added that, within the frame of reference
provided by the four alternatives, he favored alternative 4.
He
would view that course as reverting to a procedure the Committee
had followed in the past.
He saw little risk and some
gain in
such a course.
Chairman Burns said he would not consider the adoption of
alternative 4 as reverting to a prior procedure.
The Committee
might have employed that alternative in some isolated instance,
but it had never made a deliberate judgment regarding its general
desirability.
In response to a question, Mr. Eastburn said the review
made at the Philadelphia Bank indicated that the Committee had
adopted directives of the type mentioned in alternative 3 on a
number of occasions.
From time to time draft directives along
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4/15/74
the lines indicated in alternative 4 had been included among those
suggested by the staff, but he believed they had not been adopted
by the Committee.
Mr. Williams said that he, along with his colleagues at
the San Francisco Bank, believed that alternative 2 represented
the best course.
He considered it highly important that the public
be given as much information as possible about monetary policy, and
he would recommend publication in the policy record of the longer
run targets with a 6-month lag and the short-run targets with a
3-month lag.
He felt that publication of the short-run targets
alone might be highly misleading to the public.
If alternative 2
was not accepted by the Committee, he would support alternative 3.
Mr. Morris observed that he also favored alternative 2.
In his judgment, publication of the short-run ranges of tolerance
would lead inevitably to pressures for publication of the longer
run targets, for two reasons.
First, the short-run ranges would
not be comprehensible to the public unless they were placed in the
context of the longer-run targets.
Over the past 9 months or so
the Committee had adopted 2-month ranges for M1 that spread from
a lower limit of zero in one instance to an upper limit of 9-1/2 per
cent in another case; to publish such information outside the
framework provided by the long-run targets would lead to a great
4/15/74
-17-
deal of confusion.
Secondly, misses necessarily were much greater
for the short-run than for the longer-run targets, and to publish
only the former would be to give a highly inaccurate impression of
the Committee's ability to achieve its objectives.
Rather than responding to such pressures later, Mr. Morris
continued, he thought it would be better for the Committee to pub
lish the longer-run targets on its own initiative at the outset.
He agreed with Mr. Hayes that it was unrealistic to expect publica
tion of the longer-run targets in the policy record to have adverse
effects on the money market.
To participants in that market, a
policy record issued with a 90-day lag was an historical document
of no great relevance to the way in which they managed their posi
tions.
Of much more immediate concern to market participants were
the current movements in the Federal funds rate; they were aware
of the significance of that rate under the Committee's present pro
cedures, and they watched closely for movements outside the latest
range of fluctuation that might signal a change in policy.
Over
the next week or so, for example, market participants would be
waiting to see whether the Desk permitted the funds rate to move
above 10-1/4 per cent without intervening.
No sophisticated money
market operator was likely to base his actions on information in a
90-day old policy record when he had a current measure available
within a week after the meeting.
-18-
4/15/74
Mr. Wallich said he thought it would be premature at this
time to release additional information on the longer-run targets,
and accordingly he favored alternative 1.
were considerations on the other side;
He realized that there
for example, the disclosure
that the Committee was aiming for relatively low 6-month growth
rates in the monetary aggregates could contribute to the abatement
of inflationary expectations.
Information on the longer-run
objectives was likely to be misleading, however, because--given
the little that was known about the relationships involved--those
objectives often would not be achieved.
The alternative 3 formula
tion--in which desired growth rates would be described in the
directive as faster or slower than growth rates in some historical
period--would not be meaningful at present for another reason:
such statements would refer to growth rates in nominal terms,
whereas in a time of inflation the meaningful rates would be
those formulated in real terms.
Mr. Holland expressed a preference for alternative 3.
While he agreed that at this early date the Committee should not
overturn the decision it had made in December, he would not consider
adopting alternative 3 as a reversal of the December decision.
He
had arrived at one further conclusion on reading the Philadelphia
Bank's paper:
at times when the 2-month ranges of tolerance for
4/15/74
-19-
the monetary aggregates were considerably above or below the
corresponding 6-month targets, the staff might offer draft direc
tives for Committee consideration that referred to desired growth
rates "over the quarters ahead" rather than "over the months ahead."
Mr. Black said his conclusion was similar to Mr. Holland's,
except that he would prefer to use the
phrase "over the next two
quarters" on a regular basis in the directive, to make it clear
that the longer-run targets applied to a 6-month period.
that modification, he favored alternative 3.
With
It was important,
in his judgment, to give some indication of the nature of the
longer-run targets to avoid misleading the public.
Just as data
on System security purchases were subject to misinterpretation in
the absence of information on other factors affecting reserves,
so would be figures on the short-run tolerance ranges in the absence
of any indication of the nature of the longer-run objectives.
Mr. Bucher remarked that he enthusiastically endorsed
Mr. Morris' comments; like the latter, he favored alternative 2.
Mr. Mitchell observed that he had acquiesced in the present
procedure not because he was worried about the market effects of
disclosing the longer-run targets--he was not at all concerned on
that score--but because he was reluctant to make a public record of
the difficulties the System encountered in achieving such targets.
4/15/74
-20-
He thought the Committee should be quite specific in its internal
deliberations, and he hoped the day would come when its aim was
so improved that it could afford to be specific in its published
record.
At this point, however, he favored alternative 1.
Chairman Burns said he would state his own position and
then call for a poll of members' preferences among the four alterna
tives.
After pondering the question closely for a long time, he
was of the view that it would be a mistake for the Committee to
change its December decision at present.
In a memorandum to
the Committee last November he had concluded with the following
observations:
"It would be best--at least in the immediate future-
to formulate any statements in the policy record regarding longer
run targets in qualitative terms, whether or not quantitative
information is included on short-run operating ranges.
Some
experimentation along these lines will be needed, and it should
be allowed to evolve.
We need to improve our policy records, but
we also need to move cautiously.
Let us not attempt to do more
at this time than we can properly assimilate."
He had heard
nothing in today's discussion to cause him to modify that view.
Mr. Morris might be entirely right in suggesting that
the Committee
would decide to change its procedures relatively soon; indeed, he
(the Chairman) might well be urging a change in a few months.
He
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4/15/74
would expect, however, that any change would be made as a result
of the members' convictions, and not in response to pressure.
He
saw no harm in waiting a few months to see how the present proce
dures worked out.
The Chairman then called for indications of preferences
among the several alternatives.
Including Committee members and Reserve Bank Presidents
not currently serving, the preferences were as follows:
alterna
tive 1, 5; alternative 2, 7; alternative 3, 5; and alternative 4, 2.
Of the 12 Committee members, 4 favored each of the first three
alternatives and none favored alternative 4.
The Committee then engaged in further discussion, focusing
primarily on alternatives 1 and 3.
In a final poll, 6 members
indicated that they preferred alternative 1, 5 favored alterna
tive 3, and 1 abstained.
Chairman Burns observed that on the basis of those pre
ferences, no change would be made at present in the procedures
that had been agreed upon in December with respect to information
to be published on longer-run targets.
The Committee would review
the question again in a few months, after some experience under
those procedures had been gained.
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4/15/74
Before this meeting there had been distributed to the
members of the Committee a report from the Special Manager of
the System Open Market Account on foreign exchange market con
ditions and on Open Market Account and Treasury operations in
foreign currencies for the period from March 19 through April 10,
1974, and a supplemental report covering the period April 11
through 15, 1974.
Copies of these reports have been placed in
the files of the Committee.
In supplementation of the written reports, Mr. Willey made
the following statement:
Since the last meeting the dollar has undergone
a series of severe speculative attacks, which resulted
in a further decline against major currencies. The
dollar/German mark exchange rate was again the bell
wether. By March 19, when the period began, the dollar
had slipped 9-1/2 per cent below its peak in January of
this year, as the exchange market gained the impression
that the German government was either prepared to revalue
the mark once more or would at least welcome a further
sharp appreciation. Between March 19 and the bottom
of the decline on March 28 and 29, the dollar fell
another 5-1/2 per cent, and we sold $193 million
equivalent of marks and the German Federal Bank pur
chased $118 million to cushion and smooth the decline.
The dollar was also supported by the tightening of
money markets here and some easing abroad, by Chair
man Burns' testimony before the House Subcommittee on
International Finance, and by denials of any intention
to revalue issued by German authorities. Since
bottoming out, the dollar has improved 2-1/4 per cent,
with only $12 million intervention by us and none by
the German Federal Bank.
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4/15/74
During these speculative attacks the dollar
suffered a generalized depreciation as other major
currencies moved up in sympathy with the mark, includ
ing some currencies with serious underlying problems,
such as sterling, the French franc, and the yen. Except
for making very minor sales from Treasury and System
balances of French and Belgian francs, we did not
intervene to stop the dollar's decline against those
other currencies. This was mainly because we were
lacking a policy decision on handling the revaluation
clause under the relevant swap agreements.
The dollar's decline since January has reflected
some important outflows. The heavy outflows of bank
reported capital, as evidenced by the $2 billion addi
tional claims on foreigners reported in February by
United States banks, and the $1-1/2 billion in loans
to foreigners reported on an accumulated weekly basis
during March, may be in part a one-time adjustment to
the lifting of capital controls in January, but they are
no doubt in large part the result of intense competi
tion among U.S. banks in seeking foreign business.
The greatly enlarged payments this month to oil
exporting countries could put further pressure on
the dollar, as a substantial part of these flows is
channeled into short-term deposits in the Euro-dollar
market, thus creating the risk of arbitrage flows
to foreign money market centers.
In general, we continue to be faced with a volatile
and potentially turbulent exchange market situation,
with our main hope perhaps residing in the possibility
that firm credit and interest rate conditions will
prevail on this side of the Atlantic.
In reply to a question by Mr. Black, Mr. Willey said that
oil company payments were scattered throughout the month.
However,
they tended to peak around mid-month--payments today and tomorrow
would probably be the largest in April--and to rise again toward
month end.
Payments in subsequent months would remain heavy,
although perhaps not quite so heavy as those in April.
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4/15/74
Mr. Coldwell noted that the Bank of Italy had been inter
vening in the foreign exchange markets on a substantial scale but
had not drawn on the swap line with the System.
He asked what
other resources were available to the Italians.
Mr. Willey replied that the Bank of Italy had financed
their exchange market intervention in part through drawings of
about $1.9 billion on other European central banks under the EEC
agreement; they still had about $500 million available under that
agreement.
The Italians also had been borrowing in the Euro
dollar market on a rather large scale.
Apart from the swap line
with the System, they had an agreement with the International
Monetary Fund under which they could draw $1.2 billion.
Mr. Holland asked whether there had been indications of
imminent drawings on the swap lines with the System by the Bank
of Italy or other central banks in the network.
Mr. Willey replied that he was not aware of any such
indications.
Of course, when the swap line with the Bank of
Italy was enlarged earlier in the year it was clear that they
contemplated the possibility of drawing at some point.
By unanimous vote, the
System open market transactions
in foreign currencies during the
period March 19 through April 15,
1974, were approved, ratified, and
confirmed.
4/15/74
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Mr. Willey then noted that six System drawings on the National
Bank of Belgium, totaling $230 million, and one drawing each on the
Swiss National Bank and the Bank for International Settlements, of
$371 million and $600 million, respectively, would mature for the
eleventh time in the period from May 2 through May 15.
that those drawings be renewed.
He recommended
Since all three swap lines had been
in continuous use for more than a year, express approval by the Com
mittee was required for their renewal.
By unanimous vote, renewal
for further periods of 3 months
of System drawings on the National
Bank of Belgium, the Swiss National
Bank, and the Bank for International
Settlements, maturing in the period
May 2-15, 1974, was authorized.
Secretary's note:
Prior to this meeting notes by
Mr. Wallich, summarizing developments at the March
meeting of the C-20 Deputies and the April Basle
meeting, were distributed to the Committee. Copies
of these notes are appended to this memorandum as
Attachments A and B, respectively.
Before this meeting there had been distributed to the members
of the Committee a report from the Manager of System Open Market Account
covering domestic open market operations for the period from March 19
through April 10, 1974, and a supplemental report covering the period
April 11 through 15, 1974.
Copies of both reports have been placed in
the files of the Committee.
In supplementation of the written reports, Mr. Holmes made the
following statement:
4/15/74
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System open market operations over the period
since the Committee last met were devoted to an
increasingly begrudging supply of reserves to the
banking system as the monetary aggregates proved
strong and bank credit showed explosive growth.
The more restrictive System approach, in an atmo
sphere of accelerated loan demand and intensified
inflation, resulted in sharp increases in interest
rates throughout the maturity spectrum. For a time,
near-chaotic conditions prevailed in the capital
markets, where a heavy volume of new issues met
increasing investor resistance,and market under
writers sustained substantial capital losses. By
the close of the period, however, after rates had
adjusted substantially upward, the markets had
regained some semblance of stability, although an
underlying atmosphere of uncertainty prevailed.
In today's regular Treasury bill auction, I
expect that average rates of about 8.05 and 7.88
per cent were established for 3- and 6-month bills.
These are substantially below the recent highs--by
50 basis points or more--with the 3-month bill declin
ing at least 30 basis points today alone. This reflects
the very sharp rally that has taken place in the bill
market as scarcities have developed.
Given Committee instructions at the last meeting
and the indicated strength of the monetary aggregates,
the Desk moved promptly after the meeting to estab
lish a more restrictive stance in advance of the
Treasury's cash financing, which was announced on
March 20. The financing involved the auction of
$2-1/2 billion June tax-anticipation bills on March 26
and $1-1/2 billion 8 per cent 2-year notes on
March 28. The bill auction involved a larger addi
tion to market supply than had been anticipated, thus
adding to the then-upward pressure on short-term
interest rates. The note auction was aided by heavy
buying by small investors, but a total of only $1.7
billion bids were received by the Treasury and some
tenders had to be awarded at the minimum acceptable
price at a yield of 8.13 per cent, compared to the
average of 8.08 per cent.
4/15/74
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Looking ahead, the Treasury will announce the
terms of its May financing on May 1. This financing
involves a refunding of about $5-1/2 billion of pub
licly held securities maturing on May 15. Given the
still uncertain state of the market this may prove to
be a major undertaking. In order to reduce market
pressures, it would seem desirable for the Treasury
to pay off some of this maturing debt, but there is
some uncertainty about the strength of the Treasury's
cash balance in mid-May, and it will need more cash
towards the end of the month or in early June. And,
by the end of the June, there could be some debt
ceiling problems for the Treasury, too, unless new
legislation can be enacted. In any event, I would
plan to roll over the System's holding of $1.3 billion
of the maturing issues into whatever new issues the
Treasury offers in a proportion related to expected
public subscriptions.
Last Friday, it was learned that M1 is now
expected to be above the upper end of the Committee's
range of tolerance for March-April. The Desk accord
ingly on Friday planned a still more restrictive
approach to reserve supply, expecting that the Federal
funds rate will average 10 per cent or more. In this
statement week, the Federal funds rate has been running
close to 10-1/4 per cent--ithit 10-1/2 per cent at
one point today, even though we did a fair amount
of repurchase agreements--but other money and capital
market rates have tended to stabilize or improve. Should
the Committee decide tomorrow on a policy that involves
a more restrictive stance, I think it important that
this policy be effected promptly in order to establish
a new set of money market conditions in advance of the
Treasury's refunding.
The past period has been one of turbulence in the
money and capital markets. Loan demand pressure has
made banks aggressive sellers of CD's,and rates have
risen by as much as 1-1/2 percentage points.
The prime rate is quite generally at 10 per centand, as you know, one North Carolina bank raised its
prime rate to 10-1/4 per cent today. The extent of
the demand for business loans had not been anticipated
by the banks and the fervent hope now is that it was a
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4/15/74
short-run bulge involving a shift from commercial
paper, special inventory financing, a spate of
foreign borrowing, and perhaps some anticipatory
demand.
Bond dealers, particularly in the corporate and
municipal sectors, went through a trying period,
although as noted earlier, the markets had settled
down last week, and at the higher yield levels funds
were moving smoothly through the capital markets. A
heavy volume of financing lies ahead, however, and
there is an underlying note of uncertainty that could
again rise to the surface. Despite all the cries of
distress, most market participants applaud what they
consider to be a vigorous anti-inflationary campaign
by the Federal Reserve. I'm sure they recognize the
basic fact that unless inflation is gotten under
control, the future of the capital markets is bleak
indeed.
Chairman Burns asked what groups Mr. Holmes had in mind
in his comment that most market participants applauded the System's
anti-inflationary efforts.
Mr. Holmes replied that he was thinking of most dealers in
Government securities, the major banks, the more thoughtful dealers
in corporate and municipal securities, and perhaps even some stock
brokers.
The dealers were, of course, extremely unhappy about the
short-run impact of rising interest rates on their capital posi
tions; he was describing their more general philosophical attitude.
Mr. Brimmer said he would be interested in Mr. Holmes'
views on the extent to which recent foreign borrowing at U.S.
banks reflected the ending of the VFCR program or other special
factors.
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4/15/74
Chairman Burns asked in that connection whether the recent
foreign borrowing had been primarily by banks,
In response, Mr. Holmes
said he thought the bulk of the
foreign borrowing had been by banks.
There also had been a sub
stantial volume of borrowing by foreign governments, both in Europe
and elsewhere.
In general, he would attribute the rise in foreign
borrowing to a combination of factors, including the ending of
capital controls, the desire of New York banks to reestablish
their competitive positions in markets abroad, and a real demand
for dollars abroad for purposes of balance of payments financing.
In reply to questions by Mr. Holland, Mr. Holmes said the
recent decline in bill rates was a consequence of scarcity condi
tions that developed in the bill market, and was not reflected in
corresponding declines in other short-term interest rates.
Dealers
had reduced their positions in bills because of high carrying costs,
and when demands developed from foreign sources and from domestic
investors interested in short-maturity instruments, bill rates
declined substantially, following their earlier substantial rise.
Bill rates might remain around their current levels temporarily,
partly because of reinvestment demands that could be expected later
this week when the Treasury paid off maturing tax-anticipation bills.
He would be surprised, however, if bill rates remained near those
levels for long, given present rates on Federal funds and CD's.
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4/15/74
Mr. Sheehan asked whether the staffs at the Board and the
New York Bank were in general agreement with respect to their pro
jections of the monetary aggregates.
Mr. Holmes replied that the two sets of projections were
relatively close for the April-May period.
For the second quarter
as a whole, however, the New York Bank projections were somewhat
higher than those of the Board staff.
Mr. Eastburn asked how Mr. Holmes thought the markets
might react to a half-point increase in the discount rate.
Chairman Burns remarked that he might inform the Committee
at this point that the Board had acted earlier today to disapprove
increases in the discount rate--from 7-1/2 to 8 per cent--that had
been proposed by. two Reserve Banks.
A key paragraph in the Board's
letter to those Banks read as follows:
"The Board members felt
that an increase in the discount rate at this time would be taken
as a signal that the System wanted to reinforce its firming actions
and, given the sensitive condition of financial markets, such an
increase might well trigger further large advances in market and
bank lending rates.
In the Board's judgment the current economic
and financial evidence did not call for a strong signaling action
at this time.
However, the Board will remain alert to the desir
ability of an early discount rate action."
-31
4/15/74
The Chairman added that he would like to remind everyone
present that information concerning Reserve Bank proposals for
changes in the discount rate and the Board's responses was to
be held in strict confidence.
He then suggested that Mr. Holmes
reply to Mr. Eastburn's inquiry.
Mr. Holmes said he thought a discount rate increase would
be interpreted by the market as confirmation of a strong anti
inflationary stance by the System.
The impact on short-term rates
was unlikely to be as drastic as it might have been a week or 10
days ago, when the markets had not been in good shape.
he thought there would be some impact.
However,
He was not persuaded that
rates had stabilized as yet; strong technical forces were helping
market conditions at the moment, but they would not last indefinitely.
Moreover, the Treasury's large May refunding would put some pressure
on the market.
A slackening of loan demand would help a great deal;
demand appeared to have slackened in New York last week, but one
should not read too much into one week's figures.
The Chairman remarked that in the Committee's policy discus
sion tomorrow the members might want to offer any views they had
about the desirability of an increase in the discount rate, and
also about the desirability of another possible action--an increase
in marginal reserve requirements on large-denomination CD's.
The
4/15/74
-32-
Treasury's financing calendar offered some constraints on the
timing of such actions, on which Mr. Axilrod might comment at
this point.
Mr. Axilrod observed that, as Mr. Holmes had indicated,
the Treasury would announce on May 1 the terms on which it would
refund the $5-1/2 billion of securities maturing on May 15.
That
was a sizable financing, and as the members knew, market conditions
were quite sensitive.
In his judgment, Tuesday, April 23 would be
about the latest date before the financing at which a discount
rate increase should be announced; that would allow one full week
for markets to settle down before the Treasury's advisory committees
made their recommendations for the financing.
If the discount rate
were to be increased after the financing, it might be well to wait
at least until the May 15 settlement date--and perhaps a little
longer--in view of the possible difficulties of distributing the
sizable volume of new issues that would be involved.
By unanimous vote, the open
market transactions in Government
securities, agency obligations,
and bankers' acceptances during
the period March 19 through April 15,
1974, were approved, ratified, and
confirmed.
Chairman Burns observed that it would be helpful to the
Board if, in the time remaining this afternoon, the Reserve Bank
4/15/74
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Presidents would offer any views they had on two subjects:
the
causes of the enormous increase that had taken place during recent
weeks and months in bank loans, particularly business loans; and
what action, if any, in the way of an admonition to bankers might
be desirable on the part of the Board, the Chairman, or the Reserve
Bank Presidents.
Mr. Coldwell said he had had an opportunity last week to
discuss the sources of loan demand with the presidents of a number
of the larger commercial banks in the Eleventh District.
It
appeared that about half to three-fourths of their loan demand
arose because national corporations were drawing on credit lines
established earlier--years earlier, in some cases.
were for two main purposes:
The draw-downs
to replace outstanding commercial
paper, and to sustain inventory positions at current higher costs.
All of the bankers indicated that demands were heavy for real
estate as well as for business loans, but that there had not been
a major change in the volume of consumer loans.
Part of the
demand for real estate credit stemmed from the shift in the posi
tion of the REIT's; the commercial paper that had been issued by
REIT's was fully backed by bank loans or commitments.
The bankers
were not particularly concerned about the larger REIT's, but they
thought some of the smaller units might be over-extended.
In the
4/15/74
-34-
words of one banker, "We're going to have a work-out operation,
but with sufficient time and sufficient inflation, the problem
will be taken care of."
An additional reason mentioned for the
enlarged business borrowing was the desire on the part of some
local borrowers to defer planned capital market financing for a
period of 3 to 6 months.
As to the terms on which the new loans
were being made, the bankers uniformly indicated that they were
for 90-day periods, with prepayment privileges.
They expected,
if past experience was a guide, that many of the loans would be
repaid within 60 days.
Mr. Morris remarked that the situation in the First
District was similar in major respects to that in the Eleventh.
First District bankers had been surprised at the high rate at
which national corporations were drawing on credit lines; none of
those with whom he had talked had anticipated that development.
The shift of borrowers from the commercial paper market to banks,
which was attributable to the lagged movement of the prime rate,
might be slowing now.
The heavy volume of bank loans to finance
inventories appeared in part to reflect efforts by scarcity-conscious
purchasing agents to hoard materials.
That disturbed him some
what; such inventory accumulation now could be followed by a cut
back in purchasing later in the year.
borrowing at District banks.
There also was heavy foreign
4/15/74
-35-
With respect to the Chairman's second question, Mr. Morris
continued, he was opposed to moral suasion as a device to control
bank lending.
That technique could be highly successful in
countries, such as Britain and Canada, where the banking system
was so highly concentrated that it was possible to meet in one
room with the heads of banks accounting for the bulk of the
nation's banking business.
However, in the United States, where
banking was decentralized, moral suasion was much less effective
and posed many more problems.
He would reserve its use for
extreme circumstances.
The Chairman asked whether Mr. Morris considered the
recent explosion of bank lending to be troublesome.
Mr. Morris said he thought the rise in the prime rate
would tend to moderate the upsurge in foreign lending and the
shift in borrowing from the commercial paper market to banks.
Relatively, bank lending rates had been quite low for a while,
but they were now moving back into parity with competing rates.
Chairman Burns remarked that, if the prime rate were to
be relied on to achieve adequate restraint on bank lending, it
might have to rise to levels a good deal above any that had been
experienced thus far.
A question in his mind was whether it might
not be better for bankers to ration credit at rates that were
not quite so high.
4/15/74
-36-
Mr. Morris replied that he was not convinced that the
System's past efforts to persuade bankers to ration credit had
been very fruitful.
Moreover, such a procedure raised problems
of bank relations and questions of equity.
If he were to indicate
to bankers in his District that he was concerned about their lend
ing volume, they were likely to respond that they also were con
cerned but were faced with a difficult competitive problem.
On
that score, he might note that representatives of large Chicago
banks were currently in Boston, soliciting the business of the
local banks' customers.
Mr. Hayes observed that officials of three large New York
banks with whom he had talked in recent weeks had explained the
surge in loan demands in terms much like those reported by
Messrs. Coldwell and Morris.
Apparently, the heavy loan demands
were not confined to big corporations; they involved practically
all commercial borrowers, many of whom were interested primarily
in building inventories.
As had already been noted, borrowing
by foreign banks was adding to the pressure.
Mr. Hayes remarked that he found it difficult to decide
whether it was useful to make representations to banks about the
volume of lending.
He was inclined to share Mr. Morris' view
that such a procedure should be employed sparingly.
The System's
4/15/74
-37-
strong effort last summer might have been helpful, but he was not
sure how much difference it had actually made.
In any case, an
effort to use moral suasion now might be premature.
Only 2 months
ago money market rates were declining sharply and banks were coming
to the view that they had to compete more actively for business.
It had not been very long since the System had begun to give clear
signals that it was greatly concerned about inflation as opposed
to the dangers of recession, and to move too fast on a program of
moral suasion was apt to result in confusion.
In his judgment,
moral suasion would be more productive if it were undertaken after
the System had developed a more sustained record of anti-infla
tionary policy moves.
Mr. Eastburn said he had heard explanations of current
loan demand from banks in the Third District that were quite
similar to those already described.
The strong demand, which had
been unexpected, was attributed in good part to business efforts
to build inventories to protect against rising prices, including
the price increases that were anticipated when controls were dis
continued at the end of April.
Moreover, because bond rates were
rising, business borrowers were not repaying bank loans in the
manner typical of a business downswing.
-38-
4/15/74
Chairman Burns remarked that he personally had found it
quite difficult to determine the extent to which the increase in
needs for inventory financing reflected higher prices on a stable
volume of stocks or an increase in the volume of stocks.
If a
large part of the current business borrowing at banks was accounted
for by an effort to expand inventories, the economy might well be
headed for difficulties of a kind not seen in the United States
since the inventory collapse of 1920.
Mr. Eastburn went on to say that one's views about the
desirability of holding conversations with bankers would depend
in part on his expectations regarding the future course of business
loans.
While the urgency of present inventory demands might pass,
it was his guess that business loan demands would remain strong
and perhaps get stronger.
He was inclined to agree with Mr. Hayes
that a program of moral suasion would be premature at this point;
it would be unfortunate if that device were used now, only to
find that it would have been more effective if it had been reserved
for later use.
Mr. Hayes said he might note that the surge in loan demand
had been unexpected in New York also.
He had heard some suggestions
that it represented a temporary bulge, attributable to some special
factors that had not yet been recognized.
While he suspected that
4/15/74
-39-
the bulge was not temporary, he thought it would be well to wait
for evidence on that point before reacting.
Mr. Kimbrel noted that the recent rate of increase in
business loans in the Sixth District had been below the national
average rate.
Nevertheless, District bankers were explaining loan
demands in the same terms as others had mentioned--including shifts
by borrowers from the commercial paper market to banks, the desire
to defer capital market financing, and the need to finance the
higher costs of inventories, although not necessarily enlarged
physical stocks.
While the volume of new consumer loans was down,
outstandings were rising because of an increase in delinquencies
and a slowing of repayments--developments which he found rather
disturbing.
Large Chicago banks were soliciting business in his
District also, and they were being joined in that activity by some
New York and Boston banks.
Mr. Kimbrel said he would have no reservations about using
moral suasion in the effort to slow bank lending.
However, he
agreed with those who thought that its use might be a little pre
mature at this point; it would be better to wait a bit to see if
demand remained strong.
Mr. Leonard observed that the situation in the Eighth District
was basically the same as that described for other Districts.
The
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4/15/74
increase in loan demand was rather broadly based, and at least
some St. Louis banks had attributed it in part to growing needs
for inventory financing.
Construction activity recently had
risen considerably throughout the District, but the extent to
which that rise had contributed to the increase in loan demand
was not clear.
People at the St. Louis Bank had not been as
surprised by the rise in business loans as others evidently were;
for some time they had
thought that the underlying economic
situation was stronger than some analysts were suggesting, and
they interpreted the strength of loan demand as confirmation of
that view.
He might note that some States in the District had
usury laws limiting the rate of interest that could be charged,
and that in two States loans to corporations were not exempted.
In those States large commercial banks had to acquire funds in
the national money market at rates as high as or higher than, they
were allowed to charge their customers.
Mr. Mayo expressed the view that the time was rapidly
approaching when the Chairman might find it desirable to express
the System's concern about the rate of increase in bank loans,
perhaps in the course of Congressional testimony.
If loan demand
remained strong, he thought it might then be necessary for the
Reserve Bank Presidents to begin discussing the situation with
4/15/74
-41-
individual bankers, even though he shared the disinclination some
others had expressed toward that approach.
He agreed with Mr. Hayes,
however, that moral suasion tended to lose its effectiveness when
used too often.
Mr. Winn said he had heard reports of a sharp increase in
business demands for warehouse space, which tended to confirm other
indications of a widespread desire to increase inventories.
In
his judgment, however, the rise in loan demand could not be attrib
uted simply to inventory financing needs; to an important extent
it also reflected a deterioration of working capital positions and
growing problems of collecting on receivables.
Mr. Winn added that banks appeared to be confused about
the status of the "two-tier" prime rate.
One major bank in the
Fourth District had announced that, because of the rise in the
costs of funds, it was rationing loans to small businesses and
on home mortgages--the categories to which the lower prime rate
applied--but not loans on which it could charge the higher
rate.
Chairman Burns observed that any confusion
about the
two-tier prime rate would not last very long since the Economic
Stabilization Act, under which the Committee on Interest and
4/15-16/74
-42-
Dividends had been established, was expected to expire at the
end of the month.
Mr. Winn then said he was disturbed about another recent
banking development.
It appeared that some banks, in an effort
to improve their figures on earnings per share, were following
such practices as reducing their reserves against losses on loans.
Officials at one of the large bank auditing firms had advised him
recently that his firm was quite concerned about those practices.
He thought the System should watch that situation closely.
Thereupon the meeting recessed until 9:30 a.m. the follow
ing morning, Tuesday, April 16, 1974.
the same as on Monday evening.
Committee attendance was
Staff attendance was the same
as on Monday except that Messrs. Coyne and Gillum were absent,
and the following were present:
Messrs. Gramley and Reynolds, Associate
Economists
Mr. Wernick, Adviser, Division of
Research and Statistics, Board
of Governors
Mr. Pizer, Adviser, Division of
International Finance, Board
of Governors
Mr. Struble, Senior Economist,
Division of Research and
Statistics, Board of Governors
Ms. Tschinkel, Manager, Securities
Department, Federal Reserve Bank
of New York
-43-
4/16/74
Chairman Burns then called for the staff reports on the
domestic economic and financial situation, supplementing the
written reports that had been distributed prior to the meeting.
Copies of the written reports have been placed in the files of
the Committee.
Mr. Partee made the following introductory comments:
In the 4 weeks since the last Committee meeting,
the staff has had a chance to evaluate more carefully
the probable impact on the economy of the lifting of
the oil embargo. In addition, the sharp upsurge in
interest rates has caused us to reevaluate our expecta
tions for financial market flows and for conditions in
the mortgage and housing market. Since the implications
of these latter developments bear most importantly on
the outlook for early 1975, we have taken this opportu
nity also to extend our projection through the middle
of next year.
The staff forecast resulting from our review has
already been presented to you in the green book.1/ Our
purpose today, therefore, is to highlight the most
significant aspects of the revised projection, and to
discuss possible differences in economic results that
might be fostered by alternative monetary policy
assumptions.
As to the monetary and fiscal policy assumptions
underlying the projection, we assumed first that the
controls program will terminate at the end of this
month and that there will be no reimposition during
the forecast period. Given the substantial relaxa
tion of controls already effected, we expect only a
small additional impact on prices, except in the
health care field.
Second, we have assumed a Federal budget that is
somewhat more expansive over the next fiscal year than
1/ The report, "Current Economic and Financial Conditions," prepared
for the Committee by the Board's staff.
-44-
4/16/74
that proposed last January by the Administration. On
a unified budget basis, projected total outlays are
somewhat lower than in the budget message, due mainly
to prospective offshore oil sales, which are recorded
as negative expenditures. But expenditures on a
national income accounts basis are larger--due to an
expanded public employment program, the extension of
unemployment insurance benefits to a full year's
coverage, and the payment this summer of a retro
active Federal pay raise. Moreover, we have assumed
that the proposal to reduce personal tax withholding
schedules will pass and that there will be no special
tax imposed on the oil industry. The result is a
small projected budget deficit for fiscal 1975, in
full employment terms, as compared with a small sur
plus in fiscal 1974.
Third, we have assumed continuation of a monetary
policy keyed to a 5-3/4 per cent growth path in the
narrow money supply. This requires first a period of
somewhat slower growth, in order to make up for the
overshoot of recent months, and then a return to the
5-3/4 per cent path in the fall.
We believe that such a policy would be associated
with appreciably higher interest rates than anticipated
earlier. Given the stronger expansion in nominal GNP
now projected, the income velocity of money would rise
even further above its trend rate of growth. This will
put upward pressure on interest rates, judging from
past relationships, and we believe that the Treasury
bill rate is likely to approach 10 per cent by early
1975. Long-term rates seem likely to rise in similar
fashion, given projected strong financing demands,
particularly by corporate business, and somewhat limited
credit supplies. These high market rates will divert
large amounts of savings from financial intermediaries;
acquisitions of securities by households are estimated
to rise from a very modest pace over the winter to an
annual rate averaging well over $30 billion in the
quarters to come.
One final assumption should be noted. More careful
review of the domestic oil situation suggests that oil
imports are likely to rise more on the order of 1 million
barrels per day, rather than the 2 million incorporated
4/16/74
in our incremental projection at the last meeting. This
would hold imports below the trend rate of growth; the
difference is expected to be made up by voluntary con
servation--partly reflecting the effects of the substan
tially increased level of prices--and by increased
domestic energy production. Nevertheless, we have
assumed that present international oil prices will be
maintained at current levels, largely because we are
totally without guideposts as to when and by how much
prices would likely be cut.
Even with the reduced estimate of the expansion
in oil imports, the impact on our foreign trade balance
will be very large. Indeed, the expected deterioration
in net exports of goods and services contributes in a
major way to our projection of a sluggish over-all
economic recovery. Mr. Reynolds will briefly review
the current account outlook as we see it at this time.
Mr. Reynolds made the following statement:
Our projection for the balance on goods and services
is startling at first sight. That balance was in record
surplus in the final quarter of 1973, but it is projected
to worsen sharply and fairly steadily to a deficit rate
of around $6 billion by the second quarter of 1975. At
that time the deficit on all current transactions, includ
ing transfer payments, would be about $10 billion at an
annual rate.
Given the sharp rise in petroleum prices, this
dramatic change should not, I think, be regarded as an
extreme projection. The oil price rise will be having
similar adverse effects on the current payments positions
of other industrial countries. A current account deficit
of around $10 billion for this country may not be too
large in a world where all OECD countries combined are
expected to be running current deficits totaling some
$40 billion. Beyond the projection period, we would
not expect the deterioration to continue.
Virtually all of the projected $22 billion deteri
oration in the balance on goods and services over the
projection period is expected to occur in the trade
account. Petroleum imports, assuming maintenance of
present prices, are expected to increase by about
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$17 billion at an annual rate, with most of that rise
occurring early this year. Agricultural exports are
projected to decline by about $6 billion; the pattern
contemplates some further rise to a record level early
in 1974, but then a drop of one-third as prices are
assumed to decline with greater availability of sup
plies here and abroad. On all other trade, we expect
some further net improvement early this year, followed
by little further net change. We have assumed that
the change in foreign industrial economies will be
rather similar to that of the U.S. economy, with only
slow growth on average, some increase in available
industrial capacity, and a marked slowing in the
advance of industrial commodity prices.
Two large uncertainties in our current account
projections may have led us to overstate the worsen
ing in the U.S. position. First, international oil
prices may at some point fall back, rather than be
maintained as we have assumed. If there were to be
a decline of 10 per cent, for example, our oil import
bill would be reduced by nearly $3 billion at an annual
rate. Second, we have assumed that the foreign earn
ings of U.S. oil companies will not be allowed to rise
much above their late-1973 level, but they could well
rise further.
The effective exchange rate has fluctuated very
widely over the past 15 months. Our projection assumes
that the international value of the dollar would recover
somewhat and fluctuate near its February 1974 level, as
large net inflows of capital--not projected in detailwould tend to outweigh the developing current account
deficit. If, instead, the value of the dollar were to
fluctuate near its more recent rate--that is, around
5 per cent below the February rate--the effect upon
the projected goods and services balance early in 1975
would probably be small. On the one hand, import prices
would be a little higher. But on the other hand, U.S.
goods would be more competitive internationally--a
factor inhibiting the quantity of imports and encourag
ing exports. This would tend to strengthen the current
account beyond the projection period.
The marked deterioration in the balance on goods
and services over the next 15 months will represent a
4/16/74
drag on the domestic economy, but a drag of a rather
special kind. The relief from excess demand pressures
for agricultural products will not be unwelcome from a
domestic point of view. While the sharp rise in pay
ments for petroleum will create structural realloca
tion problems of various kinds, we are not projecting
much change in net real foreign demand for other U.S.
goods and services.
Mr. Gramley made the following statement on the domestic
aspects of the staff projection:
The staff expects real GNP growth to remain at
a modest rate throughout the year ending in mid-1975.
After a rebound in the third quarter of 1974, associated
with a pickup in consumer spending and in residential
construction, the rate of real expansion is expected
to fall back to around 2 per cent in the first half of
1975. With real growth remaining below our long-term
potential, the unemployment rate would move steadily
upward--to around 6-1/4 per cent. We do expect sub
stantial improvement in price performance, but--as I
will indiciate later--this reflects largely a slower
rate of increase in the prices of food and fuel.
The sluggishness of the projected recovery stems
partly from the effects of rising oil imports on
consumer purchasing power. Our fuel import bill is
expected to balloon to an annual rate of just under
$30 billion by early next year. Consumer purchases
of gasoline and oil, in current dollars, will also
rise sharply, because additional imports of oil will
largely go into increased use of gasoline in passenger
cars. The end of the embargo is thus a mixed blessing.
Car sales will be stimulated, as will other travel
related expenditures. There will be some adverse
effects in other consumer markets; however, we still
think that the effect of rising expenditures on gasoline
and oil will be partly at the expense of saving as well
as of consumption of other goods and services.
The pessimism expressed by consumers in recent
attitudinal surveys also argues against a boom in con
sumer markets. We have assumed, however, that consumer
4/16/74
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sentiment will improve with the upturn in the economy,
and that consumers will show a willingness to add to
their instalment debts and to acquire durable goods.
Actually, all major categories of consumer spending
are projected to rise a little faster than disposable
income, and the projected saving rate falls to a little
below 6 per cent by early 1975. But while growth in
real consumption expenditures exceeds the growth of
real disposable income over the projection period,
the projected rates of growth in real consumption are
relatively modest.
Prospective weakness in housing is another factor
that holds down the projected rate of expansion. Data
to be released later today will show housing starts in
March down by about one-fifth--back to the January level.
Permits rose somewhat, and we believe some increase in
starts will occur in the months ahead. But since the
last Committee meeting, interest rates have risen sharply
further, and signs of impending disintermediation have
become quite evident. With Treasury bill rates projected
to rise substantially further, savings flows to thrift
institutions could drop appreciably. Even with large
amounts of Federal financing assistance, mortgage credit
would likely be in short supply. We believe, therefore,
that housing starts would stage only a brief and abor
tive recovery and would be on the downswing again by
early 1975.
Unfavorable financial factors dominate the housing
outlook at the present time, but nonfinancial factors
are also adverse. Prices of houses have risen sharply
and are still going up, and there is a substantial
number of unsold single-family houses overhanging the
market.
Inventory investment is projected to be a rela
tively neutral factor over the next year or so, as it
was in the early part of the recovery from the 1969-70
recession. The projected pace of inventory investment
would imply a small rise in the aggregate inventory
sales ratio this quarter, and an unchanged ratio
thereafter.
As you know, the rate of inventory investment is
difficult to predict with any confidence.
We seem to
have gotten through the winter sales slump without
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developing an overhang of unwanted inventories, and so
we are reasonably confident that this sector of demand
will not be a drag on the rate of expansion. There is
some possibility that we may have underestimated the
strength of inventory demands in the near term, given
price expectations and the shortages that have plagued
businesses over the past year or so. But recent data
on inventories and new orders do not suggest that an
explosive thrust of inventory building is in the offing.
For business fixed investment, on the other hand,
both survey data and new and unfilled order figures
suggest continued strength as far into the future as
we can see. Of course, a substantial part of the pro
jected rise in current dollar outlays for fixed capital
reflects rising prices. In real terms, however, the
projected increase is over 4 per cent for the year
ending in mid-1975--a rather considerable advance in
view of the high level of investment sustained over
the past two and a half years and the limited capacity
for increasing output in the business equipment
industry.
Finally, let me comment briefly on the wage-price
implications of the projection. We continue to expect
increases in compensation per manhour at around an
8 per cent annual rate for the private nonfarm economy.
This may seem rather optimistic, even for a period of
rising unemployment, given the desires of workers to
make up for losses of real income over the past year
and the effects of the increase in the minimum wage
next month and again next January. However, the incom
ing statistics continue to point to moderation in wages,
and trade union demands are focused heavily on obtain
ing fuller protection against future increases in the
cost of living. If the rise in consumer prices moder
ates, as we think it will, a wage explosion may be
avoided.
We should be getting better gains in productivity
as economic growth resumes, and therefore some reduc
tion in the rate of increase in unit costs of produc
tion. But the best we can hope for, we think, is a
rise in unit labor costs at an annual rate of about
6 per cent.
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There is, therefore, little reason to expect
substantial moderation between now and mid-1975 in
the underlying rate of inflation--that is, the rate
of price increase after allowance for special factors.
Over the past year or so, however, average price
increases have reflected heavily the impact of rising
costs of food and fuels. However, those effects should
be wearing off over the year to come, barring supply
developments in agriculture or in the oil industry
that we cannot foresee, and this should mean a material
slowing in the rise of over-all price measures. An
unwinding of the underlying inflationary process will
take much longer than a year; but some progress on
this front may be made between now and mid-1975, if
economic conditions develop along the lines we have
projected.
Mr. Partee will conclude the presentation with
a discussion of the implications of alternative courses
of policy action for economic activity and prices.
Mr. Partee made the following concluding comments:
Our projection of the economy produces what seems
to me clearly to be an undesirable outcome. The
economic recovery is too sluggish, and it begins to
tail off again early next year. The unemployment rate
rises too much; and yet the rate of price increase
remains high, despite growing slack in labor and
product markets.
Unfortunately, there is little prospect that any
alternative course of monetary policy would bring a
substantially improved outcome. A markedly more
expansive policy would encourage greater real output
and lower unemployment, at least for a time, but the
result would be a worsening in inflationary pressures
and expectations. Conversely, a substantially more
restrictive policy might curb inflationary expecta
tions, with desirable longer-run moderation in the
actual rate of price increase, but the cost almost
certainly would be much reduced real output, lower
profits, serious financial strains, and markedly
higher unemployment.
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The options available to the Committee, therefore,
appear quite limited. But some marginal improvement in
economic performance does seem possible. Since one of
the major difficulties is likely to be the housing
sector, moreover, it would seem appropriate to provide
somewhat more support to residential construction as a
means of improving the over-all pace of economic expan
sion. The basic problem is that the continued sharp
rise in interest rates would curb the growth in savings
flows to the nonbank thrift institutions and bring
about a constriction in mortgage funds that would abort
the recovery in housing starts.
Some improvement in the performance of the inter
mediaries, and hence in the mortgage market, can be
obtained by a further increase in permissible interest
rates under Regulation Q. The ability of the thrift
institutions to finance a further rise in rates paid
is limited, but we believe that there is some room for
maneuver. Therefore, we have assumed a 1/2 point
increase in Regulation Q ceilings on certificate
accounts at all institutions, effective in the third
quarter. Given an unchanged rate of growth in M1 , we
estimate that this would improve the rate of savings
inflow to both banks and nonbanks after mid-year by
about 2 percentage points.
We have also considered the effects of some
alternative monetary policies, assuming in each case
an increase of this dimension in Regulation Q ceilings,
the effect of which is to hold down on interest rates
somewhat and improve housing starts moderately as com
pared with our green book projection. Apart from the
Q ceiling change, the alternative policies assumed are
an extension of those presented in the blue book.1/
Alternative A projects the continuation of a 6-3/4
per cent growth path in the narrow money supply,
beginning in the second quarter; alternative B pro
jects a 6 per cent M1 growth path; and alternative C
projects a 5-3/4 per cent growth path beginning in
the fourth quarter, following two quarters of reduced
growth to offset the overshoot from that path experi
enced in the first few months of this year.
1/ The report,"" Monetary Aggregates and Money Market Conditions,"
prepared for the Committee by the Board's staff.
4/16/74
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The differential economic results produced by
these alternative policies are as follows: real GNP
growth would be expected to rise somewhat above its
long-run potential under alternative A, would be at
about the long-run growth rate under B, and would
remain somewhat below it under C. The unemployment
rate behaves accordingly, dropping slightly under A,
levelling off at about 5-3/4 per cent under B, and
continuing to edge up under C. The increase in prices
moderates by about the same amount in all cases, reflect
ing the projected slowing in the rise of food prices and
in oil and other industrial materials. But our expecta
tions would be that, beyond the projection period, the
pace of inflation would moderate somewhat more under C
than A, provided that a posture of monetary restraint
could be maintained in the face of a sluggish economy
and rising unemployment.
The Chairman, noting that economic forecasting was partic
ularly difficult and uncertain at this time, invited the Committee
members to raise any questions they had with the staff and to
present their own views on the economic outlook.
Mr. Coldwell asked about the basis for the staff's expecta
tion of a sharp decline in agricultural exports.
Mr. Reynolds replied that, although there might be a slight
fall off in the physical volume of exports, the staff projection
primarily reflected a decline in export unit values after mid-1974
because of expected declines in agricultural prices.
Of course,
the extent of any such decline was uncertain; he understood that
economists at the Department of Agriculture expected a smaller drop
than that implied in the Board staff's projection.
The present
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4/16/74
dollar volume of agricultural exports--$23 billion at an annual
rate--was extraordinarily high; only 2 years ago a $9 billion rate
of agricultural exports had been considered good.
The recent price
increases that had resulted in swollen values of exports did not
seem sustainable, especially since prices had already begun to
decline in spot markets.
Mr. Mayo complimented the staff on its excellent
presentation and added that the staff at the Chicago Bank
had come up with basically the same pessimistic conclusions
about the economic outlook.
He wondered, however, whether the
Board staff was not too optimistic in its assumption that the
annual rate of increase in compensation per manhour could be
held down to 8 per cent--a rate not much higher than that pre
vailing in the last half of 1973--in view of the probable size of
labor settlements in 1974.
Mr. Gramley agreed that if the advance in compensation
did prove to be different from the staff projection it was more
likely to be higher than 8 per cent than lower.
There did not
seem to be any good explanation for the unusually small rate of
wage increases in the first quarter of 1974, when average hourly
earnings of production workers on nonfarm payrolls apparently
rose at an annual rate between 5 and 6 per cent.
The staff
had assumed an acceleration in the rate of advance of the
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-54-
index, to a range of 7-1/2 to 8 per cent.
He might note that
labor contract demands thus far had focused primarily on
negotiation of cost-of-living adjustments rather than on large
wage boosts in the first contract year.
Therefore, if the rate
of increase in food and fuel prices were to moderate over the next
year, it was quite possible that the rate of increase in compensa
tion per manhour would not be larger than 8 per cent.
Mr. Holland asked whether the staff would speculate on
the implications of the current sharp expansion in the money stock
and in business loans.
If the surge in business borrowing at banks
actually did represent financing of an inventory bulge, it was
possible that inventory accumulation in the second quarter of 1974
might match the $18 billion rate of the fourth quarter of 1973.
If
that occurred in combination with a rise in long-term interest rates,
the termination of controls, and expectations of price rises and
shortages, what would the implications be for the course of economic
developments and for the appropriate posture of monetary policy?
Mr. Gramley responded that the likelihood of a sharp
increase in inventory investment in the second quarter seemed
relatively small; available non-financial indicators of economic
activity gave no evidence of such a development.
If an inventory
bulge did occur, the odds were that it would have a depressing
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4/16/74
effect on economic activity from the third quarter on--that the
economy would be weaker than now anticipated in late 1974 and
early 1975.
It seemed unlikely, however, that an inventory bulge
would result in a significant general weakening in the expectations
of businessmen or consumers, and there was at least some chance
that it would produce business expectations of a more ebullient
economy,
Mr. Kimbrel asked for elaboration of the staff assumptions
about the impact of the minimum wage increase on employment and
prices.
Mr. Gramley said the staff had examined carefully the past
patterns of wage rate and employment changes in order to evaluate
the impact of an increase in the minimum wage on employment and to
assess the extent to which the rise might filter up through the
wage structure.
The analysis suggested that such effects would be
minimal and that the main result would be the direct impact on
compensation of low-paid workers.
It was assumed in the projection
of consumption expenditures that most of the addition to wages
would be spent.
The increase in the index of compensation per
manhour attributable to the minimum wage increase was estimated
at six-tenths of one percentage point in the second quarter of
1974, three-tenths in the third quarter, and another three-tenths
in the first quarter of 1975.
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4/16/74
Mr. Eastburn remarked that he assumed that the recent
expansion in business loans at banks was related to inventory
accumulation, associated perhaps with price speculation.
As the
economy strengthened later in the year, however, the demand for
business loans was likely to be strong and rising, and the tendency
for the prime rate to lag the commercial paper rate would increase
demands for funds at banks.
He asked whether the staff would
agree with that assessment.
Mr. Partee replied that the staff's flow-of-funds projec
tion suggested that, while the rate of increase in bank loans
would not be quite so high as in the first quarter of the year,
it would continue at a very high rate throughout the period of
the projection.
The staff had projected a high level of plant
and equipment expenditures, as well as a positive rate of inventory
accumulation throughout the projection period.
Given the expected
levelling off or decline in profits, except in the oil industry,
business financing demands would be very substantial.
Much of
that demand for funds would be met by long-term debt offerings;
because the stock market situation was unfavorable to new issues,
it was unlikely that much of the needed financing would be done
through equity offerings.
Even with the fairly heavy capital
market financing projected, there would be a substantial residual
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4/16/74
need for funds because of price increases for capital goods and
the large differential between internal funds generation and the
volume of capital investment.
He agreed that business demands at
banks would be augumented by the tendency of the prime rate to lag
increases in other rates.
The projection allowed for a small net
increase in commercial paper outstandings, but business loans at
banks were expected to rise at an annual rate of about $30 billion,
as compared with an estimated rate of over $36 billion in the first
quarter.
Mr. Brimmer remarked that the flow of funds projections
presented to the Committee this morning indicated a decline in
the share of funds supplied by commercial banks in the first half
of 1975 as compared to the first half of 1974.
At the same time,
there was a sizable increase in the growth of total funds supplied
to the credit markets.
It appeared that the share of funds raised
by the Federal Government accounted for much of that increase and
that the funds were then rechanneled to the private sector through
Government credit agencies.
Historically, a decline in the share
of funds supplied by banks and a sharp increase in the share pro
vided by the household sector was associated with a substantial
rise in the level of interest rates.
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4/16/74
Mr. Partee agreed and noted that one of the reasons the
staff expected a rise in interest rates was the necessity for the
household sector to absorb a large volume of securities.
The pro
jection called for a rise in purchases of securities by house
holds from almost zero in the winter to an annual rate of over
$35 billion in the second half of 1974.
As a result, time deposit
growth at banks would be lower and the banks' share of lending
would decline.
The Government-sponsored agencies, Mr. Partee continued,
would be a significantly more important factor in fund
flows--as
Mr. Brimmer had observed--and those agencies would, of course,
finance themselves in the credit markets.
The projection for the
second half of 1974 included an increase in Federal Home Loan Bank
advances to savings and loan associations of about $9 billion at an
annual rate and an increase of over
$12 billion in funds provided
by other credit agencies to the mortgage market.
Therefore, the
total flow of funds from the Government sector to the mortgage market
would be at a rate slightly over $20 billion, beginning with the
second half of the year.
That volume of aid was necessary to provide
sufficient mortgage financing to support housing starts at the rate
the staff projected.
Such financing, would, of course, exert upward
pressure on market interest rates; in the judgment of the staff, both
short-term and long-term rates would be around 10 per cent, an
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4/16/74
historically high level.
It was possible that rates would go even
higher; the Board's econometric model, left unconstrained, would
produce an even larger increase in rates.
Mr. Hayes noted that the projections made by the staff of
the Federal Reserve Bank of New York did not extend into 1975; but,
through 1974 at least, they were quite similar to those made at
the Board.
Like Mr. Mayo, however, he wondered whether the Board's
projections of labor compensation were not too optimistic.
He
asked in that connection how much steel wages were likely to go up
over
the next few years as a result of the steel contract settlement.
Mr. Gramley responded that it was not possible to draw any
firm conclusions yet because of the lack of information.
It was
clear, however, that the steel wage agreement was basically similar
to the settlements made in the can and aluminum industries; that
is, it involved a 3 per cent rise in wages plus a cost-of-living
adjustment clause.
The ultimate effect of the settlement on future
wages would, therefore, depend on the rate of increase of the con
sumer price index,
Mr. Hayes then asked if there were any indication yet of
how much steel prices would be raised.
Mr. Partee replied that he felt that the increase in steel
prices would be very large and that it would probably occur at the
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end of April when the controls program was terminated, because
much of the rise in steel industry costs would take effect
immediately.
With respect to the wage structure in general, Mr. Partee
continued, the advance in compensation per manhour projected by
the staff would accommodate increases for union workers well above
the estimated 8 per cent average; the projection allowed for increases
of 10 or 11 per cent for the major union collective bargaining agree
ments. However, because it was anticipated that unemployment would
rise to a rate of about 6 per cent, the staff expected increases
for nonunion workers to be smaller.
Accordingly, the average annual
rate of increase in compensation per manhour could be as low as
8 per cent in spite of a number of settlements at much higher rates.
Mr. Leonard asked for clarification of the projected drop in
capacity utilization in 1974.
He was particularly curious about the
expected decline in the index of capacity utilization in the major
materials industries.
According to the green book, that index was
expected to dip from about 95 per cent in the fourth quarter of
1973 to 91.5 per cent in the first quarter of 1974 and then to
90.5 per cent.
Mr. Partee replied that the capacity utilization projec
tions were consistent with the staff's industrial production
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estimates.
Part of the drop in the first quarter was attributable
to the substantial decline in petroleum refining, as a consequence
of reduced supplies of crude oil.
It was expected that output of
refined petroleum products would rise as the year went on, but
that the
gain would be offset by a downward drift in production
of other basic materials as a result of the projected weakness in
demand for such products.
Mr. Gramley added that the decline in the capacity utiliza
tion index was expected to end by the second quarter of 1974; the
greater part of the fall was a consequence of the decline in economic
activity during the winter.
According to the staff projection,
industrial production would increase over the rest of the projec
tion period at a rate consistent with relative stability in the
capacity utilization index.
Mr. Morris remarked that he was troubled by the Board
staff's projections for 1974 and by those made at the Federal
Reserve Bank of Boston, which were almost identical.
The latest
projections differed very little from those made 2 months earlier,
even though the current indicators becoming available during that
period suggested greater-than-anticipated strength and resilience
in the economy.
That discrepancy apparently was attributable to
the assumption about inventories--that is, to the assumption that
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the buildup in inventories had been confined largely to the
automobile industry and was now over.
He would like to have
the staff elaborate on their belief that the real indicators
did not support the inference one might draw from recent business
loan data that a strong inventory accumulation was in process.
Mr. Gramley commented that one's conclusions about the
need to revise any projections would depend on the degree of
agreement between the original assumptions and actual developments.
The Board staff had initially assumed that the decline in activity
would be short-lived and would not cumulate into a typical cyclical
downswing.
The nonfinancial indicators that had become available
over the past 2 months supported the thesis that the decline was
bottoming out and that the economy was ready to move into an
expansionary period again.
Thus, the recent data had not held
any major surprises on that score.
What was surprising, Mr. Gramley continued, was that the
data on book value of inventories for January and February did not
support the staff's projection of a $10 billion increase in business
inventories in the first quarter; it seemed likely that the inventory
rise shown in the preliminary Commerce Department figures for the
first quarter would be lower than $10 billion.
For the period ahead,
the staff might well have underestimated the strength of businessmen's
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desire to build inventories in anticipation of price increases or
because of persisting shortages.
However, since the nonfinancial
indicators, such as new orders, did not suggest a sharp inventory
buildup, he thought the odds that the inventory change would sig
nificantly exceed the staff projections were not very high.
Mr. Partee remarked that, in view of the widespread,
long-continuing reports of shortages, it seemed quite reasonable
to expect a bulge in inventory accumulation of the kind Mr. Morris
had suggested, which might be followed by a period of low inventory
accumulation and a true recession in 1975.
The staff had not
incorporated an inventory cycle in the projection, however, because
of the lack of concrete evidence to date of a big buildup.
Further
more, if there were a high rate of inventory buildup at this point,
it could well be a transitory development related to the imminent
ending of the controls program.
In response to a question about possible data problems,
Mr. Gramley remarked that there always were problems with inventory
data and such problems were accentuated in a period of rapid inflation.
The Chairman observed that the inventory data were a statistical
morass.
For one thing, information on the methods used by business
firms to value inventories was inadequate. There were indications of
a shift from use of the LIFO inventory valuation method to the FIFO
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method, but there were no reliable data.
For another thing,
inventory figures were reported in dollar terms, and the methods
He
used to adjust them for price changes were highly uncertain.
agreed that one would expect inventory investment to rise in a
period of economic recovery, but it was difficult to determine
what was actually happening.
Mr. Bucher commented that in recent conversations with
retailers he had detected a mood of concern which did not seem to
be based on their current sales volume.
With respect to Mr. Gramley's
comment that consumers had expressed pessimism in recent attitudinal
surveys, he asked how current those survey data were.
Mr. Gramley replied that no information on consumer attitudes
had become available since the results of the latest University of
Michigan survey had been released several weeks ago.
That survey had
suggested a significant decline in consumer confidence.
If the Michigan
findings had been given full credence in the Board staff forecasts, the
projections for consumer spending would have been much lower.
It was
assumed, however, that the arrival of spring weather and the expected
upturn in economic activity would encourage consumers to step up their
spending.
Mr. Partee observed that, in addition to the anticipated
improvement in consumer attitudes, the projection incorporated a
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considerable rise in consumer income in the third quarter of 1974.
First, the expected change in withholding schedules represented an
increase of $8 billion, at an annual rate, in disposable income.
As
in the case of tax refunds, the staff had allocated half of the
increase to consumption and half to savings.
Secondly, there would
be a windfall gain in income of $2 billion, at an annual rate, as a
result of the retroactive Federal pay increase.
Third, the rise in
the minimum wage rate would take effect fully in the third quarter.
And, finally, an expanded public employment program was expected to
begin in the third quarter.
Taken together, expectations of those addi
tions to disposable income and of some decline in consumer bearishness
resulted in a fairly optimistic view of personal consumption expenditures.
In reply to a further question by Mr. Bucher, Mr. Partee noted
that a half-point increase in Regulation Q ceilings on certificates had
been assumed in all three of the alternative monetary policies he
had mentioned in his earlier statement.
Of those three alterna
tives, A and B differed from the projections shown in the green
book--and discussed by Mr. Gramley today--also with respect to
the assumed rate of growth in the money supply. Alternative C,
however, incorporated the same monetary assumption as the green
book projections;
a long-run growth path of 5-3/4 per cent for M1.
In order to isolate the expected effects of the change in Regula
tion Q ceilings, therefore, one should compare the alternative C
projections with those in the green book.
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Mr. Bucher noted that such a comparison suggested that the
change in Regulation Q ceilings would have significant effects in the
first half of 1975 on housing starts, the rate of growth in real
GNP, and the unemployment rate.
Mr. Mitchell asked about the extent to which the projected
deceleration in the fixed-weight price index represented a staff
judgment rather than a direct outcome of the price equations in
the Board's econometric model.
Mr. Gramley replied that price projections incorporated
explicit staff assumptions that the rise in prices of fuel and
foods would decelerate sharply as the year went on.
Mr. Mitchell commented that the projected decline from
"two-digit" inflation to a rate of 5 or 6 per cent would then
appear to be related to improvement of supply conditions.
Mr. Gramley agreed.
He noted that an index excluding
food and fuel prices might be taken as a measure of the under
lying rate of inflation.
That measure had not increased as
sharply as the total index, nor was it expected to decline as
much.
Mr. Mitchell observed that, from the point of view of
monetary policy, it was the underlying 5 to 6 per cent rate of
4/16/74
-67-
inflation that was of concern.
However, the rates of price
advance projected under the three alternative policy courses
outlined today did not differ much from one another over the
projection period.
The staff evidently had made an implicit
judgment that a policy course which would affect prices signifi
cantly in that period would be too austere in terms of its impact
on real GNP and unemployment, and that the most that could be hoped
for with respect to prices was some improvement after mid-1975.
In response, Mr. Partee said the staff had not presented
a policy alternative sufficiently restrictive to have a signifi
cant effect on prices within the projection period because, as
Mr. Mitchell had suggested, it thought such a course would be
considered too restrictive--particularly since the unemployment
rate would be expected to rise above 6 per cent in the first half
of 1975 under the more restrictive of the alternatives presented.
It should be noted, however, that monetary policy actions affected
prices with a longer lag than they affected real output.
Simula
tions made with the aid of the Board's econometric model suggested
that under alternative A the rate of price increase would remain
as high in the last two quarters of 1975 as in the second quarter,
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4/16/74
and it might even drift up a bit.
Under the restrictive alternative C,
the rate of inflation would continue to decline; it would be down to
4-1/2 per cent by the fourth quarter, and dropping rather rapidly.
That was because an unemployment rate over 6 per cent would, in time,
slow the rise in wage rates.
Maintenance of the alternative C course
would produce very sluggish growth in the economy and an unemployment
level of about 6-1/2 per cent by the end of 1975.
If the projections
were carried through 1976, the spread between the rates of price
advance under alternatives A and C would widen further.
Mr. Mitchell then asked if savings and loan associations could
comfortably absorb a half-point increase in the rates they paid.
Mr. Partee replied that in his opinion the industry as a
whole could accommodate an increase of that magnitude.
Mr. Wallich said he found it curious that excess capacity in
the major materials industries was not expected to rise in spite of
the slowness of the projected recovery.
Stability in the capacity
utilization index while GNP growth remained below its potential
implied a low rate of investment, and that did not seem realistic.
Mr. Partee replied that the relative stability of the capacity
utilization index between the second quarters of 1974 and 1975 was
based on an expected rise of about 4 per cent in real GNP, a some
what larger rise in industrial production, and a 5 per cent rate of
growth in industrial capacity.
The estimate of the growth rate in
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4/16/74
capacity was particularly uncertain, since it depended on the dates
at which production began at plants
now under construction, the
amount of current investment that was devoted to pollution control
rather than to additional capacity, and so forth,
While the projected
rate of capacity growth was probably of the right order of magnitude,
such a rate might well prove to be inadequate.
Mr. Wallich then asked the staff's opinion about the
probabilities that the projection of real GNP would err on the
upside or the downside.
It seemed to him that there was a larger
chance of underestimating the growth of economic activity.
For one
thing, there was the potential for greater inventory expansion than
allowed for.
For another, there seemed to be considerable pressure
for additional plant and equipment spending.
Also, if conditions
with respect to the rate of price advance did not worsen, it was quite
possible that consumers would react as if they had improved.
Housing
appeared to be the main area of potential weakness, and he felt there
was some chance that activity would strengthen even in that area.
In reply, Mr. Partee expressed the view that, in terms of
the internal relationships of the model, the staff projection was
highly optimistic.
For example, consumption expenditures were as
large relative to disposable income as could conceivably be
justified.
However, there were uncertainties with regard to a
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4/16/74
number of external factors, especially inventories.
He doubted
that the rate of increase in plant and equipment expenditures in
real terms over the next six quarters would be much higher than
the projected 4 per cent, because that rate was consistent with
the capacity of the capital-supplying industries.
But the inven
tory investment projection could be low by several billion dollars.
It was also possible that the housing estimates might be a little
low, particularly around mid-1975.
depended on a number of factors:
The outlook for housing
the amount of governmental
assistance that would be forthcoming; the ability of FHA field
offices to process applications and make loans--that ability was
not so great as it had been several years ago; and the capacity
of the market to adjust--that is, whether the rates paid on savings
deposits would rise enough to maintain funds flows into the mortgage
market and whether consumers would be willing to pay 10 per cent
mortgage rates.
Mr. Mayo observed that, in order to get an appreciable
increase in housing starts above the present level, according to
the staff's analysis, it was necessary to assume not only a half
point increase in Regulation Q ceilings but also the fastest rate
of growth in M1 of those considered--the 6-3/4 per cent rate of
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4/16/74
alternative A.
He also found it significant that under alterna
tive A the annual rate of housing starts would be only 320,000
units higher in the second quarter of 1975 than the green book esti
mate, but the rate of growth in real GNP would be double that pro
jected in the green book--4.8 as compared to 2.3 per cent.
Even
allowing for the faster rate of monetary growth assumed under
alternative A, that seemed to represent an unusually strong
multiplier effect.
Mr. Gramley remarked that the econometric model suggested
that the Regulation Q change would have an even larger impact on
housing and on activity in general.
The staff had been dubious
about that result and had modified it judgmentally.
Mr. Partee noted, in addition, that the increment to the
rate of growth in the money supply under alternative A was close
to 1-1/2 percentage points over the entire projection period.
Past
experience with the model indicated that a change of that magnitude
in the growth rate of money had a significant impact on the economy
after a sufficient amount of time elapsed.
The increased money
supply stimulated not only housing but also State and local con
struction, business fixed investment, and personal consumptionthe latter through the impact on stock market prices.
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4/16/74
Mr. Morris observed that over the past 2 months there had
been a very sharp rise in interest rates and indications of the
beginning of disintermediation.
In the past such events had pre
cipitated strong protests about restrictive monetary policy in
the Congress, but he had seen no evidence of such a reaction as
yet.
He wondered if the Chairman expected that situation to
persist.
The Chairman observed that he would not be willing to
predict that the absence of protests would continue indefinitely.
However, he might note that, although he regularly received a
great deal of protest mail from the public, he had not as yet
received any communications from Congressmen critical of the
recent increase in interest rates.
He suspected that Congress
men, as well as others, were not surprised by rising interest
rates at a time when prices of goods and services were surging
and when there were expectations of substantial rises in wage
rates.
They also might be aware that interest rates were higher
in foreign countries--for example, that mortgage rates in
Canada and Great Britain were well above those in the United States.
The criticisms of interest rate trends that he had been receiving
recently were mainly from the stock exchange community and occa
sionally from owners of small businesses.
4/16/74
-73Mr. Eastburn asked whether a half-point increase in
Regulation Q ceilings would be likely to stir criticism.
The Chairman said he was skeptical about the staff's
assumption of such an increase in developing its policy alterna
tives.
While he had not discussed the matter with representatives
of the other regulatory agencies, he would expect the Federal Home
Loan Bank Board to oppose any ceiling increase
at present, even
though it might accept an increase 2 or 3 months from now.
He
might note that officials of some savings and loan associations
had complained to him that current rate ceilings were too high.
In response to a question from the Chairman, Mr. Mitchell
said the Inter-agency Coordinating Committee had not had recent
discussions of the possibility of increases in ceiling rates.
agreed with Mr. Partee's earlier statement that the savings and
loan industry as a whole could accommodate an increase in the
rates it paid, but whether the regulatory agencies would agree
to an increase in the ceiling rates was another question.
The Chairman expressed the opinion that a rather high
percentage--perhaps as much as 25 per cent--of the savings and
loan institutions would find themselves in some difficulty if
interest rate ceilings were raised,
He
4/16/74
-74Mr. Partee noted that the most recent disaggregated
income data for savings and loan institutions was for the year
1971 and, therefore, was not very useful for analyzing the
problem.
However, the Federal Home Loan Bank Board had access
to more recent information on problems of individual institutions,
and they would probably estimate that a substantial minority of
savings and loan institutions, perhaps 1,000 to 1,500, would suffer
losses.
It was not a question of those institutions going bank
rupt, but rather of having to reduce their surplus for a time.
The industry as a whole had achieved a good increase in return
on assets over the past year or 18 months, and the future profit
situation was likely to be adequate since the projected high
mortgage interest rates over the next year would mean sizable
incremental additions to portfolio income.
Mr. Partee said it might be worth emphasizing that the
increase in interest rate ceilings assumed by the staff in pre
paring the alternative projections related to certificate rates,
and did not extend to rates on passbook accounts.
The resulting
cost increase to the thrift institutions would, of course, be con
siderably less than under a more general increase in ceiling
rates.
4/16/74
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Mr. Brimmer observed that the savings and loan associa
tions would also benefit from not having to pay the new higher
levels of interest on the outstanding four-year certificates sold
since last summer.
Mr. Black said he regarded the uncertainty about the
duration of the recent business loan expansion as a key question.
The projected slowing in the growth rate of the monetary aggregates
might imply that the staff expected the business loan bulge to be
temporary.
Indeed, there were several factors which suggested that
the rapid increase in loans would not continue.
Rising bank lend
ing rates would encourage some borrowers to shift to the commercial
paper market.
Auto dealer demands for financing floor stocks would
be declining, and demands of businesses generally for financing
precautionary inventories of goods in short supply would probably
abate when shortages were relieved by the removal of price controls.
Some business borrowing had been associated with the sharp increase
in oil payments, which was unlikely to continue at the recent rate.
Finally, some bankers reported that there had been a substantial
switch, particularly by agricultural producers, from trade credit
to bank credit, and that process had about run its course.
Taking
all those factors into account, it was his feeling that growth in
business loans would probably not remain rapid.
He wondered,
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4/16/74
therefore, if it would not be reasonable to expect a slower rate of
growth in the monetary aggregates for any given level of interest
rates than had been the case in recent months.
Mr. Partee said he agreed with some of Mr. Black's points.
He might note, however, that the staff was projecting that a con
tinuing, substantial increase in bank loans to business would result
from the wide spread between plant and equipment expenditures by
corporations and their internal generation of funds for investment
purposes.
Except for the oil industry, corporate profits were
expected to decline over the projection period.
The Chairman suggested that, in addition to addressing
questions to the staff, the members express their own opinions
regarding the economic situation.
The Committee's major task was
to deliberate on monetary policy, and that could be done most
effectively if the members shared their individual views on the
economic outlook.
The projections presented by the staff were by
their nature rather conjectural, and his own forecast--were he to
present one--would be stated in rather different terms,
He would
have made other policy assumptions, and his conclusions would have
differed from the staff's in some respects.
Mr. Coldwell noted that the staff had projected an increase
of roughly one percentage point in the unemployment rate by mid-1975
4/16/74
-77-
under alternative C.
He asked whether that was a result of
an expectation of faster growth in the labor force than in jobs,
or whether it reflected an anticipated decline in jobs because of
higher labor costs, slackening demand, or problems in specific
industries.
Mr. Partee replied that the primary reason for the estimate
of higher unemployment was that the staff expected the labor force
to increase faster than employment.
No massive layoffs in depressed
industries, such as might occur in a typical severe business
cycle, were anticipated.
The staff had forecast some slowing in
labor force growth--estimating an increase of 1.3 million persons
at an annual rate as compared with the 1.6 million that might be
expected on a trend basis--but it believed that the economy would
not be strong enough to absorb the natural additions to the labor
force.
Mr. Coldwell asked whether growth in the labor force might
not be less than 1.3 million, in view of the exceptionally large
growth over the past few years.
Mr. Partee responded that a more marked slowing than pro
jected was possible; indeed, labor force growth in the past few
months had been below the projected rate.
In his opinion, however,
growth at about a 1.3 million rate was more likely.
4/16/74
-78Mr. Coldwell then said he found it difficult to believe
that there would be a difference of only two-tenths of a percentage
point in the rate of increase of the fixed-weight price index by
mid-1975 as a result of the different monetary growth rates asso
ciated with alternatives A and C.
There would be serious problems
in formulating monetary policy at this meeting if it were true that
the Committee's actions would have so little impact on the rate of
inflation.
Mr. Partee responded that, as he had noted earlier, the
differential impact of the alternative policies on the rate of infla
tion would be greater in the later part of 1975, at least if one could
accept the results yielded by the Board's econometric model.
The
Committee could, of course, also slow the rate of price increase
more within the projection period by pursuing a monetary policy
considerably more restrictive than that assumed under alternative C.
Mr. Coldwell observed that the effect of the alternative C
policy on the rate of inflation within the next year might be
greater than the staff suggested as a result of the changes in
expectations that might be generated by continued stringency in
monetary policy.
Mr. Partee agreed that that was a possibility.
4/16/74
-79Mr. Clay commented that recent developments in farm prices
offered some promise that retail food prices would stabilize during
the last half of 1974.
Since reaching a near peak in mid-February,
farm prices had slipped substantially, led by declines of about
one-third, or $2 a bushel, for wheat;
one-fifth, or $0.60 a bushel,
for corn; and 10 to 20 per cent, or $2 to $4 a hundredweight, for
cattle and hogs.
Although it was likely that meat animal prices
would rise seasonally in the summer, grain prices were expected to
trend lower as the new crops were harvested.
It was not clear, Mr. Clay continued, how food merchants
would respond to those developments, but recent information indicated
that the spreads between farm and retail prices had widened to near
record levels, especially for red meats.
If retailers showed a
willingness to let those price spreads narrow in the months ahead,
the upward pressures on food prices should ease considerably, as
the Board staff had predicted.
Mr. Clay then said he found the projections associated
with the alternative policy courses intriguing.
As he understood
it, the effects of policy actions taken now--in the second quarterwould reach significant proportions in the fourth quarter for such
variables as the unemployment rate, but there would be practically
no differential impact on prices through the second quarter of
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4/16/74
1975.
Like Mr. Coldwell, he believed that monetary policy could
affect the rate of inflation more quickly, by altering the expecta
tions of those who now thought inflation would continue at its
present pace.
Mr. Gramley said he wanted to emphasize that past experience
supported the conclusion that changes in monetary policy affected
prices with a much longer lag than they did real economic acitivity.
It was possible that a shift to a highly restrictive monetary
policy might generate a sharp change in expectations.
However,
inflation was essentially a long-run problem, and in his view it
would be unduly optimistic to expect substantial progress on the
price front within the next year or 18 months as a result of any
feasible monetary policy.
Chairman Burns observed that the current inflation differed
in one important respect from most previous periods of rapid price
increases:
there had been an explosive rise in prices of foods and
raw materials.
The markets for those goods were still highly com
petitive, by and large, and if monetary policy were to remain
moderately restrictive, it was possible that such prices would
break sharply, resulting in an effect on the general price level
much larger than past experience might suggest.
The relevant com
parisons were with the commodity inflations of 1920 and, to a
lesser extent, the Korean War period.
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4/16/74
In evaluating any projection,the Chairman continued, it
was necessary to remember that other projections had often proved
to be far off the mark, even when made by highly qualified analysts.
While the staff's projections were useful, they should not be taken
literally.
Mr. Kimbrel asked whether the Chairman considered it likely
that the Congress would restructure the tax laws so as to affect
Federal revenues during the projection period.
The Chairman said he did not expect any significant change
in the tax structure in the near future.
Mr. Kimbrel then remarked that Sixth District businessmen
had indicated in recent conversations that the economy was showing
much more strength than they had expected.
Bankers had been
completely unprepared for the recent sharp expansion in business
loans.
Businessmen were anxious about inflation and were girding
themselves for the price increases that might following the lifting
of the controls program at the end of April.
Contractors reported
that costs were rising so sharply and delivery schedules were
slowing so much that they were reluctant to make firm bids on
new contracts.
In general,
financing problems and high interest
rates were of much less concern to the Sixth District contractors
than were problems associated with availability of materials,
delivery schedules, and costs.
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4/16/74
Both banks and insurance companies, Mr. Kimbrel continued,
were becoming somewhat concerned about the quality of credit because
of the increasing frequency of delinquencies.
In general, though,
businessmen in the Sixth District felt that the worst part of the
economic slowdown was now in the past, and that the most important
current problem was inflation.
Mr. Brimmer said he found the staff's projections and analysis
useful as background material for thinking about monetary policy.
He
accepted the staff's view that the effects of monetary policy actions
should be expected to be evident first in interest rates and financial
variables and then, in sequence, in output, employment, and prices,
with lags of varying length.
Because he was particularly concerned
about the long-run inflationary situation, he felt that the Com
mittee's deliberations should focus on how monetary policy could
reenforce the efforts already under way to restrain inflation.
The objective of monetary policy should not be to revive housing
or to assure any particular short-run behavior of the unemploy
ment rate.
There were specialized instruments to provide aid to
housing, and public employment programs and unemployment compen
sation could help deal with the very real problem of unemployment.
That was the general direction of his thinking; he would offer
more detailed views on policy when the Committee turned to that
subject.
4/16/74
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Mr.
Axilrod made the following statement on prospective
financial relationships:
I would like to offer only two additional comments
to the Committee with regard to the blue book alter
natives. 1/
First, the Committee may, as a policy matter, again
wish to consider lowering the bottom of the ranges for
the aggregates.
With the aggregates running strong
relative to long-run desires, this would permit a more
rapid move back to path, at current interest rates,
should the incoming data weaken.
Second, the even keel constraint before the Com
mittee over the forthcoming weeks suggests that any
tightening of the money market--should it prove nec
essary--would be better accomplished over the next
several days.
The Treasury refunding is fairly large,
and late April through the first
week or two of May
will be a critical period in determining market atti
tudes toward the new issues and in distributing them.
Thus, it may be desirable to keep money market conditions
generally stable during that particular period. However,
if on top of recent overshoots, the aggregates are grow
ing considerably more rapidly than desired, it seems to
me that 3 weeks is an excessively long period for an
absolute even keel constraint. It may--under such
circumstances--prove desirable to permit some money
market tightening in the weeks of the financing,
particularly if market attitudes have been prepared
by some tightening prior to the financing.
Chairman Burns observed that the Committee was ready for
its deliberations concerning monetary policy.
Mr. Bucher remarked that in his view the System had pursued
a policy of restraint too far too quickly; he was uncomfortable
1/ The alternative draft directives submitted by the staff
for Committee consideration are appended to this memorandum as
Attachment C.
4/16/74
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with the Committee's general posture and with the level to which
money market rates had risen.
Nevertheless, he would not pro
pose that the Committee reverse policy precipitously.
Continuing, Mr. Bucher commented that the risks involved
in forecasting became greater as the forecasts extended further
into the future.
Moreover,
he thought that it
was important to
emphasize staff comments to the effect that the latest GNP fore
casts might be on the optimistic side.
It was important to
emphasize also that at present there was little basis for assum
ing that Government programs would be implemented to help in
dealing with the employment and housing problems, particularly
in the current political environment.
The Committee had to act
and to bear the responsibility for its actions without relying
on the assumption that some other part of Government would take
appropriate actions.
In that light, Mr. Bucher said, it was important to con
sider the trade-offs involved in pursuit of a still more restrictive
monetary policy.
Staff projections suggested that in the second
quarter of 1975 housing starts would be about 200,000 lower under
alternative C than under alternative A, and they also suggested
fairly major differences between the two alternatives in rates
of growth in real GNP and in the unemployment rate.
Therefore,
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4/16/74
he was concerned about the possibility of the Committee over
reacting.
In his view, a great deal of monetary restraint had
already been put in place, and he would wait a month to observe
its effects before considering any further tightening.
He could
accept alternative B--which represented a continuation of pre
vailing money market conditions--although he preferred spec
ifications somewhere between those of alternatives A and B.
Chairman Burns remarked, with respect to the current
political environment, that the Administration's position at
the beginning of the year was that a recession must be prevented
and that whatever needed to be done would be done.
Members of
the Administration--including the President--had been weighing
the economic situation, and in view of signs of improvement in
economic activity and of intensification of the inflation, the
present position was that a tax cut--such as had been proposed
by some members of the Congress--must be opposed.
That was a
clear and deliberate decision reached by the Administration.
Of
course, some confusion and uncertainty about Administration policy
might develop as a result of the departure of George Shultz as
Secretary of the Treasury.
In response to a question by Mr. Black, the Chairman
added that the Administration, a little reluctantly, had gone
4/16/74
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along with a recommendation that income tax withholding
rates be reduced.
While such a reduction would alter the
distribution of tax receipts during the fiscal year, it
would not change the total for the year.
Mr. Brimmer commented that he favored alternative C;
in pursuit of a policy of restraint, he did not wish to go
beyond alternative C, but neither did he wish to stop short of
it.
He wanted the Committee to take responsibility for its part
of the job, and he would encourage other agencies of the Govern
ment to take responsibility for their parts.
As he had said
earlier, there were specialized means for dealing with excessive
unemployment and for aiding housing.
He would not wish to see
the Committee assume responsibilities that belonged to others.
Continuing, Mr. Brimmer said he foresaw more pressure on
interest rates in the period ahead, and he believed that a higher
Federal funds rate was necessary.
He would be inclined to raise
the funds rate ceiling under alternative C to at least 11-1/2
per cent, and he would instruct the Manager to move the rate
toward that level.
He recognized that such a policy would result
in a slower rate of recovery in economic activity over the next
9 to 12 months than would alternative A, but the cost had to be
paid.
4/16/74
-87Mr. Bucher commented, in clarification of an earlier
statement, that there was some uncertainty as to whether other
Government agencies having responsibilities for programs affect
ing housing and employment would in fact be able to act.
ically, it
Specif
was a serious question whether FHA would be able to
perform its role with respect to the "tandem programs."
In response to a question by Chairman Burns, Mr. Partee
observed that--while administered by GNMA--the tandem plan
involved only new FHA and VA mortgages, not conventional mort
gages.
Mr. Kimbrel said he held the same policy views that
Mr. Brimmer had expressed.
While the staff's projections might
be viewed as being on the optimistic side, the System's perfor
mance in achieving its objectives was something less than excel
lent.
He favored alternative C and, like Mr. Brimmer, would set
the upper end of the range for the funds rate at 11-1/2 per cent.
Mr. Hayes observed that, in his view, persistent and
virulent inflation was the overriding problem, both domestically
and internationally.
Over the past year, growth in all of the
aggregates had been somewhat excessive for a period of rampant
inflation.
In formulating policy for the next month, consequently,
he would place the emphasis on maintaining firm money market con
ditions or achieving slightly firmer conditions.
A firm monetary
4/16/74
-88-
policy, moreover, would strengthen the exchange rate for the
dollar against other major currencies.
He had been glad to
see the funds rate edge up to 10-1/4 per cent, and he favored
specification of a symmetrical range around that level--a range
of 9-3/4 to 10-3/4 per cent, which was between alternatives B
and C.
For the longer-run M1 target and for the other aggre
gates, he favored the specifications of alternative C.
Mr. Hayes commented that the time was getting very close
when an increase of one-half of one per cent in the discount rate
would be desirable; recently some directors of the New York Bank
had expressed impatience with respect to an increase in the rate.
He thought that the increase perhaps ought to be effected as
early as the current week, provided the timing was acceptable
from the point of view of the Treasury financing.
With respect
to reserve requirements, an increase in the marginal rate on CD's
in addition to action on the discount rate would be excessive
tightening.
A reduction in the requirement under Regulation M,
to 5 per cent, along with an increase in the discount rate, would
have a favorable effect on the dollar's international position.
Mr. Mitchell said he favored alternative B.
In his
view, the market had become aware of the System's policy course,
and less sophisticated people were going to become apprehensive
4/16/74
-89-
when they saw the pattern of interest rates that would flow from
the actions that had already been taken.
The System had now
demonstrated by the recent changes in monetary policy that it
was on the side of the angels, but it could overdo it.
Addi
tional tightening--on top of the actions of the past few weekswould be excessive.
Moreover,
it might make the Treasury's
refunding problem more onerous than would be desirable from
the standpoint of the public as well as the Treasury.
He would
prefer to retain about the present policy posture,
Mr. Mitchell added that if some further action were
deemed to be necessary, he would prefer to raise the marginal
reserve requirement on CD's, with the expectation of achieving
a better and more localized effect on bank lending policies
than could be obtained through open market operations.
It
might also be desirable to do something with respect to Euro
dollar borrowings of U.S. banks; that was a question that ought
to be studied in the context of the interest rate differentials
between the U.S. market and the Euro-dollar market that might
develop as funds flowed into the latter market.
Mr. Holland commented that a policy of reasonable
restraint was appropriate at the present time.
The Committee
had leaned in that direction at the last meeting by toughening
4/16/74
-90-
its reserve provision policy, and that had turned out well.
Interest rates had moved up to levels that were starting to
slow inflows to the thrift institutions, a development that
might be characterized as mini-disintermediation.
The interest
rate increases since the last meeting had cut perhaps 2 per
centage points from the
M 3 later in the year.
prospective rates of growth in M 2 and
In his view, those two aggregates--as
compared with M1--were even more important this year than last
in analyzing the effects of policy.
The recent actions had been
in just about the right degree to dampen the recovery in housing
activity and to produce a significant anti-inflationary effect.
Before tightening further, however, the Committee should pause
for a while, because the next significant round of tightening
in reserve supply and of increases in interest rates would pro
duce full-scale disintermediation, which would precipitate a
number of other developments.
In effect, it would be a thresh
hold decision, having important consequences for financial
institutions, housing activity, the distribution of resources,
and attitudes generally.
Continuing, Mr. Holland observed that more evidence was
required to determine whether the current expansion was cyclical
in character, with a renewed generation of inflationary pressures,
or whether it was influenced by temporary factors, such as a
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4/16/74
short-run buildup of inventories in advance of the April 30
termination of the price control program.
Although such inventory
investment was not evident in the available statistics--which
were not as up to date as other statistics--it might appear when
later data became available.
If that proved to be the case, the
degree of tightening in money and credit availability that had
already been accomplished would prove to be about right; a
further tightening would be unnecessary.
Indeed, as Mr. Gramley
had suggested earlier in response to a question, a second-quarter
bulge in inventory investment would most likely lead to some
softening in economic activity in subsequent quarters.
On the
other hand, if the evidence indicated that a cyclical upsurge
in economic activity and in inflationary pressures was developing,
he would be prepared to accept a more restrictive policy.
In conclusion, Mr. Holland said he would like to con
tinue the present posture of policy until the next meeting of
the Committee, when additional evidence on the nature of the
situation would be available.
that.
Alternative B would accomplish
If the Committee favored the B language for the opera
tional paragraph of the directive, he would delete "somewhat"
from the statement that the Committee sought to "moderate some
what growth in monetary aggregates."
However, he would prefer
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4/16/74
to couch the directive in terms of money market conditions, using
the variant for B shown in the blue book--namely, ". .
the Com
mittee seeks to maintain about the prevailing money market condi
tions, provided that the monetary aggregates appear to be growing
at rates within the specified ranges of tolerance."
That language
more precisely described what he had in mind, and this was a time
to be particularly precise in describing what the Committee was
trying to achieve.
He favored the aggregates of alternative B,
although he would reduce the lower end of the 2-month ranges for
the reasons given by Mr. Axilrod.
And with a view to publication
of the specifications in 90 days, he would round the limits to the
nearest full percentage point in order to avoid a suggestion of
great precision.
He would try to hold the funds rate within a
range of 9-1/2 to 10-1/2 per cent.
Mr. Hayes remarked that, while he had indicated a pref
erance for the aggregates specified under alternative C, he would
both broaden and lower the short-run ranges of tolerance;
it would
be acceptable if the aggregates fell short of the alternative C
ranges for a brief period.
Thus, he would suggest a range like
1 to 7 or 2 to 7 per cent for M1 .
And, like Mr. Holland, he
would prefer to couch the directive in terms of money market
conditions.
However, he would prefer to say ". . .the Committee
seeks to maintain firm money market conditions and to seek
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4/16/74
additional firming if
the monetary aggregates appear to be
growing unduly rapidly."
That language indicated a little
more specifically that the Committee was prepared to tighten
money market conditions in the event of too rapid growth in
the aggregates.
Finally, with reference to Mr. Holland's
remarks, he noted that the longer-run target specified under
alternative B was 6 per cent, compared with the 5-1/4 per cent
target that the Committee had adopted at the March meeting;
in terms of the M 1 target, therefore, alternative B did not
represent a continuation of the Committee's present posture.
In response, Mr. Holland commented that at the March
meeting the Committee had established a longer-run M target
that, in his view, was too low; the 6 per cent target was
more reasonable.
By advocating continuation of the present
policy posture, he meant only that prevailing money market
conditions should be maintained.
Mr. Morris observed that a few months ago he had felt
a need to give a lot of weight to the possibility--which he had
viewed as serious--of a cumulative decline in economic activity.
Now, on the basis of the evidence of the past 8 weeks, he felt
that such a risk had been largely eliminated.
As a result,
there now was a lower potential social cost in giving a higher
4/16/74
priority to controlling the rate of growth in the money stock
in order to slow the longer-run rate of inflation.
Accordingly,
he would accept the specifications of alternative B, except for
the funds rate range.
To provide the Manager with sufficient
flexibility to assure that growth rates of the aggregates would
not exceed the upper limits of their short-run ranges, he would
raise the upper limit of the funds rate range to 11-1/4 per cent,
thus specifying a range of 9-1/4 to 11-1/4 per cent.
Mr. MacLaury remarked that he felt more than the ordinary
uncertainty about the GNP projections at this time.
While he
thought that a cumulative downturn now was less likely--if not
much less likely--he still was uncertain about the probable course
of economic activity in the second half of the year.
Therefore,
he would emphasize the various measures of the money stock, in
contrast with some speakers who had defined the degree of ease or
restraint in terms of money market conditions.
Continuing, Mr. MacLaury said growth in the monetary
aggregates--both in the recent past and projected for the
short run--was excessively rapid.
Consequently, he saw no reason
to depart from the longer-term objectives set at the March meeting,
involving a 6-month target of a 5-1/4 per cent rate of growth in
M1 to return it to the longer-term path of 5-3/4 per cent.
In that
4/16/74
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light, he favored specifications falling between alternatives B
and C.
However, he could accept the specifications of alterna
tive B if the lower limit for the M1
short-run range of tolerance
were reduced to 5 per cent; the mid-point of the range then would
be the same as the 6-1/2 per cent mid-point under alternative C.
Mr. MacLaury added that he wished to compliment the staff
for providing in the blue book the projected rates of growth for
the three measures of the money stock on the quarterly average
basis.
It was also helpful to have the reference, in connection
with one of the alternatives, to the length of time that it would
take to return growth in M1 to the long-run path of 5-3/4 per cent.
Mr. Leonard observed that he had confidence that the
techniques of formulating monetary policy and of controlling money
would improve substantially in the future--perhaps even in the
near future--even though the precise role of money in influencing
the course of economic activity was, and for some time probably
would continue to be, a subject for debate.
Once such improvement
had occurred, the Committee would find 3 months after a meeting
that monetary growth was on target, and consequently, there would
be less concern about the effects of publishing the longer-run
targets.
4/16/74
-96Continuing, Mr. Leonard remarked that it was the Committee's
practice at its meetings to examine three alternative policy
courses--A, B, and C--and it seemed to him at times that one could
determine in advance that the Committee would adopt a course close
to that of alternative B.
At the last three meetings, for example,
the Committee had rejected the A alternative because the specified
rates of growth of money were deemed to be too large and the
implied consequences for the future were not desirable.
In like
manner, the Committee had rejected alternative C because the
interest rates projected for the short term were deemed to be
too high.
So in the last 3 months the Committee had voted some
thing close to the B alternative, with perhaps some minor changes
in specifications.
However, the growth of money observed so far
this year was faster than that specified under the B alternatives;
it was even faster than growth under the A alternatives, which
had been rejected as being too fast.
At the same time, during
most of the first 3-1/2 months of 1974, short-term interest rates
were higher than had been deemed necessary or desirable in order to
achieve the desired rate of monetary growth.
Consequently, he
believed, this would be an excellent time to break away from the
B alternative and to get hawkish on inflation.
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The real question, Mr. Leonard said, was whether the
economy was or was not stronger than indicated by the staff pro
jections.
If it was stronger, adoption of either the A or B
alternative might lead to great difficulty next summer.
At that
time both rates of interest and rates of money growth might again
be higher than desired, and the Committee might have to dig in
during a period of heavy Treasury borrowing.
With that prospect,
alternative C clearly would be the better choice today.
On
the other hand, the staff projections might be right, and the
economy might not be as strong as he believed it to be.
Never
theless, he would not favor re-acceleration in monetary growth
because of the possible difficulties he foresaw.
Alternative C
was intended to return M 1 growth to a 5-3/4 per cent growth path
by September, which compared with a 5.5 per cent growth rate
during the first quarter, on the quarterly average basis, and a
4.8 per cent rate in the second half of 1973.
If it became
apparent later in the year that real economic growth was weaker
than he now expected, a more expansive policy at that time would
fit in well with the heavy Treasury financing.
It also would
cushion the decline in the rate of growth in real output that
the staff foresaw for the first half of 1975.
4/16/74
-98Mr. Mayo observed that he advocated alternative B because
he believed it would steer a constructive path--in contrast with
alternative C, which would invite serious disintermediation and
run the risk of forcing an easy money policy next autumn.
native B
Alter
represented a mildly and appropriately restrictive policy;
under it, the annual rate of growth in M1, after declining from
7.5 per cent in the fourth quarter of 1973 to 6.7 per cent in the
first quarter of this year, was projected to decline further to
5.7 per cent by the third quarter.
He favored the M1
of 6 per cent for the second and third quarters
indicated range for the funds rate.
However,
target
combined and the
he believed that
the short-run ranges of tolerance for the aggregates were too
narrow; he would widen them to 5-1/2 to 8-1/2 per cent for M1
and 6-1/4 to 9-1/4 per cent for M2.
Like Mr. Holland, he pre
ferred the variant alternative B language for the operational
paragraph couched in terms of money market conditions, as shown
in the blue book.
Noting that the Chicago Bank had been among those whose
directors had recommended an increase in the discount rate last
week, Mr. Mayo said such an increase was preferable to a further
rise in the Federal funds rate as the next tightening step; it would
confirm the tightening that had already occurred in the market and
4/16/74
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would indicate clearly that the System meant to be restrictive,
but it would not provoke further tightness.
It would be appropriate
to raise the discount rate before taking any action with respect
to reserve requirements on CD's or Euro-dollars,or with respect
to Regulation Q ceilings.
Those instruments could be used later,
with both announcement and substantive effects, and they were
subject to better control than the open market operations involved
in alternative C.
In the Chicago District, Mr. Mayo added, the recent rapid
expansion in bank credit involved borrower use of existing lines
of credit rather than aggressive efforts by the banks to expand
their lending.
In his view, that made a difference in the inter
pretation of the recent loan expansion.
Mr. Coldwell observed that, in contrast to Mr. Mayo,
he would prefer not to act on the discount rate--or reserve
requirements--at this time, because such action would raise
interest rates further and generate expectations of additional
increases.
Like Mr. Mayo, he would widen the ranges for the short
run ranges of tolerance for the aggregates, but preferring alter
native C, he would specify ranges of 4 to 7 per cent and 5 to 8
per cent for M and M2,
respectively.
And he would specify a
range of 9-3/4 to 11-1/2 per cent for the funds rate.
He was
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4/16/74
especially concerned about efforts directed toward fine
tuning; he prefered that the Manager be given, and use, greater
flexibility than in the past.
Mr. Coldwell added that he was opposed to operations by
which the Desk injected reserves over the weekend--especially
through repurchase agreements--just for the sake of "touching up
the market."
He doubted whether the market had needed much touch
ing up in the period since the last meeting and hoped that the Desk
would stay out of the market as long as developments were acceptable.
Chairman Burns remarked that it might be helpful if the
Committee's senior economist gave his policy recommendations at
this point.
Mr. Partee observed that he, like Mr. Bucher, believed
that monetary policy had been tightened quite a lot in recent
weeks, given the basic economic situation.
If not for its
potential effects on inflationary expectations, he would favor
a return to a somewhat more liberal stance with respect to the
aggregates, which might bring about some easing in money market
conditions, along the lines of alternative A.
However, he
recognized that inflationary expectations were great, and that
any move in the direction of a more expansive monetary policy
might fan those expectations; it might tend to raise the increases
4/16/74
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demanded in coming wage negotiations and to lessen business
resistance to such demands.
Accordingly, he would accept the
specifications of alternative B, although he would do so
reluctantly because they seemed likely to be associated with
inadequate economic growth over the period ahead.
Continuing, Mr. Partee said he would be prepared to see
a decline in the funds rate over the weeks ahead, should incoming
data for the monetary aggregates indicate low rates of growth,
because the Committee was tolerating high interest rates--and
their consequences--as
expansion.
a means of achieving moderate monetary
Signs that monetary expansion was moderating would
permit the Committee to ease the pressure that high interest
rates exerted on the economy.
On the other hand, since market
rates had already moved so high, he would be prepared to accept
a significant further rise only if the incoming data indicated
that monetary growth was running very much on the high side.
With respect to monetary growth, Mr. Partee observed
that the numbers becoming available in recent weeks had rather
consistently been above staff projections, but that did not
mean that incoming data would continue to be on the high side.
The past suggested that the periods when the numbers ran very
high or very low relative to projections generally were brief.
The chances were about even that a run in one direction would be
followed by one in the other direction.
4/16/74
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Mr. Brimmer remarked that recent developments, as described
in the blue book, suggested to him that the chances were greater
than even that expansion in the aggregates would remain on the
high side, given prevailing money market conditions.
In his view,
maintenance of about the funds rate range adopted at the last meet
ing, in the face of strong demands for business loans, would encourage
the banks to compete in making loans, and the System would supply
the reserves.
That had been happening since the middle of March,
and he suggested that a repetition was likely.
In response, Mr. Partee commented that the developments
that might permit an easing of money market conditions under
alternative B probably would encourage some decline in interest
rates in the commercial paper market.
Because of the lag in
the prime rate, some loan demands then would tend to shift back
into the commercial paper market, and the pace of expansion in
banks' business loans would moderate.
Chairman Burns observed that his own position, in general,
had been well stated by Mr. Mitchell.
A little more tightening
in policy was indicated, but in view of the considerable tightening
that had occurred, he would be inclined to pause for a while
before making any major move.
At present, the directive language
4/16/74
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of alternative B couched in terms of money market conditions,
as shown in the blue book, appeared appropriate.
Concerning
specifications, he would suggest that the Committee give con
sideration to a 6-month target for M1 of 5-3/4 per cent or,
preferably, 5-1/2 per cent, rather than 6 per cent as indicated
under alternative B; the longer-run targets for M2 and the credit
proxy would be adjusted correspondingly.
For the short-run
ranges of tolerance, the lower limits ought to be below those
specified under alternative B; he would suggest 3 to 7 or 3 to
8 per cent for M , with ranges for M 2 and RPD's adjusted accord
ingly.
The Federal funds rate range might be rather narrow at
this time; he would suggest 9-3/4 to 10-3/4 per cent.
Finally,
in view of the sensitive state of market conditions, it might
well be necessary for the Chairman to communicate with the
Committee before the next scheduled meeting.
In response to a question by Mr. Winn, Chairman Burns
remarked that if the specifications he had suggested proved not
to be internally consistent, the Committee had a mechanism for
dealing with the situation.
that they were consistent.
In any case, the staff had indicated
He asked Mr. Axilrod to comment.
Mr. Axilrod said he believed the specifications suggested
by the Chairman were internally consistent.
They suggested that
4/16/74
-104-
the Committee would be willing to accept a slower rate of growth
in demand deposits and currency, compared with that under alter
native B, if in fact it developed with prevailing money market
conditions.
Mr. Partee added that the funds rate was likely to move
quickly to one limit or the other of the narrow range of tolerance.
However, it was appropriate to specify a narrow range in associ
ation with a directive couched in terms of money market conditions.
Mr. Eastburn commented that he liked the direction in
which the Chairman's suggestion went, but he questioned whether it
went far enough.
There had been a number of remarks at today's
meeting about continuing the existing posture of policy.
To
accomplish that, it seemed to him, growth in M1 had to be re
turned to the growth path of 5-3/4 per cent.
Alternative C-
which specified a 6-month target of 5-1/4 per cent--was a
prescription for doing that by September.
Also, he preferred
the language of alternative C, because it placed the proper
stress on returning to the growth path.
If the Committee tol
erated the deviation from path for too long a time, it might
have to choose between,on the one hand,accepting higher aggre
gates than it really wanted and,on the other hand,accepting a
substantial adjustment to return M 1 to a reasonable path.
The
4/16/74
-105-
issue arose whether the Committee was going to adhere to the
5-3/4 per cent path, or whether, in
it was going to abandon it.
a series of small steps,
If the Committee was not going
to pursue a return to that path, it ought to focus on the kind
of growth path it did want.
Mr. Mitchell remarked that it could not yet be said that
the Committee had abandoned the 5-3/4 per cent path, although
subsequent events might indicate that it had.
The Committee had
made a change in policy recently, and the changed reserve and
money market conditions had not yet had an opportunity to affect
the aggregates.
Mr. Eastburn commented that it might take a long time
to return to the 5-3/4 per cent path if M1 grew at a rate of
5-1/2 per cent over the next 6 months.
Mr. Hayes observed that he would be uneasy about raising
the 6-month target for M1 to a rate of 5-1/2 or 5-3/4 per cent
from the 5-1/4 per cent rate specified at the March meeting.
Mr. Holland said there was a very practical reason for
adopting a 6-month target higher than 5-1/4 per cent.
In the
month since the March meeting, developments in the real economy,
interacting with developments in the banking system,had pro
duced larger increases in
M1, in M2 , and in business loans than
4/16/74
-106-
had been anticipated.
Because of the upsurge in recent weeks,
an effort to hold to an M, growth rate of 5-1/4 per cent over
the second and third quarters would require more severe restraint
than was contemplated a month ago.
In the circumstances, it
would take more time to return to the 5-3/4 per cent path than
had been expected at that time.
Chairman Burns remarked that he personally would prefer
a 6-month target of 5-1/2 per cent to one of 5-3/4 per cent.
Mr. Mitchell commented that the 6-month targets really
were not of great importance because of the uncertainty as to
whether they could be achieved.
Mr. Brimmer observed that the formulation suggested by
the Chairman--including a longer-run M1 target of 5-1/2 per centmoved a little away from alternative B toward alternative C and
was acceptable to him.
For the next month, the crucial opera
tional question was the range established for the funds rate.
In his view, the proposed ceiling of 10-3/4 per cent--which was
not much higher than the ceiling of 10-1/2 per cent adopted at
the March meeting--was not high enough.
would be preferable.
An 11 per cent ceiling
4/16/74
-107-
Mr. Mitchell asked whether the proviso clause of the
directive language proposed by the Chairman meant that the
Committee would be consulted in the event that the aggregates
appeared to be growing at rates outside the specified ranges.
Chairman Burns replied that under the Committee's pro
cedures the Manager would promptly notify the Chairman if growth
in
the aggregates appeared to be outside the specified ranges
of tolerance.
If
the departures from the ranges were significant,
the Chairman would communicate with the Committee promptly.
Mr. Holmes asked whether the proposed language meant
that the Federal funds rate should be held at its present level
as long as growth in the aggregates appeared to be within the
specified ranges or whether some gradual tightening was to be
undertaken in the event that growth in the aggregates appeared
to be moving up toward the ceilings of the ranges.
Chairman Burns replied that the second interpretation
was the correct one.
The narrow range of 9-3/4 to 10-3/4 per
cent that he had suggested for the funds rate represented pre
vailing money market conditions.
He would not object to
specifying a range of 9-3/4 to 11 per cent.
Mr. Clay observed that he found it difficult to con
template
an M1 growth rate above 5 per cent for the second
4/16/74
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and third quarters.
The economic slowdown had been mild, and
prospects for a recovery in the second half of the year were
stronger now than generally had been expected a short time ago.
For the past 6 months, monetary growth had substantially over
shot the Committee's longer-run targets, accommodating excessive
rates of inflation and thus contributing to the high level of
interest rates.
Under those circumstances, the Committee's
primary job was to slow the rate of inflation.
To achieve the
objective of lowering interest rates, inflation had to be brought
under control.
Accordingly, he preferred both the language and
the specifications of alternative C.
Mr. Sheehan remarked that he, like Mr. Morris, had shifted
his position.
Eight to 12 weeks ago, he had been worried about
the possibility of a cumulative decline in economic activity and
an unemployment rate possibly as high as 7 per cent by the end
of 1974.
Now, however, he was much more confident about the economic
outlook.
For example, an executive of a large company supplying
abrasives--which are very widely used in manufacturing--had told
him that the demand for abrasives had remained very strong despite
the drop in production in the automobile industry.
demands remained strong in the steel industry.
Similarly,
A large supplier
of materials to the glass industry had indicated that he had to
4/16/74
-109-
allocate supplies.
Businessmen were building up inventories
of raw materials and other supplies in view of the current and
prospective high rate of inflation.
Consequently, he believed
that any errors in formulating policy today should be on the
side of tightness.
Mr. Sheehan said the differences in the specifications
among alternatives A, B, and C were very narrow and hardly
worth arguing about.
He, like Mr. Brimmer, preferred to set
the ceiling for the funds rate at 11 per cent; he could accept
the other specifications suggested by the Chairman.
He preferred
the language of alternative C.
Chairman Burns then asked the members to express their
preference between the language of alternative C and that of
the variant of B couched in terms of money market conditions.
A majority of the members expressed a preference for
the language of alternative C.
Thereupon the meeting recessed until 2:25 p.m.
attendance was the same as at the morning session.
Committee
Staff atten
dance was the same as at the morning session except that Messrs.
Bryant, Pierce, and Pizer were absent.
Mr. Black observed that he agreed with much of what
Messrs. Hayes and Holland had said.
And the specifications
4/16/74
-110-
suggested by the Chairman were almost precisely those he would
establish, including 5-1/2 per cent for the longer-run M
target.
There were two basic reasons for the policy posture represented
by those specifications.
First, the worldwide inflation problem
and the fragile state of the international payments mechanism in
the context of a closely integrated international economy required
the United States to pursue a policy that was neither too tight
nor too loose in relation to the policies of other major countries.
In his view, the policy course recommended by the Chairman would
be compatible with policies abroad.
Second, interest rates had
been pushed up quite a bit in recent weeks.
As a result, growth
in the aggregates might now moderate.
Mr. Black said he agreed with the Board that this was not
the time to raise the discount rate.
If growth in the aggregates
continued to spurt and the Federal funds rate remained above 10
per cent for some time, an increase in
appropriate.
the discount rate would be
In his opinion, it would not have a great effect on
the market, and it would facilitate administration of the discount
window.
He would not change marginal reserve requirements, except
as a last resort.
Viewing them as selective controls, he was
philosophically opposed to their use.
4/16/74
-111Mr. Williams remarked that he would associate himself
with the views expressed by Messrs. Brimmer and Clay.
Concern
ing marginal reserve requirements, he would prefer that
they
not be used and, if they were, that nonmember banks not be asked
to participate in the program.
Mr. Wallich commented that he welcomed the Chairman's
suggestion for a 5-1/2 or 5-3/4 per cent longer-run rate of
growth in M1,
He would be concerned about adoption of too
restrictive a policy, because it was quite early in the
business cycle upturn to lean toward a hard line--even though
the severity of the inflation probably made both higher rates
of unemployment and other remedial programs more acceptable
politically and socially than at other times.
Moreover, the
very high levels of interest rates made him uneasy, despite the
fact that real interest rates were much lower.
The economy
should be rising, but it should not rise too fast.
If the risks
on the down side were greater than he believed them to be, there
probably would be time to take action later on.
Mr. Wallich remarked that--given the System's limited abil
ity to achieve its targets for the aggregates--the 2-month ranges
of tolerance shown under the three alternatives did not differ
much from one another and all were well within acceptable limits.
4/16/74
-112-
He favored widening the short-run ranges for the aggregates.
The Committee could be more specific with respect to the funds
rate; he preferred a range of 9-3/4 to 10-3/4 per cent.
Mr. Winn observed that there were a number of circumstances
that might have an important bearing on economic developments
which had not been taken into account in
today's discussion.
He
had in mind, in particular, the situation in the Middle East and
the political environment at home.
Chairman Burns said he agreed.
Developments in the
areas Mr. Winn had mentioned might make a Committee consultation
not only desirable but necessary during the period before the
next scheduled meeting.
The Chairman then asked the members whether a longer-run
target of 5-1/2 per cent for M1 , along with associated targets
for M2 and the credit proxywould be acceptable.
A majority of the members indicated that such targets
would be acceptable.
The Chairman next asked the members to express their
preference between a funds rate range of 9-3/4 to 10-3/4 per
cent and a range of 9-3/4 to 11 per cent.
A majority of the members expressed a preference for
the 9-3/4 to 10-3/4 per cent range.
4/16/74
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Chairman Burns observed that in view of the recent over
shoots in monetary growth, the lower limit of the 2-month ranges
of tolerance should be relatively low.
He suggested that the
members indicate informally their preference between 3 and 4
per cent for the lower limit of the range for M .
1
A majority of the members indicated a preference for a
lower limit of 3 per cent.
Mr. Mitchell commented that he could accept zero or even
a negative number for the lower limit of the short-run range for
M1 .
He would be happy to see a very low rate or even a negative
rate of monetary growth for a couple of months.
Mr. Partee remarked that the latest M1 data available
were preliminary estimates for the second week of April.
The
rate of growth now estimated for the month of April was 8 per
cent.
Thus,a zero rate for the April-May period implied a
-8 per cent rate for May.
Chairman Burns observed that if the rate of growth for
April proved to be about 6 per cent, the 3 per cent lower limit
for the 2-month range implied a zero rate of growth for May.
He
suggested that while accepting a lower limit of 3 per cent at
this time, the Committee might wish to reconsider it in the light
of subsequent developments.
4/16/74
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The Chairman then suggested that the members indicate
informally their preference between 7 and 8 per cent for the
upper limit of the 2-month range of tolerance for M1.
A majority of the members indicated a preference for
an upper limit of 7 per cent.
Mr. Holmes asked what the mid-point of a range of 3 to
7 per cent might imply for operations.
Chairman Burns replied that ordinarily, the Committee
viewed the mid-point of the 2-month range for M 1 as consistent
with the mid-point of the range for the Federal funds rate.
If
the Committee were to adopt an M1 range of 5 to 7 per cent, for
example, incoming data that suggested a rate of growth approach
ing 5 per cent would require either that the funds rate be moved
down toward its lower limit or that the Committee reconsider the
instructions.
In this case, however, the Committee was delib
erately introducing an asymmetry into the M1 range.
With the
specification of a 3 to 7 per cent range, the mid-point of the
range had no significance.
Mr. Axilrod observed that the numbers becoming available
later this week might confirm staff projections of a 7 per cent
rate of M1 growth in the April-May period.
He asked what the
implications for operations might be in the event that the data
suggested a growth rate slightly above 7 per cent.
4/16/74
-115-
Chairman Burns said that if the data becoming available
so soon after the meeting suggested a rate slightly over 7 per
cent, the Committee would want to be patient and wait for
another week's data.
Mr. Mitchell remarked that a short-run range for M1
with an upper limit of 7 per cent still seemed to him to be
inconsistent with a funds rate range of 9-3/4 to 10-3/4 per
cent.
He wondered whether the specifications implied that the
funds rate would be moved to 10-3/4 per cent and held there.
Mr. Holland said he agreed that the specifications were
inconsistent.
In view of current staff projections of monetary
growth in the April-May period, the specifications represented
an instruction to the Desk to tighten reserve and money market
conditions if the projections for the aggregates remained exactly
as they were.
Chairman Burns observed that on occasion the Committee
had adopted specifications that it recognized might be internally
inconsistent only to discover that they were consistent; at other
times seemingly consistent specifications had proved not to be so.
Considering that the Committee had a procedure for dealing with
the problem, it did not need to be overly concerned about possible
inconsistencies.
The specifications being considered should be
4/16/74
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interpreted in the light of the present market situation.
Although the Desk had been aiming for a funds rate in a range
of 10 to 10-1/4 per cent, the market was tending toward a rate
of 10-1/2 per cent.
In the period ahead, the Desk should aim
for a funds rate in a range of 10-1/4 to 10-1/2 per cent until
additional data for the aggregates became available.
He asked
Mr. Holmes how he would interpret the specifications.
Mr. Holmes replied that his interpretation was in agree
ment with the Chairman's.
Since the market had already carried
the funds rate above 10-1/4 per cent, a range of 10-1/4 to 10-1/2
per cent might be considered appropriate at present.
If the new
projections available toward the end of the current week suggested
that growth in M1 for the 2-month period was 7 per cent or above,
he would assume that the Desk ought to aim immediately at a rate
of 10-1/2 per cent and then await additional information.
There
was a danger of waiting too long and being limited by even keel
considerations; in that event, the rate might have to be held at
10-1/2 per cent rather than moved all the way up to 10-3/4 per cent.
Mr. Winn asked what circumstances would cause the Desk
to aim for a funds rate at the ceiling of 10-3/4 per cent in
the short time available before even keel.
4/16/74
-117-
Chairman Burns replied that the Desk should aim for a
funds rate in
a range of 10-1/2 to 10-3/4 per cent if
incoming
data suggested that M1 would grow in the April-May period at a
high rate, for example, 10 or 11 per cent.
Mr. Coldwell remarked that such an interpretation implied
that the Committee would be willing to accept a 7 per cent rate
of M growth in the 2-month period without seeking to change
money market conditions.
Chairman said he agreed.
In
contemplating a move in
the
funds rate from 10-1/2 per cent up toward the ceiling of 10-3/4
per cent, both the amount by which growth in M1 exceeded the
specified range and the duration of the excess should be taken
into consideration.
If any excess were small and were indicated
on the basis of data
for only one week,
he would not be inclined
to move the funds rate toward the upper limit.
The Chairman then proposed that the Committee vote on a
directive consisting of the staff's
draft of the general para
graphs and alternative C of the operational paragraph on the
understanding that it would be interpreted in accordance with
the following specifications.
The longer-run targets--namely,
the annual rates of growth for the second and third quarters
combined--would be 5-1/2,
6-1/2,
and 9-3/4 per cent for M1 ,
4/16/74
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M2, and the bank credit proxy, respectively.
The associated
ranges of tolerance for growth rates in the April-May period
would be 6 to 11 per cent for RPD's, 3 to 7 per cent for M ,
and 5-1/2 to 8-1/2 per cent for M2.
The range for the weekly
average Federal funds rate in the inter-meeting period would
be 9-3/4 to 10-3/4 per cent.
By unanimous vote, the
Federal Reserve Bank of New York
was authorized and directed, until
otherwise directed by the Committee
to execute transactions for the
System Account in accordance with
the following domestic policy
directive:
The information reviewed at this meeting suggests
that real output of goods and services declined appre
ciably in the first quarter and that price increases
were exceptionally large. The decline in economic
activity reflected mainly the impact of the oil short
age, which is being eased by the ending of the oil
embargo. In March industrial production and manufac
turing employment receded further, but retail sales
strengthened. The unemployment rate changed little,
remaining slightly above 5 per cent. Prices of farm
and food products declined in March, but increases
among industrial commodities were widespread and
extraordinarily large. Advances in wage rates were
moderate in the first quarter.
In March the dollar depreciated further against
leading foreign currencies, and the balance of payments
was in deficit on the official settlements basis. The
U.S. trade surplus diminished again in February as the
cost of imported oil rose sharply.
The narrowly defined money stock increased sharply
again in March. Broader measures of the money stock
rose more moderately, however, as net inflows of
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-119-
consumer-type time deposits at banks slowed substan
tially. Business short-term credit demands remained
strong, with demands at banks exceptionally large.
To help finance loan growth, banks in late March and
early April stepped up the issuance of large-denomina
tion CD's and also increased borrowings from abroad.
Both short- and long-term market interest rates have
risen considerably further in recent weeks.
In light of the foregoing developments, it is
the policy of the Federal Open Market Committee to
foster financial conditions conducive to resisting
inflationary pressures, supporting a resumption of
real economic growth, and maintaining equilibrium in
the country's balance of payments.
To implement this policy, while taking account
of the forthcoming Treasury financing and of interna
tional and domestic financial market developments,
the Committee seeks to achieve bank reserve and money
market conditions that would moderate growth in mone
tary aggregates over the months ahead.
The specifications agreed
Secretary's note:
upon by the Committee, in the form distributed
following the meeting, are appended to this
memorandum as Attachment D.
It was agreed that the next meeting of the Committee
would be held on May 21, 1974, at 9:30 a.m.
Thereupon the meeting adjourned.
Secretary
ATTACHMENT A
Henry C. Wallich
E.
M.
Truman
April 15, 1974
Report to the FOMC on the C-20 Deputies' Meeting
(March 27-29, 1974)
The Tenth Meeting of the Deputies of the Committee of
Twenty established the basic agenda for the last meeting (May 7-9)
of the Deputies and the final meeting of the Committee on June 12 and
13.
It was generally recognized that it was not possible or
desirable at this time to try to reach agreement on the specific pro
visions for a comprehensive reform of the international monetary
system.
There was general endorsement of the U.S. position that
international monetary reform should be an evolutionary process.
But
the French, with some support from the Italians, stated that the
Committee should merely frankly acknowledge its lack of progress.
And the representatives from the developing countries expressed con
siderable disappointment concerning the lack of agreement on the long
run reform and dismay about what was in the reform for them.
In terms of the long-run reform, therefore, a Revised Outline
of Reform will be issued following the June meeting of the Committee.
The content of this document will not differ greatly from the First
Outline of Reform issued in Nairobi last September.
But it is antici
pated that the Revised Outline will be an agreed statement endorsed by
the Committee itself, rather than just a report prepared by the Chairman
and Vice-Chairmen of the Deputies.
There will be, however, a separate
document, or set of annexes, prepared by the Chairman and Vice-Chairmen
of the Deputies that will not necessarily reflect the views of the
Deputies and the Committee.
It will describe the extent of the
remaining disagreement concerning the operational provisions for the
reformed system and will, inter alia, outline some of the options
examined by the four Technical Groups established in Nairobi
(Adjustment, Global Liquidity and Consolidation, Intervention and
Settlement, and Transfer of Real Resources).
To cover the so-called "interim period," there will be
either a separate part of the agreed Revised Outline or a separate
document containing provisions that will be implemented right away.
These provisions will include:
(a) the establishment of a high-level
Council representative of the twenty constituencies in the IMF that
will periodically review the operation and structure of the inter
national monetary system; (b) the resolution of the issues surrounding
the valuation of Special Drawing Rights; (c) the establishment of
guidelines for intervention during the expected continuation of an
exchange-rate regime of generalized floating; and (d) the basis for
review of the adjustment process and international liquidity probably
using experimentally a reserve indicator structure.
The agreement
covering the interim period may also cover (a) the possible treatment
of gold, (b) new provisions governing the use of trade restrictions
for balance-of-payments purposes, (c) special arrangements for the
developing countries, and (d) possible procedures for dealing with
oil-money flows.
It has not been decided whether or not the provisions in
such an interim package should be embodied in a set of amendments to
the IMF Articles of Agreement.
amendment approach.
The United States supported the
France, consistent with its views on the failure
of the C-20, rejected it.
Most countries reserved their positions.
Moreover, the developing countries stated that they would not support
an interim package that excluded the establishment of a link between
SDR allocation and development assistance; if they were to maintain
this position, agreement on a set of amendments to the Articles would
be very difficult.
Four aspects of the interim package received extensive dis
cussion at this meeting of the Deputies: guidelines for floating,
provisions concerning gold, the possible new provisions governing
trade restrictions, and the terms of reference for the continuing
work of the C-20 Technical Group on the Transfer of Real Resources.
On guidelines for floating, there was continued resistance
by the French to the idea that any new provisions were needed.
rest of the participants did not seem to share this view.
The
In particular,
there was general support for a guideline calling for intervention for
smoothing purposes to maintain orderly market conditions.
There was
extensive, but less than unanimous, support for a guideline permitting
intervention to moderate trends in market rates.
There was consider
able resistance to a guideline that would call for the establishment
of zones or ranges for effective exchange rates outside of which
countries could or should be more active in resisting exchange-rate
movements.
Canada, Japan, Germany, Italy, and the United States were
among the skeptics; the United Kingdom, the Scandinavians, and the
developing countries were among the more active supporters of such
a guideline.
The entire subject will be discussed by the Deputies in
Paris in May and is also being considered by the Executive Board of
the IMF.
The discussion on gold primarily involved a restatement of
previously stated positions, although the representatives of several
major countries (United States, Germany, France) did not speak at all.
A major personal statement was made by Mr. Mitchell of the United
Kingdom. He reaffirmed his support for the SDR, rejected an increase
in
the official price, rejected any procedure that would lead to
official manipulation of the market price, but had no objection to
voluntary transactions among monetary authorities at mutually agreed
prices.
The representatives of the developing countries expressed
their dismay about any arrangement concerning gold that might be
agreed outside of the IMF -- a position also taken by Japan --
and
stated their concern about the distributional implications of any
action on gold that would increase the effective reserves of a limited
group of developed countries.
Mr. Jack Bennett of the United States introduced a proposal
that, in light of present circumstances, countries should pledge not
to impose trade restrictions for balance-of-payments purposes and
that, in support of this concept, there be an amendment to the IMF
Articles requiring IMF approval of any such trade restrictions in
the future.
proposal.
Most participants reserved their positions on this
There were, however, doubts expressed concerning the
implications of the proposal for the GATT and its procedures.
The
proposal will be discussed again by the Deputies in May.
Finally, it was agreed that the Technical Group on the
Transfer of Real Resources should prepare, in cooperation with the
relevant international institutions, a detailed framework for the
study of the broad question of the transfer of real resources and
make recommendations concerning the implementation of such a study.
It is understood that this proposal might look toward the establish
ment of what has been called a "C-20 for Development."
If the final result of the C-20 exercise turns out the way
the meeting here reported on suggests, there will be no real reason
to call the effort a failure.
To develop a new monetary system
from scratch and in the abstract is an almost impossible task.
Whether
having on the shelf a plan that is agreed only in part
will help at some future point is an open question.
The history
of the IMF suggests that agreements reached in the past can be
helpful more than ten years later, even if not implemented fully
in the meantime.
On the other hand, the experience of floating is
likely to change the minds of policymakers in many ways and may
cause them to make a fresh start at some future time.
The American plan, upon which the long-run reform is based,
is highly innovative.
It seeks to reconcile the demand of mainly
the Europeans for dollar convertibility with the need of the United
States not to let convertibility hamstring domestic monetary policy.
In the course of a period of floating the Europeans may well come to
take a different view of the need for dollar convertibility.
Conceivably, also, the U.S. may come to take a different view of
its own interests in international monetary relations.
This
consideration lends strength to the view that long-run reform
should be an evolutionary process.
The group decision to focus immediate attention upon short
run matters seems to be a wise one.
Worldwide inflation in combina
tion with the great increase in oil prices will make the period ahead
a very difficult one.
This is reflected in the great difficulties
that the C-20 group had in arriving at a consensus on guidelines for
floating after both the Committee Bureau and the IMF had proposed
rather detailed formulations for that purpose.
The desire to restrain
inflation makes countries want to keep the value of their currencies
high.
Difficulties in financing the oil deficit may force the weaker
countries in the opposite direction.
In the absence of more detailed
guidelines for floating, continued international contact among policy
makers, including on the delicate subject of exchange rates and interest
rates, is urgently needed.
ATTACHMENT B
Henry C. Wallich
April 15, 1974
BIS Meeting of April 8-9, 1974
The following principal points of interest
emerged.
Inflation
There appears to be a growing resignation with respect
to
inflation and less of a sense of urgency and even of capability
to do much about it.
Among the reasons are the supply conditioned
nature of the present inflation, which has its roots in good part
in the food, oil, and other commodities situations; the weakness
of the governments in some countries,
e.g.,
the U.K. and
and the lack of a government in others, e.g.,
Italy,
Belgium and France;
finally, the familiar evidence of massive wage increases and
unwillingness
to accept
severe restraining measures.
This state
of mind seems to lead to a growing interest in means that would
make it possible to live with inflation.
An Italian plan reported
by Carli for the issuance of government bonds, the interest rate
of which would be tied to short-term market rates, possibly with
some additional indexing features, aroused considerable interest.
Zijlstra
suggested that indexing should be discussed at some
future meeting.
Lender of Last Resort
There was continued concern about the impact of Arab money
on the liquidity of Eurocurrency banks.
It seems to be taken for
granted that there will be a considerable amount of medium-term
lending based on short-term deposits.
Should a problem arise, it
was indicated, the responsibility for helping the bank or banks
in trouble could lie with the central banks of the country where
the trouble occurred, or with the central banks of the head office
of the branch if
a branch were in
trouble,
or the central bank
responsible for the currency in which the bank affected principally
operated.
Janson (Belgium)
and Masera
(Italy) indicated that their
respective central banks could not be responsible for the foreign
currency operations of banks located in their countries.
I pointed
out that a central bank could not be expected to act as lender of
last resort with respect to problems that arose in its currency
but affecting banks in third countries.
If the problem affects
a branch whose head office in turn might be affected, this would
be a different matter.
I believe that the lines of responsibilities
in this regard will need to be clarified more effectively than
they have been by the meeting on which I am reporting.
National Economic Conditions
No great concern was visible concerning the consequences
of the oil situation.
Only the Italians were quizzed intensively,
especially with regard to their anti-inflation program.
It involves
both fiscal and monetary restraints, the latter both in the form of
higher interest rates and credit ceilings.
The recent support of
the lira at a rate of about a billion dollars a month was questioned.
The Germans believe that they turned the corner in
the
first quarter and are on their way up, although housing, automobiles,
and textiles remain weak.
The British are aiming at expansion, within the context of
what was claimed to be a neutral budget.
The Japanese economy,
with inflation approaching 30 per cent per year, is slowing somewhat.
A tight monetary policy nevertheless is
intended to be maintained
to curb inflation.
Money Supply
A review of the main national
statistics
conveys the
impression that the over-all increase in national money supplies
is slowing, a development which contrasts somewhat with the
resigned attitude toward inflation.
ATTACHMENT C
April 15,
1974
Drafts of Domestic Policy Directive for Consideration by the
Federal Open Market Committee at its Meeting on April 15-16, 1974
GENERAL PARAGRAPHS
The information reviewed at this meeting suggests that
real output of goods and services declined appreciably in the
first quarter and that price increases were exceptionally large.
The decline in economic activity reflected mainly the impact of
the oil shortage, which is being eased by the ending of the oil
embargo. In March industrial production and manufacturing employ
ment receded further, but retail sales strengthened. The unemploy
ment rate changed little, remaining slightly above 5 per cent.
Prices of farm and food products declined in March, but increases
among industrial commodities were widespread and extraordinarily
large.
Advances in wage rates were moderate in the first
quarter.
In March the dollar depreciated further against leading
foreign currencies, and the balance of payments was in deficit
on the official settlements basis. The U.S. trade surplus
diminished again in February as the cost of imported oil rose
sharply.
The narrowly defined money stock increased sharply
again in March. Broader measures of the money stock rose more
moderately, however, as net inflows of consumer-type time deposits
at banks slowed substantially. Business short-term credit demands
remained strong, with demands at banks exceptionally large. To
help finance loan growth, banks in late March and early April
stepped up the issuance of large-denomination CD's and also in
creased borrowings from abroad. Both short- and long-term market
interest rates have risen considerably further in recent weeks.
In light of the foregoing developments, it is the policy
of the Federal Open Market Committee to foster financial con
ditions conducive to resisting inflationary pressures, supporting
a resumption of real economic growth, and maintaining equilibrium
in the country's balance of payments.
OPERATIONAL PARAGRAPH
Alternative A
To implement this policy, while taking account of the
forthcoming Treasury financing and of international and domestic
financial market developments, the Committee seeks to achieve
bank reserve and money market conditions consistent with growth
in monetary aggregates over the months ahead sufficient to
accommodate moderate expansion in real GNP at the higher dollar
values now prevailing.
Alternative B
To implement this policy, while taking account of the
forthcoming Treasury financing and of international and domestic
financial market developments, the Committee seeks to achieve
bank reserve and money market conditions that would moderate
somewhat growth in monetary aggregates over the months ahead.
Alternative C
To implement this policy, while taking account of the
forthcoming Treasury financing and of international and domestic
financial market developments, the Committee seeks to achieve
bank reserve and money market conditions that would moderate
growth in monetary aggregates over the months ahead.
@FedFRASER