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FORTY-THIRD ANNUAL REPORT o/the BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM COVERING OPERATIONS FOR THE YEAR 1956 16 FEDERAL RESERVE SYSTEM ANNUAL REPORT OF BOARD OF GOVERNORS DIGEST OF PRINCIPAL FEDEJlAL RESERVE POLICY ACTIONS, 1956 17 RECORD OF POLICY ACTIONS FEDERAL OPEN MARKET COMMITTEE Period Action Purpose of action January Reduced System holdings of U. S. Government securities by over $1.4 billion through sales in the market, redemption of maturing bills, and termination of repurchase agreements. Member bank borrowings! increased to weekly averages of $900 million in late January. To offset seasonal return flow of currency and reduction in reserve needs and restore degree of restraint prevailing before December action to moderate restraint temporarily. February and March Bought small amounts of Government securities at times. Member bank borrowings declined somewhat in February but increased substantially in March as result of sharp increase in required reserves. To meet changing reserve needs and avoid an increasing degree of credit restraint in view of growing tone of uncertainty as to economic prospects. April and May Discount rates raised from 2Y2 per cent to 2% per cent at 10 Reserve Banks and to 3 per cent at 2 Banks around middle of April; System holdings of U. S. Government securities reduced by $350 million. Member bank borrowings at Reserve Banks rose to over $1 billion. To increase restraint on credit expansion, in view of sharp increase in bank credit in March and indications of broad increase in spending, growing demands.for credit, and upward pressures on prices and costs. Late Mayearly August Increased System holdings of U. S. Government securities around end of May and end of June and maintained holdings at higher level than in previous period. To meet currency needs around holidays, to cover added demands for reserves around tax payment and midyear settlement periods, and to avoid increasing the degree of restraint in view of uncertainties in economic situation. AugustNovember Discount rates raised late in August to 3 per cent at the 10 Reserve Banks with rates of 2~ per cent. System holdings of U. S. Government securities increased by nearly $1 billion; member bank borrowings at Reserve Banks rose to average of $900 million in August and averaged between $700 and $800 million in other months. Discount rates increased in conformity with rise in market rates resulting from vigorous credit demands. Policies designed to increase and maintain restraint on undue credit expansion while covering seasonal and other temporary variations in reserve needs, including effects of frequent Treasury financing operations. December System holdings of U. S. Government securities and bankers' acceptances increased by over $550 million, including substantial repurchase agreements with dealers. Member bank borrowings declined to weekly averages of around $600 million, except in last week of year, and at times were less than excess reserves. To iupply reserve funds in recognition of additional pressures in money, credit, and capital markets resulting from seasonal factors and international conditions, at a time when lower liquidity ratios of banks were themselves exerting restraint on bank lending. At the beginning of the year 1956, the policy directive of the Federal Open Market Committee, issued to the Federal Reserve Bank of New York as Agent selected by the Committee to execute transactions for the System open market account, was the one that had been approved at the meeting on December 13, 1955, reading as follows: To make such purchases,sales, or exchanges (including replacement of maturing securities, and allowing maturities to run off without replacement) for the System-open market account in the open market, or in the case of maturing securities, by direct exchange with the Treasury, as may be necessary in the light of current and prospective economic conditions and the general credit situation of the country, with a view (a) to relating the supply of funds in the market to the needs of commerce and business, (b) to restraining inflationary developments in the interest of sustainable economic growth, and (c) to the practical administration of the account; provided that the aggregate amount of securities held in the System account (including commitments for the purchase or sale of securities for the account) at the close of this date, other than special short-term certificates of indebtedness purchased from time to time for the temporary accommodation of the Treasury, shall not be increased or decreased by more than $1 billion; To purchase direct from the Treasury for the account of the Federal Reserve Bank of New York (with discretion, in cases where it seems desirable, to issue participations to one or more Federal Reserve Banks) such amounts of special short-term certificates of indebtedness as may be necessary from time to time for the temporary accommodation of the Treasury; provided that the total amount of such certificates held at anyone time by the Federal Reserve Banks shall not exceed in the aggregate $500 million; To sell direct to the Treasury from the System account for gold certificates such amounts of Treasury securities maturing within one year as may he necessary from time to time for the accommodation of the Treasury; provided that the total amount of such securities so sold shall not exceed in the aggregate $500 million face amount, and such sales shall be made as nearly as may be practicable at the prices currently quoted in the open market. The policy actions listed on the following pages were taken by the votes indicated at the nineteen meetings of the Federal Open Market Committee held during 1956. 26 27 ANNUAL REPORT OF BOARD OF GOVERNORS FEDERAL RESERVE SYSTEM in consumer expenditures for services. Consumer goods purchases at retail had been about stable. Constructionactivity had been only moderately below the record rate of mid-1955, the decrease reflect ing solely reduced residential building. Prices, which had shown signs of weakening early in 1956, had strengthened in March, and key prices were firm to rising, with agricultural prices displaying more than seasonal strength. In other industrial countries, con sumer and business demands were continuing to grow, although at a slower pace. The question before the Committee was whether the economy would resume its advance, remain on the recent plateau, or decline; and the Committee's judgment was that available information pointed toward a further advance. Among the general factors leading to this conclusion were the much greater than expected plans of business concerns in all major lines for plant and equip ment expenditures, the widespread optimism of consumers as to the economic outlook and their own financial position and income prospects, and evidence of an exceptionally heavy demand for bank credit in the current month. The Committee also noted that common stock prices had risen sharply further. Growing pressures for increases in prices and wages were evident, and there was danger that if supported by further credit expansion pressures would engender an inflationary spiral. The Committee discussed the extent to which monetary policy might be used to combat an inflationary cost-price spiral and the risk of incurring temporary unemployment on the one hand, as against the risk of undermining the basis of sustained employment on the other. It was suggested that while monetary policy could not be expected to achieve all of the task of combating inflationary pres sures, the System would be derelict in its duty if it did not exercise additional restraint in this situation. In the circumstances, the Committee concluded that its instruction to take into account deflationary tendencies in the economy in effecting transactions for the System account was not consistent with the existing situa tion or the prospective renewal of growth in the economy. Ac cordingly, it deleted the qualification as to deflationary tendencies that had been added to clause (b) of the directive at the meeting on January 24, 1956, leaving an instruction to effect transactions for the System account with a view, among other things, "to re- straining inflationary developments in the interest of sustainable economic growth." In reviewing credit measures at this meeting, the Committee also discussed the relation to open market policy of possible action by the directors of the Federal Reserve Banks to increase discount rates from the 2 1/2 per cent level that had been in effect at all Reserve Banks since November 1955. It was noted that there was some feeling in the System that an increase might be necessary at an early date to prevent undue credit expansion for financing capital outlays through the banking system. On the other hand, there was some feeling that, with increasing credit demand, additional restraint would result from the Committee's policy of limiting additions to the supply of reserves to such amounts as were needed for sustain able growth in the economy. April 17, 1956 Authority to effect transactions in System account. The Federal Open Market Committee renewed without change the directive that had been approved at the meeting on March 27, 1956, which called for transactions in the System account with a view, among other things, "to restraining inflationary develop ments in the interest of sustainable economic growth." Votes for this action: Messrs. Martin, Chairman, Sproul, Vice Chairman, Balderston, Erickson, Johns, Mills, Powell, Robertson, Shepardson, Szymczak, Vardaman, and Fulton. Votes against this action: none. Since the preceding meeting eleven of the Federal Reserve Banks had increased their rates of discount effective April 13, 1956. Nine of the increases were from 2 1/2to 2 3/4per cent and two were from 21/2 to 3 per cent. (The remaining Reserve Bank increased its rate to 2 3/4per cent effective April 20.) At the time of this meeting, credit markets were in process of adjusting to the increase in discount rates that had just been an nounced. This added factor followed a period of several weeks during which the markets had been adjusting to the impact of corporate income tax payments in March, the Treasury refunding operation that had come at the same time as the tax payments, 28 29 ANNUAL REPORT OF BOARD OF GOVERNORS FEDERAL RESERVE SYSTEM and the heavy loan demand both in capital markets and at banks. The interest rate structure had risen sharply during this three week period. In considering policy for the period ahead, it was necessary for the Committee to judge the reactions of lenders and borrowers to the current restrictive policy: whether the actions taken thus far would effectively limit credit growth without serious disruption of the credit markets, or whether credit demands re mained so strong as to cause further rises in interest rates and a weakening in securities markets that might threaten a money mar ket crisis. As to economic developments, the Committee found activity continuing to move sidewise on the high plateau that had been maintained since late fall of 1955. The over-all picture was still somewhat mixed, but indications were that pressures growing out of expanding private investment were beginning to tilt activity upward. The automobile and housing markets appeared to have stabilized over the past few weeks, and other consumer markets had been on the firm to rising side. Business and investor psy chology continued optimistic, and the picture was generally one of continuing business investment boom, not only in the United States but in other industrial countries as well. The Committee therefore agreed that there should be no relaxation of pressures. However, the restrictive policy should not be pressed too strongly pending more opportunity to observe reactions to the mid-April increase in discount rates, increased pressure on bank reserve posi tions, and clarification of the economic outlook. months. Upward pressures on prices of industrial commodities had continued and new increases in steel prices were anticipated following negotiations of a new wage contract later in the spring or summer. Business demands for goods and services had risen over the months and aggregate consumer demand, including de mand for automobiles and housing, had about held its own. Money markets at the time of this meeting were not under quite as much pressure as they had been at the time of the meeting on April 17, which had followed by only a few days the increase in discount rates at the Federal Reserve Banks at a time when the credit mar kets were still adjusting to the unusual pressures of March. The Committee saw no evidence of a change in the economy that called for lessening restraint on credit expansion at this time. Demand for credit including demand in the capital markets sug gested a further bulge, although there was some feeling that the actions already taken by the Federal Reserve System to restrain un May 9, 1956 Authority to effect transactions in System account. The Committee renewed without change the directive issued to the Federal Reserve Bank of New York on March 27 and April 17, 1956 for effecting transactions in the System open market account. Votes for this action: Messrs. Martin, Chairman, Sproul, Vice Chairman, Balderston, Erickson, Johns, Mills, Powell, Robertson, Shepardson, Szymczak, Vardaman, and Fulton. Votes against this action: none. Since the meeting on April 17, 1956 no important change had become apparent in the state of the economy. Output of goods had continued at the high level that had prevailed for several due credit expansion might have a cumulative effect that would hold down the expansionary tendencies. Furthermore, there had been a decline in the liquidity position of business and of banks over a period of months which could have important effects. The Committee's decision to make no change in the existing policy reflected its belief that credit restraint continued suitable to the situation and that no change either toward increased pressure or toward relaxation would be justified at this time. May 23, 1956 Authority to effect transactions in System account. At this meeting the Committee restored to clause (b) of its di rective to the Federal Reserve Bank of New York an instruction to take into account deflationary tendencies in the economy while pursuing a general policy of restraining inflationary developments. With this change, the clause read as it had from January 24, 1956 to March 27, 1956, that transactions be with a view, among other things, "to restraining inflationary developments in the interest of sustainable economic growth while taking into account any defla tionary tendencies in the economy." Votes for this action: Messrs. Martin, Chairman, Balderston, Erickson, Johns, Mills, Powell, Shepardson, Szymczak, Fulton, and Treiber. Votes against this action: none.
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