Full text of Federal Open Market Committee Meeting Minutes, Transcripts, and Other Documents : Meeting, August 12, 1980 : Transcript

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Meeting of the Federal Open Market Committee

August 12,

1980

A meeting of the Federal Open Market Committee was
held in the offices of the Board of Governors of the Federal
Reserve System in Washington, D. C.,

on Tuesday, August 12,

1980, at 9:30 a.m.
PRESENT:

Mr. Volcker, Chairman
Mr. Gramley
Mr. Morris
Mr. Partee
Mr. Rice
Mr. Roos
Mr. Schultz
Mr. Solomon
Mrs. Teeters
Mr. Wallich
Mr. Winn
Messrs. Balles, Baughman, Eastburn, and Mayo,
Alternate Members of the Federal Open
Market Committee
Messrs. Black, Corrigan, and Ford, Presidents
of the Federal Reserve Banks of Richmond,
Minneapolis, and Atlanta, respectively
Mr.
Mr.
Mr.
Mr.

Altmann, Secretary
Bernard, Assistant Secretary
Petersen, General Counsel
Holmes, Adviser for Market Operations

Messrs. Balbach, J. Davis, R. Davis, Ettin,
Henry, Keir, Kichline, and Zeisel,
Associate Economists
Mr. Pardee, Manager for Foreign Operations,
System Open Market Account
Mr.

Sternlight, Manager for Domestic
Operations, System Open Market Account

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2 -

Mr. Coyne, Assistant to the Board of
Governors

Mr. Prell, Associate Director, Division
of Research and Statistics, Board

of Governors
Messrs. Gemmill and Siegman, Associate
Directors, Division of International

Finance, Board of Governors
Mr. Beck, Senior Economist, Banking Section,
Division of Research and Statistics,
Board of Governors
Mrs. Steele, Economist, Open Market
Secretariat, Board of Governors
Mrs. Deck, Staff Assistant, Open Market
Secretariat, Board of Governors
Messrs. Czerwinski and Doyle, First Vice
Presidents, Federal Reserve Banks of
Kansas City and Chicago, respectively
Messrs. Boehne, Brandt, Burns, Eisenmenger,
and Scheld, Senior Vice Presidents,
Federal Reserve Banks of Philadelphia,
Atlanta, Dallas, Boston, and Chicago,
respectively
Messrs. Bisignano, Broaddus, Cacy, Danforth,
and Ms. Nichols, Vice Presidents,
Federal Reserve Banks of San Francisco,
Richmond, Kansas City, Minneapolis, and
Chicago, respectively
Mr. Ozog, Manager, Securities Department,
Federal Reserve Bank of New York

Transcript of Federal Open Market Committee Meeting of
August 12, 1980
CHAIRMAN VOLCKER. Let's come to order. We have two new
faces at the table today. Another way to put it is that we have one
new face and one old face in a new guise. I want to welcome Mr. Ford
and Mr. Corrigan. You have great privileges as new members. You may
speak first, last, or in the middle when it comes to delivering some
cogent comments on what we should be doing. I'll give you a little
time to think about that. We do welcome you around the table.
I would like to mention and emphasize a matter on which I
sent you a note. We had a leak about the aggregates [targets] for the
year after our telephone consultation, which disturbed me. What
disturbed me was not just the substance of it--though I don't think it
would be considered the most damaging leak in the world in terms of
the market [effect]--but that it could happen at all. I'm not
suggesting at all that the only place a leak can come from is a
Reserve Bank, but in this particular case the reporter identified [the
information] as having come from a Reserve Bank or Reserve Banks. I
suppose it might have come from Washington in other circumstances.
Wherever it came from, there is nothing more corroding of the
confidence with which we sit around the table or in a telephone
conference and discuss [policy] than the fear that somehow there is
going to be a leak of what is discussed. I just cannot operate in
that way. I know of only one way to deal with this lack of
confidence, which I don't want to have, and that is to diminish and
diminish and diminish the [attendance at] meetings so nobody is here
but the people who actually have to be. At least then we would have
identified [the source of any leak] down to a smaller group. I don't
think anybody wants to go in that direction, but that is one of the
prices of having this kind of leak. I don't know where it came from,
and I don't care where it come from in this particular incidence, but
I do care about the matter in general. If you haven't already done
so, I would urge you to take whatever [measures necessary to convey]
the message in your own way within your own institutions to give us
the best assurance we can have that this doesn't happen again. We are
going to end up not talking very freely if it does. Enough of that.
One other thing I would mention is the meeting schedule for
1981. I don't want your reactions at the moment but perhaps we can
take that up at the next meeting and you can convey any reactions you
have before that. You will recall that I raised the question some
months ago--assuming we continue with the reserve targeting
procedures--of whether the logic somehow suggested that we should have
a meeting near the beginning of a quarter. We are compelled to do
things according to the calendar: annually, quarterly, monthly, or
whatever. Given that what we have been doing is setting the target
for every quarter, the logic seems to suggest that it would be
convenient to have a meeting near the beginning of the quarter or the
end of the previous quarter. Then perhaps a reasonable checkpoint
would be somewhere around the middle of the quarter. Doing that would
mean intervals of six or seven weeks between meetings, typically,
which is a little longer than what we have had in recent years. This
year we are scheduled to have ten meetings. I would be perfectly
happy to have more telephone updates between meetings if that seemed
desirable--if it seems like a long time between meetings. But it
still seems to me a rather attractive way of proceeding, assuming

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we're on this kind of targeting. I'd like to get your reactions to it
at or before the next meeting and then we can set some dates so people
I
can get them on their calendars, however we're going to [proceed].
can send out some tentative dates after this meeting, just so we have
something concrete to look at. But the general concept is more
important than the particular dates at this point.
I think that
covers all the extraneous business.
We need to approve more than one set of minutes.
I take it
there was a lapse in approving the minutes of a couple of telephone
conferences, Mr. Secretary.
MR. ALTMANN. We need approval for the minutes of March 7 and
May 6 and for the regular July 9 meeting.
CHAIRMAN VOLCKER. March 7th and May 6th got lost somehow.
Were they telephone conferences?
MR. ALTMANN.

Yes, they were telephone conferences.

CHAIRMAN VOLCKER.
SPEAKER(?).

So moved.

CHAIRMAN VOLCKER.
Mr. Pardee.
MR. PARDEE.

We need a motion.

Without objection, we'll approve them.

[Statement--see Appendix.]

CHAIRMAN VOLCKER.
francs and Carter bonds?

Is the Treasury behind in covering Swiss

MR. PARDEE. They are fully covered on the Carter notes. The
francs that we have accumulated recently have been put aside for
payment of interest on those notes. They [have] discussed a little
[They are leaning to the
the issue of accumulating additional francs.
view] that if we don't want any more they will acquire them. But we
still have very modest balances for the System.
CHAIRMAN VOLCKER.

Comments or questions?

Governor Wallich.

MR. WALLICH. Scott, you said that these countries would be
quick to support their currencies. Do you see any indications that
that attitude might change if they go more deeply into recession?
MR. PARDEE. It could, but the question of financing their
deficits is very important. And they want to maintain a strong
currency so they can get the funds. There's a tremendous amount of
competition among the authorities to get OPEC funds at this point.
Any slippage on your currency means that the money just isn't going to
come in your direction.
MR. WALLICH.

Thank you.

CHAIRMAN VOLCKER.
rates?

Everybody really wants fixed exchange

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fixed.

MR. PARDEE. No they want strong exchange rates rather than
In fact, a gently rising exchange rate is--

CHAIRMAN VOLCKER.
Governor Rice.

Given that everybody can't have that.

MR. RICE. You said that the market accepted the reduction of
the discount rate as largely a technical adjustment. Does that
indicate to you that the market is becoming more sophisticated or was
it just a happy circumstance of timing?
MR. PARDEE. Well, on that particular occasion, I talked to
several people who tried to interpret it.
As you recall, on that
Friday there were two other elements [involved].
One was that the
federal funds rate did ride up and the other was that a large increase
in the aggregates was published later in the afternoon.
CHAIRMAN VOLCKER.

[Unintelligible.]

MR. PARDEE. Several [market players] sent out letters or
cables around the world from New York and other centers over the
weekend trying to assess the implications. Those who said that the
rising federal funds rate and the aggregates were important were
right. And those who said that the Europeans were going to react
negatively to the discount rate were wrong. They are very
sophisticated but they can make mistakes, too.
It's very hard to
judge which way to read it.
I raised the question with some of our
senior people in the market as to whether the people who don't
understand the Federal Reserve are making money at the expense of
those who do.
I think the [answer] is that it's more haphazard:
That, in effect, handing the decision of determining interest rates
over to the market on the domestic side is very much like the exchange
market where we've turned to floating exchange rates.
I had to scold
some of the fellows a little in that they had been so pleased to have
floating exchange rates and they should be able to take advantage of
the freer market for money. But they're very nervous about it.
So if
sophistication is part of it, there's also a difference in the market
now with these OPEC funds. The OPEC funds come right into the
Eurodollar market in overnight money. It's sitting there. Where is
it going to go? It's not going to stay necessarily in overnight
money. And the sensitivity to interest rates is much greater than we
have felt for some time. If the federal funds rate goes down, it
means that the next day the Eurodollar rates will trail off in the
Eurodollar market, which means that the fellows in OPEC and others who
are moving money on that day will make a decision to put those funds
that they are moving into marks or sterling or some [other currency]
at that particular moment. If the federal funds rate is moving up at
that point, giving signals to the Euromarkets to firm a bit, then the
money will come our way. It's a very knife-edge sort of thing.
There's much more volatility in the dollar exchange rate than we've
had in other periods when not much was really going on.
MR. ROOS. How is our national interest adversely affected if
that night the OPEC people shift some of their money into sterling?
Whom does this hurt?
MR. PARDEE. It's not a question of hurting or helping at
this stage; it's just that there's more volatility.

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MR. ROOS.

Is that bad?

MR. PARDEE.
[It is] if all of a sudden we have a cumulative
movement that is triggered by it.
MR. ROOS.

Have we had such a--

MR. PARDEE. No we haven't.
We haven't had it this month and
we've been rather quick to operate. Of course, we're basically
interested in acquiring as many marks as we can to clear the decks for
the next problem.
VICE CHAIRMAN SOLOMON. I think to some extent we can take
some cheer from the fact that there is this much sensitivity to
interest rates.
It really reflects a neutral view about the likely
movement of the dollar. The fact that we're running virtually in
equilibrium this year and Germany and Japan have such large deficits
offsets a traditional pessimism about the dollar. There is a neutral
view and, therefore, we get very large movements of money in response
to very tiny differences in interest rates.
If [market participants]
still had the same pessimistic view of the dollar that they had over
most of the period in the last three years, then I don't think we'd
see this much sensitivity to interest rates. We'd see consistent
pressure on the dollar.
MR. PARTEE. The interest rate differential as reported
yesterday supports [that view].
It is 400 basis points more adverse
to the United States than it was at the beginning and the exchange
rate is the same. There is obviously a stronger undertone of
confidence in the dollar than before, as you say.
MS. TEETERS.
There must have been surplus OPEC funds
floating around in 1974-75. How long did it take for them to settle
down or disappear from the market?
MR. PARDEE.
In that case the surplus did disappear over the
course of the next two or three years. By 1977-78 there wasn't much
surplus left.
MS. TEETERS.
Yes, but they must have had some investible
funds that they didn't put some place permanently.
MR. PARDEE. Yes, a lot of that came in directly into U.S.
Treasury bills and so forth. At that time there wasn't quite so much
diversification as there is now. Also, the other central banks and
authorities were not bidding so eagerly for the funds. Now the German
finance ministry is working very hard to get as many marks in as
possible.
The Swiss have been very active, as have the Japanese.
It
has not been very open, but a lot of work is being done.
And, of
course, the French have quietly opened all the doors and windows for
people to invest in francs.
In some ways that's healthy since they
are deficit countries and the money has to go some place, so it's
better to go in places where it's in strong hands.
But there is a
difference this time. The OPEC countries are not so automatically
putting their funds in dollars and holding them there, particularly in
open ways such as in Treasury bills. And the others are pressing hard
for funds to come to their way.

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8/12/80

CHAIRMAN VOLCKER.

Do you have some recommendations?

MR. PARDEE.
Simply some renewals. With the Bank of France
we have one swap drawing for $26 million. We've been repaying our
mark swap debt but we have coming up in the next period some seven
swap drawings in the amount of $382 million. All of these are first
renewals.
CHAIRMAN VOLCKER. We do have to ratify transactions since
the last meeting. If there are no objections to renewing the swaps,
we will renew them if necessary.
MR. PARDEE.

If necessary.

CHAIRMAN VOLCKER.
MR. SCHULTZ.
SPEAKER(?).

Can I have a motion to ratify?

So moved.
Second.

CHAIRMAN VOLCKER.
Sternlight.
MR. STERNLIGHT.
CHAIRMAN VOLCKER.

Without objection, they are ratified.

Mr.

[Statement--see Appendix.]
Questions or comments?

VICE CHAIRMAN SOLOMON. Peter, to what extent have these
dealers who are under water hedged in the futures market when they met
their underwriting responsibilities?
Is it now fairly prevalent among
all of them to hedge their positions?
MR. STERNLIGHT. It's more prevalent than it was.
I don't
have fully up-to-date figures on that. I expect that they are really
long and really hurting to some degree.
VICE CHAIRMAN SOLOMON. What lag is there on their reporting
their positions in the futures market?
MR. STERNLIGHT.
It's about a week or two. We're only
getting those futures positions twice a month now, so we're not quite
up-to-date on that.
CHAIRMAN VOLCKER.

Are we changing that or--?

MR. STERNLIGHT. We're implementing a whole new set of dealer
reports. We began one schedule, which we've been getting for just a
month. Within the next few months we'll be getting a report that will
have the futures position daily, but we don't have that phased in yet.
CHAIRMAN VOLCKER.

Governor Gramley.

MR. GRAMLEY. Mr. Chairman, I was wondering if we shouldn't
talk a little about the way we respond to changes in the demand for
excess reserves in terms of the implementation of open market policy.
It isn't just a matter of letting interest rates move up in response
to an increase in demand for excess reserves.
If we do not treat that
as though it were a change in the multiplier and adjust the target for

8/12/80

nonborrowed reserves accordingly, then we're implicitly changing both
our targets for growth of the monetary aggregates as well as the level
of interest rates we consider acceptable. We wouldn't do that if we
thought this was going to be a change of [some] duration for, say, a
six-month period. We'd obviously make some adjustments. And I wonder
if we ought to think about the possibility of doing that in the short
run, recognizing of course that we'll have to reverse that once it
goes the other way. I'm curious what your comments would be.
MR. STERNLIGHT. Well, there is some adjustment. In fact, we
make modest technical adjustments in the path, which are worked out
mostly by Ed Ettin and Steve Axilrod in consultation with the Desk.
There was a modest adjustment allowing for the higher level of excess
reserves, although it went up only a small extent of the way, in the
review that was conducted a few days ago. I think your point is
certainly a valid one. Nevertheless, I would note that in a sense
that [bulge] in excess reserves is not causing us to aim for
significantly higher levels of borrowed reserves currently because at
the same time the banks have been wanting to hold a lot of excess
reserves they also--irrationally, perhaps--have come in [to the
discount window] and done a fair amount of borrowing. So one could
argue that we should also have allowed for the reserves they got via
the borrowing route. But in the forward-looking part of our path we
were not deliberately forcing the banks to borrow much more than that
roughly $100 million level that had been the starting point for
borrowings when the path was set up for this recent period.
CHAIRMAN VOLCKER. The trouble is that we can't do what you
are suggesting, I don't think, in any particular week, and then the
next week assume [the relationship] is going to go back to normal.
That has more or less been the behavior.
MR. STERNLIGHT. Yes, usually we have assumed that a high
excess reserve week would be followed by a week in which excess
reserves would be subnormal. But this time we figured that there may
have been something unusual in the demand for excess, so our
assumption was that excess reserves would come back more or less to
normal rather than to subnormal.
CHAIRMAN VOLCKER. We can make some kind of guess, whichever
way, in the following week. But we can't do anything in the actual
week when that big excess arises, I don't think.
MR. GRAMLEY. Well, we know what required reserves are
because required reserves depend upon deposits for a prior period. We
know what actual reserves are on a day-to-day basis. So, as
operations are going on, we know what level of excess reserves is
building up and we would have to interpret this as an increase in
Couldn't we
demand for excess reserves. Then the question would be:
respond to this with a recognition that we don't want to have changes
in the demand for excess reserves affect either the growth rates for
the monetary aggregates or the level of interest rates? There would
be no real reason for doing so.
MR. STERNLIGHT. Well, at some other level, I could say that
in a way we did respond to that. In that last full week that had the
$1 billion plus of excess reserves we were trying to take out the
excess, but we had no expectation that we were going to be able to

8/12/80

To have wrung it all out probably would have
wring out all of it.
sent the funds rate soaring. As it was, when we were taking out as
much of the excess as we could, the funds rate was fairly easy at
around the 7 percent level.
MR. PARTEE. I would emphasize that we do have the safety
valve of the discount window. If something began to tighten the
market, we'd automatically tend to get an increase in borrowing.
That's the reason why it's important to have the discount rate well in
tune with money rates. Fortunately it was changed just before [this
situation occurred], or I suppose the funds rate would have gone above
11 percent.
MR. GRAMLEY.
leaving our target for
what happened to other
safety valve we always
money that come about.
MR. PARTEE.
change it.

I agree, but we wouldn't use that approach for
nonborrowed reserves the same irrespective of
factors affecting the multiplier. That's the
want there for any basic changes in demand for

I guess we'll let a week occur, Lyle, before we

CHAIRMAN VOLCKER. If we could forecast that, I think you are
In that particular week, the
right. But every week is different.
banks went out and borrowed a large amount of money at the beginning
of the week, which gave them the excess. But they had already
borrowed it and that's the point at which the federal funds rate went
up. And then it was too late.
MR. GRAMLEY. My thought would be that we really don't have
to forecast excess reserves. What we want to do is to deal with the
And as it occurs,
change in demand for excess reserves as it occurs.
we can measure it.
MR. BALLES.

How would you do it, Lyle?

MR. STERNLIGHT. You're only responding to the funds rate
then, aren't you, Governor?
MR. GRAMLEY.

You're responding to what you observe as the

change in demand for excess reserves on a day-to-day basis.
to be at least one day behind.

You have

CHAIRMAN VOLCKER. But the one day behind is the day that
screws it up. The banks already did the borrowing, which made the
market tight.
MR. BALLES.

What specific things would you like to see done,

Lyle?
MR. GRAMLEY. My thought is that this is really like a change
in the multiplier. It's a shift in the demand for excess reserves
which we do not want to carry through to a change in the growth rate

of
So
be
it

the monetary aggregates or a change in the level of interest rates.
if we see excess reserves building up over the course of a week--to
sure, we're always one day behind--we can make some allowance for
as the week goes on.

8/12/80

MR. BALLES.

What would you do?

MR. GRAMLEY. I don't have any answers off the top of my
head. But this seems to me something we ought to be exploring as a
possibility.
MR. ETTIN. The only thing I can add to this argument is
the daily pattern of excess reserves historically has been a very
indicator of the excess reserves for the week. Sometimes there's
big buildup in excess early in the statement week and the average

that
poor
a
will

be far away from that because it will drop off later in the week.

Sometimes it's the exact opposite, as the people taking care of the
reserve position in individual institutions are making their own
predictions of what the daily pattern in the funds rate will be. As
for that [recent] period when the excess reserves were very large,
there had been similar periods in the past of substantial excess
reserves, say on Thursday and Friday, but they had disappeared by the
end of the [statement] week. So, it's very difficult to predict.
CHAIRMAN VOLCKER. I don't think we're going to resolve this
here but, as I remember that week, unbeknownst to us they borrowed a
whole lot of money on Thursday. We [questioned why] they would borrow
so much money on Thursday. We thought they were going to end up with
big excess reserves and we figured they would be reducing them [the
next day] presumably. Then they borrowed a lot over the weekend. The
market remained tight. By that time they were locked into the excess
reserves and most of them were left in. If the excess was going to
continue the next week and we knew it, then I think you're perfectly
right. But I don't know how we can manage it within the week.
MR. GRAMLEY. Well, Ed's argument is a very persuasive one if
what has happened on a day-to-day basis in the reserve period up to a
particular point can in no way forecast what is going to happen over
the rest of the period or what the average for the whole week is
[going to be].
That's a persuasive argument for not, in effect,
chasing our tail.

MR. WALLICH.

I am concerned about the danger of chasing our

tail because if excess reserves go up and we say there is this demand

for reserves and we have to accommodate it and supply some more, then
excess reserves might go up further. We would feel impelled to
accommodate that again. Isn't there a danger that we'll find
ourselves involved in supplying more reserves than are needed?
MR. GRAMLEY. I think there would be if we didn't take them
back out after the demand went down. That's only possible if in fact
we can use what's happening over the first three days of the reserve
period, let's say, as a reasonable approximation for what's likely to
happen over the period as a whole. What we need to look at isn't just
what is going to happen in the last couple of days of the reserve

period but what is going to happen over the period as whole.

Maybe we

could take a look at this to see whether or not your hypothesis is

correct.

If it is, then my suggestion has no merit whatever.
CHAIRMAN VOLCKER.
MR. MORRIS.

We'll take a look at it.

Peter, with respect to the discount rate and

your job of managing the availability of reserves, how would you

8/12/80

describe the optimum relationship of the discount rate to the funds
rate under the new operating procedures?
MR. STERNLIGHT. I think we'd like to have a band for the
federal funds rate a few percentage points wide so we have the most
flexibility. It depends at any particular point on approximately what
level of borrowings we're looking toward. In the recent period, when
the objective was to have borrowings around the $100 million level,
the relationships have made pretty good sense, with the discount rate
at a point such that funds could vary from moderately below to
something above the discount rate. [It helps] to have the discount
rate somewhere well within that band where we would expect the funds
rate to be moving.
MR. MORRIS.
your expected level?

[Preferably] on the high side of the band of

MR. STERNLIGHT. Well, I don't know. Yes, if borrowing is
going to average as low as $100 million, I would expect the funds rate
would more often fall below [the discount rate] than above. To pick
numbers out, I'd say from 8-1/2 to 10-1/2 percent surrounding, in a
somewhat lopsided way, a 10 percent discount rate.
MR. MORRIS. Are you saying we should aim for a frictional
level of borrowing--that that should be the norm?
MR. STERNLIGHT. No, not for all time. I think it has made
sense given the objectives that the Committee set out a month ago on
wanting to achieve the aggregates that it specified.
CHAIRMAN VOLCKER. Let me try to answer what I think you're
getting at. When we have a very low level of borrowings, frictional
or very close to frictional, it's natural and convenient to have the
discount rate above the federal funds rate, presumably not by too
much. But if we have a sizable level of borrowing, which we don't
have [now], the federal funds rate will go above the discount rate.
And there's not much we can do about it. That's the dilemma we're in
because the banks won't borrow unless the funds rate is above the
discount rate. So we can't have a penalty [discount rate] under those
circumstances. I may be exaggerating a bit, but if we try, it just
keeps ratcheting the rates up.
MR. PARTEE.

We make it move up?

MR. ROOS. Mr. Chairman, we were disturbed, as perhaps Frank
was, that in the Bluebook for the first time there was a reference to
the relationship between the fed funds rate and the discount rate. I
think it would be a mistake in policy, or at least in practice, if we
caused or inhibited the movement of interest rates for the purpose of
maintaining some relationship between the fed funds rate and the
discount rate. That's a totally new concept, I think.
CHAIRMAN VOLCKER. I think you may be interpreting that the
opposite of the way the staff meant you to interpret it. The idea is
not to manage the funds rate below the discount rate.
MR. ROOS.

It's to move--

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8/12/80

CHAIRMAN VOLCKER. It just says that with a given level of
borrowings this is what we would expect the federal funds rate to be.
And the higher borrowings are, the higher the federal funds rate will
be relative to the discount rate, wherever the level may be.
MR. ROOS.

Well, I must have misinterpreted that.

MR. MORRIS.
If I interpret you [correctly], Paul, what
you're saying is that it really doesn't matter what the discount rate
is, as long as the level of borrowing is predictable.
CHAIRMAN VOLCKER. Oh, I think it does matter where the
discount rate is.
All I am saying is a very simple thing. It's very
difficult or impossible in the short run to maintain a penalty
discount rate when borrowings are sizable, given the way we do
everything else--the lagged reserve accounting and these paths and all
It's not hard to do, obviously, when the borrowings are
that.
But the problem that we had before--and that we may have now
minimal.
to a slight degree--is that when the discount rate was way above the
federal funds rate and borrowings were in fact minimal, as soon as
borrowings became appreciable the federal funds rate would jump way up
to the discount rate. Whereas if the discount rate was lower, the
That is the main
discount rate is somewhat of a drag on that process.
reason why some of us, at least, wanted to get the discount rate down.
That way, as soon as we ran into any borrowing we wouldn't have too
sharp a jump in the federal funds rate. During a period like we've
had in the last three months, I would say it would have been very
convenient to have a floating discount rate--to let the discount rate
just go down with federal funds rate--and avoid all these announcement
But if we did that, what do we do when borrowings increase
effects.
and we begin putting a little pressure on the money market? The
discount rate would go up very fast and maybe we wouldn't want it
going up all that fast. We haven't got any brake on the increase in
the federal funds rates from a fairly low level of borrowings.
MR. WALLICH.

Unless we supply reserves.

CHAIRMAN VOLCKER. Yes, unless we prevented the [rise in]
borrowing, in which case we wouldn't be getting the restraint we'd be
looking for. That's the dilemma that we have perceived. If we could
adopt a floating discount rate on the down side and an administrative
But I think we'd end up
one on the up side, it would be all right.
with more confusion than we started with. We did have a problem on
the down side because we were afraid every time we moved [the discount
rate] that we would be giving rise to more expectations than we
wanted.
MR. PARTEE.
The trouble is that we would need to float the
differential as well as the rate in some way so that we've got moves
To put it another way-from above to below the funds rate.
VICE CHAIRMAN SOLOMON. We have to have the flexibility to
send some kind of policy signal if our situation requires it. And if
we were to have a completely symmetrical automatic relationship, we'd
be tying our own hands.
CHAIRMAN VOLCKER.

Well, that's another aspect.

-11-

8/12/80

MR. SCHULTZ. That was exactly what happened to us this last
time. We wanted to get the discount rate down but we were very
nervous about the foreign exchange problem. [Unintelligible] policy
that had to come to an end. Then we changed the path. Given the
change in the path, it became almost essential that we just go ahead
and bite the bullet and lower the discount rate, which we did. It
just so happened that we got lucky because at the same time the fed
funds rate was strengthening. But the real reason was to attempt to
lower that gap because, given the change in the path, we needed to do
it.
MR. MORRIS. Back in the days when we were controlling the
funds rate, it didn't make much difference where the discount rate
was. But now I think it does.
CHAIRMAN VOLCKER.

I think it does, too.

MR. MORRIS. I think we need a concept of what rate
relationships make the most sense in terms of controlling the rate of
growth in bank reserves.
CHAIRMAN VOLCKER. Yes, but what I am resisting--and this
confusion arises all the time--is the concept that there is a rate
relationship that makes sense on both sides of the cycle. I don't
think there is. There may be a general concept [that makes sense]
when there's practically no borrowing. Then I would think, ideally,
we'd keep [the two rates] pretty close. Look at the other extreme
Suppose we really
that we were facing maybe a month or two ago:
forced excess reserves on the system; the funds rate might have gone
way way down if we had done that. I am not sure we would have wanted
the discount rate to go down to 5 percent, if that's where the funds
rate had been going for a few weeks. And there's the more general
consideration that Tony mentioned. I don't see how we get out of this
box with an automatic rate, although it would have been convenient for
a period of a couple of months or weeks.
MR. BAUGHMAN. It is implicit in your observations that there
is little or no reluctance to borrow in this equation.
CHAIRMAN VOLCKER. No, I think implicit in what I am saying
is that there is a reluctance to borrow and that's why we can't keep a
penalty rate on the way up.
MR. BAUGHMAN. Is it also thought that the reluctance varies
with the level of borrowings?
CHAIRMAN VOLCKER. I don't know whether I'd put it that way.
There is a reluctance. And the higher the level of borrowings, the
more we have moved on the reluctance schedule, so the higher the funds
rate gets relative to the discount rate. The more reluctant borrowers
we have, the higher the federal funds rate will be relative to the
discount rate.
MR. BAUGHMAN. It seems to me that if the reluctance to
borrow increased with the level of borrowings, that would tend to
moderate the suggested inability to maintain a penalty rate when
borrowings are high.

8/12/80

-12-

CHAIRMAN VOLCKER. I think it's still harder, if I understand
you correctly. I think we just move along a schedule of reluctance;
we have more reluctant borrowers with a high level of borrowing. That
means the federal funds rate will be more above the discount rate.
MR. BALLES.
point. If we were to
tie the discount rate
your ability to carry

I would like to ask Peter a question at this
go along with the Banking Committee proposal to
to market rates, how do you see that affecting
out the Committee's directive?

MR. STERNLIGHT. It could have an effect on the way we tie in
a level of borrowing in our path. I'm not sure I want to try to
extemporize entirely on how it might impede our [operations]. But
instinctively I feel it would call for some adjustment in the way we
have operated in the past with a borrowing level that tends to fall
We have had borrowing levels that
out as the differential [changes].
rise because demands for required reserves exceed what we have allowed
for in the path. If we also had a discount rate that was going to be
moving up along with that, it could set in motion this kind of
ratcheting process unless we made some adjustment.
MR. WALLICH. Isn't it a technique [that resembles] a halfway
[move] toward closing the window altogether? If the gap between the
funds rate and the discount rate--that is, the penalty-- were large
enough, clearly, nobody would borrow. And we would be operating
purely on nonborrowed reserves.
CHAIRMAN VOLCKER. I think it's quite clear what would happen
if we didn't change our techniques, which might have some implications
for whether to change them. What would happen is that we would get
more volatility in the federal funds rate in the short run.
MR. GRAMLEY. Is it necessary to think of tying the discount
rate just to the federal funds rate? If one is worried about the
ratchet possibilities, another way to go is to tie it to some market
rate of interest or to a combination of market rates. If looked at in
that way, it would still be a penalty rate in some sense.
MR. MAYO. But if we used the bill rate, Lyle, given what
bill rates have done, we would have a different problem on our hands.
MR. GRAMLEY. Well, I was thinking of tying it perhaps to
something other than the bill rate--to a combination of bill rates and
other things--precisely because the bill rate is so sensitive to
things like foreign demand and technical scarcities in the market.
MR. MAYO.

Well, the Canadians--

MR. BALLES. One can also be judgmental rather than automatic
in a formula. We could have a basket of rates but not reduce [the
relationship] to a simple formula. We could vary the relation between
the basket and our rate if we wanted to go the tying route, I think.
MS. TEETERS. I don't think that would get us out of the
problem we've been talking about because if we tied it to a longerterm rate it's going to switch from being a penalty rate to being a
subsidy rate when the yield schedule inverts.

-13-

8/12/80

MR. MAYO. We always used to show a three-way average rate to
our directors, just as a point of contact, [using the rates on]
finance paper, Treasury bills, and commercial paper--all fairly short
term. We have had to abandon that recently. We give them the table
but we don't talk about it because we think it's out of whack.
MR. EASTBURN. If I remember right, Paul, after the change in
procedure last fall there was to be a paper written by the staff on
this whole question of the [funds] rate and the discount window.
CHAIRMAN VOLCKER. Yes, I thought there was.
stand on all of this? We discussed this once before.

Where do we

MR. EASTBURN. I think the legislation came along and
preempted that to some extent.
CHAIRMAN VOLCKER. I don't remember how far we got on that.
We did have a preliminary discussion about it at one point. Did you
ever circulate a paper?
MR. ETTIN. No, not to my knowledge. There are some drafts
of some of the papers, but President Eastburn is right:
The resources
have been diverted for work on the Monetary Control Act.
CHAIRMAN VOLCKER. I had forgotten that that had never been
done formally, and I think we ought to do it. Meanwhile, I have been
answering Congressional and other inquiries along the lines that I
have been expounding at this table. I don't think this situation is
totally satisfactory, but I don't think the answer is just to
[establish] an "automatic" discount rate for the reason that I
suggested and for Tony's reason--whatever weight one gives that
reason, which is something people have debated back and forth. I
don't think technically we have the [alternative of doing that]
without changing other things.
I think it would call for rather
profound changes in path setting, or maybe in whether we open up the
discount window or close it, as Henry was suggesting.
MR. EASTBURN. It's [further] complicated by the fact that we
now have the thrifts in the situation, which involves Home Loan Bank
rates and so on.
CHAIRMAN VOLCKER.

Yes, Mr. Ford.

MR. FORD. With regard to the comment of what to peg it to:
Should we go to a floating discount rate, my feeling--[given my prior
experience at a commercial] bank--would be in line with what Lyle
said. We should consider an alternative that no one here has
mentioned [yet], and that is tying it to something like the bank issue
rate on CDs.
From the point of view of the money desk manager of a
major bank--and those are the people we are dealing with--whether or
not the bank goes to the discount window obviously depends on its
alternative sources of funds.
And in terms of maturity matchings,
since borrowings through the discount window are not normally
overnight but rather are done on a more than overnight basis, I would
suggest that the staff in its analysis of this question look at the
possibility of applying it to the reserve adjusted CD rate for major
banks on large quantities of money. That would make the movements in
the discount rate less volatile since a longer maturity [is involved]

8/12/80

-14-

and would tie it to the alternative source of funds that money desk
managers tend to consider. Also, we might consider having the
discount rate normally set close to that reserve adjusted cost-perhaps a little below it to give us some leverage--because then
[money managers] would want to come in if we set our rate just a
little below, but the reluctance factor would sort of balance that
out. It would give us some leverage over them.
MR. KEIR. I was just going to comment that we did have a
footnote in that earlier study on the discount window, which sort of
reviewed the conclusions that come from these other papers we have
been doing. The expectation is that those papers will be completed as
soon as the staff gets through this other work that they are doing on
the discount window.
CHAIRMAN VOLCKER. We have to ratify the transactions of the
Domestic Desk. Without objection. Mr. Kichline.
MR. KICHLINE.

[Statement--see Appendix.]

CHAIRMAN VOLCKER. Why don't we discuss the economic
situation and outlook at this point. Mr. Eastburn.
MR. EASTBURN. One of the most interesting questions is what
is going to happen to housing because that may be a clue to how fast
the recovery will be. I think the situation with respect to interest
rates and the availability of money cuts two ways. A lot of people
out there are watching mortgage rates and are waiting to get into the
market if they think the bottom has definitely been reached.
Therefore, if they see an upward movement in mortgage rates, that
could induce some demand to become effective. On the other hand,
there must be a lot of other people who will be discouraged as
mortgage rates go up. Do you have any feeling about that, Jim?
MR. KICHLINE. That has constituted a large debate in the
preparation of our forecast. I would say that in the very short run
we would expect the argument to hold that people will jump in. That
is, if we are talking about a rise of just a few basis points, those
folks who were out of the market in the second quarter but were on the
verge of buying may in fact be prompted to move off the fence. In
general, however, we believe the impact of tighter financial
conditions--in the sense of rising mortgage rates throughout the
forecast period, which is implicit in our forecast--would have a
significant damping effect. There are two other factors and one is
Our forecast implies slower rates of
[particularly relevant].
increase in deposits at thrift institutions than in previous cyclical
periods when interest rates declined and stayed low. I might mention
another factor, which is that the growth of real disposable income in
our forecast is really very small--certainly much smaller than in past
cycles. And we expect that to act as a drag on generating effective
demands for housing.
MR. SCHULTZ. One other factor is the effect of actions by
the Federal Home Loan Bank Board. Monthly payments are the crucial
If the FHLBB proposes that thrifts drop
[factor for most homebuyers].
downpayments from 20 to 10 percent and that [mortgage terms] go from
30 to 40 years, that will considerably lower [the initial outlay and

-15-

8/12/80

then] the monthly payments. What effect will that have on the whole
picture? That's another factor that probably will be important.
MR. KICHLINE. Oh, I think that's right. That whole area of
alternative mortgage instruments is a positive feature, particularly
for younger families. But past experience generally indicates that
these [practices] grow fairly slowly, particularly in an environment
in which the institutions are rather risk averse, which they seem to
be.
If one starts talking about going out 40 years instead of 30
years, in a fixed-rate environment with today's inflation I think a
number of institutions will be fairly reluctant to move in that
direction.
MS. TEETERS. Jim, why don't you tell us what happens to
interest rates under the monetary assumptions we have? Where does the
mortgage rate go?
MR. KICHLINE. For the third quarter we have the quarterly
average rate on conventional mortgages at around 12-1/4 percent, which
is where it is now, and it goes to the 13-1/4 to 13-1/2 percent area
by the latter part of 1981.
So in effect, it's drifting up throughout
this period.
CHAIRMAN VOLCKER.

Mr. Black.

MR. BLACK. Mr. Chairman, the main point of difference we had
with the staff continues to be that we expect less inflation than they
have been forecasting recently. The Greenbook analysis places almost
all the emphasis on the supply side. It talks about the effect of
rising oil prices and food prices and unit labor costs causing
inflation, but it really doesn't address this question of the
continued deceleration we have had--and that we see prospectively--in
the money supply. Nor does it address the shift toward a greater
surplus in the high employment budget. We would place great weight on
this slowdown in the money supply and some also on that shift in the
fiscal mix. This will represent about the third year of deceleration
in the money supply if [it continues] next year.
If anything was
right with that October 6 policy, somewhere along the way we are going
see some effect on prices. And we think it will come sooner than the
staff does.
It's easy to forget that the rate of increase in prices
had hovered at double digits before the last downturn and we got [it]
down to 4-1/2 percent but we let the aggregates get away from us and
[inflation] went back up. Most people don't remember that.
We also
think that if we are partly right on this, we will have less upward
pressure on interest rates than the staff expects, both because of the
removal of the inflationary premium on long rates and probably less
growth in nominal GNP and more growth in real GNP than the staff is
projecting.
CHAIRMAN VOLCKER.

Governor Wallich.

MR. WALLICH. It seems to me that the development President
Black describes would imply either that there will be differential
wage movements--because we know the movement in the organized sector
is for fairly strong increases, the pressures would have to be in the
much larger [non-union] sector--or very severe pressures on corporate
profits.
Is there any other place where a decline in interest rates
would work or where productivity would [lead to] a decline in prices?

8/12/80

-16-

MR. PARTEE.
MR. WALLICH.

Raw materials prices.
The dollar could rise.

MR. MORRIS. The difference is that in 1974-75 we had a
V-shaped recovery. For a short while we had very big gains in
productivity, which were reflected in a big decline in the inflation
rate. If we don't get the V-shaped upturn, the rate of gain in
productivity is going to be a lot less; I guess that's the reason why
you're pessimistic on prices, as I look at this chart.
MR. KICHLINE. That's a principal reason. Unit labor costs
in our view are going to be coming down, but precious little. We also
have the social security [increase], I might add. That adds directly
to business costs beginning in January, and we assume that will be
passed through quite quickly. We have the food and energy situation
added on, and it's hard to be optimistic there. So overall, our view
is that our [inflation] forecast, given our GNP, is perhaps on the low
side of what many people might come out with.
CHAIRMAN VOLCKER. I don't know how you forecast interest
rates but in the long-term area with your mortgage rate, your bond
rate must be up in the neighborhood of 13 to 14 percent. That would
be an extraordinarily high interest rate compared to your price
indices at the end of next year. It would be the highest real
interest rate, in my memory anyway, for a long time. Any comment?
MR. KICHLINE. I'll give you the answer you're looking for
first, and that is that we forecast interest rates with great
difficulty. It comes from a combination of the model exercise as well
as judgmental forecasting. And we take the monetary policy assumption
as given, which is 4-1/4 percent [M-1A growth] for 1981. Implicit in
that [assumption] is a substantial further downward shift in the money
demand function. So in effective terms money is growing more rapidly.
But simply to hold money growth to 4-1/4 percent, even with a downward
shift, implies to us a substantial further increase in interest rates.
CHAIRMAN VOLCKER.

Short-term interest rates.

MR. KICHLINE. We have short-term rates rising above longterm rates by the end of this forecast period. So we're once again
back to an inverted yield curve. That seems to me rather an unusual
situation for a very sluggish recovery with inflation coming down, if
people believe that. But it's very hard to envisage a significant
decline in long rates unless one believes that price expectations are
changing dramatically and that, in fact, our inflation forecast is
wrong. Otherwise, yes, we come out with rising real rates. And
that's one of the reasons why we have a sluggish recovery.
MR. MAYO. A $60 billion budget deficit doesn't help on the
rate side either [even] if we keep our eye on the ball of the monetary
aggregates.
CHAIRMAN VOLCKER.
forecast [interest rates].

Well, I will agree that it's hard to
Mr. Winn.

MR. WINN. I have to differ with my colleague on the left on
price expectations. I sense quite a feeling that our inflation

8/12/80

-17-

problem is not behind us. Labor is very restive, with food costs
being a real trigger for their demands. Secondly, new car prices are
going to surprise people. Every business that I can find is quietly
trying to raise its prices to position itself. In that kind of
environment, I think there's an explosive side. The other factor is
the political environment on top of that, with everybody trying to
out-promise everybody else. If we just look at what has happened to
sensitive materials prices in the last few weeks as well as all of the
others, it seems to me that, despite our roller coaster ride, we have
not dented inflation expectations very much. I think we have a real
groundswell for an explosive development on that side again. In spite
of all we've done, we haven't laid to rest the inflation expectations
very much.
MR. BLACK. Mr. Chairman, I never meant to imply that we had
at this point. All I meant to imply was that by next year, with a
continuation of the policy we've begun, I would expect some
significant effect on prices, or else our actions have been completely
futile. And I don't think they have been.
CHAIRMAN VOLCKER.

Mr. Balles.

MR. BALLES. It seems to me, Mr. Chairman, that we have a
good news/bad news syndrome here today. In terms of recent economic
statistics as well as the updated and revised forecasts of both the
Board's staff and our own staff at San Francisco, we see a better
outlook for the economy and better news on the unemployment front.
But both sets of forecasts show a worsening picture on inflation.
CHAIRMAN VOLCKER. When you say "better"--I just want to help
Mr. Altmann a little [in preparing the record of Committee member's
views]--are you saying better than the staff is projecting?
MR. BALLES. No. I mean both staffs are now forecasting more
inflation, less decline in real GNP, a shorter period for the
recession, and less of a rise in the unemployment rate than they were
a month ago.
CHAIRMAN VOLCKER. I just wanted a clarification of your
statement. You're not saying you are necessarily more optimistic than
the staff?
MR. BALLES.

No.

CHAIRMAN VOLCKER.
month, which they are too.

You're more optimistic than you were last

MR. BALLES. I find no quarrel with the general thrust of
their updated forecast relative to where they stood a month ago. It's
better on the real side, better on unemployment, and worse on
inflation. To put our current recession in some perspective, for what
it may be worth, we went back and looked at the behavior of prices
during the last two recessions. We looked at the behavior of the GNP
deflator--and I had forgotten this, frankly--but it turned out that at
the end of the last recession, the GNP deflator was no better than it
had been at the beginning of the recession. That was also true of the
recession prior to that. In fact for the 1974-75 segment, it was four
quarters after the trough of the recession that the inflation rate, as

-18-

8/12/80

measured by the GNP deflator, hit its low point. Now, if I look at
what seems to lie ahead--if the Board's staff and my staff are correct
that this dip in the economy will be over by the fourth quarter of
this year and we will then be into the next expansion phase, as weak
and anemic as it may be--to the [projected] GNP deflator by the end of
'81, which is four quarters after the now projected trough of the
recession, I get very disturbed indeed. The Board's staff shows the
GNP deflator still rising at an 8.7 percent annual rate. My staff
would be a bit more optimistic. But that's an awfully high inflation
rate to have at the beginning of the next expansion phase of the
cycle.
Also, with respect to the comments a little earlier on where
long-term rates are headed, with special attention to the mortgage
rate, I am distressed to see how high those rates are forecast to be.
But I am also convinced that we won't get those rates lower than that
12 to 13 plus percent for both the corporate bond issues as well as
mortgage rates until we get the inflation rate down. Obviously, longterm interest rates are very heavily influenced by both actual and
expected inflation. I think we have a real dilemma here.
CHAIRMAN VOLCKER.

Mr. Corrigan.

MR. CORRIGAN. In terms of the real economy, Mr. Chairman, I
would be inclined also to view it as a little better this month than
it looked last month. I am also inclined to the view that, at least
over the next couple of quarters, the real economy might be a bit
stronger than the staff forecast. But I am only willing to say that
for the next couple of quarters. I think, for example, that we may
see a little more strength in housing in that period and that auto
sales might be a little stronger than is suggested simply because of
the greater availability of fuel efficient cars. Partly because of
consumer credit reductions but also because of what's happening in the
stock markets, consumer balance sheets are probably a good deal
stronger than they were, which I think is consistent with that
development. But looking out a bit further I see some risks,
including the point that has already been made about what will in fact
happen to interest rates and what that may mean for housing and
capital goods. On the price side, we have a situation where in the
near term the CPI certainly will look better. But my own perception,
like that of others, is that the price outlook and [inflation]
expectations actually have deteriorated in the last month or so. The
unit labor cost situation, of course, looks terrible. The budget
deficit situation, in terms of its implications for expectations, is a
The weather and [its impact on] food prices is an
matter of concern.
unknown, but at least for now I think it can only work in one
direction. And I sense a growing element of concern in the markets
[about] the recent money statistics and what they may portend for
inflation over a longer period of time. The fiscal [side], as has
been said, is full of uncertainties. The one thing we are sure of is
that the deficits are going to be big. Financing requirements of the
Treasury are going to be substantial, whatever that implies.
Certainly we think we know something about what it implies for
interest rates. In summary, as I look at the situation, I think the
relative risks have shifted. While we still have a weak economy, in
the near term it may be a little stronger than we thought it was. But
the price situation, if anything, looks a little worse--conceivably a
good deal more than a little worse--rather than a little better.

-19-

8/12/80

CHAIRMAN VOLCKER.

Mr. Wallich.

MR. WALLICH. I share John Balles' view that the real sector
looks a little better and inflation looks a little worse. I think
that's a fairly general impression among forecasters.

I also see two

characteristics of our economy that seem to be visible now. It has
very quick defenses against a sharp downturn, given that the downturn
didn't go very fast. Automatic stabilizers went into action and seem
to have been holding-MR. PARTEE.
MR. WALLICH.

It went pretty fast.
That's what I said.

CHAIRMAN VOLCKER.

It caught--

You say the downturn went pretty fast?

MR. WALLICH. The downturn went fast but didn't go very far.
It caught itself pretty fast, and we are already beginning to feel the
counterforces on the other side. That is, interest rates are already
beginning to rise, which I think could choke off the expansion. In
other words, the economy now reacts very quickly on both sides. What
we have not gotten at all out of the recession is much adjustment.
There doesn't seem to have been time for much adjustment in corporate
balance sheets or household balance sheets. I don't think anybody's
expectations and behavior patterns are likely to have been changed
very much by this experience. Not to put too fine a point on it,
nobody has gone broke. Nobody has been hanging on the cliff for a
very long time except some of the thrift institutions. In other
words, this has been a surprisingly mild recession. It is very
unlikely to have [set the stage for] much long-term improvement if in
fact it now takes off from here. It's not likely to change our
attention, expectations, or behavior in a favorable direction if [the
economy] bottoms out quickly and resumes a modest advance, as seems
likely. So the conclusion I draw is that this is a situation that
calls for continued restraint in order to get some more effect out of
the situation.
CHAIRMAN VOLCKER. Mr. Kichline, I meant to ask you earlier,
and I didn't, about consumer balance sheets. Governor Wallich says
they haven't had a lot of time to improve all that much. There has
not been much time, that's for sure; but the decline in debt at least
has been much sharper, I think, than in earlier recessions. How does
the improvement in the consumer's financial position look compared to
earlier recessions? Do you have any judgment on that?
MR. KICHLINE. As you know, the ratio of debt outstanding to
disposable personal income peaked [last] summer, in the third quarter
of '79. It came down a little in the fourth quarter and a bit more in
the first quarter. We don't have a final second-quarter figure but,
obviously, given what has been happening with the run-off in consumer
debt and the slow growth in mortgage debt, there was a significant
further improvement in the second quarter. I would think the change
in debt outstanding we've seen in the second quarter is just a huge
change in terms of historical [patterns of] debt reduction. So while
it hasn't gone very far, my guess would be that it ranks with some of
the largest declines in consumer debt outstanding that we've seen in a
six-month period.

-20-

8/12/80

MR. SCHULTZ. Jim, I thought I saw some figures the other day
that [the ratio] had peaked at 18 or so percent and has dropped now to
less than 15 percent in this very short period of time.
MR. KICHLINE. Yes, that's just for consumer debt. We've
combined consumer and mortgage debt, and the mortgage debt helps that
story because it grew at a much reduced rate in the second quarter. I
don't have the figures at hand.
MR. GRAMLEY. Mr. Chairman, another point that Mr. Corrigan
mentioned, which I think is worth remembering, is that we've had a
very marked upswing in the stock market this time in contrast to a
very very weak stock market in late '74 and in '75. We were massively
destroying consumer wealth in that earlier recession and this time I
think we're creating it. It would make a big difference if we took
that into account, too.
MR. CORRIGAN. Yes, if one looks at both the asset side and
the liability side, we really do have a-MS. TEETERS. But didn't interest rates hold up for a longer
period in the recession of 1974-75? We've had a terrific drop in
interest rates, which is going to have a bouyant effect on the stock
market at this point.
MR. GRAMLEY. I don't think they held up particularly. They
didn't go down as fast as they did this time, but my recollection is
that interest rates started declining about September or October '74
and continued on down into the spring of '75. In terms of timing
there has not been a lot of difference, but the speed of movement is
certainly [different].
CHAIRMAN VOLCKER.
business picture?

Are there any other comments on the

MR. MAYO. The stock market seems very unreal and a lot of
people are predicting that we will have a correction. Of course, our
former Secretary of the Treasury announced he was selling all his
holdings and the market went up 20 points in the next two days!
MR. PARTEE.

It's based on his past record!

MR. MAYO. I see a lot of the investment people from LaSalle
Street and almost without exception they are expecting at least a 75
to 100 point correction.
MR. MORRIS. Of course, that never happens when the judgment
is unanimous that it's going to happen.
MR. MAYO.

I know.

CHAIRMAN VOLCKER. Mr. Altmann is left at this point with
saying [in the policy record for this meeting] that you all agree with
the staff's outlook. Is that the impression you want to leave him
with?
MR. MAYO.

Basically, it's all right.

8/12/80

-21-

MR. PARTEE. I am impressed by the signs of the economy
I don't know to what extent we
catching as we've [eased our policy].
should regard that as unusual. The decline in consumer spending was
exceedingly rapid and took us to pretty low levels in real terms in
some areas such as automobiles. It may not be that unusual to have a
little recovery after we've had a decline of that extent--a little
catching up--particularly with money and credit conditions easing.
So, I guess I am not as convinced by the evidence that the recession
is nicely bottoming out and that it won't be very long before we get
an upturn. I don't agree that this is conclusive since [the period of
improvement] is so brief and since it seems any market would have a
little see-sawing when big changes occur. I wouldn't agree with the
comment that Henry made that nobody has gone bankrupt. I believe
bankruptcies are at an all-time high all over the country. Small
businesses are going bankrupt and the automobile dealers are having a
major shakeup. It's just that no big companies have gone bankrupt
because we didn't permit Chrysler to do so. Otherwise we would have
had a big bankruptcy as we've had before. Also I would point out that
there is a long tail on this. If Bob is right, even if the staff is
right in their price projections, we're going to have a period of
quite restrained profit performance. And when that occurs, there is a
frequency distribution around it; some [firms] are going to be a lot
less good than average and they might be bad enough to go bankrupt.
So there's still a lot to be played out. What gives me most pause
about being somewhat bearish about the outlook is the stock market,
which has performed extraordinarily well, and sensitive industrial
materials prices have moved up without fail for two months or more by
a rather marked amount. And there are a lot of people out there who,
unlike us, are putting their money behind their forecasts. They say
that profits are going to go up--I presume in order to justify the
stock market--and that prices are going to go up because of the demand
for raw materials. And that does give me a pause. So, I am just
uncertain. But I wouldn't be quite as favorably inclined on the
outlook as the discussion around the table has [suggested] so far.
MR. GRAMLEY. I'd just like to add a few comments. I am very
much in agreement with the staff's forecast for real activity. All
the signs are now pointing to a fairly near-term bottoming out of the
recession and to the recovery beginning in the monthly statistics
before the end of the year, although it may well be that the real GNP
figure would be negative for the fourth quarter. To comment further
on what Governor Wallich was saying, I think the business community
learns something a little different from each recession. In the
recession of 1974-75 what the business community learned was that by
Jove they better not have excess inventories. They didn't forget
that. So they are reacting very strongly in this recession, as they
did throughout the whole recovery. In this recession what I think
they will have learned is that they better not borrow at the prime
plus 2 percentage points because the interest rate risks they face are
ferocious, given the kind of inflation that we have and given the
policies that the Federal Reserve is now following. That is going to
have a very, very sobering influence on planning in the business
community in the next several years.
I am more pessimistic than the staff on the price outlook for
next year. I think compensation is not going to moderate as much as
the staff indicates. More of a rise in prices relative to
compensation than the staff has forecast is likely also. I think

-22-

8/12/80

That businesses are going to
that's what the stock market is saying:
raise prices to get profit margins up as soon as activity begins to
improve. That's exactly what Chrysler is doing in pricing its K cars.
But the price situation for next year poses for us a very profound
problem. The staff has a weak outlook for economic growth and a very
weak outlook by historical standards for a recovery period, despite
the fact that they're assuming--with no good basis for it, really, and
they know that--that the money demand function is going to shift down
again. If it doesn't and if prices go up still more than the staff is
forecasting, then holding to the kind of targets that we have is going
to produce a very, very sick economy. It's something we don't have to
face as a Committee now, but it's something that is going to give us
agony as the next 18 months unwind.
CHAIRMAN VOLCKER.

Mr. Roos.

MR. ROOS. As perhaps the two newest members might not know,
we base our projections on output and prices primarily on the rate of
money growth, M-1B specifically. Our projections show a significant
difference in what will happen depending on whether M-1B grows, for
example, at a rate of 3 percent or 5 percent or 7 percent from the
third quarter of this year on. Let me very briefly give you the
different results that we would anticipate for GNP growth in 1981. If
money were to grow at only a 3 percent rate, we would see real GNP
growth throughout 1981 at a negative rate of minus 1/2 to minus 1
percent, whereas if we persist in our announced target of about 5
percent money growth, we would see positive real GNP growth of
approximately 3/4 to 1 percent. If we lost our good judgment--that's
a subjective statement--and permitted money to grow at a 7 percent
rate, we would see real GNP growth at a rate of between 2-1/2 to 3
percent next year. Price-wise, there is also a significant
difference. If we had the 3 percent money growth next year, by the
end of '81 we would see a deflator of maybe 6-3/4 percent by the
fourth quarter of next year. If we persist in our 5 percent growth,
we feel that prices as measured by the deflator would rise at about 71/4 percent rate on an annual basis. And if we lost our good judgment
and went to 7 percent growth, the deflator would be up close to 8
percent, as we see it, by the end of next year. So we feel there is a
significant degree of responsibility in our hands in determining the
rate of money growth and thereby influencing both prices and output
for 1981.
CHAIRMAN VOLCKER. A lot of people might conclude from that
analysis that good judgment is 7 percent, Larry.
SPEAKER(?).

But you don't know about '82.

MR. ROOS. I'm a 5 percenter, Mr. Chairman.
a bad word--5 percenter--wasn't it?

That used to be

MS. TEETERS. I'm a little surprised at the strong change in
sentiment based on so few facts. We have a few good numbers or a few
numbers that aren't terrible. That's about what it comes down to. We
don't have a good indication of what the third quarter will be yet.
The labor force data on the payroll basis are going to catch up with
us. We've just had some good luck on the size of the labor force in
the last month or so. I would also point out that the past five years
have been characterized by a good quarter followed by a bad quarter.

-23-

8/12/80

It hasn't been a smooth recovery or [pattern of] growth anyway. Many
times we thought we were on the verge of a recession and then recouped
from it. So, I think [the economy] is just jiggling around. I am
also terribly concerned about 1981 because I think we have a very
strong possibility, with the low rates of growth that are being
projected, that this will turn into a 1959/1961 situation where we'll
have a double recession--one right after the other. There is just no
strength in this particular forecast; [activity is at] very low
levels. I think this forecast has the longest string of negative
business investment--if it turns out to be as forecast--on record.
That gives us a very, very poor outlook over a fairly long period of
time. So I don't think we need to hit the horse any harder than we're
doing at the present time. We've knocked it off its feet. Let's give
it a chance to rest awhile and hopefully let it get up at some point
rather than constantly pushing it back down again. I would say that
if we move for any further restraint, we're almost guaranteeing that
the housing market will not recoup. The prices of cars are such that
nobody can buy them; and even though the industry is trying to push up
prices, the consumer is in no position to meet those higher prices.
We have a lot of uncertainties at this point. I think we've gotten
something out of [our posture of restraint]. I'm worried about
prices. But we haven't had any time at all for [our policy] to be
reflected in the current statistics.
CHAIRMAN VOLCKER.
have coffee].
MR. ETTIN.

Why don't we turn to Mr. Ettin [and then

[Statement--see Appendix.]
[Coffee break]

CHAIRMAN VOLCKER. Why don't we have what I hope
relatively brief general discussion or questioning of Mr.
then we'll get around to the [policy] specifications. We
it up. We have an hour and a quarter. Henry has put his
too, but we'll let Mr. Eastburn go first.

will be a
Ettin and
can divide
hand up,

MR. EASTBURN. Right before we adjourned, Ed was giving some
parameters for M2. I said to him [during the coffee break] that M-1A
is not much good to us anymore and M2 doesn't seem very good either,
so we're reduced to M-1B, I think.
CHAIRMAN VOLCKER. Which isn't very good either.
at these too carefully. That's [the message].
MR. EASTBURN.

Don't look

It's the least worst, perhaps.

CHAIRMAN VOLCKER.

Try M3.

MR. EASTBURN. I was just asking whether he had any guesses
on that, particularly. I'm looking for something in the Bluebook, but
I can't put my finger on it, about the presumption that the recent
changes in interest rates are going to narrow the gap. How confident
do you feel about that and what do you think the magnitude of that
might be?
MR. ETTIN. We're reasonably confident that that's the trend,
because as market rates rise relative to the ceiling rate on passbook

-24-

8/12/80

accounts, we think that's going to slow down. It's hard for me to
estimate how much that strength in savings deposits is adding to M-1B
because the amount of ATS accounts relative to M-1A is relatively
small. I would say maybe 1/2 percentage point, but that number is
pulled out of [the air].
The point is that I'd make it on the modest
side.
CHAIRMAN VOLCKER. I don't really think we can assume any of
these numbers are the right numbers. We know M-1A is bad because more
goes out of demand deposits than from M-1B; but to the extent [funds]
go out of savings deposits into M-1B, that measure also is distorted.
We just don't know the extent of this.
MR. MORRIS.

Maybe we ought to move to L.

CHAIRMAN VOLCKER. Well, I tell you: The M3 chart is such a
beautiful one that I am tempted to move to M3; we're right in the
middle [of the range].
MR. WALLICH. M3 is another of those [variables] that
maintains its stability because one [component] goes down and
something else goes up, which is a little suspect.
MS. TEETERS.

That's what we thought we were doing with M2.

CHAIRMAN VOLCKER.

You had some comments, Henry?

MR. WALLICH. I really want to say the same as Dave: M-1A is
not much good and M2 is not much good. Isn't the main argument in
favor of M-1A--and the reason why we keep talking about it--that it is
used in the model?
MR. ETTIN.
emphasis on it.

That's the reason why the staff places particular

MR. WALLICH.
MR. KICHLINE.

Can't we re-program [the model]

for M-1B?

Certainly, but the model is not the problem.

CHAIRMAN VOLCKER. What makes you think M-1B is [any better]?
To say that M-1B is better than M-1A, you are making an assumption
that there is very little movement from savings deposits into M-1B.
That may be true, but I don't think you know it.
MR. WALLICH. There is another guide that we could go to,
which is to look at what happened in 1974-75. The impressive
experience at that time was that we all underestimated--except maybe
your distinguished predecessor by one--the increase in velocity that
we were likely to get. So, I ask myself: Do we see something in the
economy that implies a very large increase in velocity? All I can see
is that we have had a tremendous experience of very high interest
rates and, as someone just said, the economy has learned [from that].
As Lyle said, [firms] learned not to borrow at the prime rate plus two
percent. I think they also learned not to have idle money around with
a prime rate of 20 percent. So that may be the thing that has
triggered a new increase in velocity.

-25-

8/12/80

MR. ETTIN. If I may, Governor Wallich, I would point out
that to the extent that kind of [positive] ratchet effect would be
hitting [velocity] after a sharp run up [of interest rates then],
Each
interest rates would be hitting money demand [negatively].
period with that impact should be shorter and shorter; indeed, the
evidence we have is that when it first begin in 1974 it took a little
longer than the next round. I think the evidence supports that the
drop-off [in demand for M1] in the second quarter was very shortlived.
CHAIRMAN VOLCKER. Yes, one could argue just that. I think
we had a big impact in the second quarter, but now because we have had
that impact it will make the velocity relationship even tighter than
it was before.
[implies]

MR. PARTEE. The staff projection for the third quarter
a decline in every velocity measure.

MR. WALLICH.
falling income by--

Well, that's simply the result of dividing a

MR. PARTEE. But what is [velocity in] the second quarter,
except the simple result of dividing income by money supply?
MR. WALLICH. Yes, but one has to think about what happens at
a constant level of interest rates in order to measure the velocity
trend. We have to hold the rates constant and then see whether or not
there is an increase.
CHAIRMAN VOLCKER.

Governor Partee.

MR. PARTEE. Well, I wanted to talk about this very subject.
I wanted to indicate that I am somewhat dubious about giving much
importance to M2 in the current environment for several reasons.
Number one, our range for M2 was developed on the basis of a
relationship the staff presented to us some time ago, which might have
been right or might not have been right. Certainly, it is at least
dealing with an instrument that has different components in it than
before. Number two, the top end of our range for M2, an aggregate
which includes most kinds of instant liquidity that people can think
of, is 9 percent. That is about equal to the rate of inflation; so at
the top end that means the real value of liquid assets will not
change. That doesn't sound all that great. And we have the [prospect
of] these shifts of the sort that Ed was mentioning, which do strike
me as possible. M3 is better than M2, I think, because of the
possibility that M3 components--that is, large CDs [primarily]--are
moving to identified M2 components as a result of interest rate
strategies and so forth on the part of holders. I don't find M-1A all
that bad an indicator. I think what we have to recognize about M-1A
is that it has a downward bias. That is, there is some shifting away
from M-1A, and we can't quite quantify it, but the basis for M-1A's
relationship to the economy is pretty well established over time and
has been pretty well researched. M-1A still does have currency in it
and it still does have demand deposits in it so that we see what the
relationship might be. It seems to me the best thing to do is to look
at M-1A principally and make an allowance--I don't care whether we
make it a 2 percent allowance or what--for the understatement of the
growth rate that is occurring because of shifts into other

8/12/80

-26-

instruments. I think that's the safer way to go. An alternative way,
along our usual lines of suggestion, is why not average M-1A and [M1B] and say that's our goal, on the [grounds that] neither is right.
One has an understatement and one has an overstatement, so let's take
the average. It can't be all that bad. But I think M2 is very
dangerous to use importantly in trying to steer monetary policy, and I
would certainly advise against that.
CHAIRMAN VOLCKER.

Mr. Gramley.

MR. GRAMLEY. First, I'd like to compliment Ed on some
perceptive remarks on the interpretation of these numbers. This is
the kind of thing we always need to watch very carefully to see if we
can analyze the particular factors that are influencing the growth
rates of these numbers. None of them is perfect and we need to try to
make some judgments about what is influencing their behavior. I guess
I don't really understand, Ed, the comments that you made on ATS
deposits. Let me ask a question first and then ask you to elaborate a
bit. Do you have hard information on the ATS deposits? Or is this an
estimated number based on an assumption that so much of the growth of
savings deposits must be in ATS accounts?
MR. ETTIN. We have hard numbers for member banks and
estimates and samples for nonmember banks.
MR. GRAMLEY. Could you make that point again that you were
making about ATS deposits?
MR. ETTIN. The ceiling rate for ATS accounts and regular
passbook accounts at commercial banks is identical, at 5-1/4 percent.
One would presume, because our evidence is that everybody is paying
the ceiling rate, that it would be unlikely that an ATS account holder
would have both an ATS account and a regular savings account. It's
probably one account. To the extent, for whatever reason, that
passbook accounts generally have been strong, some of the [depositors]
who would be increasing their savings account funds would call their
account an ATS account. So the measure of those transaction balances
would be biased upward.
MR. GRAMLEY.

Thank you.

MR. MORRIS. It's also true of NOW accounts, even though
A lot of the NOW
there is a penalty, a quarter [point lower return].
account total really, in a sense, represents savings accounts.
MR. ETTIN. While that's true, I feel less certain that the
big run-up in savings may also be [spilling] over into NOWs because we
have heard, and have some evidence, that people in fact have a NOW
account and a savings account. I don't know how much weight to put on
it. We don't know. I am more certain about it for ATS accounts
because there is no ceiling differential.
CHAIRMAN VOLCKER. We [face] a real problem next year, in my
role wearing my other hat as Depository Institutions Chairman, on
whether to differentiate these rates. There is going to be a lot of
arguing about that. Mr. Corrigan.

-27-

8/12/80

I am inclined to the
MR. CORRIGAN. Two quick questions, Ed.
same view that you articulated in terms of M2 and these asset
If that's right, is it also your judgment that
preference shifts.
If
that pattern will likely continue for at least several months?
anything, presumably in this environment, we are talking about at
least a couple of months in which money market certificates or savings
certificates are going to be perhaps even more competitive.
MR. ETTIN. My answer, President Corrigan, would depend on
To the
how rapidly interest rates rise over the next several months.
extent that market rates do rise, I think there will be some slowing
in M2 because market instruments will look somewhat more attractive.
But I don't think it will make a great difference.
MR. CORRIGAN. One other quick question. I have heard that
there is already talk in the markets, for whatever it's worth, of a
very, very, large money supply number this Friday. Do your numbers
suggest that?
MR. ETTIN. Yes, our preliminary estimates suggest that in
the week of August 6th there will be an increase in M-1A of over $3
I think the market talk may be reflecting Mr. Sindlinger,
billion.
who is expecting an $8 billion increase in the first two weeks.
MR. CORRIGAN. The number I've heard--and I've heard it from
So I was just wondering.
two sources--is $4 to $5 billion on M-1.
MR. ETTIN.

Part of it also is the social security--

CHAIRMAN VOLCKER.

Mr. Mayo.

Ed made the point very well
MR. MAYO. A couple of points.
on savings bond redemptions; that has eased off a little now. But a
lot of that money is just parked waiting for what people think will be
[higher] interest rates, I think. Also, the Treasury has a 9 percent
bond coming due August 15, which was subscribed to by a lot of
[individuals], at least in our area. They are already making
inquiries as to what [return] is available [on Treasury securities]
"Oh well, I'll put [the proceeds] in a
and typically are saying:
money market mutual fund when it comes due. So we will be seeing more
But
of that, which again leads credence to the fascination with M3.
it also gets to the point that the further out we go in the Ms, the
less control we have over what we are doing. So I think we have to be
I'm inclined to differ a
careful not to get too fascinated with M3.
little with Chuck [on the relative merits of] M-1A and M-1B. We'd
have to adjust either one of them, whatever we were doing, and M-1B
may be the better one going out a year or so. Also, that is what the
I think not much attention is paid to M2 in the
market is looking at.
everyday market. Whether Peter [Sternlight] and Allen [Holmes] would
agree with that or not, [I don't know].
MR. STERNLIGHT. I think M2 gets less attention largely
because it only comes out monthly. There has been some notice taken
of it.
CHAIRMAN VOLCKER. We hope 18 months from now M-1B will be
that number, and we will have washed out all these--

-28-

8/12/80

MR. MAYO. Well, we hope so. We will have a different reason
maybe a year from now. But the further out in the Ms we go, the more
trouble we get into in terms of what we can influence. I feel we are
better off sticking pretty much with M-1A and M-1B for the moment.
CHAIRMAN VOLCKER.

Mr. Roos.

MR. ROOS. I'm in line with what Bob said. Our research
department has done quite a bit of work recently in checking the
predictive value of these various aggregates. Their conclusion is
quite clearly that M-1B has predicted output much more accurately than
the other aggregates. If we can ever get this material edited, Mr.
Chairman, we will circulate our wisdom to this wiser body if you'd
like.
CHAIRMAN VOLCKER.
MR. ROOS.

We will look at it with great interest.

Thank you, sir.

CHAIRMAN VOLCKER.

Lyle, you had a comment?

MR. GRALEY. I was just going to say that Mr. Sternlight is
right [about M2].
And we might be well advised to choose an aggregate
for which we only have monthly figures.
CHAIRMAN VOLCKER. Any other general comments? I take it
there is a good deal of acceptance of some of Mr. Ettin's comments,
and there is some question about being too serious about M2. Maybe I
have misstated that. [Perhaps it's more accurate to say] we should
look at it but there is some reason to think it may be somewhat
distorted on the up side.
MR. WALLICH. Just a comment. If we are getting sufficiently
frustrated with the aggregates, there is the old standby of real
interest rates, after tax. We have done a certain amount of work on
that now.
MR. PARTEE.
MR. WALLICH.
MR. PARTEE.

The "old standby" of real interest rates?
After tax, real interest rates.
Your old standby.

MR. WALLICH. I've mentioned it from time to time here.
just wanted to tell you that it's available now. It has been run
through the computer, so perhaps it has acquired a little more-CHAIRMAN VOLCKER.
circulate that.

I

Along with Mr. Roos' material, you can

Now we have to turn to the serious business of the Committee.
A number of people, John Balles and others, have described our basic
dilemma in that we have both a serious inflation problem--or more
pessimism about inflation and great sensitivity to expectations of
inflation--against a rather shaky business recovery. So some of the
things one might ordinarily think would be good for the business
recovery may not be good for the business recovery if they maximize
the inflationary uncertainties and have an adverse repercussion on the

8/12/80

-29-

market for that reason. As one market caller put it to me the other
day, if the money supply really goes up very sharply for a couple of
weeks, we will have big increases in long-term interest rates. I
think that is descriptive of the kind of dilemma we are in. I don't
know how we get out of that without going through a painful process of
deflating the inflationary expectations, which are not deflated yet.
And I don't know how they get deflated without deflating the economy
more than one would like to see it deflated. I don't have a ready
answer to that.
MR. MAYO. Paul, there is one other option that we haven't
explored for a long time. It's probably not practical, but as I told
a number of you, when I was in Frankfurt some years ago, Emminger
said:
"Mayo, we've got one advantage here over you folks that we are
"We
I asked:
"What is that?" He said:
never going to give up."
have no weekly figures on the money supply and we're never going to
have any."
Arthur Burns even threatened at one point to put out daily
figures on the money supply to point up the absurdity [of following
short-term fluctuations so closely] and then obviously thought better
of the idea. Is there any chance in the reporting from all these
40,000 customers we have now--it's probably too late even to suggest
it--that we can solemnly decide that we should have only monthly
figures on the money supply? Or is the world too sophisticated to
accept that?
CHAIRMAN VOLCKER. My instinct is that we couldn't get by
with it. And I don't really think it would cure the problem. People
would wait for the monthly figure.
Bob.

MR. PARTEE. We couldn't do it unless we didn't collect them,
Then we wouldn't have anything for our own use either.

MR. MAYO. Well, that's the problem. But it's tempting to
talk about; we'd have one eruption a month instead of four.
CHAIRMAN VOLCKER. It would help in terms of these intramonthly gyrations, but I don't think it would deal with the dilemma
that I am referring to, which is a real dilemma for the economy.
Actually, the Washington Post had a good editorial just the other day.
They put the same dilemma [in terms of] New York versus Washington.

Washington wants to expand whenever the economy gets into a recession
and New York will run for cover with inflationary expectations if that
happens, which will undermine the expansion. Therefore, you can't do
either. And I think there is a lot of reality to that.
I don't know if it will speed up the process or not but, if I
may, let me give you something to shoot at. When I look at these
pretty charts--though obviously when we are talking about differences
as small as those in "A" and "B," it is not a widely different
picture--I come away with the feeling that alternative A is not in any
sense off course. Under alternative A, so far as the M-1A figure is
concerned--it's not true of M-1B, which has been rising more rapidly-if we took off from M-1A the target for the quarter is the same as
It is consistent with a higher M-1B
[the one we had previously].
figure according to the current estimates, if they are any good, and a
considerably higher M2 figure than we were talking about at the last
meeting. But those charts don't give a very disturbing picture; in
fact, they give a rather nice picture. If we held to it and just

8/12/80

-30-

extended [money growth] at the same rate, M-1A would end up right at
the bottom of the range for the quarter or a little above it by the
time we got to December. M-1B, if I am right, would be just about in
the middle, or maybe a bit below for the quarter and a little above in
December. For M2, alternatives A and B are very close together, but
it's high in either case. M3 is in the middle.
We are dealing with an extremely [unintelligible.] The
market, as nearly as I can read it, has anticipated some tightening
which hasn't taken place. Maybe another way of stating it is that
they also have a heavy supply of securities. They see better business
news and anticipate perhaps a bigger increase in the money supply and
assume that would bring a higher federal funds rate. That may or may
not be true. I myself don't see any reason, particularly, to bias
that question at the moment. If we are satisfied with something like
the alternative A money supply figures, I don't think we have to do
anything now to bias where we are in terms of the federal funds rate.
I am talking, really, about the borrowing figure at the moment. If
the money supply comes in higher, that doesn't imply, with our
ordinary techniques, that [policy] would be tighter. But [in that
event] we would have seen evidence that the money supply is in fact
running even [above] this figures which looks all right. Or if it
came in lower, we would be moving somewhat in the other direction. So
I would be inclined, in general terms, to take something like "A" and
unbias the decision this week. I don't know whether that means $100
million of borrowing or maybe a trifle less than that, but something
in that neighborhood. And as I say, if the money supply comes in-just in M-1A terms with similar changes in the others--at 9 percent,
let's say, the borrowings would go up and presumably we'd get an
increase in the funds rate. If it came in weaker, as I guess the New
York projection suggests, we could perhaps run down to truly
frictional levels of borrowing and the funds rate might go in the
other direction. But in either case, there would be better evidence
than we have at the moment. I don't think it's clear that we are off
course, if we discount M2 a little at the moment. So I don't see any
reason for a bias at the moment in one direction or another,
particularly given the sensitivities in the market. With the dollar
in a little better shape, conceivably we could make the bottom end of
the federal funds range a little less close to the current market
level than it is. I don't know that we have much risk of running into
either of those constraints, but it might look a little better. So we
could alter that a bit if you wanted to, but those are the very
general thoughts that I have. Why don't you proceed from there,
Governor Schultz.
MR. SCHULTZ. Well, as everyone around this table knows, I
believe that inflation is the major problem and that hasn't changed at
all, so I think we have a long hard pull ahead of us. I believe,
though, that alternative B would be a mistake at this time because it
seems to me, short term, that we are already getting some restraint.
Interest rates have already backed up some, and I think it is not
likely that mortgage rates will come down from where they are. They
might rise a little. One of the things we didn't talk about is the
fact that mortgage rates are much more sensitive to bond rates because
of the passthroughs. We have this enormous backlog of securities that
are sitting there, and it's just hard for me to see that mortgage
rates are going to come down any; they might even back up a little.
We have already seen some of that in California, where they are

8/12/80

-31-

particularly sensitive to this kind of thing. So it seems to me that
the path we are presently on is already giving us some restraint. I
get the feeling that we are doing reasonably well at this point and I
don't see much sense in trying to shut down further. In addition, I
have a feeling that longer term we may need some flexibility next
year. I don't know what shape recession we're going to have--whether
it will be a square root or an L or a W or whatever. But one
characteristic I think it will have--and I think properly so--is that
it will be a very slow recovery. I don't see how we can get out of
the mess we are in without that slow recovery, because I don't see how
we are going to be able to get unit labor costs down without some
pain. And we are not getting very much pain in this economy at this
time; corporations still are looking to increase prices, as President
Winn said. And until there is some real restraint on them in terms of
their corporate profit margins--and I think there will be next year--I
doubt that they are going to start getting really serious about trying
to hold wage rates down. So it seems to me that we are looking at a
very slow period of recovery for next year. I have the feeling that I
would like to go into next year [with money growth] near the middle of
the range, and not biased toward the bottom, to give us the kind of
flexibility we may need. So my feeling is that alternative A is much
superior [to alternative B], both for the short run and the long run.
MR. BALLES. I'd like to present the case for alternative B.
The dilemma that I described earlier might be put in a little broader
context. If you remember, last spring quite a few of us were a little
worried about the undershoots in the aggregates and the fact that
failure to achieve [our objectives for] them might unnecessarily and
considerably exacerbate the recession that was then under way. I've
been pleased, of course, by the catchup in the aggregates produced in
the June and July figures--and they're pretty solid--and in the
projected August figures. I suppose part of what determines how one
comes out here depends on one's reading of the tea leaves on the
business outlook but also on the judgments one makes as to which M is
the lesser of the evils in terms of its reliability as a predictor. I
have to say that on the outlook I came out much closer to the views
Governor Gramley has articulated than the opposite view. And with
respect to M-1A versus M-1B versus M2, the research that we've done at
our Bank indicates that M-1B is a better predictor of future price
movements than M-1A. Now, they're both obviously contaminated to some
extent, but I think M-1B is less so than M-1A. For that reason, and
because of the failure to achieve any significant progress thus far on
the inflation front--especially if one looks at the staff's forecast
on where inflation will be by the end of 1981--I am very concerned.
So, all things considered--in view of the catchup we've now had on the
Ms and in view of what I consider to be a less gloomy or, if you like,
a more optimistic outlook in terms of the recession being shorter and
shallower than we had earlier expected-- I'd begin to shade [money
growth down] a little now. Speaking for this year as a whole, I'd
move broadly in the direction of aiming somewhere in the lower part-certainly at or below the midpoint--of the range we have set for M-1B,
which I would consider the most reliable of the three Ms for the
moment. That may change next year when we get NOW accounts. But I
wouldn't be unhappy if we reduced our sights a shade and tried [for
growth in] M-1B at what we had said in July would be our target for
the third quarter, which is around 8 percent. So "B" or "B minus"
would be the way I would lean, Mr. Chairman.

8/12/80

-32-

CHAIRMAN VOLCKER.
MR. BALLES. Yes.
June-to-September quarter.
CHAIRMAN VOLCKER.
MR. BLACK.

"B minus" meaning even less than "B"?
I'd like about 8 percent for M-1B for the

Mr. Black.

Mr. Chairman, I come out very close to the

[approach] you advocated.

I don't see much difference between "A" and

"B" and I have a slight preference for "A."

I lean, like most here,

toward M-1B for the reasons indicated, although I duly heeded your
admonition that we ought not to take this at face value. There's a
temptation, I think, to go with "B" because of the inflation we see.
But if the staff is right in its projections on M-1B, that would mean
that its growth would decelerate to a rate of 5.5 percent this year
from 7.6 percent last year and 8.1 percent the year before. That
seems to me sufficiently fast deceleration to work toward gradually
reaching a noninflationary rate of expansion in the aggregates. And
it would set the stage for a further reduction next year, as we have
promised every one we would [seek].
I do have a little concern about
the overshoot in M2 because of the credibility problem, but the
overshoot is very small; and as others have stressed, the [narrow]
aggregates are looked at much more carefully than M2. And I think the
points that Ed Ettin made about M2 are quite valid. But if for some
unexpected reason M2 did come in high, we might want to take another
look at it.

I also have sympathy for your position that maybe we

ought to [reduce] the lower end of that funds rate range. I have long
stated that I don't favor any range on the funds rate, but I think we
might be having in the aggregates the kind of [pattern] Chuck Partee
was stressing on the behavior of consumer spending, where we have very
rapid declines and then a bounceback. So with the abandonment of the
special credit restraint program, the aggregates may have taken off
more than they ordinarily would have. If that is the case, we might
have to come down a little more on interest rates in order to keep the
aggregates on target. Therefore, I would be inclined to drop the
lower end to about 7-1/2 percent.
CHAIRMAN VOLCKER.

Governor Wallich.

MR. WALLICH. I want to second John Balles for many of the
same reasons [he cited].
When we talked about the recession some
months ago, it was frequently said that we shouldn't be too tight

because of the danger that we might overshoot on the low end. Now we
see that it's likely, although not certain, that this will be a milder
recession than anticipated. And that doesn't give me any reason for
wanting to go on a more expansionary course. I don't see much
achieved by the recession so far. There have been no great changes in
expectations. It may well be that a few years from now we will look
at this experience as something that was unnecessary because it didn't
produce anything except a resumption of inflation from a new higher
plateau into new and higher levels. I think we're in some [danger] of
concluding that because it's reasonable to expect the recovery to be
slow we therefore ought to be relatively easy now. If we are
relatively easy now, we will be prejudicing our policy next year
toward being still easier, precisely because the recovery is likely to
be slow. Finally, as I look at our policy for next year, if we take
the hypothetical assumption that we go for the midpoint of the ranges
that we've now supplied, which are 1/2 percentage point below this

-33-

8/12/80

year's ranges, that will mean a drastic reduction in the rate of money
growth in early 1981. For instance, on M-1A the range is 3 to 5-1/2
percent. So presumably we would have to shift to somewhere close to
the midpoint of that from what on the present course is [growth of]
7-1/2 percent from the second to the fourth quarter of this year if we
go with alternative A. If we go with alternative B, we will be
shifting to the midpoint of 3 to 5-1/2 percent, or about 4-1/2
percent, from the 6-1/4 percent rate B implied for QII to QIV of 1980.
If we look at M-1B a similar picture prevails; the midpoint of its
range of 3-1/2 to 6 percent is 4-3/4 percent. And we would have to
shift to that from 9-1/4 percent [growth] on "A" or 8-1/4 percent on
"B." These could be some very drastic changes in course, if we really
were to stick by our policy when the economy begins to turn around. I
would rather minimize the degree of change that we have to introduce-not go down so far with interest rates now and not have to change
their direction so drastically, or else abandon the proposed targets.
That is why I would go with "B."
CHAIRMAN VOLCKER.

Governor Gramley.

MR. GRAMLEY. Mr. Chairman, I probably am as optimistic as
almost anybody around the table about the prospects for the end of the
recession in the near term, but it is still a forecast. And there is
absolutely nothing in the statistics yet that suggests that a turn has
occurred. We all agree, I think, that the recovery next year is going
to be quite weak. I don't see any reason at all, therefore, to let
interest rates go up at the present time. I don't mind staying where
we are. I don't know if interest rates need to go down to shorten the
recession but I certainly don't think we need to knock the [economy]
in the head once more and make sure we have killed inflationary
expectations. I just don't think that's a feasible course. We have
to remember that the staff is forecasting a recovery so weak that
unemployment does not go down at all. I think that's as weak a
recovery as we need. I agree with Governor Schultz completely in that
respect. But if the recovery is so weak that unemployment continues
to rise, then I don't think we're following a policy that we can stick
with over the long run. That's the only way we can deal with this
problem: To look at it as a very, very long-run problem and a longterm commitment [on our part] to try to bring inflation down. So, I
am quite prepared to go with your suggestion of alternative A. I
would wonder, if we go in that direction, if we shouldn't do something
about taking M2 out [as an operational variable] because if M2 keeps
going up as rapidly as it has been, we might end up having to turn the
screws to push interest rates up. And that may not be what we want to
do.
CHAIRMAN VOLCKER.
SPEAKER(?).

What did M2 do in the last month?

It grew at a 17 percent rate.

VICE CHAIRMAN SOLOMON.
taking M2 out.
MR. GRAMLEY.
with M-1A and M-1B and
three are mentioned in
its target level, then
M-1A and M-1B did not.

I don't understand what Lyle means by

In the directive we have targets for M2 along
we're giving the same weight to the three; all
the directive as such. So if M2 were to exceed
we would begin to tighten up again, even if

-34-

8/12/80

VICE CHAIRMAN SOLOMON. Well, from what I understand, the way
the staff calculates the reserve paths, it is basically a qualitative
correction of a path constructed primarily on M-1. If M2 is moving up
very rapidly, it's not given equal weight by any means.
MR. PARTEE.

It doesn't have much arithmetic effect, I agree,

Tony.
CHAIRMAN VOLCKER. Well, it may; the only effect it can have
is if we change the path on the basis of [its behavior].
MR. WALLICH. If we eliminate those aggregates that misbehave
in our view, what kind of credibility do we have?
VICE CHAIRMAN SOLOMON. We're still left with the fact that
at the end of the year the public and the Congress are going to see
what the behavior of M2 was in relation to the targets.
MR. GRAMLEY. They will probably also see that M-1A is at the
lower end of that chart.
CHAIRMAN VOLCKER.

Governor Partee.

MR. PARTEE. As a well-known Washington philosopher a few
"If the thing ain't broke, don't fix
years ago was fond of saying:
it."
I don't think the thing is broke here. It seems to me [the
aggregates] have been moving rather nicely along their path with an
interest rate performance that was, if not pleasing, at least
acceptable to almost everybody after that abysmal April break in the
numbers. And as you said, Mr. Chairman, a continuation of our earlier
statement [regarding our objectives for the quarter], particularly in
terms of the profile for M-1A but to a large degree for M-1B, would be
alternative A. It seems to me that that's the path we have and it's
working quite fine. So I would certainly [support] that. I do
believe that there will be a tolerance in the society as a whole,
though not in Washington, of higher interest rates if we can say:
"Look, we've had a big rise in the aggregates so we've got to resist
But if we have higher
that rise because that will bring inflation."
interest rates because we're fiddling around with a path that we
earlier specified with the Congress--and if we're on that path or
would have been on it had we not changed it--there isn't going to be
that tolerance. I think that's a very dangerous game to get involved
in. We may have an explosion in the aggregates; some are forecasting
it. If we do, then we'll raise interest rates. But we may not. And
if we don't, I don't think we have any basis for trying to bias
interest rate movements upward. So I would take "A" for sure.
CHAIRMAN VOLCKER.

Governor Rice.

MR. RICE. Mr. Chairman, I come out very close to the
position that you set forth for the reasons that you did and for the
reasons set forth by Governors Schultz, Gramley, and Partee. I would
simply emphasize that the outlook for the economy is for a slow
recovery--one which will be lackluster and far from robust. It also
looks as if it is going to be interest sensitive because, as has been
noted, the recovery in housing is going to be interest sensitive and
the recovery in investment is probably going to be interest sensitive.
We have to note that under either alternative A or alternative B,

8/12/80

we're likely to see some increase in interest rates. The increase in
interest rates under alternative B will be significantly greater than
under alternative A. And at this point we have to be very careful not
to do anything unnecessarily that would choke off the recovery. It
seems to me distinctly possible that fiddling around [and getting]
interest rates up runs the risk, as Governor Partee suggested, of
choking off the recovery before it begins. So it seems to me that
alternative A is a much [safer] course to take.
CHAIRMAN VOLCKER.

Mr. Eastburn.

MR. EASTBURN. I think it is clear that we have a timing
problem here. It is compounded by the fact that we're in a cycle with
no precedent and we don't really know how to time our action. On the
one hand, Nancy's earlier comment is right that in the discussion
about the business outlook we really are basing our opinions on some
fairly small evidence over a short period of time. That would lead
one to alternative A. On the other hand, Henry's argument has a lot
of [merit] in that we're dealing with an exceptionally difficult
situation and we have the possibility of [substantial] growth in the
aggregates ahead of us. So perhaps we should take this opportunity to
move earlier than we ordinarily would to meet that. Between those two
positions, I come out about in the middle. I'd take "A" and shade it
There is a one point [difference in the growth rates] in
toward "B."
the two alternatives, which is wider than we have quibbled about at
times. I don't think it's quibbling too much to [aim for] something
in the middle. That's what I'd do.
CHAIRMAN VOLCKER.

Mr. Mayo.

MR. MAYO. We are again, I think, magnifying very small
differences. I could be comfortable with either "A" or "B," but I
lean toward "A" basically for the reasons that have already been
stated. As for the recession, everybody is looking for good news now
and I think they have over-emphasized what little good news has been
in the papers. We probably have at least another six months to go
before we get any real positive signs of economic recovery. I would
rather, as the cliche at the moment goes, "keep our powder dry" and
stick with "A." I do not worry at all about the overshoot in M2; in
fact it helps, especially with M-1A coming out at the low end under
It tends to illustrate again the fragile nature of
either "A" or "B."
these figures. It isn't that we should say cavalierly that the
targets aren't worth anything, but let's be practical about it. We
have our own little security blanket here of being at the low end on
M-1A, in the middle on M-1B, and overshooting on M2. So what? It
doesn't bother me. It gives us a beautiful array to illustrate our
point that there is no such thing as the perfect aggregate. I would
also comment that if we narrowed our ranges, which some of our friends
on Capitol Hill wish we would do, it wouldn't solve anything. We
might end up below on M-1A and way over on M2 and be in the same
situation we are now. It wouldn't make us any better hewers to the
line, if I can put it that way. So, I lean toward "A" as the
solution.
CHAIRMAN VOLCKER.

Mr. Solomon.

VICE CHAIRMAN SOLOMON. I hate to disappoint the Washington
Post editorial [staff], but between "A" and "B," I prefer "A" [even

-36-

8/12/80

though I'm a New Yorker].
I have a slight preference for splitting
the difference, as Dave Eastburn suggested, and going with a $75 to
$100 million borrowing assumption. But-MR. PARTEE. When you say split the difference, Tony, do you
mean the July-to-September difference?
VICE CHAIRMAN SOLOMON. Yes, and that would give us for July
to September [6] percent for M-1A, [about] 7-1/2 percent for M-1B, and
9 percent for M2 with, as I say, a $75 or $100 million borrowing
assumption. But if the consensus is for alternative A, I'd go along
with that.
I certainly prefer it to alternative B.
CHAIRMAN VOLCKER.

Mr. Roos.

MR. ROOS.
I have a preference for alternative B.
It's not a
sharp preference, but I base my position on a belief that because of
increased business borrowing and the extent of borrowing by the
government, an increase in interest rates toward the end of this year
is probably inevitable. And if, as I sense, there is a reluctance
among some of us to permit interest rates to rise because that would
be viewed as contributing to cutting off the [recovery]--if indeed one
were to occur--then I would see the prospect of expansionary policies
ahead. So I'd much rather position ourselves in a more restrained
position a la "B" than the other alternative. But I'm not going to
dig in my troops on that particular decision because I don't think
there's that much difference [between the alternatives].
CHAIRMAN VOLCKER.

Governor Teeters.

MS. TEETERS.
I would prefer "A."
For once we don't have to
worry about the international value of the dollar currently, which is
somewhat of a relief.
CHAIRMAN VOLCKER.

Wait a week.

MS. TEETERS. Yes, I know that. Given that, we seem to be on
a pretty steady course and we're getting where we want to go with it.
It seems unconscionable to raise interest rates when the economy is
still going down--and I don't think anybody expects the third quarter
to be a positive number on real growth. I would say if we are going
to have to raise interest rates for international reasons, I certainly
would like to save the room and do it at a later date. So I would
come out in support of "A" and just leave [the path] the way it is at
the present time.
VICE CHAIRMAN SOLOMON. I don't think there has been much-let me use the word "distortion"--in domestic monetary policy by
international considerations in the time that I've been on the FOMC.
There have been some considerations of timing, maybe a 1/2 point
difference from time to time on the low end of the fed funds range.
It hasn't been very significant.
CHAIRMAN VOLCKER. The position I've taken publicly, in the
sense of responding to Congressional inquiries, is that it was a
consideration in the background and tended to parallel the more
important considerations of what we had domestically.
[For example],
we didn't press for as quick a makeup of the shortfall in the money

8/12/80

-37-

supply as we theoretically could have. That was not a decision based
just on international grounds, although that happened to be an
ingredient in that decision.
MR. SCHULTZ. I think the Congressional comment was that he'd
make a very good prisoner of war because he'd tell the enemy-CHAIRMAN VOLCKER.

I think [my statement] is also true.

Mr.

Winn.
MR. WINN. I am a bit on the fence. I guess I'd join those
who favor splitting [the difference] in terms of the target set-up.
I'm a little confused, as I listen to the conversation, as to whether
we're following our resolve to try to target the aggregates or whether
we're back on an interest rate course. It seems to me that we've all
based this [analysis] on a projection of growth in the aggregates that
may or may not occur. If it doesn't, then it seems to me that we have
some responsibility to get the path back up and let the [funds] rate
hit the bottom. If the aggregates explode, it seems to me that we
have to face the interest rate problem right now. And we will have
deferred it. I've been around this table for some time, and I've seen
us drag our feet time after time and then get caught in a real
squeeze. I'd rather face it now if this explosive problem-CHAIRMAN VOLCKER. You are saying, I think, that the question
to debate now is between assuming that the aggregates are going to
explode and biasing the decision upward-MR. WINN. No, I wouldn't bias it upward. I'd wait and see
what happens. But if the aggregates explode, it seems to me we'd have
to face it.
CHAIRMAN VOLCKER. Well, I didn't hear anybody saying
anything different, but I agree the temptation historically has been
not to do anything about it. Mr. Ford.
MR. FORD. Well, as one of the novices here, I must say I am
very relieved by the narrow range and the bias of the two alternatives
before us in that I see no danger that the markets-CHAIRMAN VOLCKER.
alternatives.

You are not necessarily confined to those

MR. FORD. I may choose at some future date to suggest a
third. But I like the way the alternatives have been structured here
because whichever way we go with this decision there seems to me no
danger that we'll be reading in the newspaper--even without a leak but
after due time when we release the [record]--that we biased ourselves
toward getting off the path that we set last October. We will
probably not be accused of loosening monetary policy based on limited
information of a recovery, and so on. So either way we go, I think
this decision can be viewed in the marketplace as a reasonable one.
With regard to the arguments on whether we should make this minor
adjustment toward tightness, [as in] "B," I am persuaded by [several]
things. First of all, I've seen virtually no evidence of price
softening, which is what the name of the game is supposed to be as I
understand it.
[Our goal is] to promote a view in the world which
says that we're determined to wring inflation out of the economy. And

-38-

8/12/80

the facts as I have heard them and see them are that we're not seeing
that price relief yet. The second argument that persuades me is the
one that Mr. Wallich made, assuming he is correct about the course of
the aggregates and that we will have to crank down the numbers later.
For smoothing reasons, I find it rather persuasive to think ahead and
to try to avoid the need to bring the aggregates down later at a time
that may inopportune. Also, with the limited evidence we have that
the aggregates may be expanding in the next few days, I would lean,
along with the rest of the splitters, toward "B."
MR. ROOS.

It's nice to have you aboard.

CHAIRMAN VOLCKER.
MR. MORRIS.

Mr. Morris.

I would support "A."

MR. BAUGHMAN. Mr. Chairman, I would be inclined toward "B."
We see the economy essentially as the staff has in its outlook, with
the exception of the strength in interest rates. I am inclined to view
the strength we see in interest rates as temporarily greater than
justified by what is happening in the economy. So I think there may
be a softening rather than a continued rise in interest rates. The
[behavior of] inflation, as has been mentioned, is critical. There
has been no reference to the presumably substantial additional thrust
to prices that is going to flow from the food sector. I think it's
going to be very difficult to keep that from simply passing through,
as our policies over a period of years have permitted energy prices to
pass through and raise prices generally through the economy. I think
it would take pretty substantial restraint to keep that from happening
again, in this instance flowing from food. Also, I am inclined to
think that we're seeing a rather rapid buildup in liquidity in the
economy, whether it appears in the particular measures we call money
or in other measures. In this inflationary environment, it's entirely
possible that people will behave with less money the way they normally
would behave with more money. So I think "B" would be the preferable
posture right now.

CHAIRMAN VOLCKER.

Mr. Corrigan.

MR. CORRIGAN. Mr. Chairman, I am very comfortable with "A"
at this time. I say "at this time" because I am inclined to the view
that the near-term risks on the aggregates are probably on the up
side. I am willing to wait and see what happens. But if in fact that
strength in the aggregates were to materialize, a lot of this debate
about rates would be academic because the mere fact of that strength
would quickly reflect itself in higher interest rates in the
marketplace in any event. If that too were to occur, we would be a
lot closer to the kinds of real dilemmas we were talking about
earlier, which were very well captured in Governor Wallich's comments
about the task of getting back to where we want to be for 1981. So, I
think "A" is fine for now, but if indeed the aggregates do run strong,
we're going to to have a dilemma immediately in front of us. All of
this underscores to me the point that somehow, somewhere, we have to
get help from other elements of public policy in this [fight against]
inflation. And I just don't see that coming. I'm not sure how or
where we get it.
CHAIRMAN VOLCKER.

Mr. Czerwinski.

-39-

8/12/80

MR. CZERWINSKI. Mr. Chairman, it is our view that
alternative B might result in a more rapid run-up in interest rates
than might be desirable. On the other hand, alternative A would push
M2 above the top of its range, which might not be desirable from a
perception standpoint, particularly with all the attention being given
lately to the ranges established by the Committee. So for those
reasons, we would tend to favor the ranges that were suggested by
President Solomon, [about] 6 percent for M-1A, around 7-1/2 percent
for M-1B, and about 9 percent for M2.
CHAIRMAN VOLCKER. Well, there seems to be a good deal of
agreement around the table. I think what really happens between now
and the next meeting is going to be determined, by everybody's
specifications, by what happens to the aggregates. And since that
range of uncertainty is much greater than the one percentage point
difference between these figures [for the quarter], that is the
perspective in which I would view this, as many people already have.
My main concern is that we not bias this. The bias is more in the
borrowing level that we start with than in the difference between "A"
and "B."
Actually, the difference between "A" and "B" is more than
one percentage point for the remainder of the quarter; it's 1-1/2
percentage points. Considering the lags and all the rest, we don't
have a lot of room for changing this between now and the end of the
quarter. The predominant view is clearly "A," but there was some
sentiment for "B," obviously, and some people were willing--and maybe
prepared--to go in between. I suppose the practical choice is whether
[or not] we go with A. If we did, I would be inclined to put the
federal funds rate range at 8 to 13 percent if we want the [width of
the range to be] 5 percentage points. It's 5-1/2 points now, but we
could [set it at] 8 to 13 or 8 to 14 or 8 to 13-1/2 percent. So let
me assume something like that for the moment.
MR. ROOS.

Wouldn't that have a perceptions effect?

CHAIRMAN VOLCKER. Well, I've thought about that. I am not
sure it's going to have much effect because it will come out a month
[The funds rate] either will have been
[or so after this meeting].
there or not have been there. I don't know; I may be wrong. I have
thought about it and I am not sure it will have one because of the
delay in the release of the record. I think it would have an effect
if we were announcing this today. What do you think, Peter?
MR. STERNLIGHT. Well, it's true that you won't announce this
today. You will be announcing in a few days that at the July meeting
the funds range was 8-1/2 to 14 percent. So if the market should see
the Desk being more accommodative--if the numbers worked out that way
--and funds were trading in the 8 to 8-1/2 percent range, then I think
they would get the idea before [the new range is released.], perhaps
even in the next-CHAIRMAN VOLCKER. If the funds rate works out that way, I
agree. But it won't work out that way, presumably, unless the money
supply is also running pretty low.
MR. RICE.

What's the advantage of narrowing the range?

CHAIRMAN VOLCKER.
wanted to lower it.

My purpose is not to narrow it; I just

8/12/80

-40-

MR. PARTEE.
the width 6 points?

Why don't we make it 8 to 14 percent and make

MR. SCHULTZ.
I think 8 to 14 percent looks better; that
leaves the top of the range at the same place.
MR. PARTEE.

[The top of the range] doesn't seem operational.

MR. SCHULTZ.
MS. TEETERS.
these specifications?

I think that would be important.
What do you expect the funds rate to be with
You expect it to be around 10 percent, right?

MR. STERNLIGHT. With borrowing averaging $100 million, I'd
expect it to be a little more often below 10 percent than above,
perhaps in a range of 9 to 10-1/4 percent.
MS. TEETERS.
So that's basically an increase in the rates
over the month from where they are now.
CHAIRMAN VOLCKER. If you want 8 to 14 percent, that wouldn't
bother me. Just to complete this, I would start off the borrowings at
maybe $75 million--I'm thinking of the federal funds rate at around 9
percent or a little more, perhaps 9 to 9-1/2 percent now--if that's
the [borrowing] number that's consistent with that [level of the funds
rate].
We are just talking about the first week here really, but I'd
be inclined to say $75 million. Let me just test the sentiment and
see whether this in-between [number is acceptable].
The intention is
to put the quarterly figure in the directive now?
SPEAKER(?).

Yes.

CHAIRMAN VOLCKER. So we are really talking about the top
part of this [Bluebook] table if we assume that.
And that's probably
the safest thing. If we went halfway, the rates would be 6-1/2,
8-3/4, and 11-3/4 percent, if I calculated correctly. Now, that makes
a bigger difference for the remaining part of the quarter, but those
are the numbers that would appear in the directive. As I said, there
was a clear majority for "A."
Let's see whether people are happier
with the halfway between numbers.
MR. ETTIN. Mr. Chairman, [some of] those who talked about
splitting the difference were talking about the numbers for July to
September. Just arithmetically, if you do it for the June-toSeptember figures, you are biasing the numbers a little tighter for
the remaining two months of the quarter.
CHAIRMAN VOLCKER.
directive, right?
MR. ETTIN.

June to September is what appears in the

Yes.

CHAIRMAN VOLCKER. Presumably, it means the difference for
the July-to-September figure is halfway in between, too, doesn't it?
Isn't that correct arithmetically?
It's just a bigger distance in
between, in effect.

-41-

8/12/80

MR. ETTIN. Yes, but given the fact that July itself was
stronger for each of the aggregates than the targets adopted the last
time-CHAIRMAN VOLCKER. But don't we get the right July-toSeptember numbers if we average those numbers in the table below?
I don't think so.

MR. ETTIN.
MR. PARTEE.

I would think so.

CHAIRMAN VOLCKER.
MR. PARTEE.

Did we publish June to September last time?

CHAIRMAN VOLCKER.
for July to September].
MR. ETTIN.
MR. MAYO.

What we would have is 6 percent

[for M-1A

We'll publish it in a few days.
What we did before was 7, 8, and 8 percent.

CHAIRMAN VOLCKER.
MR. PARTEE.

It isn't immediately obvious to me.

For the quarterly figure, right?

For the third quarter.

MS. TEETERS. If we took the midway point, what would you
expect to happen to the funds rate?
CHAIRMAN VOLCKER. Well, it biases [the funds rate] a bit
I am saying we don't bias it at all
toward rising subsequently.
initially. But in practice what it says, just looking at M-1A--if the
arithmetic is correct--that we have an objective of 6 percent growth
from now to the end of the quarter instead of 6-3/4 percent [under
"A"].

VICE CHAIRMAN SOLOMON. But if we assume only $75 million in
borrowing, we are going to be supplying more reserves.
CHAIRMAN VOLCKER.
MR. PARTEE.

For the first period, that's right.

$25 million more.

CHAIRMAN VOLCKER. What we are looking at in practice is that
if the $3 billion figure holds up for this week--I don't know whether
it will--it will depend to some degree upon the projections
thereafter. We will get a preliminary figure for the week after. But
if the $3 billion held up and there wasn't any reason to think it was
going to be reversed immediately, we would presumably have a higher
borrowing level a couple of weeks from now. And your straightforward
projection of "A" even implies a slight increase in interest rates,
you believe.
MR. ETTIN.

In my view, yes.

CHAIRMAN VOLCKER. Those estimates are obviously unreliable,
but even [a forecast of] an ordinary figure for next week is
unreliable. These figures have been jumping all over the place. But

-42-

8/12/80

if [the estimate] held up, whatever path we set now is likely to imply
more borrowings. That's one of the reasons I don't want to set the
path so we get an increase now and then automatically get an increase
two weeks from now. That, I think, is [moving] too strongly.
MR. STERNLIGHT. Mr. Chairman, if that estimated $3 billion
increase [in M-1A] holds up, I don't think anything would flow
automatically from that in terms of raising the borrowing because we
would build the paths assuming that $3 billion.
CHAIRMAN VOLCKER. It depends.
Right now the $3 billion, as
I see it, depends upon your projection-MR. STERNLIGHT.

Yes.

CHAIRMAN VOLCKER. If the $3 billion is a harbinger of [M-1A]
running high, it's going to affect [borrowing].
We can technically
allow for that if your subsequent projections say no [it will not run
high].
But presumably you would want to allow for [an increase in
borrowing] if the next preliminary figure is another $3 billion or so.
There's an element of judgment here. You can wash it out completely
if you think it's of no significance. But in the path-VICE CHAIRMAN SOLOMON. I have no reason to assume that our
[estimate] is any more correct than Ed's, but our calculation is that
alternative A does not involve even a slight increase in interest
rates. It might involve a slight decrease in interest rates,
depending upon the assumption.
CHAIRMAN VOLCKER. Well, we're saying interest rates. What I
am talking about is the federal funds rate. I am not sure that the
other rates aren't too high relative to the federal funds rate right
at the moment. So if it worked out that we didn't get an increase in
the federal funds rate, the other rates might come down again. We are
talking now about expectations among other things.
What we are
talking about operationally, just to repeat it, is that if we went
halfway in between, that involves knocking three quarters of a
percentage point off the growth objective for the period between now
and the end of September. And there's no assurance about that; we
never come out that close. We are not going to have a 3/4 percentage
point difference in any measurable way. What we will have is a
somewhat higher level of borrowing and, therefore, a somewhat higher
level of the federal funds rate however the aggregates finally come
out. So the bias--well, bias may not be the right word. It sets up
an increased probability of a somewhat higher federal funds rate,
obviously, the more we reduce the aggregate numbers.
VICE CHAIRMAN SOLOMON.
CHAIRMAN VOLCKER.

As contrasted to alternative A.

Yes, as contrasted to alternative A.

VICE CHAIRMAN SOLOMON.
I think we are trying to walk a
balance here because we don't want a perception in the markets that
there has been a shift in policy.
If it does work out that the fed
funds rate is at the floor--that we have to move toward the 8 percent
floor--which I would be willing to live with, particularly combined
with the intermediate target between "A" and "B," we would be flirting
a little with a possible adverse reaction in the long market.
There

-43-

8/12/80

If we go for alternative
could be a perception of a definite easing.
A, we might be well advised to keep the funds floor where it is.
MR. WALLICH. There has been a great deal of discussion of
that abroad, a great deal of exploration of that in the market and an
So, I think if they smoked out that we
interpretation of our actions.
are willing to let the funds rate go to 8 percent on average, that
would be regarded as a clear signal that we have eased.
MR. PARTEE.
aggregates.

It would be associated with weak growth in the

MR. WALLICH. Well, if they understood the process correctly.
But since they always look at the interest rate anyway-VICE CHAIRMAN SOLOMON. I would rather [not] lower the floor
to 8 percent, Chuck, if we [went with] the compromise.
MR. PARTEE.
either way.

It's such a small issue that I am prepared to go

CHAIRMAN VOLCKER. It's a question of which way the
I'll put them both to a vote for preferences. Let me
preference is.
take the compromise first with an 8 percent floor in this case and an
initial borrowing assumption, let's say, of $75 million. We'll take
all of the decisions on the easy side and go.
MS. TEETERS.

Are they consistent?

CHAIRMAN VOLCKER.
MR. GRAMLEY.
MR. PARTEE.

"A minus."
This is "A minus" or "B plus."

What's the alternative?

CHAIRMAN VOLCKER.
MS. TEETERS.

Who knows?

What goes with this--"A" or "A minus"?

CHAIRMAN VOLCKER.
MR. GRAMLEY.

Well, anything is consistent.

"A."

On "A" would you drop the floor to 8 percent,

too?
CHAIRMAN VOLCKER. There may be a little argument about that.
Let me put it this way, just so you have
I'd be willing to, but--.
two choices in front of you. One is 8 to 14 percent and $75 million
not interpreted too closely--we're only talking about a $25 million
That's
difference here--with the numbers halfway between "A" and "B."
one choice.
MR. ALTMANN.
MR. PARTEE.

On June to September?
It's the same either way.

CHAIRMAN VOLCKER. It's the same, assuming the arithmetic
It involves different numbers, but the numbers
translation is right.

-44-

8/12/80

are halfway between those in "A" and "B."
let me say.
MR. PARTEE.

That against "A" straight,

With 8-1/2 to 14 percent.

Those are our two

choices.
CHAIRMAN VOLCKER.
MR. SCHULTZ.

That and $100 million of borrowing.

It's not a big difference, is it?

CHAIRMAN VOLCKER.

No.

MR. MORRIS.
I find it hard to understand why we have a more
liberal funds range with a more restrictive monetary growth rate.
CHAIRMAN VOLCKER. Well, it looks a little funny. The
argument is Tony's here, in that he doesn't want to take too much risk
of the funds rate going too much lower.
So the more we risk it on one
side, the more he wants to block out the risk on the other side.
MR. PARTEE. Where are all these people who thought there was
going to be explosive growth in the aggregates?
I guess they are not
represented.
CHAIRMAN VOLCKER.
likely to be up than down.

My gut feeling is that
But that's a feeling.

[growth]

is more

VICE CHAIRMAN SOLOMON. But we never know. So if we are
going to be perceived as planning our targets on M-1B, and M2 to some
degree, I think it makes some sense to be a little cautious.
CHAIRMAN VOLCKER.
understand them?

Let's take those two choices.

Do you

MR. WALLICH. It's 8 percent and $75 million on the one and
8-1/2 percent and $100 million on the other. We are not offered
anything "better" than that?
CHAIRMAN VOLCKER. What can be better than these wonderful
options?
As a matter of pure preference, it's likely to be 50/50,
but let me just try. The first one is the halfway in between with the
adjustments that I suggested.
SPEAKER(?).
MR. ALTMANN.

Voting members only?
Voting members, please.

Five.

CHAIRMAN VOLCKER. That leaves me with straight "A."
I'd
like a show of hands to see if everybody is voting. That's five.
didn't vote. Who else didn't vote?
MR. WALLICH.

I

I didn't vote.

CHAIRMAN VOLCKER. Well, that's what I was afraid of.
have exactly [half who voted for each].

We

MR. PARTEE. Do you want to try a straight "A" with 8 to 14
percent and $75 million?

-45-

8/12/80

CHAIRMAN VOLCKER. Well, in some sense that's more liberal
than either. What about that one? The trouble is we are going to get
It seems as if these two
more intense feelings the other way, too.
choices are going to maximize the vote, and I suspect there is a lot
of indifference between them.
MR. PARTEE.
MS. TEETERS.

Why don't you try "can live with" on "A"?
We could [all probably]

live with either one of

them.
CHAIRMAN VOLCKER.

I suspect everybody could live with either

one.
MR. PARTEE.

Then you can state your preference.

CHAIRMAN VOLCKER.
preference.
MR. GRAMLEY.

Yes, I guess it comes really down to my

We're giving the Chairman unlimited power!

CHAIRMAN VOLCKER. Oh, I guess I'd go with the "B plus" or "A
minus" one, whatever you want to call it.
MS. TEETERS.
specification?

Is it possible to get that sort of peculiar

MR. PARTEE.

Sure.

MR. MORRIS.

The Committee can specify anything.

MS. TEETERS.

I know, but I'd like to know if it works or

not.
CHAIRMAN VOLCKER. Well, in fact, we are expecting the funds
rate to fall well within the [range].
MR. PARTEE. Yes, we're just lowering the lower limit on the
funds range; we may not use it at all.
MS. TEETERS. Yes, but the way we are setting the policy is
to bias the funds rate up.
MR. PARTEE.

Well, it has plenty of room to go to 14 percent.

MR. MORRIS.

But we are starting with

[borrowing of] only $75

million.
CHAIRMAN VOLCKER. The Secretary points out to me, and he's
probably right in one sense, that if we go halfway in between, we will
have fractions that we have never used before for quarterly growth
rates.
MR. SCHULTZ. Take them up one quarter point toward "A" and
that will take care of everybody!
MR. PARTEE. Yes, except for the M-1A figure, which we could
leave [at the precise average] of 6-1/2 percent.

-46-

8/12/80

CHAIRMAN VOLCKER. Maybe that is the way to do it.
Let me
try to modify this again. This comes a little closer to "A," I guess.
What would be in the directive is 6-1/2, 9, and 12 percent.
I think
that does look a little better somehow.
MR. ALTMANN.

That's for June to September.

CHAIRMAN VOLCKER.
directive.
MS. TEETERS.

Yes, that's what would appear in the

Again, are those consistent relationships?

CHAIRMAN VOLCKER. Look, the staff projection of a consistent
relationship has been off by 2 percentage points, I think.
MR. SCHULTZ.

The staff takes an awful beating!

CHAIRMAN VOLCKER.
I don't say that in any way as criticism
of the staff but only of the reality of the uncertainty inherent in
these numbers and the idea that we could project down to the quarter
That may be a better [formulation] anyway. Why
percentage point.
6-1/2, 9, and 12 percent in the directive.
don't we vote on that:
MS. TEETERS.

And the funds range is what--8 to 14 percent?

CHAIRMAN VOLCKER.
MS. TEETERS.

Yes.

And what about borrowing?

CHAIRMAN VOLCKER. We can put $75 to $100 million in there.
If you want to say $75 million, that's fine with me. Whatever you
say. When the staff makes that great judgment about how to handle the
$3 billion bulge that appears next week, it will be more important
than whether we have a borrowing assumption of $75 or $100 million,
but I think we've given the staff a tone with which to approach this
that they understand.
VICE CHAIRMAN SOLOMON.
If I had a different last name, I'd
tell you it was truly Solomonic!
CHAIRMAN VOLCKER.
voting on?

Does everyone understand what we are

MR. ALTMANN.
Chairman Volcker
Vice Chairman Solomon
Governor Gramley
President Morris
Governor Partee
Governor Rice
President Roos
Governor Schultz
Governor Teeters
Governor Wallich
President Winn
President Balles
SPEAKER(?).

Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes

I think you ought to congratulate Henry.

8/12/80

-47-

CHAIRMAN VOLCKER. Governor Wallich will have a concurring
statement.
September 16 is the date of the next meeting and we will
discuss the future calendar at that meeting on the basis of some
memorandum I will send you before then.
END OF MEETING