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Notes for FOMC Meeting
August 14, 1979
Scott E. Pardee
In the first two weeks following the last FOMC meeting, the dollar came under
repeated bouts of selling pressure, as the exchange market reacted negatively, first to the
delay of President Carter's energy address, then to the address itself, then to the
resignation of his cabinet, then to the list of names of those who were asked not to stay
on, and then to statements by Treasury Secretary designate Miller and by President Carter
effectively ruling out a new program to help the dollar. During that stretch, which was
not seen so much as one of economic crisis as a crisis in leadership, the U. S. authorities
acted vigorously to stave off what could have been a real rout for the dollar. On behalf of
the Federal Reserve and the Treasury the Desk intervened extremely forcefully in the
market, virtually around the clock, selling $2.5 billion of marks, of which $1.1 billion
was in the Far East. In addition, the Federal Reserve raised the discount rate and the
Federal funds rate on July 19. These actions helped, and the pressures on the dollar lifted
in late July, particularly after Mr. Volcker was named the next Chairman of the Federal
Reserve. It's fair to say that not only was Chairman Volcker's appointment welcomed in
the market, but so were the things he said in press conferences and at the Senate
confirmation hearings on curbing inflation, on the need for a stable dollar, and on
maintaining the independence of the Federal Reserve.
Dollar rates were somewhat firmer in very quiet trading in early August, and we
did not intervene again for ten trading days. Selling pressure emerged again last Friday,
however, following poor producer price figures for the United States. We sold $250
million of marks, split evenly between the System and the Treasury. The dollar has
firmed somewhat yesterday and today, which helped calm the market again.
Even though the selling pressures have eased off in August, we have seen little
reflux of funds back into the dollar. Almost everyone we talk to outlines a pretty bleak
scenario for the dollar, reflecting varying degrees of disgruntlement over the performance
of the President, over the attitudes of members of the White House staff, over what many
consider the inability of the Administration to shape a coherent economic policy and get
it through Congress, and over what appears to be the continuing chaotic state of energy
policy. This is intensely personal stuff and yet it becomes translated into an
unwillingness to believe that the dollar is going anywhere but down.
Before the November 1 program last fall, I characterized the shift in the market's
mood from one of skepticism to one of cynicism, and I'm afraid that cynicism is
surfacing again. It is reinforced this time by the market's belief that European central
banks, and in particular the Bundesbank, are not prepared to buck heavy selling pressures
on the dollar. Those countries have also had a heavy jolt of inflation; and the central
banks, through several rounds each of interest rate hikes, have showed that they are
prepared to use monetary policy vigorously to counter the effects of external price rises,

such as the oil price, on their domestic economies. In intervention policy at least, the
Bundesbank has been helpful, with some timely purchases of dollars when the
dollar/mark rate has approached the 1.80 level. Moreover, Bundesbank officials have
not, as yet, uttered a word of complaint about the domestic liquidity effects of our own
heavy sales of marks.
I might add that there is still a great deal of talk in the market of a new package of
measures, to achieve the same kind of dramatic effects of last November 1. People are
not sure, however, what would be in such a package, and some of the pessimism around
reflects the recognition that it would be difficult to put together something credible.
At the same time, some accept the plausibility of a more favorable medium-term
scenario. In this, the economic slowdown here at a time of continuing growth abroad
would lead to a dramatic improvement in the U. S. trade and current accounts. That
turnaround, coupled with continuing monetary restraint here to avoid short-term capital
outflows, could give a strong underpinning to the dollar later this year and in 1980. This
scenario is close to official thinking, but few in the markets are willing to bet on it for the
On operations, we have taken opportunities this month to liquidate some $150
million equivalent of mark swap debt, so that our net increase in drawings on the
Bundesbank amounted to $1,143 million, leaving current drawings at $2,048 million.
Also, we paid off our $32 million of Swiss franc debt to the Swiss National Bank at a
modest profit.

F.O.M.C. Meeting
August 14, 1979

Reporting on open market operations, Mr. Sternlight
made the following statement:
Since the July 11 meeting of the Committee, the
Account Management has encouraged a gradual firming of money
market conditions in response to strengthening aggregates and
a weakening dollar.

For about the first week of the period

the Desk continued to aim for the 10 1/4 percent Federal funds
rate that was sought since late April.

By July 20, with Board

staff estimates suggesting monetary growth at or slightly above
the tops of the Committee's ranges, and the dollar faltering
amid uncertainties about U.S. energy policy and shifts in key
cabinet positions, the Desk began, after Committee discussion,
to seek a funds rate around 10 1/2 percent, the top of the
range adopted at the July meeting.

The move coincided with

the announcement of a 1/2 percent increase in the discount rate,
to 10 percent.

Initially, to give greater force to the move

and be as helpful as possible to the dollar, the Desk sought
a "relatively firm" 10 1/2 percent funds rate.

A week later,

July 27, estimates of aggregate growth had strengthened somewhat
further, while the dollar had steadied partly in reaction to
news of Mr. Volcker's nomination as Chairman.

In view of the

strong aggregates, the Committee voted to raise the upper limit

of the funds range to 10 3/4 percent, instructing the Manager
to aim in a 10 1/2 - 10 3/4 percent range, depending on further
developments with the aggregates and with the dollar.
then began seeking a funds rate around 10 5/8 percent.

The Desk
The next

bit of data on the aggregates appeared a trifle weaker, while
the dollar was holding its own and the objective accordingly
remained at 10 5/8 percent into the first full week of August.
By last Friday, however, the latest information on aggregates
was slightly stronger again while the dollar was once more under
pressure following publication of a bad price number for July.
Accordingly, the Desk adjusted its objective slightly further
to aim for a funds rate of 10 5/8 percent or a shade higher.
In practice, the funds rate often tended to exceed
the Desk's objective, in part because of fairly persistent
shortages of securities available for repurchase agreements.
Also, in a period of gradual firming there was some tendency
for market participants to overanticipate, and carry the firming
a bit beyond the Desk's intention of the moment.

For the whole

period, the funds rate averaged about 10.62 percent, up 33 basis
points from the previous intermeeting interval.

Before last

Friday's further slight firming move, market participants seemed
to be pretty well agreed that the System's objective was 10 5/8
percent, even though the weekly averages had been coming in a
bit higher.

At present, there is some market uncertainty about

the Desk's objective--where it is and where it is going.


think that the System is already aiming at 10 3/4 percent; others

would place the objective slightly lower but on the way to that
level, or perhaps higher.

Still others are not sure that we

have really changed from 10 5/8 percent.
There were large reserve needs during the period
because of increased required reserves, lower float, lower
holdings of foreign currency, and a decline in member bank

Reserves were supplied through outright purchase

of $850 million of Treasury bills in the market the day of the
last meeting, net purchases of $1,167 million of bills from
foreign accounts, $482 million of agency issues in the market,
and yesterday about $975 million of Treasury coupon issues
for delivery today and tomorrow.

This is a substantial grand

total of roughly $3 1/2 billion in outright purchases, but
this did not violate our intrameeting leeway because it includes
bill purchases on the day of the last meeting, which came under
the previous leeway.

There was also substantial use of repurchase

agreements on most days, and matched sale-purchase transactions
to absorb reserves on a few days.
Most short-term rates rose about 15 to 50 basis points
over the interval, with the larger increases about in line with
the boost in the funds rate.

Treasury bills rose somewhat less

in rate than most other short paper, as bills were in demand
from foreign central banks, and from the Desk for RP collateral.
Three- and six-month bills were auctioned yesterday at average
rates of about 9.50 and 9.48 percent, compared with 9.27 and
9.16 percent shortly before the last meeting.

Rate rises for some Treasury coupon issues maturing
in around a year were as much as 55 basis points, but for 2- to
10-year issues the increases were mainly about 10-30 basis points.
For the longest issues most yields were a more moderate 7 to 10
basis points higher, as some encouragement was taken that the
central bank, under its new leadership, would show strengthened
resolve to combat inflation.

This view also helped elicit a

good response to the Treasury refunding issues, which in turn
tended to buoy general market sentiment.

In the refunding, the

Treasury raised about $2.4 billion in new money through the sale
of $7 1/4 billion of 3-year, 7 1/2-year, and 30-year issues at
rates of 9.06, 9.00 and 8.91 percent, respectively.

The two

shorter issues soon rose to moderate premiums in secondary
market trading although these gains faded by the end of the
period amid new concern about inflation and the dollar.


long bond, which was bid for after the market had already risen
in price, traded close to issue price for a time, and then slipped
to a discount at the end of the period.

The dealers have made

reasonably good progress in distributing their awards of the new
issues, especially of the long bond.

The System's coupon purchases

yesterday provided a further opportunity to make sales.


dealer holdings of over-one-year issues came down to about $465
million by last Friday, from a high of about $1.1 billion after
the bond auction.

This compares with a net short of about $500

million just before the last meeting.

In coming weeks, new Treasury

financing may well include a 5-year note and a cash management bill
in addition to rollovers of maturing issues.

In recent days we have sought to monitor development
closely in the commercial paper market, to see whether Chrysler's
difficulties are having any impact comparable to the situation
in 1970 when Penn Central's failure caused many investors to
pull away from the paper market.
to the earlier experience.

Today, we see nothing comparable

Chrysler Financial Corp. has had to

repay some $700 million in commercial paper in recent days, and
has drawn on bank lines, but there has been little or no discern-

ible effect on other paper issuers.

No significant change is

reported in rate spreads between top-grade and lesser issuers.

Joseph S. Zeisel
August 14, 1979


Available information continues to suggest a further weakening

of the economy over the balance of this year.

An easing of gas supplies may

currently be permitting some rebound in activities that were constrained by

fuel shortages.

However, the fundamental factors which have been damping

growth all year are still operating to slow overall activity, and the

economy will be digesting the effects of the recent OPEC price hikes for

some time to come.

The major factor in the 3-1/3 percent annual rate decline of real

GNP in the second quarter was the sharp drop in personal consumption


Much of this weakness represented the collapse of large

car sales in response to uncertainties regarding fuel availability.

transitory considerations aside,


the fundamentals underlying consumption

have been weak for some time, particularly real personal income growth.

And the principal forces supporting income gains--production and employment--

show signs of continued deterioration.



Industrial production appears to have edged down further in July

to only fractionally above its level last December.

Last month's decline

reflected a reduction in output of autos and other consumer goods as

well as trucks.

But auto assemblies were still at an 8.8 million rate

in July, down only 3 percent from June, and well in excess of the rate of


Industry schedules have now been trimmed sharply further to a

7.3 million unit rate in August.

Other things being equal, such a cut in

production of autos and parts would have the effect of reducing the industrial

production index from 1/2 - 3/4 percent this month.

As a result of the sluggishness of economic activity, demand for

labor has weakened perceptibly in recent months.

Although the overall

unemployment rate has changed little, nonfarm payroll employment figures

show an increase of only 30,000 jobs in July (strike adjusted), as compared

to an average monthly gain of 160,000 over the second quarter, which itself

was only half the monthly rise during the first quarter.


employment dropped in July for the fourth month in a row to a level 130,000

below its March peak.

With employment conditions weakening and prices continuing up sharply,

real personal income declined in June, for the fifth time in six months, to

- 3 a

level more than 2 percent

below its

December peak.

It is probable that

real personal income dropped again in July.

Moreover, consumer attitudes are reported to have deteriorated

further recently.

Both the Michigan and Conference Board surveys indicate

consumer confidence

to be at the lowest level since the 1974-75


Reflecting these factors, consumer demand has remained sluggish.

Total retail sales increased only four-tenths of 1 percent in July, and although

the figures

retail sales

for May and June were revised up, in real terms last month's

total was about 5-1/2 percent below the year-end level.

The drop in auto sales contributed substantially to this decline.

Demand for cars already had begun to weaken in the April-May period, undoubtedly

largely the result of reduced real income and heavy debt burdens.

shortages developed, unit sales dropped further in June

rate for domestic models, with particular weakness

When fuel

to a 7-1/4 million

among the larger gas guzzlers.

Unit auto sales picked up in July to an 8.1 million rate--probably in response

to price concessions

as well as

increased availability of fuel.

However, this

was still 10 percent below the first quarter sales rate, and well under the rate

of production.

As a result, already large dealers'

cularly for the less fuel-efficient models.

stocks rose further, parti-

- 4 -

In addition to the buildup of unsold cars in dealers' hands,

there was a relatively rapid accumulation of total manufacturers' inventories

through the end of the second quarter.

For the quarter as a whole, manufac-

turers' stocks in book value terms increased at a $36 billion annual rate--

the largest quarterly advance since the third quarter of 1974.

Some of this

may have been the result of disruptions to shipments due to fuel shortages

and protests by independent truckers.

And while inventory ratios generally

are not inordinately high, except for/autos, we expect downward production

adjustments to constrain further stockbuilding, particularly in an environ-

ment of weakening demand.

Of course, the outlook for overall activity depends importantly

on the

performance of capital spending.

Business fixed investment in real

terms fell in the second quarter as shipments of equipment dropped and truck

sales continued the decline that began toward the end of last year.

same time, nonresidential construction put-in-place remained strong.

At the


far as the future is concerned, while orders for capital equipment recovered

some of their previous losses in May and June, the level of such commitments

remained below the spring peak, even in current dollar terms.


business commitments for construction spending also indicate a slackening of

- 5 Homebuilding has held up surprisingly well of late, with private

starts rising by 6 percent in June to a 1.9 million annual rate.

Most of

the recent strength has been in the multifamily sector, reflecting both an

increased number of HUD subsidized units and continued demand for rental

housing--as indicated by the fact that rental vacancy rates

to a record low.

are very close

In contrast, activity in the single-family sector has been

relatively stable in recent months at a level well below last year's rate.

But the demand for these houses



homes to a

March 1975.

apparently has continued

to weaken;

June for both new and existing homes and pushed


months supply at current sales rates,

sales dropped

the stock of unsold

the largest

overhang since

With financial conditions in mortgage markets relatively tight

and mortgage commitments of S&Ls trending down, the outlook continues to be

for reduced housing activity for the remainder of this year.


balance,the staff is still forecasting a decline

for the current quarter, at a bit under 2 percent.

in real GNP

Consumption and business

spending may not be quite as weak as in the second quarter, but inventory

accumulation should be considerably below last quarter's high rate.


continue to forecast comparatively small quarterly declines in real GNP into

6 -


early 1980,

reflecting weakness


in housing, reduced business

outlays for both fixed capital and inventories and quite sluggish consumer



the absence of new fiscal initiatives,

be contributing little

to growth over the next year and a half.

any substantial further shocks,


government spending will


But short of

appears that economic recovery should

next spring as housing activity bottoms out in response to underlying



outlays pick

up and consumer spending begins to recover

as growth in real income resumes.

The projected sluggishness of domestic demand

relative to growth abroad should also be operating to increase the balance on

net exports through the middle of next year.

Overall, however, we are still

forecasting a very modest rise in real output of less than 1 percent during 1980.

In this environment we would expect a considerable weakening of the

demand for labor.

Employment adjustments have been quite small so far, as

evidenced by the stability of the unemployment rate and the sharp declines

in productivity.



industrial employment todrop substantially

over the balance of this year and into early 1980;

should show further modest growth.

the service sectors

We continue to project a rise

in the unemployment rate to close to 7 percent by the end of this year and to

about 8 percent by the close of 1980.

- 7 The price



outlook for

this year remains




of the poor

of productivity, but also reflecting the rapid runup of energy

The rate of increase in consumer prices in June--1 percent--was about

the same as the average earlier



this year, despite an easing of food prices,

the energy component of the CPI posted the largest monthly advance on

record, 5.6 percent.

Energy prices are expected to continue up at a rapid

clip for the balance of the year, since only part of the

rise has as yet passed through domestic markets.

large OPEC price

The sharp July increase of

1.1 percent in producer prices reflected in part a substantial increase in

the price of energy.

But for 1980, we continue

to feel that the combination of weaker

markets, a resumption of productivity growth, and an assumed moderation of

energy price increases will result in some easing of the rate of inflation.

However, the process of getting-inflation under control is likely to be

lengthy, and we are still forecasting a rate of increase in the fixed-weighted

gross business product price index of about 8-1/2 percent in the last quarter

of 1980.

FOMC Briefing
S. H. Axilrod
While the staff has projected a slowing of M-1 growth over the
August-September period compared with the rapid expansion of the previous
four months, the August-September projection remains high relative to the
Committee's longer-run target.

With the funds rate at about the current

level, M-1 growth is projected to be at a 7 percent annual rate, which
translates to about 8 percent after adding back ATS effects.
M-2 growth for the two-month period is

longer-run range.



projected to be high relative to

these projections prove out, M-1

by September

would be in the upper half of its adjusted longer-run range,
the bottom panel of the chart on page 10 of the blue book,

as shown in

and M-2 close

to the upper limit of its longer-run range.
Despite these recent developments,

staff analysis indicates that

the Committee might well hit its longer-ran aggregate targets for 1979
without any further rise of interest rates--indeed with some decline.
But this requires a very substantial deceleration in money growth in the
fourth quarter.

There are two main reasons for expecting this to occur.

One is the continued weakness projected for real economic activity over the
balance of the year.

The second is

the view that the recent build-up in

cash balances--both demand and savings deposits--is in part temporary,
reflecting economic uncertainties

associated with the energy crisis, and

will not last.
A very brief review of money supply developments

since November

may be helpful in evaluating recent and prospective tendencies.


in the fall of last year and continuing through this winter the demand

for M-1 clearly shifted downward relative to income and interest rates,
as compared with part historical experience.

This downward shift followed

the introduction of ATS accounts in November and the coincidental rise

of market


rates stemming

from policy actions in

dollar support program--all of which

connection with the

jolted the public into even greater

recognition of the relatively high cost of idle cash balances,


savings deposits.
The main question at the time was how long would the downward
shift last.

The staff felt that it would be much shorter than the about

two-year downward shift
and ensuing changes
recent downward shift



followed the interest

money technology.

be none in


interpretation is

rather rapidly in


the second quarter


Our quarterly

and there probably

the third--both quarters of negative income velocity of M-1.

Savings deposits at banks,


On superficial analysis,

might seem to be about over already.

econometric model shows no shift

rate peak of 1973-74

made difficult

by the summer energy crisis.

after contracting since last fall,

begin expanding

June and the expansion has continued thus far for three

growth has also been relatively rapid over that period.


developments could reflect mainly a temporary, precautionary response to the
of economic uncertainties,

sudden intensification
And to the


that they do,

demand deposits above current

as noted


they should soon be reversed as

transactions needs and savings deposits

above normal precautionary needs are moved into other higher-yielding
The preceding analysis
of probability the relatively
aggregates projected in

the fall

suggests why with some reasonable degree

high 2-month August-September

the blue book may be

and thus my be consistnt
But after reversal

followed by

with the Committee's

of whatever

ranges for the

slower growth in

part of the recent

cash build-up




is still

demand will be weak
some degree,

highly uncertain

whether underlying money

because the earlier downvard shift re-emerges in

or whether underlying money demand will be strong because

normal historical relationships reassert themselves.

Our staff projections

for the fourth quarter of this year--and incidentally for 1980-assume that a
downward shift in money demand re-emcrges,
earlier this year.

though a less marked one than

Without such a shift the Committee might still

hit the

1979 longer-run target for M-1 after appropriate ATS adjustment and also
its M-2 target, but growth would be in the upper half of the ranges, or
possibly above the upper limit depending in part on near-term interest rate

Thus, failure of a downward demand shift to emerge later

this year could bring into question either the attainability of the

longer-run monetery targets or the viability of the staff'S interest rate
in GNP forecasts.
However that may be,

immediate reasons that

there are still

Committee may wish to consider for adjusting the current two-month AugustSeptember blue

toward-attaining longer-run targets.

This could involve

ment into instructions for guiding the Desk.
advanced for such an approach.

the odds more

book projections for the aggregates to tilt

One is


Three arguments

might be

prudential: when the level of money

in the upper half of the longer-run range,

two-month growth rates might

best be relatively moderate so as to increase the odds of

downward adjust-

achieving that

A second argument relates to possible direct impacts on the economy:

the build-up in cash balances,
inflationary pressures
being spent on

may lead to stronger

though temporary,

than projected because the



end up

goods and services rather than being shifted to other

financial assets.

A third argument relates to

effects on market

continued relatively rapid growth of the aggregates without


of response by the System would further weaken the dollar on exchange markets
and would erode efforts to dampen inflationary psychology domestically.