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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 on Tuesday, August 18, 1964, at 9:30 a.m.

Mr. Martin, Chairman
Mr. Hayes, Vice Chairman



Messrs. Ellis, Bryan, Scanlon, and Deming, Alternate
Members of the Federal Open Market Committee
Messrs. Bopp and Clay, Presidents of the Federal
Reserve Banks of Philadelphia and Kansas City,

Mr. Young, Secretary
Mr. Kenyon, Assistant Secretary

Mr. Broida, Assistant Secretary
Mr. Hackley, General Counsel
Mr. Noyes, Econonist
Messrs. Furth, Garvy, Holland, Jones, Mann, and
Ratchford, Associate Economists
Mr. Coombs, Special Manager, System Open Market
Mr. Molony, Assistant to the Board of Governors
Mr. Cardon, Legislative Counsel, Board of Governors
Messrs. Partee and Williams, Advisers, Division of
Research and Statistics, Board of Governors
Mr. Reynolds, Associate Adviser, Division of
International Finance, Board of Governors
Miss Eaton, General Assistant, Office of the
Secretary, Board of Governors
Mr. Coldwell, First Vice President of the Federal
Reserve Bank of Dallas


Messrs. Eastburn, Taylor, Fossum, and Tow, Vice
Presidents of the Federal Reserve Banks of
Philadelphia, Atlanta, Minneapolis, and
Kansas City, respectively
Mr. Sternlight, Assistant Vice President of the
Federal Reserve Bank of New York
Mr. Meek, Manager, Securities Department, Federal
Reserve Bank of New York
Mr. Stiles, Senior Economist, Federal Reserve
Bank of Chicago
Mr. Arena, Financial Economist, Federal Reserve
Bank of Boston
Upon motion duly made end seconded,
and by unanimous vote, the minutes of the
meeting of the Federal Open Market Com
mittee held on July 28, 1964, were
Under date of July 31, 1964, there had been distributed to the

members of the Federal Open Market Committee copies of the report of
audit of the System Open Market Account and of the report of audit of
foreign currency holdings, both made by the Board's Division of Examina
tions as at the close of business May 22, 1964, and submitted by the
Chief Federal Reserve Examiner under date of June 26, 1964.

Copies of

these reports have been placed in-the files of the Committee.
Upon motion duly made and seconded,
and by unanimous vote, the audit reports
were accepted.
Before this meeting there had been distributed to the members of
the Committee a report from the Special Manager of the System Open Market
Account on foreign exchange market conditions and on Open Market Account
and Treasury operations in foreign currencies for the period July 28
through August 12, 1964, and a supplementary report covering the period


August 13 through August 17, 1964.

Copies of these reports have been

placed in the files of the Committee.
Supplementing the written reports, Mr. Coombs said the gold stock
would remain unchanged again this week.

The Stabilization Fund now had

$188 million on hand, with prospective drains between now and the end of
the month of about $38 million, leaving a prospective month-end balance
of $150 million.

Partly owing to the Viet Nam and Cyprus disturbances,

the Gold Pool had taken in only $6 million so far this month.


Russians had remained out of the market and, if recent reports of a much
improved Russian wheat harvest were borne out, there might be much less
of a windfall from Russian gold sales this coming fall and winter.
The Viet Nam and Cyprus situations had created a certain amount
of tension on the exchange markets, Mr. Coombs said, but with the excep
tion of some buying pressure on the Swiss franc the markets remained in
reasonably good balance.

During this period the New York Bank was, of

course, constantly prepared to intervene against any speculative develop
ment and, as on previous occasions, it consulted with the foreign central
banks as to appropriate tactics.

Meanwhile, market knowledge that the

central banks and governments were working together to maintain stable
market conditions had tended to suppress speculation at its source.
Sterling had become subject to some selling pressure during the
past two days, Mr. Coombs said, after getting through the first two weeks
of the month in good order.

As far as he could tell, the recent selling

pressure seemed to emanate from Germany and France and might reflect



rumors of a further deterioration in British trade figures as well as
expectations that the election date might be announced within the next
week or so.

The Bank of England continued to pursue its tactics of

yielding to pressure on the spot rate and, as in July, this had resulted
in some tendency for the forwards to tighten as the floor level of $2.78
was approached.

The strength of the forward sterling rate was a gratify

ing indication of the underlying strength of market confidence in the
determination of the British Government, backed up if necessary by massive
credits, to maintain the sterling parity.

On the other hand, just as in

July, the tightening of the forward discount as the spot rate declined
might open up an arbitrage margin in favor of London.

Mr. Coombs thought

that if a risk of such arbitrage developed, it might be well to move
into the market again to buy sterling spot and sell it forward with the
objective of forestalling private arbitrage flows.

This was a tricky

operation, since it was necessary to be extremely careful not to exert
undue downward pressure on the forward sterling rate and touch off any

speculative reactions.
In addition to the continuing credit squeeze in Europe, Mr. Coombs
said, some tightening of credit conditions in Canada was now evident.


the past four tenders, the Canadian bill rate had moved steadily up from
3.60 per cent to 3.82 per cent.

Commercial bank liquidity ratios were

down, while rates on U. S. dollar deposits, Canadian dollar deposits,
and finance paper had all tended to move up.

Meanwhile, however, the

forward Canadian dollar had moved from a premium to a discount and, at
the present moment, there was no arbitrage margin favoring Canada on the



bill rate comparison.

On the other hand, he had the impression of

continuing flows of U. S. corporate funds into U. S. dollar deposits at
Canadian banks as well as uncovered placements in Canada by U. S. corpo
rations anticipating investment outlays.
Mr. Coombs commented that at the last meeting he had mentioned
that the dollar holdings of the Swiss National Bank were roughly $200
million above their traditional ceiling of $175 million.

Since that

meeting, a combination of a new Swiss franc bond issued by the Treasury
to the Swiss National Bank and some payoff on maturing Treasury forward
contracts had reduced the surplus dollar holdings of the Swiss National
Bank to about $170 million.
Finally, Mr. Coombs said, the worsening of the U. S. balance of
payments situation had so far gone largely unnoticed on the exchange mar

Although the dollar remained strong, reports of the deterioration

were now beginning to leak out, however, and if the deficit was allowed
to proceed unchecked the situation could become potentially dangerous.
For the past six months or so, the dollar had been riding a wave of
renewed confidence.

Market disillusionment could produce some strong

speculative reactions in the market and greater resistance from the
Continental central banks to accumulating U. S. dollars.
In response to a question by Mr. Hickman, Mr. Coombs said it
might be desirable for the System to buy spot sterling in addition to
any spot purchases made concurrently with forward sales.

If the pound

came under attack and the British authorities chose to defend it, the
System, by stepping into the market itself, could help reinforce



confidence and nip the speculative movement in the bud.

Such operations

might also give the System a freer hand with respect to swaps between
spot and forward sterling.
Mr. Hickman then commented that some Canadian banks were inviting
nonbank corporations in the Fourth District to invest in dollar-denominated
time deposits in Canada at interest rates 15-25 basis points above the
U. S. rate on certificates of deposit.

He asked what, if anything, the

System could dc to alleviate this situation.

Mr. Coombs replied that

Canadian agencies were offering a rate of 4.25 per cent, as compared with
3.9 per cent currently being quoted on CDs by U. S. banks.

In his judg

ment, a rise in the U. S. rate to 4 per cent, the maximum permitted by
Regulation Q, would have little effect on these outflows.

Thus, the

Regulation was limiting the ability of U. S. banks to compete effectively
with Canadian banks for the funds in question.
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the System Open Market transactions in
foreign currencies during the period
July 28 through August 17, 1964, were
approved, ratified, and confirmed.
Mr. Coombs noted that the System had outstanding with the Bank
for International Settlements a $13 million swap of sterling against

Swiss francs, which would mature on September 10.

At the moment he did

not see any possibilities, aside from selling gold to the Swiss, of revers
ing this swap before the next maturity.

Consequently, he requested

Committee approval of its renewal for another three months.

that this would be the fifth renewal of the swap in question.

He noted

Mr. Mitchell asked what the objections were to paying off the
sterling-franc swap with gold.

Mr. Coombs replied that there was a

question of priorities in liquidating various liabilities to the Swiss.
He understood from conversations with them that their main objective
was to reduce their outright dollar holdings.

Accordingly, he thought

they would much prefer to have any gold sales used for this purpose
rather than to close out the sterling-franc swap, which they regarded
simply as a means for moving from one currercy to another.
Mr. Coombs said


In any case,

in his judgment the principle of early reversibility

that the Committee followed did not apply as forcibly to this kind of
transaction as it did to drawings under reciprocal currency arrangements.
Renewal for another three months of
the $13 million swap of sterling against
Swiss francs was approved.
Before this meeting there had been distributed to the members
of the Committee a report from the Manager of the System Open Market
Account covering open market operations in U. S. Government securities
and bankers' acceptances for the period July 28 through August 12, 1964,
and a supplementary report covering the period August 13 through August 17,

Copies of these reports have been placed in the files of the Com

In supplementation of the written reports, Mr. Sternlight
commented as follows:
Financial markets came through the recent three-week
period displaying the underlying stability that has become
customary in the face of crisis or near-crisis developments.
The Treasury's sale of about $4 billion of 18-month notes,
to replace the August 15 maturities not turned in during

last month's advance refunding, proceeded smoothly, and
dealers made further progress in distributing the large hold
ings of bonds taken on during the advance refunding. The
market had a jittery moment or two when news from Cyprus came
closely on the heels of Southeast Asian developments, and
when this was followed up by market advisory letters making
reference to adverse payments developments and possible in
flationary pressures, but no sizable selling was pressed into
the market and a feeling of confidence in current rate levels
has remained.
Indeed, the confidence during the oast three weeks has
been such that dealers have been in no particular hurry to
work down their holdings of longer term issues taken in the
advance refunding. Progress in distributing their holdings
has been most noticeable in the 5-to-C year maturity area
where dealer positions have worked down from over $800 million
after the advance refunding books closed to just under $500
million last Friday. Holdings of over-20 year maturities have
moved down irregularly from about $360 million to around $300
million. Dealers also hold a sizable block of the new 18
month notes that were paid for yesterday--although, of course,
the potential exposure on an issue of this maturity is much
less than in the case of longer term holdings.
As described in the written reports, the condition of
the money market varied from day to day during the past three
weeks, but generally remained within the range of variation
prevailing in recent months. In the early part of the recent
period the money market was fairly comfortable as dealer
financing needs were light and some of the major money market
banks tended to be underinvested. Practically all Federal
funds trading was at 3-1/2 per cent, but the flow was large
and member bank borrowings were modest. As the period pro
gressed and market supplies of securities increased--in good
part reflecting additional bill sales by the Treasury--the
dealers turned with their enlarged financing needs to the
money market banks.
The availability of Federal funds con
tracted and a larger portion of bank reserve needs had to be
met at the discount window, but there were no signs of undue
On balance System operations provided $295 million
reserves during the period, with sizable injections in the
early part of the interval partly offset later on as the
usual midmonth factors came into play. Temporary reserve
needs were met in part through the extensive use of short
term repurchase agreements, while the more lasting reserve
needs were met through outright purchases of both bills and
coupon issues--the latter being undertaken once the books
were closed on the Treasury's note offering.

Treasury bill rates edged a little higher during the
recent period, continuing the upward movement from the low
point touched just before the Treasury's announcement of a $1
billion bill strip on July 20. The rise seems to have reflected
not only the enlargement of supplies offered by the Treasury
but also a let-up in investor demand once the advance refunding
was over and a firmer tendency developed in the money market.
In the period immediately ahead, the bill market may face some
of the sane influences as in the past fw weeks, since the
Treasury plans to raise about $1 billion quite shortly through
the sale of a March tax anticipation bill, while investor
demand may be seasonally light. On the other hand, the large
seasonal reserve needs associated with the month-end and with
Labor Day lie just ahead and presumably the bulk of these
reserves will be supplied through System bill purchases. More
over, it will probably not be long before the continued genera
tion of corporate liquidity injects increased demand for short
term money market instruments.
The markets in corporate and tax-exempt securities have
been uneventful recently--as is usual in the midsummer period.
The small volume of new corporate offerings reaching the market
was fairly aggressively bid for but was taken up rather slowly
by final investors, and dealers have been willing to hold on to
their positions in view of the light calendar. State and local
issues have been in good supply and at one point during the
recent period the dealers' "Blue List" of advertised inventories
worked up above $700 million but underwriter bidding has been
restrained and progress has been made in moving bonds into
investors' hands--in some cases at small price concessions. A
major test faces this market next week with the scheduled sale
of $320 million Columbia Storage Power project bonds.
At the moment, no major Treasury financing operation is
in immediate prospect. As noted above, the Treasury plans to
sell about $1 billion of March tax bills in the near future
and several auctions of tax bills of roughly similar size are
tentatively scheduled for the balance of this year, but opera
tions of this scope should present no problem for the absorptive
powers of the market. The dealers continue, of course, to hold
a sizable block of securities taken in the recent refunding
operations but good progress is being made in distributing these
issues and progress can be expected to continue, barring a
drastic change in the interest rate outlook.
Mr. Mills noted, as background to a question in his mind, that
the Committee had before it a staff draft of a proposed directive of the
conventional type and also a prototype of the kind of directive that



would be used if the Committee adopted the reasoning and the philosophy
that had been set out for further study.

It seemed from the closing

paragraphs of both directives that the Desk was being asked to keep an
attitude which really was tied to the rate of interest.

In supplying

and withdrawing reserves, the Desk would allow some oscillations in
rates, but in the final result it would produce rates approximately at
a level that was predetermined.

His questions were whether in the course

of its operations the Desk was working toward some magnitude of free
reserves, and what emphasis it put on the tone of the market.

His con

cern was based on a feeling that the reactions of dealers and other
participants in the market had been deadened by the nature of operations
over a protracted period of time, and that the consequences of any sud
den change in interest rates resulting from a change in the directive
would be more far-reaching and disturbing than if a freer market was
Mr. Sternlight said that the Desk considered various factors in
association--the tone of the market, statistical measures of reserve
availability, and rough ranges of money market interest rates.

In day

to-day operations the Desk was guided mainly by the aim of maintaining
some level of reserve availability.

It also was attentive to the factors

summed up by the word "tone," because reserve estimates might be off for
one reason or another and because there frequently were changes in reserve

The Desk did not aim specifically at any given pattern of

interest rates, but tried to achieve the degree of reserve availability



and the conditions in the market that were associated with the general
range of interest rates that the Committee bad indicated it desired.
With respect to the matter of the market's being upset by a
substantial change in rates, Mr. Sternlight said, some readjustments
would be called for whenever the Committee made a major change in policy,
whatever guideline was used.

There had been such periods of readjustment

in the past, most recently a year ago when the discount rate was raised.
In his judgment the market was able to cope with such developments.
Mr. Daane asked what range of free reserves Mr. Sternlight
thought would be consistent with the recent behavior of interest rates
and other money market variables.

Mr. Sternlight replied that the Desk's

recent operations had been aimed at a free reserve figure of $100 million,
with fluctuations of perhaps $50 million on either side.

At times the

figure might fall outside of that range due to circumstances beyond the
control of the Desk.
Mr. Mitchell asked whether additions to the supply of Treasury
bills, such as would occur shortly with the sale of the tax anticipation
bill that Mr. Sternlight had mentioned, might not alter the relations
previously existing among bill rates, free reserves, and other variables.
If it did, could the Desk manage operations in such a way as to maintain
the existing consistency among the guides mentioned while achieving the
same monetary results?
Mr. Sternlight replied he would not expect that a sale of bills
in the volume the Treasury planned would produce any great problem for
the Desk.

The market was expecting a sale of tax bills, and the increase



supply would tend to be offset by the kind of broad investment demand

that had been exhibited more or less regularly.

There might be:some

problem in the very short run, and some day-.o-day accommodation might
be necessary while the market was taking up the new supply of bills.
But this would be only a temporary accommodation.
Mr. Mitchell commented that the immediate effect would be to
provide additional reserves,

although they might be withdrawn subsequently.

Mr. Sternlight agreed.
at work in

Ellis noted that Mr.

Sternlight had explained the factors

the last three weeks which led, among other things, to a rise

of about 6 basis points in

the bill


In Mr.


judgment this

rise was within the context and scope of the present directive.


asked whether in Mr. Sternlight's view a further rise of 5 or 6 points,
perhaps resulting from further bill issues, also would be within the
context of the directive, or whether the Desk would feel constrained to
supply enough reserves to moderate such a rise.

Sternlight replied that the bill

within the 3.45-3.55 per cent range,

rate had fluctuated recently

and currently it

was about 3.50 per

Thus, even with a further rise of 5 basis points or so the rate

would still be within the recent range.

There would be another set of

circumstances, however, if as a result of a new supply of bills the rate
moved significantly above 3.55.

However, he regarded the directive to

the Desk as geared primarily to reserve availability.
the Committee met frequently enough to reset its
satisfied with the bill rate.

In his judgment

guides if


was dis-


-13Mr. Hayes said he thought it important to avoid putting too much

emphasis on the bill rate as such; the general tone of the money market
was of greater significance.

There could be wide swings in the bill rate

at times when the tone of the money market was reasonably steady.
Mr. Balderston referred to Mr. Sternlight's comments that
increased corporate demand for money market instruments was expected,
and noted that he had understood some corporations, particularly in the
auto industry, were faced with financing needs.

He asked whether cor

porations were expected to be buying or selling short-term instruments
on balance in the near future.
Mr. Sternlight replied that the next few weeks were likely to
be a period of seasonally light corporate demand for short-term securities,
particularly because the auto companies would be letting up on their pur
chases, but in September corporate demand was apt to be heavy again.


during the next few weeks he did not expect the sort of turnaround from
buying to selling by auto companies that typically had occurred a few
years ago.

They had reorganized their financing operations so that they

ordinarily did not have to sell bills in any volume; they made adjustments
by modifying their rate of buying.
Thereupon, upon motion duly made and
seconded, and by unanimous vote, the open
market transactions in Government secur
ities and bankers' acceptances during the
period July 28 through August 17, 1964,
were approved, ratified, and confirmed.
Chairman Martin then called for the staff economic and financial
reports, supplementing the written reports that had been distributed



prior to the meeting, copies of which have been placed in the files of
the Committee.
Mr. Noyes presented a statement on economic conditions as follows:
While it is true that the economy has continued on its
impressive upward course, with little change in the rate of
advance and no spectacular movement in the broad price indexes,
it would be wrong to say that there has not been some shift in
the economic climate. There has been a subtle, but basic,
change in attitude, and too much movement in sensitive indus
trial commodity prices to dismiss lightly.
The Board's index of industrial production rose another
full point in July--up seven points, or 5-1/2 per cent, from
a year ago, and an even more impressive 5 points, or about 4
per cent, from January.
Capacity is an illusive concept, but no matter how one
conceives of it or attempts to measure it, there can be no
doubt that, with production increasing at an annual rate of
over 8 per cent, the rate of use of our physical resources
moved up in the first seven months of the year.
Similarly, there undoubtedly has been an improvement in
our use of human resources.
The sharp decline in unemploy
ment from June to July to 4.9 per cent may be suspect, but the
downdrift from figures which were averaging around 5-1/2 per
cent last winter, to something in the 5 per cent range this
summer, is unmistakable. In terms of the so-called gap
between actual and potential GNP, as se: forth in recent
reports of the Council of Economic Advisers, there was a
reduction in the gap, from 4.3 per cent of potential GNP at
the end of 1963, to 3.8 per cent in the second quarter of
1964. Thus, we have made real inroads into our unutilized
backlog of both manpower and plant capacity so far in 1964.
On the average, wholesale prices increased 4/10ths of
one per cent from June to July. Despite a 1 per cent month
to-month rise, farm products and foods were still well below
both a year ago and the 1957-59 average. On the other hand,
the 2/10ths of a per cent rise in industrial commodities put
them 3/l0ths of a per cent above a year ago, and 1.1 per cent
above the 1957-59 average.
These are small differences, and it now appears unlikely
that there will be much further increase in the wholesale
price index from July to August. The weekly index, based on
a smaller sample, declined a little after mid-July, and then
rose only moderately in early August. Thus, there is very
little basis, even taking into account the latest data, for
modifying the generalization that the broad average of whole
sale prices is still well within the narrow range in which it
has moved since the late 1950's.



Only when we turn to a daily index of market-traded com
modities do we find any dramatic changes in the recent period.
For example, the 13 industrial materials, in the BLS daily spot
index averaged 101.4 per cent of the 1957-59 average in June.
This index had risen 1 per cent by mid-July--specifically to
102.5 on July 15.
It gained another percentage point by
July 31, when it stood at 103.6. It jumped to 106.3 by August
10, and has drifted down very slightly since then. Thus, we
do see in the narrow area of market-traded industrial commod
ities an impressive upward price movement, extending over
several months and accelerating in early August.
This movement in the BLS spot index, and in similar
privately-compiled indexes of market-traded commodities, has
undoubtedly contributed to the enhanced concern about the pos
sibility of inflation, which has been reflected in quite a
number of newspaper stories and market comments. Widespread
discussion of the possibility of an across-the-board increase
in steel prices, and speculation about the effect of the high
first-half profits of auto companes on the wage settlement
in that industry, are also cited as reasons for growing con
cern about the continuance of price stability.
I have tried to set forth the facts about recent price
movements as fully and fairly as I could. They do not lend
themselves readily to brief summarization, but one might say
that the broad measures are still quite stable, while market
traded conmodities, notably copper and steel scrap, have.
moved up sharply, with some accompanying increase in infla
tionary sentiment.
More generally, confidence in the continuation of rising
levels of output and employment, with or without rising prices,
seems to have increased. I have been e:posed recently, for the
first time, to analyses by two careful students of the building
industry, who feel that construction in the months ahead will
be limited by supply rather than demand factors. Sources
within the automobile industry seem, almost incredibly, to be
expecting another very good year, encouraged perhaps by what
they regard as strong current performance.
Speculation, which seemed to be gaining some ground a
month or so ago, that we might see an upper turning point
early in 1965, has all but completely vanished.
It is hard to be critical of the recent performance of
the economy--it has been little short of magnificent. By the
same token, it is hard to argue that some lessening of credit
ease, either to moderate the rate of monetary and credit expan
sion or for balance of payments reasons, would have serious
adverse effects on domestic output and employment in the
present circumstances.



Mr. Holland made the following statement concerning financial
Economic expansion in recent months has been accompanied
by large and growing financial flows.
The sustaining influence
of such flows into the central financial markets undoubtedly
helps to explain the resilience of these markets in the face
of the large Treasury advance refunding and the succession of
international uncertainties.
Bank credit and deposit expansion has played a large role
in these recent financial movements. On an average daily basis,
total ban. credit and deposits expanded at about an 8 per cent
annual rate during the June-July period, and further expansion,
although perhaps at a somewhat more moderate rate, appears
underway in August. Money supply climbed $2.2 billion from the
last half of May through the first half of July; it fell back
$200 million in the last half of July, and we now estimate it
rose again by a more moderate $400 million in the first half
of August. Taken together, the increases in this measure since
the second half of May have been at a ,.even and one-half per
cent annual rate. This expansion, of course, comes on the
heels of rather small money supply additions earlier in 1964,
and the annual rate of growth over the year to date is only
about 4 per cent. Nonetheless, this ha. been the strongest
surge of money supply increases since last fall.
I should point out that the summer's addition to the money
stock has not been idle. Debits to checking accounts have risen
just as fast as deposits, holding the July rate of money turn
over outside New York City at the advanced 35.5 annual rate of
the second quarter. GNP is apparently rising at a rate almost
as fast. Clearly, there has been more money work to be done.
Undergirding this growth in money .upply, and reflecting
the general business advance, has been a fairly steady growth
in bank loans extended to nonfinancial customers, that is, to
businesses, consumers, farmers, and on real estate. July's
$900 million growth in such loans was a little below the first
half average, but it brought the annual rate of growth for such
loans thus far in 1964 to over 10 per cent, compared with 9 per
cent in the similar months in 1963.
Other kinds of bank earning assets, however, were under
going sharp fluctuations over the past six weeks, making
comparisons of aggregate single-date figures quite confusing.
Bank holdings of Governments have been particularly volatile,
as banks first sold large amounts of securities in the favor
able atmosphere created by the Treasury's July advance refund
ing moved temporarily into very liquid positions, then bought



sizable blocks of the bill strip and one-year bill offerings,
and bid heavily for the 3-7/8 per cent, 18-month cash refunding
offering for which payment was made yesterday.
The consequences of such bank maneuverings were reflected
in the easy money market atmosphere that developed in middle and
late July and that was only erased in the past two weeks as
banks picked up the weight of their own and dealer participa
tions in the latest Treasury financings. Now we are back with
a money market in a snug but more balarced position. In fact,
the readings of most money market indicators are quite similar
to those as we approached the fall season a year ago, with the
chief exceptions being that the three-month bill rate is about
15 basis points higher today and free reserves fractionally
Last fall, however, as well as the year before, you will
remember that the reinforcement of cyclical with seasonal demand
forces resulted in several months of strong money and credit
expansion. How much of a repetition of that pattern we can
expect this year is a matter of conjecture at this moment, but
it seems to me reasonable to expect that the objective of moder
ate further credit and monetary expansion in the period ahead
would more likely be served by maintenance of the slightly firrer
money market conditions that have emerged in these past two
weeks, rather than the fluctuating but on average somewhat
easier climate of money market conditions and marginal reserve
availabil:ty that has prevailed since last spring.
It would be well to expect that a policy aimed at preserv
ing recent money market snugness would on occasion lead to
tighter readings in one or two areas. For example, bank
borrowing might be expected to move up further on occasion,
for during the fall's heightened financing activity reserve
needs and reserve flows do not always mesh as well as in more
tranquil times. Moreover, the Treasury bill rate could move
up a little further in the weeks ahead, for reasons already
outlined by Mr. Sternlight.
I am compelled to emphasize, however, the narrowness of
the range within which current monetary policy could be altered
without risk of producing sharp and substantial reactions within
the financial system.
In the capital markets, dealers have heavy inventories of
both long-term Government and municipal securities. Right now
they feel assured that there will be no substantial change in
monetary policy. But a rise in the bill rate of more than a
very few basis points, or a few weeks of low reserve figures,
could easily upset that assurance and produce a significant
upward move in long-term interest rates.
In the money market, Federal funds flows, already reduced
from their July bulge, would be likely to dwindle further as

bill rates rise.

Reduced Federal funds flows would pinch New

York City banks particularly, and again risk the generation of
a cumulative spiral of money market pressures.

Here the feedback into the CD market becomes a cause for
concern. Market reports suggest that most big CD's are now
being initially issued at no less than a 4 per cent rate, even
by prime-name banks, with the only variable being the number

of months to maturity. In this circumstance, second- and third
line banks, even good ones, are likely to have some of their
customers pre-empted by money market banks as the latter come
under greater pressure. With some uncertainties about CD's
already prevalent because of a handful of problem cases, the
ingredients for a serious contraction, or at least a central
ization, cf CD demand exist.
Finally, there is the broader question of impinging upon
local bank credit availability. Without reciting all the
details, let me simply point out that bank liquidity ratios
have been worked down low enough to imply that at least a
fraction of the banks are approaching the point where some
reconsideration of lending policies will occur. That point
cannot be defined with precision, but it is one to be approached
very gingerly.

To sum up, the robustness of money and credit demand seems
to give some grounds for reconsideration of the proper mone
tary policy at this juncture, but the room for prudent maneuver
is limited indeed. I myself do not read the financial signs
as yet being so definitive as to impel a change in monetary
policy at this point, but I think they are such as to be com
patible with a mild change, if that should be regarded as
desirable because of either domestic business or balance of
payments developments.
Mr. Furth presented the following statement on the balance of
The U. S. payments deficit remains uncomfortably large.
The preliminary unadjusted July figure of $612 million is,
after seasonal adjustment, certainly no larger and probably
smaller than the April deficit of $484 million. But whereas
last spring the deficit nearly vanished again in the follow
ing month of May, the tentative data for the first two weeks
of August suggest for this month another sub:;tantial deficit.
Unless the second half of the month brings substantial improve
ment, the deficit for the two months, July and August, would
be at least as large as the deficit for the entire second



And as you know, the figures for the second quarter were
themselves disappointing. In consequence of a revision in the
estimate of "special" receipts and in the seasonal adjustment
factor, the seasonally adjusted deficit for that quarter is
now put at $740 million, and the seasonally adjusted deficit
for the first half of the year at $960 million.
The increase in the deficit between the first and the
second quarter was due to three items: the trade surplus was
reduced by $270 million, as exports declined slightly and
imports rose; domestic issues of foreign, largely Canadian,
securities rose by $130 million; and the deficit on transac
tions other than merchandise trade and flows of financial
capital--i.e., services, direct investments, and government
expenditures abroad, as well as errors and omissions--rose
by $170 million. The outflow of short-term bank credit and
liquid funds remained at near-record levels but long-term
bank lending to foreigners declined.
We should remember, however, that the deficit figures
appear so large only because of the peculiar way in which we
compute the payments balance. A recent study undertaken by
Mr. Lederer, the payments expert of the Department of Commerce,
confirms the view frequently expressed by San Francisco's
Mr. Grove that commercial banks often tend to make their
loans to foreigners equal to the volume of their foreign
deposits. Obviously, if a U. S. bank receives a deposit from
abroad and relends the same amount to a foreigner, this trans
action cannot in any meaningful sense be considered to hurt
the net liquidity position or the balance of payments of the
United States. And the same applies to the converse case,
in which a foreign bank receives a deposit from a U. S.
resident and reinvests it in the U. S. money or credit mar
It should not be beyond the ingenuity of U. S. statis
ticians to present our payments data in a way that gives
recognition to these relations.
Such a reform would be important because, for instance,
in the second quarter the rise in U. S. bank credit to for
eigners and the movement of U. S. money-market funds abroad
was practically equal to the entire U. S. deficit--$600 mil
lion as compared with a seasonally unadjusted deficit of $623
million; and as much as one-fourth of these movements should
probably be considered as cancelling out a corresponding rise
in foreign deposits with U. S. banks and foreign investments
in U. S. money and credit markets.
Data on movements of U. S. bank loans and deposits
abroad are not yet available for the first six weeks of the
current quarter. But in this latest period, the larger part
of the deficit--$600 million out of an unadjusted total of
$820 million--represented an increase in foreign private
No doubt a substantial part of that amount
dollar holdings.



should again be cancelled out by corresponding increases in
U. S. private liquid claims on foreigners. On the so-called
"official settlement" basis--which is also subject to serious
weaknesses but which, on balance, is ordinarily less mislead
ing than the conventional basis of our payments calculationthe U. S. payments position in the current quarter so far
would actually be much less unfavorable than in the second
quarter, although still much less favorable than in the first
quarter or in the first half of the year as a whole.
But while our conventional method overstates the econom
ically significant size of the deficit, the existence (or

rather the reappearance) of a serious payments gap is confirmed
by all alternative methods.
Three possible explanations for this deterioration come
to our mind. First, it would be surprising indeed if the
political uncertainties of the forthcoming election, together
with the higher tension in the Mediterranean and the Far East,
were not reflected in some capital flows, including especially

"leads and lags" in commercial and financial payments. And,
indeed, for the first time in several years, relatively siz
able funds have been reported moving uncovered into sterlingpresumably because the holders feel certain that a sterling
devaluation will neither precede nor inediately follow the
British elections due in October.
Second, there have been rumors that some banks were
shifting funds to Europe in order to be able to expand their
lending through the Euro-dollar market in case the interest
equalization tax should be extended to bank loans.
And third, the restrictive policies of many European
countries, which in June had already led to a sharp decline
in imports from the United States, are bound further to reduce
U. S. exports; and they are increasingly compelling a with
drawal of funds from the United States. The latest example:
the Netherlands authorities have based the publicity for their
anti-inflationary program primarily on the deterioration in
the Netherlands payments balance. But in July and August,
the Netherlands Bank experienced such a rapid inflow of
dollars that it requested the Federal Reserve to draw $30
million in guilders under our swap arrangements.
Chairman Martin then called for the usual go-around of comments
and views on economic conditions and monetary policy, beginning with
Mr. Hayes, who presented the following statement:

For several months now we have watched events unfold
both at home and abroad, and some of us have had the uneasy
feeling that the time might be approaching when a moderate
change of policy would be required if the signs of deteriora
tion in the U.S. balance of payments received further con
firmation. Our hands were tied while the Treasury was
carrying out its major advance refunding program and taking
care of the remaining August maturities, and while the mar
ket was given time to digest the large volume of new securi
ties offered in these programs. That period is now past,
and we are free to move if we believe a move is desirable.
To my mind, the worsening of the payments deficit in the
second quarter, followed by a dramatic further deterioration
since mid-year, and coupled with the further evidence of
vigor in the domestic economy, points clearly to the need
for a reduction in the present degree of monetary ease.
The strength of the domestic economy and the brightness
of its prospects are highlighted by the sizable July increases
in industrial production and retail sales, continued low
inventories in relation to sales, reports of enlarged capi
tal spending plans associated with higher corporate profits
and increased manufacturing capacity utilization, and the
consumer spending potential resulting from the tax cut.
Retail sales so far this year have exceeded those of a
year earlier by 5 per cent, double the rise in the compar
able months last year. In this context, the recent slight
softness in residential construction is not disturbing.
The reduction in unemployment is highly encouraging.
While the new low rate for July involves but one month, com
parisons of longer periods are also encouraging. In the
period between the last quarter of 1963 and the months of
May, June, and July, 1964, 1.4 million more persons were
employed, while the civilian labor force rose by 1.1 million.
On the other hand, between the last quarter of 1962 and the
three-month period May-June-July 1963, employment rose by
only 900 thousand while the labor force rose by 1 million.
We have been fortunate in the last several years in
having a relatively stable price situation, but questions
are now arising as to whether that situation will continue.
It is too early to know whether the rise in sensitive raw
industrial prices in early August by 3-1/2 per cent above
the June average is due mainly to temporary factors. Trial
balloons for higher prices are appearing from time to time,
notably from the steel industry. While announcements of
specific price changes continue to be mixed in direction,
more are on the up side than on the down side. The outcome
of the current labor negotiations in the auto industry could
have an important effect on prices; while the auto companies



could probably absorb substantial wage increases without an
increase in auto prices, a too generous settlement could set
the stage for pervasive wage and price pressures.
Developments in the international area are most disturb
ing. The second-quarter balance of payments deficit was at
a seasonally adjusted annual rate of $3 billion, up sharply
from the first quarter, and considerably in excess of the
$1.6 billion (annual rate) deficit recorded in the second
half of 1963. The deficit for July, as indicated by the
"flash" figures, was very bad. While some of the bad July

showing was due to seasonal and other special factors, the
size of the deficit is appalling, especially when we reflect
on our national record of large annual deficits for some six
years, despite the great effort expended in recent years to
reduce the deficit.
The second quarter of 1964 was marked by deterioration
in the trade accounts--both exports and imports; in the ser
vice accounts; and in certain Government accounts.

As for

the remainder of 1964, it is apparent that the cyclical trend
is against us as regards imports of goods and services; we
are not likely to have the benefit of extraordinarily high
agricultural exports; and direct investments have been ris
ing. At the same time, there is little evidence that there
will be areas where receipts will rise or outflows will
decline in sufficient volume to offset the probable losses.
Recorded short-term capital outflows have been running
at an annual rate of $2.5 billion in the first half of this
year. Little solace can be gained from the fact that these
outflows declined slightly between the first and second
quarters--that decline is altogether trivial in the light of
the heavy total for the first half as a whole. It is strik
ing that actual recorded outflows in the first half of this
year were roughly twice as large as in all of 1963, or all
of 1962. thus, the potential for bringing about some favor
able balance of payments effects through efforts to dampen
down short-term capital outflows is large. It should be
noted that interest rates have been rising abroad, and that
interest rate differentials, both covered and uncovered,
have been moving against us this year, although they may
now be reaching a level from which further advances are
much less likely.

The money supply so far this year has risen at about
the same rate as over the same period last year, after a
distinct slowing down during the first four months. Al
though the money supply plus time deposits has not grown as
rapidly this year as last, the growth has been substantial.
I am impressed by the fact that despite relatively high and



rising loan-deposit ratios the barks as a group are still
prepared to lend money rather generously both here and abroad.
There is no evidence that the economy i; not obtaining an
adequate supply of credit, including bank credit.
The firmer tone in the money market since completion of
the most recent Treasury financing has been helpful, but in
my judgment open market. operations should now be employed to
bring about a further firming of short-term interest rates.
I have in mind a gradual and cautious move leading to a
three-month bill rate of perhaps 3-3/4 per cent, with due
consideration of the impact on the longer term capital mar
kets. This would probably entail continuation of the Federal
funds rate consistently at the discount rate, an increase
in member bank borrowing, and free reserves in a range fluc
tuating around or somewhat below zero.
After such a change has been brought about by open
market operations, an increase in the discount rate will
undoubtedly be advisable. However, I would not favor an
anticipatory discount rate increase at this time but would
envisage use of the discount rate later to confirm our
action in the open market area.
While the proposed policy change would clearly entail
a higher level of short-term interest rates and some upward
pressure on rates generally, it does no. envision any sharp
cutback in the flow of bank credit to the economy. In this
connection, we should bear in mind that the shift in policy
last July had only minor effects in slowing the growth of
bank deposits and nonbank liquidity. Over the past year,
money supply plus time deposits has advanced 7-1/2 per cent,
only slightly below the 8 per cent rise in the previous year.
Nonbank liquidity has risen 6-1/2 per cent, as compared with
7-1/2 per cent in the previous year.
The robust domestic economy should be able to take such
There is
a policy change in stride without adverse effects.
not sufficient evidence of incipient inflationary pressures
to suggest a positive need for reduced ease on domestic
grounds, but this might become an important supplementary
consideration some time in the coming months.
A reduction in monetary ease should be helpful not only
in its direct effect on short-term capital flows but also
as a signal to the world of the United States' determination
to take affirmative steps to defend the dollar. Failure to
act promptly to protect the dollar in the light of recent
payments developments could easily lead to an erosion of
confidence which in turn would make the dollar more vulner
able to speculative attacks. The impending annual meeting
of the International Monetary Fund and the International
Bank in Tokyo will tend to focus attention of the payments
positions and policies on the major countries. In these



days of international incidents, and of questioning and testing
this country's political and military leadership in the world,
a strong dollar is a particularly vital element of national
The directive should be revised substantially to reflect
the further deterioration in the balance of payments, the
fact that Treasury financing operations are no longer a policy
consideration, and the change to a policy of reduced monetary
ease. I have specific language to suggest at the appropriate
Mr. Shuford reported that production and employment in the St.
Louis District had shown little change this year.

After expanding

steadily through 1962 and 1963, total payroll employment had remained
unchanged since January.

Industrial production in the District, as

indicated by electric power use, had risen only slightly since January.
This continuation of activity on a high plateau was shown in St. Louis,
Little Rock, and Memphis.
Mr. Shuford commented that there were some indications of a rise
in spending in the District in recent months.

After virtual stability

from August 1963 through April of this year, check payments had risen
rather markedly.

Business loans had risen at about a 5 per cent annual

rate since April, in contrast to the stability shown from January to
Despite the apparent limited strength in the District economy,
banking developments resembled what might be expected in a strong
economic expansion.

Loan-deposit ratios had risen since January, con

tinuing a rise that began in 1961.
expanded, Mr. Shuford noted.

Most categories of loans had

The investment portfolios of District

banks had declined relative to deposits, largely reflecting decreases


in holdings of Treasury securities.

Bank deposits rose from January

to July at a seasonally adjusted annual rate of 10 per cent, primarily
as a result of growth of time deposits.

While there had not been any

appreciable increase in borrowing from the Reserve Bank in recent weeks,
it was significant that there recently had been inquiries by two of the
District's larger commercial banks regarding the mechanics of borrowing
against eligible paper.
Nationally, Mr. Shuford said, the economy appeared to be contin
uing a strong expansion.

Industrial production, employment, and retail

sales continued to show substantial gains in July, and there was further
improvement in the unemployment situation.

While the economic expansion

was reasonably balanced and had not shown any clear inflationary tenden
cies, some upward pressure on prices had emerged.
The salient monetary developments, Mr.

Shuford said, were the

continued rapid increases in bank reserves, loans, and deposits, and,
in recent months, sharp increases in money.

These developments had

occurred within an environment of continued stability in interest rates.
Recently, Mr. Shuford noted, there had been some concern about
the ability of banks to accommodate further loan expansion.

Since early

1962 bank loans had risen relative to deposits and since early 1963 bank
investments had declined.

Bank holdings of Governments had dropped

This situation might mean that if credit and money expansion

were to be kept within reasonable limits demand for credit might push
interest rates up markedly.


As to policy, Mr. Shuford favored moderate expansion in money,

at a rate similar to the average rate of expansion since the beginning
of the year.

This would mean some reduction from the recent rate of

From December to July money increased at a 4 per cent annual

rate and reserves behind private demand deposits rose at a 3.7 per cent

However, from May to July these rates of increase were 8.5 per

cent and 10 per cent, respectively.

A moderation from the recent high

rates of expansion of reserves and money might result in somewhat less
ease in money market conditions, but in the context of the domestic and
international situations this would not appear to be undesirable.


fore, Mr. Shufcrd said, he would not be disappointed if somewhat lower
free reserves and somewhat higher short-term rates were required to
moderate the recent rapid monetary expansion.

Also, this undoubtedly

would result in increased borrowings from the Eederal Reserve Banks,
which sho.ld be expected and accepted.
Mr. Shuford said that these aims perhaps could be accomplished
under the existing directive, but he was inclined to agree with Mr. Hayes
that some revision in the directive was appropriate in order to reflect
somewhat less ease in money market conditions.

He thought the first

paragraph of the staff draft was satisfactory, but he would suggest the
following alternative language for the second paragraph:

"To implement

this policy, System open market operations shall be conducted with a
view to accommodating moderate expansion in aggregate bank reserves,
while maintaining orderly conditions in the money market."

The principal

aim was to place primary emphasis on the expansion of reserves and the



money supply, rather than specifically on recent conditions in the money

Mr. Shuford said he would be glad to see Mr. Hayes' suggested

draft, which he suspected he would find also acceptable.
Mr. Bryan remarked that the available figures for the Sixth Dis
trict continued to indicate a robust economic expansion.

As he had

mentioned before, new plant and equipment announcements seemed to be
running at record levels.
On the national scene, Mr. Bryan said, he had been pleased by
the expansion in the economy.

At the same time he was somewhat alarmed

by recent price developments, which Mr. Noyes had described so well.
He disliked making predictions, but he suspected that the economy pres
ently was at a stage where further price increases could be expected,
since marginal work forces were now being combined with marginal plant.
He also was concerned by the fact that the money supply, however defined,
seemed to have increased in the last 90 days at a rate greater than the
economy reasonably could be expected to absorb if this rate of expansion
were to continue.
With this situation in mind, Mr. Bryan said, he had come to the
conclusion that the Committee ought to move toward reducing the level of
free reserves.

While he was somewhat reluctant to mention a specific

figure, he would concur in Mr. Hayes' suggestion that the target be
moved from the $100 million level down to zero, sometimes producing net

borrowed reserves and sometimes net free reserves.
Mr. Bopp said business continued to be favorable in the Third
District with labor demand showing the greatest strength.

In July,



unemployment decreased substantially in most areas; Scranton had been

reclassified from "E" to "D", leaving the District with no major areas
of considerable labor surplus for the first time since the series began
in 1955.

Department store sales and new car registrations continued to

show gains in year-ago comparisons.
Unemployment claims in Pennsylvania and Delaware remained favor
able, Mr. Bopp commented.

In July, insured unemployment rates dropped

considerably i: a majority of labor market areas.

In recent weeks the

Northeast Coast steel index had increased at a better than national rate.
On the financial front, the basic reserve position of reserve
city banks continued on the deficit side, averaging about $49 millio.
for the three-week period ending August 12.

Although the reserve city

banks borrowed for the first time in a month, borrowing at the discount
window continued to be light.
Net loans adjusted at weekly reporting member banks increased
by $123 million compared to a year-ago increase of only $12 million,
Mr. Bopp said.

The cumulative increase in not loans since January was

substantially higher than it was during the comparable period last year.
Business loans rose by $11 million and investments were $6 million higher
in the three weeks ending August 12.

Both business loans and investments,

on a cumulative basis, were running well above last year.
Mr. Bopp continued to be impressed by the steady upward pace and
the broad strength of economic activity.

He was equally impressed by the

lack of any pronounced pressure on prices and resources.

Despite develop

ments in the Far East and scattered price hikes and talk of hikes,



domestic supplies remained ample and unit costs stable.
The unemployment picture, on the other hand, provided less cause
for optimism than might at first appear warranted.

To a considerable

extent, the July decline in unemployment was associated with withdrawals
from the labor force and perhaps with difficulties in timing of the sur
vey week.

Moreover, the percentage of those unemployed 15 months or

over remained uncomfortably high.
In view of the price and employment developments, Mr. Bopp felt
that about the same degree of ease that had prevailed in recent weeks
continued to be appropriate to domestic conditions in the coming three
week period.
On the international front, the sizable second-quarter deficit
and the contribution of short-term capital outflows to that deficit
could not be ignored.

The substantial July deficit added to his concern.

He believed, however, that the evidence to support a general tightening
of monetary policy should be conclusive before such a move was made.
Given the tight liquidity position already prevailing, the banking sys
tem was likely to respond rapidly to Federal Reserve action, and there
was a real danger that sudden tightening for balance of payments reasons
could dampen the forward momentum in domestic business.

For these

reasons, he would avoid a general move toward restriction.

However, he

would like to see short-term rates move more consistently around the 3.5

per cent level or slightly above.

If this required operations in coupon

issues to supply reserves, Mr. Bopp would favor such action.

Also, he

said, the Board might wish to give consideration to a change in reserve



requirements as a method of meeting the coming seasonal need for reserves
while avoiding downward pressure on short-term rates.
Mr. Bopp added that the staff's proposed directive appeared
Mr. Hickman said that information on the general business situa
ticn that had become available since the last meeting had not altered his
impression that the pace of economic activity was moderate and sustainable.
Production and distribution had continued to expand, as had the money
The most recent report on the labor force was heartening, but


should be inte:preted with caution, particularly since the sharp decline
in unemployment was associated with a decline in the labor force and
little gain in employment.
Steel output in July, on an unadjusted basis, remained virtually
unchanged from June; however, allowing for the normal seasonal and for
the number of working days, steel output rose, according to the Cleveland
Bank's estimates, to an annual rate of about 130 million ingot tons, an
increase of 6 million tons from June.

There was more and more talk of

steel production of at least 120 million ingot tons for 1964, an increase
of 2 or 3 million tons from the earlier projections of the Bank's staff.
Domestic new car sales in the first ten days of August, Mr.
Hickman noted, were 22 per cent higher than a year earlier, the best
showing since 1955.

Auto production would be off sharply in August, as

expected, and inventories would decline rapidly.

It was, of course,

even more difficult than usual to interpret auto figures at this time of
the year.


In the Fourth District, recent production and employment trends

were also difficult to interpret because of model changeovers, plant
shutdowns, vacations, and the like.

In a number of areas in the District,

the seasonally adjusted rate of insured unemployment had increased.


was most pronounced in the Lorain-Elyria area where the temporary layoff
of Ford employees had caused unemployment claims to triple, a situation
that had occurred last year, but two weeks later.

In contrast, a return

to normal operating schedules in other areas had brought the unemployment
rate down from previously reported high levels, notably in Toledo.


for the most recent three weeks, through the first week of August,
indicated that unemployment patterns in major labor market areas were
less favorable than at the time of the Committee's last meeting, with
the seasonally adjusted rate of insured unemployment up in nine areas,
down in three, and unchanged in two.

On the other hand, the Labor Depart

ment's July rat'ngs of major labor market areas showed a number of improve
ments in the Di:;trict.

Three of the areas moved from Group C to Group B;

two from D to C; and one from E to D.

Only two of the centers remained

in Group D, namely, Pittsburgh and Wheeling.
Another development in the Fourth District might be of interest
to the Committee, Mr. Hickman said.

The Reserve Bank's most recent semi

annual survey of municipal bonds held by District reporting banks revealed
that in the first half of this year there was a no:iceable lengthening in
average maturity, reflecting primarily an increase in issues due to mature
in over ten years.

In addition, the survey showed that reporting banks

held proportionately more issues rated Baa or lower.


Mr. Hickman observed that the news of the sharp deterioration in

the second quarter balance of payments had been received with concern by
bankers and industrialists in the District.

At the directors' meeting

last Thursday, the view was expressed that the U. S. balance of payments
problems had not been solved in any fundamental sense.

About all that

had been accomplished was to buy time through the use of various pallia
A member of the Cleveland Reserve Bank board, who was serving
on the President's Advisory Committee for the General Agreement on Tariffs
and Trade (GATT) Negotiations, was rather discouraged about the state of
these negotiations.

He reported that so far the ground rules had not

been established as to what was to be negotiated, primarily because of
disagreements among European nations.

There seemed to be generally some

sentiment among the board members that American industry was at a compet
itive disadvantage with respect to tariff and nontariff barriers, and
that U. S. antidumping legislation was in need of a general updating.
Mr. Hickman said he had been puzzling over recent reports on the
U. S. balance of payments, and had tried to compare these movements with
changes in covered yield differentials.

From observations for a very

short period, he though he could detect a rough inverse relationship
between payments flows and the Canadian differential, with some tendency
for flows to lag behind yields.

Although his examination of these relation

ships was cursory, the problem might warrant further study.


it might be useful to relate short-term capital flows, gross and net, to



different countries (particularly Canada) to the corresponding yield
Insofar as monetary policy was concerned, Mr. Hickman said, in
his judgment the Committee should continue to provide sufficient credit
to support economic growth without inflation.

Against the background

of the most recent balance of payments developments, however, he again
felt compelled to recommend that the Committee think in terms of slightly
less ease.

He was not suggesting that the Committee fail to provide the

credit needed to support sustainable domestic expansion.

But he did

believe that a moderate firming of rates and a moderate reduction in
credit availability would help the balance of payments, without con
straining business expansion.

He added that

he was thinking in terms

of a slightly more modest approach than those recommended by Mr. Hayes
and Mr. Bryan.

He would favor free reserves in the neighborhood of $50

million and a bill rate of around 3.60 per cent.
Mr. Daane said he had a great deal of sympathy for the view that
the Committee might have overstayed a bit on the side of ease.

If the

Committee could be in a posture of slightly less ease without the dif
ficulty of getting there, he would have considerably more sympathy for
this view.

He also shared the concern others had expressed about the

balance of payments, and he agreed that recent developments would argue
for a less easy policy, particularly if it could be demonstrated clearly
that such a policy would be helpful in overcoming the deficit.
On the other hand, Mr. Daane said, he felt that Committee policy
had been appropriate in light of domestic economic conditions and also



in light of Treasury financing considerations.

The operations of the

Desk, he thought, had been most helpful to the Treasury and at the same
time had been consistent with the intentions of the Committee.
In his judgment, Mr. Daane continued, moving the free reserve
figure down a few million dollars would not accomplish very much, if it
accomplished anything.

If free reserves were reduced still further, as

Mr. Hayes had suggested, Mr. Daane thought the Committee would be up
against the problem that Mr. Holland had mentioned; there was only a
narrow range within which to operate without risking adverse effects on
the financial markets and consequently on the domestic economy.
Mr. Daane said he came out about where Mr. Bopp did, believing
that the Committee would not be justified in taking a decisive step
toward less ease at this time.

Pressure on prices was not yet evident,

and the factors underlying the deterioration in the balance of payments
were still hazy.
Mr. Daane concluded that the Committee should not make a change
in policy, and that it should avoid any move toward real restriction.
He pointed out in this connection the unusual situation with respect to
Treasury financing--there was a period from now until November in which
there would be no financing.

The timing of a policy shift was still

very much in the hands of the Committee, Mr. Daane said, and he would
favor deferring such a shift, possibly until about a month from now.
The Committee then would have more information on the balance of payments
and would be in a better position to determine whether a policy change



would be helpful; and it could see whether the domestic economy was
continuing to demonstrate vitality and strength.
Within this general framework of no change in policy, Mr. Daane
would leave the Desk latitude to operate in terms of a free reserve tar
get range of zero to $100 million.

His conception was that doubts should
In fact, the most recent

be resolved on the side of somewhat less ease.

developments in the market anticipated to some extent those he would
like to see continued for the next three weeks, and he favored maintain
ing prevailing conditions, taking care to insure that free reserves did
not fall below zero.

Accordingly, he would change the second paragraph

of the staff's proposed directive to read "To implement this policy,
System open market operations shall be conducted with a view to maincain
ing the somewhat firmer conditions in the money market that have prevailed
in the most recent week, while accommodating moderate expansion in aggre
gate bank reserves."
Mr. Mitchell said he would make three comments on the domestic

First, the economy undoubtedly was performing better recently,

in good part as a consequence of appropriate fiscal and monetary policies.
Secondly, the economy was not characterized by any significant excesses.
It was surprising that anyone should think that something must be done
to an economy that was functioning so well.

In connection with Mr. Noyes'

comments on recent price movements, price changes were necessary to make
a free enterprise economy work efficiently, and they were a matter of
concern only when they become pervasive in the same direction.
no indication that this was the case at present.

There was

The economy was now



moving ahead toward the national economic objectives endorsed in the
recent tax cut legislation, and it was doing so without significant
His third point, Mr. Mitchell said, related to the recent
increase in the growth rate of the money supply.

The Committee had not

called for such a money supply increase; it had occurred, but not as a
result of any decision specifically made by the Committee.

This indi

cated to him that the Committee did not have close enough control over
the money supply to make it respond sensitively in the short run; the
Committee did not know enough about linkages in

this area.

Money supply

changes had tended to be lumpy, although to some extent the uneven
growth might be a consequence of poor seasonal adjustment factors.


any case, he was satisfied with the growth rate over the past seven or

eight months and he would not now want to take steps to alter it.
On the problem of the balance of paynents, Mr. Mitchell said,
after hearing Mr. Furth's statement, he felt that it would be unfortunate
if the Committee were to rely

this time.

on an old mythology to do something at

He believed it was not the policy of this nation to admit

that the dollar was overvalued and that it was national policy that the
dollar would be defended to the last ditch.

It certainly would not be

desirable for the Committee to use monetary policy to achieve the equiv
alent effect of devaluation, i.e.,

by shrinking the domestic price level.

Also, Mr. Mitchell continued, it was said that the Committee
could use monetary policy to influence short-term and long-term capital

But Mr. Furth's analysis suggested that there were statistical



and analytical deficiencies in the way that capital flows were treated,
and that if these were corrected a large component of the deficit would

If the Committee were not in a position to bring its excel

lent analytical resources to bear on the problem, it might be justified
in taking a naive policy action.

But since the Committee was informed

as to the shortcomings of the balance of payments data and analysis he
thought that it would be a serious mistake to uncritically use the bal
ance of payments conventional wisdom as a reason for a policy change at
this time, either to deal with the basic balance or with capital flows.
It seemed to Mr. Mitchell that the Committee needed to exercise
great caution at this time because of the possible impact of a policy
change on financial market psychology.

Even a small change might be

misconstrued as an initial step toward larger changes.

He had no objec

tions to the targets Mr. Hickman had mentioned except for the danger of
exciting an adverse psychological reaction, which might be extremely
difficult to check once underway.
In sum, Mr. Mitchell said, the economy was well on the road to
achieving the goals sought for it, and there were no excesses requiring

The balance of payments problem was still present, but in part

it apparently was illusory and in part it was subject to attack by special
techniques, such as including bank lending to foreigners under the inter
est equalization tax.

He concluded, therefore, that no change should be

made in policy at this time.

He would be agreeable to the directive as

submitted by the staff, and also to the amendment suggested by Mr. Daane.



Mr. Robertson said that he agreed with most of the conclusions of
Messrs. B.pp, Daane, and Mitchell.

He then made the following statement:

The kind of business and financial developments we have
been hearing about recently are the most likely precursors
of a need to change monetary policy that we have had in the
past three years. But I use the word "precursor" deliberately,
for I think it is not at today's meeting but at the meetings
lying ahead of us this fall that policy ought to be adapted
to these developments, provided that by then they have ripened
into trends.
Among the developments I have in mind are the recent
drop in unemployment, the strong bank credit and money expan
sion in June and July, and the large July balance of payments
deficit. But it is also true that these statistics bounce
around a good deal. To put it blantly, they fluctuate a
good deal more than we are prepared to have monetary policy
fluctuate, and therefore we are well advised to keep watch
over these developments until we are fairly sure they are
going to persist before we decide to shift monetary policy
The very latest evidence in each of these areas seems
somewhat more moderate in nature than the early July figures
suggested. If we rush in with a policy change, we could be
embarrassingly off in our timing. Any appreciable changein
policy at this juncture runs some real hazards of generating
sharp adverse reactions in the banking system and the financial
markets. Furthermore, I would not want to see any alteration
of monetary policy that could serve as an excuse for not pur
suing more pointed and effective means of dealing with what
ails our balance of payments, and I have here particularly in
mind the lending activities of a few of our largest banks.
Fortunately, I think we are in a position to be able to
wait and see whether what we are seeing are simply fluctua
tions or more underlying trends. Our price structure is still
fundamentally stable, and we have still a sizable margin of
unutilized resources. With a real economy whose reflexes have
been demonstrably more phlegmatic in this expansion than
earlier, I see no reason to fear that events will run away
from us if we continue our "watchful waiting" a few weeks longer.
Mr. Robertson said he would accept the directive as prepared by
the staff but, like Mr. Mitchell, he also would hate no qualms about
accepting Mr. Daane's suggested amendment.



Mr. Mills commented that in the light of domestic economic
developments and international financial developments, and taking irto
account the lag between the time of inception of a policy action and the
accomplishment of the results sought, he was persuaded that the Committee
should move to a moderately less easy monetary and credit policy.


approach, however, should be gentle and cautious; the Committee should
probe carefully to discover the responses of the financial and busiress
community to such a change.

The reason for caution focused on a concern

about the over-all position of the commercial banks and the trend toward
ever-lessening liquidity.

A policy that would reduce the bank's capacity

to lend could have unfortunate effects under these conditions.


there was no great reason to anticipate an increased demand for credit
this fall, even the seasonal demand on the banking system that would
certainly eventuate was bound to have interest rate and credit effects
of importance.
In that connection, Mr. Mills said, there was the likelihood of
a peculiar that the Committee could expect on the balance of pay
ments prcblem.

If the Committee had a slightly less easy credit policy

and the commercial banks found themselves less able to meet the credit
demands that would be made on them, their first reflex, in his judgment,
would be to curtail foreign lending.

In other words, Mr. Mills said,

banks have looked upon their domestic loan activity as their primary
responsibility, and when a requirement for exercising selectivity arose,
he would anticipate a withdrawal of foreign credits.

The favorable

effect this would have on the balance of payments would be in addition



to whatever effect resulted from some stiffening of interest rates in
this country.
Mr. Mills repeated that he was persuaded that the Committee
should move to a moderately less easy monetary policy, but on a provi
sional and probationary basis, to determine what the over-all reaction
would be.

He would accept Mr. Hickman's fornula of free reserves around

the $50 million level and a bill rate of around 3.60 per cent, even
though he recognized that a bill rate of 3.60 per cent might create a
temptation for banks to make greater use of the discount window for
arbitrage purposes.
Mr. Wayne reported that Fifth District business was apparently
continuing the moderate and orderly advance of recent months.


sentiment as measured by responses to the Richmond Bank's survey was
slightly improved and indications were that unemployment had declined
a little.

The textile industry was prcsperous and production was up


There had been very few price reductions in finished goods

since the equalization payments were initiated last April and this
should mean a larger margin of profit.

The U. S. Department of Agri

culture forecasts for the coming year were for the largest domestic
consumption of cotton since 1950-51.

These conditions caused almost

half of the normally pessimistic textile respondents to report improved
profits prospects for the period just ahead.

It should be noted, how

ever, that pressures for increased wages were building up.


production continued to recover and in July was slightly above the
level of a year earlier.

Construction activity remained at a high level


in most parts of the District.

Retail sales, off somewhat during July,

apparently had picked up a bit at the beginning of this month.


rains had improved farm crop prospects in all five States.
Although the national economy at midsummer seemed to be maintaining
its moderate advance, Mr. Wayne said, there were numerous cross-currents.
Employment gained significantly in the first seven months of 1964, sugges:ing that the tax cut helped to achieve at least one of its major ains.


the only sector of the economy that exhibited any strong momentum was new
plant and equipment expenditures.

Gains in retail sales had been modest

compared to increases in disposable income, inventory accumulatiors had
been remarkably low, and prices generally had been quite stable.


struction expenditures had been almost stationary for several months, and
manufacturers' new orders had shown small declines for two successive

These diverse developments and the behavior of the leading

indicators suggested that a considerable part of the stimulus provided by
the tax cut was required to offset declining tendencies which were nor
mally present after more than three years of business expansion.


important question at the moment appeared to be whether business capital
outlays and consumer spending could carry the economy forward while new
momentum was being generated in other important sectors.
Mr. Wayne said it seemed to him that the Committee's present
posture was appropriate to prevailing conditions and he would not change

The suggestion that somewhat less ease would not do violent damage

to the economy was not enough--such a risk could be justified only by
compelling pressures elsewhere, which he did not yet see.




more ease would not be suitable in the light of international conditions.
On the other hand, Mr. Wayne said, he would not like to see appreciably
less ease, first, because in his estimation conditions in the domestic
economy did not require it and, second, because the market and the bank
ing system were likely at this point to react more strongly than usual
to any tightening move.

This position seemed to be in accord with the

views expressed by Mr. Holland and others.

There were indications, such

as the recent successes of Treasury financing, that the market had with
some reluctance come to the conclusion that interest rates were likely
to remain stable for some time.

Any distinct move on the part of the

Committee toward less ease might change that opinion and trigger read
justments of holdings which would push interest rates upward considerably.
The banking system would soon be faced with a large seasonal increase
in demand for accommodations.

The loaa ratio was quite high and holdings

of short-term Governments were low, Mr. Wayne noted.

Any move toward

reduced availability of reserves could produce a substantial tightening
by the banking system.
Mr. Wayne favored no change in the discount rate, no change in
policy at this time, and a directive essentially similar to the present

The draft directive submitted by the staff, with the amendment

proposed by Mr. Daane, would be acceptable to him.
Mr. Clay said the domestic economy's performance was generally
quite good.

Yet, there continued to be room for expansion within the

framework of orderly and sustainable economic developments.

In fact,



despite some improvement in unemployment over the past year, unemployment
still remained a problem.

What needed to be underscored was that the

problem existed even though economic activity had increased substantially.
The rapid growth in manpower and other resources and the increase in
productive efficiency afforded the explanation.

The expansive trends

in output potential were continuing with manpower of working age growing
at an increasing pace.

What was apparent, then, was that the unemploy

ment problem remained of tolerable proportions only within a growing
volume of economic activity and that any deceleration in the pace of
economic advance would rapidly accentuate the problem.
The international balance of payments deficit remained a matter
of concern, Mr. Clay commented.

Recognition must be given, however, to

the substantial improvement that had occurred despite the less favorable
recent developments.

Moreover, the most recent data did not provide

adequate inforration for judging fully the sources of the adverse develop
ments and the nature of the problem.

It was apparent, however, that the

Committee would need to observe future developments closely and analyze
carefully what was taking place in the international payments area.
Mr. Clay thought that the domestic economy did not call for any
movement toward monetary restraint.

Rather, it needed an expansive

monetary policy designed to foster further growth in economic activity.
A continuation of the monetary policy of recent months would be in line
with the needs of the domestic economy, in his judgment.

Despite the

recent unfavorable developments in international payments, on balance it



appeared preferable to continue monetary policy without any basic change

at this time.
Pursuit of such a policy, Mr. Clay continued, should aim to
provide sufficient reserves to the banking system to permit commercial
bank credit to expand at about the same rate that it had thus far this

In carrying out this program, money market conditions should be

maintained essentially within the pattern of the last three weeks, with
the 90-day Treasury bill rate generally within the range of that period.
Mr. Clay felt the staff draft of the economic policy directive would
serve well for the period ahead.

He wouldmake no change in the Federal

Reserve Bank discount rate.
Mr. Scanlon reported that businessmen and bankers in the Seventh
District were generally agreed that the current business expansion would
maintain its momentum through the remainder of the year.

The main basis

for longer run optimism in the District was found in the trend of invest
ment expenditures.

Midwest producers of various types of capital goods

informed the Chicago Bank that incoming business either was setting new
records or was the largest since 1957 or some earlier period.

Farm equip

ment shipments continued to run 8-10 per cent above last year's level and
this margin was expected to continue through the year, although at the
beginning of this year most analysts had forecast a level or declining
trend of farm equipment sales.

Although there wa

considerable concern

over a possible slowdown in total construction, Dodge contracts in the
Midwest were 18 per cent above last year in the first half compared with



a rise of 8 per cent for the nation and there was reported to be a huge
volume of heavy construction projects in the planning stage.
In July, Mr. Scanlon said, District department store sales were
13 per cent above last year and were at a record high after seasonal

Preliminary evidence for August suggested a continuance of

high level department store sales.

Employment continued to rise and

unemployment continued to decline in the District, although changes were
modest in both cases.

At present, 10 of the 25 major labor markets

classified in the B group--40 per cent--were in the Seventh District,
although only 15 per cent of all major labor markets were in the region.
Business loans of weekly reporting banks had declined less than
usual since midyear, Mr. Scanlon said, and early August figures suggested
a seasonal upswing in credit demand similar to that which occurred last

Recent strength was due mainly to increased borrowing by firms

in retail trade and extractive industries.

Growth in consumer loans had

remained modest.
On the whole, Mr. Scanlon commented, District banks had been able
to handle their reserve positions without difficulty.

Although dealer

loans had been reduced, they remained at a relatively high level.


holdings of both Governments and other securities also had declined.
Large Chicago banks had maintained rather comfortable reserve

One reported a substantial decline in CDs outstanding early

this month, and another had been a rather steady net seller of Federal

Borrowing at the discount window had remained low.


As to policy, Mr. Scanlon said it seemed to him that once again

the Committee was concerned with matters of timing.

He believed that

for reasons mentioned by Mr. Wayne and others the Committee must move
cautiously in waking any policy changes.
the views expressed by Mr. Daane.

For the same reasons, he shared

The directive prepared by the staff

was acceptable to him, with the changes in the second paragraph proposed
by Mr. Daane.

Mr. Scanlon would not change the discount rate.

Mr. Deming commented that recent economic developments in the
Ninth District differed little from those he had reported earlier.
ever, he would like to mention one significant item.


He had referred at

previous meetings to a survey which the Minneapolis Bank conducted at
six-week intervals of about 20 large corporations with headquarters in
the District that operated nationally and in some cases internationally.
This sample was surveyed twice each quarter--once at the beginning and
again about half way through the quarter--on prospects for employment,

production, prices, and so forth.

The returns had been generally opti

mistic recently, and they continued to be so in a survey completed just
within the past few days.

This last survey, however, gave a much greater

indication than earlier ones of expectations of price advances.


earlier surveys typically one or two firms would report that they expected
their own prices to go up, and one or two would indicate that their
prices probably would go down.

In the latest survey five of the 20

respondents reported that they had already made some price increases in
the quarter, and only two reported declines.

For the balance of the

quarter, six respondents expected increases and only one a decline.



This pattern, of course, might be partly seasonal, but there was a
stronger indication than earlier of upward price movements.
With respect to policy, Mr. Deming said, he concurred in the
statement of Mr. Noyes that the economy seemed to be able to take some
what more monetary snugness; in Mr. Holland's statement that the room
for maneuver was not great; and in Mr. Daane's observation that the
Committee had a fair amount of time in which to make a policy change.
He was concerned about recent balance of payments developments, even
after allowanes for the statistical illusions to which Mr. Mitchell
had referred, and for the fact that monetary policy by itself could not
resolve all of the difficulty.

It seemed to Mr. Deming that an upward

movement in short-term interest rates could hardly injure the balance
of payments situation and it might conceivably do some good; it could
be viewed as a type of insurance.
Also, Mr. Deming said, as Mr. Hayes had suggested the Board
might want to give some consideration to a reduction in reserve require

The staff memorandum indicated that it would be necessary to

provide about S1.5 billion of reserves on balance until early in December,
and approximately $650 million during the next three weeks.

A volume of

reserves roughly equivalent to the latter figure would be released by a
1/2 point reduction in reserve requirements for either demand or time

It might be possible to take care of reserve needs during

the next three weeks by a reduction in reserve requirements, and to
absorb reserves in the following three weeks by selling bills in the



market, in the process inducing more borrowing and raising the bill rate
by about 10 basis points
It would be consistent with this kind of policy to let free
reserves go down to about $50 million on average, Mr. Deming said.


thought this could be accomplished under the proposed staff directive
with the modification suggested by Mr.. Daane.

It would not involve any

significant change in policy at this time, but would put the Committee
in a better position to move in either direction later.

He would not

change the discount rate at present.
Mr. Swan reported that in California and Washington, the only
States in the Twelfth District for which July employment figures were
available, total employment increased more than seasonally in that month.
However, the increase was largely in agricultural employment and followed
an abnormal decline in June.

Nonfarm employnent showed very little

In California, moderate increases in government, service, and

construction employment were offset by a decline in manufacturing employ
ment, which reflected another drop in defense- and space-related indus

On the other hand, in Washington there was a slight increase in

aircraft manufacturing employment; defense-space employment in that State
now had gained slightly for two successive months.

Western steel produc

tion rose in the first part of August and demand for nonferrous materials
was strong.

Department store sales in July showed substantial gains on

a year-to-year basis, although less than the gain nationally.
Mr. Swan said that District banks had continued under considerable
reserve pressure in recent weeks.

In the three weeks ending August 12



borrowing from the Reserve Bank rose substantially, and in the week ending
August 12 District banks accounted for about one-quarter of the total
member bank borrowing in the country.

It had been some time since major

banks in the District had been net sellers of Federal funds on a large

The flow of savings into savings and loan associations picked up

a little in June but for the second quarter as a whole the increases were
less than in either the first quarter of 1964 or the second quarter of
Mr. Swan said he found himself in substantial agreement with
It seemed to him that the domestic situation was

Mr. Wayne on policy.

going along quite well and offered no basis at this point for changing

The international situation, of course, concerned him as it

did everyone else.

He had the uncomfortable feeling, however, that if

it became necessary to act on account of that situation--and this was a
real possibility--a slight tightening would have little effect; that an
overt move, including a change in the discount rate, would be needed to
have a real impact on the flows of funds.

He was not prepared to recommend

such a move at this point, considering both the international and the
domestic situations together.

Therefore, he would favor no change in

policy now, although he did think that the question might well simply be
one of timing.

Mr. Swan would accept the directive as drafted by the

He would not object to the amendment suggested by Mr. Daane,

although he did not think the language proposed necessarily implied the
somewhat lower level of free reserves that Mr. Daane had mentioned.


Mr. Coldwell commented that Eleventh District conditions remained

about as they had been during the past several months.

Industrial pro

duction, construction, retail trade, and general business conditions were
all advancing and now were at record levels.

The agricultural outlook had

been brightened considerably by widespread rains over the past few weeks.
Prospects of improved pastures might have reduced pressure for forced
marketings of cattle at present prices, which were 9 per cent below a year
Mr. Coldwell said banking conditions in the District showed
evidences of sunmer doldrums.
investments increased.

Loan demand had weakened slightly while

There had been two bank failures tied to owner

ship changes and brokerage of CDs, and these seemed to be the main
centers of controversy in the District.

New bank charters were also

under considerable fire, raising talk about branch banking in Texas,
where banks were limited to one office by the constitution.

Banking con

ditions, however, were not substantially different from those of recent

Major banks in the reserve cities seemed to have all the loan

demand they could take care of at the moment, and were attempting to
farm out participations.

At the same time, agricultural loan demand was

exceptionally high, and the agricultural banks were trying to send some
of their ;oans back to the city banks.
Mr. Ellis commented that the recent cool weather in New England
seemed to have helped department store sales, which in the most recent
four weeks had averaged 8 per cent ahead of last year.

Demand balances

at all types of savings institutions also had been rising.

At mutual



savings banks in the District balances had expanded by almost 1 per cent
in June alone.

Other trends in the region continued to show the pattern

of strength that he had reported at recent meetings.
With respect to policy, Mr. Ellis sa:d that the steady expansion
in the races of production, distribution, and consumption, as described in
the staff reports, was so nearly ideal that the burden of proof rested on
anyone who sought a realignment of the underlying financial supports of
present trends.

He knew of nothing that approached proof of a need to

change monetary policy, but there were some disturbing indications that a
change would be wise.

If domestic and international considerations were

not divorced, one would have to conclude that there were excesses in the
economy--including excessive bank lending to foreigners, excessive capital
outflows, and an excessive deficit, all of which contributed to the mone
tary policy problem.
In his judgment, Mr. Ellis continued, the Committee had to satisfy
itself on the answers to three questions:

( ) Was the worsening in the

U.S. balance of payments significantly attributable to long- and short
term capital flows that were materially influenced by excessive availability
of funds responding to attractive rate differentials?

(2) Was it reason

able to expect that a modest modification in monetary policy, such as a
10-point rise in short-term rates and somewhat lessened availability of
reserves, would have any appreciable effect on these capital flows?
(3) Would such a modification in monetary policy be consistent with the
long-term needs of the domestic economy?



Mr. Ellis said his own answers to these questions were tentative.
With regard to the first question, the staff reports indicated that short
term capital flows were up sharply in June, with two-thirds of the outflow
representing movements of liquid funds; and that the outflow of short-term
bank credit was up somewhat from the moderate level that had prevailed
since February.

Obviously, data for more than one or two months had to be

analyzed for long-run trends, but the present evidence of the trend was

On the second question, Mr. Ellis felt that expectations

about the eventual impact of monetary policy actions had to take account
of their possible effects on principal trading partners abroad.


action in substantially increasing the discount rate might well draw

A more modest move probably would not, but of course it

might also have much less effect on flows.

As to the third question-

whether a modest policy move might be consistent with long-term needs of
the domestic economy--Mr. Ellis noted that reserves, bank credit, and the

money supply had been expanding sharply over the past two and one-half
months, at rates that probably were not compatible with sustained growth

without inflation.

It seemed to him fair tc conclude that the financial

stimulus had been doing more than its share in recent months.

And, as

Mr. Noyes had said, the economy appeared to have the strength to withstand
lessened case.

Mr. Ellis concluded, therefore, that monetary policy should be
shifted slightly to a position of lessened ease.

In effect, he said, he

was prepared to accept some of the "mythology" to which Mr. Mitchell had



referred of the impact of monetary policy on the balance of payments.


favored a free reserve target of around $50 million, with the expectation
that short-term rates might move up gradually to the 3.55-3.65 per cent

Mr. Ellis thought the directive approach suggested by Mr. Hickman

came closest to what he preferred.

He noted that he had been attracted

by Mr. Deming's analysis.
Mr. Balderston remarked that at the last meeting of the Committee
he had urged scme slight adjustment of the current posture of monetary
policy with a view to minimizing foreign lending, in light of the prospect
for an adverse balance of payments for the year as a whole.

This step was

proposed as a contribution to the protection of the U.S. gold supply.


the same end he also had suggested a reduction in reserve requirements as
a means for supplying seasonal reserve needs this fall.

The broad reasons

he had advanced were that bank loans ard investments had been growing at
an annual rate of about 8 per cent since early 1961; that big corporations
possessed liquid funds in increasing amounts; that in most European coun
tries other than Germany, both short- and long-term rates had advanced
during the past year; and that the incentive to place funds abroad should
not be allowed to strengthen.

It should now be added, Mr. Balderston said,

that since these comments were made three weeks ago, the worsening of
international payments had become even more disquieting.
The proposal be had made at the last meeting, Mr. Balderston
recalled, involved a modest shift in monetary policy to nudge bill rates
upward gradually, with a target of about 3.60 per cent for the three-month
bill but with an upper limit of 3.75 per cent for the six-month bill.




had favored then, and he continued to favor, permitting a larger portion
of expansion in bank reserves to be financed from advances by the Federal
Reserve Banks to member banks.

To achieve these ends would require let

ting free reserves drop experimentally, close to zero and perhaps even
below if monetary policy was to assume a slightly different posture with
out setting off such a shrinkage of negotiable CDs as to create a problem.
Mr. Balderston then turned to the possibility of substituting a
reduction in reserve requirements for open market operations in meeting
seasonal reserve needs.

According to estimates of the Board's Research

Division, he said, during the seven weeks from October 22 to December 9
it would be necessary to provide about $1..9 billion in reserves, net,
assuming that there was not an outflow of gold to be compensated for.
If required reserves were to expand at a 3 per cent rate over that inter
val an additional $80 million would be necessary, bringing the aggregate
reserve need for the period to nearly $2 billion.

If this need were met

by reductions in reserve requirements, appropriately timed, the resulting
gold cover would be less than otherwise by aoout $1/2 billion, and the
volume of "free gold" would be higher by that: amount.. Mr. Balderston
noted that $1/2 billion represented about one-fifth of the existing stock
of "free gold," and about one-fourth of the "free gold" that might other
wise remain at the year-end seasonal trough.

This amount also would be

equivalent to the net gold loss of the U. S. since January 1963.
As to the directive, Mr. Balderston said, he would want to hear
Mr. Hayes' suggestion, but he was not averse to the staff draft with
Mr. Daane's amendment.


Chairman Martin commented that the discussion of policy today

turned on the questions of degree and timing.

He had been debating the

best course of action in his own mind, and he felt that good cases could
be made for and against a policy change at this time, as in fact they
had been made at this meeting.

In his judgment the burden of proof

probably was on those who wanted to make a change in policy.
The question that concerned him most, the Chairman continued,
was whether the Committee could operate in so delicate a manner as not
to disturb the market.

Even a small shift could have a psychological

With respect to timing, the Committee had until the middle of

November to act on policy as far as Treasury operations were concerned.
One could take the position that the Committee should begin now to move
in a gradual manner, or the alternative position that action should be
postponed until it could be seen whether a more significant move was
called for.
Chairman Martin said that if he were doing this on his own his
inclination would be toward the kind of policy change that Mr. Mills had
aptly termed "provisional and probatiorary."

He thought that the Com

mittee's policy up to this point had been appropriate.

The degree of

ease that had been maintained had been helpful to the economy, and,
incidentally, to the Treasury.

Now he would favor letting free reserves

trend down to a zero to $50 million range.

However, if the Committee

thought it could not take such action without having an unfortunate
psychological impact, it might be best to wait until more significant
action was clearly appropriate.

The matter could be argued either way.


In sum, Chairman Martin said, he did not think a substantial

policy change was called for at present; the choice was between a modest
move now and perhaps a more significant move later.

He felt personally

that the balance of considerations was in favor of a modest move now.
If this was the sense of a majority of the Committee, there remained the
question of hov to formulate an appropriate directive.

He then invited

Mr. Hayes to distribute the proposed directive the latter had referred to
earlier, the second paragraph of which read:

"To implement this policy,

System open market operations shall be conducted with a view to maintain
ing somewhat firmer conditions in the money market than have prevailed,
on average, during recent months."
Mr. Hayes remarked that a majority of members seemed to leap
toward moving toward a slight firming of conditions, although there were
differences in degree within the majority and other members favored no

In his judgment, the second paragraph of the staff draft as

amended by Mr. Daane would be inconsistent with what he took to be the
consensus of the Committee.

In particular, to call for maintaining

recently firmer conditions seemed to imply a continuation of the bill
rate at its current level of about 3.50 per cent, whereas he understood
the consensus to favor having the bill rate climb a bit further.


respect to his own proposal, he would now suggest use of the word
"slightly" rather than "somewhat" in qualifying "firmer conditions."
Mr. Hayes added that he would like to comment on some observations
that had been

made in the go-around.

He did not think the Committee could

conjure away the balance of payments problem by references to "mythology."



The problem was real and, if he understood Mr. Furth correctly, it was
serious whatever definition of the deficit one might favor.

It certainly

existed in the minds of foreigners who read the figures published on the
U.S. payments balance.

He also disagreed with the argument that this

problem should be dealt with primarily by means other than monetary policy.
Other approaches, such as moral suasion and the interest equalization tax,
might also be helpful, but monetary policy certainly had a role to play in
the attack on the problem, particularly since capital flows had been so
important in the deficit.
Also, Mr. Hayes said, he would like to point out that no one had
suggested shrinking the domestic econony in the effort to deal with the
balance of payments problem.
not fragile.

In his judgment the economy was robust and

What he thought the Committee had in mind was some slight

slowing of the rate of credit expansion.

Even that was uncertain; he

would hope that the effect on the domestic economy would be negligible.
Finally, on the question whether the Committee had to refrain from all
policy moves because of possible psychological market reactions, Mr. Hayes'
feeling was that the longer the Committee permitted the freezing of inter
est rates to persist the worse its position became for taking action later.
Mr. Daane said, in reference to Mr. Hayes' comment on his (Mr.
Daane's) proposal for the directive, that it had been his intention to
call for a continuation of the present firmer money market conditions with
the clear understanding that somewhat higher bill rates might eventuate,
particularly since the Treasury would be coming into the market and
corporate demand for bills was expected to be light.

In his judgment the



language he had suggested would not be inconsistent with a slightly higher
bill rate.

As he conceived it, however, this language would be inconsist

ent with negative free reserves.

He felt strongly that negative figures

would produce major expectational effects in the market.

He had suggested

a target range of zero to $100 million rather than zero to $50 million in
order to reduce the probability that a negative figure would be produced
Mr. Hayes noted that the Committee's, previous directive had called
for "maintaining about the same conditions in the money market" and that
there had been some small changes within the context of that directive.
In his opinion, if the consensus favored a modest further firming the
directive issued at this meeting should say so explicitly.
Mr. Mitchell concurred in this view.

He noted that what was at

issue was the question of a change in policy.

To sharpen the focus on

this question, he said, the alternatives posed might best be the original
staff draft and the language proposed by Mr. Hayes.
Mr. Robertson suggested that the Committee might best resolve the
issue by considering the following language:

"To implement this policy,

System open market operations shall be conducted with a view to maintain
ing slightly firmer conditions in the money market, while accommodating
moderate expansion in aggregate bank reserves."
Mr. Swan commented that this language still left a great deal of
uncertainty with regard to the targets implied.
that this problem was unavoidable.

Chairman Martin remarked

He thought it was the intent to suggest



trending, in a modest and gradual fashion, toward zero but not negative
free reserves, giving due consideration to the tone and feel of the market.
The objective was to achieve a very modest firming.
Mr. Hayes said the Committee must recognize that once free reserves
were brought close to the zero level, human skill was not adequate to
guarantee that negative reserves might not result inadvertently.

He agreed

that it clearly was the intent to avoid negative figures if possible.
Mr. Daane said he would not subscribe to the conclusion that the
Committee was prepared to accept the possibility that negative free re
serves might inadvertently result in, say, two or three successive state
ment weeks, because he would expect such a development to produce an
adverse reaction in the market.

In his judgenent it would be hard to

trend down from a level of free reserves that already was near $60 million.
Mr. Hayes replied that Mr. Daane evidently did not want to change policy
from what it was now.

Mr. Daane agreed, saying that within the present

policy posture he was willing to accept

the slightly firmer conditions

that had come about.
After further discussion, Chairman Martin suggested that the
Committee vote on a directive with a first paragraph as proposed by the
staff and with a second paragraph as suggested by Mr. Robertson.
Thereupon, upon motion duly made
and seconded, the Federal Reserve Bank of
New York was authorized and directed,
until otherwise directed by the Committee,

to execute transactions in the System
Account in accordance with the following
current economic policy directive:



It is; the Federal Open Market Comittee's current policy
to accommodate moderate growth in the reserve base, bank credit,
and the money supply for the purpose of facilitating continued
expansion of the economy, while fostering improvement in the
capital account of U.S. international payments, and seeking to
avoid the emergence of inflationary pressures. This policy
takes into account the continued orderly expansion in economic
activity, and essential stability in interest rates, unit labor
costs, and commodity price averages, including the moderate
reactions in markets generally to military incidents in the
Far East and Mediterranean. It also gives consideration to
the recent. improvement in rates of unemployment and industrial
capacity utilization, the substantial increases in the money
supply in June and July, and the large U.S. balance of payments
deficit in July.
To implement this policy, System cpen market operations
shall be conducted with a view to maintaining slightly firmer
conditions in the money market, while accommodating moderate
expansion in aggregate bank reserves..
Votes for this action: Messrs.
Martin, Hayes, Balderston, Hickman,
Mills, and Shuford. Votes against this
action: Messrs. Daane, Mitchell,
Robertson, Swan, and Wayne.
Chairman Martin commented that he knew everyone present appreciated
the importance of preserving the confidentiality of Open Market Committee
deliberations and decisions.
It was agreed the next meeting of the Committee would be held on
Tuesday, September 8, 1964.
Thereupon the meeting adjourned.