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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, D. C., on Tuesday, August 18, 1970, at 9:30 a.m.

Mr. Burns, Chairman
Mr. Hayes, Vice Chairman

Mr. Brimmer
Mr. Daane
Mr. Francis
Mr. Heflin
Mr. Hickman

Mr. Maisel
Mr. Mitchell
Mr. Robertson

Mr. Sherrill
Mr. Swan
Messrs. Galusha, Kimbrel, Mayo, and Morris,

Alternate Members of the Federal Open
Market Committee
Messrs, Clay and Coldwell, Presidents of the Federal
Reserve Banks of Kansas City and Dallas,
Mr. Broida, Deputy Secretary
Messrs. Kenyon and Molony, Assistant Secretaries
Mr, Hackley, General Counsel
Mr. Partee, Economist
Messrs, Axilrod, Craven, Garvy, Hocter,
Parthemos, Reynolds, and Solomon, Associate
Mr. Coombs, Special Manager, System Open Market
Messrs. Bernard and Leonard, Assistant Secre
taries, Office of the Secretary, Board of
Mr. Cardon, Assistant to the Board of Governors
Mr. Coyne, Special Assistant to the Board of
Mr. Williams, Adviser, Division of Research and
Statistics, Board of Governors

Mr. Wendel, Chief, Government Finance
Section, Division of Research and
Statistics, Board of Governors
Miss Eaton, Open Market Secretariat Assistant,
Office of the Secretary, Board of Governors
Mr. Melnicoff, First Vice President, Federal
Reserve Bank of Philadelphia
Messrs. Eisenmenger and Tow, Senior Vice Presi
dents, Federal Reserve Banks of Boston and
Kansas City, respectively
Messrs. Sternlight, Brandt, Scheld, Nelson,
and Green, Vice Presidents, Federal Reserve
Banks of New York, Atlanta, Chicago,
Minneapolis, and Dallas, respectively
Mr. Bowsher, Assistant Vice President, Federal
Reserve Bank of St. Louis
Mr. Gustus, Economic Adviser, Federal Reserve
Bank of Philadelphia
Mr. Sandberg, Securities Trading Officer,
Federal Reserve Bank of New York
Chairman Burns noted that Mr. Mayo was attending his first
meeting of the Federal Open Market Committee today and said he was
happy to welcome him to the Federal Reserve family.
Secretary's note: Advices had been received
of the election by the Federal Reserve Banks
of Cleveland and Chicago of Mr. Robert P.
Mayo, President of the Federal Reserve Bank
of Chicago, as alternate member of the Fed
eral Open Market Committee to represent those
Federal Reserve Banks for the balance of the
one-year term expiring February 28, 1971;
and it appeared that Mr. Mayo was legally
qualified to serve. Mr. Mayo had executed
his oath of office prior to this meeting.
By unanimous vote, the minutes of
actions taken at the meeting of the Fed
eral Open Market Committee held on July 21,
1970, were approved.

The memorandum of discussion for the
meeting of the Federal Open Market Com
mittee held on July 21, 1970, was 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 21 through August 12, 1970, and a supplemental
report covering the period August 13 through 17, 1970.

Copies of

these reports have been placed in the files of the Committee.
In supplementation of the written reports, Mr. Coombs said
that since the last meeting of the Committee there had been sizable
flows of funds into most of the continental European currencies
as well as the Canadian dollar.

As American banks had reduced

their borrowings from their London branches, Euro-dollar market
conditions had eased substantially.

Meanwhile, credit had remained

tight in most of the continental markets.
Earlier in the period, Mr. Coombs continued, the Euro
dollar market became particularly attractive to German industrial
borrowers and the subsequent heavy inflows of dollars into Germany
began to erode the restrictive credit policy of the German Federal

Last week the Federal Bank took strong countervailing action

in the form of higher reserve requirements, and the prospective new
squeeze on German bank liquidity might soon induce a new cycle of
German industrial borrowing abroad.

Aside from frustrating the



credit policy of the Federal Bank, such shifts of funds from the
Euro-dollar market into Germany were seriously aggravating the U.S.
deficit on official settlements account.

On the other hand, those

shifts did not appear to be creating potential operating problems.
As the members might recall, the Germans had sold $500 million in
gold to the U.S. Treasury last winter on the understanding that they
could buy that amount back at any time.

There were no indications

that they were thinking of exercising that option, or even of asking
the United States to draw on the swap line or to go to the Fund.
However, Mr. Coombs observed, some operational problems were
arising in connection with the Swiss franc.

Several weeks ago an

informal agreement had been reached with the Swiss National Bank to
liquidate the System's Swiss franc swap debt of $185 million through
a package arrangement involving a Treasury sale of $50 million of
gold and Federal Reserve use of $15 million of Swiss franc balances.
For its part the Swiss National Bank undertook to hold on an uncov
ered basis the remaining $120 million now covered by an exchange
guarantee under the swap.

The gold sale had gone through last Fri

day, August 14, and the remainder of the transaction would be
executed as soon as the market rate reached a level at which neither
the Federal Reserve nor the Swiss National Bank would suffer a loss
on the deal.

Meanwhile, however, the Swiss National Bank had taken

in still another $100 million, which would push their uncovered
dollar position to a new peak of $800 million.

Mr. Coombs thought there was some likelihood that the over
all strength of the Swiss balance of payments position, combined
with tight money market conditions, would continue to pull dollars
into Switzerland.

Those inflows could suddenly assume massive pro

portions if speculation developed over current legislative propos
als that would permit the Swiss Federal Council to alter the Swiss
franc parity without prior clearance with the Swiss Parliament.


thought, however, that the System could probably count on the cooper
ation of the Swiss National Bank in avoiding any undue pressure on
the dollar if such heavy inflows into Switzerland should materialize.
Mr. Coombs noted that the System also had had to draw a
total of $160 million on its Dutch guilder swap line, leaving a
margin of only $140 million available.

The Dutch balance of pay

ments position had been fairly strong for many months past, but
the recent heavy flow of funds into Amsterdam mainly reflected
speculation on a revaluation of the guilder.

Market sources

generally attributed that flurry of speculation to a recent report
of the Organization for Economic Cooperation and Development which
implied that it might have been well for the Dutch to have revalued
at the same time as the Germans.
Mr. Coombs reported that System debt in Belgian francs had
reached the $85 million mark as the Belgian current account
position had recently shown

surprising strength, with perhaps also

some sympathetic reaction to speculation on the guilder.

There had



also been a fair amount of market speculation in the Canadian dollar
where the rate immediately reflected every new rumor and was provid
ing the more skillful of the market operators with many profit-making
In the case of Italy, Mr. Coombs continued, the tourist
season had reduced the drain on the Bank of Italy's reserves well
below that of earlier months, but the lira remained seriously
threatened by the combination of a deteriorating current account bal
ance and capital flight.

The dollar balances of the Bank of Italy

had now been reduced to a level at which the Bank would soon have
to consider whether to reactivate the swap line or to make a new
drawing on the International Monetary Fund.

In view of the diffi

culties the Italians faced in holding a government together, much
less those of devising an effective stabilization program, the Bank
of Italy might prefer to approach the Federal Reserve first.


Bank of England might also find itself compelled before long to
draw upon the swap line.

Sterling was beginning to sag once again

as exports seemed to have leveled off while imports were continuing
to rise.

He noted in that connection that the rate of wage infla

tion in Britain was becoming one of the highest in Europe.


a third possibility, to which he was alerted only yesterday, might
be activation of the swap line by the Bank of Mexico.

The death

last Friday of Governor Rodrigo Gomez, and the resignation of the
Minister of Finance, Ortiz Mena, had simultaneously taken from the



Mexican scene two unusually competent officials.

The Bank of Mexico

might want to counter any disturbance in Mexican financial markets
by strengthening Mexico's dollar reserve position through a swap
In general, Mr. Coombs said, he could see imbalances devel
oping in the exchange markets which would probably require extensive
financing through the swap network between now and year-end.


the exception of the United Kingdom, however, there were available
to each country involved very sizable backstop facilities in the
way of Fund quotas and SDR's which could be used, if necessary, to
pay off swap debt within the traditional maturity schedule.
By unanimous vote, the System
open market transactions in foreign
currencies during the period July 21
through August 17, 1970, were approved,
ratified, and confirmed.
Chairman Burns then invited Messrs. Brimmer, Hayes, and
Galusha to report to the Committee on their recent foreign trips.
Mr. Brimmer noted that he had been abroad almost all of the
time since the date of the Committee's preceding meeting, having left
the country that afternoon and not returning until two days ago.
He had spent three weeks of that period in Africa, followed by three
days in Denmark.

Since he expected to complete a written report

on his African trip by next week and would have copies distributed
to Committee members, he would touch on only a few highlights today.


Mr. Brimmer observed that he had visited a number of African
central banks, and had delivered an address in Liberia.

In that

country the U.S. dollar was still circulating as the official cur
rency, and the question of whether or not to establish a central
bank was being debated in and out of government.
be resolved next year.

That issue would

All African countries had been extremely

disappointed with the basis that had been chosen by the Interna
tional Monetary Fund for allocating Special Drawing Rights; they
had favored an alternative basis under which developing countries
would have received a larger share of total SDR's and could have
applied them to development financing.

Another subject he had

discussed was the planned African Development Bank.

At some point

the United States would have to make a decision regarding the basis
on which it would participate in that bank.
In Denmark, Mr, Brimmer continued, he had visited the
National Bank and talked with officials about a number of matters.
During his stay in Denmark there were news stories regarding a report
in a magazine (International Commerce) published by the U.S. Depart
ment of Commerce which presented an extremely critical assessment of
the Danish economy.

Both the American Embassy and the National Bank

had expected a question to be raised during the press conference he
held following his meeting with the Board of Governors of the
National. Bank.

In particular, the latter thought a question might

be raised as to how the Federal Reserve would view its swap line



with the National Bank if the position of the Danish balance of
payments was as bad as reported.

However, that question was not

asked. On an unrelated matter, Danish officials were somewhat
concerned about the possibility of demonstrations by radical ele
ments from Sweden, France, and Germany during the Bank and Fund
meetings in September, and they were making plans to cope with any
such activity.
Mr. Hayes noted that on his recent visit to the Soviet
Union he had been accompanied by Mr. Garvy, and that Mr. Galusha
had joined them for part of the time.

The primary purpose of the

trip, insofar as Mr. Garvy and he were concerned, was to get
acquainted with senior officials of the principal national finan
cial institutions of the U.S.S.R., and to learn something about
their policies and operations.

Mr. Garvy already knew a great

deal about those institutions and had met their leaders on his
previous trips, whereas he (Mr. Hayes) had arrived in Russia with
a minimum of background knowledge.
Mr. Hayes observed that they had visited the State Bank,
which performed all the central, domestic commercial, and savings
banking functions of the entire country and which had some 300,000

They also had called at the Ministry of Finance, the

Bank for Foreign Trade, and the International Bank for Economic
Cooperation--the last of which served as a sort of payments union
of the Eastern bloc countries.

In each case their reception had



been extremely cordial, and their hosts had made a real effort
to enlighten them--in some instances, at their request, through
visits to operating departments and branches in addition to oral
presentations and answers to their questions.

They had learned

a great deal, but he should mention two major qualifications.
First, the Soviet economic system was so highly controlled by
central authority that their concept of banking and credit policy
was rather far from that in the United States.

There were,

however, important similarities also--as in trying to stimulate
savings, effecting money payments throughout a huge country,
recognizing needs for mechanization, and so forth.

The second

qualification was that in Russia there was a powerful and inher
ited tradition of secrecy, which had limited sharply their ability
to get far beneath the surface in the conversations.

It was,

however, worth noting that the head of the Foreign Department of
the State Bank had taken great pains to inform them of the essence
of the agreement to create a Comecon Investment Bank, information
on which was to be released only after the end of their visit.
Mr. Hayes said that no specific requests or business pro
posals had been put to them at any time.

The Moscow Narodny Bank

blocked-account grievance had been mentioned, but the Russians
had promptly dropped the subject after his brief explanation as



to why the Federal Reserve was in no position to play any active
part in that matter.

They had received only negative replies

to the questions they raised in various offices as to the
prospects for ruble convertibility and Russian participationin
the International Monetary Fund and World Bank.

The Russian

officials seemed to regard their trip, as they did, as an effort
to develop some personal contacts that could lay the groundwork
for more concrete cooperation at some future date when the cir
cumstances might be more favorable.

It appeared clear that

the Russians would like to see more trade with the West and more
access to advanced Western techniques.
Mr. Hayes remarked that even a two-week stay in Russia
inspired one to think he could make a few accurate comments on
that huge and mysterious land.

There were many sharp contrasts

between things that struck one as impressive and hopeful and
those that created an image of desperate inefficiency.

But he

would not take the Committee's time now to go beyond that gener
Mr. Galusha observed that after Russia he had visited
Rumania and Hungary.

In both countries people had been cordial

and had given him warm receptions.

A number of people had pri

vately expressed views about the participation of their country



in the International Monetary Fund, and had indicated eagerness to
exchange information with U.S. officials on the workings of their
respective economies.

A great desire to develop trade and banking

relations was expressed at various levels.
Mr. Galusha added that he had prepared a written report on
his trip, copies of which he would be happy to supply on request.
Mr. Solomon then presented the following statement on inter
national developments:
As Mr. Coombs has mentioned, the German Federal Bank
last week announced a very high marginal reserve require
ment on bank liabilities--40 per cent on demand and
time deposits. At the same time, the special reserve
requirement on bank liabilities to non-residents was
The particular difficulty that was faced by the
German central bank is notable because it exemplifies a
general problem; namely, in a world in which private
capital is able to move readily and in huge amounts, how
can a country sustain a monetary policy that is signifi
cantly tighter or easier than in other countries? We
live in a world that is increasingly integrated insofar
as capital mobility is concerned but still far from
integrated in terms of fiscal policy and other influences
that cause differences in the degree of demand pressure,
capacity utilization, and inflation.
In the German case, tight monetary policy combined
with a high marginal reserve requirement on German
banks' borrowings from abroad led German businesses to
by-pass the German banking system and borrow directly
from foreign banks. A form of disintermediation was
occurring across Germany's borders. In the second quar
ter of this year, German business firms borrowed net
$500 million from abroad. The result was not only
to add considerably to Germany's reserves as the foreign
exchange was converted into marks for use in Germany,
but also to undermine the Federal Bank's effort to



restrict credit-financed expenditures in Germany.


Federal Bank has apparently now decided that it cannot

prevent the inflow of foreign funds and it has moved to
a highly restrictive policy designed to offset the
effects of the inflow. Whether it succeeds remains to
be seen. It is certainly possible, as Mr. Coombs has
suggested, that the capital inflow will accelerate.
It is worth noting the similarities--as well as
the differences--between the current German problem and
the problem the Federal Reserve faced last year when U.S.
banks were borrowing heavily in the Euro-dollar market
as a way around monetary restraint here in the United
States. Because of the special role of the dollar in
the international monetary system, the inflow of Euro
dollars did not increase over-all credit availability
in the United States. But the American banks with
branches abroad are also the major lenders to business
and their ability to borrow abroad no doubt blunted the
impact of Federal Reserve restraint on the availability
of loans to the business sector. When the Federal Reserve
imposed the marginal reserve requirement on Euro-dollar
inflows, we were able to apply it to head office borrow
ings from branches and to branch loans to American resi
dents. But the Federal Reserve was just as powerless
as the German Federal Bank to place an impediment on
direct borrowing from foreign banks.
There are, of course, still other channels by which
foreign funds can enter an economy and thwart the inten
tions of the monetary authorities.
Canada faced a similar problem before the authori
ties there decided to let the exchange rate float. They
feared that monetary measures designed to mop up inflows
of foreign funds would simply raise Canadian interest
rates, which would attract additional funds from abroad.
The problem is a general one.
If the problem concerned only the balance of pay
ments, it would be easier to cope with. That is, the
increases and decreases of countries' reserves that
result from capital flows induced by differential
monetary conditions could be handled by the swap net
work and other credit facilities and by an adequate
supply of reserves.
But the undermining of monetary policy is more
difficult to deal with.
What can be done about it?
One approach that has often been suggested is to
widen the margin for exchange rate fluctuation around
parities. If, instead of the present 3/4 or 1 per cent



margin up and down, the range of possible fluctuation
were, say, 2 per cent each way, greater insulation
between national money markets might result. At the
moment, however, the Common Market countries are talking
about narrowing margins among themselves. If they adopt
wider margins at all, it would only be when they can all
do it together against the dollar--and that may be far off.
Another approach is to impose controls or taxes of
one sort or another on capital flows. Certainly the
existing U.S. programs to restrain capital outflow,
although they are far from airtight, do help to pre
serve some autonomy for U.S. monetary policy: they
limit the outflow of U.S. capital at times when monetary
and credit conditions are relatively easy here.
Other countries may turn to some form of restraint
on inflows or outflows of capital as a way of preserving
some autonomy for their monetary policies. One can guess
that the German Federal Bank might have been pleased if
it had been possible in recent months to impose a tax
(a reverse Interest Equalization Tax) on borrowings
abroad by German businesses.
We shall certainly be hearing more and more about
this problem as time goes on. The OECD has begun a
study of it and it will soon be on the agenda of Working
Party Three.
While the United States is fortunate in that its
monetary policy is more immune than that of other coun
tries, we are certainly subject to the balance of pay
ments effects of capital flows induced by differential
monetary policy. For this reason, as well as our concern
for how other countries manage their monetary affairs,
I assume that American officials will want to participate
actively in the discussion of this problem in the various
forums where it is likely to arise.
Mr. Brimmer observed that U.S. banks had substantially
reduced their Euro-dollar borrowings recently--some, perhaps, to
levels below their reserve-free bases.

He asked for Mr. Solomon's

views regarding the near-term outlook for such borrowings and the
implications for monetary policy.


Mr. Solomon remarked that, as the members might recall,

he had commented on that question at some length in his state
ment to the Committee at its meeting in late May.

As he had

noted then, whether individual banks drew down their Euro-dollar
borrowings below the levels of their reserve-free bases would de
pend to a large extent on how dependent they expected to be on
the Euro-dollar market in the future; and that in turn would
depend in large part on their expectations with regard to rate
ceilings under the Board's Regulation Q.

On balance of payments

grounds, therefore, it would be desirable to keep banks uncertain
with respect to Q--although, of course, the Board's decisions in
that area should not be determined on those grounds alone.

On the

more general policy question, he did not think that the possibility
of short-term capital outflows should be an overriding considera
tion in the formulation of monetary policy.

In his judgment the

best policy stance from the balance of payments--as well as the
domestic--point of view was that which would avoid a deepening
contraction on the one hand and a resurgence of inflationary
pressures on the other.
The Chairman 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.


-16Mr. Partee made the following statement concerning economic

The economy currently is best characterized as being
on dead center. True, real GNP rose a bit in the
second quarter, but the increase--amounting to 0.6 per
cent, annual rate--was so small as to be insignificant.
Total industrial production has been unchanged for
three months now--May, June, and July--at a level about
3 per cent below the year-earlier peak, with recent
output increases in consumer durable goods and materials
offsetting further declines in business and defense
equipment. Manufacturers' new orders showed little
change during the second quarter, after having fallen
appreciably in the first. Employment has continued to
decline, with reductions in both manufacturing and
other lines and involving both production and office
workers. But even here the rate of new layoffs has sub
sided, and insured unemployment--a measure of the jobs
situation among experienced workers--has leveled off
at about 3.6 per cent of total covered employment.
The presumption now is that the economy will soon
be moving upward again, though the recovery may well be
delayed and distorted for a time by an auto strike
beginning in mid-September. Ignoring the auto strike
prospect, which is uncertain and which in any event
would be a temporary factor, the staff GNP projection
presents our judgment as to the structure and dimen
sions of the expected pickup. That projection envisages
a continued growth in consumption expenditures, at about
the first-half average pace, buoyed by the ending of the
surtax and some decline in personal saving from the high
second-quarter rate, in the face of slower expected
expansion in personal income. It depends importantly
on a fairly sharp recovery in housing, which already
seems to be under way, and on a gradual but marked
acceleration in State-local expenditures over the next
year. On the other hand, the projection allows for a
moderate decline in capital spending from this point on,
and for further declines in defense spending involving
both procurement and manpower. Inventory investment is
seen as an essentially neutral factor until at least
early 1971, although there will be cross-currents in
product classes and undoubtedly considerable month-to
month variation.



This projection naturally seems to me both reason
able and most probable among the alternative forecasts
that might be made at this time, but it must be recog
nized that there are important uncertainties in the
current situation. The most vital, in my view, concerns
business capital expenditures. A downturn now seems
clearly in process, but we have very little to go on as
to how sharp or extended it will prove to be. Virtually
all of the factors thought to influence capital spending
plans are negative. Markets are soft, profits are down,
external funds are still costly and difficult to obtain,
liquidity is strained and balance sheets heavy with
short-term debt, and capacity is more than ample every
where except in the utility and perhaps the fuel
industries. We have had a protracted period of relatively
heavy capital investment, and businessmen must surely
now be less optimistic about the resumption of rapid real
growth in their markets.
The situation seems in many respects similar to
that in late 1957, following which plant and equipment
expenditures dropped 20 per cent over the next four
quarters. On the other hand, new orders for business
capital equipment have declined only moderately to date,
with second-quarter order volume 8 per cent below the
fourth-quarter 1969 peak, and none of the spending
surveys--though all are out of date--has given any
indication of a sharp break in spending. Accordingly,
we have reduced capital spending over the next year by
only 4-1/2 per cent--perhaps 9 or 10 per cent in real
terms--though we recognize that the risk is in the direc
tion of a larger decline. If a significantly greater
reduction should develop, of course, there would be
important secondary effects on consumption, inventory
investment, and capital spending itself.
A second major uncertainty concerns the degree of
strength that may reasonably be expected of consumer
spending. We have followed a middle course in this area,
I think, so that consumption could turn out either
weaker or stronger than we have projected. July retail
sales data do not provide much evidence one way or the
other. The advance report is that sales rose moderately,
after two months of little change. However, sales in
that month could have benefited from an initial response
to the ending of the surtax and efforts to beat the
price rise for 1971 model cars; and the indicated riseless than 1 per cent--was not very large in any event.



The case for relative weakness in retail sales is based
on the proposition that consumers remain gloomy, that
family budgets are hard pressed by inflation, that
investors have been hurt by the stock market decline,
and that there is widespread concern about possible
unemployment or reductions in earnings. The case for
greater strength is that consumers have been conserva
tive in their spending for a long time, and that
attractive new merchandise or bullish national or inter
national news developments could quickly bring them out
of their lethargy. We have assumed simply that the
personal saving rate will gradually decline, partly
because it was lifted in the second quarter by special
income supplements that were not immediately spent
and partly because a declining saving rate has typ
ically resulted from a slowing in income growth such as
we have projected.
If the outlook is one of essentially neutral con
sumer behavior and declining business investment, which
we believe to be the case, much will depend on actually
getting the projected increases in housing and State
and local spending. The situation in housing looks
quite favorable, with savings flows to the depositary
institutions much improved recently and building permits
already turning up. The sharp July rise in housing
starts--occurring entirely in multi-family unitsshould probably be regarded as an aberration, but even
so starts are well above the winter lows. Further
increases in residential building seem certain over
the year ahead, although there is no way of knowing how
important high interest rates and restrictive credit
terms, as well as sharply rising construction costs,
will prove to be as constraining factors. Similarly,
there appears to be a large backlog of State-local
capital projects, although the extent to which high
interest rates and limited prospects for increased
revenues may serve to hold back such programs is not
yet evident.
I want to emphasize once again that, even if
spending in these areas does accelerate sharply and the
staff projection is generally borne out, we do not an
ticipate a rapid rebound in economic activity. Real
growth in the second half of 1970 is expected to be at
an annual rate only a little above 2 per cent, barring
an auto strike, and then to accelerate to a rate
slightly above 3 per cent in the first half of 1971.



Such an increase would be below growth over the same
period in the economy's capacity to produce. It would
be associated with a further moderate decline in util
ization of plant capacity and, given the current
emphasis on cost cutting and the prospects for improve
ment in productivity, unemployment would undoubtedly
continue to trend upward. Moreover, the upturn would
be starting from a point where there is substantial
underutilization of resources, as evidenced by a 5 per
cent unemployment rate and an operating rate in
manufacturing estimated at well under 80 per cent of
capacity. In these circumstances, there is virtually
no risk that economic recovery over the year ahead
would add to the inflationary problem through stimula
tion of excess--or even robust--demand in product or
labor markets.
It seems to me, therefore, that the need for
stimulative public economic policies is clearly indi
cated. Such policies could generate additional demand
for unused resources, and they would provide some
insurance against an unexpected deterioration in the
private sector, such as in capital spending. Fiscal
policy has turned increasingly stimulative in recent
weeks and months, but our projections are still for a
substantial surplus on a high employment basis in the
first half of 1971, even after allowing for another
Federal pay raise. This surplus would still be some
what higher than in calendar 1969, when public policy
was aimed at slowing the economy.
Monetary policy has also been moderately stimula
tive this year, as reflected not only by growth in the
money supply fluctuating around 4 per cent but also by
the recent actions freeing up bank credit flows and by
the irregularly downward movement in short- and long
term interest rates. I still believe that there is a
need for more rapid monetary expansion, however, and
for a more substantial decline in interest rates.
Therefore, I continue to favor the adoption of alterna
tive B of the directive drafts.1/ This, in combination
with the Board's reserve requirement action yesterday,

1/ The alternative draft directives submitted by the staff
for Committee consideration are appended to this memorandum
as Attachment A.



would provide the basis for a financial market environ
ment conducive to a more certain, and a more satisfactory,
recovery in the economy over the next year or so ahead.
Mr. Axilrod made the following statement concerning finan
cial developments:
Three distinctive tendencies appear to have char
acterized financial markets in recent weeks. One has
been the very large net inflows of funds to bank and
nonbank savings institutions. Banks have, of course,
bid rather aggressively for money market oriented funds
through offerings of large negotiable CD's. In late
June and in July they added, net, about $1 billion per
week to such liabilities. In the first half of August,
however, banks have become considerably less aggressive
in the CD market--either because their initial restocking
after the suspension of Regulation Q ceilings on short
maturity CD's had gone far enough in light of expecta
tions as to interest rates or loan demand or simply
because they may have begun to fear a further shortening
of the CD maturity structure.
At the same time as banks have bid for a large volume
of CD funds, net inflows of other time and savings deposits
have also increased very rapidly. In July, such deposits
rose on average by almost $3 billion, or at a seasonally
adjusted annual rate of about 18 per cent, one of the
largest increases since we have had the series. Paral
leling this time deposit increase at banks, net inflows
of deposits to savings and loan associations and mutual
savings banks were at a 12 per cent annual rate last
month, well above the 7 per cent rate of the second
quarter, and the largest monthly increase since
April 1967.
A second tendency evident in financial markets
recently has been for the decline of interest rates that
had been under way earlier in the summer to show distinct
signs of hesitation. In corporate bond markets during
the past week yields have backed up under the weight of
a continuing very large actual and prospective volume
of public bond offerings. At a little above 8-1/2 per
cent on new high-grade offerings, corporate bond yields
are currently well below their early summer highs but
they remain more than 30 basis points above their lows
of earlier in the year. And, reflecting the recent



weakness in the corporate market as well as the sizable
overhang of new Treasury issues in dealer hands, yields
on intermediate- and long-term Treasury notes and bonds
remain about 60 basis points above their late-winter and
early-spring lows. In the municipal market yields have
dropped fairly substantially in the weeks since the last
FOMC meeting, but there too they remain about 35 basis
points above earlier lows.
With the summer decline in long-term market inter
est rates appearing to have lost its momentum, and with
that momentum not having carried such yields even back
to lows of earlier in the year, traditionally sticky
mortgage interest rates have remained quite sluggish
despite large net savings inflows to thrift institutions.
The recent decline in the implicit yield on 6-month FNMA
commitments may presage some general reduction in inter
est rates on home mortgages themselves. But the yield
spread of home mortgages over corporate bonds has not
yet improved sufficiently to suggest a very sizable
shift toward this type of mortgage under current circum
stances on the part of diversified lenders.
A third characteristic of financial markets recently
has been the continuing tendency of investors to shy away
from lower-quality investments. In the commercial paper
market, major financial institutions do not appear to be
having much difficulty rolling over maturities, but
many less-than-prime borrowers apparently are--and, in
total, nonbank-related paper outstanding has dropped by
about $2-1/2 billion over the past two months on the
basis of preliminary data and after allowance for the
traditional seasonals. Investors in the corporate bond
market have also become more selective, as illustrated by
the further widening in the yield spread between outstand
ing Baa and Aaa bonds from around 95 basis points at the
time of the last FOMC meeting to around 130 basis
points currently.
These various characteristics of financial markets
in recent weeks seem to reflect rather generalized pre
cautionary attitudes. Consumers appear to be placing
funds in the safest forms of saving, at the expense
of market instruments and perhaps to a degree at the
expense of current consumption. And those investors
choosing market instruments are becoming quite selective.
Meanwhile, corporations are still attempting to restruc
ture debt and seemingly to rebuild liquidity. While all
this certainly cannot be taken as evidence of a liquidity



crisis, it does add up to an economy whose demands for
liquidity, and safety, in one form or another, are large.
For monetary policy, this would seem to indicate the
need for an above-average generosity in supplying reserves
and money and, what is of course closely related, an
effort to make credit more generally available. This
would encourage interest rate declines and a wider dis
tribution of credit supplies. With cautionary attitudes
prevalent, I doubt that the resulting dispersion of
funds, at declining rates, through mortgage, State and
local government, consumer, and business debt markets
would generate inflationary expectations and I believe
that the greater diffusion of credit would give more
assurance that the projected recovery in economic
activity will indeed be achieved.
While it is obviously too early to say much, if
anything, about the immediate market impact of the
Board's just-announced modest net reduction in reserve
requirements, one might expect the announcement to lead
to some little easing of credit markets. This might
develop in anticipation of the marginal improvement in the
reserve positions of the great bulk of member banks. But
any significant easing of credit markets is likely to
depend on the nature of accompanying open market opera
Under current economic conditions, and given the
financial developments noted earlier, I would tend to
think that a continued effort to seek money supply growth
up in a 5 to 6 per cent annual rate range would produce
a set of credit market conditions that would accommodate
liquidity and precautionary demands for funds while also
encouraging flows of credit to help stimulate needed
additional spending in such areas as construction and
State and local government services. The reserve require
ment reduction would complement such an open market
policy by encouraging banks to move more actively into
mortgages and State and local government securities, and
in the process contributing to money supply expansion.
But to assure the desired money supply growth and the
enhanced availability of credit, and to move long-term
interest rates down from the still historically high
levels, it will probably prove necessary to permit some
further easing of money market conditions over the next
four weeks--an easing that might be characterized by
first moving the Federal funds rate down to around 6-1/2
per cent or so.


In reply to a question by Mr. Morris, Mr. Axilrod remarked

that the projections of housing starts given in the green book 1/
probably would have to be raised somewhat if savings inflows to
thrift institutions were maintained at something like the recent

Mr. Partee added that it was unlikely that savings balances

at nonbank institutions would continue to grow at the 12 per cent
annual rate recorded in July.

However, the staff's current pro

jections of housing starts were only a little higher than those
presented in the June chart show, and those projections had been
associated with growth in savings at nonbanks at a 7 per cent

If growth continued at, say, a 9 or 10 per cent rate, hous

ing starts might well be higher than now projected.
Mr. Hickman asked whether the market might have difficulty
in digesting the expected large supply of corporate and munic
ipal securities even if the Federal funds rate was moved down
to about 6-1/2 per cent and other money market rates adjusted
Mr. Axilrod said he thought that such a reduction in the
Federal funds rate--following the Board's reserve requirement
action, as modest as it was--would make it considerably easier

to market the forthcoming corporate and municipal offerings.


would also reduce the likelihood of anxious selling of Treasury
1/ The report, "Current Economic and Financial Conditions,"
prepared for the Committee by the Board's staff.



notes and bonds by dealers, although one could not guarantee that
such selling would not occur in any case.
Mr. Mitchell noted that in connection with directive
alternative B the blue book1/ specified a growth rate for money
of 6 per cent in the fourth quarter.

While one might agree that

a temporary acceleration of growth in money was desirable, he
wondered whether it was necessary for the Committee to commit
itself now to a 6 per cent rate through the end of the year.
Mr. Partee expressed the view that adoption of alterna
tive B today would not involve such a commitment, since the
Committee could change its target at subsequent meetings.


staff had included data for the fourth quarter in the current
blue book because the third quarter was now about half over, and
one needed to show what a new path of growth would entail.
Mr. Axilrod added that the Committee's policy decisions
for each inter-meeting period presumably were facilitated by infor
mation on the longer-run paths for money that appeared consis
tent with various short-run growth patterns.

He then noted that

he personally had recommended an annual growth rate for money
in the range of 5 to 6 per cent, a range much like that approved
at the previous meeting.

1/ The report, "Monetary Aggregates and Money Market Condi
tions," prepared for the Committee by the Board's staff.


Chairman Burns commented that the money supply target the

Committee had adopted at its previous meeting was more accurately
described as a 5 per cent growth rate--subject to the significant
qualification that, if there were any deviations, the Committee
would prefer that they be in the upward direction.

As to the

short-run growth patterns for money, he thought there was remark
ably little difference between the weekly figures set forth in
the blue book under alternatives A and B for the period until the
next meeting.

Those figures were identical through the week

ending September 2, and in the two subsequent weeks they differed
by only $200 million--an amount that might be considered negli
gible, given the magnitude of estimating errors.
Mr. Axilrod observed that the identity in the two sets
of money supply figures through the week ending September 2
reflected the staff's assumption that changes in money market
conditions would affect the growth rate of money only with some

The difference between the two average growth rates shown

for the month of September--4-1/2 per cent under alternative A
and 6 per cent under B--was a meaningful one, he thought.


over, the change in money market conditions needed to move toward
the more rapid money growth rate under alternative B was suf
ficiently great, in his judgment, to have a considerable impact
on the general atmosphere in financial markets almost as soon
as the change was effectuated.


Mr. Daane remarked that while the Committee formerly had

been charged with "money market myopia" he thought it now was
guilty of "monetary aggregate myopia."

In his judgment the recent

sharp focus on what struck him as relatively small differences in
aggregate growth rates was misplaced; the need now was not to
achieve some predetermined rate of growth of money but rather to
move the economy off dead center by reducing interest rates and
increasing reserve availability.

To sharpen the issue, he would

ask the staff what course they would expect open market opera
tions to take if it turned out that, say, a 6 per cent growth
rate in money was attainable with no change from prevailing money
market conditions.
Mr. Partee replied that that was a question of policy to
be decided by the Committee.

More generally, he thought it should

be noted that the alternative possible growth rates for money set
forth in the blue book were, at bottom, simply indexes to alterna
tive sets of monetary conditions--sets which included financial
market as well as monetary aggregate variables.
Mr. Axilrod agreed that the question Mr. Daane had posed
was a policy matter.

If asked

for a recommendation, he would

suggest that prevailing money market conditions be maintained if
they should prove to be consistent with a 6 per cent growth rate in

He did not think that outcome was very likely, however.



Mr. Maisel noted that the Desk had acted to ease money
market conditions in the period since the previous meeting of
the Committee--because, as he understood it, growth in money
appeared to be falling below target.

He suspected that condi

tions were easier now than they would have been if at the July
meeting the Committee had been employing the type of money market
target it had used prior to this year.
Mr. Daane commented that if the Committee had been employ
ing a money market target at its previous meeting it might have
instructed the Desk to "err on the side of ease," as it often had
in the past.

He asked whether the outcome would have been differ

ent in that event.
Mr. Sternlight replied that in this particular period the
outcome probably would not have been appreciably different.
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 domestic open market operations for
the period July 21 through August 12, 1970, and a supplemental
report covering the period August 13 through 17, 1970.

Copies of

both reports have been placed in the files of the Committee.
In supplementation of the written reports, Mr. Sternlight
commented as follows:
The past several weeks have been characterized
by relative calm in the financial markets, compared
with the threatened turbulence earlier in the summer,



in the wake of the Penn Central insolvency and the sub
sequent rechanneling of funds normally going through the
commercial paper market. In the commercial paper market
itself, the total outstanding volume has tended to
stabilize, both for dealer-placed and directly-placed
paper. However, some issuers are finding it difficult
to regain their previous share of the market and to pay
off bank debt to the extent they would like. And a few
have continued to lose ground as investors remain wary
and selective. So, while quiescent, one cannot dismiss
the possibility of fresh difficulties from this sector.
Elsewhere in the financial markets, a notable
development of the recent period was the Treasury's
successful combined refunding-cash raising operation.
The public subscription for more than $2.8 billion of
a 3-1/2-year issue and over $1.7 billion of a 7-year
issue offered in the exchange testified to some con
siderable measure of market confidence in current rate
levels in the intermediate-term area, while the heavy
subscription for the 1-1/2-year note enabled the Trea
sury to raise more than $2 billion of net new cash
after covering attrition on the exchange portion of the
operation. A possible cloud in front of this silver
lining is that the dealers still have a substantial
inventory of the three new issues. Their holdings were
nearly $1.4 billion the day after the subscription books
closed on August 5. By last Friday the total had come
down to about $1.1 billion--indicating some progress,
but with a substantial distribution job remaining to be
done. The dealer holdings as of Friday included a little
over $500 million of the 7-year issue.
The market in intermediate-term Treasury issues,
which was the area in which the Treasury financed, was
firm through most of the period, with the new issues
trading at premiums as much as 1/2 point above the offer
ing price. Toward the close of the period prices eased
back and the premiums declined, but did not entirely
In the longer-term capital market the recent period
showed mixed results. There was a net decline in tax
exempt yields which was aided by bank buying in the wake
of enlarged deposit resources and more permissive Internal
Revenue guidelines. But there was a rise in corporate
yields which partly reversed the price rally earlier in
the summer, as additions to the forward calendar disap
pointed earlier expectations of an abatement in demand
for long-term financing. A sizable volume of long-term



Federal agency financing is also adding to the competi
tion for long-term investment funds. The market is
having some difficulty in digesting a $300 million issue
of 15-year Farmers Home Administration mortgage partici
pation notes, while a $200 million 20-year issue of
mortgage-backed bonds guaranteed by the Government
National Mortgage Association was announced last week
for sale toward the end of this month.
Returning to the short-maturity end of the market,
Treasury bills have tended to rise a bit in rate despite
the slightly easier conditions of reserve availability
that I will mention shortly. This came about as dealers,
after rebuilding their inventories substantially in July
with the help of two Treasury auctions of tax-anticipa
tion bills, subsequently found investor demand a little
disappointing. Possibly, the competition with newly
issued bank CD's proved more formidable than it seemed
to be just after the Q ceiling was suspended on the
shorter maturities. Another factor, possibly, was the
return of some investors to the commercial paper market,
reducing the demand for Treasury bills from those who
had turned to them in the more immediate wake of the Penn
Central insolvency. In yesterday's auction of 3- and
6-month bills, average issuing rates were 6.53 per cent
and 6.59 per cent, respectively, up from 6.39 and 6.44
per cent the day before the last meeting.
A primary concern to the Account Management during
the recent period was the performance of the money supply
in relation to that anticipated at the time of the last
Committee meeting. We also looked at the credit proxy
and various reserve aggregates, but it had seemed clear
from the discussion that particular attention was to
be directed to the money supply, with the objective of
achieving about a 5 per cent growth rate--perhaps a
little more rather than a little less--in the current
quarter. As we found weekly results falling short of
the path projected to be consistent with the desired
quarterly growth rate, easier money market conditions
were permitted and then a little more aggressively
fostered. The Federal funds rate came down about 1/2
percentage point for the period on average and most

recently has been in the area of 6-5/8 to 6-7/8 per
This move, while distinct and becoming increas
ingly noticeable to the market, was undertaken cautiously
in view of the fact that New York Bank staff projections
continued to show a satisfactory growth rate for the



quarter, and in the light of indications that recent
money supply data might have understated the effective
money supply because of certain technical changes in
handling interbank payments. We do not yet have good
estimates of what the impact of these practices might
have been on the statistics. Adding to the uncertainty,
in the weeks ahead we may get some reversal of the impact
of certain of these practices which the major New York
City banks have been asked to stop.
Whether the recently somewhat easier money market
conditions have put us back on the desired path cannot
be said with certainty, although it may be noted that
the shortfalls from the path were declining as the period
progressed and the latest week is even estimated to have
slightly surpassed the path. Of course, not too much
should be made of a single week's result. To be reason
ably confident of achieving a growth rate of 5 per cent
or a little over, it would seem from our present vantage
point that the easier conditions of recent days should
be continued. If additional weekly data should continue
to suggest a shortfall from the Committee's objective
for the quarter then still further easing would be in
order. And, of course, a Committee decision to aim
for more rapid growth than was sought last time would
presumably call for a more distinct easing.
A point on which we would appreciate receiving any
guidance the Committee may have to offer is the weight
to be given to the credit proxy in the period ahead.
In the recent period that weight was minimal, and this
was probably a necessary concomitant of the uncertainty
we faced in assessing the reintermediation by banks to
fill the gap left by the shrinkage in commercial paper.
While some of that uncertainty remains, it may be that
the Committee would want to restore some of the atten
tion previously accorded to the proxy.
Yesterday's action by the Board on required reserves
was announced after the close of normal trading hours,
and as yet there is no general reaction to report. I
would expect, on balance, a constructive impact, with
the package as a whole probably taken to be a moderate
accommodative step. The impact of the added burden on
money market banks that have been active in issuing
commercial paper through holding companies should be
more than offset by the net release of reserves country
wide. The tax-exempt market may benefit particularly.
As for meshing this move with open market operations,
that question for the most part still lies ahead of us,



since apart from what one might call "psychological
impact" the specific reserve effects of the action do
not occur until October 1.
Chairman Burns stated that he wondered whether the reference
to "presumably" in a sentence about future policy was inadvertent.
He then referred to Mr. Sternlight's comment that the Desk had ex
ercised caution in its easing move partly because of the possibil
ity that statistical problems were producing a downward bias in
the money supply numbers.

He asked whether the current understand

ing of those problems was not still in the "guessing" stage.
Mr. Sternlight agreed that that was the case with respect
to the amount of the bias.

However, he thought the direction of

the bias was reasonably clear.
In response to the Chairman's request for comment,
Mr. Axilrod said that while the level of the money supply might
be biased downward because of the problem Mr. Sternlight had men
tioned, it was not clear whether or to what extent the magnitude
of that problem was increasing and, therefore, it was not clear
what the effect would be on the rate of change in the money

Moreover, there had been a sharp drop in Euro-dollar

borrowings over the past several weeks.

Data were not yet

available to determine how much, if any, of the decline might be
reflected in reduced overnight Euro-dollar borrowing; but to the
extent that it was, there might be some upward bias in recent
money supply figures--a counterpart to the apparent downward bias
known about for some time that was related to the practice of



running Euro-dollar transactions through Edge corporations.

In his

opinion, not enough information was available to support any state
ment about the nature of the net bias, particularly as it pertained
to short-term effects on the rate of change in the money supply.
Mr. Sternlight concurred in Mr. Axilrod's observations about
the uncertainty of the net impact on the short-term rate of change
in the money supply.
Chairman Burns expressed the view that no weight should be
given in open market operations to the possibility of bias in the
money supply numbers until the uncertainties that had been mentioned
were resolved.
Mr. Brimmer noted that in the past at about this time of
the year the staff usually had completed revisions of recent money
supply statistics--reflecting benchmark adjustments to call report
data, revisions of seasonal factors, and occasionally other adjust
ments needed to deal with accounting problems.

He asked when the

revised data might: be available this year.
Mr. Axilrod said he was not sure, but suspected that the
revisions would not be available until autumn--partly because it
was likely to take until then to develop adequate information on
the kinds of biases he had mentioned earlier.
Mr. Partee added that FDIC data from the mid-year call
reports, which were often used along with earlier call report data
to make benchmark adjustments for nonmember banks, were not


available as yet.

He thought it would be highly desirable to have

such data before completing the revision.
Mr. Brimmer said that until the revisions in question were
completed he would be dubious about the reliability of any projec
tions extending five months into the future.
Mr. Daane commented that the Committee seemed to be giving
the Desk an almost impossible assignment when it couched its instruc
tions in terms of a variable such as the money supply for which the
data were so uncertain.

In his judgment the Committee could have

accomplished much more in the direction of the desired degree of eas
ing recently if it had formulated its instructions in terms of money
market conditions.

He favored such a course today.


he proposed the following language for the second paragraph of the
To implement this policy, while taking account of
the effects of other monetary policy action, System open
market operations until the next meeting of the Committee
shall be conducted with a view to achieving somewhat
easier conditions in the money and short-term credit
markets; provided, however, that operations shall be
modified to resist any tendency for money to deviate
significantly from a moderate growth pattern.
In reply to a question, Mr. Daane said he personally would
like to see net borrowed reserves brought closer to zero.
Mr. Francis observed that, as he had understood the Com
mittee's instructions to the Desk at the preceding meeting, they
had involved giving consideration not only to the money supply but
also to money market conditions and the even keel constraint.
Having participated in the morning telephone conference call during



the past four weeks, he had closely observed the Desk's operations
from day to day; and it was his feeling that the Desk had done an
excellent job in carrying out a very difficult assignment.
Mr. Swan noted that Mr. Sternlight had asked whether the
Committee now wanted to have greater weight given to the bank credit
proxy in the conduct of open market operations.

In that connection

he (Mr. Swan) wondered whether the anticipated expansion in bank
credit was likely to reflect reintermediation for the most part, or
whether some significant proportion would involve a net increase in
total credit.
Mr. Axilrod replied that he had some difficulty with the
meaning of the concept of reintermediation.
time deposits had shown an unexpected surge.

Recently consumer-type
What was occurring,

he thought, was a movement into such deposits--partly as a result of
currently cautious attitudes--of funds that might otherwise have been
invested in market instruments, such as equities, or gone into

He would expect the rate of growth in total time

deposits to taper off, partly because banks--after they had made
their initial adjustment to the suspension of ceilings on short-term
CD's--were likely to become less aggressive in seeking large nego
tiable CD funds from such investors as businesses and State and local

In addition, consumers were likely to reduce their

rate of saving in the form of time deposits once the economy began
to improve and uncertainties about the outlook decreased.



Mr. Hayes expressed the view that the Committee should not
place undue emphasis on week-to-week fluctuations in the money supply,
which had relatively little significance; rather, it should focus on
the growth rate over a period of several months.

He then observed

that he was not sure that the possibility of a downward bias in the
money supply statistics should be ignored completely in the conduct
of open market operations.

Admittedly, there were uncertainties in

the matter, but he thought enough was known to justify giving at
least marginal weight to the possibility of such a bias.
Chairman Burns said he would favor ruling out that considera
tion completely until such time as the staff was prepared to advise
the Committee that there were reasonable grounds for indicating at
least the direction of the bias.
Mr. Hickman remarked that if the Committee were to adopt a
6 per cent growth rate for money as its target but the public desired
to expand its money holdings at, say, only a 4 per cent rate, the
additional reserves supplied presumably would show up in the form of
time deposits.

In light of that possibility it was not clear to

him that the Committee could rely on either money or bank credit
for purposes of formulating policy.
Mr. Axilrod said he did not believe any one measure--money,
bank credit, money market conditions, or whatever--could be taken as
a certain guide for policy.

While it was his opinion that in the

period since the Committee had been giving increased weight to the



money supply it had achieved better results than it had at times
in the past, he did not think there was a close, direct connection
between money supply and GNP.

It was his view that a given growth

rate for money served, in effect, as an index of policy and would be
associated with particular credit and general liquidity conditions
that in turn would affect GNP.
Mr. Partee remarked that if the Committee sought to make
money expand more rapidly than the demand for money was growing--as
Mr. Hickman had suggested might happen--interest rates presumably
would decline and this would encourage a substitution by investors
of time deposits for market instruments.

He noted that interest

rates on average had not in fact been moving down recently.
Mr. Hickman then said he thought it would be desirable at
present for the Committee to give consideration to interest rates
and conditions in securities markets as well as to the money supplyparticularly in light of the probable volume of capital market
financing over coming months and the need to foster a recovery in
the housing industry.
Chairman Burns noted that there were different methods of
measuring money supply growth rates for particular periods which
apparently were of equal validity but which nevertheless could give
different results.

For example, as noted in the current blue book

the monthly patterns for the third and fourth quarters associated
with alternative A for the directive involved annual rates of growth
of 5 per cent in both quarters, when the quarterly changes were



measured by comparing the levels in the final months of successive

When measured by comparing the average levels for the

full quarters, however, the growth rates were found to be 3.5 per
cent in the third quarter and 4.5 per cent in the fourth.
Mr. Heflin asked whether the publication of the July whole
sale price index had played any role in blunting the recent bond
market rally.
Mr. Sternlight replied that the initial headlines indicating
that the index had risen substantially might have had some effect on
attitudes of market participants.

However, whatever concern was

created diminished when it became clear that the component for in
dustrial commodities had increased only a little.

Mr. Axilrod

concurred in Mr. Sternlight's observation.
Mr. Coldwell said he agreed with Mr. Axilrod that the
Committee had made some progress recently with respect to policy

At the same time, he also agreed with earlier comments

to the effect that the Committee should emphasize growth rates in the
aggregates from quarter to quarter, rather than focusing on weekly
or monthly changes.
Mr. Brimmer referred to a statement in the blue book in
dicating that, if the Federal funds rate were consistently around
6-1/2 per cent in coming weeks, "expectational factors could be
generated which could increase bank and other investor demands for


debt obligations.

This might lead to interest rate declines on a

broader front...."

He asked whether such a reduction in the Federal

funds rate might not have the opposite effect of setting off interest
rate advances, by persuading market participants that the System
had given up in its efforts to control inflation.
Mr. Axilrod replied that he would expect such a result only
if investors thought the economic outlook was quite strong.
By unanimous vote, the open
market transactions in Government
securities, agency obligations,
and bankers' acceptances during
the period July 21 through August 17,
1970, were approved, ratified, and
The Chairman then suggested that the Committee turn to a
general discussion of the economic and financial situation and
Mr. Brimmer observed that he was deeply troubled by the
rapid growth in bank credit that had occurred in recent weeks and
that was projected for the period ahead.

In his view a continued

high rate of bank credit expansion might well regenerate expecta
tions of further inflation.

He thought that in making its policy

recommendations today the staff had not given enough weight to the
possible impact of the course it proposed on inflationary
Turning to the directive, Mr. Brimmer said that in his view
the instructions the Committee had issued at the previous meeting



were subject to misinterpretation.

He hoped the Committee would do

better in formulating its instructions today.
Chairman Burns said he disagreed with Mr. Brimmer's comment
on the directive.

Indeed, he thought the instructions the Committee

had issued at the previous meeting were clearer than any since he
had become a member.

They included three essential elements:


primary attention was to be paid to the money supply rather than to
bank credit.

Second, the target path involved a 5 per cent rate of

growth in money over the third quarter.

And finally, if there was

to be a deviation from the target path, it was the preference of a
majority of the members that it be in an upward direction.
Mr. Mitchell said he sympathized with the view that the
money supply alone was not a satisfactory guide to policy at this

He agreed with the staff regarding the desirability of

some increase in the growth rate for money, and he would be pre
pared to accept the 6 per cent rate recommended by Mr. Partee if it
proved consistent with the other policy objectives he had in mind.
However, he would not want to adopt such a growth rate in the second
half of the year as a specific target for policy.
At present, Mr. Mitchell continued, he thought monetary
policy should facilitate the necessary increases in residential
construction activity and State and local government outlays by
fostering expanded flows of funds to savings intermediaries and a



gradual softening of long-term interest rates over the next several

So long as those objectives were realized he would not be

concerned about the particular rate of growth in the bank credit

As to the directive, he favored revising the opening sentence

of alternative B to read as follows:

"To implement this policy, the

Committee seeks to promote gradually easing conditions in credit
markets and somewhat greater growth in money over the months ahead
than occurred in the second quarter, while taking account of per
sisting liquidity problems and allowing bank credit growth to reflect
a continued shift of credit flows from market to banking channels."
He would interpret "gradually easing conditions" as calling for a
Federal funds rate fluctuating around 6-1/2 per cent at the start.
Mr. Hayes indicated that his assessment of the outlook for
real economic activity differed little from that presented by
Mr. Partee today.

However, he (Mr. Hayes) was rather confident that

activity had already turned up and that the economy was no longer
at dead center.

He agreed that among the key expenditure sectors

determining the pace of the expansion would be housing, State and
local governments, and perhaps consumers.

There also could be an

important amount of stimulus from Federal spending, particularly
if there were a Government pay raise early next year, and from the
elimination of the inventory drag.

He hoped the rate of expansion

could be kept moderate and thought there was a reasonable prospect
of doing so.


Mr. Hayes observed that the stock market decline had had a

considerable, and in his view favorable, impact on expectations and in
particular on capital spending plans.

However, the evidence of a slow

down in the rate of increase in prices was tenuous at best.

He hoped

that continuing productivity gains would dampen the rise in costs,
but he found excessive wage demands and settlements to be a worrisome

He agreed with Mr. Brimmer that the danger of reviving

inflationary expectations was real and had to be taken into account by
the Committee.

While a sizable increase in bank credit in the last

month or two had been appropriate, in view of the shrinkage in the
commercial paper market following the Penn Central insolvency, he would
be troubled by continued rapid bank credit growth now that the com
mercial paper market seemed to be stabilizing.
Mr. Coldwell said that the level of economic activity ap
peared to be on a plateau and was likely to remain on a plateau with
perhaps some uptilt over the next few months.

He thought that con

siderable imbalances were developing in the economy--including sub
stantial wage-cost pressures and sizable unemployment--that might
prove inimical to sustained growth later.

If his assessment was

correct, an upturn in activity was more likely than a recession,
but the latter could not be ruled out.

In those circumstances he

would advocate a little stimulus from monetary policy but he felt
such stimulus should be of modest proportions.
Mr. Heflin said he agreed with Mr. Hayes that the economy
probably had bottomed out.

The important question at the moment



was how rapid the upswing would be.

He was concerned that the

economy currently was subject to the worst of two worlds--namely,
rising prices and rising unemployment.

He was in general agree

ment with the staff GNP projections for the remainder of the year,
although he thought the projected level of unemployment might be
too low.

In that connection he noted the continuing additions

to the labor force at a time when defense manpower needs were
being cut back and businesses were holding down their labor require
ments in a period of rapidly increasing wages and rising
On the other hand, Mr. Heflin continued, inflationary
expectations had not died out as attention continued to be focused
on inflationary wage settlements and rising price indicators. He
agreed with Mr. Sternlight that the reaction to the July increase
in the wholesale price index would have been much more pronounced
if the rise in the industrial component of the index had not been

It now appeared that inflationary expectations were

tied more to recent and prospective wage settlements than to any
feeling that demand was overly buoyant.

However, he did not

believe that the specific basis for the inflationary attitudes
made any difference so far as borrower and lender incentives were

Given that situation, he

thought monetary policy

should not get into a position of endorsing and validating cost
push inflation.



Mr. Morris commented that he agreed with Mr. Mitchell on
the need to focus on the level of housing and State and local
government spending, given the prospective weakness in plant and
equipment expenditures.

It would be helpful if the staff could

provide some guidance regarding the level of housing starts likely
to be needed in 1971 to meet over-all economic objectives; that
level might well be as high as 1.8 or 2.0 million starts.

He had

been impressed by the substantial rebound in starts in July--a
rebound that occurred as a result of improvement in the availa
bility of funds and despite continuing high interest rates.


thought the July experience suggested that the housing market had
considerable vitality.

In that connection he believed it would be

a mistake for monetary policy to try to nudge long-term interest
rates down.

As the experience of 1967 indicated, interest rates

would not remain at reduced levels unless investors became con
vinced that inflation had been brought under control.
Mr. Morris then said that as a member of the directive
committee he was extremely pleased with the progress the Open
Market Committee had made in that area.

Also, he agreed with

Chairman Burns that the directive issued at the previous meeting
was the clearest thus far.

The great advantage of directives of

the recent type was that they left far less room than earlier
directives for misunderstandings and disagreements regarding the



nature of current policy.

He thought the Desk and the staff were

to be commended for the manner in which they had adapted to the
new type of directive, and he personally would be unhappy if the
Committee were to return to directives of the old type.
Mr. Francis commented that it had been popular to criti
cize stabilization actions and the performance of the economy over
the past year.

However, given the strong inflationary momentum

gradually built up from 1964 through 1968, he believed that stabi
lization actions had, on the whole, been applied satisfactorily
and that the economy had performed as well as could reasonably
have been expected.
The rate of price increase had not been slowed much, if
at all, Mr. Francis remarked.

However, the rise had stopped

accelerating, and all econometric models now indicated that a
moderation of the upward price movement was likely this fall.
Cutbacks in real output had been much less than in other periods
when inflationary pressures were reduced.

Unemployment had

risen to 5 per cent of the labor force, but when spending was
rising fast enough to keep the unemployment rate at about 4 per
cent, strong upward pressure was exerted on prices and price

In the period from 1962 through 1964 unemployment

had averaged about 5-1/2 per cent of the labor force, and at the
cyclical peak between the 1958 and 1960 recessions the unemploy
ment rate had dropped no lower than 5 per cent.



Mr. Francis said that much of the current unemployment was
structural and could not be obviated except temporarily and with
adverse price effects by stimulation of total spending.

In view of

the strong inflationary momentum, and the lags in the effects of
monetary actions, quick results in obtaining relatively stable
prices and a reduction of transitional unemployment should not be

Attempts directed at rapid cures or fine tuning had

usually caused more serious problems later.
Mr. Maisel said he was somewhat surprised that Mr. Francis
had raised the issue of structural unemployment in his remarks today.
It was his belief that that question had been resolved some years
ago, and he hoped the debate was not about to be renewed.
Mr. Maisel then observed that the staff's projections of
real GNP had proved highly accurate in the past and he was willing
to accept their latest projections as reasonable, given the under
lying assumptions.

If those projections were realized, however, the

gap between actual and potential real GNP would be between 5.5 and
6 per cent by the second quarter of 1971.
not satisfactory as a goal of policy.

In his judgment, that was

He also agreed with

Mr. Mitchell on the necessity of stimulating an appropriate flow
of funds to such key sectors as housing and State and local gov

Monetary policy was a better instrument than fiscal

policy for closing the gap between actual and potential real GNP
since it would also bring about these needed sectoral improvements,
which would require a reduction in the level of interest rates.



Referring to Mr. Morris' comment regarding long-term interest
rates, Mr. Maisel said he would agree that efforts to nudge such
rates down would be unsuccessful if their current levels were pri
marily a result of inflationary expectations.

However, an inter

esting recent study suggested that prevailing high interest rates
were related much more to a shortage of liquidity in the economy
than to inflationary expectations of investors.

That suggested to

him that over the next year the Committee should seek to increase
liquidity gradually, while observing the impact on interest rates
as time went on.
Mr. Kimbrel remarked that his own reading of the economic
statistics was perhaps slightly less bullish than that of the green
book, but it was not contradictory to the view that the economy was
leveling out or was already on the upswing.

Nevertheless, if

comments from his Sixth District contacts could be more generally
applied, some adjustments in inventories still lay ahead.


there was a feeling held by quite a few of his contacts that the
recovery in their own areas would be delayed and would be sluggish
when it did come.

He had heard from some of the retailers in the

District that they expected sales for the rest of the year to rise
only slightly.

If that were true in the District and elsewhere,

it would indicate that the consumer might not be ready to shoulder
the burden of the recovery.

That possibility was not reassuring

to hopes for a booming economy.



In fact, Mr. Kimbrel continued, he personally saw nothing
in the current figures to indicate that the recovery would be rapid
or that there would be a return to vigorous economic growth in the
near future.

Such a development, of course, would not be anything

There had been periods of slow growth before, notably in the

early 1960's.

He did not think the possibility of a repeat perform

ance could be ruled out, especially if the declining trend in
defense spending continued.

On the other hand, he would point out

that in at least one important respect conditions were far different

Instead of stable prices, one had yet to see a decline in

either wholesale or consumer prices to normal levels.

Under those

circumstances, while he was persuaded that monetary policy should
continue on a course of moderate ease, policy could not in his
opinion afford to be overly easy at this time.
Mr. Daane recalled that at the previous meeting of the
Committee he had been skeptical about the staff's view that consumer
spending would rise enough to offset the shortfalls in capital spend
ing, partly because he had thought the cutback in capital spending
would be greater than indicated in the staff's projections.


he was prepared to accept the staff's new projection of capital spend
ing but he remained unconvinced that consumers could be counted upon
to spark and sustain an upturn in economic activity.

It had been his

impression on a recent trip to Michigan that attitudes were still



being affected by the stock market decline and that people were
concerned about rising prices.

Against that background, he thought

monetary policy should lean in the direction of providing for the
greater availability of funds to which Mr. Mitchell had referred.
He recognized the desirability of avoiding a policy sufficiently
stimulative to rekindle inflationary expectations.
Mr. Daane said that while he would not favor an effort to
force long-term interest rates down, he would not be unhappy if a
reduction occurred as a result of monetary policy actions related to
subsequent economic developments.

And he thought the Desk should

resist any upward pressures on long-term rates in the period ahead,
when there would be a substantial volume of private offerings
in the capital markets and a very large volume of Treasury financing.
Mr. Daane noted that earlier today he had suggested shifting
from the present type of directive, focusing mainly on the money
supply, to one with a primary instruction cast in terms of money
market conditions and a proviso clause relating to money.


that remained his first preference, he would consider acceptable a
directive along the lines Mr. Mitchell had proposed.
Mr. Melnicoff indicated that he viewed recent and prospective
developments in the real economy very much as the staff did.


ever, he thought inflationary expectations were by no means
dissipated and that an undue easing of policy might stimulate them
and make it most difficult to bring inflation under control.




noted that Mr. Partee had suggested seeking a more substantial
decline in interest rates and more rapid monetary expansion in
order to make an economic recovery more certain, and that
Mr. Axilrod had suggested that policy be more than usually generous
in meeting the current large liquidity needs.

He would note that

any policy course that seemed to assure vigorous economic recovery,
or to guarantee that all liquidity needs would be met, would at
the same time run a serious risk of validating inflationary ex
Mr. Melnicoff said his policy recommendation at the moment
was a pragmatic one--namely, to continue on the present course on
the grounds that recent policy had been successful.

He thought

the Board's action yesterday in amending Regulation D had been well
timed and well conceived.

That action would serve as a good test

of the current state of inflationary expectations, since it would
be interpreted as representing some easing of monetary policy.


preference would be to observe the reactions of market interest
rates before deciding whether to take any further easing action.
Accordingly, he would prefer alternative A of the draft directives.
Mr. Hickman said that some decline in interest rates would
seem desirable under current circumstances in order to assure an
adequate flow of funds to the mortgage market, State and local
governments, and corporations.

He also thought that monetary policy



should resist any backup in interest rates.

In his view, a 5 per

cent annual rate of growth in the money supply over the second half
of the year was likely to be consistent with those objectives,
whereas a 6 per cent growth rate might well prove overstimulative.
The Committee had approved a 5 per cent target at its previous
meeting and he felt that continuing efforts should be made to achieve

Accordingly, his preference was for alternative A of the draft

Mr. Mayo said he had found the analysis of the economic
outlook presented by the staff today to be quite similar to that
developed at the Chicago Bank.

While he personally did not consider

the economy to be on "dead center," he did think it was still slug

There were some signs of an upturn, although the more

definitive signs for which people were carefully watching had not
yet materialized.

He shared Mr. Morris' view regarding the impor

tance of housing in the economic outlook, but he feared that the
recent bulge in housing starts might be short-lived unless there
was some further moderation in long-term interest rates.

He did

not think monetary policy should try to force interest rates down,
but he felt policy could have some marginal influence in that
Mr. Mayo indicated that he was philosophically inclined
toward Mr. Daane's proposal for the directive because he also had



reservations about an unduly narrow focus on the monetary aggregates.
However, he thought that since the increased emphasis on the money
supply in recent directives seemed to have proved useful, he was not
prepared to endorse Mr. Daane's proposal at this time.

He did

believe that it would be desirable to include a reference to the
objective of easing credit conditions, as Mr. Mitchell had suggested.
He remained concerned about inflationary pressures in the economy,
but thought that economic activity was sufficiently sluggish to
warrant a 6 rather than a 5 per cent target growth rate for the
money supply.
Mr. Swan observed that there appeared to be much less concern
now than a few months ago about a cumulative downtrend in economic

However, there also seemed to be increased acceptance

of the view that the upturn would be more gradual than thought ear

Those changes in expectations were a desirable development,

he thought.
Mr. Swan said that, like others, he was disappointed by the
lack of substantial progress in curbing rapid wage and price
advances and was concerned about the risk of feeding inflationary
pressures by fostering overly rapid expansion in the monetary

He would have no objection to reaffirming the 5 per

cent target rate for growth of money that was agreed upon at the
previous meeting, but he believed that a faster rate of expansion
might carry grave implications.



Mr. Swan noted that the flow of funds, particularly to
bank and nonbank thrift institutions, had improved in recent weeks.
Although he could not cite firm evidence, it was his impression
that the availability of credit had increased at Twelfth District

Savings and loan

associations had experienced sizable in

flows of funds in July, and in California the inflows in August
were likely to prove relatively good despite the recent Trea
sury financing.

Those developments were of the kind that were

needed now, and he would not want the System to do anything at
this point that might tend to reverse them.
Mr. Robertson made the following statement:
I believe that current monetary policy is about
on track. As I see it, the task of this Committee con
tinues to be that of treading the very narrow way
between providing too much and too little stimulation
to the economy. For instance, if our policy permits
an annual rate of growth in money supply much in
excess of 5 per cent over a longish period, and if the
rate of bank credit expansion does not begin to
slow down from its recent unusually rapid pace, I
foresee dangerous and excessive stimulation which will
negate all we have been trying to achieve and bring
back the kind of inflationary psychology we were facing
earlier. The rate of increase in over-all prices is
still too high for the nation's welfare, despite
emerging areas of some price softness. Over-all price
increases still seem to be stimulating inflationary
settlements in collective bargaining, as judged by the
data for the second quarter of this year which
reflected the construction and trucking industry settle
ments. And we have ahead of us important wage contract
negotiations in the manufacturing areas, with auto
worker contracts expiring in mid-September.
While current wage and price developments are not
particularly heartening, we do finally appear to be



seeing a significant improvement in productivity in
the nonfarm private economy as a whole and an associ
ated sharp reduction in the rate of increase in unit
labor costs. This should work toward moderating
upward price pressures. Of course, this gain in pro
ductivity has been partly at the cost of reduced
employment and working hours. And this, in turn,
reflects the reduction we have seen in real demand
for goods and services, principally as a result of
declining defense outlays, the ending of the capital
goods boom, and weakness in the residential construc
tion area.
It would not be desirable in my opinion to seek to
secure further productivity gains at the expense of
employment opportunities and our policy should be
designed to avoid such a development--which means, for
the near future, a growth in monetary aggregates which
might be typified by about a 5 per cent growth rate
for money.
The Board's reserve requirement action, modest as
it was, should be considered as an element, but only
as an element, in such a monetary policy; i.e., as an
aid in maintaining such a growth rate in monetary
aggregates. However, depending upon how it is inter
preted by the public, it may serve to bring about
slightly easier credit conditions sooner in the
important mortgage and State and local government
security markets--and this will be an aid in sustain
ing aggregate demand and employment.
In order to help achieve this objective, I hope
the Manager will not endeavor to prevent the Federal
funds rate from declining some, or net borrowed re
serves from diminishing somewhat. However, I would
not want to see him seek a sharp drop in the Federal
funds rate because I would not want to see any
magnification of the announcement effects of our
reserve requirement action. Rather, I would hope our
action would be considered as an attempt to clear up
the status of bank-related commercial paper while
avoiding any significant change in our over-all policy.
Alternative A of the directive drafts seems to mesh
with these views and therefore I would vote for it in
preference to alternative B.


Mr. Sherrill said he thought the economy was in a period

of hesitation and could go either way.

It was his impression

that the business community was making increasingly conservative
decisions which might well lead to a decline in economic activity,
particularly if business psychology were to be further depressed
by the failure of some important firms.

He thought that monetary

policy should be sufficiently stimulative to insure against the
risk of a serious downturn in economic activity and to foster a

At the same time, he would not want policy to become

overly stimulative.
Mr. Clay remarked that he did not think a change in mon
etary policy, or in its emphasis, was desirable at this time.
The Committee had to pursue further the narrow path between too
much restraint and too much stimulus in order to reach the long
term goal of orderly economic growth with stability in prices.
Considering the length and intensity of the inflationary boom, the
adjustment had been relatively moderate.

There did not appear to

be evidence of the development of a cumulative downturn.

On the

other hand, aggregate activity appeared to have bottomed out and
was showing some indication of a slight upturn.

There was some

evidence of lessening of inflationary price pressures, but that
problem was responding slowly and would require a considerable
period for the necessary adjustment.
tinued to be particularly troublesome.

The wage-cost aspect con


It seemed to Mr. Clay that monetary policy had done its

part rather well during 1970 with respect to both financial and
nonfinancial developments.

Moderate growth in financial aggregates

should continue to be the policy goal.

It would require patience

to avoid taking a more stimulative posture, but moderation was
necessary in order to avoid an intensification of the price infla
tion problem.

Recognition also had to be given to the fact that

Federal fiscal policy was becoming increasingly expansive.
Mr. Clay said the bank credit and money supply figures
were difficult to interpret at this moment.

Bank credit growth

was running much higher since the modification of Regulation Q,
and involved a substantial shift of credit from market to banking

The Committee needed to be alert to the possibility

that a significant portion of the bank credit growth might not
involve such a shift, however.

Some part of the growth might

arise from a restructuring of deposits from demand to time accounts.
To the extent that that situation prevailed, money supply growth
was muted and that fact needed to be taken into account in set
ting the money supply targets.

He thought both bank credit and

money supply developments should be watched closely in the period
Mr. Galusha said he viewed as realistic the paths for var
ious economic variables projected by the staff on the assumption
of a 5 per cent growth rate in the money supply, except for prices;



he suspected that the problem of cost-push inflation would prove
to be much more intractable than implied by the projections.
But there was little that monetary policy could do to alter that
While the projections might otherwise be realistic,
Mr. Galusha continued, he agreed with Mr. Maisel that they did not
represent appropriate goals for the Committee.

In particular,

looking toward the second quarter of 1971, he thought the pro
jected level of unemployment--5.7 per cent--was too high to be taken
as a national objective, and the projected growth rate in real
GNP--3.3 per cent--was too low.
In his judgment, Mr. Galusha observed, the appropriate
course for policy at this time would be intermediate to the courses
associated with directive alternatives A and B.

Thus, he thought

the target for the money supply should be growth at a rate some
where between 5 and 6 per cent.

Over the period until the next

meeting, the 3-month Treasury bill rate might most often appear
in the 6 to 6.25 per cent interval; member bank borrowings would
average closer to $800 million and net borrowed reserves closer
to $700 million; and the Federal funds rate would most often be
at or below 650 per cent.

He thought those specifications might

be similar to those Mr. Daane had in mind, but he was not
Mr. Daane said he would prefer a lower net borrowed reserve


Chairman Burns said he hoped those who thought the economy

had turned up were correct, but he did not believe such a conclu
sion was justified by the available evidence.

It seemed to him

that the recent configuration of many economic factors--including
labor market conditions, corporate profits, new orders for plant
and equipment, and the rate of formation of new businesses--was
not consistent with the patterns that had been associated with
economic recoveries in the past.
At the same time, Chairman Burns continued, he thought
great progress had been made in checking and changing inflationary

In his judgment too much attention was being paid to

the price indexes and not enough to the impressive body of evidence
revealing a change in attitudes.

For one thing, businesses had

become highly cost-conscious in recent months, and the cost-cutting
process had already gone much further than many people realized.
For example, manufacturers had been making sizable cutbacks in
employment not only of production workers, but also of office
staffs. Thus, employment of nonproduction workers in manufacturing
had been reduced significantly in each of the five months through

That was a dramatic new development; in the comparable

months of the 1960-61 recession nonproduction worker employment
had continued to expand in every month but one.
A second indication of the change in attitudes was the
downward revisions being made in capital spending plans, the



Chairman remarked.

Those cutbacks were still in their early

stages and would probably continue for a period of at least nine
to twelve months.

Given the present cost-consciousness of the

business community, a prompt revival of capital expenditures
appeared to be extremely unlikely.
A third piece of evidence, Chairman Burns said, was the
heightened quality-consciousness of investors that Mr. Axilrod
had mentioned.

In the market for corporate bonds, for example,

offerings of the highest grade were being taken up readily at
declining rates while those of companies of lesser reputation
were encountering some difficulty.

That was demonstrated by

the spread between yields on Aaa and Baa bonds--one of the
most sensitive and useful measures of sentiment in financial

Before the Penn Central insolvency, that spread had

been fluctuating in a range of 70 to 80 basis points.


quently it increased week by week, most recently reaching a
level of 132.basis points.
Also,the Chairman continued, he understood that while
bankers were anxious to accommodate the demands of their best
customers, they were considering loan applications from others
more searchingly than earlier.

And consumers had become quite

cautious in their spending behavior; they were avoiding luxury
goods and seeking out lower quality items.

That was indicated

by recent increases in the proportion of total new car sales



accounted for by small cars,domestic and foreign; by the sales
performance of black-and-white television sets relative to color,
and of small TV's relative to large; and by the size of the price
reductions merchants were having to make to dispose of last year's
models of various durable goods.
Chairman Burns went on to say that, if he was right in his
judgment that psychology had changed drastically in recent months,
there would be much less risk now than earlier in some easing of
credit conditions.

That was the direction in which he thought the

Committee should move; he was inclined toward some version of
alternative B today.

He held that preference not because he was

dissatisfied with the objective for the money supply the Committee
had agreed upon at the last meeting, but because that objective
had not been fulfilled.
The Chairman then remarked that it might be desirable,
before any particular directive was put to a vote, to determine
the sentiment of the Committee with respect to the positions
implied by the successive clauses of the modified version of
alternative B proposed by Mr. Mitchell.

He asked the members to

indicate first whether they would like to see gradually easing
conditions in credit markets, and seven members responded
Mr. Coldwell observed that he would prefer to have the
objective formulated in terms of "slightly easier conditions" in



credit markets, since "gradually easing conditions" seemed to
imply a commitment to a continuing move.
Chairman Burns remarked that the distinction was more
than a semantic one.

In his opinion there was much to be said for

seeking a gradual easing.

Prevailing levels of interest rates

and member bank borrowings were extraordinarily high by historical
standards, and if the present degree of tightness continued for
much longer he thought a serious problem would arise in connection
with residential construction.

There was a pent-up demand for

housing, mortgage funds were becoming available on a scale that
was thoughthardly likely only a few months ago, and building
activity was responding.

But that adjustment might prove short

lived; with interest rates at their present levels and with
construction costs rising, a large proportion of middle-income
families could not afford to buy houses.

Thus, he thought a

gradual easing of credit market conditions would be desirable.
If pursuit of that objective was found to be stimulating infla
tionary sentiment, or if the economic situation changed substan
tially in other ways, the Committee could modify its goals; to
his mind there would be no implied commitment with respect to
future policy.
Mr. Francis said that from conversations with officials
of savings and loan associations and suburban banks in his District



he had concluded that inflated costs, rather than high interest
rates, were the major impediment to home buying.
With respect to the positions implied by other clauses
in Mr. Mitchell's proposed directive, it was determined that the
Committee members were unanimous, or nearly so, in their desire
(a) to see somewhat greater growth in money over the months
ahead than occurred in the second quarter, when growth was at
an annual rate of 4.2 per cent; (b) to take account of persisting
liquidity problems; and (c) to allow bank credit growth to reflect
a continued shift of credit flows from market to banking channels.
In expressing their views, individual members offered certain
qualifications regarding language.

Thus, it was suggested that

in light of the recent abatement of liquidity pressures it was
more accurate to speak of "possible" rather than "persisting"
liquidity problems; and that in view of the uncertainties
regarding shifts of credit flows from market to banking
channels, it was better to refer to "any" rather than to "a"
continued shift of that kind.
The Chairman then suggested that the Committee consider
the target growth rate for the money supply.

As he had noted

earlier, for the next four weeks there was very little difference
in the growth paths associated with alternatives A and B.


the longer run, however, the former called for growth at a 5 per
cent annual rate and the latter for growth at a 6 per cent rate.


After discussion, Chairman Burns remarked that the

Committee might again want to adopt a 5 per cent annual rate of
growth as its target for money, on the understanding that if there
were any deviations from that target rate the preference was that
they be in an upward rather than a downward direction.

It was

determined that most members favored a 5 per cent target with
such an understanding.
The Chairman then proposed that the members indicate their
preferences between two alternatives for the second paragraph of
the directive:

alternative A, as shown in the staff drafts; and

the version of alternative B proposed by Mr. Mitchell, with two
language modifications that had been suggested--to refer to
"possible" liquidity problems and to "any" shift of credit flows
from market to banking channels.
Mr. Maisel remarked that Committee agreement on the
wording of the directive would still not resolve the question
of the specific operating instructions to be given to the Desk.
He thought the Committee should choose between the money market
conditions associated with alternatives A and B in the blue book.1/
His own preference was for the alternative B conditions.

1/ The blue book statement regarding money market conditions
in connection with alternative A read as follows: "Achievement
of a 5 per cent money supply growth might require a Federal funds
rate generally around 6-1/2- 6-3/4 per cent, member bank borrow
ings dropped to an average of around $800 - $900 million, and net
borrowed reserves in a $700 - $800 million range.
Such a set of
(continued on next page)

Mr. Hickman expressed a preference for the conditions
associated with alternative A.
Mr. Mitchell noted that the directive language he had
proposed called for gradually easing credit conditions.
Chairman Burns commented that as he understood the
Committee's wishes the degree of easing to be sought would be
that which appeared best calculated to result in a 5 per cent
growth rate for the money supply, with any deviations on the
high rather than the low side.
It was determined that six members (Messrs. Hayes, Brimmer,
Francis, Hickman, Robertson, and Swan) preferred alternative A,
and six (Messrs. Burns, Daane, Heflin, Maisel, Mitchell, and
Sherrill) preferred the modified version of Mr. Mitchell's proposal.

(continued from preceding page) money market conditions might be
accompanied by some decline of interest rates in short-term credit
markets in consequence of greater provision of nonborrowed reserves
by the System. The 3-month bill rate would probably decline in a
6-1/8 - 6-1/2 per cent range."
The corresponding statement in connection with alternative B
read as follows:
"Encouragement of the more rapid growth in the
money supply indicated above would entail a more generous provi
sion of nonborrowed reserves by the System. As a result, net
borrowed reserves would likely move into a $500 - $700 million
range, member bank borrowings drop to $650 - $800 million, and
the Federal funds rate might generally be in a 6 - 6-1/2 per cent
range. A relatively sharp drop in Treasury bill rates, as well
as other short-term rates, probably would accompany such an
easing in the money market, particularly if the Federal funds
rate moves down close to the discount rate and engenders expec
tations of a discount rate reduction. It is not improbable
that the 3-month Treasury bill rate would drop below 6 per cent
under those circumstances."



It was suggested that the two alternatives again be put to
the Committee after certain additional modifications had been made
in each.

The modification in alternative A was to substitute

"moderately greater growth" for "moderate growth" in the state
ment that "the Committee seeks to promote moderate growth in
money over the months ahead."

The modification in the other

alternative was to substitute "some easing of" for"gradually
easing" in the statement that "the Committee seeks to promote
gradually easing conditions in credit markets."

It was found that

no member had shifted his preference from one alternative to the
other as a result of those modifications.
The Chairman then noted that while the Committee's prefer
ences were evenly divided between the two alternatives, a majority
had concurred in the substance of each of the successive clauses
of the language Mr. Mitchell had proposed.

He suggested that the

Committee vote the latest version of that alternative up or down.
Questions were raised as to whether, in the interest of
clarity, certain language changes might be desirable in the
proposed second paragraph and also in the staff's draft of the
first paragraph.

It was agreed that in view of the lateness of

the hour the resolution of those questions should be left to the
judgment of the Chairman, in consultation with the staff.
Mr. Sternlight said he would like to raise a question about
operating strategy if the Committee should adopt the directive
language proposed.

If after some easing of credit conditions it



appeared that the money supply was expanding on a path consistent
with growth over the longer run at an annual rate of 6 or 7 per
cent, should priority be given to the objective of easier credit
conditions or to the money supply target?

In other words, should

the Desk back off from the degree of ease initially achieved under
the directive?
Mr. Mitchell expressed the view that no harm would be done
by money supply growth at a 6 or 7 per cent rate during the brief
period until the next meeting of the Committee.

Accordingly, he

would not favor backing off under such circumstances.
Chairman Burns said he would not be disturbed by an over
shoot, particularly in light of the earlier undershoot.

He would

not necessarily have the same view if the growth rate was higher
than that Mr. Sternlight had mentioned or was tending to stay
high for a sustained period.
Messrs. Hayes, Brimmer, and Francis indicated that they
planned to dissent from the proposed directive.

Mr. Hayes said

he would like to submit for the record certain remarks on monetary
policy which he had prepared but had not had an opportunity to

It was his hope that in future meetings the Committee

would resume its earlier practice of having a "go-around," in which
the members commented in turn on policy and the directive, before
the Committee voted on a directive.
Chairman Burns remarked that that procedure would have been
followed today had time permitted.

He invited members who so

desired to submit statements on policy for the record.



With Messrs. Hayes, Brimmer, and
Francis dissenting, 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:
The information reviewed at this meeting suggests
that real economic activity, which edged up slightly in
the second quarter after declining appreciably earlier
in the year, may be expanding somewhat further. Prices
and wage rates generally are continuing to rise at a rapid
pace. However, improvements in productivity appear to be
slowing the rise in costs, and some major price measures
are showing moderating tendencies. Credit demands in
securities markets have continued heavy, and interest
rates have shown mixed changes since mid-July after
declining considerably in preceding weeks. Some uncer
tainties persist in financial markets, particularly in
connection with market instruments of less than prime
grade. In July the money supply rose moderately on
average and bank credit expanded substantially. Banks
increased holdings of securities and loans to finance
companies, some of which were experiencing difficulty in
refinancing maturing commercial paper. Banks sharply
expanded their outstanding large-denomination CD's of
short maturity, for which rate ceilings had been suspended
in late June, and both banks and nonbank thrift insti
tutions experienced large net inflows of consumer-type
time and savings funds. The over-all balance of pay
ments remained in heavy deficit in the second quarter,
despite a sizable increase in the export surplus. In
July the official settlements deficit continued large,
but there apparently was a marked shrinkage in the
liquidity deficit. In light of the foregoing develop
ments, it is the policy of the Federal Open Market Com
mittee to foster financial conditions conducive to
orderly reduction in the rate of inflation, while
encouraging the resumption of sustainable economic
growth and the attainment of reasonable equilibrium in
the country's balance of payments.
To implement this policy, the Committee seeks to
promote some easing of conditions in credit markets and
somewhat greater growth in money over the months ahead
than occurred in the second quarter, while taking account
of possible liquidity problems and allowing bank credit



growth to reflect any continued shift of credit flows
from market to banking channels. System open market
operations until the next meeting of the Committee shall
be conducted with a view to maintaining bank reserves
and money market conditions consistent with that objec
tive, taking account of the effects of other monetary
policy actions.
Mr. Hayes' statement on policy read as follows:
It seems to me that the proper role for monetary
policy in the current setting is to continue to encourage
the resumption of moderate real economic growth--and I
would stress "moderate"--over the next four quarters.
The probability that such moderate growth will be accom
panied by some further increase in the unemployment rate
should not deter us, although naturally we must keep an
eye on the extent to which unemployment may worsen.
There is good reason to expect that the rate of infla
tion will gradually diminish over the coming year if
the economy develops along the lines we now consider
most likely. Probably the biggest achievement arising
from our past efforts has been the marked check to
inflationary psychology which has occurred over the past
two months particularly. While that period's disturbing
financial developments could not be considered desirable
in themselves, they have certainly contributed impor
tantly to this change of sentiment. At this juncture
it would be most unfortunate if an overt easing move by
the System were to revive some of the inflationary
expectations that have been effectively dampened. It
is clear, especially in view of the continuing excessive
wage demands and settlements, that the inflationary
virus in the economy is still very dangerous. And
apart from domestic considerations, the danger is
pointed up by our unsatisfactory balance of payments
position, and by growing uneasiness abroad about the
dollar, based in good part on fears that the United
States may give up the anti-inflationary fight before
it has been won. Furthermore, the prospect of a
Treasury deficit which our staff now estimates at close
to $12 billion for fiscal 1971 suggests that consider
able stimulus will come from fiscal developments.
Like other members of the Committee I too have
been disappointed that the growth of the money supply
has recently been running somewhat below our target.



I would hope that open market operations would be aimed
at encouraging a growth rate of about 5 per cent. This
should be compatible with a Federal funds rate a shade
under 7 per cent, and a net borrowed reserve position
in the range of $600 to $800 million, assuming that
special borrowing at the discount window associated with
stresses in the commercial paper market continues to
decline. However, if the money supply growth rate con
tinues to fall short of our 5 per cent target, I believe
somewhat easier money market conditions and a lower
range for the funds rate--say around 6-1/2--might prove
necessary. It goes without saying that we should try
hard to get to the bottom of the statistical problem
with respect to the money supply referred to in the blue
book. Meanwhile, we should not lose sight of bank credit
growth, and here I would hope that the rate would moder
ate from its recent very high level in view of the
indications that total outstanding commercial paper is
no longer shrinking significantly.
As I have already indicated, I would oppose an
overt move of ease at this point. I am glad that yester
day's move, which struck me as highly constructive, was
modest in amount and was not presented as a significant
easing action. The added burden on the New York banks
seems small enough to be handled without great diffi
culty. I might add that at some juncture over the coming
months I would like to see the suspension of Regulation Q
ceilings applied to CD's maturing beyond 90 days.
As for the directive, I would like to see a minor
change in the opening sentence of the staff's draft, to
make it read "real economic activity...appears to be
expanding further" rather than "may be expanding somewhat
further." Also, I would suggest eliminating the clause
"and some major price measures are showing moderating
tendencies" from the third sentence. Alternative A for
the second paragraph seems about right, although I would
insert the word "possible" before "continued shift of
credit flows from market to banking channels."
Mr. Brimmer submitted the following statement for the
As I read the unfolding evidence, the performance
of the American economy is quite mixed. However, on
balance, it appears that a cumulative downturn in real



economic activity is not likely. Rather a modest expan
sion in output during the remainder of 1970 and into

1971 seems the more likely prospect. Consumer and
residential construction outlays are likely to be
stronger while business fixed investment will probably
be weaker than had been expected.
Thus, the plant and
equipment boom--which has been a main source of infla
tionary pressure in recent years--appears to be waning

Nevertheless, despite the progress we have made
in reducing excess demand in the economy, we have
made little actual headway against inflation. Prices
are still rising at an unacceptably rapid rate. For
example, in the second quarter the implicit GNP

deflator rose at an annual rate of 4.2 per cent, com
pared with about 5.5 per cent in the first quarter
(after allowing for the Federal pay increase) and
4.7 per cent for all of last year. In the current
and following quarters, further modest easing in the
rate of inflation will probably occur, but by year
end the GNP deflator may still
be rising at an annual
rate of about 3-1/2 per cent. Thus, the battle to
check inflation in the United States remains to be won.
Under the circumstances, the proper objective for
monetary policy should continue to be the fostering of
modest growth in bank credit. The aim should be to
provide a modest increase in the liquidity of the
economy without stimulating renewed inflationary
Consequently, we should be careful to
avoid such an expansion in the availability of bank
credit that expectations of renewed inflation will
be rekindled.
Mr. Francis submitted the following statement for the
Pursuing money market goals, particularly during
periods of even keel constraint, has continued to
cause problems of managing the monetary aggregates.
From February to May money rose rapidly, but since
mid-May it has risen little. In view of the desire
of this Committee to maintain a moderate growth of
monetary aggregates, this uneven performance has
been disappointing. Even if the economic impact of
our actions since the beginning of 1970 has been
nearly the same as that of a more steady monetary growth,



it is unwise, I believe, to control money so loosely.
Unless monetary aggregates are moving as desired
within periods of less than five or six months, we have
no assurance of adequate control.
Our directives so far this year have been calling
for moderate growth in both bank credit and money.
the past two months, bank credit has risen sharply
while the money stock has changed little.
This Com
mittee needs to decide now which of the two aggregates
is to be followed or how the two are to be weighted.
The rapid growth in bank credit reflects primarily a
sizable reintermediation of funds which formerly flowed
through other avenues, and not an addition to total

credit. Hence, bank credit may now be misleading as
a proximate guide, and I suggest that actions be taken
to foster a moderate growth in the money supply.
Over the past year and a half, money has risen at
an average 3 per cent annual rate. Since the beginning

of this year growth has been at a faster 4 per cent aver
age rate.

I believe that money should continue to

expand at a moderate rate in the near future.

The 4 to

5 per cent trend rate of alternative A seems appropriate.

It would be desirable, in my opinion, if growth in money
were steadier than it has been in the past year, even
if this results in more variability of interest rates
and other market conditions.
According to estimates of the St. Louis Bank, if
money expands at a fairly steady 4 to 5 per cent pace,
total spending would rise slightly faster than the growth
in productive capacity and price increases would grad
ually moderate from the 5.3 per cent rate in the first
half of 1970 to about a 4 per cent rate in late 1971.
Real output, according to these estimates, would rise
only slightly in late 1970, but would increase at about
a 3.5 per cent annual rate in the last half of next year.
Mr. Maisel submitted the following statement for the record:
Alternative B of the staff draft directives is in
my view an appropriate directive for the interval until
the next meeting of the Committee. Alternative B
Much of the
properly focuses on growth in money (M1).
Committee's discussion at recent meetings was concerned
with the risk of unduly rapid growth in money, as a
consequence of a temporary reversion to greater emphasis
on money market conditions.
Fortunately, the latest
directive was written in symmetrical terms that allowed



the Desk to adapt operations to a shortfall from the
desired growth of money. This experience illustrates
the problems that would be involved in a return to an
old-style directive stated in terms of money market
In the current situation, the impact of yesterday's
Regulation D action by the Board, including the reac
tions of dealers and banks,
is unknown as yet.
dealers have large inventories and the odds are that
they will not increase them further. Thus, the
impact will probably be largely on expectations. There
reason for concern but one cannot
seems to be little
be sure. The uncertainty regarding those reactions
is an argument in favor of adopting alternative B.
That alternative calls for an easing of credit market
conditions, but it also gives the Manager some guidance
as to what to do if there are unexpected developments.
He need not fight lower interest rates if the aggre
gates are in line, but he would react if there is a
change in expectations and a large spurt in money.
This I think is the proper approach. We should meet
liquidity needs at a more rapid rate but should not
Alternative B, as written, would
get carried away.
protect us against the latter possibility.

was agreed that the next meeting of the Federal Open

Market Committee would be held on Tuesday,

September 15,

9:30 a.m.
Thereupon the meeting adjourned.

Deputy Secretary




August 17, 1970
Drafts of Current Economic Policy Directive for Consideration by the
Federal Open Market Committee at its Meeting on August 18, 1970
The information reviewed at this meeting suggests that
real economic activity, which edged up slightly in the second
quarter after declining appreciably earlier in the year, may be
expanding somewhat further. Prices and wage rates generally are
continuing to rise at a rapid pace. However, improvements in
productivity appear to be slowing the rise in costs, and some
major price measures are showing moderating tendencies. Credit
demands in securities markets have continued heavy, and interest
rates have shown mixed changes since mid-July after declining con
siderably in preceding weeks. Some uncertainties persist in finan
cial markets, particularly in connection with market instruments
of less than prime grade. In July the money supply rose moderately
on average and bank credit expanded substantially. Banks increased
holdings of securities and loans to finance companies, some of which
were experiencing difficulty in refinancing maturing commercial
paper. Banks sharply expanded their outstanding large-denomination
CD's of short maturity, for which rate ceilings had been suspended
in late June, and both banks and nonbank thrift institutions experi
enced large net inflows of consumer-type time and savings funds.
The over-all balance of payments remained in heavy deficit in the
second quarter, despite a sizable increase in the export surplus.
In July the official settlements deficit continued large, but
there apparently was a marked shrinkage in the liquidity deficit.
In light of the foregoing developments, it is the policy of the
Federal Open Market Committee to foster financial conditions con
ducive to orderly reduction in the rate of inflation, while
encouraging the resumption of sustainable economic growth and the
attainment of reasonable equilibrium in the country's balance of

Alternative A
To implement this policy, the Committee seeks to promote
moderate growth in money over the months ahead, while taking account
of persisting liquidity problems and allowing bank credit growth to
reflect a continued shift of credit flows from market to banking
channels. System open market operations until the next meeting of
the Committee shall be conducted with a view to maintaining bank
reserves and money market conditions consistent with that objective,
taking account of the effects of other monetary policy action.

Alternative B
To implement this policy, the Committee seeks to promote
somewhat greater growth in money over the months ahead, while
taking account of persisting liquidity problems and allowing bank
credit growth to reflect a continued shift of credit flows from
market to banking channels. System open market operations until
the next meeting of the Committee shall be conducted with a view
to maintaining bank reserves and money market conditions consist
ent with that objective, taking account of the effects of other
monetary policy action.