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


on Monday and Tuesday,

December 16-17,

beginning at 4:00 p.m. on Monday.




Burns, Chairman
Hayes, Vice Chairman





and Morris,

Alternate Members of the Federal Open
Market Committee
Messrs. Eastburn, Francis, and Balles,
Presidents of the Federal Reserve Banks
of Philadelphia, St. Louis, and San
Francisco, respectively
Mr. Broida, Secretary
Mr. Altmann, Deputy Secretary
Mr. O'Connell, General Counsel
Mr. Partee, Senior Economist
Mr. Axilrod, Economist (Domestic Finance)
Mr. Solomon, Economist (International Finance)
Messrs. Brandt, Bryant, Davis, Doll, Gramley,
Hocter, Parthemos, Pierce, and Reynolds,
Associate Economists


Mr. Holmes, Manager, System Open Market


Coombs, Special Manager, System Open

Market Account
Mr. Wonnacott, Associate Director, Division
of International Finance, Board of

Mr. O'Brien, Special Assistant to the

Board of Governors
Messrs. Keir, Kichline, and Wernick, Advisers,
Division of Research and Statistics,
Board of Governors
Mr. Pizer, Adviser, Division of International
Finance, Board of Governors
Mr. Zeisel, Associate Adviser, Division of
Research and Statistics, Board of
Mrs. Junz, Associate Adviser, Division of
International Finance, Board of Governors
Messrs. Taylor and Wendel, Assistant Advisers,
Division of Research and Statistics,
Board of Governors
Messrs. Siegman and Truman, Assistant Advisers,
Division of International Finance,
Board of Governors
Mr. Peret, Assistant to the Director, Division
of Research and Statistics, Board of
Mr. Smith, Chief, Financial Markets Section,
Division of International Finance, Board
of Governors
Messrs. Beeman and Enzler, Senior Economists,
Division of Research and Statistics, Board
of Governors
Mr. Roxon, Senior Economist, Division of
International Finance, Board of Governors
Mr. Annable, Economist, Division of Research
and Statistics, Board of Governors
Miss Morisse, Economist, Division of Inter
national Finance, Board of Governors


Miss Pruitt, Economist, Open Market Secre
tariat, Board of Governors
Mrs. Ferrell, Open Market Secretariat
Assistant, Board of Governors
Mr. Rankin, First Vice President, Federal
Reserve Bank of Richmond
Messrs. Eisenmenger, Boehne, and Scheld,
Senior Vice Presidents, Federal Reserve
Banks of Boston, Philadelphia, and
Chicago, respectively
Messrs. Jordan and Green, Vice Presidents,
Federal Reserve Banks of St. Louis and
Dallas, respectively
Mr. Kareken, Economic Adviser, Federal
Reserve Bank of Minneapolis
Mr. Keran, Director of Research, Federal
Reserve Bank of San Francisco
Chairman Burns welcomed Mr.

Baughman to his first meeting

of the Open Market Committee since he had been named President
of the Federal Reserve Bank of Dallas.

He noted that Mr. Baughman

was a long-standing member of the Federal Reserve family and had
attended Committee meetings in the past as an officer of the
Federal Reserve Bank of Chicago.
Secretary's note: Prior to this meeting
Mr. Baughman had been elected as alternate
member of the Committee representing the
Federal Reserve Banks of Atlanta, St. Louis,
and Dallas, to fill the unexpired portion of
the one-year term ending February 28, 1975,
and had executed his oath of office.


Chairman Burns noted that the staff's report on the
economic and financial situation at this meeting would take the
form of a chart presentation.

He asked Mr. Partee to begin the

Mr. Partee made the following introductory statement:
The purpose of today's meeting is to review and
discuss the staff's updated economic projections,
which were detailed in the green book,1/ and to
examine the possible consequences of various alterna
tive public policy strategies.
Because of the rapidly
changing economic situation, both at home and abroad,
it is especially important to evaluate where our
economy stands at the present time. Therefore, before
turning to the projection and to its possible implica
tions for policy, Mr. Gramley first will examine the
state of the economy and Mr. Reynolds the world economic
setting as it impinges on us.
Mr. Gramley made the following


Incoming economic statistics indicate a marked
deterioration since the end of the summer in the
condition of the national economy. New orders for
durable goods, in real terms, peaked a year ago, but
began to fall sharply in September--much as they did
in the early months of the 1969-70 recession. New
car sales have been extremely weak this fall, and
retail sales outside of autos have also been soggy.
Permits for residential buildings, meanwhile, have
continued to decline along the downward path that
began early in 1973.
Recently, weaknesses have shown up in a dramatic
way in employment and output. Industrial production
earlier this year had been moving generally sideways,
as weakness in consumer durables and construction

1/ The report, "Current Economic and Financial Conditions,"
prepared for the Committee by the Board's staff.


products was counterbalanced by increasing output of
business equipment. In October, industrial output
declined moderately, but last month cutbacks in
production were widespread, and the total index fell
by 2.3 per cent--of which only three-tenths is attrib
uted directly to the coal strike.
The length of the
average workweek in manufacturing also dropped further
last month, as did factory employment, and the unem
ployment rate rose sharply. Moreover, there are large
further declines in employment occurring in December,
judging by announced layoffs in autos and other indus
tries and the further sharp rise in the latest figures
on initial claims for unemployment insurance.
The recent intensification of recessionary forces
has brought with it a marked change in business inven
tory policies. The ratio of inventories to GNP final
sales, in real terms, has been rising since early 1973,
and is now very high by standards of recent yearshigher than at the end of the 1969-70 recession. But
the business community did not express much discomfort
with the level of inventories until fairly recentlyprobably because prices were skyrocketing and scarci
ties continued to be prevalent until last summer or
early fall. The series on vendor performance--which
indicates the per cent of companies in the Chicago
area reporting slower deliveries--actually reached
its peak over a year ago, but it did not drop below
the 1969 peak until this summer. Of late, the index
has been falling rapidly in response to an improving
supply situation, and the attitudes of businesses
toward inventories also have been undergoing a marked
change. Comments in the red book1 / and elsewhere
indicate that business firms in many lines are now
making strenuous efforts to pare their stocks by
cutting production, canceling orders, postponing
receipts of goods, and making shipments ahead of
promised delivery dates.
Businesses are also scaling down their fixed
investment plans. New orders for nondefense capital
goods, in constant dollars, have dropped about 18 per cent

1/ The report, "Current Economic Comment by District," prepared
for the Committee by the staff.


over the past 3 months--almost as large a decline as
in the entire 1969-70 recession. Construction con
tract awards--the floor space series--are also in a
downward trend for both commercial and industrial
buildings. The bearish story told by these series is
reflected in the latest Commerce survey, which indi
cates a deterioration of capital spending plans and
a probable decline in real business fixed capital
expenditures in the first half of next year.
To be sure, there is still considerable strength
evident in the investment plans of major materials
producers. But there is also unusual weakness in
electric utilities, in commercial construction, and
in demands for trucks. And announced reductions or
cancellations of capital spending plans by industrial
firms are accelerating. Our staff tally of newspaper
and other published reports here at the Board indicates
a larger volume of cancellations by industrial firms
in November than during the entire first 10 months
of the year.
These developments in the business sector are
related to more fundamental underlying weaknesses in
residential construction and in consumer purchases of
goods since early 1973. Relatively speaking, the
decline in real goods purchased by consumers has been
much less than the falloff in residential construction.
But the absolute magnitudes were similar during the
period from the first quarter of 1973 to the third
quarter of this year. In 1958 dollars, goods pur
chases of consumers fell $12 billion over this period,
while residential construction declined $11-1/2 billion.
In the fourth quarter of this year, real durable goods
purchases are declining as fast as residential con
struction in relative terms, and much more in absolute
A falloff in residential construction during the
course of a business expansion is, of course, a familiar
phenomenon associated with rising interest rates and
tight credit conditions. The pronounced weakness we
have seen in real consumer purchases of goods since
the spring of 1973, however, is unusual. It probably
reflects a variety of factors--supply scarcities that
retarded economic expansion, the energy crisis, and


waning consumer confidence. An important consideration,
however, is the effect of inflation on consumers' real
income, including the substantial drain of purchasing
power to the OPEC countries caused by the higher price
of oil.
Real disposable income per household began to
turn around the middle of 1973, and since then has
fallen about 5 per cent. In the postwar period,
declines of this magnitude have been rare. Real
disposable income of households went down less during
the recessions of 1953-54, 1957-58, and 1969-70, than
it did during the past year. Actually, there is only
one other period in postwar history--the year from
mid-1946 to mid-1947--when real household income
declined as much or more than we have seen recently.
Then, as now, controls had been lifted and prices
were rising rapidly.
Inflation has eroded the strength of demand in
the private sector in yet another way--through its
influence on economic policy. Early in 1973, the
rate of inflation began to exceed the rate of growth
of the nominal money stock, so that real money
balances began to decline. By the fourth quarter
of this year, the real money stock had dropped about
8 per cent from its earlier peak. Previous declines
in the real money stock during the postwar period
usually were followed by recession.
During this recent period of declining real
money balances, there has also been a marked shift
toward surplus in the high employment budget, as
inflation has increased Federal receipts while
expenditures were being restrained. It is hard
to know what significance should be attached to
any given level of the high employment surplus or
deficit. Nevertheless, the very substantial move
ment toward surplus since late 1972 must have been
a contributing factor to the weakening of aggre
gate demand.
Thus, the direct and indirect consequences of
inflation have led to so marked a slowing in economic
activity over the past year that we now find ourselves
in the midst of strong contractive forces. Other
countries are in similar straits, as Mr. Reynolds'
report will indicate.


Mr. Reynolds made the following comments concerning
international developments:
In major industrial countries abroad, as in the
United States, economic activity has weakened rapidly
in recent months. Consumer spending is sluggish,
investment plans are being curtailed, efforts are
being made to hold down or reduce inventories, exports
are leveling off or declining, and unemployment is
The authorities in a number of countries--includ
ing Germany, Canada, Australia, the Netherlands, and
the United Kingdom--are now moving to ease fiscal and
monetary restraints. In other countries, however,
including Japan, France, and Italy, the authorities
do not yet feel free to relax because they are still
grappling both with very serious inflationary pres
sures and with external payments problems. They are
hoping that the United States and Germany will take
the lead in resisting a cumulating world-wide
Germany is well placed to take anti-recessionary
actions, and is doing so. Prompt application of
fiscal and monetary restraints early in the 1972-73
boom began to damp the growth in domestic demand
early in 1973.
Indeed, real GNP less net exports
has been declining for nearly 2 years. Only a large
surge in net exports kept total output from declining
last year. This year, total output has declined. The
unemployment rate has risen to its highest level since
the late 1950's.
Meanwhile, price inflation in Germany has been
relatively well contained. The cost of living index
has recently been rising at only a 6-1/2 per cent
rate, and price increases for industrial products
have slowed to an 8 per cent rate.
Germany removed a special tax on investment late
last year, and allowed an income tax surcharge to
expire in mid-1974. Monetary policy began to ease
in October. Forthcoming easing actions on the fiscal
side include a very substantial cut in income taxes
on January 1, equal to about 1-1/2 per cent of GNP,


a bonus of 7-1/2 per cent on private investment
projects begun by mid-1975, additional public invest
ment, and assistance to the unemployed. The German
Federal Bank has stated that growth in the monetary
base of about 8 per cent during 1975, compared with
6 per cent during 1974, should be consistent with
renewed economic growth and further abatement of
In Japan, output has been declining since late
1973. The petroleum crisis had particularly sharp
effects on Japanese output and prices in the first
quarter of this year. Since then, tight money and
official requests to restrain investment outlays
have brought further output declines to which inven
tory liquidation has contributed. The Japanese have
had considerable success in slowing inflation and in
reversing an earlier balance of payments deteriora
tion. But since consumer prices are still rising at
an annual rate of more than 16 per cent, and since
the payments position is still viewed with concern,
the authorities are not expected to ease their
restraints on demand until next spring, perhaps
after the April wage agreements. The decline in
activity may bottom out during the first half of
1975, but little recovery is likely until the
second half.
Industrial production is now also declining
in Italy and Canada, and has shown little net change
in the United Kingdom for nearly 2 years. In France,
there has recently been some hesitation in output
and considerable downward revision of investment
Italy, facing rampant inflation and a serious
payments problem, is trying to maintain the stringent
monetary and fiscal restraints adopted last summer.
France has recently intensified some restraints.
Britain, also plagued by very serious inflation,
has felt able only to remove in July and November
the restraints that had been imposed last March.
Canada, on the other hand, has recently introduced
an expansionary budget and reduced interest rates.
As for the less developed countries, thus far
both the OPEC and non-OPEC countries have been


rapidly expanding their imports. But now the non-OPEC
countries are having to tighten their belts as their
export earnings and reserves decline, and this will
contribute to a further weakening of world demand.
Payments difficulties have already led some countriesBrazil, for example--to impose new trade restrictions.
Thus the general outlook is for some continuing
decline in world economic activity at least into
early 1975. We project some recovery later on in
the year, but we are more than usually uncertain
about these projections. The timing and strength
of any pickup will depend importantly on the course
of events in the larger countries--the United States,
Germany, and Japan.
The current world-wide recession is beginning
to be reflected in a decline in the volume of U.S. non
agricultural exports. The volume of such exports is
projected to decline by about 12 per cent in the four
quarters to mid-1975, and may recover only slightly
during the following year. Agricultural exports are
also now declining in both volume and value, reflect
iig low U.S. harvests. Export demand, therefore, is
not expected to be an important contributing factor
to recovery in our own economy.
Meanwhile, the increasing weakness of U.S.
demand is reducing our imports, and thus contribut
ing to the slowing of world trade. The volume of non
fuel imports has been drifting downward from a peak
reached in the first quarter of 1973. A further signif
cant decline of about 14 per cent is projected during
the four quarters to mid-1975, with renewed import
expansion beginning only in 1976. Fuel imports are
expected to stabilize in volume and value during 1975
at about the level reached late this year. Even if
some new effective conservation measures are imposed,
it seems rather unlikely that oil imports can actually
be reduced as the economy begins to recover.
The net effect of the foregoing considerations
is that the U.S. trade deficit is projected to increase
somewhat further in 1975, and that by early 1976 the
deficit on goods and services may be running at about
a $6 to $9 billion annual rate. This would imply a
current account deficit of the order of $10 to $13



billion a year. Such a deficit would represent only
a moderate share of the $40 billion current deficit
expected for all OECD countries combined.
So far in 1974, net capital flows into the
United States have matched our widening current
account deficit without much net change in the
effective exchange rate for the dollar. The
weighted average value of the U.S. dollar in
terms of 10 leading foreign currencies is now
about the same as it was just after the second
devaluation early in 1973, although there have
been large fluctuations.
It seems likely that direct capital inflows
from OPEC countries will increase further next
year from the recent rate of over $1 billion a
month, and that net private outflows may be small.
Hence net inflows could well continue to cover
the growing current account deficit without much
change in the exchange rate. Indeed, there could
be a tendency for even larger capital inflows, and
for some upward pressure on the exchange value of
the dollar.
In summary, the United States does not seem
to face much difficulty in financing its large
deficit on current account. The international
questions that loom largest now are (a) how deep
and extended the world-wide slump in economic
activity will prove to be, (b) how can countries
manage the recovery while minimizing the risks of
renewed inflation, and (c) how can balance-of
payments adjustments and financing for other
countries be smoothly and cooperatively achieved.
Mr. Pierce made the following comments on the staff pro
jections of U.S. economic activity:
As for the policy assumptions underlying the
staff's projection, Federal budget outlays are
assumed to be $307 billion for fiscal 1975 and
$339 billion for fiscal 1976. No new fiscal
stimulants are assumed, but we continue to incor
porate expanded programs for unemployment insurance



and public service employment. In addition, our
spending estimates do assume some slippage in the
Administration's announced budgetary goals.
As for monetary policy, M1 growth in the first
half of 1975 is assumed to make up the shortfall
since last summer--returning thereafter to a 5-3/4
per cent path from mid-1975 through the remainder
of the projection period.
The policy stance implied by these assumptions
is fairly restrictive. Even giving full allowance
for its measurement and conceptual problems, the
high employment budget surplus would rise substan
tially further. Conditions in financial markets
would ease with declining economic activity and
gradual improvement in price performance, but would
be firming again when economic activity begins to
turn up.
We believe real GNP is falling sharply in the
current quarter, and a continued decline is in
prospect during the first half of 1975. By the
second quarter of next year, real GNP is projected
to be 3.9 per cent below the second quarter 1974
level--as large a decline as in any postwar reces
sion. Measured from the fourth quarter of 1973,
the over-all projected drop is 6.0 per cent.
This is a steep recession, but there is some
basis for expecting an upturn in real output beginning
in the latter part of 1975. In the absence of more
stimulative policy action, however, we believe that
growth in real output will remain below the nation's
long-term potential growth, and will be well short of
the rates characteristic of most postwar recoveries.
The course of inventory investment seems likely
to be a major source of weakness over the next two
quarters. There is evidence of sizable unintended
inventory accumulation in the current quarter, as
sales--particularly of autos, appliances and other
consumer durables--have fallen sharply, and are sub
stantially below production levels. At least a brief
period of outright inventory liquidation now seems
probable. But, if final sales begin to pick up in
real terms, as we are projecting, a return to moderate
rates of accumulation may occur by early 1976. This



would be consistent with some improvement in the
level of stocks relative to sales beginning around
the middle of next year.
A principal source of the expected turnaround
in final sales would come from residential construc
tion. Housing starts are projected to hit a trough
this winter, and then to begin a slow recovery,
reflecting the improvement in savings flows and
mortgage credit conditions already under way. We
expect a moderate further decline in short-term
interest rates in the first half of 1975, and thus
some additional pickup in savings inflows to non
bank intermediaries.
As economic activity recovers later on, however,
interest rates are projected to begin rising again,
because growth in nominal GNP is projected to exceed
substantially the rate of increase assumed for M1.
Savings inflows, therefore, fall off again and hous
ing starts flatten out at a level far below their
earlier peak,
Additional firming in final sales around the
middle of next year is expected to come from personal
consumption. Consumption has been affected adversely
for some time by declines in real disposable income.
And because of rising unemployment, a further drop
in real purchasing power of consumers is projected
for the first half of 1975. Thereafter, several fac
tors--including a slower rate of inflation, a July 1
cost-of-living increase in social security benefits,
and a leveling off and then modest increase in employ
ment--will contribute to some improvement in real
disposable income, and hopefully to a strengthening
in consumer markets. The modest character of the
projected pickup in consumer spending can perhaps
best be illustrated by reference to auto sales. With
the modest recovery expected for real disposable
income, and with unemployment continuing high, we
would project a return of new car sales to about a
10 million annual rate by mid-1976--roughly the rate
of sales for the first half of 1974, when the energy
crisis was depressing auto demand.
How vigorous an economic recovery we can
realistically expect later next year and on into
1976 probably will depend most importantly, however,

on the course of business fixed investment. Until
recently, this sector has served as an important
support for the economy. Outlays for fixed invest
ment in 1958 dollars are, however, falling signifi
cantly in the current quarter, due partly to a steep
decline in fleet car and truck sales. With rates of
capacity utilization falling, even for major material
producers, with corporate profits also under pressure,
and with business expectations worsening rapidly, real
outlays for business fixed investment seem likely to
decline through all of 1975. Heavy investment by major
material producers will, we believe, act to limit the
extent of decline. But, we see no reason for expect
ing any recovery in real business fixed investment,
given the very modest increases expected for consumer
Our staff GNP projection implies substantial
weakness in labor markets. Employment is projected
to decline sharply over the first half of next year
and to show relatively little strength thereafter.
Even though labor force growth is projected to be
quite slow, the unemployment rate would rise sharply
in the first half of next year--to about 7-3/4 per
cent by the middle of 1975--and then drift up more
slowly to around 8-1/4 per cent by mid-1976. This
estimate takes into account the effects of the
assumed public service employment program, which
reduces the unemployment rate by about three-tenths
of a point.
Growing slack in both labor and product markets
should improve the outlook for wages and prices. In
response to high and rising unemployment rates, the
rate of increase in compensation per manhour is
expected to slow moderately over the projection
period. Productivity should also improve once
real output turns up again, so that the rise in
unit labor costs is expected to drop off to around
a 5 per cent annual rate by the middle of 1976.
We expect marked improvement in price performance
to begin showing up in the fixed-weighted index for
private product in the first half of next year, even
though retail food prices may still be rising substan
tially. Optimism with regard to prices of nonfood



commodities is warranted, we believe, by the recent
behavior of wholesale prices, and by the intensely
competitive conditions now prevailing in consumer
markets. Further progress on the price front is
probable as the year progresses, particularly if
food output increases as expected. By the middle
of 1976, we project that the rise in the fixed
weighted index will have slowed to an annual rate
of about 5-1/2 per cent--about the same rate of
increase as for unit labor costs.
In summary, the staff now expects a rather steep
recession followed by a weak recovery that leaves
unemployment drifting upward through mid-1976. Sub
stantial progress is expected, however, in reducing
the rate of inflation to a figure which, though high
by historical standards, would represent an enormous
improvement over the recent past.
Mr. Partee made the following concluding remarks:
The staff has had to adjust its projections as
the downturn in economic activity has gathered
momentum this fall. We first presented estimates
for all of 1975 in August--estimates which, at
that time, seemed on the pessimistic side. However,
the near-term decline in activity, as measured by
real GNP, is now expected to be substantially deeper,
and the rise in unemployment much larger, with the
rate escalating rapidly to about 8 per cent by next
summer. Despite the extent of this writedown, how
ever, I do not believe that we are exaggerating the
weakness in the outlook. The country now is clearly
in the midst of a cumulating recession, and there
appears to be some distance to go before a turn
around can reasonably be expected. Indeed, our
projection still does not allow for a very substan
tial over-all inventory liquidation, or for a siz
able drop in capital spending, or for the effects
of possible major difficulties in financial markets
at home and abroad.
As in our August projection, we still anticipate
some upturn, albeit from a much lower level of activity,
beginning in the second half of 1975. But there is no



basis at present for projecting a vigorous recovery,
in the absence of new stimulative actions in either
the fiscal or monetary area. In the four quarters
from mid-1975 to mid-1976, we now anticipate an
increase in real GNP of only about 2-1/2 per cent;
this would mean further increases in the unemploy
ment rate throughout the projection period.
The basis for the projected upturn lies in
possible favorable developments in three sectorsinventories, consumer spending, and housing. In
the case of inventories and consumer spending, we
could easily find that events not allowed for in our
projection could impair or delay the chances for a
turnaround. For example, if real business fixed
investment spending turns out to be significantly
weaker than the moderate decline we have projectedmore, say, like that of 1957-58--retrenchment in
the desired inventories of capital goods producers
and loss of jobs in that sector would work to delay
recovery in aggregate inventory investment and in
real consumption expenditures.
The projected upturn in housing rests, I believe,
on somewhat more solid ground, since any additional
weakness in other sectors would help to ease the
mortgage market further and strengthen the financial
basis for a housing recovery. Nevertheless, the rise
in projected housing starts is far less than normal,
partly because of the demoralized state of the multi
family residential market and partly because we do
not expect the recent improvement in savings inflows
to persist beyond the second quarter of next year,
given the present assumptions as to the pace of
monetary growth.
The difficulty is that the projected turnaround
in real GNP, combined with moderating but still sub
stantial inflation, will boost the rise in nominal
GNP abruptly beginning in the second half of 1975.
The projected growth rate of about 9 per cent in
nominal GNP would be far in excess of the assumed
growth in money, implying significant upward pres
sure on market interest rates and a consequent
dampening of savings inflows to the thrift institu
tions. At the same time, private credit expansion



would be tending to accelerate, reflecting mainly a
pickup in mortgage borrowing but also continued sub
stantial growth in business credit. And Federal
borrowing needs, because of the decline in revenues
associated with the recession, will be mounting
Putting all of these considerations together,
our flow of funds projection indicates that there
will be only a relatively brief drop in the total
volume of funds raised during the current quarter
and the first two quarters of 1975, followed by a
sizable rebound in the second half of 1975 and on
into 1976. This implies sizable household purchases
of securities again, beginning in the second half
of next year, in order to balance supplies and demands
in the credit markets. Such purchases are indicated
to be less than in the recent tight money period, but
they still are large enough to require attractive
terms on the part of issuers.
Thus, the need to place securities with individ
uals and the shortfall of money growth relative to
projected nominal GNP both suggest that interest
rates will be rising again in the second half of
next year. Our estimate is that the commercial
paper rate is likely to increase to about 9 per cent
by year-end 1975 and to 10 per cent by mid-1976historically high levels, particularly in the con
text of soft product markets and a declining rate
of inflation--and that long-term rates also will
be turning upward. It should be noted also that
we do not expect any appreciable easing of long
term rates in the interim, because new corporate
offerings in the capital markets are projected to
remain exceptionally large.
In view of the extreme weakness of the economy
that is in prospect over coming months, it seems
highly probable that the Administration and Congress
will opt for more fiscal stimulus than is assumed
in our basic projection. We have tried to estimate
how the economy might respond to a more stimulative
fiscal posture, with no change in monetary policy.
The additional stimulus assumed includes a sizable
boost in expenditures, a 5 per cent cut in personal



tax rates, and a larger investment tax credit--the
total package adding up to about $20 billion by
early 1976.
We would expect such a program to add measurably
to the expansion in real GNP, beginning in the second
quarter of next year. The rise in the unemployment

rate consequently is reduced

by several tenths of a

point, though it still reaches almost 8 per cent by
the end of the projection period. On the other hand,
the improvement in price performance would probably
be somewhat less favorable than in the basic
We believe, however, that the effects of the
additional stimulus on real activity, in the absence
of accommodative shifts in monetary policy, would
rather quickly run out of steam. This is because
the more expansive fiscal policy requires additional
deficit financing, thus putting credit markets under
increased pressure. Hence, interest rates rise more
than otherwise would be the case, savings inflows to
the institutions are further curtailed, the market
value of existing financial asset holdings is eroded,
and private expenditures for housing and for other
purposes are discouraged. Because of these counter
productive effects, stronger fiscal stimulus would
not be expected to provide a lasting substitute for
greater monetary ease under current circumstances,
but rather would require the support of a more
liberal supply of money and credit.
Our second policy alternative, therefore, adds
to the program of fiscal stimulus with a more expan
sive monetary policy, as indexed by M 1 growth on a
7-1/4 per cent path, but forgiving past shortfalls.
Real GNP growth is considerably increased, and
would be expected to exceed the economy's long-run
4 per cent growth potential through most of the
projection period. As a result of stronger economic
expansion, the unemployment rate tilts downward late
next year, though the level is still projected to be
about 7-1/4 per cent in the second quarter of 1976,
after a full year of recovery. The improvement in
the inflation rate is also distinctly less than in
the base projection, however, with the increase in



the fixed-weight deflator moderating to about a
6-1/2 per cent rate in the first half of 1976.
As I have said in previous meetings, the
Committee is faced with extremely difficult choices
in formulating its policies at the present time.
These alternative projections provide additional
evidence as to the substance of the trade-off
We believe that the combination of fiscal
stimulus and a somewhat more expansive monetary
policy, beginning now, would produce a markedly
more robust economic upturn after mid-1975, though
we think that it would still
far short of a
Given the current weakness of the economy,
and the very substantial continuing underutiliza
tion of resources that we foresee under even the
most favorable projection alternative presented,
this seems a highly desirable outcome.
But the
cost is that the inflation rate would be expected
to show appreciably less improvement than might
otherwise be achieved, and that cost would remain
with us well beyond the time period of this
But the Committee
The choice is one of policy.
should recognize that the decisions it makes now,
given the lags in policy impact, will importantly
influence both the probabilities that the economy
will in fact turn up again about mid-year, as we
have projected, and the shape that the recovery
takes. Further, the Committee needs to be aware
that it is apt to face a very difficult problem
once economic recovery commences; a policy posture
indexed by long-term growth in M1 at anything like
the 5-3/4 per cent pace currently sought, even given
our comparatively optimistic outlook as to the course
of inflation, is likely to bring a fairly prompt
upturn in interest rates. That resurgence in rates
would occur even though the economy remains far
below optimum levels, and at a time when unemploy
ment is still likely to be at 7-1/2 per cent or



Mr. Black referred to Mr. Partee's comments about the
consequences of the second policy alternative, involving a
7-1/4 per cent growth rate in the money supply as well as more
fiscal stimulus.

He asked when that growth rate was assumed

to begin.
Mr. Partee replied that the 7-1/4 per cent growth rate
in M1 was assumed to start at the beginning of 1975.

The growth

rate was taken as constant, with no attempt to compensate for the
shortfall in growth during the summer and fall of 1974.
In reply to a question by Mr. Balles, Mr. Partee said the
7-1/4 per cent rate was assumed to continue throughout the projec
tion period--that is, through mid-1976.

Given the limited extent of

the recovery projected for that period, it seemed unlikely that
an interim change would appear desirable.
Committee adopted such a target rate now

Of course, if the
it would in fact have

many opportunities before mid-1976 to modify the target in light
of the actual progress of the recovery.
Mr. Black observed that one possible course for policy
would be to raise the rate of growth of the money supply now with
the expectation of reducing it--perhaps to the present longer
run target rateof 5-3/4 per cent--at a later time, when the economy
was recovering.

He asked about the likely consequences of such a



Mr. Partee replied that he also had reflected on that

He would expect interest rates to rise sharply at

the time money growth was slowed, whatever stage the recovery
had reached at that point.

In his judgment, it would be extremely

difficult to tolerate such a rate advance if it came at a time
when unemployment was still high and resource utilization generally
was well below optimal levels.

He thought the recovery would have

to be well advanced before the Committee would be prepared to
contemplate a significant slowing in the growth rate of money.
Mr. Black noted that the lags in the effects of monetary
policy usually were much longer for prices than for production
and employment.

Presumably, one cost of a temporary acceleration

in the rate of money growth would be a higher rate of inflation
2 or 3 years from now.
much higher?

The important question, however, was how

He asked whether the staff had any views on that

In response, Mr. Gramley observed that the magnitude of
the effect was suggested by the projected impact on prices of the
two policy alternatives Mr. Partee had described.

According to

the Board's econometric model, the more stimulative fiscal policy
would add about one-half of a percentage point to the rate of
inflation in the middle of 1976.

If the more expansive monetary



policy also was followed, the rate of inflation would be a full
percentage point higher.

Even with both types of stimulus, how

ever, there would be continuing improvement in the performance of
prices throughout the projection period.

That was because, even

at the end of the period, the rate of unemployment would still be
in the 7-1/2 per cent area and a sizable gap between potential
and actual output would remain.
Chairman Burns asked whether the staff had experimented
with projections based on assumptions about the rate of growth in
M2 rather than M1.
Mr. Gramley replied that projections had not been made on
that basis, although that would, of course, be feasible.


procedure actually employed was to assume a specific growth rate
for M1 and to permit the model to determine market interest rates.
The differential between market rates and the rate of return on
savings deposits then determined the volume of savings flows to
banks and, therefore, the rate of growth of M2 .
Mr. Partee observed that the definition of M


would have to be modified if there were a significant trend toward
extending checking privileges to savings accounts at banks or
other thrift institutions.

No such modification had as yet been



In response to questions from Mr. Mitchell, Mr. Pierce
said the Board's econometric model would yield a higher rate of
inflation than shown by the judgmental projection


However, he would tend to agree with the judgmental fore
In that projection, the primary reason for the expected

slowing of the inflation rate was rising unemployment.

It was

anticipated that the rate of increase in food prices would be
less than the Department of Agriculture seemed to be expecting,
but still relatively rapid--about 10 per cent or more.


the rate of increase in wages was expected to decelerate suffi
ciently to permit a substantial slowing of the rise in most
non-food commodity prices.
Mr. Mitchell asked about the staff's assessment of a view
expressed at the meeting last week of the Board and its economic
consultants, to the effect that the recent increases in prices of
oil and foods were one-time events which had led to unavoidable
increases in the general price level but which had no necessary
implications for the subsequent rate of inflation.
In reply, Mr. Pierce remarked that an exogenous change in
prices was not necessarily a "once and for all" event because it
could affect the rate of advance of wages, and that in turn would
have implications for the future course of prices.




however, the rate of inflation depended on the long-run course of
monetary policy.

Thus, while the level of prices might inevitably

be raised by an exogenous increase in the price of oil or other
commodities, the subsequent rate of inflation could eventually be
Mr. Gramley added that the staff's assumptions about the
nature of wage settlements did not differ radically from those
mentioned at the meeting with the economic consultants.


though quite large settlements were expected in major collective
bargaining agreements, it was anticipated that there would be
significant slowing in the rate of wage advance in the more
competitive sectors of the economy.

Furthermore, as the rate of

increase in consumer prices slowed, the size of the cost of living
increases under escalator clauses would decline.

Over all, the

rise in average compensation per manhour was projected to slow to
an annual rate of about 7-1/2 per cent by mid-1976.

That seemed

to be a reasonable expectation in light of the projected high
level of unemployment.
Mr. Mitchell then noted that in the staff presentation a
good deal of emphasis had been placed on the rate of growth of
real money balances.

He asked if the staff believed that the

Committee should focus on the real rather than the nominal supply
of money.



Mr. Gramley said he would not recommend that the Committee
set its targets in terms of the real money stock; to do so could
be dangerous.

However, he thought the Committee should give care

ful attention to changes in real money balances.

The economy had

experienced price increases that were largely a consequence not
of current policy decisions but of such factors as excess demand
in past periods, increases in oil and food prices, and the removal
of price controls.

In the context of such price rises, the Federal

Reserve had maintained a relatively slow rate of growth in nominal
money, and real balances had declined by about 8 per cent from
their peak level.

That was bound to have a serious effect on the

Mr. Partee added that the staff would suggest that in
setting its targets for growth in the nominal money stock the
Committee take account of the changes that had occurred in the
real balances; in effect, it should modify its targets for the
nominal money stock in light of the changes in the real stock.
In response to questions by Chairman Burns, Mr. Partee
said the tax cuts provided for in the policy alternative were
assumed to go into effect as of the beginning of 1975.

The assump

tions made in connection with the investment tax credit included
an increase in the credit from 7 to 10 per cent and changes in



the investment tax rules somewhat more liberal than those worked
out by the Treasury in connection with the Presidential message
of October 8; in particular, it was assumed that the deprecia
tion deductions would not be eliminated, as called for under
the Administration's proposal.

The modifications of the in

vestment tax credit were taken to be a one-time, permanent

The 5 per cent reduction in personal income taxes also

had been treated as a permanent change, because much of the effect
of a tax cut announced as temporary would be reflected in a rise
in savings rather than in spending.

That did not mean, of course,

that taxes could not be raised again later.
The Chairman then asked what the staff thought the net
effect would be of a simultaneous decrease of, say, $20 billion
in both Federal expenditures and business taxes.
In response, Mr. Pierce said the econometric model would
indicate that such a policy was deflationary, on balance, because
it would result in a rise in savings.

He thought the net effect

would not be large, although the precise outcome would depend on
which business taxes were reduced.
Mr. Partee remarked that if he were considering such policy
actions in connection with a judgmental projection he would come
to the same conclusion.

A cut in the corporate income tax rate,



for example, was likely to be reflected in some rise in ex ante
savings, in either the corporate or the personal sector, so that
the increase in private spending would be smaller than the reduc
tion in Federal spending.

If, however, the action with respect

to business taxes was a kind that greatly increased investment
incentives, it was possible that the effects of the reduction in
Federal spending would be offset.
Chairman Burns observed that in his opinion the effects
would be strongly expansionary rather than deflationary; a $20
billion tax cut would create a wholly new environment for busi
ness enterprise, and businessmen would react

by putting their

brains, their resources, and their credit facilities to work.
His disagreement with the staff on that point reflected a basic
difference in interpretation of how the economy functioned and
how fiscal stimulants and deterrents worked their way through
the system.
Mr. Sheehan noted that at the Committee's September
meeting Mr. Gramley had expressed the view that if the rather
bleak economic projection presented then was in error, the error
probably was in the direction of underestimating the downward
adjustment that lay ahead.

He wondered whether the staff thought

the gloomy projection presented today was likely to prove to have
erred on the optimistic side.



Mr. Gramley replied that, while the projection represented
the staff's estimate of the most likely outcome, he still thought
that any errors were likely to be in the direction of optimism.


might note in particular that the projection called for a decline
of 9 per cent in real fixed investment by business from the third
quarter of 1974 to the second quarter of 1976.

Business investment

had dropped 16 per cent during the 1957-58 recession, and it was
not inconceivable that a decline of that magnitude would occur in
this recession.
Mr. Partee said his instincts suggested that economic
activity would be somewhat weaker than projected.
however, that economists often

He noted,

were unduly bearish because of

the difficulty of anticipating where sources of strength would

He might note also that the basic projection did not

allow for fiscal stimulus, aside from the expected rise in budget
expenditures to $307 billion in fiscal 1975.

It was highly prob

able that fiscal policy would be more stimulative than assumed,
and that that would tend to shift the actual outcome in the
direction of a less steep decline and a less protracted period
of weakness than indicated by the projection.
Mr. Hayes asked what the staff thought the effect on
interest rates might be if the Federal deficit were financed
largely by inflows of funds from the OPEC countries.



Mr. Partee replied that there was not likely to be much
effect on the general level of interest rates because the funds
would simply be transferred from other investors to OPEC inves

However, since the OPEC investors were more likely to

purchase Government securities than other investors were, there
might well be more downward pressure on yields of Governments and
upward pressure on rates in other credit markets, such as the
mortgage market.

Also, the exchange rate for the dollar might

be strengthened if the inflows were large and the funds were not
reloaned abroad.
Mr. Reynolds noted that the staff estimated that inflows
of OPEC funds would be roughly $16 to $18 billion in 1975, of
which perhaps two-thirds would be invested in U.S. Government
Mr. Hayes then observed that he found the staff projection
of deterioration in the trade balance puzzling.

Given the weak

ness in the domestic economy, it seemed likely to him that U.S.
imports would weaken relative to exports.
Mr. Reynolds noted that there was, naturally, considerable
uncertainty attached to a projection of the trade balance as far
out as mid-1976, and it would be surprising if the forecast were
accurate within a margin of $3 or $4 billion.

The trade balance



was projected to deteriorate through most of the projection period
because it was usual for U.S. imports of materials and consumer
goods to turn up rather quickly at the beginning of a recovery in
the domestic economy, whereas there ordinarily was a much longer
lag between an economic upturn in foreign countries and a rise in
U.S. exports.

That lag was long because foreign industries tended

to utilize the domestic capacity that had been idled during the
recession before increasing purchases of industrial materials and
capital equipment from the United States.

If the projection were

to be extended beyond mid-1976, it probably would begin

to show

an improvement in the U.S. balance of trade.
Mr. Francis noted that according to the staff's basic
projection, which assumed a 5-3/4 per cent growth rate in M1,
interest rates would turn up in the latter part of 1975 but would
not return to the recent peak levels at any time during the projec
tion period.

If, however, the Committee were to adopt a longer

run target for M

of 7-1/4 per cent, which the staff had presented

as a policy alternative, he wondered whether interest rates would
not ultimately rise to levels above the recent peaks.
In response, Mr. Partee remarked that one reason the staff
did not anticipate a return to recent interest rate peaks during
the projection period was that it did not expect the economy to



be subjected during that period to the severe stresses experienced
in the past year and a half.

As had been suggested earlier, if

the Committee adopted a 7-1/4 per cent growth rate target, it would
be desirable to reduce the target at some juncture after the level
of resource utilization had increased.

The point he had tried

to make was that it probably would not be feasible to reduce the
target as long as unemployment was still very high;

the reduction

would have to be made carefully and gradually, as the rate of
unemployment declined.

He thought it would be possible, by use of

the Board's econometric model, to develop a strategy for policy
that would ultimately result in both a lower steady-state rate
of inflation and a higher level of resource utilization than that
estimated for the projection period.

However, that outcome prob

ably could not be achieved until well beyond mid-1976.
Mr. Mayo observed that one way of attaining an average
rate of growth in M

of 7-1/4 per cent for some temporary period

would be to start out with faster growth--at a rate, say, of 8-1/2
per cent--and then gradually reduce the rate.

He asked whether

the staff thought such a course would improve the chances of getting
back to a 6 per cent growth rate without untoward effects.
In response, Mr. Partee remarked that an earlier injection
of money, such as suggested by Mr. Mayo, would speed up the recovery,



so that the level of resource utilization might be higher than
otherwise at the time the 6 per cent growth rate in money was

However, a rate of growth in the money supply as high

as 8-1/2 per cent for more than a month or two would be likely
to exacerbate market expectations of inflation.

A growth rate of

7-1/4 per cent was within the range of recent experience and there
fore probably would not have that effect.
Mr. Mayo concurred in Mr. Partee's observation about the
probable consequences of an 8-1/2 per cent growth rate in the
money supply.

He added that, because such a growth rate probably

would lead observers to believe that the System had given up the
fight against inflation, longer-term interest rates might begin
to back up immediately.
In reply to a question by Chairman Burns,



remarked that the staff had not assumed that wage and price
controls would be reimposed.
The Chairman then observed that, historically, upturns in
the wholesale price index and in economic activity had tended to
be roughly coincident.

In the staff projection, however, the rate

of increase in the price level--as measured by the fixed-weighted
GNP deflator--continued to decline throughout the projection period,
although economic activity began to recover after mid-1975.


asked whether that was because the deflator was dominated by con
sumer rather than by wholesale prices.



Mr. Partee said that was the principal explanation.


sale prices of sensitive materials were likely to be much weaker
than the deflator during the next 6 months, and if the recovery
was slow--with substantial unemployment and unused industrial
capacity--the behavior of such prices could remain rather favor

It was his recollection that, following the 1960-61 reces

sion, the wholesale industrial price index did not increase
noticeably until the latter part of 1964, after the recovery had
been under way for several years.

Sensitive raw materials prices

began to turn up in the fall of 1963.
In response to a further question by the Chairman,
Mr. Gramley observed that the projected upturn in corporate
profits--to nearly the third-quarter 1974 level by mid-1976appeared rather large in view of the weakness of the projected
recovery in activity.

Those profits figures suggested that the

rather optimistic price projections were not unjustified, if the
assumption that the rate of increase in compensation per manhour
would slow to 7-1/2 per cent by the end of the projection period
was correct.

That was because a faster price advance than pro

jected would result in an even larger increase in corporate pro
fits, and that would seem unlikely given the projected degree of
slack in the economy.



Mr. Wallich commented that the projected level of profits
after inventory valuation adjustment would represent only about 6
per cent of GNP, which was not particularly high for a recovery
Mr. Partee said that was true for recoveries in general.
As Mr. Gramley had suggested, however, the staff was concerned
that the profits projection might be too high for the type of
recovery anticipated.

Accordingly, it had examined the figures

thoroughly before presenting them.
Mr. Partee added that he shared Mr. Gramley's view that
the price projection might seem to be on the optimistic side.


personally would have hesitated to present such a projection had
it not been for the test of reasonableness offered by the profits

In reply to a question by Mr. Coldwell, Mr. Gramley said
the labor force was expected to increase quite slowly during the
projection period--by about 700,000 persons between the fourth
quarters of 1974 and 1975, and by 900,000 persons between the
second quarters of 1975 and 1976, when the recovery was expected
to be under way.

The normal increase was roughly 1.5 or 1.6 million.

It was anticipated that high unemployment rates would tend to
discourage workers from entering the labor force.



Mr. Partee added that there had been little evidence of
the "discouraged worker" effect until very recently, and over the
last year or so the increase in the labor force had been larger
than normal.

If it turned out that the "discouraged worker"

effect was offset by the encouragement to labor force participa
tion caused by the impact of inflation on family budgets, the
projected unemployment rate would, of course, prove to be too low.
Mr. Coldwell noted that the economies of most industrial
countries seemed to be in roughly the same phase of the cycle

He asked about the implications of that fact for

U.S. monetary policy.
In reply, Mr. Partee observed that some foreign nations
had already undertaken expansionary economic policies and others
were expected to follow suit.

Thus, if the United States adopted

more stimulative domestic policies it would not be far out of
step with most other industrial countries.

There was a possibility,

in an environment of slack markets all over the world, that foreign
business firms would be more alert than U.S. firms to opportunities
for increasing exports.

In that event, net exports would deteri

orate by more than the rather moderate amount the projections



In response to a further question by Mr. Coldwell,

Mr. Gramley observed that the declines in production and employ
ment thus far in the current recession were about as rapid as in
any other postwar recession.
Mr. Wallich asked about the methods the staff used in
projecting interest rates.

In that connection, he noted that

both long-term and short-term rates were projected to be in the
neighborhood of 10 per cent in mid-1976 and that the rate of
inflation was projected to moderate to about 6 per cent at that

The implication was that real interest rates would

rise from current--in some cases, negative--figures to a level
of about 4 per cent.

It seemed to him that there would be more

downward pressure on interest rates than the projection implied.
For one thing, the slowing in the rate of inflation should influ
ence investor expectations.

Furthermore, as Mr. Hayes had men

tioned earlier, OPEC investors would be placing funds in the
United States.

While it was true that such placements would

not involve a net inflow of funds, the change in ownership of
the funds--from oil consumers to the OPEC countries--should result
in some shift away from consumption and towards investment.
Mr. Partee observed that the staff used various kinds of
information in projecting interest rates.

Among other things, it

considered the relationship between money supply and nominal GNP;



the results of the Board's econometric model simulations, which
allowed for inflation premiums; and flow-of-funds projections,
which made possible sectoral analyses.

For example, the flow-of

funds data suggested that the current problems in the municipal
bond market would continue through mid-1975 and that corporate
bond offerings would remain heavy throughout the year, both of
which implied that households would have to be heavy purchasers
of securities.

While he would not place great confidence in any

specific numerical projection of interest rates, he did expect
the general level of rates to rise, given the magnitude of the
projected increase in nominal GNP.
Mr. Gramley said he agreed with Mr. Partee's observations.
He also agreed with Mr. Wallich's view that the real interest
rates projected appeared to be high, assuming declining infla
tionary expectations.

If businessmen came to believe that the

rate of inflation would moderate substantially, interest rates
would have to decline considerably or business fixed investment
might be weaker than projected.
Mr. Eastburn observed that productivity typically began
to increase in the recovery phase of the cycle.

In recent con

versations with businessmen in the Third District, however, it
had been reported that productivity was increasing markedly now.
He asked about the staff's assumptions regarding the likely trend.



Mr. Partee noted that productivity had declined sharply
thus far in 1974.

The projection called for progressively smaller

declines through mid-1975 and progressively larger increases there

The rate of improvement shown was less rapid than that in

the econometric projection.

However, it was more rapid than

historical experience would suggest; typically, gains in produc
tivity had remained small until there was a substantial accelera
tion in economic activity.
Mr. Zeisel added that it was unusually difficult to assess
the likely course of productivity at this time.

The recent sharp

deterioration suggested that manhours worked had not yet been
adjusted downward sufficiently.

On the other hand, if real out

put were to decline further in the first half of 1975 at the rate
projected, a significant improvement in productivity would involve
a decline in employment deeper than seemed realistic.
Chairman Burns expressed the view that a rapid increase
in productivity would result in a dramatic improvement in business
expectations and an upgrading in business spending plans.
Mr. Eastburn then noted that in the discussions he had
mentioned, Third District businessmen had evidenced great concern
about the real estate situation, especially the plight of REIT's.
He wondered what assumptions the staff had made about the outlook



for REIT's and the steps the Government might take to ameliorate
the situation.
Mr. Partee replied that, while some REIT's or construction
firms might fail, the staff had not assumed a financial collapse in
the real estate industry that would seriously affect the banking
system, and therefore no Government programs to assist REIT's had
been allowed for in the projection.

There was, of course, a pos

sibility of severe shocks to the financial system from serious
difficulties in the real estate industry or failures of major
corporations here or abroad.

However, it was impossible to

predict such situations or to estimate the effects they might
have on real output.
Mr. Holland asked what the implications would be for the
staff projection if it were assumed that interest rates would not
rise in the second half of 1975.

He might note two possible

situations in which interest rates would remain stable.


there might be a change in the attitudes of private investorsresulting from a moderation in the rate of inflation--that would
induce them to participate in mortgage markets, for example, with
out any rise in interest rates.

Second, in mid-1975 the Federal

Reserve System might become sufficiently satisfied with the modera
tion in inflation and the increase in productivity to pursue a
monetary policy that would keep interest rates stable.


In response, Mr. Partee said he thought the outcomes in
the two situations would be different.

In the first case he

would expect the shape of the yield curve to change; it would
become more downward sloping as investors, no longer fearing
renewed inflation and higher interest rates in the future, became
willing to buy relatively more long-term securities.

Such a

development would lower real long-term rates of interest and
would encourage investment in business fixed capital and in hous


In the second case, he would expect the whole term struc

ture of rates to be lower than otherwise.

Since that would

improve credit availability generally, it would have more favor
able implications for output than the first case,
Mr. Gramley remarked that the terms in which Mr. Holland
had described the first case referred only to the attitudes of
lenders; in his judgment, it was necessary to consider borrowers'
attitudes as well.

As Mr. Partee had suggested, a shift in the

preferences of lenders from short-term to long-term assets would
tend to lower long-term rates.

However, if rates did not decline

fast enough to keep pace with the abatement of inflationary expec
tations of borrowers, there might be little positive stimulus to

Unless there also was some assistance in the form of

an accommodative monetary policy, the outcome was as likely to be
negative as positive.



Mr. Partee added that the decline in long-term interest

rates to which he had referred would, in effect, be offset by an
increase in short-term rates if the preferences of borrowers
shifted to short-term debt because they expected further declines
in long-term rates.
Mr. Holland then hypothesized a situation in which the
inflationary expectations of both lenders and borrowers abated
at about the same rate, resulting in a level of nominal interest
rates significantly lower than projected and in stability in real
rates of interest.

He asked if expenditures on housing and busi

ness investment would be stimulated by such developments.
Mr. Gramley expressed the view that if real interest rates
did not change, a decline in nominal rates would not in itself
result in an increase in investment.

The decline in nominal

rates might, of course, be associated with other developmentssuch as an improvement in the availability of mortgage creditthat would encourage spending,
Mr. Partee remarked that a decline in nominal interest
rates by itself could result in some marginal improvement in hous
ing demands, insofar as home buyers probably were less sensitively
attuned than other investors to the role of inflation in affect
ing the real costs of particular interest rates.



Mr. MacLaury noted that the staff's projection

of an

upturn in the latter half of 1975 was based on an expectation of
favorable developments in three sectors--inventories, consumer
expenditures, and housing.

He wondered about the extent to which

the spending increases were predicated on an assumed improvement
in the stock market.
Mr. Pierce replied that some improvement in the stock
market was assumed in the econometric projection, and the result
ing wealth effect had some impact on consumption spending.


ever, the consumption figures so obtained were surprisingly
close to those shown in the judgmental projection, in which the
increase in real consumption reflected an improvement in real
disposable income.

Thus, the stock market did not appear to be

a major factor.

MacLaury then noted that the availability of mortgage

credit and the level of mortgage interest rates ordinarily were
taken to be the main determinants of the demand for housing.


wondered whether it was not also important to consider the rise
in the cost of housing relative to consumer real income.
In response, Mr. Pierce observed that in the staff projec
tion consumer incomes rose more rapidly than prices after mid-1975;
that was one factor in the expected increase in housing expenditures.
Thus, the real income constraint was projected to become less important



in holding down the demand for housing.

The relatively low level of

real interest rates also should encourage housing demand.

He would

emphasize, however, that the projected improvement in housing starts
was rather weak in comparison with the rapid expansion typical of
previous housing cycles.
Mr. Partee added that there was likely to be some delay in the
upturn in multifamily housing--which had been an important factor in
the recovery phases of recent housing cycles--as a result of the atti
tudes of both builders and lenders and of the volume of unsold units.
Moreover, the improvement in inflows to thrift institutions was not
projected to continue beyond mid-1975, and there was no reason to
believe that mortgage lenders would liberalize terms substantially.
Since the price of housing had become an increasingly important con
sideration to buyers in recent years, easy credit terms were likely
to be more necessary than usual to encourage an upswing in housing.
The Chairman remarked that he would describe the recovery
in housing projected for 1975 as quite vigorous.

However, the rise

was shown as tapering off in 1976.
Mr. Kimbrel asked if the staff believed that the legislation
permitting U.S. citizens to buy gold would have a significant impact
on the rate of growth of the money supply.
Mr. Partee said he thought that legislation would have
little or no effect on the demand for money.

Most gold purchases



were likely to be made with funds shifted out of interest-bearing
balances or the securities markets.
Mr. Reynolds added that the projection of net exports
allowed for an increase of about $1 billion in gold imports in

Any such projection was, of course, subject to a great

deal of uncertainty.
Mr. Winn noted that the projection necessarily took no
account of such unpredictable factors as major financial shocks,
war in the Middle East, and new approaches to the energy problem
or other changes in Administration policy, except insofar as they
affected the budget estimates.

He wondered which of such factors

the staff thought were most likely to alter the forecast significantly.
Mr. Partee said that, aside from the possibility of financial
shocks, the major source of uncertainty with respect to the projec
tion probably was the threat of war in the Middle East.

An abrupt

change in the psychology of businessmen or consumers also could
have significant effects.

The consequences of a mandatory program

to reduce oil imports by, say, one million barrels a day would depend
on when it was put into effect and how it was administered, but he
thought it was unlikely that any such program would have a signif
cant impact on the economy during the projection period.
Chairman Burns commented that if such a program were adopted it
probably would dampen real economic activity still more and increase the



rate of inflation somewhat.

There were many who urged--in his opinion,

correctly--that the Government should deal promptly and effectively
with the energy problem, but they often overlooked the costs involved.
The Chairman then remarked that the staff had presented a
cyclical analysis that did not touch on some highly important long
range problems of economic policy which were not irrelevant to
monetary policy.

First, for almost a decade there had been a

genuine and deep depression in corporate profits.

Second, during

that decade there had been very little growth in productivity.
Third, one of the most significant changes that had occurred in
the structure of income distribution, and one of the most often
overlooked, was the decline in the proportion of the national
income going to workers and investors.
It was his belief, Chairman Burns continued, that the nation
required economic policies that would deal with those longer-range
problems and not just with problems of the cycle.

It was necessary

to consider what economic policies were needed--and how monetary
policy could contribute--if existing trends were to be modified in
such fashion that the nation would achieve the prosperity it could
and should have; otherwise, the country could face stagnation in

longer run.

And one of the most serious of the nation's prob

lems--which had been recognized in today's presentation--was that of
secular inflation.



Thereupon the meeting recessed until 9:30 a.m. the follow
ing morning, Tuesday, December 17, 1974.

The attendance was the

same as on Monday afternoon except that Mrs. Junz, Miss Morisse,
Miss Pruitt, and Messrs. Annable, Beeman, Enzler, Gramley, Kichline,
Parthemos, Peret, Pizer, Reynolds, Roxon, Siegman, Smith, Taylor,
Truman, Wendel, Wernick, Wonnacott, and Zeisel were absent, and
the following were present:
Mr. Guy, Deputy General Counsel
Ms. Tschinkel, Manager, Securities Department,
Federal Reserve Bank of New York
Mrs. Farar, Economist, Division of Research and
and Statistics, Board of Governors
By unanimous vote, the minutes
of actions taken at the meeting of
the Federal Open Market Committee
held on November 19, 1974, were
The memorandum of discussion
for the meeting of the Federal Open
Market Committee held on November 19,
1974, 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 cur
rencies for the period November 19 through December 11, 1974, and
a supplemental report covering the period December 12 through 16.



Copies of these reports have been placed in the files of the
In supplementation of the written reports, Mr. Coombs
made the following statement:
At the time of our last meeting, we were inter
vening in four different European currencies to check
a heavy wave of speculation against the dollar. The
four European central banks concerned reinforced our
efforts by similar operations in their own markets,
and this concerted intervention quickly brought about
a sharp recovery of the dollar rate. Later in Novem
ber, however, the dollar began to sag once more, largely
reflecting market expectations that another big German
trade surplus would be reported for October. To check
an unduly sharp rate decline, we joined forces with
the German Federal Bank in dollar support operations
on two occasions in the latter part of November and
in the process borrowed and sold a total of slightly
more than $26 million worth of marks. This pushed
our mark swap debt at that point up to $268 million.
As our own trade figures for October showed
remarkable strength, however, the dollar recovered
and we were able to go into the market on the other
side, buying in not only $85 million worth of marks,
but also $22 million worth of Dutch guilders and
$8-1/2 million worth of Belgian francs. These pur
chases were used to pay off entirely the Dutch
guilder and Belgian franc debt we had incurred
earlier in the month and to pay down our swap debt
to the German Federal Bank to $185 million.
Since then, the dollar has shown renewed weak
ness, partly reflecting the continuing decline of
interest rates here in the face of steady or more
slowly easing interest rates in Europe, as well as
the report that Kuwait had contracted to buy $400
million worth of Daimler-Benz shares and would be
in the market to buy a corresponding amount of

marks to finance the purchase. Furthermore, the
dollar also began to experience some pressure from



the year-end window-dressing activities of many
European banks. Finally, last week we seemed to
have suffered some backwash of pressure on the
dollar from heavy operations by the Bank of England
to check a speculative attack on sterling.
Despite these troublesome developments, the
markets remained fairly orderly and we allowed the
dollar to slip down gradually until yesterday, when
the rate on the mark threatened to go through the
2.44 level, roughly where it was at the time of the
last Committee meeting. We intervened yesterday
afternoon, selling about $7.5 million worth of
marks in the process, and in view of the way in
which market conditions were deteriorating we sug
gested to the German Federal Bank that it might buy
dollars at the fixing this morning. The Federal
Bank did buy about $10 million at the fixing, but
new selling pressures on the dollar subsequently
emerged and the dollar rate has now dropped by
roughly three-fourths of one per cent since last
night's close.
Two reasons have been cited for the overnight
weakening of the dollar. First, the price of gold
rose sharply, from $183 to $190 per ounce, follow
ing the announcement in the Martinique communique
that President Ford and French President Giscard
d'Estaing had agreed that it would be appropriate
for countries wishing to do so to value their gold
holdings at current market prices. It is not
entirely clear why those developments should be
translated by the market into a prospective weak
ness of the dollar; perhaps they are viewed as the
first of a series of steps that would culminate in
a new realignment of parities. Secondly, Kuwait
is reported to be acquiring marks to complete the
financing of its purchases of Daimler-Benz shares.
It appears that the time has come again for con
certed intervention to counteract the rather severe
deterioration of confidence in the dollar that has
occurred since yesterday. The Swiss National Bank
has offered to provide the System with up to $20
million worth of Swiss francs for intervention in
New York beginning at the time their markets close,



which would be 10 a.m. here. It might also be desir
able for the System to make a small drawing on its
Swiss franc swap line in order to engage in supplemen
tary operations. Intervention in guilders and Belgian
francs on a small but visible scale would also be
desirable, but as usual the main effort probably
should be made in marks.
One item that might be considered as good news
is that the System has now paid off $300 million of
the roughly $725 million of foreign exchange con
tracts of the Franklin National Bank which it had
purchased from Franklin in September under a special
Committee authorization. I would hope that the bulk
of the remaining contracts will be disposed of by
early February. So far, the net outcome in terms
of profit and loss has been well within the estimated
In reply to a question, Mr.

Coombs expressed the view that

declines in U.S. interest rates relative to European rates had con
tributed to the recent weakness of the dollar.

It was, of course,

not only relative levels of interest rates that mattered, but also
the size of any forward premiums or discounts on currencies.


the moment the forward premiums on marks and Swiss francs, for
example, were in the neighborhood of 1-1/2 to 2 per cent, which
made the interest rates available in those countries quite attrac

While the United States had been urged by various foreign

statesmen to adopt policies designed to check recessionary tenden
cies and thus avoid precipitating a world-wide recession, he
thought there was room for other countries to be more helpful
in that regard than they had been.



Mr. Wallich remarked that it would be useful for the
Committee to give some thought to the level of dollar exchange
rates that might be desirable under current circumstances.


terday's presentation by the staff suggested that the condition
of the real economy was worse than had been thought earlier and
the outlook for inflation perhaps was not quite as bad.


domestic monetary policy would respond to that information in
some manner, and he thought some response in terms of exchange
rate policy might also be called for.

He had no preconceived

notions regarding the conclusions that should be reached.
In reply to the Chairman's request for comment, Mr. Coombs
said it was his view at the moment that the dollar was still
grossly undervalued.

Anyone traveling in Europe today would be

shocked at the prices being asked--not simply of tourists at
hotels and restaurants, but for goods and services generally.
The exchange rate for the Swiss franc had risen by well over
50 per cent in the past 3-1/2 years, and that for the mark was
up by nearly 50 per cent.

He saw no basis at the moment for pre

suming that the dollar was overvalued or for believing there was
anything to be gained by letting dollar rates slip.

To his mind,

the evidence pointed to precisely the opposite conclusion; even
to permit the dollar to remain at current levels for a protracted



period would serve only to generate further inflationary pres
sures in the United States, and in due course--if a worldwide
recession lay ahead--to create distortions

in the pattern of

world trade.
Mr. Francis said he had not been under the impression that
the present level of the dollar was contributing to inflation to
the extent Mr. Coombs had implied.
In response, Mr. Coombs remarked that a low value for the
dollar tended to raise the cost of all imports and to give exporters
an incentive to increase dollar prices.

The effects were sizable,

since U.S. foreign trade now amounted to approximately $200 billion
per year.
Chairman Burns observed that Germany's foreign trade surplus
was now running at an annual rate of about $20 billion.

He asked

what implications Mr. Coombs thought that might have for the mark
dollar exchange rate.
In responding, Mr. Coombs said he might first note that
along with that trade surplus Germany had a large deficit on
invisibles, including tourism and remittances of foreign workers.
Secondly, Germany had benefited from the problems of two close
trading partners, the United Kingdom and Italy; there had been a
huge shift of trade in the area which accounted for an important



component of the German trade surplus.

Finally, he thought

Germany had been enjoying a seller's market in recent years in
which a rise in the exchange rate for the mark had simply added
to the value of its exports.

That situation could change, and

German industry could very well find itself far less competitive
than one might expect on the basis of the recent record.


export orders already appeared to be tailing off.
With respect to Mr. Coombs' concluding comment, the
Chairman remarked that he had been hearing such statements for
the last 2 or 2-1/2 years.
Mr. Coombs replied that the evidence in the recent figures
was fairly distinct.

In any event, he would not want to forecast

Germany's foreign trade in 1975 by extrapolating the trends of,
say, 1973 and 1974.

He thought an inflection point had been

reached, and that it would be well to await the actual figures.
Mr. Morris expressed the view that Mr. Coombs had an
exaggerated impression of the domestic inflationary consequences
of the foreign exchange situation.

In his view, the recent weak

ness of the dollar had been fairly well confined to its relation
ship to the mark and Swiss franc; the dollar had not been weak in
relation to the currencies of other major countries, with which
the United States conducted the bulk of its foreign trade.



In response to a question, Mr. Bryant observed that the
average value of the dollar in terms of 10 leading foreign cur
rencies, on a trade-weighted basis, had declined by about 3 per
cent in recent months, after having risen somewhat more from the
1974 low reached in May. While that measure of the dollar's
value had undergone wide fluctuations in the past 2 years, per
haps the most significant point was that its current level was
not greatly different from that in March 1973, just after the
second devaluation.

With respect to the issue of the inflationary

consequences of declines in the exchange rate, he thought it was
important. to distinguish between rate movements that were con
sidered likely to be transitory and those that were not.


would be much more concerned about the inflationary impact of
the latter.
Chairman Burns remarked that the distinction Mr. Bryant
had mentioned could be difficult to make in practice; a fluctua
tion that appeared to be transitory at the time often proved to
have been the beginning of a long-run movement.
Mr. Coombs commented that there was a real danger of under
estimating the significance of a decline in the dollar exchange

Taken by itself, a decline of, say, 5 per cent in a short

period might not appear unduly serious.

Such a movement, however,



could generate forces that resulted in a much larger decline, if
traders who suffered losses on their dollar holdings become dis
inclined to retain their dollar receipts, perhaps even overnight.
Such a situation had developed on two or three occasions over
the past 2 years; after an initial decline the dollar had seemed to
hit an air pocket and had fallen sharply further.

He would want

to guard against a repetition of that pattern, particularly in
the context of the more general present question concerning the
direction of flows of oil revenues.

With respect to Mr. Morris'

observation that the recent weakness of the dollar had been mainly
in relation to the mark and Swiss franc, a decline in the dollar
rate against a number of key currencies could have unfortunate
psychological effects on commodity markets.

Since many commodity

prices were quoted internationally in dollar terms, such declines
could lead to speculative and inflationary reactions.
Mr. Solomon said he would like to offer a comment about

While it was true that Germany was making large net pay

ments on nontrade items, it would have a current account surplus
this year of more than $10 billion, even though--like other
industrial countries--it was an oil importer.

Moreover, accord

ing to the best estimates the surplus would persist in 1975,
although it might be smaller than in 1974.

Under current



circumstances, it was normal for an oil-importing country to have
a deficit on current account.

He thought the present disequilib

rium in Germany's balance of payments was tremendous--perhaps as
large in absolute terms

as the disequilibrium in the U.S. pay

ments balance had been in 1971.

It was his personal view that,

by one means or another, the mark would appreciate against other
Mr. Solomon added that a generalized downward movement
in the dollar would, of course, raise costs in the United States.
In arriving at a judgment regarding the proper rate for the dollar,
however, it was important to distinguish between movements against
the mark--and possibly also the Swiss franc, which was now a haven
currency because of the possibility of a new Mideast war--on the
one hand, and more generalized movements on the other.
Mr. Hayes said he might mention in passing that German
and Swiss bankers had indicated to him in recent months that in
their judgment, the dollar was substantially undervalued in terms
of the mark and Swiss franc.
Mr. Coombs observed that questions about the fundamentals
presumably would be resolved to some degree over the course of 1975.
However, the System was faced with an immediate market situation
that had nothing to do with fundamentals.

The present situation



had been generated to a large extent by such factors as Kuwaiti
purchases of marks to finance the acquisition of Daimler-Benz
shares, interest rate inducements to move funds into Germany, and
public statements by German officials a month or so ago express
ing no objection to an appreciation of the mark.

Funds were flow

ing into Germany not because market participants expected some
particular outcome with respect to the German trade balance in
1975 but for much more immediate reasons largely related to
Mr. Wallich remarked that he did not mean to debate with
Mr. Coombs about the current situation in the market.

He might

note, however, that attitudes toward foreign exchange rates since
they had begun to fluctuate a few years ago were similar in some
respects to the attitudes toward U.S. Government bond prices
around the time the peg was removed in 1951.

There was great

concern both before and shortly after the removal of the peg
that bond prices would fall sharply and persistently and thatunless the Federal Reserve stabilized bond prices--the nation
might be exposed to considerable instability in both financial
markets and markets for goods and services.

The concern about

freely fluctuating bond prices proved to be much exaggerated, and
to the extent it was not, the nation learned to live with the




He would much prefer to have exchange rates remain

stable; he considered stable exchange rates, in contrast to fixed
bond prices, to be desirable.

At present, however, he thought

such stability could not be achieved.

Accordingly, he would

favor tolerating some movement, both up and down, in exchange
Mr. Coombs remarked that that was precisely the course
the Desk had been following.

He thought a problem arose only

when exchange rate fluctuations threatened to get out of hand.
By unanimous vote, the System
open market transactions in foreign
currencies during the period Novem
ber 19 through December 16, 1974,
were approved, ratified, and confirmed.
Mr. Coombs noted that a System drawing of $54.6 million
equivalent on the German Federal Bank would mature for the first
time on January 10, 1975.

There was some likelihood of a favor

able movement in the mark-dollar exchange rate after the turn of
the year, when

year-end window dressing would subside, that

would enable the System to pay off the drawing at maturity.
would assess the chances of full repayment as about even.


recommended renewal of the drawing in the event that repayment
was not feasible.



Possible renewal for a further
period of 3 months of the System
drawing on the German Federal Bank
maturing on January 10, 1975, was
noted without objection.
Mr. Coombs then reported that two System swap drawings on
the National Bank of Belgium, totaling $31.8 million equivalent,
would mature for the fourteenth time on January 17 and 24, respec

He had not yet heard whether the U.S. Treasury had

received the expected letter from the Belgian Ministry of Finance
indicating that the Belgians would not accept the Treasury's pro
posals regarding loss-sharing on repayments of the System's Belgian
franc swap debt outstanding since 1971.

In any event, he would

recommend that, as a precautionary measure, the Committee approve
renewal of the two drawings if necessary.

Because the Belgian

swap line had been in continuous use for more than one year, express
authorization by the Committee was required if the drawings were to
be renewed.
Mr. Holland said it appeared from Mr. Coombs' comment that
not much had been done recently to expedite repayment of the Belgian
franc drawings.

He asked whether Mr. Coombs had held further discus

sions of the matter with Belgian officials during the December Basle



Mr. Coombs said he had discussed the matter with an
official of the Belgian National Bank during the Basle meeting.
The latter had indicated that to his knowledge there had been
no change in the Ministry's position, but that he was not sure
whether the Ministry's letter to the U.S. Treasury had been dis
patched as yet.

He (Mr. Coombs) thought it would be desirable

to wait until the Treasury had received the letter before press
ing the question of System repayments.
Chairman Burns asked whether Mr. Coombs could urge the
Belgian authorities to expedite the letter, and
he would do

Mr. Coombs said

By unanimous vote, renewal for
further periods of 3 months of two
System drawings on the National Bank
of Belgium, maturing on January 17
and 24, 1975, respectively, was

Secretary's note: A report by Mr. Solomon on the
November meetings of Working Party 3 and the Group
of Ten Deputies, distributed to the members prior
to this meeting, is appended to this memorandum as
Attachment A. A report by Mr. Wallich on the
December Governors' meeting in Basle, distributed
during this meeting, is appended as Attachment B.
Before this meeting there had been distributed to the
members of the Committee a report from the Manager of System Open
Market Account covering domestic open market operations for the
period November 19 through December 11, 1974, and a supplemental



report covering the period December 12 through 16.

Copies of

both reports have been placed in the files of the Committee.
In supplementation of the written reports, Mr. Holmes
made the following statement:
Since the Committee last met, open market
operations worked towards a steady decline in
the Federal funds rate. With M 1 coming in at
the lower end of the Committee's range of toler
ance, nonborrowed reserves were supplied more
generously and member banks reduced their borrow
ing at the discount windows substantially. By
the close of the period, the Desk was seeking a
pace of reserve supply that was expected to result
in a Federal funds rate of about 8-3/4 per cent or
a little below.
Interest rates--particularly in the Treasury
sector--declined on balance in response to the lower
funds rate, the cut in the discount rate, and grow
ing evidence of a weakening economy. Average rates
of 7.06 and 6.86 per cent were established on 3
and 6-month bills, respectively, in yesterday's
regular Treasury bill auction, down 47 and 57 basis
points from the average set in the auction just
prior to the last meeting.
In anticipation of further declines in interest
rates, dealers built up inventories of Governments,
agencies, and other securities. Attempts to lighten
inventories from time to time resulted in some con
gestion in the corporate and particularly the munici
pal market. Conditions in the latter market, in fact,
neared a state of crisis as dealers were forced to
take heavy losses on New York City bonds and notes
in the absence of the usual demand from commercial
banks and casualty companies. There has been con
siderable concern about the ability of New York City
and some other municipalities to raise money needed
early in the new year, and a series of meetings between
market participants and city officials is currently
under way. Tax-exempt yields reached an all-time high
over the period and a number of New York City issues
were yielding 10 per cent or more.



Seasonal pressures were evident in the short-term
credit markets, and banks bid aggressively for CD's as
tax- and oil-payment dates approached. A number of
major banks were particularly aggressive in building
up CD's in an apparent effort to cut back on their
reliance on Federal funds by the year-end statement
Open market operations had to contend with large
and erratic movements in market factors affecting
reserves over the period. Banks also had problems
in managing their own reserve positions with excess
reserves unusually high in late November and early
December. Reserves were added to the banking system
through outright purchases of over $1 billion of
Treasury bills, $212 million of Treasury coupon
issues, $360 million of Government agencies and
about $200 million of bankers' acceptances. Day
to-day reserve variations were handled by over $10
billion of repurchase agreements and about $8 billion
of matched sale-purchase contracts, of which about
half were made directly with foreign accounts.
Activity for foreign accounts remains very heavy,
particularly around oil-payment dates. Given the
size of dealer inventories, availability of securi
ties has been ample. In our go-around on Friday,
for example, we were offered $2-1/2 billion Govern
ment agency securities--by far the largest offering
of such securities that we have ever had. Dealer
positions in agencies at the time amounted to $1.9
billion, somewhat less than what we were offered.
As far as the Treasury is concerned, it
announced on Friday a yield auction of 2-year notes,
set for December 23, to roll over a year-end maturity.
In addition, it appears likely that the Treasury will
have to borrow $1 to $1-1/2 billion to meet a low
point in its cash position in early January. Tenta
tively, it has been considering the reopening of two
coupon issues, but there is a possibility that a
very large petro-dollar transaction may provide the
Treasury with the cash it needs via an issuance of
special securities directly to a foreign account.
As noted in a recent weekly report, the Desk
has added another dealer firm--Blyth Eastman Dillon



Capital Markets--to the list of firms with which we
do business. This brings the number to 26, an all-time
high. At the same time, we added another firm--Gold
man Sachs--to the list of primary reporting dealers
and we will probably add that firm to the trading
list before long.
Mr. Black said it was not clear to him why commercial
banks had not been more active in the market for municipals, in
view of their increasingly cautious attitude toward lending and
the widespread feeling that interest rates probably would decline
In reply, Mr. Holmes said he thought the main reason was
that many of the larger banks that previously had been active in
the municipal market now had sizable tax deductions which could be
utilized only if they had taxable income.

Accordingly, they had

lost interest in tax-exempt income.
Mr. Coldwell asked whether another factor was not the
increase in insurance coverage of public deposits and the conse
quent reduction in collateral requirements on such deposits.
Mr. Holmes said he doubted that that factor was of major
importance, although the question might warrant further investigation.
Chairman Burns asked whether growing concern about the
quality of some municipal issues might not be serving to restrain
bank investments in such securities.



Mr. Holmes replied that there definitely had been growing
concern about quality, particularly with respect to the issues of
New York State, New York City, and certain other municipalities.
He would have thought, however, that the assessments of relative
quality were fully reflected in the wide yield differentials that
had emerged; municipalities that were considered good risks could
borrow at 5-1/4 per cent while others were forced to pay 10 per cent.
Mr. Hayes said it was possible that large New York City
banks might be holding down their investments in municipals because
they recognized that they were purchasers of last resort for the
city's issues and wanted to maintain funds for possible use in
that connection.
Chairman Burns remarked that such a course, if New York
banks were in fact following it, seemed

likely to ensure that they

would have to act as purchasers of last resort.
Mr. Holmes noted that many nonbank security dealers had
decided not to bid on New York City issues in January unless the
situation changed drastically.

They were relying on the large

stake that New York City banks had in avoiding any possibility of
default on outstanding debts by the city.
Mr. Mitchell observed that there was no question that market
participants considered New York City securities to be poor risks
and that they were justified in that view.



Mr. Morris expressed the opinion that the problem was not
confined to New York.

There appeared to be a generalized weakness

in the municipal bond market stemming from technical strains, par
ticularly the strains imposed by tax-exempt pollution control bonds.
He might note, incidentally, that in his judgment granting tax
exemption to such bonds represented extremely poor public policy.
Mr. Mitchell said he was not persuaded that the problem
was one of generalized weakness.

The Federal income-sharing program

had provided enormous assistance to State and local governments in
dealing with their financing problems.

Moreover, the fact that

good municipals were still selling readily at favorable yields
suggested that the problem arose from large differences in quality.
In reply, Mr. Morris noted that municipal bond indexes
based on high-grade municipals were now at record highs, and that
yield spreads between such securities and high-grade corporate
issues were very narrow by historical standards.
Mr. Holland remarked that the recent weakness in markets
for high-grade municipals appeared, at least in part, to reflect
the transition now under way toward sales of such securities on
a more taxable basis.
Mr. Mitchell said it was clear that banks were now less
interested in acquiring municipals than they had been for some

That attitude no doubt reflected the problems banks had



encountered in trying to meet the needs of REIT's

and of necessitous

borrowers generally, and their opportunity to charge off losses.
Mr. Axilrod commented that, from the investors' point of
view, the problem appeared to be a genuine one affecting the munic
ipal market as a whole.
active in the market.

Banks, as had been noted, had not been
In addition, casualty companies had become

less interested because reductions in profits had reduced their
investible funds.

Finally, he would hazard the guess that the

interest of individual wealthy investors had declined partly because
they were less certain than usual about their own tax brackets, and
partly because erosion of tax receipts and the current widespread
uncertainties made them doubtful about municipal securities in
In reply to a question by Mr. Coldwell, Mr. Holmes said he
thought it should be possible to continue acquiring Treasury coupon
issues in reserve-supply operations over coming months.
By unanimous vote, the open

market transactions in Government
securities, agency obligations,

and bankers' acceptances during
the period November 19 through

December 16, 1974, were approved,
ratified, and confirmed.

Mr. Axilrod made the following statement on prospective
financial relationships:



During recent months, the staff's forecast of
interest rates that are associated with particular M
growth rates has been gradually lowered in line with
the weakening of actual and projected economic activty.
Except for alternative D, all of the alternatives 1/
presented to the Committee in the blue book 2/ presume
some further easing of the money market. Alternative D
represents our estimate of the likely course of mone
tary aggregates if money market conditions are unchanged.
Given the further weakening in projected GNP, that
alternative lowers the longer-run growth rate for M1
below the 5-3/4 per cent path that the Committee had
previously considered to be desirable.
The easing in money markets that is implied to
greater or lesser degrees by alternatives A through
C would be consistent with the weakening in credit
demands that has developed in short-term markets in
recent months. The degree of easing implied by
alternative C is modest. It involves raising the
Committee's desired longer-run growth rate for M1
to 6 per cent. Such a growth rate means that the
shortfall below path of recent months would not be
compensated for except over a longish period of time,
with consequent downward effects on GNP, though prob
ably minor relative to current projections.
Alternatives B and A--especially A--involve a
more substantial easing of the credit market. As the
blue book notes, alternative B involves an M 1 growth
that makes up for recent shortfalls from the 5-3/4
per cent M 1 path by around mid-year, and contemplates
a decline in the funds rate to around 8 per cent by
the early weeks of next year. Alternative A involves
a more rapid growth in M 1 and more substantial easing
of money market conditions. Under this alternative,
the level of M1 would hit the old 5-3/4 per cent path
by March, and thereafter--unless there were a substan
tial reversal of interest rate declines by late
winter or early spring--would rise above that path at
an average annual rate of about 7-1/4 per cent.

1/ The alternative draft directives submitted by the staff for
Committee consideration are appended to this memorandum as Attachment C.
2/ The report, "Monetary Aggregates and Money Market Conditions,"
prepared for the Committee by the Board's staff.



In weighing its monetary strategy over the weeks
ahead, the Committee may wish to take account of four
(1) The technical position of securities markets,
particularly bond and stock markets, is on the weak
side. The municipal and corporate bond calendar is
sizable and the volume of U.S. Government and Federal
agency securities in dealer hands is large. Some
further decline in short-term rates would, by reduc
ing the costs to banks and dealers of carrying security
inventory, help to stabilize bond market conditions.
A rate decline would also lead to some further easing
in mortgage markets, of course, as inflows to thrift
institutions were sustained.
(2) Further declines in interest rates would be
consistent with experience during the interest rate
cycles of 1957-58, 1959-60, and 1969-71. In the first
two cycles, the peak-to-trough movement lasted from
6 to 7 months, and short-term interest rates declined
relatively much more than thus far in the current
cycle. For example, the funds rate declined by 85
to 95 per cent in the earlier two periods (though
starting from a relatively low level), while in
1974 it has declined about 35 per cent in the 5-1/2
months since its early-July peak. On the other hand,
the funds rate is declining thus far this year at a
relatively faster pace than in the 1969-71 period of
declining rates--a period when the peak-to-trough
movement in the funds rate lasted 15 months and the
relative decline over that period was about 66 per cent.
(3) With regard to money supply, in light of
recent shortfalls in M1 growth relative to path, the
Committee may wish to consider raising the upper limit
of the 2-month ranges of tolerance for M, by about a
percentage point.
(4) M2 growth, on the other hand, has been fairly
strong, though no stronger than we expected at the time
of the last meeting. Thus, there are no shortfalls in
M 2 growth to be compensated for. However, the Com
mittee may wish to consider tolerating substantial M2
growth, at least for a while, in order to accommodate
expanding demands for liquidity on the part of the
public, banks, and thrift institutions. At institu
tions, these demands are reflected in a continued
reluctance to ease lending terms and standards in the
current environment, even though interest rates have



Mr. Morris noted that in his comments about recent short
falls in the monetary aggregates Mr. Axilrod had implicitly taken
August 1974 as the base for measuring longer-run growth rates.
While he understood the reasons for the choice, he believed that
June 1974 would be a better base; to use August was to omit 2 months
of very slow growth in the aggregates, and consequently to under
state the actual shortfall.

Also, since Congress and the public

tended to think of monetary growth rates in terms of quarterly
periods, calculations based on June would be more readily under

Assuming an August base was retained in the next blue

book, it would be useful to add a chart showing longer-run growth
rates measured from June.
Chairman Burns observed that the consequences of moving
the base back in time depended on how far it was moved.


Mr. Morris had noted, the average growth rate would be reduced by
a 2-month shift, back to June.

It would be raised, however, if

the base were shifted back further, since growth rates had been
high in a number of months in early 1974.

Mr. Axilrod observed that the staff had proceeded from
the premise that the Committee had faced the issue of the extent
to which there should be compensation for earlier misses when, at
its September meeting, it had first adopted a longer-run target
measured from August.



Mr. Coldwell asked whether in preparing its projections
the staff had modified the earlier assumptions regarding the
length of lags, such as that between changes in money growth
rates and economic activity.
Mr. Partee replied that no change had been made in the
assumed lag between changes in money and activity.
Mr. Axilrod added that, similarly, there had been no
change in the assumptions regarding the relationship between
money and interest rates.

However, a point that might be rele

vant to Mr. Coldwell's question was the one he (Mr. Axilrod) had
made at the end of his statement--namely, that an apparent increase
in the demand for liquidity was influencing lenders to maintain
rather restrictive lending policies, despite the recent marked
declines in short-term interest rates.

Thus, the continued high

degree of lender caution in the early stages of a downswing in
interest rates was resulting in more credit rationing than might
be expected at this point and a slower response to the effects of
the easing than might otherwise be the case.

He doubted that that

situation would persist in the face of continued improvements in
bank liquidity.
Mr. Coldwell asked whether the situation Mr. Axilrod
described was not partly a consequence of the System's efforts



to get individual banks to operate more prudently with respect
to liability management and capital positions.
In reply, Mr. Axilrod said he thought bankers' experiences
in the inflationary environment of the past year--particularly the
inability of many borrowers to repay loans and the volatility of
certain deposit flows--was a more basic cause of their current
Mr. Bucher noted that during a meeting of economic con
sultants with the Board last week one speaker had criticized the
strategy of fostering a gradual decline in the Federal funds rate.
He had urged the System to focus on the level of interest rates
rather than on the direction of
funds rate rapidly


and to reduce the

to the level that present recessionary pros

pects suggested would eventually be required, rather than stretch
out the decline.

He asked Mr. Partee for his reaction to that

consultant's criticism.
In reply, Mr. Partee said that while he had not attended
the meeting with the consultants he was familiar with the argument
Mr. Bucher had cited.

There was no doubt that a prompt, sizable

decline in interest rates would have a greater impact on future
spending behavior than a gradual decline, because it would reduce
the incentive to postpone spending in the expectation of still



lower rates.

The difficulty with the proposal, as he saw it, was

that it assumed certainty on the policy makers' part about the con
sequences of a radical change in interest rates.

In recent years

the Committee had been focusing more on monetary aggregate targets
because of the problems it had experienced earlier with interest
rate targets.

At present there would be less risk associated with

a reduction in interest rates than, say, 2 months ago, both because
the aggregates had been falling short of the Committee's targets
and because the economic outlook had weakened considerably.


so, however, the precise consequences of a sharp reduction in
interest rates remained unclear.

Growth in the aggregates would

be stepped up substantially, but it was hard to say by how much;
and the effects, over time, that the rate reduction would have on
expectations and on spending behavior were highly uncertain.


advocate a prompt, sizable reduction in rates was to ignore all
such uncertainties.
Chairman Burns added that the proposed sharp reduction in
interest rates would intensify the risk that a renewed rise in
rates would occur at a time when economic activity was still reced
ing--a risk that was minimized
been following.

by the approach the Committee had

A marked interest rate reduction also could have

highly disturbing consequences for foreign exchange rates.



Mr. Bryant observed that some foreign countries were con
strained from following expansionary policies at present by balance
of payments considerations as well as by domestic inflation, and
would be more likely to move quickly toward stimulus if U.S.
interest rates were to fall sharply.

That group certainly

included the United Kingdom and perhaps also Japan.

As indicated

in yesterday's staff presentation, such countries were looking to
the United States and Germany to take some lead in resisting a
cumulative world-wide recession.
The Chairman remarked that the United States had taken
some lead in that regard--a fact which he thought policymakers
abroad would acknowledge.
Mr. Wallich said he had a hypothetical question about the
possible consequences of a discontinuous policy, involving a marked
easing now, followed by a return to the prior policy stance after
the objectives for economic activity had been achieved.

He wondered

whether the level to which interest rates would have risen at the
latter point would be different from their likely level if policy had
not been eased, but for some reason the objective for activity had
been attained anyway.

In other words, would a rise in rates be

anticipated simply because the counter-cyclical policy was expected
to be successful?

Or was there something inherent in the behavior



of markets that would produce a sharp rate advance in reaction to
the discontinuous policy?
Mr. Partee replied that, while there probably would be
some market response, he would expect interest rates to increase
primarily because of the rise in GNP.

He might note that a pattern

typical of past business cycles was for the money supply to grow
more slowly, or even decline, in the last stage of the boom and
the beginning of the recession, and to grow rapidly after the
recovery began.

According to his recollection, the recovery phase

of all postwar cycles had been marked by rapid monetary growth.
If, as suggested by the staff's projections, real GNP began to
recover in the second half of 1975, there would be a similar
tendency for growth in money to accelerate.

Indeed, that ten

dency was expected to be stronger than usual because of the
anticipation of a continuing substantial rate of inflation;
nominal GNP was projected to be growing at a rate of about 9
per cent.

Presumably the Committee, which was now paying increased

attention to growth rates in the monetary aggregates, would resist
a sharp acceleration in money growth.

Accordingly, increases in

interest rates were likely to be sharper than at corresponding
points in earlier recoveries.



Mr. Axilrod said he would offer an additional point.


a marked decline in interest rates would encourage recovery in
activity, unemployment could remain substantial for a time.


such circumstances, the Committee could be faced with the dilemma of
either permitting what might appear to be a premature reversal of
the interest rate decline as recovery began or permitting substan
tial reserve and money creation.

Presumably the Committee would

want to take that risk into account.
Mr. Wallich asked whether the staff thought a discontinuous
policy of the kind he had suggested would result in a higher ultimate
level of interest rates as well as a faster increase.
In reply, Mr. Axilrod remarked that it was difficult to be
precise about the ultimate level of rates because of the problems
of assessing, this far in advance, the effects on rates of any
diminution of inflationary expectations.

However, assuming the

staff's GNP projections were reasonably accurate, a cutback in the
rate of growth in M 1 from, say, 7 to 5 per cent in mid-1975 would
undoubtedly be associated with a substantial increase in interest

If activity were weaker than projected the outcome for rates

would, of course, be quite different.
Mr. Balles said he had been puzzled by the changes since
summer in the ratio of currency to demand deposits.




currency holdings increase

more rapidly than demand deposits in a

period of rising interest rates, because of the greater interest
sensitivity of demand deposits.

This year, however, despite the

fact that most short-term interest rates had been declining


the summer, the ratio of currency to demand deposits had continued
to rise at a remarkably rapid pace.

From July to November, for

example, currency in the hands of the public increased by nearly
$2-1/2 billion while demand deposits rose only $800 million.

As a

consequence of that development, the rapid rise in the monetary base
had not been reflected in a proportional rise in M1.

He wondered whe

ther the staff thought the rapid growth in currency was a transitory
phenomenon or one which reflected some deep-seated trend perhaps rela
ted to uncertainty about the economic outlook.

The issue was relevant

to the Committee's policy decision today, since it affected the growth
rate of the monetary base that would be required to achieve whatever
rate of monetary growth the Committee decided upon.
Mr. Axilrod replied that the staff had noted the recent
step-up in the growth of currency; monthly increases were now on
the order of $600 million, compared with a more normal $350 or
$400 million.

A study had been undertaken of the reasons for that

development but it was too early to say what the conclusions
might be.

He would add, however, that the

behavior of currency



did not constrain the growth of M1 so long as the Committee employed
reserve or Federal funds rate targets and not monetary base targets.
With reserve and funds rate targets, the Desk automatically replaced
any reserves that were drained from the banking system by increases

the volume of currency in


Mr, Bucher said he understood that the rise in currency
holdings was particularly marked for bills of large denomination.
Mr. Partee commented that inflation could account for greater
use of larger denominations.
Chairman Burns remarked that if one were to speculate on
the causes of the shift to larger denominations, he might mention
inflation; possibly some hoarding, because of diminished confidence
in banks; and perhaps a certain marginal reluctance on the part of
scattered retailers to accept checks as freely as formerly.

Mitchell noted that, in

addition, some merchants had

stopped accepting certain credit cards because of the costs involved.
Mr. MacLaury asked whether recent innovations in payments
practices, including the one of making payments through thrift institu
tions, had proceeded far enough to begin affecting the behavior of
the money supply.

If so, he wondered whether the staff had a pro

gram for keeping the Committee informed of the nature and meaning
of such structural changes.


-77Mr. Axilrod replied that a brief--and perhaps oversimpli

fied--answer to Mr. MacLaury's first question was that such innova
tions had not yet gone far enough to affect M1, but clearly were
going to do so at some point in the future.

The staff was monitor

ing developments with respect to NOW accounts in New Hampshire and
Massachusetts, which were now of a size such that their addition
to M
would affect the rounding of the first figure after the
decimal in calculating growth rates.

The staff also would be

observing closely third-party payments practices at savings and
loan associations and any similar developments with respect to
the use of savings deposits at banks.

At some point it probably

would be desirable for the Committee to begin putting more empha
sis on M 2 and M3, or perhaps to begin using an indicator part
way between those measures and M1.

It was hard to say just when

that point would be reached, but he suspected it would be within
a fairly moderate period of time.
Mr. Partee remarked that some newly defined monetary
aggregate probably would be required.

He added that thus far

there seemed to be more talk than action with respect to the

actual institution of new payment techniques--except, of course,
for the NOW accounts in New Hampshire and Massachusetts.


at least, was the conclusion he had drawn from an informal survey



by the Reserve Banks a few months ago.

The situation could change

at any time, however, and it was important that the System be
prepared to make any needed adjustments.
Chairman Burns asked whether there had been any recent
studies of the turnover of time and savings deposits at commercial
banks and thrift institutions.
Mr. Axilrod replied that to his knowledge no comprehensive
information on that subject was available currently.


studies had been made at times in the past, including some at the
Chicago Reserve Bank under the leadership of Mr. Mitchell.
Mr. Mitchell added that the Home Loan Bank Board also had
made one or two studies.

In addition, time series on withdrawals

from savings and loan associations were available.
Chairman Burns observed that the meanings of the various
monetary aggregates had been in the process of changing for a number
of years.

He thought it would be desirable to have figures on the

turnover of time and savings deposits at banks and thrift institu
tions, and of the M2 and M3 aggregates, made available to the Com
mittee and the Board on a systematic and continuing basis.
Figures on turnover also should be presented systematically
for M1, the Chairman continued.

The willingness to use money--that

is, the rate at which money turned over, or its velocity--underwent



tremendous fluctuations; velocity was a much more dynamic variable
than the stock of money, and when no account was taken of it, any
judgment about the growth rate of M1 was likely to be highly incom

At one time analysts had tended to emphasize velocity.


recently, however, the emphasis had shifted to the money stock,
and the subject of velocity was now relatively neglected in mone
tary discussions, including the Committee's own deliberations.
For example, one of the gaps in yesterday's discussion was the
failure to consider the turnover of demand deposits.
Mr. Mitchell said he agreed that the turnover of demand
deposits was a highly relevant issue,


good deal of information

on that subject was available, but the staff was not incorporating
the data in its analyses and the System had been considering dis
continuing its collection.

He might note that turnover at New York

City banks now exceeded 300 times a year.
The Chairman observed that Mr. Mitchell was referring to
data on transactions velocity, whereas in his own earlier comments
on M1 he had had income velocity in mind.

To illustrate the

fluctuations he had mentioned, he might note that in the fourth
quarter of 1970 income velocity of M1 declined at an annual rate
of about 4 per cent but in the very next quarter it rose at a rate



of about 8 per cent.

While that was a short-run movement, the

data also indicated that there were enormous cyclical changes.


was clear that a low rate of growth in the money supply, if fore
tified by a large rise in velocity, could finance a rapid expan
sion in business activity; apparently that was the way the economy
Mr. Partee said he might note in defense of the staff that
they had tried to make something of the data on transactions
velocity but had not been able to.

With respect to income velocity,

the staff's projections included a measure, in the form of a strict
relationship between the growth rates of the money supply and of

That measure did change cyclically; for example, the

income velocity of money implied by the judgmental projection
declined at an annual rate of 2 per cent in the first two quarters
of 1975 and then rose at rates of 3 or 4 per cent beginning in the
third quarter.

In the staff's view, changes in velocity were

largely a function of interest rates.

Thus, the decline projected

in the first half of next year was in sympathy with the expected
decline in interest rates, as well as a relative decline in the
volume of transactions.

The upturn expected after midyear was

associated with the large increases anticipated in both interest
rates and transactions volume.



Mr. Wallich said he would agree that changes in monetary
velocity were important and that interest rates were a main deter
minant of them.

He noted, however, that while income velocity

was customarily measured in terms of current levels for both
income and money, monetary effects were ordinarily viewed as
occurring with a lag of 6 months or so.

He thought it would be

useful to take account of that lag by relating the current level
of GNP to the level of the money stock 6 months earlier.
Mr. Bucher observed that, partly because of actions by
the Board and other regulatory agencies, an increased proportion
of savings inflows at banks and thrift institutions had been
going into time certificates of deposit with long maturities and
onerous withdrawal penalties.

Those regulatory actions were

probably having a major effect on the average rate of turnover
of M2 and M3, apart from the effects of market interest rates
and economic conditions.
Mr. MacLaury said he would stress the distinction between
cyclical and secular developments.

As Mr. Partee had suggested,

cyclical changes in velocity might well be determined primarily
by interest rates.

His own concern, and evidently that of

Mr. Bucher also, was with secular changes.

The latter might

well require changes in definitions of the monetary aggregates.



Chairman Burns remarked that he would seriously question
the linking of income velocity to interest rates exclusively.
That would be correct if and only if interest rates determined
the volume of economic activity.

In fact, however, interest

rates were one among many factors that determined activity.
Mr. Axilrod asked whether his understanding was correct
that the Committee wanted to know whether the rate of turnover
of various types of deposits was moving up toward that of demand
deposits as one means of determining whether the definitions of
the monetary aggregates should be adjusted.

If so, he thought the

point Mr. Bucher had made should be underscored.

The growth of

4-year time deposits, which to his mind were similar in character
to notes and bonds, was tending to reduce turnover of total time

Other kinds of secular developments no doubt were tend

ing to raise turnover.
The Chairman commented that it was important to check
the definitions of the aggregates.

However, it was no less-

and perhaps more--important to consider how the aggregates were

If, as he suspected, time deposits increasingly were tak

ing on the characteristics of demand deposits, the Committee
should be paying progressively more attention to M 2.

The Com

mittee had shown a tendency, to which he had contributed, of
emphasizing M1 heavily--sometimes, it seemed, almost to the



exclusion of the other aggregates.

It should be recognized,

however, that the world was not standing still.

In his judgment,

studies of the velocity of various types of deposits would be
extremely useful.

He thought work along those lines should be

organized and carried out despite the expense that might be
Mr. Mayo remarked that very little was known about the
turnover of currency.

Because of that lack of knowledge, the

subject was largely ignored.
Chairman Burns observed that changes in turnover of
currency would, of course, be reflected in measures of the
income velocity of M1 . While such measures were available,
hardly any attention was paid to them.

In his view, income

velocity was a far more important variable than the rate of
growth of the money stock.
Mr. Partee referred to the proposed studies of various
types of deposits and said he was concerned about the point
Mr. Bucher had made.

Virtually all of the increase in time

deposits in recent years had been in the form of certificates,
which had a low turnover.

Thus far, staff efforts in the area

had been focused on obtaining additional information on pass
book savings as and where they seemed to take on a high degree of




Data were now being collected on NOW accounts, and the

Federal Home Loan Bank Board had been advised that the System would
want information on accounts that offered third-party payment priv
ileges as they were authorized.

The development of systematic data

on turnover of, say, all passbook savings deposits at banks and at
savings and loan associations would involve a large and expensive
collection effort,
Chairman Burns said he recognized that fact.
Mr. Mitchell observed that the data available for past
periods would offer a good base on which to build.
Mr. Wallich commented that under current circumstances
much of the growth in demand deposits was likely to originate in
the acquisition of securities by banks.

Since the stimulative

effects of expansion in bank holdings of short-term securities
was much less than that of loan expansion, it would be desirable
for the Committee to pay more than the usual amount of attention
to changes in the composition of the assets of the banking system.
Chairman Burns then called for the Committee's discussion
of monetary policy and the directive, noting that the decision to
be reached today was of greater than ordinary importance.
begin, he would make a few comments of his own.


First, the Com

mittee had taken action to ease money market conditions gradually
over recent months, in recognition that the economy was moving



into a recession.

In his opinion, any drastic change in that

policy course would be a great mistake, although some further
easing would be appropriate.

He hoped that the members would

continue to bear in mind that inflation remained a serious prob
lem, that the inflation was largely responsible for the current
recession, and that failure to bring inflation under control
would aggravate some of the country's longer-term economic


Second, monetary policy was only one of the policy

instruments available.

At present the Administration was engaged

in a serious and thorough reappraisal of economic policy, and
significant steps would be taken to limit the recession and to
initiate forces of recovery; the only uncertainty concerned the
shape and scale of the measures to be taken.

Finally, the money

stock was a highly complex economic variable, as this morning's
discussion had demonstrated.
Mr. Bucher, recalling his earlier question regarding
criticism of System policy by one of the Board's economic con
sultants, said he agreed with Mr. Partee's response.

Also, he

was in agreement with the remarks that the Chairman had just made.
He shared the staff's concern about the strength of recessionary
tendencies and was aware of the arguments favoring a more drastic
easing in policy, but he did not think such a policy would be



appropriate at this time.

For a number of reasons, he believed that

policy should continue to be eased gradually.

Like the Chairman, he

believed that stimulative fiscal actions would be taken, and he thought
that such actions in all likelihood would be larger in scope that
those assumed for purposes of the staff projection.

Second, he thought

that consumer psychology should improve in the second half of 1975
and, consequently, that the upturn in economic activity might well
be stronger than the recovery projected by the staff.


monetary policy no longer could have much effect on economic activ
ity in the first half of next year.

Finally, press comments, the

behavior of the stock market, the gold fever, and perhaps also the
increase in currency holdings testified to a loss of confidence
in the financial system.

In those circumstances, System actions

that might be perceived as panic reactions would be counter-produc
tive in that they would induce a further deterioration in confidence,
having adverse consequences for both the international situation and
the domestic economy.
Accordingly, Mr. Bucher said, he preferred to continue
policy on the course that it had been on in recent months.


would counter any tendency for interest rates to move back up,
and preferred that rates decline slowly.

Believing that specifica

tions approximating those of alternative B were consistent with his
objectives, he favored that alternative.



Mr. Hayes observed that he agreed with the Chairman's
remarks concerning the problems now being faced, and he agreed
also that fiscal policy was likely to become more stimulative.
With respect

to the economic situation and outlook, the assess

ment of the staff at the New York Bank was very similar to that
of the Board's staff.

The situation undoubtedly was weaker

than had been thought even a month earlier, and like Mr. Partee,
he would stress that the projections did not take account of
possible shocks and financial turbulence.

On the other hand,

the inflation threat remained. Unless a pronounced reduction in
the rate of inflation was achieved within the next year or so,
the outlook for the behavior of prices in the next economic upturn
and over the longer term would be particularly troublesome.


a good deal of attention had to be paid to the international situa

In the process of easing monetary policy, it would be unde

sirable for the United States to get too far ahead of major
European countries.
With those thoughts in mind, Mr. Hayes remarked, he believed
that the Committee should seek to assure adequate but moderate growth
in the monetary aggregates over the months ahead, avoiding any
actions that might even suggest that the economy would be flooded
with easy credit.

If short-term interest rates declined further



in the absence of excessive monetary growth, he would be pleased.
Accordingly, he preferred the specifications of alternative C,
but with two modifications.

In view of the New York Bank's pro

jection of a 3 per cent rate of growth in M1 over the December
January period, he would specify a 2-month range of 3 to 7 per cent,
rather than 4-1/2 to 6-1/2 per cent as in the blue book, in order
to lessen the probabilities that it would become necessary to
seek a Federal funds rate at the lower end of its specified range.
And he would prefer

a range of 7-3/4

to 9-1/4 per cent for the

funds rate, rather than 7-1/2 to 9-1/4 per cent, to establish a
midpoint of 8-1/2 per cent.

He hoped that the Desk would aim to

move the rate down to the midpoint promptly, and then move the
rate down further if incoming data suggested that growth in the
aggregates was weak.

He liked the language of alternative B,

except that following the statement "...the

Committee seeks to

achieve bank reserve and money market conditions consistent
with somewhat more rapid growth in monetary aggregates over the
months ahead" he would add "than has occurred in recent months,"
in order to avoid a possible inference that the Committee was
seeking a more rapid rate of growth than the 7 per cent of



Chairman Burns said he agreed that if the Committee wished
to adopt the language of alternative B, it would be desirable to
modify it in the manner and for the reasons that Mr. Hayes had
Mr. Morris commented that for a number of months he had
felt that the Committee had pursued an easier monetary policy much
too gradually and, consequently, that it had helped to produce a
deeper recession than was socially useful.

In other words, the

slack in the economic system would be greater than the amount
required to diminish the rate of inflation; an

8 per cent rate

of unemployment--as was now projected for the second half of 1975was not needed in order to achieve that objective.

At the same

time, he was concerned that the Committee had not achieved its
objectives for monetary growth in the second half of 1974 and
that as a result it had produced
climate than it had sought.

a more restrictive financial

It seemed unlikely, in retrospect,

that any member of the Committee would have advocated the 3.5
per cent annual rate of growth in M1 that would be recorded for
that period.

In his opinion, the Committee had not achieved its

objectives for growth in the aggregates in late 1974 for the same
reason that it had not done so in the second half of 1968 and in
the second half of 1972:

now as then, the Committee was reluc

tant to move interest rates to the necessary extent.



At this juncture, Mr. Morris continued, it was important
to make up the shortfall in monetary growth and to do so at a
fairly rapid pace.

He believed that monetary policy still could

have some impact on developments in the latter part of 1975, and
the Committee was obliged to take steps to mitigate the severity
of the recession.

Consequently, he favored alternative A, which

was expected to result in M1 growth of 5.5 per cent over the 12
months ending in June 1975.

However, growth in the first half of

1975 would be at a 7-1/4 per cent rate, and he would not advocate that
fast a rate of growth for more than 6 months.

Once economic activ

ity began to recover, the target for monetary growth should be
Mr. Morris remarked that he hoped such a policy position
would not be described as pushing the panic botton.

In any case,

he would prefer that the phrase be abandoned, because it imputed
a degree of moral weakness to a particular policy judgment.


believed that such a more expansive policy and further reductions
in short-term interest rates in the immediate future would help
to ease the financial strains in some sectors of the economy and
would increase the chances for economic recovery in the second
half of next year by contributing to a revival in residential

construction activity and by hastening the inventory correction.




as he had suggested at the November meeting of the


monetary growth tended

just as it


to fall

short during reces

to overshoot during expansions,


pursuit of alternative A would lessen the risks of inadequate
The Committee would face

the period ahead,

monetary growth in

a more difficult problem next summer.
as had been noted




Once the economic revival

the excellent

staff presentation

control of the monetary aggregates would necessitate

a rise in short-term interest rates.

One could argue for pursuit

of a more conservative policy at this time in

order to moderate

the reversal in

but he believed



short-term rates next summer,

was more important now to adopt a policy that would

mitigate the severity of the recession.

Mayo commented that,

point of view,

he believed

that it

monetary policy could have in
activity in

the next 6

while understanding Mr.


exaggerated the role that

influencing the course of economic

to 12 months.

He was concerned

that a

policy that was too expansie at this time would intensify the
problems to be confronted next spring.

He was

concerned also that

fiscal policy would prove to be even more expansive than anyone
now anticipated;



anxiety to fight recession,

the Adminis

tration's program for fiscal stimulus was likely to exceed current



expectations, and the Congress was likely to go beyond Administration

The resulting fiscal policy, and the need to accommodate

sizable Treasury financings next autumn, likely would exert upward
pressure on the rate of monetary growth as well as on interest

To the extent that the Committee could act now to temper

those pressures, it had a responsibility to do so.
In that light, Mr. Mayo said, he favored the specifications
of alternative B; that alternative was intended to make up the
shortfall in M 1 growth by next June.

He believed that the range

of 7 to 9 per cent for the Federal funds rate was just about right,
although he might shade it a little in.the direction of the 6-1/4
to 8-1/2 per cent range of alternative A.

After the beginning of

the new year he would watch for opportunities to reduce reserve
requirements further and to cut the discount rate again.

At that

time, such policy signals might be appropriate.
Mr. Black observed that he agreed with the staff's assess
ment of the outlook for economic activity.

Clearly, the recession

was going to be deeper and was likely to last longer than generally
had been thought 6 months ago.

Nevertheless, in view of the severity

and the persistence of inflation over the past year, monetary policy
had been just about right.

It was not at all clear that monetary

policy had contributed to the present downturn or that anything



could have been done to improve the situation without producing
undesirable side-effects.

Now, however, the time had come for

some stimulative measures with respect to either fiscal policy
or monetary policy.

Like others, he anticipated more stimulative

fiscal measures, and he would want to bear that in mind in formu
lating monetary policy.

It was important to look beyond the trough

in economic activity so as to attempt to avoid the development of
an unsustainable, inflationary boom that would intensify problems
later on and cause another and more serious recession.
arising from an overly enthusiastic

The risks

effort to promote recovery

were great, especially because of the unprecedented inflation
over the past 10 years.
For the present, Mr. Black concluded, the Committee ought
to avoid any substantial acceleration in the rate of growth in money
and credit.

However, it was important that the Committee take what

ever action was necessary to restore growth in M1 to the path contem
plated earlier in the year--that is, to a 5-3/4 per cent growth
path from the August base.

Such action was desirable not only to

make up for the shortfall but to allow for the probable decline
in the income velocity of money as economic activity declined

To restore growth to the 5-3/4 per cent path, he in

clined toward the longer-run targets of alternative B, but he was



concerned that the further sharp reduction in the funds rate
associated with that alternative would risk overly rapid mone
tary growth in the months ahead.

Therefore, he prefered specifi

cations between those of alternatives B and C.

Specifically, he

favored a funds rate centered on 8-1/4 per cent, with limits of
7-1/2 and 9 per cent.

He hoped that in the December-January

period the aggregates would grow at rates more or less in accor
dance with the specifications of alternative B, but he would be
reluctant to specify longer-run targets any higher than those of
alternative C.
Mr. Wallich observed that until now, the new information
at each Committee meeting had suggested that the situation was
worse than had been expected a month earlier with respect to both
the developing weakness in the real economy and the rate of infla

The two types of deterioration compensated for one another

and suggested that monetary policy be held stable.

This month,

however, while the economic outlook again appeared to have deteri
orated, the outlook for inflation had not worsened further and
might even have improved.

That created an opportunity for a

policy response.
Mr. Wallich remarked that a policy of complete stability
in the rate of monetary growth still had

certain attractions.



In particular, it would help in the Committee's effort to avoid
inferences that it had given up the fight against inflation, an
effort that had been marked by a considerable measure of success
thus far.

Such a policy also commended itself because it was a

good way to avoid the mistake sometimes made in the past of over
reacting to

changes in the economic situation.

However, a policy

of completely stable monetary growth would clearly be second best
under present circumstances; a better course would be to seek a
rate of monetary growth somewhere between a stable rate and one
reflecting an overreaction.

Even such a course, however, if con

tinued indefinitely, would run the risk of provoking an inflation
ary expansion in activity, as had occurred in the past.


could come about either through an immediate recovery leading


a prompt resurgence of inflationary pressures or, more likely,
through a delayed recovery leading to an accumulation of liquidity
that would fuel an inflationary surge later on.
Alternatively, Mr. Wallich continued, the Committee might
pursue a more expansive policy on a temporary basis, building in
safeguards to ensure that the rate of monetary growth would be
cut back in time to avoid a massive surge in economic activity
later on.

As suggested by the analysis in the blue book, a tem

porary acceleration in the rate of monetary growth might be regarded



as a means of making up for last summer's shortfall from the Com
mittee's longer-run targets; once the shortfall had been made up,
the rate of growth would be slowed.

When viewed in that light,

the subsequent slowing in the rate of monetary growth should
receive considerable public support, even though the resulting
increase in interest rates would, as always, provoke dissatisfac

One possibility would be for the Committee to announce that

would seek a more rapid pace of monetary growth for 6 or 9

months and then would slow growth to a rate that generally was
regarded as consistent with halting inflation.

Such an announce

ment--through its effect on expectations--probably would serve
both to bring interest rates down more promptly than otherwise
and to avoid some of the upturn in rates that would normally
occur at the time monetary growth was slowed.

That approach,

which was similar to the one recently taken by the German author
ities, would represent a departure for U.S. monetary policy and
would have to contain some escape clauses.
If the Committee agreed on an increase in the rate of
monetary growth that would be only temporary, Mr. Wallich said,
he would favor the specifications of alternative A.
he would favor the B specifications.




Chairman Burns remarked that the German authorities, in
announcing their monetary targets, intended to give notice to the
business community and, in particular, to the labor unions that
prices and wages somehow would have to adjust within those param
eters of monetary policy.

Thus, the policy was designed to promote

restraint in price and wage determination.

The authorities would

be in a position to say to one group or the other that its actions
were impeding the Government's policy to restimulate the economy.
In the political setting of the United States, the Government was
not equipped to do that.
Mr. Wallich noted that he had circulated to Committee
members a short summary of the discussion at the BIS meeting on
December 9, which included some comments on the German policy.
Mr. Kimbrel observed that economic developments in the
Atlanta District appeared to be about as gloomy as elsewhere in
the country, and the staff at his Bank now believed that the
recovery in activity would develop even more slowly in the second
half of next year than suggested by the projections in the green

Confidence was continuing to weaken, and inflation remained

a pervasive influence on business decisions--although further
moderation in the rate of increase in prices would bring about
some improvement in attitudes.

With respect to the behavior of



banks, the System directly or indirectly had contributed to some
rebuilding of liquidity.

It appeared unlikely that the banks

immediately would relax their lending standards even if additional
funds suddenly should become available, and strong efforts by the
System to bring about such a change would not be productive.
Continuing, Mr.

Kimbrel remarked that in

the past the

System often had over-reacted to recessionary developments,


he believed that the recent policy of pursuing a gradual easing
had been appropriate.

If the recovery proceeded more slowly than

projected, that might argue for some slightly faster monetary

At the same time, however, he was impressed by the prob

abilities that measures to ease fiscal policy would be both
significant and prompt.

With that prospect in mind, he believed

that any action now that significantly reduced interest rates
might force the Committee to face the difficult decision to raise
rates later on at a time when the unemployment rate was still
undesirably high.

At this time, international considerations also

argued against a further easing of interest rates.
Accordingly, Mr. Kimbrel said, he preferred the specifications
of alternative C, although he would not want to see the Federal funds
rate rise above 9 per cent.

He hoped that in the near term it

be within a range of 8-1/4 to 8-1/2 per cent.




Mr. Francis remarked that the current decline in economic
activity differed from past recessions in a number of respects.
First, it was one of the few declines, if not the only one, to
have developed without having been preceded by stabilization
policy actions that brought it about.

Second, there had been an

absolute decline in the country's capacity to produce, caused by
the agricultural and energy problems, by the distortions result
ing from the wage and price controls, by the new environmental
and safety standards, and by changes in foreign exchange rates.
When recovery in economic activity began--and he believed that
it would begin before long--less idle capacity would be avail
able than might be supposed.

As a result of those develop

ments, some redistribution of wealth had occurred; the standard
of living, on average, had declined; and the value of the nation's
capital stock had been reduced.
With respect to inflation, Mr. Francis observed that the
rise in prices in 1974 was just about double the increase that
he would have expected to result from the policy actions that
had been taken.

Special factors, such as the energy and agri

cultural problems, had contributed to the rise in prices in 1974.
However, those factors would not continue to exert strong upward
pressure in 1975, and the rate of inflation would subside.




that view was borne out, and if the country did not embark on a
massive program to fight the recession, confidence in the dollar
might be restored.

that growth in M1 over the second half of 1974

would be at an annual rate of less than 4 per cent, Mr. Francis
remarked that a somewhat faster rate would be desirable in the
first half of 1975.

Accordingly, he favored alternative D, which

specified a longer-run target of 5-1/2 per cent.

Greater injec

tions of money were not needed at this time.
Mr. Eastburn commented that the issue today was whether
or not the Committee would attempt to fine-tune monetary policy.
To many, it would be desirable to accelerate monetary growth for
a time and then to slow it later on, especially in view of the
lags with which monetary policy affected economic activity.
However, that could involve larger fluctuations in interest
rates than the public was prepared to accept.


although his instincts led him toward alternative A, he favored
alternative B as a more practical and safer course.


the short-run targets, he would agree to widen the ranges for the
Mr. Coldwell remarked that he had little doubt that the
recession was deepening and broadening.

Public policy responses,



which so far had been fairly well restrained, were likely to
become more aggressive and more visible.

Monetary policy had

to be adjusted to the new degree of weakness in the economy, but
the policy response had to be restrained in order to avoid creat
ing an excessive amount of reserves and having an adverse impact
on expectations.

Monetary policy could make its greatest contri

bution by continuing to ease on a slow and steady course.
Mr. Coldwell said he would prefer an operational paragraph
for the directive couched in terms of money market conditions,
primarily because he had very little confidence in the money
supply statistics.

Thus,he would say "To implement this policy

while taking account of developments in the domestic and interna
tional financial markets, the Committee seeks some further modest
easing of bank reserve and money market conditions expecting that
monetary aggregates will continue to expand at a moderate rate in
the months ahead."

With that language, he would associate the

longer-run targets of alternative C and the short-run specifica
tions of alternative B.

A Federal funds rate range of 7 to 9

per cent, as under alternative B, seemed appropriate.

He would

like the Desk to move the rate down gradually to the neighborhood
of 8 per cent by the time of the next meeting in mid-January,
resisting any tendency for it to rise above 9 per cent or fall
below 7 per cent.



Mr. MacLaury observed that he, like Mr. Morris, thought
that yesterday's staff presentation was excellent.

He agreed

that the outlook for economic activity was quite weak and that
prospects for the behavior of prices were less discouraging than
they had been.

In his view, it was questionable that recovery

in activity would develop in the second half of next year.


he would not accept the real money supply as a policy target, he
was discouraged by its rapid decline in recent months--a decline
that had resulted in part because the Committee had not achieved
its targets for growth in the nominal money supply in the third
and fourth quarters of this year.

Because of that shortfall,

he would urge caution in claiming that policy had been eased over
recent months.

Policy had eased in terms of interest rates but

not in terms of growth in the monetary aggregates.
Mr. MacLaury said he believed, as he had at the time of
the last meeting, that it would be appropriate to raise the Com
mittee's longer-run objectives for monetary growth, and he would
accept the longer-term targets of alternative B.

However, to

increase the chances that those targets would be achieved, he
would adopt the short-run ranges for the aggregates of alterna
tive A.

With them, he would associate the Federal funds rate

range of alternative B, which probably would result in the



funds rate being moved to the lower limit of its range.


others, he was aware that the problem of an upturn in interest
rates would have to be faced next year, as it had been in 1972
and earlier periods.

The suggestion made

perhaps, offer a way out.

by Mr. Wallich might,

Another, if weaker, suggestion was to

advocate publicly a monetarist view--perhaps more strongly than
most Committee members normally would prefer--in order to foster
acceptance of the idea that the System was pursuing a growth path
for the aggregates and tolerating whatever interest rate changes

Such a strategy might, perhaps, mitigate the essen

tially political problem that would be created by increases in
interest rates at a time when the unemployment rate was still very
Mr. MacLaury added that he concurred in the Chairman's
remarks of yesterday afternoon concerning cyclical versus longer
range problems of economic policy.

He believed that Federal Reserve

officials might make a contribution to public understanding of those
problems through speeches and other means.
Chairman Burns said he had an uneasy feeling

that too

much emphasis tended to be placed on the behavior of the money
stock and too little on the income velocity of money--which, as
he had observed earlier, was subject to tremendous fluctuations.



Fundamentally, velocity depended on confidence in economic prospects.
When confidence was weak, a large addition to the money stock might
lie idle, but when confidence strengthened, the existing stock of
money could finance an enormous expansion in economic activity.
Continuing, the Chairman observed that a great deal of
attention had been drawn to the shortfall in monetary growth during
the summer.

Whether there had been a shortfall in a meaningful

sense, however, depended on the length of the period chosen for
the measurement of growth.

Taking a somewhat longer period, one

could argue that there had been an overshoot rather than a short

A policy geared to compensating for every shortfall

would be too mechanical.

If the Committee followed such an

approach, additional shortfalls in the period ahead would result
in successive increases in the growth target--for example, to
7 or even 7-1/2 per cent.

Once the shortfall finally had been

made up, the Committee then would have to face the difficult prob
lem of slowing the rate of monetary growth.

The members might

plan now to slow growth later on, but when the time arrived, they
would find it a difficult step to take.
Chairman Burns remarked that for some months, the long
run target for growth in M1 had been at an annual rate of 5-3/4
per cent, and he believed it made sense now to raise the target



to 6 per cent.

That would be well above the rate required to

achieve the objective of returning the economy to a path of long
run price stability; the long-run rate of monetary growth consis
tent with long-run price stability probably was 2 per cent.


accepting a rate of 6 per cent, therefore, he recognized that it
represented an accommodation of a considerable degree of infla

For the December-January rate of growth for M1,

set a range of 4-1/2 to 7 per cent or 5 to 7 per cent.
ing the Federal funds rate, it

he would

would be a mistake to aim for a

reduction as great as 1-3/4 percentage points in a 4-week period;
therefore, he would set the lower limit of the range at 7-1/2
per cent.

At the same time, he would not want to see the rate

go up, and so he would set an upper limit of 9 per cent.
Mr. Balles observed that on some grounds he was tempted
to join Mr. Morris in advocating alternative A, particularly since
one of the great advantages of monetary policy was its flexibility.
A primary reason for that temptation'was the expectation of a much
sharper decline in economic activity than had been expected several
months ago.

The current recession might prove to be nearly

L-shaped, with a sharp decline followed by only a sluggish recovery.
In view of the longer-term problem of inflation, however, he viewed
that as a risky course.

If the rate of inflation were still high

when the recovery in activity began, it could well undermine the



viability of the capital markets over the longer term.

As he had

indicated a month ago, if the rate of inflation now were 6 per cent
rather than nearly twice that rate, and if there were no strong
fiscal stimulus on the horizon, he would favor a policy as expan
sive as alternative A, if not more expansive.

As far as the out

look for inflation was concerned, he was skeptical that the rate
of price increase would slow as much as suggested by the staff
All things considered, Mr. Balles said, he favored alterna
tive B.

Under that alternative, the annual rate of growth in M1

from the fourth quarter of 1974 to the second quarter of next
year would be 6.6 per cent, on the quarterly average basis.


favored such a rate, even though normally it would be unacceptably
high in terms of the objective

of returning to a path of price

stability, because he believed that the income velocity of money
would decline over the next several quarters.

For the Federal

funds range under alternative B, he preferred not to raise the
lower limit of the range to 7-1/2 per cent, as suggested by the
Chairman, and was inclined to let the rate go below 7 per cent, if
necessary to achieve the targets for the aggregates.

In his view,

the Committee's target for M1 growth had not been achieved in part
because the funds rate constraint had interfered with the provi
sion of an adequate volume of reserves.



Mr. Holland commented that yesterday's staff presentation,
which necessarily had been limited in the number of policy options
that it could review, had not considered a policy course that al
lowed for an inflection in the rate of monetary growth at some point
during the projection period.

In his view, a policy adjustment was

needed now, and another adjustment would probably be needed again
in the spring or early summer.

Somewhat more accommodating mone

tary conditions were appropriate in the present circumstances of
deepening recession, although conditions should not be made so easy
as to thwart the dampening of inflation that seemed to be under

Such a policy course had to take account of the more stimula

tive fiscal policy in prospect and of international pressures.


dramatic drop in interest rates now would have unfavorable con
sequences internationally.

His preference was for continuation of

the gradual decline in interest rates along with moderate growth
in the monetary aggregates.
Continuing, Mr. Holland observed that in the present
situation he would stress the behavior of M 2 and M 3 much more
than that of M1 for the principal reason that the financial system
was in the process of making a stock adjustment.

Both banks and

nonbank thrift institutions were in very illiquid positions and

were working hard to improve their liquidity.

The improvement



was desirable so that those financial institutions would be better
able to weather the shocks to confidence and other problems in pros
pect next year.

Moreover, the improvement probably had to occur be

fore the institutions would be willing to relax their lending terms
and conditions significantly.

Consequently, he advocated a sizable

increase in the inflow of time and savings deposits to banks and
to savings and loan associations in order to facilitate the stock
adjustment so that by late winter or early spring both kinds of
institutions would gradually ease their lending policies.


also hoped for rates of growth in M 2 and M3 that were higher rela
tive to growth in M1 than projected by the staff, and he believed
such higher rates were reasonable as well as desirable.
Accordingly, Mr. Holland said, he favored a long-run rate
of growth of around 9-3/4 per cent for both M2 and M3, as shown
under alternative B, and he believed that would be consistent
with the 6 per cent growth rate for M1 shown under alternative C.
For the short-run targets, he favored ranges close to those
under alternative B.

Thus, he could accept a range of 5


7 per cent for M1, as suggested by the Chairman, and a range of
7-1/2 to 10 per cent for M2 .

He believed that those rates of

growth could be achieved with a Federal funds rate range of 7-1/2
to 9 per cent, provided that the Manager used the entire range;



he would urge that the rate be moved all the way down within its
range by the time of the next meeting, if necessary in order to
achieve the targeted rates of growth for the aggregates.


respect to the mix of policy instruments, he expected that he would
be an advocate of further action to reduce reserve requirements,
Finally, he favored the language of alternative B, as modified by
Mr. Hayes, but he preferred to call for more "vigorous" rather than
more "rapid" growth in monetary aggregates.

Mitchell remarked that yesterday's staff presentation

had confirmed his view about the outlook for economic activity.
If the staff's projection was seriously in error, he believed the
probability was very high that economic activity would be much
weaker than projected, and he was dismayed that the situation
seemed to have got that far out of hand.
Mr. Mitchell said he could think of no time when the mone
tary aggregates were less useful for policy purposes than they were

That view was crystalized by the sharp decline in real money

balances that had been noted in the staff presentation.


decline--rather than suggesting that the bottom was falling outpointed up the importance of taking note of the secular uptrend
in the turnover of money.
continued to be strong.

He believed that uptrend had been and

Another uncertainty in the interpretation



of the monetary statistics arose in connection with Euro-dollars;
he suspected that at least some part of the Euro-dollar-based
money supply should be included in the U.S. money supply.


generally, he thought M1 was becoming increasingly obsolete as a
monetary indicator.

The Committee should be focusing more on M2,

and it should be moving toward some new version of M3--especially
because of the participation of nonbank thrift institutions in
money transfer activities.

Some of those institutions were offer

ing 5-1/4 per cent on time accounts from which funds could be trans
ferred into a demand deposit by making a telephone call.
Continuing, Mr. Mitchell said monetary policy by itself
could not turn the economy around; some contribution from fiscal
policy would be desirable.

However, monetary policy could make a

unique contribution by achieving a lower level of interest rates.
His primary objective would be to achieve a level of rates that
would encourage the increased volume of borrowing in mortgage and
capital markets essential to the kind of revival in economic activ
ity that would be needed in 1975.
one because efforts

The operation would be a tricky

to achieve somewhat lower rates could give

rise to expectations of further reductions, which would defeat the

Perhaps the best policy would be one that provoked

vigorous criticism both from those who thought easing was being



carried too far and from those who thought it was not being carried
far enough.

Such a policy, if it could be achieved, would generate

real uncertainty as to the course of interest rates.

With respect

to the policy choices suggested by the staff, therefore, he
favored a course between alternatives A and B.
At this point the meeting recessed.
2:30 p.m., with limited staff attendance.

It reconvened at
Following comments by

Chairman Burns on the possible nature of the Administration's
economic proposals, the meeting continued with the same attendance
as at the morning session.
Mr. Sheehan observed

that a degree of optimism seemed to

have developed regarding the rate of inflation.

If the staff

projections proved to be correct and the annual rate of increase
in the GNP deflator fell to about 5.5 per cent by the second
quarter of 1976, considerable progress would have been made, but
that was still a very high rate.

And because of certain struc

tural problems, including particularly those having to do with
the determination of wages, he was skeptical that inflation would
abate to that extent, even though prices of some commodities were
likely to decline.

It the last few days, steel prices had been

raised by about 10 per cent, and one airline had announced a
dramatic increase in wages.

Although it was also true that




sizable cut in wages had been announced by another airline, that
company was on the verge of bankruptcy.
Continuing, Mr. Sheehan remarked that the fiscal policy
response to the recession was likely to be excessive, and he
agreed with those who held that Federal Reserve policy had been
and could continue to be a steadying force over the next 6 to 12

He would avoid a substantial shift in policy, as had been

made so often in the past, preferring to continue on the track of
gradual easing.

So far, the System had not pursued a policy that

could be characterized as giving up the fight against inflation,
and he hoped that it would not do so now.
Mr. Sheehan observed that, like some other members of the
Committee, he believed that a considerable amount of attention
should be given to M , which had grown at a substantial rate in
October and November. For the period ahead, he preferred specifi
cations closer to those under alternative C than under alterna
tive B. For the Federal funds rate, he favored the range of
7-1/2 to 9 per cent that the Chairman had suggested; he would

not want

to see the rate rise, nor would he want to see it

decline over the next 4 weeks by as much as would be possible
under alternative B.



Mr. Winn remarked that, although the staff presentation
had been excellent, the view of prospective economic developments
was likely to change as much over the next 3 months as it had over
the past few months.
subject to change.

Thus, the Committee's targets also would be
In light of the considerable uncertainty regard

ing the outlook and also because of possible shocks to the economy
that could not be foreseen, he would tend to follow a middle-of
the-road policy.

Accordingly, he favored specifications between

those of alternatives B and C.
Mr. Clay observed that the recession under way and the
increase in unemployment were necessary to some degree in order
to reduce the rate of inflation, and he saw some signs that the
rate was slowing.

The rise in unemployment tended to provoke the

reaction that the money supply ought to be expanded more rapidly,
but the System had as much responsibility to seek price stability as
In any case, the current reces

it did to pursue full employment.

sion had not been caused by an inadequate supply of money.
past 3 years, M1 had grown at an

Over the

average annual rate of more than

6 per cent--a rate widely regarded as excessive.

The excess money

that had been created would be available to finance expenditures
when the economic climate improved.



Mr. Clay said an increase in the rate of monetary growth
at this time would not solve the country's economic problems.


the contrary, an excess of money would encourage various kinds of
inefficiencies and would raise the rate of inflation, leading
still higher unemployment later on.


The Committee should focus

its attention on pursuing a rate of monetary growth that would
restore efficiency and price stability.
he favored alternative D.

To begin to achieve that,

Recognizing that he had little support

for that preference, however, he would accept alternative C.
Mr. Baughman observed that views concerning the economic
situation had been undergoing change and no doubt would continue
to do so in the period ahead.

At their latest meeting, the

of the Dallas Bank uniformly had reported that over the

period since their preceding meeting activity in the industries
with which they were familiar had weakened substantially.


similarly, he expected that the staff's assessment of economic
prospects would continue to change, although he thought yesterday's
presentation was excellent.
Mr. Baughman said consideration of the Committee's longer
run targets for monetary growth needed to take account of the
reduction in capacity that Mr. Francis had called attention to.
In making a judgment about the appropriate rate of monetary growth,



the Committee more or less was deciding how much of the inflation
it would validate.

He would not quarrel with the M

growth rate

of 5-3/4 per cent that the Committee had pursued for some time--a
rate which, in his judgment, was about twice that required to meet
the economy's needs in a situation of stable prices.


he would accept the specifications of alternative C.
Chairman Burns suggested that the Committee consider first
the language for the operational paragraph of the directive.


believed that the main choice was between alternative B as modified
by Mr. Hayes and Mr. Coldwell's proposal, and he suggested that
the members be polled with respect to their preference between
the two versions.
The poll indicated that a majority preferred the language
of alternative B as modified by Mr. Hayes.
With respect to the longer-run targets, the Chairman
observed that most members appeared to favor either alternative B
or alternative C, and he called for an informal expression of
preference with respect to those alternatives.
A majority of the members expressed

a preference for the

longer-run targets of alternative C.
The Chairman then asked the members to indicate informally
whether they could accept a range of 7-1/2 to 9 per cent for the
weekly average Federal funds rate in the period until the next meeting.



A majority of the members indicated acceptance of that
In response to a request by Mr. Mitchell, the Chairman
asked the members to indicate whether they would accept a lower
limit of 7 per cent, rather than 7-1/2 per cent, for the funds
rate range.
A majority of the members indicated that they preferred
7-1/2 per cent for the lower limit.
Chairman Burns asked the members to indicate whether they
could accept the following ranges of tolerance for the annual
rates of growth in the aggregates over the December-January period:
5 to 7 per cent for M1, 7-1/2 to 9-1/2 per cent for M2,

and 9 to

11 per cent for RPD's.
A majority indicated acceptance of those ranges.
Mr. Winn asked whether a December-January range of 5 to 7
per cent was consistent with the other specifications.
Chairman Burns noted that the Committee had a mechanism
for dealing with inconsistencies that developed among the specifi
cations in the inter-meeting period.

He then asked Mr. Axilrod to

Mr. Axilrod observed that if the projections were correct,
the short-run ranges of tolerance for the aggregates suggested by



the Chairman would imply a Federal funds rate within its proposed
range, but below the 8-1/4 per cent midpoint.
Mr. Coldwell said Mr. Axilrod's comment suggested that the
Desk would need to act promptly to lower the funds rate within the
proposed range.

In the event that subsequent developments suggested

that the Desk should aim for a funds rate below 8 per cent, he hoped
that the Chairman would consider consulting with the Committee before
the Desk proceeded to do so.
A number of members expressed objections to Mr. Coldwell's
suggestion, and the Chairman observed that a majority evidently
did not favor it.
Mr. Mitchell remarked that he objected to the proposed
9-1/2 per cent upper limit for growth in M2, because it would
operate as a constraint in the event of a sizable reflow of con
sumer-type time and savings deposits to banks in the period ahead.
He preferred an upper limit of 11 per cent, although he would

accept one a little below that.
Mr. Holland said he agreed that the upper limit for the
M 2 range was too low, and he also believed that the longer-run

target for M2 should be raised.



In response to a request by Mr. Mitchell, Chairman Burns
asked the members to indicate their preference between 9-1/2 and
10-1/2 per cent for the upper limit of the M2 range of tolerance
over the December-January period.
The members' preferences were evenly divided between
those two figures for the upper limit of the range.
The Chairman said he would recommend an upper limit of
10 per cent for the M2 range.

He then proposed that the Committee

vote on a directive consisting of the staff's draft of the general
paragraphs and alternative B, as modified by Mr. Hayes, for the
operational paragraph.

It would be understood that the directive

would be interpreted in accordance with the following specifications.
The longer-run targets--namely, the annual rates of growth for the
period from November 1974 to June 1975--would be 6, 9, and 6 per
cent for M1, M2 , and the bank credit proxy, respectively.


associated ranges of tolerance for growth rates in the December
January period would be 9 to 11 per cent for RPD's, 5 to 7 per
cent for M1, and 7-1/2 to 10 per cent for M 2


The range of tolerance

for the weekly average Federal funds rate in the inter-meeting
period would be 7-1/2 to 9 per cent.



Messrs. Mitchell and Wallich indicated that they planned to
dissent from the proposed directive.
With Messrs. Mitchell and
Wallich dissenting, the Federal
Reserve Bank of New York was autho
rized and directed, until otherwise
directed by the Committee, to execute
transactions for the System Account
in accordance with the following
domestic policy directive:
The information reviewed at this meeting suggests
that real output of goods and services is falling sub
stantially further in the current quarter. Price and
wage increases are continuing large, although not so
large as earlier this year. In November declines in
industrial production and employment were sharp and
widespread, and the unemployment rate increased further,
from 6.0 to 6.5 per cent. In recent weeks additional
production cutbacks and layoffs have been announced.
The November rise in wholesale prices of industrial
commodities, although substantial, remained well below
the extraordinarily rapid rate in the first 8 months
of the year.

Since mid-November the dollar has declined somewhat
further against leading foreign currencies.
In October
the U.S. foreign trade deficit was reduced sharply for

the second consecutive month, while there were continued
net inflows of bank-reported private capital and of invest
ments by oil-exporting countries.

Growth of the narrowly defined money stock increased
in November to an annual rate of about 7 per cent. Net
inflows of consumer-type time and savings deposits remained
strong at banks and continued to improve at nonbank thrift
institutions, and the more broadly defined money supply

measures again expanded appreciably. Bank loans increased
only moderately. Most market interest rates, after rising
in the second half of November, subsequently turned down
again. Yields on State and local government securities,



however, continued under upward pressure. Effective
December 9, Federal Reserve discount rates were reduced
from 8 to 7-3/4 per cent.
In light of the foregoing developments, it is the
policy of the Federal Open Market Committee to foster
financial conditions conducive to resisting inflationary
pressures, cushioning recessionary tendencies and encour
aging resumption of real economic growth, and achieving
equilibrium in the country's balance of payments.
To implement this policy, while taking account of
developments in domestic and international financial
markets, the Committee seeks to achieve bank reserve
and money market conditions consistent with somewhat
more rapid growth in monetary aggregates over the
months ahead than has occurred in recent months.
Secretary's note:
The specifications agreed
upon by the Committee, in the form distri
buted following the meeting, are appended to
this memorandum as Attachment D.
It was agreed that the next meeting of the Committee would
be held on January 21, 1975, at 9:30 a.m.
Thereupon the meeting adjourned.



Robert Solomon
December 11, 1974

Report on November Meetings of Working Party 3
and The Group of Ten Deputies

The Working Party examined the balance of payments prospects
of OECD countries for 1975.

For the OECD as a whole, the current

account deficit in 1975 is expected to be roughly the same as in
1974, close to $40 billion, assuming the price of oil stays where it

Rapidly rising OECD exports to OPEC countries will be offset by

increasing OPEC interest earnings.

In the latter part of 1975, how

ever, the OECD current deficit is expected to begin to decline.
The distribution of the deficit among OECD countries raises

A disproportionate share of it ($15 billion) is projected

to lie with the smaller OECD countries:

Spain, Australia, New Zealand,

the Scandinavian countries, Austria, Portugal, Greece and Turkey.
Among the larger countries, Germany is expected to continue to have
a substantial ($5 billion) current account surplus, though smaller
than in 1974.

The United States and Canada are expected to have

larger current account deficits in 1975 while the positions of Japan,
Italy and the United Kingdom improve.

Although these changes for the

larger countries are regarded as being in the right direction, they
still leave an unsatisfactory distribution of the total OECD deficit.
The hope was expressed that more expansionary policies in
the countries with relatively strong balance of payments positions,

while those with weaker positions experienced a resultant increase in
exports to the stronger countries, would improve the distribution of
current account positions while also contributing to resumption of
economic expansion in the OECD area as a whole.

The possibility of

some change in relative exchange rates was not ruled out.
As to the financing of current account deficits, the most
vulnerable countries appeared to be reasonably confident about the
next 6 months or so (this was before the Saudi Arabian decision not
to accept sterling in payment for oil exports).

They all have lines

of credit that have not yet been drawn and the U.K. was receiving a
substantial amount of OPEC funds.

It was agreed that countries

borrowing directly from OPEC countries should not provide indexed
loans nor denominate their borrowings in the currencies of OPEC
The decline in short term interest rates in the United
States was cited as one explanation for the movement of the DM-dollar
exchange rate, but no complaints were voiced about U.S. monetary
The Deputies of the Group of Ten focused mainly on the
Kissinger-Simon-van Lennep proposals for a backstop financing facility
among the OECD countries to complement market channels and the IMF.
The U.S. proposal was well received by the Deputies of most countries,
with some hesitation by the German and Japanese representatives.

Most of the discussion concerned details of the plan.


Among the issues

Should the facility be based on government to government

lending through the BIS or on government guarantees that would permit
the BIS to borrow in markets and lend to countries in need, or both?

How should quotas--for both borrowing and lending--be established

and should borrowing rights and lending obligations be equal for each

What conditions should be attached to use of the facility

and how would its use be related to drawings on the Fund?
The Deputies established a working group to examine the
technical aspects of the proposals.

A report is expected in time

for the January Ministerial Meetings of the Group of Ten and the IMF
Interim Committee.

Henry C. Wallich
December 17, 1974

Report on BIS Meeting - December 9, 1974

The BIS meeting on December 9 covered an unusually wide
range of topics.
The Eurocurrency Committee examined the BIS' current effort
to collect more complete data on banking claims on developing countries,
which is going forward satisfactorily, and the assembly of information
on regulatory and supervisory practices, which has been virtually

Some dissatisfaction was voiced with delays in the collec

tion and dissemination of Eurocurrency data.

Attention was drawn to

the interest of the International Monetary Fund in entering this field,
and suggestions were made for expediting data handling at the BIS.
The governors' meeting discussed and adopted a proposal for
the creation of a new staff committee to deal with problems in the area
of bank liquidity, solvency, and related matters.

Each central bank

would nominate two staff representatives, one for regulation and super
vision and one for data gathering, who would meet from time to time
under the chairmanship of George Blunden of the Bank of England.
Exchange of information, rather than harmonization of national practices
is to be the objective.

The new group would parallel in some respects, but

not compete with or supersede, the committee of regulators and super
visors of EEC countries now functioning under the chairmanship of Albert
Dondelinger of Luxembourg.

Governors Mitchell and Wallich talked to

Mr. Dondelinger and sought to make arrangements to bring his group to
Washington for an exchange of views some time early next year.

Governor Richardson said that he was contemplating a letter
addressed to the London banks on the subject of their foreign exchange
Governor Mitchell discussed the structure of U.S. bank regula
tion and supervision, making clear the diversity of arrangements and
by implication, the difficulty of any coordination with procedures abroad.
He also described the foreign banking legislation put forward by the
Federal Reserve Board, indicating that it had had a good Congressional
and public reception.

There were no adverse comments.

There was a brief discussion of U.S. gold legislation and
Treasury activities with respect thereto.

In setting these forth,

Governor Wallich broadly followed the testimony of Chairman Burns before
the Gonzalez subcommittee on December 5, without taking a pronouncedly
negative attitude toward U.S. policy or raising the specter of
possibly alarming consequences.

Very few questions were asked.

The most interesting discussion concerned the recent announce
ment of the German Bundesbank that they would expand the monetary base
at a rate of 8 per cent for the next year.

The purpose of this policy

announcement was stated to be to give the government, labor, and business
a fixed frame of reference for their planning with respect to wage and
price setting and financing.

Dr. Emminger explained the derivation of

the growth rate of the monetary base, which makes allowance for fore
seeable rates of inflation, real growth, and changes in the relation of
the base of the money supply and the money supply to GNP.

The base was

chosen in preference to M1

because M1 in Germany has proved to be less

stably related to GNP than the base.
In the discussion, questions were raised concerning the ability
of the Bundesbank to stick to its targets, the possible effects of a
rigid limitation of base growth upon the ability to intervene in
exchange markets to keep the mark from rising, and the effect on
interest rates.

It was noted that, for a country with a large inter

national sector like Germany, the new policy seemed to give a remarkably
high priority to domestic considerations.

A somewhat extreme formulation

of the policy, not by a German representative, was that the Bundesbank
was telling the labor unions what nominal GNP was going to be and was
leaving it to them how they wanted to split it between price increases
and real increases.


December 16,


Drafts of Domestic Policy Directive for Consideration by the
Federal Open Market Committee at its Meeting on December 16-17, 1974
The information reviewed at this meeting suggests that
real output of goods and services is falling substantially further
Price and wage increases are continuing
in the current quarter.
large, although not so large as earlier this year.
In November
declines in industrial production and employment were sharp and
widespread, and the unemployment rate increased further, from
6.0 to 6.5 per cent. In recent weeks additional production cut
backs and layoffs have been announced.
The November rise in
wholesale prices of industrial commodities, although substantial,
remained well below the extraordinarily rapid rate in the first
8 months of the year.
Since mid-November the dollar has declined somewhat further
against leading foreign currencies. In October the U.S. foreign
trade deficit was reduced sharply for the second consecutive month,
while there were continued net inflows of bank-reported private
capital and of investments by oil-exporting countries.
Growth of the narrowly defined money stock increased in
November to an annual rate of about 7 per cent. Net inflows of
consumer-type time and savings deposits remained strong at banks
and continued to improve at nonbank thrift institutions, and the
more broadly defined money supply measures again expanded appre
ciably. Bank loans increased only moderately. Most market
interest rates, after rising in the second half of November, sub
sequently turned down again.
Yields on State and local government
securities, however, continued under upward pressure. Effective
December 9, Federal Reserve discount rates were reduced from 8 to

7-3/4 per cent.
In light of the foregoing developments, it is the policy
of the Federal Open Market Committee to foster financial conditions
conducive to resisting inflationary pressures, cushioning recessionary
tendencies and encouraging resumption of real economic growth, and
achieving equilibrium in the country's balance of payments.

Alternative A
To implement this policy, while taking account of develop
ments in domestic and international financial markets, the Committee
seeks to achieve bank reserve and money market conditions consistent
with more rapid growth in monetary aggregates over the months ahead.
Alternative B
To implement this policy, while taking account of develop
ments in domestic and international financial markets, the Committee
seeks to achieve bank reserve and money market conditions consistent
with somewhat more rapid growth in monetary aggregates over the
months ahead.
Alternative C
To implement this policy, while taking account of develop
ments in domestic and international financial markets, the Committee
seeks to achieve bank reserve and money market conditions consistent
with moderate growth in monetary aggregates over the months ahead.
Alternative D
To implement this policy, while taking account of develop
ments in domestic and international financial markets, the Committee
seeks to achieve bank reserve and money market conditions consistent
with relatively slow growth in monetary aggregates over the months


December 17,
Points for FOMC guidance to Manager
in implementation of directive



(As agreed, 12/17/74)

Longer-run targets (SAAR):
(December plus first
quarters, combined)

and second


Short-run operating constraints:


Range of tolerance for RPD growth
rate (December-January average):

9 to 11%

Ranges of tolerance for monetary
aggregates (December-January average):

5 to


7-1/2 to 10%


Range of tolerance for Federal funds
rate (daily average in statement
weeks between meetings):

7-1/2 to



Federal funds rate to be moved in an
orderly way within range of toleration.


Other considerations:
account to be taken of developments in domestic
and international financial markets.

If it appears that the Committee's various operating constraints are
proving to be significantly inconsistent in the period between meetings,
the Manager is promptly to notify the Chairman, who will then promptly
decide whether the situation calls for special Committee action to give
supplementary instructions.