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MEMORANDUM OF DISCUSSION

A meeting of the Federal Open Market Committee was held
in the offices of the Board of Governors of the Federal Reserve
System in Washington, D. C., on Tuesday, December 17, 1968, at
9:30 a.m.
PRESENT:

Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.

Hayes, Vice Chairman, Presiding
Brimmer
Daane
Galusha
Hickman
Kimbrel
Maisel
Mitchell
Morris
Robertson
Sherrill

Messrs. Bopp, Clay, Coldwell, and Scanlon,
Alternate Members of the Federal Open
Market Committee
Messrs. Heflin, Francis, and Swan, Presidents
of the Federal Reserve Banks of Richmond,
St. Louis, and San Francisco, respectively
Mr. Holland, Secretary
Mr. Sherman, Assistant Secretary
Mr. Kenyon, Assistant Secretary
Mr. Broida, Assistant Secretary
Mr. Molony, Assistant Secretary
Mr. Hackley, General Counsel
Mr. Brill, Economist
Messrs. Axilrod, Hersey, Kareken, Mann,
Partee, Reynolds, Solomon, and Taylor,
Associate Economists
Mr. Holmes, Manager, System Open Market
Account
Mr. Cardon, Assistant to the Board of
Governors

12/17/68
Mr. Coyne, Special Assistant to the
Board of Governors
Mr. Williams, Adviser, Division of
Research and Statistics, Board of
Governors
Mr. Wernick, Associate Adviser, Division
of Research and Statistics, Board of
Governors
Mr. Keir, Assistant Adviser, Division of
Research and Statistics, Board of
Governors
Mr. Bernard, Special Assistant, Office of
the Secretary, Board of Governors
Miss Eaton, Open Market Secretariat Assis
tant, Office of the Secretary, Board
of Governors
Mr. Lewis, First Vice President, Federal
Reserve Bank of St. Louis
Messrs. Eisenmenger, MacLaury, Eastburn,
Jones, Tow, Green, and Craven, Vice
Presidents of the Federal Reserve
Banks of Boston, New York, Philadelphia,
St. Louis, Kansas City, Dallas, and
San Francisco, respectively
Mr. Garvy, Economic Adviser, Federal Reserve
Bank of New York
Messrs. Wallace and Scheld, Assistant Vice
Presidents of the Federal Reserve Banks
of Richmond and Chicago, respectively
Mr. Cooper, Manager, Securities and
Acceptance Departments, Federal Reserve
Bank of New York
Mr. Hayes called on Mr. Robertson, who said he would like
to advise the Committee in advance of today's open market policy
discussion

of the status of two other Federal Reserve policy issues

that were being considered by the Board of Governors.

The Board now

had pending before it discount rate actions by eleven Reserve Banks,

-3

12/17/68

of which two involved no change in the existing 5-1/4 per cent
rate, seven involved an increase of 1/4 percentage point to 5-1/2
per cent, and two involved an increase of 1/2 percentage point to
5-3/4 per cent.

The Board's tentative thinking was to approve

the 1/4 percentage point increases while withholding action on
the others until the directors of those Reserve Banks had had a
chance to meet again following the Board's action, but a final
decision was being held in abeyance.
In addition, Mr. Robertson continued, the Board was con
sidering a proposal to buttress the discount rate rise with the
simultaneous announcement of an increase in member bank reserve
requirements on demand or time deposits, to take effect in the
week beginning January 16, 1969.

That action would be tailored

to absorb between $450 and $650 million of the seasonal return
flow of reserves.

If that were done, open market activities should,

of course, avoid washing out that tightening of reserve positions.
Mr. Robertson went on to say that the Board recognized,
as he was sure everyone else did, that the discount rate increase
had already been well discounted by the money market.

A combination

of discount rate and reserve requirement increases would represent
overt action with significant announcement effect, sufficient to
have a salutary dampening impact on inflationary expectations.

12/17/68

-4

However, it was necessary to weigh the pros and cons of such an
announcement effect--from both the domestic and the international
standpoints.
Mr. Robertson indicated that the Board had decided to hold
off action on those matters until after this morning's Federal Open
Market Committee meeting, in order to provide for the maximum pos
sible coordination of the System's policy instruments.

Assuming

all went well, the Board would expect to meet on the discount rates
and reserve requirements some time later this afternoon, or perhaps
tomorrow, and announce whatever action was decided upon.
Mr. Robertson then noted that the staff had prepared drafts,
labeled alternatives "A" and "B,"

of a current economic policy

directive for the Committee's consideration.1 /
third alternative, labeled "C,"

He would offer a

which would provide in the second

paragraph for coordination of open market policy with possible
discount rate and reserve requirement actions.

In his proposal

the description of the Committee's general policy stance at the
end of the first paragraph would be as shown in the staff's
alternative B, except for a clarifying language change.
Specifically, Mr. Robertson said, alternative C would be
the same as the staff's draft until the last sentence of the first
paragraph.

It would then continue as follows:

1/ The staff's drafts are appended to this memorandum as
Attachment A.

12/17/68
In this situation, it is the policy of the Federal
Open Market Committee to foster financial conditions
conducive to the reduction of inflationary pressures,
with a view to encouraging a more sustainable rate
of economic growth and attaining reasonable equilib
rium in the country's balance of payments.
To implement this policy, System open market
operations until the next meeting of the Committee
shall be conducted with a view to attaining somewhat
firmer conditions in money and short-term credit
markets, taking account of the effects of other
possible monetary policy action; provided, however,
that operations shall be modified if bank credit
expansion appears to be deviating significantly
from current projections.
He wanted to put all this before the Committee at the
outset this morning, Mr. Robertson observed, so that it could
be taken fully into account in the discussion.

He added that

under the present lagged procedure for calculating required
reserves, an increase in requirements effective January 16 would,
of course, be related to deposits held in the week beginning
January 2.
Mr. Hayes commented that it was very helpful to the
Committee to have heard Mr. Robertson's remarks before the
go-around on open market policy.
Mr. Daane observed that it might be desirable to under
score the point that the matters to which Mr. Robertson had
referred were still under consideration by the Board and that no
action had been taken.

12/17/68
Mr. Brimmer agreed that it was not possible at this point
to anticipate the actions the Board might take.

It was his im

pression, however, that members of the Board were in agreement
on the desirability of a discount rate increase, and that the
question remaining open concerned the desirability of increasing
reserve requirements as well.
By unanimous vote, the minutes
of actions taken at the meeting of
the Federal Open Market Committee
held on November 26, 1968, were
approved.
Mr. Daane asked whether there would be any objection to
a small clarifying revision, which he described, in the memorandum
of discussion for the meeting held on November 26.

There was

general agreement that the indicated revision should be made.
The memorandum of discussion
for the meeting of the Federal Open
Market Committee held on November 26,
1968, was accepted.
Before this meeting there had been distributed to the
members of the Committee a report from the Special Manager of the
System Open Market Account on foreign exchange market conditions
and on Open Market Account and Treasury operations in foreign
currencies for the period November 26 through December 11, 1968,
and a supplemental report covering the period December 12 through
16, 1968.

Copies of these reports have been placed in the files

of the Committee.

12/17/68
In supplementation of the written reports, Mr. MacLaury
said there would be no change in the Treasury gold stock this
week.

Moreover, since the Stabilization Fund now held $536

million, there should be no need for any reduction in Treasury
gold for the foreseeable future.
So far as the gold markets were concerned, Mr. MacLaury
continued, the calm that had prevailed even during the most
severe days of the currency crisis in November had continued,
with the somewhat higher prices apparently reflecting the fact
that South Africa, after having sold gold in November, had
dropped out of the market again for the time being.

Although

South Africa still faced a major problem in marketing its output,
it should be noted that reserve figures for the last few weeks
indicated that the South African payments position had again
moved into surplus, permitting them to stockpile production for
the time being.
Mr. MacLaury observed that when Mr. Coombs reported to
the Committee at its previous meeting he had just returned from
the Bonn meetings and was still waiting to see how the markets
would react to the German and French decisions not to change their
parities.

A little over three weeks had now gone by, and he

(Mr. MacLaury) thought it was fair to say that the German measures
had been successful in the short run, at least in reversing the

12/17/68

-8

sizable inflows that had built up so strongly in November.
$900 million had left Germany in the last week of November.

Nearly
Al

though the outflow since then had been erratic--and, indeed, had
been reversed temporarily on December 5 when the report of the
German Council of Economic Experts seemed to suggest that a mark
revaluation still lay ahead--on balance funds had continued to
move out in size this month, partly on the basis of market swaps
by the German Federal Bank.

Thus far in December the gross outflow

from Germany had been on the order of $1.5 billion.

The net outflow

was considerably less--about $600 million--because maturing forward
contracts the Federal Bank had made in September were falling due.
As the Committee would recall, Mr. MacLaury continued, the
German authorities had agreed that it would be desirable to offer
outright forward cover into German marks both in Frankfurt and in
New York when the markets reopened following the Bonn meetings.
In view of the great uncertainties that were bound to be present,
that initiative was highly desirable, both as a confirmation to
the market that a revaluation of the mark was out of the question
for the time being and as an inducement to start funds actually
moving out of Germany.

During the five trading days of the last

week in November, when the Federal Bank was offering outright
forward marks at a 3 per cent premium, it sold a total of $236
million equivalent; while the Federal Reserve, in parallel opera
tions, sold a total of $72.5 million in New York.

12/17/68
The bulk of that business was done in the early days of
the last week of November, Mr. MacLaury noted.

As the week

progressed, not only did the demand for outright forward cover
seem to taper off, but the German Federal Bank also became con
cerned that its offer of outright forward cover would provide a
means by which foreigners speculating on a mark revaluation could,
in effect, remain in marks without foregoing interest as was
designed to be the case for those who held on to mark deposits.
In other words, the German authorities felt that the offer involved
a potential conflict of policy objectives.

Accordingly, beginning

in December the Federal Bank withdrew its offer of outright forwards,
in the belief that the main purpose of the offer had been accomplished
and that it could be reinstituted if market developments called for
such action.

Instead, the Federal Bank offered a more attractive

rate--2-3/4 per cent--on swaps with German commercial banks.

The

Federal Bank sold dollars spot and bought them back forward, with
the provision that the banks themselves undertake foreign invest
ments for the same maturity as the maturity of the swap.

The

technicalities of those operations were rather complex, and an
additional complexity was added by the agreement to share with the
German Federal Bank the profits on outright forward operations
undertaken by the Federal Reserve in New York.

However, he had

no doubts concerning the usefulness of that forceful but temporary
operation under the market conditions then prevailing.

12/17/68

-10

In that connection, Mr. MacLaury said, he should mention
that the Special Manager had not overlooked the Committee's re
quest at its previous meeting for a memorandum on the possible
need to enlarge the authority for System forward operations.
When Mr. Coombs mentioned that subject three weeks ago, there had
been a real possibility that forward operations in marks could
expand rapidly to absorb the existing authority.

That turned out

not to be the case; as he had indicated, the System's total sales
of forward marks had come to only $72.5 million.

Therefore, since

there was still considerable leeway under the $550 million limit
specified in the Committee's present authorization, it was felt
preferable to delay the memorandum until the need for a higher
limit was clearer.

Obviously, he could not rule out the possibility

that developments in the market might force the Special Manager to
request expanded authority to undertake forward operations, perhaps
under emergency circumstances.

But every effort would be made to

give the Committee adequate time to consider such a request by
circulating a memorandum on the subject in advance.
As he had already indicated, Mr. MacLaury continued, a
sizable net amount of dollars had moved out of Germany in the last
few weeks.

By and large, however, those funds had not gone back

into sterling or French francs.

Sterling in particular had had a

rocky time since the Bonn meeting.

It was hard to say exactly why

-11

12/17/68

sterling should have continued to look as sick as it had in much
of the recent period, given the measures announced by Chancellor
Clearly, one underlying factor had been the persisting

Jenkins.

uncertainties that had plagued the exchange markets since the
Bonn meeting, at which nothing had really been settled.

Equally

important, confidence in the Labor Government was at such a low ebb
that it was almost taken for granted that any measures announced
would somehow go awry.

He thought that overblown expectations

concerning the Basle discussions of recycling of speculative funds
also had had a temporary backlash effect on sterling, while the
renewed although transitory speculation in the mark a week and a
half ago was, understandably, unsettling.

At the same time,

there were rumors of dissension within the British cabinet and
even rumors that Prime Minister Wilson might resign.
Mr. MacLaury noted that the cost to the Bank of England
of support for sterling in the four trading days starting December 5
amounted to more than $350 million, not counting another $100 mil
lion of support in the forward market in that period.

Those losses

were offset to a considerable extent last Wednesday and Thursday
(December 11-12) by inflows resulting from short covering and
buying in anticipation of good figures on British foreign trade in
November.

But the fact remained that the Bank of England had had

to increase its swap drawings on the System by $750 million since

12/17/68

-12

the beginning of November, bringing the total of such drawings
to $1,150 million and the aggregate of Britain's short-term debts
once more to over $3 billion.

It hardly had to be said that there

was very little evidence as yet of any reversal in Britain's for
tunes.

Under such circumstances it was not surprising that

counsels of despair were being heard again, and that sterling
remained in a precarious state.
By contrast, Mr. MacLaury continued, the harsh French
measures in the area of exchange controls had apparently had their
desired effect, at least in the short run.

By requiring French

commercial banks to unwind--in effect, to break--outstanding
forward contracts with their customers and to turn over to the Bank
of France the spot foreign exchange held as cover for those contracts,
the authorities had given a one-shot boost to official reserves
amounting to several hundred million dollars in the last ten days.
It remained to be seen whether such measures would be successful
in the longer run.

For the time being, however, the franc was off

the floor and the French had been able to reduce their short-term
debts, including their swap drawings on the System which were down
from a peak of $611 million to a present level of $490 million.
Trading in most other currencies had been uneventful,
Mr. MacLaury observed, although local money market pressures in
Switzerland and the Netherlands had tended to strengthen rates for

-13

12/17/68
the respective currencies.

He should mention, however, the

Euro-dollar market where normal year-end patterns had been
distorted by the huge movements of funds into and out of Germany.
On balance, although rates had risen during the past three weeks
by about 1/4 percentage point on most maturities, there had been
only occasional stringencies in the market.

As a result, the

Bank for International Settlements had put only $80 million into
the Euro-dollar market on the basis of drawings on the Federal
Reserve, compared with some $350 million over the year-end last
year.
Mr. Galusha asked whether Mr. MacLaury would comment on
the possible implications for sterling of an overt change in
U.S. monetary policy.
In reply, Mr. MacLaury noted that he had described the
present position of sterling as precarious.

While he could not

say precisely how precarious the situation was, he thought there
clearly would be some risk for sterling in U.S. monetary action.
On the basis of the information available to him he doubted that
limited action--involving, say, a small increase in the Federal
Reserve discount rate--would prove to be the final straw for the
pound.

More vigorous action would entail greater risks, but he

was unable to assess them with any confidence.

12/17/68

-14

Mr. Mitchell asked whether technical considerations
taken alone suggested that sterling would prove vulnerable to
a change in the discount rate.
Mr. MacLaury replied in the negative.

He noted

that--given the present discount on forward sterling--the
relationships between market interest rates in Britain and,
say, in the Euro-dollar market were such as to provide no in
centive for covered flows of funds to the United Kingdom.
Britain's disadvantage in such comparisons was so large that
the small further disadvantage that would result from an
increase in the U.S. discount rate was not likely to have a
significant technical effect.

The more important question, he

thought, would involve possible psychological effects.
Mr. Mitchell then asked whether U.S. monetary action
taken for domestic reasons was likely to have a significantly
adverse psychological effect on sterling.
Mr. MacLaury responded that, in the longer run, actions
to strengthen the dollar obviously were in the best interests
of sterling and of the general international payments mechanism.
But considerations of timing were very important.

Even before

the November exchange crisis the British had felt that their
short-term debts were about as high as they could justify, and
since then they had had to borrow an additional $750 million.

12/17/68

-15

Clearly, there was a risk that the point was near at which the
British would decide that they were not prepared to take on any
further debt; and such a decision obviously would have important
implications for the dollar.

He could not say whether any par

ticular actions by the System would bring them to that point.
Mr. Robertson remarked that on the basis of some
international telephone conversations he had held this morning
he had concluded that a 1/4 point increase in the discount rate
would not cause concern, but that a larger discount rate increase
would cause serious concern.

Additional action in the form of

some firming of open market policy and an increase in reserve
requirements might cause some concern, but not of a serious nature
since the amount of tightening involved probably had already been
largely discounted.
Mr. Daane noted that there had been some recent dis
cussions within the U.S. Government of the degree of precariousness
of the sterling situation, following the receipt of certain advice
from Under Secretary Deming who was in London.

Mr. Deming had

described the general attitude prevailing in the British financial
community in terms that suggested the desirability of exercising
some caution in U.S. monetary policy actions.

However, from the

Under Secretary's comments it seemed clear that a 1/4 point
increase in the Federal Reserve discount rate was not expected
to cause any serious disturbance to sterling.

-16

12/17/68

Mr. Daane added that the information Mr. Robertson had
received this morning obviously was more current than that which
Mr. Deming had transmitted earlier.

But he (Mr. Daane) was some

what puzzled by the report that additional Federal Reserve action,
such as an increase in reserve requirements, would not be a source
of serious concern.

As Mr. MacLaury had pointed out, the question

was not simply one of technical relationships; account also had
to be taken of the possible effects on market psychology, which
were largely unpredictable.

There might also be effects on the

internal political situation in Britain that would have consequences
for governmental decisions.
Mr. Hayes said that on the basis of recent discussions he
also had the impression that a small increase in the Federal Reserve
discount rate would not have serious consequences for sterling.
The possible implications of more overt action were extremely dif
ficult to evaluate.

He understood that Mr. Solomon would comment

on the subject in his remarks later in the meeting, and members of
the Committee presumably would give their views in the course of
the go-around.
Mr. Maisel then said that he would like to comment on
another matter.

Increasingly in recent months, because he had been

unable to understand how individual actions were expected to aid
in achieving either the Committee's short- or long-term goals,

12/17/68

-17

he had been concerned as the System's foreign operations and
commitments had expanded.

His unease had increased during the

past period when the System seemed to be conducting foreign and
domestic operations with opposing goals.

Domestically, the System

was fighting to slow down reserve expansion and to hold up short
term rates as an aid in reducing inflationary pressures.

Through

System swaps with the BIS it was increasing reserves and was
striving to ease Euro-dollar rates, which had the effect of main
taining or increasing the availability of credit in U.S. domestic
markets.
While he recognized that opposite short-term actions might
be completely logical, Mr. Maisel continued, a careful review of
past reports and analysis of such swaps showed no indication that
the Committee had considered their domestic implications, nor was
there any measure or much discussion of what cost-benefits the
Committee expected from its actions.

It had given a broad

delegation of powers to the Special Manager to operate so as to
aid in avoiding disorderly exchange markets.

It did not seem to

have asked him to consider the impacts of his acts on domestic policy
objectives.

It had not asked him to consult with the Committee

when taking actions nor had it requested him to report his analysis
of the impact of those actions.

The Committee appeared to have

been operating with a minimal analytical model and decision-making

-18

12/17/68

process, particularly when comparison was made with the detailed
examination and daily concern evidenced in the domestic sphere.
Similarly, Mr. Maisel said, today he would not feel as
uncomfortable as he did about having voted to commit over $6
billion of the System's resources if he were clearer in his mind
As he had participated

as to what theory supported their use.

in meetings of the Committee, it had seemed to him that there
had been several different implicit assumptions as to why par
ticular loans were or were not made.

Yet each had been justified

in most general terms as meeting the Committee's foreign currency
directive.

Even though he had been on the Committee as long as

half the members, he could recall few, if any, discussions at
meetings of the logic of any particular operations similar to
the discussions in the domestic sphere.
In conclusion, Mr. Maisel said he had to admit that having
reviewed the generalness of the Committee's instructions to the
Special Manager, he felt most uncomfortable over what now appeared
to him to have been a neglect of his responsibility in the matter.
He wondered whether other members of the Committee had the same
feeling.

The fact that the Committee had authorized potentially

conflicting operations worried him, as did the magnitude of the
System's commitments.

He would hope that in the future the Com

mittee might be able to get a better analysis in its reports of

-19

12/17/68

both the immediate and the ultimate objectives of specific
operations so that it could make the necessary judgment as to
whether or not it was fulfilling its responsibilities.
Mr. Hayes said it would be desirable to have comments
from both Mr. MacLaury and Mr. Holmes on the subject Mr. Maisel
had discussed.
Mr. MacLaury observed that the Account Management had
been highly cognizant of the problem of conflict between foreign
and domestic operations--not only potential but actual conflict.
The potential for conflict was implicit in the very existence of
the System's swap network, since drawings and repayments had con
sequences for bank reserves and the money market.

Staff working

in the foreign area were in continual contact with Mr. Holmes,
consulting about operations day by day and when necessary hour by
hour.

On the basis of such consultations, for example, arrangements

recently had been made with some of the System's swap partners to
invest their dollar inflows or proceeds of drawings in a manner
designed to create as few problems as possible for domestic
operations.
Mr. MacLaury noted that Mr. Maisel had referred specifically
to the recent BIS operations in the Euro-dollar market financed by
drawings on the System.

The BIS undertook such operations only

with the Special Manager's concurrence so the associated swap

-20

12/17/68

drawings could be closely controlled by the System.

Recently,

for example, because of the problem of conflict the BIS had been
told to limit its placements in the Euro-dollar market financed
by drawings on the Federal Reserve to the minimum consistent
with the maintenance of orderly conditions, and in any case not
to exceed $150 million.

In accordance with those instructions

the BIS had placed only $80 million in the market, far less than
it might otherwise have done.
Mr. Holmes said he could confirm Mr. MacLaury's statement
about the close relationship maintained between the staffs con
cerned with domestic and foreign operations.

Foreign operations

obviously were a matter of importance to the domestic staff since
they affected reserves and sometimes led to complications, but on
the whole he thought the two staffs had worked together well.
Mr. Maisel remarked that he was not questioning the ad
equacy of coordination in day-to-day operations.

Rather, he was

raising the much broader problem of conflicts in objectives, which
he thought was illustrated well by the recent operations aimed at
easing the Euro-dollar market.

Those operations had the effect

of keeping funds in the United States that otherwise would have
gone back to the Euro-dollar market.

They might also have fostered

the belief that the System was prepared to act as the lender of
last resort in the Euro-dollar market, and consequently might have

12/17/68

-21

led U.S. banks to borrow a much larger amount of Euro-dollars
than they would have otherwise.

The question of whether such

operations were desirable was likely to become increasingly
important if firming actions by the System put greater pressure
on the Regulation Q ceilings, since the volume of U.S. bank
borrowing in the Euro-dollar market would then become critical.
Mr. Hayes said he thought Mr. Maisel had raised an in
teresting point, and he agreed that there was some degree of
conflict in the objectives of such foreign operations and domestic
operations.

At the same time, the scale on which the BIS had put

funds into the Euro-dollar market recently was small; and he thought
the ends served were sufficiently important to outweigh any inci
dental disadvantages from the domestic point of view.

In any case,

the effects on domestic financial markets could be offset readily
by open market operations.
Mr. MacLaury observed that at the time of the last BIS
meeting Mr. Coombs had advised the group of gold and foreign
exchange experts that, while the System was prepared to put some
funds into the Euro-dollar market, such operations obviously might
conflict with U.S. domestic objectives.

Accordingly, he had asked

that other central banks stand ready to place funds in the market,
either in conjunction with the Federal Reserve operations or in
lieu of them.

With respect to one of Mr. Maisel's comments, he

12/17/68

-22

questioned whether the System's posture could be described
appropriately as that of a "lender of last resort" to the Euro
dollar market.

That description would fit a lender who left the

initiative to the borrower; in the present case, the System made
the decisions on when it was desirable to give assistance to the
Euro-dollar market.

He had heard some comment in the New York

financial market to the effect that the Federal Reserve was putting
back with one hand what it was taking with the other, but he did
not believe that such an assessment was accurate.
Mr. Mitchell remarked that he was a little disturbed by
the suggestion in earlier comments by Mr. Holmes that the Desk had
not been able to offset fully the impact of international trans
actions on the domestic money market.
Mr. Holmes said that, by and large, it had been possible
to offset the impact of international transactions, although on
occasions when the flows had been very heavy it had taken a few
days to do so.

Insofar as there were problems, they were matters

of fine tuning which on the whole were not serious.
Mr. Hickman recalled that the Desk had experienced problems
a few weeks ago in connection with investments of dollars that were
flowing into Germany, some of which originated in drawings on the
System's swap lines.

Both those transactions and their subsequent

reversal had had some rate effects despite the Manager's best efforts
to avoid them.

-23

12/17/68

Mr. Hickman added that he was concerned not only about the
implications of the operations in the Euro-dollar market but about
the general problem posed by the fact that System foreign currency
operations were creating a large volume of dollars at a time when
domestic considerations argued for restraint.
Mr. Brimmer said he was inclined to share the views
Mr. Maisel had expressed.

It seemed to him that there typically

was less advance consultation with the Committee in connection with
major operations in the foreign currency area than on the domestic
side.

Of course, it was not always possible to anticipate the

kinds of foreign operations that would be required in the period
before the next meeting of the Committee.

But that did not seem

to be the whole explanation for the present situation.

For example,

at the November 26 meeting the Special Manager might well have com
mented on the matter of possible operations in the Euro-dollar market.
Mr. Brimmer noted that the Committee followed the practice
of reviewing its foreign currency directive annually, at the March
organization meeting, and rarely considered it at other meetings.
Perhaps it would be desirable to undertake such reviews on a some
what more frequent basis.

The staff might be asked to look into

the pros and cons of such a procedure.
Mr. Hayes remarked that it was clearly useful for the
Special Manager to report to the Committee on possible operations,

12/17/68

-24

to the extent that he could foresee major flows likely to call for
particular operations.

For the most part, he thought the Special

Manager did what he could in that connection.

However, it seemed

to him (Mr. Hayes) that the occasions on which one could see very
far ahead in the foreign currency area were few.

He recalled that

at the Committee meeting in late October, only a few weeks before
the major crisis of November emerged, the thrust of the discussion
was that conditions in foreign exchange markets were tranquil.
Nevertheless, Mr. Hayes continued, he thought the subject
was worth pursuing.

He would suggest that the staff, including

the Manager and Special Manager, look into it and prepare a mem
orandum that the Committee could consider in due course.

In the

meantime, he was sure the matter would be kept in mind by both
Managers.
There was general agreement with Mr. Hayes' suggestion.
By unanimous vote, the System
open market transactions in foreign
currencies during the period Novem
ber 26 through December 16, 1968,
were approved, ratified, and
confirmed.
In response to Mr. Hayes' request for his recommendations,
Mr. MacLaury reported that five drawings by the Belgian National
Bank, totaling $45.5 million, would mature for the first time in
the period from December 20, 1968, to January 10, 1969.

He

-25

12/17/68

anticipated that most if not all of those drawings would be paid
off by year-end, since the Treasury was expected to purchase $60
million of Belgian francs in connection with the planned recon
stitution of the U.S. gold tranche position in the International
Monetary Fund.

If any of those drawings were still outstanding

at their maturity dates, however, he would recommend their renewal.
Renewal of the five drawings
by the Belgian National Bank was
noted without objection.
Mr. MacLaury noted that a $200 million drawing by the
Bank of England would reach the end of its second three-month
term on January 2, 1969.

He would recommend renewal of that

drawing if, as he expected, the Bank of England so requested.
Renewal of the $200 million
drawing by the Bank of England was
noted without objection.
Mr. Hayes then asked Mr. Solomon to report on developments
at the recent meeting of Working Party 3 that the latter had
attended.

Mr. Solomon said that in the interest of saving time he
would summarize the statement he had prepared and submit the full
statement for inclusion in the record.

He then summarized the

following statement:
Working Party 3 met in Paris last week and,
naturally, focused on the three countries--Germany,

12/17/68

-26-

France, and Britain--that were most affected by the
intense currency speculation of November.
It was pointed out at the outset of the meeting
that the basic payments positions of these three
countries in the period just before the crisis seemed
to be improving rather than worsening. The United
Kingdom had an over-all balance of payments surplus
in the third quarter--temporary though it may have
been--and the over-all deficit in October was very
small. France was in rough balance in October.
And Germany was in small over-all deficit in October.
This set of facts confirms the observation I put to
this Committee three weeks ago:
that the crisis had
its origin in a belief by the market that the German
Federal Bank would not be able to maintain the easy
money policy that was making possible a massive
capital outflow compensating the very large German
trade surplus.
In any event, the crisis had occurred and
measures had been taken by the three countries. The
Working Party attempted to evaluate the effects of
these measures.
The German authorities continue to believe that
their 4 per cent border tax adjustment will reduce the
trade surplus by about $1 billion. They also believe
that the domestic expansion has sufficient dynamism so
that additional fiscal measures will not be necessary
to offset the $1 billion reduction in the trade surplus.
But monetary policy in Germany can now continue as it
was, whereas, in the absence of what Dr. Emminger called
a "de facto revaluation" the German Federal Bank would
have had to shift toward greater restraint for domestic
reasons.
The French representative began his presentation
by decrying the agitation for a conference to deal with
international monetary reform, which, he said, only
stimulated speculation. The French expect their own
budgetary and credit measures plus the German measures
to improve their basic balance of payments by about $1
billion in 1969. If capital flight subsides, this
would leave the French in a comfortable payments posi
tion. In fact, if and when confidence is restored, the
deflationary policies could probably be relaxed somewhat.

12/17/68

-27-

The big question is whether social and political unrest
will arise before confidence in the currency has been
restored.
The additional budgetary and credit measures adopted
by the United Kingdom have been wrongly interpreted as
still another dose of deflation for the British economy.
The fact is that these new measures are intended only to
put Britain back on the track that was foreseen at the
time of devaluation. Both consumer expenditures and
imports have been considerably higher than was planned
a year ago and the balance of payments improvement has
been correspondingly poorer. The major open question
regarding the United Kingdom is its incomes policywhether wage demand can be held in check.
The underlying balance of payments has been
improving--and last month's trade deficit was the lowest
in a long time. But despite this trend toward improvement,
there remains a pall of deep skepticism in the exchange
market. The good trade figures announced last week had
very little market effect. The skepticism is based, no
doubt, on political uncertainties in Britain as well
as economic uncertainties. In these circumstances
sterling continues to be vulnerable to shocks; witness
the reaction to developments in the Middle East recently.
It seems all too probable that another severe shock and
an attendant large loss of reserves would push Britain
to a floating exchange rate--with highly unpredictable
effects on the international monetary system. Yet the
underlying economic situation does not call for a lower
exchange rate for the pound.
Under these conditions, the Federal Reserve must
weigh the advantages of any announcement effect it seeks
at home against the risks that a big announcement effect
could knock sterling off its parity. An uptrend in
interest rates in the U.S. and in the Euro-dollar market
would not by itself hurt sterling, which is already at
a 3 or 4 per cent disadvantage owing to the discount on
forward sterling. The danger comes rather from a more
generalized reaction by the market, perhaps irrationally,
that an abrupt tightening of U.S. monetary policy would
have financial and real effects greater than sterling
can bear.
Before this meeting there had been distributed to the
members of the Committee a report from the Manager of the System

-28-

12/17/68

Open Market Account covering domestic open market operations for
the period November 26 through December 11, 1968, and a supplemen
tal report covering December 12 through 16, 1968.

Copies of both

reports have been placed in the files of the Committee.
In supplementation of the written reports, Mr. Holmes
commented as follows:
Since the Committee last met three weeks ago, the
financial markets have undergone a psychological crunch
much more severe than warranted by actual developments.
There were really no sensational developments either at
home or abroad to account for the deterioration of market
psychology. Rather, it appeared that as business devel
opments continued to reflect greater strength in the
economy than had been anticipated earlier, fears of
inflation were sharpened. The unexpected increase in
the prime rate to the 6-1/2 per cent level prevailing
earlier in the year tended to focus attention on the
pressures existing in the economy and heightened expec
tations of a tightening of monetary policy. In addition
to regular seasonal factors associated with the dividend
and tax period, technical factors--such as the need for
the System to absorb large amounts of reserves created
by a sharp decline in the Treasury balance and an
unexpectedly high level of float--and persistent sales
of Treasury bills by foreign monetary authorities also
added to market pressures on interest rates.
The net result was to produce a sharp upward thrust
on interest rates in all maturity areas, bringing rates
in most instances to levels above the peaks prevailing
in May and June of this year. The three-month bill
rate, for example, moved up by about 1/2 of a percentage
point from the 5.46 per cent level prevailing at the
time of the last meeting. In yesterday's regular
Treasury bill auction average rates of 5.97 and 6.02
per cent, respectively, were set for three- and
six-month bills, up 52 and 45 basis points from the
auction just preceding the last meeting of the Committee.

12/17/68

-29-

The capital markets were equally hard hit, with U.S.
Government securities feeling the competition of
corporate yields that reached 7 per cent or more,
while tax-exempt issues reached their highest yields
since 1934. The capital markets were faced with a
substantial volume of undigested new issues which
had been offered late in November together with
large blocks of tax-exempt industrial revenue bonds
that were seeking to beat the January 1 deadline
when newly-sold industrial revenue issues larger
than $5 million will lose their tax-exemption
privilege. There were a number of syndicate termi
nations during the period, while postponement or
cancellation of new corporate and municipal issues
amounted to about $360 million. By the close of
the period it appeared that the sharply higher rate
levels were beginning to attract investor interest
and new issues were moving well.
The conduct of open market operations was a
complicated and frustrating experience. As you know,
midway in the period the credit proxy for December
appeared to be showing a 9 per cent or more annual
growth rate, above the 5 to 8 per cent range antic
ipated at the last meeting. This clearly called for
implementation of the proviso clause. Treasury bill
rates, however, were already 1/4 of a percentage point
or more above the upper end of the range considered
likely at the last meeting, and the market was
considerably less than enthusiastic about absorbing
the Treasury bills that we had to sell for foreign
accounts. The Treasury's cash position also proved
to be a millstone around the neck of open market
operations. As you know, the Treasury had to borrow
a modest amount directly from the System on two days
last week and $430 million over the week-end. Thus,
the Treasury, after taking account of a run-down of
its normal balance with the Reserve Banks, has been
supplying the market with almost $1-1/2 billion of
reserves. Hong Kong flu also added unexpectedly to
the supply of reserves as increased absences led to an
increase in holdover float at the Reserve Banks.
Given this need to absorb reserves, and with the
Treasury bill market in a tender state, extensive use
was made of matched sale-purchase agreements with over

12/17/68

-30-

$3-1/2 billion of such agreements entered into during
the period. The availability of this technique--rather
than complete reliance on outright sales of billshelped to avoid an undesirable further degree of pressure
on Treasury bill rates and perhaps a disorderly market.
I might add parenthetically that during the week ended
December 11 outright sales of $280 million were made in
the market and $290 million to foreign accounts. Even
with this volume of reserve absorption, the Federal
funds rate generally remained at 5-7/8 per cent. A rate
of 6 per cent or above would have been more consistent
with implementation of the proviso clause but the risks
involved in pushing that hard appeared too great to
undertake.
At the current level of rates, Treasury bills have
become very competitive with bank CD's, so that, as the
blue book1/ notes, CD attrition in December is expected
to be somewhat greater than seasonal. Major banks had,
however, undertaken a precautionary build-up of CD's in
November and excessive pressures are unlikely if bill
rates tend to stabilize or edge lower and if Euro-dollars
remain marginally available until the year-end and under
go the usual seasonal increase thereafter. The possibility
of a significant squeeze on CD's cannot be ruled out,
however, if banks aggressively seek to rebuild balances
after the December attrition.
The Treasury, as you know, raised $2 billion in
cash in an auction of June tax-anticipation bills on the
day of the last meeting. Banks, which were enthusiastic
bidders at the time, were quite disappointed in the value
of the tax-and-loan credit associated with their subscrip
tion, as the Treasury cash drain was greater and came
sooner than was generally anticipated. Early sales by
banks of tax bills helped put pressure on rates during
the period. Treasury cash balances at the Reserve Banks
should get back in shape in a day or so as tax receipts
come in, but there is some risk that direct Treasury
borrowing from the System will be required by the middle
of next month in the absence of cash borrowing in the
market. Although no decisions have been made, a
borrowing of $1 to $1-1/2 billion announced before the

1/ The report, "Money Market and Reserve Relationships," prepared
for the Committee by the Board's staff.

-31-

12/17/68

end of the month is a possibility and would appear
desirable from the System's viewpoint in order to
avoid the side effects of a low Treasury cash position
that has plagued us during the current period.
As far as the outlook for interest rates is
concerned, I have little to add to the discussion in
the blue book. Certainly, there has been a significant
rate adjustment over the past three weeks which may, as
is often the case, have gone too far. The market has
obviously discounted fully some modest firming of
monetary policy, and seasonal factors should favor a
stabilization or some edging down in rates. There is
a good possibility, should the Committee decide on a
firming of money and credit conditions, that the
market might view it as beneficial to a more balanced
economy in the longer run, and this might tend to limit
the strength and duration of any further rise in interest
rates. One can never be sure of the market's reaction,
however, and it is clear that visible evidence of a
slowdown in the rate of economic expansion and of a
braking of the inflationary psychology is a prerequisite
for more settled market conditions.
I should note that we have added a new firmFrancis I. duPont & Co.--to the list of dealers with
whom we do business. DuPont has been conducting oper
ations in Government securities for some time and has
been reporting its transactions to the New York Bank
for several months. We have carefully reviewed their
operations and are convinced that they are capable of
making adequate markets in Government securities and
will make a useful contribution to the functioning of
the market. This brings the list of dealers with whom
we do business to 21, of which 13 are nonbank dealers.
In reply to a question by Mr. Mitchell, Mr. Holmes indicated
that the dealers had made good progress in reducing their holdings
of longer-term U.S. Government securities over the past three weeks.
Their current positions in securities due after five years were
about $325 million, down from $600 million at the time of the
Committee's previous meeting.

-32

12/17/68

Mr. Brimmer asked Mr. Holmes for his judgment of the
probable impact on domestic financial markets in the period ahead
of various combinations of monetary policy actions, some of which
had already been suggested today.

The specific combinations he

(Mr. Brimmer) had in mind were firming through open market operations
together with a discount rate increase (1) of 1/4 point, (2) of
1/2 point, or (3) of 1/4 point, along with some increase in reserve
requirements.
Mr. Holmes replied that the market appeared already to
have discounted a 1/4 percentage point increase in the discount
rate and some concurrent firming through open market operations.
If such actions were accompanied by the announcement of a small
increase in reserve requirements--designed, say, to absorb about
$500 million of reserves effective in mid-January, when a seasonal
bulge in reserve availability was projected--the psychological
effect of the announcement probably would put some modest upward
pressure on interest rates.

In his judgment a 1/2 point discount

rate increase would have a greater impact on market psychology and
interest rates than would the combination of a 1/4 point rise and
a small increase in reserve requirements.
In response to a question by Mr. Daane, Mr. Holmes noted
that at current levels of Treasury bill rates banks were already
under pressure from the Regulation Q ceilings.

On a bond-equivalent

-33

12/17/68

basis, the three-month bill was currently yielding around 6-1/8
per cent and the six-month bill around 6-1/4 per cent.

At the

moment short-term interest rates were under seasonal upward
pressures.

The duration of those pressures was somewhat uncertain,

but on the basis of the normal seasonal pattern one would expect
rates to stabilize or perhaps even to decline in January.
Mr. Daane asked whether, if both discount rates and
reserve requirements were increased, there would be any technical
advantage from the point of view of the Desk in having the two
actions announced simultaneously.

In particular, would there be

any loss in deferring announcement of a reserve requirement increase
until early January?
Mr. Holmes replied that he had no particular feeling as to
the relative impacts of a combined announcement or two announcements
separated by a week or two.

In any case, from the technical point

of view, the timing of the announcement of a reserve requirement
increase was much less important than the effective date of such
action.

As had been indicated, current projections suggested the

desirability of January 16 as the effective date.
In answer to a question by Mr. Maisel, Mr. Holmes indicated
that the reserve projections for coming weeks were based on the
assumption of a "normal" Treasury balance at the Reserve Banks.
did not know how realistic such an assumption was, particularly

He

12/17/68

-34

since the level of the Treasury balance would depend importantly
on the Treasury's mid-December tax receipts, which were still
being estimated.
Mr. Brimmer inquired whether a discount rate increase of
only 1/4 point might not be counterproductive, since the market
seemed to have fully discounted such an action.
Mr. Holmes replied that he did not think so.

Although

the market might view a 1/4 point increase as a minimal change,
it was likely to be regarded as a signal that further tightening
actions by the System were to come.
By unanimous vote, the open
market transactions in Government
securities, agency obligations, and
bankers' acceptances during the
period November 26 through Decem
ber 16, 1968, were approved,
ratified, and confirmed.
Mr. Hayes then called for the staff economic and financial
reports, supplementing the written reports that had been distributed
prior to the meeting, copies of which have been placed in the files
of the Committee.
Mr. Partee made the following statement concerning economic
developments:
The outpouring of economic good news over recent
weeks has been so overwhelming that, for a staff pro
jecting a slowing in expansion, it has seemed almost
unbearable. Seldom can I remember a time when the

12/17/68

-35-

statistics, including both new numbers and revisions
for past months, have shown such dramatic and broadly
based strength. New orders, retail sales, employment,
and earnings are all up, and the unemployment rate has
dropped to the lowest level in many years. The offi
cial plant and equipment expenditures survey indicates
exceptional strength over the winter quarters, and the
business inventory increase in October was far larger
than had been expected. To top it off, we will be
publishing today a 1 per cent rise in the industrial
production index for November along with some further
upward revisions for other recent months. Excluding
steel, the index since mid-year is now shown to have
increased at a 5 per cent annual rate.
Under the circumstances, the staff GNP projection
for this quarter has been lifted substantially--again.
The current dollar increase, as shown in the green
book,1/ is now estimated at $18 billion, and it is
likely to be even higher if inventory accumulation
does not slow sharply from the October rate. The GNP
gain projected for the first quarter also has been
raised significantly, reflecting the further increase
in planned plant and equipment expenditures and the
effects of higher investment on personal income flows
and on consumption. Thus, for the time being at least,
much of the slowing in economic expansion that was
projected when the surtax was enacted continues to
elude us. This is not to say that the tax increase
has not had any effect, but rather that its initial
impact appears to have been swamped by the unexpected
strength in private demands, first in consumption and
now in business investment.
The obvious explanation for this strength is that
inflationary expectations, in an atmosphere of sharply
rising prices and continuing steady increases in pro
duction costs, are inducing additional current
expenditures in anticipation of future needs. This
effect seems strongest with regard to the acquisition
of fixed assets, where higher prices are enshrined in
the basic cost structure. This would help .to explain
both the upsurge in plant and equipment, at a time
when operating rates are relatively low, and the strength

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

12/17/68

-36-

of residential construction in the face of continuing
very high financing costs. But the widespread infla
tionary psychology also may be conditioning business
attitudes in favor of somewhat higher levels of
inventories than otherwise would be desired, and it
could contribute to consumer decisions to satisfy some
of their wants now rather than later. Certainly credit
demands, on the part of both business and consumers,
have been running a good deal stronger than expected.
Anticipatory buying, to the extent that it is
taking place, adds a new dimension of instability to
the business situation. Additional spending tends to
produce its own supporting income, of course, but it
seems most unlikely that an expansion based importantly
on anticipation of future needs would not sooner or
later hit a serious snag. At present, for example,
the near-term prospects for both consumption and
Government demand would not seem to warrant a major
step-up in business inventory investment. Consumer
spending, following the mid-summer surge, has advanced
in recent months at a more moderate rate, and another
upsurge seems a rather remote possibility in view of
the increased tax bite in the first half of next year.
And Federal purchases of goods and services do appear
to be leveling out, in line with budgetary constraints;
renewal of a significant uptrend seems neither likely
nor possible before well into next year. Real progress
towards peace in Vietnam, should it come, would open up
a wider variety of options for the new Administration,
of course, and could alter substantially both the
budgetary and business outlook.
Making no allowance for this last possibility, the
staff projection continues to be for a marked slowing in
expansion, though from higher levels of resource utiliza
tion, through the first half of 1969. Real growth is
still expected to slow to 3 per cent or less in the
period ahead, and with that slowing should come some--but
not much--lessening in demand pressures on the labor force
and other markets. The main analytical support for
expecting a cooling off is that the Federal budget will
be moving strongly into surplus, reflecting both the
hold-down on expenditures and a ballooning in tax receipts.
In addition, financing capabilities would appear to
preclude any significant further rise in residential

12/17/68

-37-

construction activity beyond the large increase
already reflected in the fourth-quarter estimates.
I still believe that the slower growth model is
generally descriptive of the most likely course of
developments, but I must admit that the odds favoring
a stronger pattern, at least in the short run, have
increased considerably in recent weeks. It might
well be that business inventory accumulation will
continue above expectations for a time and that the
plant and equipment survey findings do signal the
beginnings of a new investment boom. If so, consumers
could be expected to adjust their expenditures to the
higher levels of income that would result, and the
momentum of this process could continue to carry the
economy strongly upward well into the new year. With
labor scarcities limiting the nation's effective
production potential, the result would likely be a
continuation--if not intensification--of current
inflationary pressures, carrying with it the potential
for a more severe reaction later on.
If the Committee believes that this is too big a
risk to take, and I am inclined to think it is, it
should act to support recent market developments that
serve to increase the cost and limit the availability
of credit. But if it does so, the very real risk on
the other side should also be taken into account.
Aside from possible effects on business psychology,
which are difficult to achieve and tricky to interpret,
the major impact of increased monetary restraint on
spending might not come until next spring and summer,
by which time the economy--in line with the standard
forecast--could be cooling off for other reasons as
well. I will leave it to Mr. Brill to discuss the
policy alternatives that seem to afford the greatest
chance of steering successfully through this exceedingly
difficult time path of events which I fear may lie ahead.
Mr. Brill made the following statement regarding financial
developments:
I am indebted to Mr. Partee for resolving the
difficult issues of the day, leaving for me the simpler
problem of suggesting how monetary policy might extricate

12/17/68

-38-

the economy from increasing inflationary pressures.
The problem before the Committee today, it seems to me,
is not whether to tighten policy, but how and how much
to tighten. I say this with full recognition of the
lagged effect of policy actions, and in recognition and
support of the staff projection of impending moderation
in the economy, as the full thrust of fiscal restraint
begins to take hold. This must sound like a broken
record, I am sure, but I still cling to the faith that
economic fundamentals will prevail. As Mr. Partee has
indicated, in the near-term outlook the fundamentals
are:
(a) a fiscal position swinging from large deficit
to large surplus; (b) a consumer sector which has had its
fling and is now about to be hit by a large increase in
required tax payments; and (c) credit market conditions
that, if maintained, should sharply limit expansion of
housing activity.
Unfortunately, the business community appears
oblivious to these fundamentals. In the face of so
many factors promising to limit growth in final
demands in the months ahead, businesses are adding to
inventories at a rapid clip and increasing investment
in new plants at a boom rate. It doesn't seem to me
likely that the prospects for final demands of consumers
and Government are strong enough to validate these
business plans; it is more likely that businessmen's
inflationary expectations are building in imbalances
which will result in a painful correction at some time
down the road, and System action is needed now to keep
these imbalances from becoming even worse.
If this identification of the critical factor in
the present situation is correct, it suggests some
criteria for the System in its choice of monetary tools
at the moment and for the intensity of their use. The
analysis suggests, for example, that the tools employed
should have a high degree of visibility to get the
message across throughout the business community. If
businessmen can be persuaded to believe that our
determination to curb inflation is as dogged as in
1966, so much the better. It might prove possible to
achieve a modification of business psychology without
too strenuous or prolonged a monetary squeeze.
But we dare not count on winning the battle so
cheaply. Business loans soared in November--and

12/17/68

-39-

continued rapid expansion in inventories would intensify
business demands for credit accommodation. The experience
of recent episodes of restraint emphasizes that business
financing enjoys a preferred status in bank portfolios,
and many other categories of would-be borrowers will
feel the impact of monetary restraint before business
loans are curtailed significantly.
Still, it would be preferable to employ those
tools of policy which offer the best odds--even small
ones--of mitigating the impact of restraint on nonbank
intermediaries and housing, given the present housing
shortage, the economic and social costs of perpetuating
or deepening the shortage, the somewhat overextended
position of mortgage lending institutions, and the
imminence of a major interest-crediting period. I do
not suggest that housing finance could or should be
completely insulated from monetary restraint. But if
we have some option, we should be emphasizing the use
of tools that might have relatively less impact on the
short- and intermediate-term interest rates most
competitive with thrift institution inflows, and be
less concerned about the impact of additional restraint
on long-term rates.
Turning to the issue of the extent of tightening
needed, we must recognize that taut conditions already
prevail in financial markets, particularly in the
market for CD funds, where banks are virtually priced
out all along the maturity scale. Banks did anticipate
run-offs by aggressive solicitation and pricing of CD's
late last month, and thus may be able to cope with
substantial run-offs over the balance of December. But
CD maturities in January are large, and the pressure of
market rates continuing at or above ceilings could bind
banks severely and produce strong reactions in the
markets in which they make their portfolio adjustments.
Seasonal availability of investment funds in the
early weeks of the new year should tend to provide some
relief from these pressures, as might renewed availability
of Euro-dollar funds after the year-end, and the switching
of CD funds into bills would tend to establish an equi
librium ultimately. The balancing process, however, is
likely to be painful. In sum, it probably would not
require much further tightening in policy to get a sharp
reduction in the rate of bank credit growth, although

12/17/68
it will be more difficult to achieve a cutback in
credit to business unless loan demands cool off.
Weighing the alternative actions available to
the System against the criteria noted above, it
seems to me that an increase in the discount rate,
reinforced by appropriate open market actions to
bring the cost of borrowing to the nonbank public up
to higher levels, measures up well on some counts. It
is certainly a highly visible act--perhaps too much so
for international reasons. But a minor change--such as
a 1/4 point increase--might not produce the domestic
visibility we seek. Not only has the market already
discounted it, but because we took pains in describing
the August reduction of a 1/4 point as a technical
adjustment, it is likely to prove difficult to persuade
the public that rescinding it constitutes a significant
increase in the intensity of monetary restraint. If
that were the only overt signal of policy action given
now, it might become a subject of derision rather than
awe.
We can probably achieve more restraint through main
taining market uncertainty, by tightening open market
operations and leaving the discount rate at 5-1/4 per
cent, than by a mild overt action that has already been
overdiscounted. In time, changes in market conditions
and in the pace of bank credit expansion--such as those
specified in connection with directive alternative B
in the blue book 1/--would convey our message to the
financial community.
A one-half point rise in the discount rate would
be more impressive, and therefore, according to at least
one of the criteria set forth earlier, more appropriate.
It might, however, constitute more tightening than

1/ The blue book passages referred to read as follows: "If
the Committee decides to seek firmer credit conditions, it might
wish to consider a complex including a Federal funds rate around
6-1/8 - 6-1/4 per cent, member bank borrowings in a $550 - $750
million range, and net borrowed reserves of $250 - $550 million.
Under such conditions, the 3-month bill rate might move in a
5.75 - 6.10 per cent band . .

.

. the bank credit proxy is likely

to show slower growth. Only a little slowing may become evident
in December, with the principal effects likely to be in January
and thereafter. Growth in the bank credit proxy could be in a
2 to 5 per cent range, on average, in January, or possibly lower
as banks make sales of securities that had been postponed to the
new year for tax purposes."

12/17/68

-41-

needed--financial over-kill, if I can use a discredited
term. It would undoubtedly produce sharp reactions in
money and other credit markets, with unnecessarily harsh
impact at the maturities most influential on the course
of flows to intermediaries. It would aggravate the CD
run-off problem, create intense pressure to raise
Regulation Q ceilings--a policy action it would be pref
erable to postpone--and could result in a contraction
(not just a slower expansion) in bank credit. There
does not seem to be much justification for so abrupt a
shift in policy.
There is another combination of policy actions which
better satisfies, as I see it, the criteria of visibility,
rate structure impact, and intensity of effect. This
would be the combination of a small discount rate actionto relieve some of the pressure on the discount window
arising when the gap between the discount rate and market
rates widens unduly--along with confirmatory open market
operations, plus an increase in reserve requirements,
announced promptly but with the increase in required
reserves not becoming effective until mid-January, after
the interest-crediting period at thrift institutions and
at a time when reserves have to be absorbed seasonally.
By relieving the Desk of the necessity of selling bills
to absorb reserves, the package of actions might tend to
limit the rise in bill rates, and thereby moderate the
impact on institutional flows. Bank adjustments to the
higher reserve requirements are more likely to be diffused
across the maturity spectrum, and to have a little more
effect on long- rather than short-term rates.
To summarize the effects of the alternative actions
discussed, and using as a fulcrum the blue book specifi
cations for alternative B--no overt action but tightening
through open market operations--I would expect that adding
a 1/4 point increase in the discount rate to the package
would yield about the same parameters except possibly for
a slightly lower bill rate range as market uncertainties
are relieved. Adding a reserve requirement increase to
the package may result in a shade lower bill rate range,
but somewhat more upward pressure on long-term rates,
and somewhat lower bank credit expansion in January--say,
in the 1 to 4 per cent range compared with the 2 to 5
per cent range under the blue book alternative B. A 1/2
point increase in the discount rate would push all market
rates up significantly from present levels, and reduce

-42

12/17/68

bank credit expansion to a rate hovering around zero.
These seem to be the System's options, at least in
terms of domestic considerations.
Mr. Hickman asked whether Mr. Brill thought that a 1/4
point increase in the discount rate accompanied by an increase
in reserve requirements was likely to push bill rates considerably
below current levels and thereby lead to less disintermediation
than was projected.

He also wondered if it might not be preferable

to delay a decision on a reserve requirement increase until there
was better evidence of the amount of disintermediation that was
likely to occur.
Mr. Brill replied that a 1/4 point rise in the discount
rate coupled with an increase in reserve requirements probably
would not result in significantly lower bill rates than were pro
jected in conjunction with alternative B in the blue book.

With

the package of a discount rate action and a reserve requirement
action, the three-month bill rate might hold in a 5.80 to 6.10
per cent range in December and decline to a 5.75 to 6.00 per cent
range in January.

The top of the latter range would thus encompass

the currently prevailing rate.

With respect to the second question,

as Mr. Robertson had noted, under the present lagged reserve
accounting procedure an increase in reserve requirements effective
in the week beginning January 16 would relate to deposits held in
the week beginning January 2.

That fact probably limited the

-43

12/17/68

amount of time an announcement of a mid-January reserve
requirement increase could be delayed.

However, it might be

feasible to delay the announcement until a bit after the turn
of the year.
Mr. Hayes agreed that such a delay probably would be
practicable.
In response to a question, both Mr. Holmes and Mr. Holland
indicated that according to their recollection the usual interval
in recent years between the announcement and effective dates of
changes in reserve requirements had been at least a week.
Mr. Mitchell commented that if the announcement of a
1/4 point increase in the discount rate was expected to have an
insufficient impact on market psychology, a simultaneous announce
ment of an increase in reserve requirements might be desirable.
On the other hand, unlike open market operations--which could be
flexibly adapted in light of developments--a change in reserve
requirements could not be readily reversed.
Mr. Hayes observed that the problem facing the System
at the moment was more than usually complex.
Mr. Hersey then made the following statement on inter
national financial developments:
When I spoke here ten weeks ago, I urged the
Committee to give full consideration to the long-run
problems of checking inflation and halting the

12/17/68

-44-

deterioration of our international trading position.
That would still be my counsel today--again with
emphasis on the long-run nature of these problems.
In the past three months the main components
of the U.S. balance of payments--with one important
exception--have not changed greatly so far as we
know. I will mention just two of the principal
items. First, the merchandise trade surplus in the
two months September and October still averaged an
annual rate of under $1 billion. Second, foreign
net purchases of U.S. corporate stocks apparently
leveled off in the second and third quarters at an
annual rate of nearly $2 billion.
Over all, by watching the weekly and monthly
data on official reserve transactions and on changes
in U.S. liabilities to foreign banks and branches,
we can estimate the net position on current account,
Government economic aid, and all private capital
movements other than the inflow of liquid funds
through commercial banks abroad. With rough adjust
ment for seasonality, the only good months this year
were June and July. For the third quarter as a whole,
including July, the deficit measured in this way was
at an annual rate approaching $2 billion. In the
four months August through November it was apparently
running at an annual rate of about $4 billion--perhaps
a little less than that in late summer, but apparently
somewhat more in October-November.
The one large recent change relates to means of
financing the adverse balance of which I have been
speaking. This change is the cessation of large net
inflows of funds to U.S. banks through their branches
abroad since the middle of September. In the previous
12 months there had been a net inflow of about $3-1/2
billion. If this inflow through commercial banks
abroad is now drying up and if the underlying payments
position is not improving significantly, we must not
be surprised to see large additions to the net claims
of foreign monetary authorities on the United States.
This in fact was occurring in October and November.
No one can say when the next international
exchange market crisis will hit someone, or hit us.
Talk of a mark revaluation coming soon after the
September 1969 German elections, if not before, is

12/17/68

-45-

not likely to have been quenched by Germany's recent
actions. Next March the French people and their
government will be making crucial decisions about
money wages and inflation.
The United States should be raising defenses
against a coming crisis. One way--essential in the
long run--is to slow our inflation and thereby improve
the current account of our external transactions. It
is hard to see other immediate possibilities. Intensi
fication of capital controls or further enlargement of
swap lines in advance of clear need would be of doubtful
value, I think. Some equilibrating changes in currency
parities may be required eventually. At the moment,
however, an overt effort by the United States Government
to hasten such changes would, as I see it, only tend to
accelerate the thing we have to fear, and need to guard
against: namely, gradual weakening of foreign habits
of holding dollars. In any case, changes in parities
will not remove the necessity of restraining U.S.
inflation.
The principal contribution that monetary policy can
make to the defense of our external financial position
is through stability of the price level. Some academic
writing about "the policy mix" seems to assume that
monetary policy affects the balance of payments primarily
through interest rates and their effects on capital
movements. This seems to me a mistaken emphasis. No
doubt monetary policy aimed at slowing inflation will
bring higher interest rates--at least so long as expec
tations of inflation are as widespread as they now are.
But it is the slowing of inflation that is most needed
for dealing with the balance of payments problem, not
higher interest rates per se.
Let me spell out what I mean. First, large inflows
of short-term capital, such as we were getting through
the Euro-dollar market until September, do not make a
lasting contribution to equilibration of payments, and
therefore are far less to be desired than is an enduring
improvement of our competitive position. Second, flows
of capital are by no means determined solely by interest
rates. As you know, the big inward movements of long-term
capital in the past year have been to buy equities, not
U.S. Government bonds--and not U.S. corporate bonds except
those which U.S. companies were selling on relatively
unfavorable terms to comply with the direct investment

12/17/68

-46-

controls. In the case of short-term funds, the past
year has amply demonstrated the importance of confidence
or lack of confidence in currency parities as a factor
influencing availability of funds in the Euro-dollar
market. In the real world we have very little power
to fine-tune the flows of capital to and from the United
States through interest rate policy.
To sum up, so long as expectations of depreciation
of the domestic value of the dollar persist and fears
of external depreciation lie below the surface, high
interest rates in the United States are a necessity
rather than a virtue. The test of an effective monetary
policy, for the balance of payments as well as domesti
cally, is not what it does to interest rates but whether
it helps in the long slow process of halting the inflation
of prices.
May I now add a few words on the question of whether,
or to what extent, action by the Federal Reserve at the
present juncture should be inhibited by fears of repercus
sions on the position of sterling and--through sterling,
at one remove--on the dollar itself. I would like to
say two things. First, irrational speculative reactions
are very difficult to analyze and predict. From the
point of view of U.S. balance of payments policy, there
may be a choice between taking measures desirable for
checking U.S. inflation, on the one hand, and on the
other, not taking those measures because they might
indirectly react adversely on the dollar through
speculative capital flows. As Mr. Solomon has already
suggested, the difficulty of choosing between such
alternatives may be narrowed if the first alternative
is limited to taking whatever anti-inflationary actions
appear absolutely essential, not merely desirable. As
I see it, this does argue against dramatic announcement
effects.
Secondly, under present circumstances there is
little reason to fear that moderate changes in U.S.
money market rates would generate interest-sensitive
flows of funds out of sterling, or inhibit inward
movements. At present, sterling interest rates in the
open part of the London money market are typified by
the 7-1/2 per cent rate on three-month lending to local
authorities. Three-month Euro-dollar money has been
around 7 per cent for several weeks--which compares with
6 per cent at the end of September. Inflows to sterling

12/17/68

-47-

are not occurring, because no one wants to move in that
direction uncovered and the cost of forward cover is
prohibitive. The 3-month forward discount on sterling
went to 7 per cent per annum last Wednesday, and was
still above 4 per cent yesterday.
It should also be noted that U.S. banks' Euro-dollar
borrowings have been fluctuating widely since September,
with no clear trend. Apparently the banks have been
willing to pay rising rates to hold on to funds, but have
not found much availability of new Euro-dollar money.
The flight from the franc went mainly into German marks,
and there was probably some movement into marks from
dollars too. After the crisis the Euro-dollar market
remained fairly tight. In the week from December 4
to the llth, however, U.S. banks were able to increase
their borrowings considerably. Speculative movements
out of sterling may have helped them, and probably also
the ebbing of mark speculation and the German Federal
Bank's market swap operations.
Under all these circumstances, a moderate tightening
of U.S. monetary conditions might well lead to a further
rise in Euro-dollar rates. This might be followed by a
similar rise in London rates for local authorities. If
not, and if the interest rate incentive for moving,
uncovered, out of sterling into dollars were to be
increased a little, it is hard to imagine who would
respond to this additional incentive. The treasurers
of international companies, who make it their business
to avoid currency depreciation losses even at a sacrifice
of interest income, have no doubt already moved all they
can. Sterling area central banks still thinking of making
a change in long-standing habits of where to hold their
reserves, are not going to be motivated to act by small
changes in rate relationships. Finally, the group that
might conceivably move on a covered basis--covered, that
is, back into sterling--is limited mainly to financial
institutions in Britain. For these investors, the large
discounts on forward sterling have already created large
covered interest incentives to move into dollars. For
them, the British exchange controls are an effective
deterrent, and a slight change in interest differentials
would mean nothing.
In brief, speculative attitudes and the forward
discounts on sterling reflecting these attitudes will

12/17/68

-48-

be far more important determinants of flows out of or
into sterling in coming weeks than interest rate
relationships will be.
Mr. Hayes then began the go-around of comments and views on
economic conditions and monetary policy with the following statement:
The business outlook remains very strong, with no
real evidence yet of a slowdown. Indeed, nearly all the
data becoming available since the last meeting have con
tributed to a picture of greater-than-expected expansion.
Not only is the fourth-quarter GNP gain likely to be
almost as large as that for the third quarter, but more
doubt has now been cast on the validity of projections
showing a much more moderate growth rate in the first
half of 1969. Commerce-SEC data on future capital
spending and the 3.3 per cent unemployment figure were
the most dramatic of the new statistics. Along with
the disturbingly high recent increases in major price
indices, they underlined the fact that an inflationary
spiral, abetted by a very tight labor market, continues
to be our most challenging problem.
Current and prospective balance of payments trends
continue to give cause for great concern, even though
the recorded liquidity deficit for 1968 promises to be
relatively small. As for 1969, we are almost sure to
see some considerable deterioration on capital account
since capital inflows have been so large this year.
Unless we can achieve a major improvement in the trade
balance--which does not at the moment look terribly
hopeful--the underlying liquidity deficit next year
may be of the same order of magnitude as the estimated
$3.5 billion for 1968. And unfortunately the recorded
liquidity balance in 1969 will undoubtedly be much
closer to the underlying balance than in 1968 because
the outlook is poor for further large increases in
nonliquid dollar holdings of monetary authorities.
Also, since there seems to be little likelihood of
additional inflows of private foreign funds via the
overseas branches of U.S. banks on anything like the
magnitude of the current year, 1969 may also bring an
official settlements deficit in the $2-1/2 to $4 billion
range in contrast with this year's expected surplus. All
of this, of course, points up the vital need to improve
the trade surplus.

12/17/68

-49-

As I have said at several recent meetings, I am
disturbed by the persistent tendency of credit proxy
growth rates to exceed preliminary projections by wide
margins. There is little doubt in my mind that the
growth of bank credit and the various monetary variables
remains excessive in view of the inflationary pressures
in the economy. If the current December projection for
the bank credit proxy is realized, it would mean a
fourth-quarter gain in bank credit of 11-1/2 to 12 per
cent following a 13 per cent rise in the third quarter.
While the recent strong rise in bank credit in part
reflects reintermediation through large CD's, this is
not reassuring in light of the fact that total credit
flows also appear to be rising rapidly. The member
banks in our District expect business loan demand to
remain strong during the early part of 1969. It is
interesting to note that so far deposit inflows to the
thrift institutions--as well as the growth of mortgage
holdings--have held up well despite the pronounced
firming of market interest rates, no doubt in part
because there is less "hot money" in the thrift insti
tutions now than in 1966. However, the year-end
interest crediting period could uncover weakness here
that is not yet apparent in the statistics.
There is no doubt in my mind that the major objective
of monetary policy under these circumstances should be to
seek an appreciably slower rate of bank credit expansion
as a contribution to the long-sought slowing of the economy.
However, I would advocate gradual and persistent pressure
in preference to any massive moves, but any action or
combination of actions must be significant enough to have
some effect on inflationary psychology. I would tend
to rely mainly on open market operations, together with
supporting discount rate action.
A good case can also be made for a change in the
near future in reserve requirements. A modest increase
could play a useful role in bringing home a tighter policy
to all banks and, if timed to occur in mid-January, could
obviate the need for sizable open market operations to
absorb reserves. However, I have some feeling of reluc
tance to announce a reserve requirement change at this
moment, when sterling is in such a delicate state. While
the situation may turn out to be no less touchy a couple
of weeks from now, I nevertheless have some preference
for seeing this decision deferred for a week or two in

12/17/68

-50-

the hope that it may then be possible to assess a
little more accurately the degree of vulnerability of
the international situation.
It seems to me that the Committee should instruct
the Manager to seek somewhat firmer money market con
ditions. In any case, regardless of any prospective
discount rate action, we might have in mind a Federal
funds rate in the range of 6 to 6-1/2 per cent, with
emphasis on the upper part of this range if the discount
rate is raised. Member bank borrowings might be from
around $600 to $800 million, which might imply net
borrowed reserves of $300 to $600 million. I would be
inclined to accept whatever range of bill rate levels
the market might itself establish, within reason of
course. As a matter of fact, it is not at all unlikely
that short-term market interest rates have largely
anticipated a firming of monetary policy including a
1/4 point rise in the discount rate.
As for the directive, I like alternative C as
proposed by Mr. Robertson. It seems to me that we might
do without the proviso for the next four weeks if explicit
firming action is taken at this time, but I do not feel
too strongly on this score. In any event I would not be
disturbed if the rate of credit growth were to drop close
to zero for a month or so.
At a special meeting of our directors last Friday
they voted to increase the discount rate by 1/4 percent
age point. It is my understanding that the boards of a
number of other Reserve Banks have taken similar action,
and it would be my hope that the Board of Governors will
approve these actions promptly. While I had earlier
felt that any discount rate action by the Reserve Banks
might better be deferred until after our discussion today,
I realize that the happenstance of the meeting dates for
many of the Banks' boards of directors was a valid reason
for advancing this timetable. Another reason why I had
favored some delay on the discount rate was the very
delicate situation with respect to sterling which mani
fested itself in the early part of last week. Since then
we have had favorable British trade and balance of payments
news; and while the market effect of this news has been
a good deal less than might have been hoped, nevertheless
I would think that the British position will not be
appreciably harmed by a 1/4 point increase, much of which
certainly has been discounted already by market rates.

12/17/68

-51-

After all, it is market rates which are of the greatest
significance with respect to short-term capital flows
into and out of the United Kingdom.
Our directors considered the alternative possibility
of a 1/2 point increase. However, I recommended a 1/4
point increase both because of the delicate position of
sterling and of the exchange markets in general and
because of the disturbed and pessimistic state of mind
in our own bond and money markets. It seemed to me
unwise for the System to make such a sharp move as to
put severe pressure on the bill market and other markets
at a time when seasonal pressures are especially high
in any case and when an artificial pattern of open
market operations has been forced by an exceptionally
low Treasury balance and a complex series of foreign
funds flows.
I am quite aware that we may have to make an
additional discount rate move before many weeks or months
have passed, either to provide a stronger psychological
signal or to support the firmer open market policy which
I am now advocating. I believe it would be clearly
preferable to consider this possibility as a separate
step following a full review of conditions, including
the tender international situation, after the turn of
the year. In brief, it seems to me that what is needed
in the way of monetary policy now is a gradual but steady
increase of pressure on the banks' reserve positions,
through a judicious combination of policy actions, until
such time as we see progress in our anti-inflationary
efforts.
Since our chief immediate objective is to slow the
expansion of bank credit, and since Regulation Q has
barely begun to bite, I would defer consideration of any
change of the ceilings at least for several weeks until
we can review the whole situation in the new year. If
in the meantime the existing ceilings tend to put the
banks under some increased pressure, so much the better
from a domestic point of view.
Mr. Francis commented that inflation was continuing at a
4 per cent annual rate, and expectations of future inflation
appeared to be heightening.

The fiscal stance of the Government

was changed about five months ago, but thus far economic excesses

12/17/68

-52

had not been reduced.

There seemed little question that a

restrictive monetary policy had to be pursued in order to provide
the necessary total restraint to end the inflation.

But an

apparent conflict arose between the desirability of taking
effective action against inflation and the desirability of pre
venting a further rise in interest rates.

Under such conditions

in the past, attempts had been made to use devices other than
simply restricting bank reserves, but with very little over-all
success in slowing inflation.
It should be pointed out, Mr. Francis continued, that
raising reserve requirements--as opposed to selling securities--in
the hope of providing monetary restraint while minimizing upward
pressure on interest rates had not generally been able to accomplish
the desired objective.

For example, in January 1968 the System had

raised reserve requirements,absorbing $550 million of reserves, to
obtain some monetary restraint without placing direct upward pressure
on interest rates.

But the effect of that action had immediately

been more than offset by greater open market purchases, and total
Federal Reserve credit, even adjusted for the change in reserve
requirements, continued to go up at an excessive 15 per cent annual
rate in the first quarter of 1968.
Mr. Francis recalled that indirect attempts at credit
restraint had had a similar ineffective result.

The System had

12/17/68

-53

imposed regulation on banks' ability to attract time deposits; it
had increased and broadened margin requirements on stocks; it had
used moral suasion with bankers; and it had changed discount rates.
Yet, month after month, the total effect of the System's actions
had remained expansionary; Federal Reserve credit had continued
to expand rapidly.
Since neither fiscal actions nor selective monetary controls
had produced desired results, Mr. Francis suggested that now was
the time to return to a proven course of action.

Control of monetary

aggregates, when used, had been effective in slowing spending, both
in this country and others.

In the past four years, those monetary

aggregates had usually been rising at record rates, and spending
had been rising excessively.

In one period, 1966, the aggregates

had been slowed, and after a brief lag total spending had slowed
and interest rates had fallen.
It seemed to him, Mr. Francis said, that the System should
now avoid contriving special devices in a vain hope that inflation
could thereby be curbed while temporarily higher interest rates
were avoided; instead, the System should begin to use its traditional
tool of over-all money and credit limitation.

In view of the serious

inflationary situation, he recommended that steps be taken immediately
to slow the rates of increase of Federal Reserve credit, the monetary
base, and the money supply.

The current high interest rates were,

in great part, a reflection of strong inflationary expectations.
The adverse effects of any resulting temporary rise in interest

12/17/68

-54

rates from a slowing in the growth of monetary aggregates were
likely to be more than offset by the benefits of a more balanced
economic expansion.

Lower interest rates were likely next summer

only if the rate of monetary growth was now slowed, reducing
inflation and inflationary expectations.
Mr. Francis said that a recent study done at the St. Louis
Reserve Bank indicated that with the existing stance of fiscal
policy, if money continued to grow at a 6 per cent annual rate
throughout the coming year, gross national product would rise at
an excessive 8 per cent annual rate.

Under those conditions real

output might rise about 4 per cent and prices would probably continue
to go up at a 4 per cent rate.
If money was slowed to a 4 per cent annual rate of growth,
Mr. Francis continued, the Bank's research indicated that GNP would
rise at a 7 per cent rate in the first half of next year and at a
6 per cent rate in the second half.

Some of the slowing might

initially be in real product, as inflationary forces take time to
extinguish, but the estimate was that such a course in spending
would be consistent with a 3.5 per cent rise in real output and a
gradual decline in the rate of inflation from the current 4 per cent
rate to a 2.5 per cent rate in the last half of next year.
Of course, Mr. Francis added, if monetary policy became
more restrictive, inflation could be eliminated more quickly, but

12/17/68

-55

economic activity could become unduly restrained.

For example,

the study indicated that if money were held unchanged over the
next four quarters, growth in total spending would slow sharply
from the recent 9 per cent rate to a 1 or 2 per cent rate by the
second half of next year, with real product declining.

He would

place in the record a table of the Bank's projections of GNP
growth next year under various money growth assumptions.1 /
Mr. Francis said he realized the results of the recent
research might be challenged, but until they were refuted by
empirical evidence he felt they were the best guide to monetary
actions.

Hence, he urged that the Committee direct the Manager

to increase Federal Reserve credit and the monetary base at rates
which would foster a 4 per cent rate of growth in money.

If money

growth varied from that 4 per cent trend in one period, attempts
should be made in immediately succeeding periods to return to the
directed course.

Later, as inflationary pressures gradually

receded, the target rate of money growth might be reduced to 3-1/2
or 3 per cent.
It was the view of the board of directors of the St. Louis
Bank that the discount rate should be raised by at least 1/2 of a
percentage point, Mr. Francis reported.

Market rates had increased

that much or more since late last summer.

1/

With appropriate open

Appended to this memorandum as Attachment B.

-56

12/17/68

market policy he saw no need for an increase in reserve require
ments.

However, if the decision were to combine an increase in

the discount rate with an increase in required reserves, he would
favor a simultaneous announcement of the two actions.
Mr. Kimbrel remarked that for some time he had believed
the rate of credit expansion to be too great for the continuing
health of the economy.

At the same time, he had recognized the

many constraints involved in adopting and executing a firmer
policy and the risks inherent in adopting the more restrictive
policy.

He had left the last meeting wondering if the Committee

really had not gotten enough new evidence to justify a more
restrictive policy, as had been implied by some persons in the
discussion.

What was especially disturbing at the moment was

the development of inflationary expectations.
Therefore, Mr. Kimbrel said, since the last meeting of
the Committee he had been making a sort of informal poll of the
state of inflationary expectations held by Sixth District directorsboth at the home office and at the four branches--and by businessmen
and bankers.

He had made no formal tabulation, but the consensus

seemed to be practically unanimous that further inflationary
developments were anticipated and that it was a wise man who made
his decisions to spend and invest in accordance with that certainty
of further inflation.

12/17/68

-57

Mr. Kimbrel observed that in the Sixth District the signs
of a slower growth noted earlier had apparently given way to a faster
tempo.

Nonfarm employment, following two months of no change, prob

ably rose in November.

Despite only a small gain in new instalment

loan extensions at banks in October, the outstanding volume rose
sharply and in November business and consumer lending at large
District banks was stronger.

Construction activity had exceeded by

a substantial margin the strong national performance during 1968.
Thus, Mr. Kimbrel continued, he had been sympathetic with
his directors late last week when they concluded that an increase
in the discount rate would be an appropriate action as a step toward
dampening the state of inflationary expectations.
some time the appropriate size of the increase.

They debated for
They recognized

that some of the pressures pushing up the rates might be temporary.
They considered the possible disintermediation effects of too large
an increase and the possibility that an increase of as much as 1/2
percentage point might strengthen inflationary expectations rather
than dampen them.

They also doubted that this was an appropriate

time, during a change of Administrations, to take the more dramatic
move toward raising the rate by 1/2 rather than 1/4 percentage point.
They also had debated the interpretations that could be assigned to
the change by foreign sources.

It would be preferable, they believed,

to raise the rate by the lower figure, since that could be justified
on technical grounds.

12/17/68

-58

As for the directive, Mr. Kimbrel said he favored
alternative C proposed by Mr. Robertson.

The market conditions

set out in the blue book in conjunction with the firming alter
native would seem appropriate with an increase of 1/4 point in
the discount rate accompanied by an early announcement of upward
adjustment of reserve requirements.

He would prefer to see any

rise in Regulation Q ceilings postponed for the time being.
Mr. Bopp remarked that the green book and the reports by
the staff gave ample evidence of the developing economic strength
and the consequent need for more restraint.

He would add only

that the staff at the Philadelphia Bank projected even greater
strength in the second quarter of 1969 than suggested by the green
book estimates.
Mr. Bopp said that after learning of the discount rate
action of other Reserve Banks on last Thursday evening (December 12),
he felt that this was an opportunity to test the Philadelphia Bank's
ability to respond promptly in considering a rate change, as was
envisioned in the report on the discount mechanism.

The occasion

was felt to be appropriate because the directors had been disposed
to move a week earlier and had refrained primarily because of the
absence of the Chairman and Deputy Chairman, who were here in
Washington.

The decision to call a special telephone meeting was

made Friday morning.

The meeting was held at 10:30 with seven

12/17/68

-59

directors available.

He recommended an increase of 1/2 percentage

point to give clear notice to the market of the Federal Reserve's
intention to restrain the growth of money and credit.

The directors

voted for the 1/2 point increase; but they would accept a 1/4
point increase if that was the maximum that the Board of Governors
was prepared to approve.
Mr.

Bopp added that if

the discount rate were raised,

it

would be important to follow up with a more restrictive open market
policy.

He would prefer to see a smaller increase in

bank credit

than the Board's staff projected on the basis of existing money
market conditions.

Inasmuch as the market probably had not fully

discounted an increase in the discount rate of 1/2 point, and
inasmuch as some seasonal factors would be providing pressure,

the

Desk might be able to let the market do some of the tightening on
its own.

In any case,

the correct course,

as he saw it,

was to

move gradually toward more restraint and not attempt to make up
for past increases in money and credit.
Mr. Bopp said he would favor adoption of alternative C
of the draft directives.

However,

he was not at all certain that

the money market conditions associated with the firming alternative
in

the blue book would accomplish the necessary reduction of growth

in the money and credit aggregates.
to slowing down growth in

The Desk should give priority

bank credit even if

that required tighter

conditions in the money market than those described in the blue book.

-60

12/17/68

Mr. Hickman commented that a pervasive and persistent
inflationary psychology was preventing the economy from achieving
a balanced and sustainable rate of growth.

Unexpected strength

in consumer outlays and capital spending indicated that the GNP
gain this quarter would be considerably above recent expectations.
Consumers were offsetting smaller gains in

income by reducing

personal savings and by taking on personal indebtedness at a
record rate.

The November rebound in retail sales coupled with

the sharp upgrading of capital spending plans over the near term
suggested stockpiling on the part of consumers and businessmen
as a hedge against further price inflation.
Mr.

Hickman said he agreed with the Board's staff that

economic activity should moderate somewhat during the next six
months, assuming of course that consumers responded as predicted
to smaller increases in disposable income.
gains in GNP were still

Nevertheless,

expected

too high to permit any measurable easing

of price pressures or significant improvement in the nation's
balance of trade.

In

short,

despite relatively low plant

utilization rates in manufacturing in general, the economy had
over-full employment and price inflation.

He added that the

situation had not been essentially different in its broad outlines
last summer,

when the Committee also had been faced with an economy

operating at forced draft with price inflation.

12/17/68

-61In that environment, Mr. Hickman saw no justification

for continuing the expansionary monetary policy that in practice
had been in effect since the fiscal package of last summer.

The

appropriate policy was to put the commercial banks under moderate
pressure, so as to keep them on the razor's edge of disintermediation.
In his opinion, the 91-day bill rate should be kept in the 5.75 to
6.00 per cent range, which would discourage further intermediation
and make it difficult for banks to recapture all the CD's that they
might have lost at mid-month.

He would not favor any further in

crease in Regulation Q ceilings at this time, and he would not favor
any other immediate dramatic action on the part of the Board of
Governors that might have the effect of shaking confidence in weak
currencies without slowing the growth of bank credit.

Since he

felt that growth in the bank credit proxy should not exceed
6 per cent, as a maximum, he was obviously not pleased with the
9 per cent growth rate (including Euro-dollars) projected by the
staff for December.

Accordingly, he would vote for alternative C

of the draft directives.

On the other hand, he would emphasize

that he wanted credit restraint, not a crunch.

Thus, he would be

disturbed if the rate of bank credit expansion fell much below
4 per cent and would therefore prefer a two-way proviso.

The board

of directors of the Cleveland Reserve Bank had acted last Friday
to increase the discount rate by 1/4 percentage point, and he
favored early approval of that action by the Board of Governors.

12/17/68

-62

Mr. Sherrill remarked that the information that had
become available since the previous meeting clearly indicated
the need for firming through open market operations and possibly
also through other instruments of monetary policy.
the firming actions taken should be visible.

He believed

However, because

he also thought they should be carefully controlled, he would
rely heavily on open market operations.

He favored alternative C

of the draft directives.
In addition, Mr. Sherrill said, he was inclined toward an
increase in the discount rate of 1/4 percentage point.

He would

not advocate any other action at present because he thought the
System had a more powerful means at hand for achieving the needed
effect on expectations.

Given continuation of the current

Regulation Q ceilings, firming actions of the type he favored
probably would trigger a sizable amount of disintermediation--if
not during the rest of December then in January when banks were
faced with large CD maturities.

As pressures increased, bankers

undoubtedly would begin to probe to discover the Board's attitude
concerning the Q ceilings; and if it became clear that the Board
was not disposed to raise the ceilings, their expectations would
change rapidly.
businessmen.

Bankers would in turn communicate their views to

That indirect approach seemed to him to offer a better

hope of changing businessmen's expectations than would the announce
ment effects of particular policy actions.

-63

12/17/68

Mr. Brimmer recalled that at the previous meeting of the
Committee he had indicated that information concerning the 1969
balance of payments program probably would be available to Committee
members by the time of today's meeting.

As of the moment, however,

the Administration still was not in a position to make an announce
ment, although it was hoped that the program could be made public
within a few days.

Because of the conflicting proposals for a

foreign credit restraint program for banks in 1969, there had been
agreement within the Government, including the Federal Reserve,
that for the present the 1968 program should be continued essen
tially unchanged, with only a few minor technical modifications.
The program would be reviewed in early 1969 and he would report
to the Committee at that time.
With respect to monetary policy, Mr. Brimmer thought that
determined, but not drastic, firming action was desirable.

He

believed the System could best serve its over-all objectives at
this time by making use of a combination of policy instruments.
In that connection, he had been impressed by the assessments given
this morning by Messrs. Holmes and Brill of the possible market
impact of various combinations of policy actions.

He was presently

inclined to favor a 1/4 percentage point increase in the discount
rate, but he wanted to hear the views of all the Committee members
before reaching a final position with respect to both the discount
rate and possible reserve requirement action.

-64-

12/17/68

Mr. Brimmer indicated that he favored alternative C of
the draft directives.

Since open market operations would have

to be modified to accommodate whatever additional policy actions
the Board might take, he would not attempt to specify any partic
ular configuration of target conditions in the money and short-term
credit markets.
Mr. Maisel remarked that the System seemed to be faced
with two main alternatives for policy at present.

One was to

attempt to curtail expansion in the monetary aggregates by
tightening through open market operations and making a technical
1/4 point increase in the discount rate.

The second was to seek

a significant effect on expectations by taking additional or
stronger actions, perhaps including a 1/2 point rise in the
discount rate, an increase in reserve requirements, or use of
moral suasion.
In his judgment, Mr. Maisel said, the System's record in
estimating the psychological effects of its policy moves was not
outstanding.

For example, it had been surprised by the effects

on expectations of its actions in 1966 and again this summer.
When faced with a situation in which the range of possible outcomes
was wide, one could act either as a gambler or a risk averter.
Personally, he thought it would be better in the present situation
for the System to act as a risk averter, and not gamble on achieving
some particular impact on expectations.

-65

12/17/68

Mr. Maisel said he would favor alternative C for the
directive, in the expectation that under such a directive the
Desk would steadily exert pressure on the market.

The proviso

clause was of particular importance now in view of the existing
uncertainties and especially in light of the fact that the System
would be supplying a very large volume of reserves in the next
five weeks to offset the effects of technical factors.

If re

serve demands should rise sharply he would hope that the Desk
would not fully satisfy them.

Rather, it should employ a grad

uated response under the proviso clause, letting the market
tighten itself rapidly as reserve demands increased.
Mr, Daane said that the proper course of action for the
System seemed clear; the only questions concerned the pace at
which the System was to move and the particular forms of its
actions.

Without prejudicing the positions he might take in

the Board's deliberations later today, he would note that he
agreed with those who favored persistent firming rather than
dramatic or abrupt action.

In his judgment the System had

overreacted in easing during the summer, and he hoped it would
not overreact in firming now.

That view had been reinforced by

Mr. MacLaury's comments on the precariousness of the British
situation, and by the observations of Messrs. Solomon and Hersey.
In brief, Mr. Daane remarked, he favored a step-by-step
approach, beginning with a 1/4 point increase in the discount

12/17/68

-66

rate and firming through open market operations.

Later, if

circumstances warranted, further actions could be takenperhaps an increase in reserve requirements effective in Janu
ary, another increase in the discount rate, or both.

It was his

personal judgment that by taking a dramatic combination of actions
now the System would risk much on the international side.

At the

same time, it would not gain appreciably in terms of its domestic
objectives; the latter would be better served by an orderly
sequence of actions over a period of time.

He favored alterna

tive C for the directive.
Mr. Mitchell commented that there seemed to be agreement
today on the need for tightening but a good deal of disagreement
on the appropriate means.

Personally, he thought the System's

actions should be definite and definitive; he was inclined toward
a 1/4 point rise in the discount rate, a small increase in reserve
requirements, and firming through open market operations.

In his

judgment such a combination of actions would not be "dramatic,"
but it would be noticeable.
Certainly, Mr. Mitchell continued, it would be desirable
to offset the easing of short-term interest rates which the blue
book said might develop in coming weeks in the absence of policy
action.

He inferred from Mr. Brill's remarks today that the

12/17/68

-67

combination of policy actions which he (Mr. Mitchell) favored
would not produce an unduly large amount of disintermediation
at banks.

In any case, the System had tools--open market opera

tions and Regulation Q ceilings--that could be brought to bear
if necessary for keeping the amount of disintermediation within
appropriate limits.
Mr. Mitchell remarked that Mr. Francis' objective of
slowing expansion of the money supply evidently was about to
be achieved; the staff projected money supply growth at an annual
rate in the range of 3 to 6 per cent in December and at a lower
rate in January even if policy remained unchanged.

He

(Mr. Mitchell) agreed that it was important to slow the growth
in the monetary aggregates, including bank credit, and he thought
that result would be assured by firming actions of the type he
had suggested.

There remained the question of whether the

pattern of interest rates that emerged would be appropriate to
the current situation, including that in the foreign exchange
markets.

None of those who had spoken about the latter problem

today had described the mechanism by which System policy actions
might produce a crisis for sterling, but it seemed to be agreed
that somewhat higher U.S. interest rates in themselves would
not endanger sterling.

12/17/68

-68

Mr. Mitchell said he was inclined to agree that the
domestic economic expansion would slow as a result of fiscal
restraint--if not in the first quarter, then in the second.
Moreover, the incoming Administration probably would be inclined
in the direction of economic restraint.

If the System was to

take action to deal with the existing inflationary psychology,
the present moment might offer almost the last chance.

In his

judgment that argued for a combination of definitive actions now,
rather than a series of measures spread out over time.
Mr. Mitchell indicated that he was prepared to vote for
alternative C for the directive.

However, he would prefer to

abbreviate the statement of the Committee's general policy stance
at the end of the first paragraph to emphasize the primary objec
tive of reducing inflationary pressures.

Specifically, he

suggested a statement to the effect that it was the Committee's
policy "to foster financial conditions conducive to the reduction
of inflationary pressures."

In the second paragraph he would

omit the word "somewhat" from the phrase "with a view to attaining
somewhat firmer conditions in money and short-term credit markets."
Mr. Heflin reported that Fifth District business exhibited
the same general trends and characteristics reflected in the latest
data on the national economy.

Recent information for the District

reflected a rather general exuberance, with only some sectors of

12/17/68

-69-

the textile industry reporting any slackening of activity.

He

continued to hear an increasing number of expressions of concern
over the persistence of inflationary pressures.
Mr. Heflin commented that the latest data on the national
economy were disturbing and pointed up what now appeared to be a
persistent tendency on the Committee's part to overestimate the
moderating effects of the surtax.

As he interpreted the recent

figures, the economy might well be experiencing a speedup rather
than a moderation.

He remained convinced that the fundamental

problem was the strong inflationary psychology that now seemed
to have permeated all business, consumer, and financial decisions.
The unexpectedly large increases in inventories suggested that much
of the current increase in expenditures was of an anticipatory
nature, and that seemed to be the case with consumers as well as
businesses.

Similarly, inflationary expectations appeared to have

taken much of the sting out of any restraining effects that high
and rising interest rates might be expected to exert.

Businessmen

could be counted on to recognize indebtedness as an excellent hedge
against inflation and he believed that that was a major factor in
the continuing large volume of credit demands.
Over the past several meetings, Mr. Heflin said, he had been
reluctant to support any overt tightening move largely out of a
concern over unsettled conditions in domestic and international
markets.

Moreover, he kept hoping that the expected deceleration

12/17/68

-70

in the business advance would materialize and allow the System to
avoid actions that risked serious disruption of credit markets.
The latest business statistics had dissipated those hopes and,
while he recognized that the tax burden would increase in the
first quarter, he was convinced that that would not be a sufficient
offset to the strong inflationary psychology the System was con
fronted with.

He thought that additional measures were necessary

and that the problem had assumed a degree of urgency that required
those measures to be taken sooner rather than later.
From the standpoint of the System's contribution to a
solution of that problem, Mr. Heflin thought the best thing that
could be done today was to put the business and financial community
on notice, as unequivocally as possible, that the System was deter
mined to slow down the recent excessive money and credit growth.
He believed that the best way to do that was through a 1/4
percentage point discount rate increase coupled with an increase
in reserve requirements, and he favored immediate announcement of
both moves.
As for open market policy, it seemed to Mr. Heflin of
prime importance to shape operations with a view to slowing the
rate of bank credit and money growth.

He believed that to be the

case regardless of what the System elected to do with the discount
rate.

Many sophisticated observers had come to regard credit and

12/17/68

-71

money growth as the principal indicators of the System's policy
posture and they probably would watch those indicators as a test
of the System's determination.

In the current situation, he

thought it was important that bank credit not be allowed to grow
any faster than 6 to 8 per cent per year.

A somewhat slower rate

might be desirable, although he would not want to see any absolute
decline--especially one associated with large-scale disintermediation
and demoralized markets.

He would favor a directive instructing

the Desk to seek somewhat firmer conditions than had prevailed last
week, with Federal funds trading at 6 per cent or above and member
bank borrowings moderately higher than in recent weeks.

He favored

alternative C of the draft directives.
Mr. Clay commented that accumulating evidence underscored
the inappropriateness of monetary policy in recent months.

It had

been geared to a pattern of economic activity that had not materi
alized.

On the contrary, it had resulted in excessive growth of

bank credit, which had increased the demands upon resources and
intensified price inflationary pressures.

Moreover, the course of

those developments, including the persistent upward movement of
costs and prices, had heightened the prevailing inflationary
expectations among both businessmen and consumers.
That pattern of developments, Mr. Clay felt, had to be
modified so as to reduce the demands upon the economy and to

12/17/68

-72

alleviate the excessive pressures upon resources and prices.

As

a part of that program, the strong inflationary expectations had
to be dispelled.

That could not be accomplished without slowing

down the rate of economic expansion.

Every reasonable effort

needed to be made to avoid a downturn in economic activity, but
it had to be admitted that such a risk existed.

In the effort to

avoid such a development over recent months, the policy pursued
had compounded the problem and increased the very risk that it
sought to avoid.

Continued failure to move policy to a restrictive

posture would involve an alternative risk of accelerating the cost
price inflation.
Mr. Clay said that omission of an action to increase the
discount rate by the Kansas City Reserve Bank last week was based
upon a view that the initial restrictive action should be taken by
open market operations.

An increase in the discount rate could be

justified in terms of interest rate alignment.

A change in the

discount rate also could be used to give a signal to the market.
The main need, however, was a shift to a slower rate of expansion
in member bank reserves and bank credit, and that could be better
accomplished by a change in open market operations.
that change also would affect interest rates.

Presumably,

It seemed a better

choice, however, than to begin with the interest rate repercussions
of a discount rate adjustment before a change in open market oper
ations was instituted.

Then the discount rate change could follow

12/17/68

-73

as a routine action.

As of now, that view seemed to be more

related to a discount rate increase of 1/2 than 1/4 of a percent
age point.

If the discount rate action did come at the outset

rather than later as suggested here, the Kansas City Bank could
be expected to fall in line at the next regular establishment
of its discount rate.
Mr. Clay noted that an increase in member bank reserve
requirements was another means by which reserve availability
and bank credit growth could be restrained.

If such action was

taken, the proposed open market operations change would need to
be modified accordingly.

There was room for concern about a delay

of implementation of reduced reserve availability until mid-January,
however, despite seasonal forces.
Mr. Clay said that alternative C was his choice for the
directive.
Mr. Scanlon said he would summarize the remarks he had
prepared on District economic conditions and national financial
developments, and submit the full text for the record.

He then

summarized the following statement:
The evidence of recent weeks strongly supports
the view that private spending has not been dampened
and, indeed, may be accelerating. In the Seventh
District we find an increasing acceptance of the
prospect of very large wage increases and further
price increases. Consumer buying, construction, and
business investments in inventories and plant and
equipment are all vigorous.

12/17/68

-74-

There is a strong presumption that the additional
momentum generated by the private economy in the second
half of 1968 is related to the highly expansionary
monetary policy as measured by growth in any of the
aggregates of liquid assets or credit. Inflationary
forces took time to reach their current strength, and
it would be difficult and undesirable--perhaps impossibleto deflate plans and expectations quickly. But a start
should be made.
Christmas sales of both hard and soft goods are
reported to be excellent, with many customers "trading
up" (buying more expensive merchandise). Sales of new
and used autos in recent weeks have been sufficiently
strong to cause manufacturers to project 1969 sales
almost as high as in 1968. Truck sales are expected to
at least equal 1968.
Some business firms report the supply of available
workers to be the poorest since World War II. They refer
not only to skilled workers, but to persons with suffi
cient aptitude to profit from in-plant training.
Information from District banks indicates that
credit demands are stronger than seasonal. Business
loans have risen much faster since early November than
in the comparable period of any recent year, reflecting
gains distributed over a wide range of industries.
Moreover, most of the banks participating in the new
loan commitment survey expect takedowns on outstanding
commitments to increase moderately in the current
quarter. Only one said commitment policies have become
more restrictive.
So far, however, the banks appear to have met
demands without a great deal of strain, and borrowing at
our window has been light. The large banks have continued
to acquire a substantial volume of funds in the Federal
funds, CD, and Euro-dollar markets. In addition, they
have reduced their holdings of U.S. Government securities
and have some room to make further adjustments here.
Growth in aggregate monetary and credit measures
so far this month again appears to be exceeding estimates
made at the last meeting and has continued much faster
than appropriate if we hope to achieve moderation in
activity and to reduce price pressures. Events of recent
weeks have brought into sharp focus the serious effects
of both past and expected price inflation on wage and
salary negotiations and the implications of large

-75

12/17/68

increases in labor costs on future price trends.
With almost no firm indications that the economy is
weakening, additional restraint is needed. Even
assuming some weakening will develop after the first
of the year, monetary expansion at current rates is
unnecessarily high.
The rise in market yields since the latest prime
rate adjustment may, of course, slow bank credit by
shutting off sources of CD money. To the extent that
higher rates are seasonal or reflect the reduction of
speculative positions in securities due to changed
expectations about rate trends, these effects may be
quite temporary. On the other hand, the way business
prospects look now, private credit demands plus State
and local government needs may continue to strain
resources into the early part of next year and cause
problems with Regulation Q ceilings.
Mr. Scanlon added that he thought the System should
increase monetary restraint through action that would clearly
convey its intent to fight inflation more vigorously.

An in

crease in the discount rate could serve that purpose.

More

important, the Committee should aim for a slower growth in
credit and money, permitting market rates to find their own
level within that framework; no more reserves should be provided
through the net effects of open market operations than would
yield a 3 per cent growth rate in total reserves.

Severe or

abrupt changes in market conditions should, of course, be
prevented.
Mr. Scanlon indicated that alternative C of the draft
directives was acceptable to him.

He would favor the more direct

and forceful language suggested by Mr. Mitchell, but only if such
language fully reflected the Committee's policy intentions.

12/17/68

-76

Mr. Scanlon noted that at their meeting last week the
directors of the Chicago Reserve Bank had debated at length
whether to propose a 1/4 or a 1/2 percentage point increase in
the discount rate.

They felt that a 1/2 point increase was

desirable from the standpoint of domestic economic considerations,
but they recognized that such an increase would place Q ceilings
under additional pressure.

They also had hesitations with

respect to the international effects of such a move.

Several

directors who were connected with businesses having substantial
investments in Great Britain observed that if it were true that
the pound parity would stand or fall depending on whether the
System raised the discount rate by 1/4 or 1/2 point, the chances
were that it would go to a floating rate in any event.

The

directors thought that the Federal Reserve should be concerned
about the international effects of its actions but that it should
not overdo such concern.

They felt that a 1/4 point increase not

accompanied by other firming actions might have to be followed by
another modest increase, partly because market participants had
already discounted a 1/4 point rise and some were expecting a
larger move.
On balance, Mr. Scanlon said, he would favor a 1/4 point
increase in the discount rate accompanied by the announcement of
a modest increase in reserve requirements.

He thought that if the

12/17/68

-77

reserve requirement change was not announced in conjunction
with the discount rate increase, there might be a perverse
effect on market expectations.

He agreed with Mr. Brill that

current Q ceilings were exerting pressure on banks.

As the

latter had implied, however, banks were in a more liquid
position to meet such pressure than one or two years ago.
Mr. Galusha remarked that his earlier confidence that
the pace of growth in real GNP would decrease significantly had
been shaken by recent developments.

While he had not entirely

given up hope for some moderation, he felt that increased
monetary restraint would be appropriate.

He favored a 1/4 point

increase in discount rates to 5-1/2 per cent, coupled with a
modest increase in reserve requirements.

He would urge, however,

that the Committee proceed cautiously, at least for a time.

The

Federal Reserve should signal its concern, but not by forcing
market interest rates appreciably higher.
A 1/4 point increase in discount rates had apparently
been largely discounted in the market, Mr. Galusha observed.

If

discount rates were increased, even modestly, short-term rates
might not decrease seasonally as much as they otherwise would.
But that would, he believed, be all to the good.

With even a

modest increase in reserve requirements, market rates could go
higher.

The Manager might, however, let the effects be felt

12/17/68

-78

only very gradually.

Signaling its concern, but without forcing

market rates sharply higher, should therefore be easy enough for
the System to manage.
There had already been a rather impressive increase in
market interest rates, Mr. Galusha continued.

If it were for him

alone to decide he would have the Manager maintain the current
three-month bill rate within a narrow range around 5.90 per cent.
He would have the Desk resist any pronounced tendency for that rate
to increase, just as he would have the Desk resist any pronounced
tendency for the rate to decrease, even seasonally.

There was

considerable risk, it seemed to him, in letting short-term market
rates go significantly higher, as well as significantly lower.
Banks were prepared--in some measure, anyway--for a run-off of
CD's.

But if short-term rates went much higher, the reaction

could be extreme.
Mr. Galusha said he had not yet been able to rid himself
of the feeling that consumers were going to respond to increased
income taxes in the first quarter of next year.

If they did,

businessmen could be badly embarrassed by all the additional
capacity they were hurrying to install.

Conceivably, the Committee

might be viewing the economy this morning from near the peak of
a boom.

He was not confident that such was the case, but he did

not dismiss the possibility as wildly remote.

-79-

12/17/68

Mr. Galusha added that the directors of the Minneapolis
Reserve Bank shared his uncertainty about the economic outlook.
That had been apparent at their last meeting, less than a week
ago, particularly in their discussion of the discount rate.

They

had voted to continue the present 5-1/4 per cent rate mainly
because they thought that a 1/4 point increase would not accomplish
any worthwhile objective unless accompanied by some other firming
action, and that a 1/2 point increase would be too large and
totally disruptive.
Mr. Galusha commented that the approach involving several
policy instruments discussed by Mr. Brill today had considerable
appeal, especially in the cautious use of each tool viewed
separately.

He agreed with Mr. Sherrill that the Regulation Q

ceilings represented the fixed jaw of the vise against which the
System had to exert its tightening action on banks and, through
them, on the business community.

The availability of funds, not

signals or rates, was the key consideration.

If businessmen could

obtain the funds, it would be very hard for them to postpone
programmed expenditures in the current inflationary environment.
Mr. Galusha concluded by noting that he favored alternative
C of the draft directives.

As he had indicated, he would want

the Manager to resist a decrease, even seasonal, in the bill rate.
He would not mind if, in consequence, the Federal funds rate
averaged somewhat more than 6 per cent.

-80-

12/17/68

Mr. Swan observed that he found himself in general
agreement with Mr. Galusha.

The continued strength in the

economy and the larger than desired growth in bank credit called
for tightening despite the possibility of a reversal of seasonal
pressures in the period ahead.

As had already been noted, the

question was not whether to firm but how much and by what means.
Mr. Swan noted that he favored alternative C for the
directive.

He thought there was much to be said for deleting

the word "somewhat" from the second paragraph, as Mr. Mitchell had
suggested.

Such a deletion would not necessarily imply targets

for money and short-term credit market conditions different from
the blue book specifications for the firming alternative, but it
would help clarify the Committee's intent to make a definite change
in policy.
At the same time, Mr. Swan said, he would favor a discount
rate increase of 1/4 rather than 1/2 of a point, despite the
possibility that the smaller increase had already been discounted
by the market.

In his judgment a 1/4 point increase was likely

to have some significant announcement effect if it were accompanied
by definite firming action through open market operations.

He

certainly thought that the Regulation Q ceilings should not be
raised at present.

He hoped that circumstances would not arise

in the near term that required an increase in the ceilings and

12/17/68

-81

that, if such an increase proved necessary, it would be made
reluctantly.
Mr. Swan added that a case could be made for a modest
increase in reserve requirements, if the System's move toward
firming needed additional support.

He would prefer to delay

such action, however, until there had been a chance to assess
the market's reaction to the discount rate change and the
firming through open market operations.

In his judgment there

would still be time, prior to the turn of the year, to announce
a reserve requirement increase with a mid-January effective date.
Mr. Coldwell said he would omit the remarks he had pre
pared on District and national economic conditions and turn
directly to policy.

His conclusion was the same as it had been

at the preceding meeting--namely, that firming was needed.
With respect to open market operations, he favored alternative C
for the directive, with the word "somewhat"

deleted as Mr. Mitchell

had suggested.
A 1/4 point increase in the discount rate would be
acceptable to him in the present circumstances, Mr. Coldwell
continued.

However, in his judgment the visibility of such action,

by itself, would be too low; he would much prefer the simultaneous
announcement of increases in both the discount rate and reserve
requirements.

While he recognized that the matter was the

12/17/68

-82

responsibility of the Board rather than the Committee, he
hoped that the reserve requirement increase would apply to time
and savings deposits and that it would be made effective before
the mid-January date that had been suggested.
The choice between time and demand deposits for the
increase in reserve requirements was an important one, Mr. Coldwell
remarked.

He thought the Committee had a smaller than desirable

degree of control over the rates of expansion in aggregate de
posits and bank credit because reserve requirements were so
much lower on time than on demand deposits; as a result of the
larger multiplier in the case of time deposits, a given rise in
reserves could support much more rapid growth of total deposits
when the expansion was primarily in time rather than in demand
deposits.

An increase in the requirements on time deposits would

lessen that problem.

Also, by making CD's less profitable to

banks, it was likely to encourage some disintermediation, which
he thought would be desirable at present.
Mr. Coldwell added that he favored making the reserve
requirement increase effective before mid-January partly to
obtain a more rapid reaction at all banks than could be hoped
for through tightening open market operations.

The impact of such

action could be moderated by the Desk's operations.

In any case,

open market operations could be shifted from the reserve-absorption

12/17/68

-83

side to the reserve-supplying side, which would help moderate
bill rate pressures.
Mr. Morris remarked that the monetary policy of the past
few months had been based on an expected pattern of economic
developments that had not been realized and that was not likely
to be realized in the months immediately ahead.

Since the System

had misjudged the strength of the economy, its policy had been
excessively expansionary.

He thought the System would have to

be alert this coming spring to make sure that it was not whipsawed
into an opposite sort of mistake.

However, he believed that at

this meeting the Committee had to recognize the current excessive
business strength by moving to a policy which would slow substan
tially the rate of growth of bank reserves and the money supply.
In the present context, Mr. Morris continued, the way in
which such a policy change was implemented was all-important.

It

should not be implemented abruptly or in a manner that would
generate a panic response from the market.

Ironically, although

the Federal Reserve had not placed any real pressure on the banking
system since early June, the recent alignment of short-term money
rates with CD ceiling rates had placed banks in a position in which
even a modest change in policy, abruptly applied, could produce
severe pressure on them.

It was important in that sort of situation

not to give the market the impression that the Federal Reserve was
over-reacting to a past mistake.

-84-

12/17/68

Mr. Morris believed that the proper strategy for imple
menting a more restrictive policy at present was to control the
post-Christmas decline in short-term money rates, keeping the
banks on the verge of massive disintermediation without pushing
them over the brink.

That, he believed, was essentially the

sort of policy described in alternative C for the directive, if
he understood it correctly.

Such a strategy would be best served,

he thought, by an increase of 1/4 point in the discount rate to
5-1/2 per cent plus an increase in reserve requirements, with both
actions announced simultaneously.

The reserve requirement in

crease appealed to him not only because of its constructive
announcement effect, but also because it offered an important
tool for use in slowing the growth in the money supply without
putting as much pressure on short-term money rates as would an
equivalent action in open market operations.
Mr. Morris thought there was clearly a need for an
announcement effect in the present situation, and he would be
concerned that the effect of a 1/4 point discount rate change
alone would be too feeble.

The need was for a slower rate of

monetary growth rather than higher interest rates, and he
believed that the market would interpret a reserve requirement
increase along those lines.
As he had indicated, Mr. Morris said, he favored alter
native C for the directive.

Both of the changes Mr. Mitchell

-85-

12/17/68

had suggested were acceptable to him.

Since he believed that a

precipitous policy change would be unwise, he thought it was very
important that the proviso clause be two-way and that the Manager
be prepared to implement it in either direction, depending on bank
credit developments.
Mr. Robertson made the following statement:
Obviously, we are at a critical decision point
for the System today. Since we last met, the stream
of economic statistics becoming available has looked
significantly stronger. More importantly, signs of
spreading inflationary expectations have multiplied.
It looks very much like inflationary fever is out
running real economic expansion, moving us into an
increasingly unstable situation. Furthermore, these
inflationary feelings have pervaded the financial
markets, adding to upward pressures on interest rates
and credit flows.
Time after time in recent months the System has
felt inhibited in how vigorously it could move against
these developing pressures. For a while it was the
expected onset of fiscal drag that gave us pause, but
now, with the benefit of hindsight, that appears to
be too little and too late to be adequately effective.
At one time or another, even keel financing consid
erations at home or tense international markets led
us to stay our hand. Most recently, the build-up
of late-year seasonal pressures on already hard-pressed
debt markets led us to proceed carefully.
Even so, we did pull the monetary reins tauter
from time to time during this interval--partly through
the workings of the proviso clause, whose firming
instructions to the Manager we usually confirmed at
succeeding Open Market Committee meetings. Reserve
availability was moderated somewhat, relative to what
it might otherwise have been, and the upward movement
of interest rates was thereby reinforced. By now,
with market rates so high as to be a serious challenge
to the attractiveness of time deposits at banks and
thrift institutions, we are beginning to impose a
powerful constraint on the further expansion of credit
by these institutions.

12/17/68

-86-

But all this may not be enough to deal with the
current intensity of inflationary attitudes. Perhaps
the Federal Reserve needs to take significant and overt
action to begin to calm down this ebullience. We are
comparatively free to move in that direction today.
To my mind, a quarter-point increase in the discount
rate is an essential part of such a move. But this also
may need to be buttressed by a moderate increase in re
serve requirements, applicable after the middle of
January. Such action would round out a package with an
unmistakable signal of indisputable strength that the
Fed was going to fight this wave of inflationary
sentiment. In my view, the only factor which raises
a question about the wisdom of these moves is their
potential international impact.
Insofar as open market policy is concerned, it
needs to be geared to the market conditions resulting
from either or both of these actions, depending upon
whatever decisions are made by the Board this after
noon. In other words, it should be designed to seek
substantially firmer reserve availability and related
money market conditions--about as suggested in the
blue book in connection with the firming alternative.
The language changes Mr. Mitchell has suggested in
directive alternative C would be all right with me,
but I would also be willing to vote for C in the form
I originally proposed. So long as disintermediation
does not run so rampant as to trigger the two-way
proviso clause on the downside, I think the Manager
ought to keep money markets significantly tighter,
thereby resisting any seasonal credit easing and
pressing down hard on bank credit growth.
This sort of a policy prescription seems to me to
be the right way for the System to challenge, responsibly
but firmly, the rising inflationary expectations around
us.
In reply to a question by Mr. Hickman, Mr. Robertson said
he favored an increase in reserve requirements on the grounds that
a 1/4 point increase in the discount rate, by itself, probably
would have an insufficient impact on market psychology.

He had

satisfied himself in his telephone conversations this morning that

-87-

12/17/68

a reserve requirement increase would not have seriously adverse
international implications.

He had also received some indications

this morning that some other central banks would be taking firming
action shortly, and to his mind that enhanced the importance of
System action.
Mr. Hayes said he thought this morning's discussion had
been an excellent one.

He found it hard to recall a meeting at

which the use of all of the instruments of monetary policy had
been considered in so thorough and integrated a fashion.

While

recognizing that responsibility for certain instruments lay with
the Board, he believed that today's go-around demonstrated the
desirability of using Committee meetings as a forum for such
wide-ranging discussions.

Particularly since the subject matter

of the debate had been so broad, it might be well for him to
stress the confidentiality of the Committee's deliberations.
Mr. Hayes then remarked that he would add a word on the
subject of possible international reactions to System policy
actions.

He did not think one could always assess probable

international developments on the basis of purely rational con
siderations; a case in point was the situation in which a
politically strong head of state made decisions that ran counter
to all economic logic.

In any event, it was well to keep in mind

that events in the international financial area often followed
unpredictable courses.

12/17/68

-88Mr. Hayes went on to say that Mr. MacLaury had talked by

phone with Mr. Coombs this morning about the possible implications
for sterling of action by the System to increase reserve require
ments.

In Mr. Coombs' view, there would be some advantage in

postponing the announcement of any reserve requirement increase
until the foreign exchange markets were in the doldrums charac
teristic of the Christmas holiday period.

On the other hand, his

main concern earlier had been to avoid a timing that might have
vitiated the favorable effects for sterling of the announcement
of good trade figures for November.

That was no longer a concern,

and the likelihood was small that there would be some other
favorable development in the near future that would suggest
postponement of the action.

In general, sterling remained on

the razor's edge, but the risks involved a great many factors in
addition to a change in U.S. reserve requirements.

He thought

that in the final analysis the System should act in the way best
calculated to strengthen the dollar.
As to open market policy, Mr. Hayes continued, it appeared
from the go-around that the Committee was unanimously in favor of
firming.

For the directive, the members seemed to prefer alternative

C, as proposed by Mr. Robertson, to the staff's alternative B.
Several members had spoken in favor of one or both of the two changes
Mr. Mitchell had suggested in alternative C.

He (Mr. Hayes) was

-89

12/17/68

sympathetic to Mr. Mitchell's proposal that the word "somewhat"
be deleted from the instruction in the second paragraph to seek
"somewhat

firmer conditions in money and short-term credit
He was advised by Mr. Holland that there was a good

markets."

rationale for that deletion, in that the money market conditions
associated with the firming alternative in the blue book involved
a more substantial change from prevailing conditions than often
had been the case in the past when the directive had called for
"somewhat firmer" conditions.
Mr.

Daane remarked that if

the word "somewhat"

were

deleted the directive would indicate more clearly than otherwise
that the Committee was making a definite change in its policy
stance.

On that basis, he would certainly favor the deletion.
Mr.

Hayes then proposed that the Committee vote on

alternative C for the directive, with the word "somewhat"

omitted

from the second paragraph.
By unanimous vote, the Federal
Reserve Bank of New York was authorized
and directed, until otherwise directed
by the Committee, to execute trans
actions in the System Account in
accordance with the following current
economic policy directive:
The information reviewed at this meeting suggests
that over-all economic activity is expanding rapidly
and that upward pressures on prices and costs are
persisting. Market interest rates have risen consid
erably further in recent weeks.
Bank credit growth
has been sustained by continuing strong expansion of

12/17/68

-90

time and savings deposits, while growth in the money
supply has accelerated and U.S. Government deposits
have declined. The U.S. foreign trade surplus remains
very small and the over-all balance of payments appar
ently worsened in October and November. In this
situation, it is the policy of the Federal Open Market
Committee to foster financial conditions conducive to
the reduction of inflationary pressures, with a view
to encouraging a more sustainable rate of economic
growth and attaining reasonable equilibrium in the
country's balance of payments.
To implement this policy, System open market
operations until the next meeting of the Committee
shall be conducted with a view to attaining firmer
conditions in money and short-term credit markets,
taking account of the effects of other possible
monetary policy action; provided, however, that
operations shall be modified if bank credit expan
sion appears to be deviating significantly from
current projections.
It was agreed that the next meeting of the Committee
would be held on Tuesday, January 14, 1969, at 9:30 a.m.
At this point, all members of the staff withdrew from
the meeting except Messrs. Holmes, Holland, Hackley, Kenyon,
Brill, Axilrod, and Broida; and Mr. Harris, Coordinator of
Defense Planning, Board of Governors, entered the room.
Mr. Holmes reported to the Committee with respect to the
Government's investigation of the leak of information on the
Treasury refunding of August 1967, and he responded to questions.
Thereupon the meeting adjourned.

Secretary

ATTACHMENT A
December 16, 1968
Drafts of Current Economic Policy Directive for Consideration by the
Federal Open Market Committee at its meeting on December 17, 1968
ALTERNATIVE A
The information reviewed at this meeting suggests that over
all economic activity is expanding rapidly and that upward pressures
on prices and costs are persisting. Market interest rates have risen
considerably further in recent weeks. Bank credit growth has been
sustained by continuing strong expansion of time and savings deposits,
while growth in the money supply has accelerated and U.S. Government
deposits have declined. The U.S. foreign trade surplus remains very
small and the over-all balance of payments apparently worsened in
October and November. In this situation, it is the policy of the
Federal Open Market Committee to foster financial conditions conducive
to sustainable economic growth, continued resistance to inflationary
pressures, and attainment of reasonable equilibrium in the country's
balance of payments.
To implement this policy, System open market operations until
the next meeting of the Committee shall be conducted with a view to
maintaining about the prevailing conditions in money and short-term
credit markets; provided, however, that operations shall be modified
if bank credit expansion appears to be exceeding current projections.
ALTERNATIVE B
The information reviewed at this meeting suggests that over
all economic activity is expanding rapidly and that upward pressures
on prices and costs are persisting. Market interest rates have risen
considerably further in recent weeks. Bank credit growth has been
sustained by continuing strong expansion of time and savings deposits,
while growth in the money supply has accelerated and U.S. Government
deposits have declined. The U.S. foreign trade surplus remains very
small and the over-all balance of payments apparently worsened in
October and November. In this situation, it is the policy of the
Federal Open Market Committee to foster financial conditions con
ducive to the reduction of inflationary pressures, with a view to
encouraging sustainable economic growth and attaining reasonable
equilibrium in the country's balance of payments.
To implement this policy, System open market operations until
the next meeting of the Committee shall be conducted with a view to
attaining somewhat firmer conditions in money and short-term credit
markets; provided, however, that operations shall be modified if bank
credit expansion.appears to be deviating significantly from current
projections.

ATTACHMENT

Projected Change in GNP *
With Alternative Rates of Change in Money Stock
Annual Rates of Change from Previous Quarter

Quarter

Assumed Rates of Change In Money Stock

2%
8.3%

8.3%

8.3%

7.0
7.1

3.6

5.6

3.6

8.3%

6%

5.7

IV **

4%

6.3

1968

6.1

1969

* Assumed alternative rates of change in money from IV quarter
1968 to IV quarter 1969. Government spending is assumed to rise
at a 5 per cent annual rate.
**

Board Staff's estimate in green book, December 11, 1968.