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APPENDIX PETER D. STERNLIGHT NOTES FOR FOMC MEETING DECEMBER 20-21, 1982 Desk operations since the last meeting were undertaken against a background of fairly close-to-path performance for the broad monetary aggregates that have been the main focus of policy. The narrow money supply continued to grow strongly, and this was essentially accommodated by Desk operations, in line with Committee instructions. Punctuated by two cuts of 1/2 percentage point in the discount rate, most short-term interest rates declined somewhat, in most cases by about 1/2 percentage point. Most longer-term rates, in contrast, were unchanged to slightly higher over the interval as the market faced heavy current and prospective supplies and some market participants expressed concern about the implications of recent developments for future inflation. Early in the period, when estimates of M2 growth were slightly ahead of path and generating reserve demands also a little above path, the Desk was aiming for nonborrowed reserve levels consistent with borrowing in the $300 million area, compared to the initial assumption of $250 million. Later, as M2 was seen to be just about on or even a little below path, the intended borrowing gap narrowed, to around $230 million in the latter weeks of the interval. Actual borrowing levels occasionally exceeded intentions by a fair margin, however, reflecting some overestimates of reserve availability, and underestimates of demand for excess reserves. -2The Federal funds rate, which had run quite close to the 9 1/2 per cent discount rate from mid-October through mid-November, moved down just about coincidentally with the November 19 posting of a 9 per cent discount rate to vary just slightly below that new discount rate level. The weekly averages were in a range of about 8.70 to 8.90 per cent. The further reduction in the discount rate to 8 1/2 per cent announced last Monday, December 13, was not accompanied quite so soon by a decline in the funds rate, probably because of lingering effects of reserve scarcities carried over from last Wednesday when a shortfall in reserve availability and unexpectedly high demand for excess reserves caused a large bulge in borrowing. These effects seemed to be abating by last Friday afternoon and today, as funds settled in to trade at 8 1/2 - 5/8 percent, The meeting of seasonal reserve needs, especially currency outflows, and the accommodation of strong M1 growth, called for large reserve injections in the recent period. The System's outright holdings of bills were increased by about $2.7 billion including $1.1 billion bought from the market and $1.6 billion from foreign accounts. This nearly used up the $3 billion lee- way for intermeeting changes in outright holdings. The System also took delivery of $900 million of coupon issues, bought the day of the last meeting, which counted against the temporarily enlarged leeway of the previous period. agreements, either for the System or customers, Repurchase were used on a number of occasions to augment reserves temporarily, while matched sales were employed once in the market as well as each day with foreign customer accounts. Seasonal forces will reverse ground soon after the turn of the year, releasing a large volume of reserves that we will want to absorb. Interest rates registered mixed changes over the intermeeting period, ranging from moderate declines at the short end--not fully matching the 1 per cent decrease in the discount rate--to small increases for some longer term issues. Aided by a lower Federal funds rate and some decline in day- to-day financing costs, bill rates were down roughly 50 basis points over the period. Today, 3 and 6-month issues were auctioned at around 7.85 and 8.10 per cent, respectively compared with 8.45 and 8.54 per cent just before the last meeting. It may be noted, though, that the mid-November bill rates were about a half percentage point or so higher than The Treasury continued to borrow heavily in mid-October. in the bill market since the last meeting, raising about $15 billion in that sector. Other short rates such as those on commerical bank CDs came down, net, about as much as bills. paper and Supplies of private paper were more limited than bills, with some periods of actual shrinkage in commercial paper and CDs. Major commer- cial bank prime rates were reduced just 1/2 percentage point, early in the interval to 11 1/2 per cent, Bank payments of temporarily above-market rates on new money market accounts may be a factor tending to hold up the prime rate for the time being. There was a different story in the longer-term market, where rates were little changed or even slightly higher on balance over the period. The continued evidence of a weak economy provided support to the market, but present and prospective supplies of new issues were huge, and there was some concern that official encouragement of lower rates and complacency regarding strong money growth might be overdone. Including issues still to be paid for, the Treasury raised about $13 billion through coupon offerings during the period: adding the 7 and 20-year issues to be sold tomorrow and Wed- nesday, that figure would be over $20 billion. Not long ago, that would have been a year's worth of additions to the coupon market. For Treasury issues in the 3-10 year range, most yields were about unchanged to down 20 basis points over the period. For issues over 10 years, most yields were up 20 to 30 basis points. Corporate yields moved a little higher over the period while the volume tapered off from the exceptionally high October level. In the tax-exempt market, yields also worked higher for long-term issues while a record volume came to market in November. December volume has abated somewhat, but is still relatively high for the month as issuers have sought to come to market before the turn of the year. Legislation now on the books would rule out issuance of bearer securities after year-end, although a last minute effort is being made to delay the deadline. -5Reference was made earlier to the likelihood of having to undertake large reserve absorptions in the next several weeks. On present projections, $3 and $4 billion. the amount could run between In light of this, I recommend that the Committee temporarily enlarge to $4 billion the standard lee- way in the authorization for domestic open market operations. James L. Kichline December 20, 1982 FOMC BRIEFING Since the last meeting of the Committee signs of weak- ness in aggregate economic activity have persisted. now forecasting a decline in percent at an annual rate. real GNP this the available sense quarter of information on than a month or two ago the economy that the Obviously, hand. appointed in judgment earlier making a similar this forecast may Indeed, the economy remains quite sustained upturn is not yet gives recession recovery is near at that 1 to 2 have firmed a bit. close and could conceive staff is But the drop reflects a resumption of inventory liquidation, as final demands all, The a Over- greater is drawing to a we have been this year and disone still be premature. sick and the basis for assured given the mixed a developments to date. The labor market surveys for November sizable cutback in nonfarm employment -average monthly in durable industries, goods where 10.8 percent. manufacturing, orders have edged down 100,000 from the and a rise in the losses were concentrated such as machinery been weak and Initial claims for unemployment first week of December at Job another about the same as declines earlier this year -- unemployment rate to indicate and metals inventories high. insurance were still high in the around 600,000 per week, but they have the peak rates in late September and - early October. production 2 - The information available curtailments of permanent job also points to a on plant closings slackening 0.4 percent decline in the index was half preceding two months. to expand, tions in output. ments, including Output of success while most other major an upturn in oil and sectors gas well is on the rise showed reduc- stocks Auto sales in November more than 2 percent year. drilling following In addition, this associated with the industry's through a combination of earlier cutbacks in production and sales unit that in each of the However, there were a few encouraging develop- in reducing excess month. in November, the defense and space equipment con- the steep declines through much of this month auto output the pace losses and temporary layoffs. While industrial production fell again tinued in and incentive programs. in fact accounted for much of increase in total retail sales during that Auto sales early in December slipped below a 6 million which was not unexpected rate, weaker sales sales other following strong sales given the usual pattern incentive programs. than autos and nonconsumer items rose nominal terms in November, not an especially of Retail percent in strong performance. Reports on sales in December, from the Redbook, the press, and directly generally from major only fair tional the in retail the first activity. chains, half In the rise in sales similar suggest of December amidst staff sales aggressive forecast we have assumed a to November and were promosmall the reports to date appear consistent with tern of 3 that assumption. - We also have assumed that pat- sales will persist early in on income 1983, reflecting constraints growth. In the housing sector, firmly established. the recovery in activity is Housing starts in November rose one-fourth to over a 1.4 million unit rate with both single and multifamily units contributing to the rise; permits also rose but by much less than starts. expected, and weather. jected perhaps were affected by In any event, support contrast, business quarter seems likely for capital goods first half seems roughly of further, The but in contrast have not been inclined to make year. quantitative and incoming evidence, the in however, last meeting to other recent projections, we further appreciable downward revi- spending, the other major sectors currently exhibiting a drag on activity -- is a Shipments and the forecast. Along with capital exports this smaller, declines line with our expectations at the Committee and, sions to investment spending remain weak, and other of next year. in fixed is pro- to activity overall. to show another sizable drop. qualitative evidence points to the the unseasonably good the housing sector on average to continue providing In orders The November starts figures were higher than -- also seem reasonable basis inventories and to be going through the worst now and there for expecting smaller declines early next Together with some growth of consumer spending and further - expansion real in housing growth next activity, 4 - this should lead to a return of quarter. Both wages and prices have been behaving about as expected and changed. that portion of The wage the hourly earnings sector in index this little under 6 percent, 2 the staff forecast is particular year looks quite good, likely to show a rise percentage points Moreover, we are expecting productivity to cent ment high, On the price this year, owing to percent -- less than half the although temporary the latest factors in environment of a large degree of of a 2 perthe rate of a year a substantial improve- monthly figures were measured prices. forecast contains further reductions in kets. expand around there also has been side with less than in 1981. this year and unit labor costs in 1982 should be in neighborhood of 4-4 ago. little slack energy a bit inflation next year in labor and product The in an mar- NOTES FOR FOMC MEETING December 20, 1982 Sam Y. The dollar has reversed Cross course in recent weeks and entered what many think might be an extended declining trend. early November the dollar had traded at in December it was dollar moved 2.60 in terms back down close to 2.40; from a high of about in terms 2.79 to a major factor in the market's reappraisal has been a officials pointing to a sharp deterioration in the U.S. Whereas, felt that weak U.S. trade balance, in the U.S. of yen, the 2.42. A series of foreign officials trade and as well) currency previously, most market participants had economic activity would limit the worsening in analysts are now looking for a move into deep current account competitiveness (and by some of German marks, low of about projections by U.S. accounts next year. Thus, while in principally associated with and even without much pick-up in U.S. our deficit eroding price domestic demand and output. Expectations of lower U.S. role in the market's thinking. cut in the discount rate the in our the German mark. of record the authorities were Still, triggered where it dropped Many in interest rates would not be projections rates have also As you know, the most recent on December 13 dollar in the exchanges against interest 1-3/4 percent overnight the market felt that uncertainty about a rapid fall thereby pushing nominal exchange rates. the future. lead (and real) and cushioning the dollar's decline. the Federal encourage domestic a rapid decline facilitated--and official comfortable with a drop in dollar Reserve to tighten up, feels surprise a sharp sell-off of of thought maintains that inflationary concerns will school a U.S. trade deficits would not be made--unless there is considerable interest rates higher played One school the Federal U.S. Another Reserve can go considerably farther to recovery and would in the dollar. in any event not move to counter Meanwhile, European officials, prospect in U.S. of continued recession interest rates, rates were reduced on December EMS 2. centers lending abroad official In other centers the authorities reduction exchange rate from lowering interest This has been the case in the United Kingdom and in the weaker currency countries such as France the EMS joint float have heated European currencies have had that large rates, up a and Italy. great deal In fact, tensions in recently. question whether existing parities will heavy before Pressure continue adjustment programs, to be defended particularly optimism has developed in bridging finance by central growing resolve of countries economic difficulties One exchange on the French franc was that international debt problems are being better market. seeing last weekend's meeting of EMS Finance Ministers. Tentative and cautious and the rise of dollar, and market participants, intervention has been needed to maintain the for long at that cost. Weaker difficulty keeping pace with the the mark against the declining their about the 1983, have welcomed the and in several pressures have constrained rates. in deeply concerned have all like Brazil the market dealt with. IMF and private bankers, and Mexico to address provided some reassurance result has been a lessening to the of the demand for dollar liquidity which previously had been an important source of the dollar's strength in the exchanges. Recently the dollar's decline has been cushioned corporate demand, by good in part related to year-end payment needs, and by professional short-covering in relatively thin end-of-year markets. In fact, the degree of support for the dollar that emerged lower levels was participants sufficiently impressive as to scale back their to prompt earlier estimates at the some of how rapidly dollar exchange rates would ease in the near term. Since the last meeting of the Committee, the Bank of Mexico was granted facility, drawings of $190 million on the combined U.S. BIS leaving $560 million still available as of close credit of business Also, the Mexican authorities were granted yesterday. renewals of two earlier drawings totalling $117.2 addition, it was announced that billion of short-term financing Mr. under the extended of the $1.85 facility to Mexico--will recommend This will Line in continuous use since Institution 9/7/82 Bank swap arrangement-- billion combined U.S.- represent the first renewal Amount ($ millions) of Mexico BIS credit 17, 1983. for three of the drawings: Current Term Maturity I Requires Amendment May be made Public 35.0 1st R. 1/7/83 3 mos. N/A Bank of Mexico 24.0 1/18/83 3 mos. N/A Bank of Mexico 35.0 1st R. 1/25/83 3 mos. N/A Bank of Mexico 17.5 1st R. 1/26/83 3 mos. N/A Bank of Mexico 35.0 1st R. 1/27/83 3 mos. N/A Bank of Mexico 1st R. 2/17/83 3 mos N/A In addition, the Reserve swap with February 4, 1983. part on the due date, is substantial. 14.0 1st R. $160.5 $700 million swap the Banco but the amount repaid Mexican situation is likelihood of a need regular at the time. in whole or in still very to request a I would propose that we be extension if needed, drawing under the de Mexico will fall due on We hope to have this uncertain, and the further totalling $160.5 million, mature between now and February Total Federal provided $1.23 that these drawings, listed below, be extended more months. In to Brazil. million Federal Reserve special as part million. the U.S. Treasury has Chairman, six swap drawings, $325 three-month further extension prepared to provide a
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