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APPENDIX f o r FOMC' H e e t i n g Februsry 6, 1979 S c o t t E. P a r d e e Xctes I i months o f L e a d s and l a g s w e r e a m a j o r a d v e r s e f a c t o r . 1.978. In effect, a i r n o s t e v e r y o c e w h o v a s ~ o i n gt o s e l l d o i l z r s i n ezr!~y 1 9 7 9 had s o i d them i n ].ate ir: t h e f i r s c w e e k s o f stabilized of 1978. T h u s dollar r a t e s J 2 c u i r v oore on n e w s e l l i n g p r e s s u r e t h a n iis a r r s u ! : T r k i n f advanta:. on Janusr? 0- of t h e lack of buyirig. the o'c.lla+'s b e t t e r 18 t h e B u z d e s b a n k t c o k s t e p s c s a b s o r b cone., SCEE of t h e e x c e s s l i q u i d i t y i n t h e G e r n a n b ~ n k i n gs y s t e ~ h r o u g h t 2 ti$hten<rg r e s e r v e r e q u i r e m e n t s an.$ pi hfke i n the a T h e S v i s s 2 n d .Ii?p,ai:c;~e a u t ; : o r i t i e s Lo~bs1-2 a t e , r 2150 r e l a x e i s o m e sf t h e = o r e c n e r c 3 s b i r r i e r s t o i z f l s x s o f f u n d s v k i c h rkej- had impose6 l e s t y e s r . p s i i c y s t e p I n p e r t i c u l a r gave u s a l : 2 c t l i z z ' s resiliency i n : k c in;r2ss $ : i c e r f su:h 2 T 5 e C ? r m a n cl;.cttar:; but z c t i ~ n% G ? Z E tliz '3 ; the marker. T h e n e ~ rt ; ~ r d ; e i c r t h e m a r k e t pres;<enr!s sit:: ?care, rez:. 5 T 6 t C cf foilow-up L r i o n adciress and budget pre t e s t i m o n y b y senior c i f i c i a l s , Z h 2 i r x s . r ; E : i l l e r ,:a n;srket reinained S e c r e t a r y Bl.um2nthal. monetary p o l i c y . a receptive mood including A t first, tke s k e p t i c a l n h o c t t h e ~ . e s s a r ec o r n i n g o u t o f 01 austerity i n : I s c a l h'ashiiigton Moreover, !?c tiis xes p o l i c y arid r c s i r s l . n L j a B u t r e p o r r s t h a t Congress was p e r h a p s i n added t o t h e c r e d i b i l i t y of io many m a r k e t t h a t rressige. participants h e r e 2 n d zbroad t h e f a c t t h a t t h e F e j e r a l f u n d s r a t e remained s t e a d y even after s o m e w e e k s o f weak ~ o n e t a r ya g g r e g a t e s w a s see^ as tangible 3 e v i d e n c e of the det-rmination of t h e Z1.S. authcrities to d e a l w i t h t h e i n f l a t i o n and d c l l a r p r o b l e m s . A t t h e 6.ime t i m e , the prolonged p o l i t i c a l u p l i f ; > \ : a l i n I r a n !:ch*,an t c i - ; ; i s e s e r i o u s e c c n o r n i c q u e s ~ i c . r ! c , stemming f r o m t h e h z l t of on o n e h a n d , t h e cil. e x p o r t s from t h a t c o u n t r y t h e p c t e n t i ~ lc a n c e l l a t i o n o f and (Lintracts by t h e i r a n i a n government and the other. ho.2 Mcreover, Ire? 3 2 s :c came t o t h e -:eeting, dangerous cr n t 1 v , 2 shif:s of 3ece~ber T r z n i a a ~ i f x 2 t i ~ w?s ~ o t e n t i s l l ym C r e i : J a ~ a r2 n d l i ~ s t e r aE u r o p e ,-o 3 s e q u ~ , r r 2 : - ;.. i.v T h e rn.r::er ~ u y y i - ~ l t lls. bi G o \ - e r n a r h n e e s u ~ a e s t e 2 I n :he i s 1 t h a t r5e t3 I r a n i a n f i r m s on t h e r e w a s t h e i ~ m e d i a t ep r o b l e ~o f 7sy i t s vie^:, m a i o r import 1r 2 n i I e -e 1 r. , - tFE , funds i n t o "iinrs. rhac the 2.S. e r . t j.;? par:, Ji: 13 rhis SOTE iarse as s t t r i b u t e d 2'3j!jn w h o h a 3 z l r e a d p s c l d t c c - s p o r t e r c ; i: : ::er:s;c)- 2nd d o l l a r s icrward against :heir 0%-n c u r r e n c i e s a n d n3w r e v e r s e d t h e : c s e i v e s c n ?.he p o s s i b i l i t y t k a t t h e y w o u l d n c , t b e r e c e i v i n g dollars after who s a v t h z all. In part, Iranian i t w a s b y some p o r t f o l i o m s n s g e r s , situ;tir;n as being a major u n c e r t a i c r y f o r those c u r r e n c i e s fcr s e v e r a l mo3ths i f r u s n lias n o t a l l i r r s d o l l z r s ; commodity p r i c e s /is t o ti? have. b e e n the gold rate differential month Eu:--dollnr !~onger. T. ~r,e ?rice ane o t h e r scrony,. t h e ? ~ a l s i ~ c p - exci:afigil ci i n f a y o r of not r k e do1li.r ii-. !a:€ siiddenly began t3 n,zrk.et f o r c c s b e g a n January bite, tho ixterest vjth the three- r a t e i i i o ~ e t l i n r , 6 p e r c ~ n rn b o v e t h s t for 4 i!uru-isarlis, p?cri.t';i: ~ 1 1 3 1 1ij UII'TF o v e r tile ra:c and 10 percenr over three-months !;uro-yel;, ir;r f o r Euro-Swiss francs. The m o v ~ n e n t i n t o d o l l a r s o n t h e l a s t d a y s o f J s n o a r y and t h e f i r s t d a y s o f t a c t i a l v o l u m e arid w o u l d F e b r u a r y was i n v e r y s u b s - have l e d tc a sharp r a l l y f c r t h e d o l l a r except Eor t h e massive i n i e r r e n t i o n of banks. L e s t week, we and t h e Cerman, of c e n t r a l banks s o l d a t o L J 1 T h i s w a s p a r t l y tc a v o i d Swiss, c o n i i t i o n s o r t h e upside f o r t h e d o i l s r us y e s t c r d s y and of The r ' o i i a r t o repay sxap debt. Ir: a l l , today. S5.i b i l l i i . n , ~~2 cleared I.El!.iiPz L . j _ i ' have r e p i f d partici~~::n:s CF znd 7 t c t e l of B tt:e t h e %a:&: Japanese deb: however, t l i i t ;-!1at p e r c e p t i o n sf r i s k o n t h e p a r t 7:1t ;I c)i~~:,i. n i :nr mnrkrt's PEC h.zs b e e n w e saw l a s t r;eek of expectations about t h e n e a r - t e r ~ i io u t l o o k f o r market rv~luntion ~ . i ~ p ~ ~ ~ . : c ; 5 ne n t : . t!ie forecast rather jEst peak $1.5 > i l l i o z . d e f i c i t i s sti.11 a It's ~ t ~ e1 a b l e o n ~ n j l l i ~ ,i:o ~ S.3.?> k , 5 l l j c ~ : . ~ ~ : ~ ~ ; J ~ i ; > e n i i ~ S sg ! i i l i : ~ n : l l . the U.S. 2 ' ; ~;'ist s;rcjs, was a s h i f t o f disertrrly iron t h e earl:> 2tnua.r: a x a y c o ~ ; p i e t e I p :a n d h.- ( - 1 -! Lhe C13rket. s e t z l s d b a c k somewhat T t i S w i s s f r a r i c d e b t h a s beer? h a I v e 2 , d.5: and Japanese $1.8 b i l l i o n i n t o o u t b r e a k of :he cextral U.S. t h a n an a c t u a l i t y . inflation rrale And i.n are 2 s gloomy i n t h e exchange market a s b e t o r e . that concerns f o r very quickly. 2 the market's whiie, a t t e n t i o n was d i v e r t e d and b e a r i s h p s y c h o l o g y to other could resurface F.O.M.C. MEETING FEBRUARY 6, 1979 R E P O R T OF OPEN MARKET O P E R A T I O N S - Reporting on open market operations, Mr. Sternliqht made the following statement: During the seven weeks since the December 19 Conunittee meeting, the Account Management has aimed for conditions of reserve availability consistent with Federal funds trading at or slightly above 10 percent. This represented a slightly firmer stance than was sought just prior to the December meeting. Despite a progress- ive weakening in estimated growth of the aggregates, the System's funds rate objective was maintained--in response to supplementary instructions from the Committee. Thus in late December, when the aggregates, taken together, were estimated to be slightly to the soft side of the specified ranges, the Desk was directed to hold its objective steady pending a further review at the Committee.'s telephone conference call on January 12. At that time, growth was estimated to be even a bit weaker but after reviewing broader factors such as the state of the economy, price behavior and the international position of the dollar, the Committee left the objective unchanged. Significant further weakening for M1 and M 2 in the two months ending in January showed up in the data becoming available late last week, but with today's meeting so close, the Account Management continued its approach unchanqed. As it worked out, the funds rate was in fact at or slightly above 10 percent on most days. The exceptions were several days a r o u n d year-end when t h e combination of l a r g e d o l l a r flows and c a u t i o u s bank r e s e r v e management produced u n u s u a l demands f o r excess r e s e r v e s which t h e D e s k could n o t f u l l y meet, l e a v i n q t h e f u n d s r a t e h i g h e r t h a n d e s i r e d , and a few Wednesday a f t e r n o o n o c c a s i o n s of u n d e s i r e d ease o r t i g h t n e s s . The a v e r a g e r a t e o v e r t h e whole p e r i o d was a b o u t 1 0 . 1 5 p e r c e n t . D i s c o u n t window b o r r o w i n g a v e r a g e d a l i t t l e o v e r $1 b i l l i o n f o r t h e period--up s e v e r a l hundred m i l l i o n from t h e p r e v i o u s i n t e r m e e t i n g p e r i o d . To a c h i e v e r e s e r v e o b j e c t i v e s , t h e System Account was a v e r y s u b s t a n t i a l o u t r i g h t seller o f s e c u r i t i e s over t h e p a s t seven weeks--to a n e x t e n t t h a t r e q u i r e d two i n c r e a s e s i n t h e leeway t o c h a n g e o u t r i g h t System h o l d i n g s between Committee m e e t i n g s . Sales were n e a r l y c o n t i n u o u s t h r o u g h t h e p e r i o d , e x c e p t f o r t h e s e v e r a l days o f t i g h t n e s s around year-end, and a g a i n y e s t e r d a y , when t h e Desk p r o v i d e d t e m p o r a r y reserves t h r o u g h r e p u r c h a s e agreements. T o t a l s a l e s and redemptions came t o n e a r l y $5.7 b i l l i o n . c l u d e d s a l e s of a b o u t $1.6 This in- b i l l i o n of b i l l s and $360 m i l l i o n o f a g e n c y i s s u e s i n t h e m a r k e t , a b o u t $2,750 m i l l i o n of b i l l s s o l d t o f o r e i g n a c c o u n t s , and $ 9 0 0 m i l l i o n of b i l l s redeemed a t m a t u r i t y . The f i r s t of t h e l a r g e s a l e s of b i l l s i n t h e m a r k e t caused some t e m p o r a r y u n c e r t a i n t y among t h e l e g i o n s o f Fed w a t c h e r s , l a r g e l y because of t h e i n f r e q u e n c y of such s a l e s , b u t t h e second s a l e of b i l l s and t h e s a l e of a g e n c i e s w e n t off w i t h b a r e l y a r i p p l e . I S e v e r a l f a c t o r s combined t o produce t h e abundance o f r e s e r v e s , i n c l u d i n g d e c l i n e s i n Treasury b a l a n c e s , h i g h f l o a t , s e a s o n a l r e t u r n flows of c u r r e n c y a f t e r t h e year-end, and l a t e r i n t h e p e r i o d r e d u c t i o n s i n r e q u i r e d r e s e r v e s and warehousing o f f o r e i g n c u r r e n c y f o r t h e Treasury. Reserves a r e expected t o be a b u n d a n t through t h e n e x t s t a t e m e n t week, b u t a f t e r t h a t we e x p e c t t o s u p p l y reserves f o r some weeks. R i g h t now i t a p p e a r s t h a t a r e t u r n t o t h e u s u a l $ 3 b i l l i o n o f leeway t o change o u t r i g h t h o l d i n g s between Committee meetings--down level--should from t h e temporary $ 6 b i l l i o n provide s u f f i c i e n t operational flexibility. A t some t i m e though, t h e Committee may wish t o c o n s i d e r e n l a r g i n g t h e normal leeway l i m i t a t i o n g i v e n t h e p r o s p e c t o f l o n g e r i n t e r v a l s between Committee m e e t i n g s and t h e growth i n t h e s i z e o f f a c t o r s affecting reserves. D e s p i t e t h e s t e a d y F e d e r a l f u n d s r a t e , most market i n t e r e s t r a t e s d e c l i n e d during t h e period s i n c e t h e l a s t meeting, especially i n t h e l a t t e r p a r t of t h e i n t e r v a l . A t f i r s t , yields on a number of i n s t r u m e n t s moved h i g h e r , p a r t l y i n r e a c t i o n t o t h e System's s l i g h t f i r m i n g a t t h e December m e e t i n g , a s w e l l a s t o i n d i c a t i o n s o f s t r e n g t h i n t h e economy and p e r s i s t e n c e of i n f l a t i o n . A f t e r a b o u t mid-January t h e t r e n d i n r a t e s w a s downward a s t h e m a r k e t became more i m p r e s s e d w i t h t h e l a c k of growth i n t h e a g g r e g a t e s , t h e improvement i n t h e d o l l a r o v e r s e a s , and t h e prospect of more moderate c r e d i t demands from t h e T r e a s u r y and o t h e r borrowers t h a n had been a n t i c i p a t e d e a r l i e r . Most Treasury issues m a t u r i n g i n 1 t o 5 y e a r s d e c l i n e d a b o u t 25 t o 5 0 b a s i s p o i n t s i n y i e l d o v e r t h e p e r i o d . T r e a s u r y i s s u e s were down a b o u t 1 0 t o 3 0 b a s i s p o i n t s . Longer In t h e s h o r t - t e r m a r e a , t h e r e h a s been a n e s p e c i a l l y marked d e c l i n e i n r a t e s on bank CD's which had been b i d up a g g r e s s i v e l y i n t h e f i n a l months of 1978 b u t came down by 5 0 t o 1 0 0 b a s i s p o i n t s s i n c e midDecember. P a r t of t h e rise and s u b s e q u e n t d e c l i n e was p r o b a b l y s e a s o n a l , b u t a l s o banks a p p a r e n t l y o v e r - p r e p a r e d f o r a n t i c i p a t e d c r e d i t demand and r a t e p r e s s u r e s which f a i l e d t o d e v e l o p a s e x p e c t e d . On t h e o t h e r hand, T r e a s u r y b i l l r a t e s came down a more m o d e r a t e 25 b a s i s p o i n t s o r so f o r l o n g e r b i l l s and t h e r e w a s l i t t l e n e t change i n r a t e s on 3-month b i l l s , where s u p p l i e s were e n l a r g e d by System s a l e s and a s w i t c h from f o r e i g n o f f i c i a l a c c o u n t p u r c h a s e s t o s a l e s a s t h e d o l l a r improved. Y e s t e r d a y , 3- and 6-month b i l l s were a u c t i o n e d a t a v e r a g e r a t e s of a b o u t 9.19 and 9.31 p e r c e n t , compared w i t h 9.24 and 9.52 p e r c e n t t h e d a y b e f o r e t h e December meeting. Today t h e market i s b i d d i n g on $2.25 b i l l i o n of 8 - y e a r T r e a s u r y n o t e s , t h e f i r s t p a r t of t h e F e b r u a r y r e f u n d i n g o p e r a t i o n t o replace $3 b i l l i o n m a t u r i n g n o t e s h e l d by t h e p u b l i c and r a i s e a b o u t $1 1/4 b i l l i o n . The second p a r t o f t h e o p e r a t i o n w i l l b e t h e s a l e tomorrow of $2 b i l l i o n a d d i t i o n a l 8 3/4 2008. p e r c e n t b o n d s of - W e expect t o r o l l o v e r t h e S y s t e m ' s $ 1 . 7 b i l l i o n h o l d i n g of m a t u r i n g n o t e s , d i v i d e d between t h e t w o i s s u e s i n a b o u t t h e prop o r t i o n s they a r e offered t o t h e public. There i s c u r r e n t l y a d i v e r s i t y o f view i n t h e m a r k e t s about r a t e prospects. Few p a r t i c i p a n t s a r e c o n v i n c e d t h a t w e have a l r e a d y seen t h e p e a k s i n t h e c u r r e n t c y c l e , b u t a number seem t o f e e l t h a t r a t e s a r e c l o s e enough t o t h e i r h i g h s t h a t some moderate moves t o g e t i n v e s t e d are a p p r o p r i a t e . Others believe t h a t s i g n i f i c a n t f u r t h e r i n c r e a s e s could l i e ahead--to be a p p r o a c h e d when monetary a g g r e g a t e s resume t h e i r growth and t h e monetary a u t h o r i t i e s continue t h e i r a n t i - i n f l a t i o n a r y e f f o r t s . James L. K i c h l i n e February 6 , 1979 INTRODUCTION -- F M CHART S O O C HW For t h i s meeting of t h e Committee t h e s t a f f has r e a s s e s s e d t h e f o r e c a s t of economic and f i n a n c i a l developments i n 1979 and extended t h e f o r e c a s t through 1980. This r e p r e s e n t s an u n u s u a l l y long p e r i o d f o r t h e judgmental f o r e c a s t , b u t we f e l t i t would be h e l p f u l t o t a k e a n e a r l y look a t a l l of 1980, p a r t i c u l a r l y i n l i g h t of t h e HumphreyHawkins Act. The f o r e c a s t has been prepared i n a n environment o f more t h a n u s u a l u n c e r t a i n t y regarding t h e i n t e r p r e t a t i o n and i m p l i c a t i o n of r e c e n t econoxic and f i n a n c i a l developments. Thus a good d e a l o f r i s k a t t a c h e s t o t h e f o r e c a s t we w i l l be p r e s e n t i n g today. The f i r s t c h a r t in t h e m a t e r i a l s d i s t r i b u t e d t o you d i s p l a y s t h e p r i n c i p a l p o l i c y assumptions t h a t u n d e r l i e t h e f o r e c a s t . Interest r a t e s a r e assumed t o remain n e a r c u r r e n t l e v e l s i n t h e f i r s t h a l f of 1979 and t o move moderately lower t h e r e a f t e r . This assumption i s c o n s i s t e n t w i t h t h e midpoints of t h e l o n g e r - r u n i n t e r e s t r a t e r a n g e s f o r 1979 p r e s e n t e d as A l t e r n a t i v e B i n t h e Bluebook. 11-1 growth i s assumed t o average 6-1/4 p e r c e n t o v e r t h e n e x t two y e a r s , a f t e r a d j u s t i n g f o r t h e e f f e c t of ATS s h i f t s on M - 1 growth. In addition, some f u r t h e r downward s h i f t o f money demand i s assumed as d i s c u s s e d i n t h e Bluebook. For f i s c a l p o l i c y we have assumed o u t l a y s of $493 b i l l i o n i n t h e c u r r e n t f i s c a l y e a r and $538 b i l l i o n i n FY 1960. The d i f f e r e n c e s between t h e s t a f f ' s F e d e r a l budget o u t l o o k and t h a t o f t h e Administration are shown i n t h e n e x t c h a r t . Our e s t i m a t e o f o u t l a y s i n 1979 i s s i m i l a r t o t h a t of t h e A d m i n i s t r a t i o n -2b u t w a n t i c i p a t e l a r g e r o u t l a y s i n 1980 r e f l e c t i n g o u r somewhat h i g h e r e i n t e r e s t r a t e s and l e v e l of unemployment, as w e l l a s an assumption t h a t c e r t a i n c o s t l i m i t i n g measures w i l l n o t be a c c e p t e d by t h e Congress. On t h e r e c e i p t s s i d e , t h e d i f f e r e n c e i n 1980 i s accounted f o r mainly by o u r e x c l u s i o n of t h e c o s t s of a r e a l wage i n s u r a n c e program--which p r e s e n t l y does n o t appear t o have much s u p p o r t i n t h e Congress. r e s u l t i n g budget d e f i c i t i s shown i n t h e bottom p a n e l . The Even though t h e p r o j e c t e d d e f i c i t i n 1980 i s about $4 b i l l i o n l a r g e r t h a n t h e Administracion p l a n , we would view our f i s c a l assumptions g e n e r a l l y a s being r e s t r i c t i v e . The n e x t c h a r t d i s p l a y s s e l e c t e d i n d i c a t o r s of r e c e n t e c o n o n i c activity. P r o d u c t i o n , employment, and r e t a i l s a l e s a l l r o s e strongl!. i n the f i n a l q u a r t e r o f 1976. Over-all, r e a l G P r e p o r t e d l y r o s e a t N a s u r p r i s i n g l y s t r o n g 6 p e r c e n t annual r a t e . t h i s y e a r w i t h a good d e a l o f momentum. Thus we a p p a r e n t l y e n t e r e d The l i m i t e d i n f o r m a t i o n a v a i l a b l e f o r a c t i v i t y i n January, n o t a b l y t h e employment s i t u a t i o n , s u g g e s t s appreciable strength. blr. Zeisel w i l l continue the presentation with a discussion of t h e s t a f f ' s domestic n o n f i n a n c i a l f o r e c a s t . Joseph S. Z e i s e l February 6, 1979 FOMC CHART SHOW Although t h e economy a p p a r e n t l y e n t e r e d t h i s y e a r w i t h a good d e a l of momentum, fundamental f o r c e s s t i l l appear t o s u g g e s t a d i s t i n c t slowing of a c t i v i t y by s p r i n g . The f i r s t c h a r t of t h e n o n f i n a n c i a l s e c t i o n p r e s e n t s t h e average a n n u a l rates of growth o f real GNP and i t s major s e c t o r s o v e r t h e p a s t two y e a r s , and our p r o j e c t i o n s f o r t h e n e x t two. A s i s e v i d e n t , we 2 r e f o r e c a s t i n g a s i g n i f i c a n t l y weaker r a t e of re21 growth i n each of t h e key income g e n e r a t i n g s e c t o r s - - housing, b u s i n e s s f i x e d i n v e s t m e n t , and government--and s o f t e n i n g of consumer demand. an a s s o c i a t e d Over t h e n e s t two y e a r s , r e a l GNP i s p r o j e c t e d t o expand a t l e s s t h a n a 2 p e r c e n t a n n u a l r a t e . While a slowing t o such a pace i n c r e a s e s t h e economy's v u l n e r a b i l i t y t o s h o c k s , we a r e n o t f o r e c a s t i n g a r e c e s s i o n , given t h e p o l i c y a s s u m p t i o n s , and t h e a p p a r e n t a b s e n c e o f s u b s t a n t i a l d i s t o r t i o n s i n t h e economy a t t h e p r e s e n t time . A major f a c t o r r e t a r d i n g growth i n o u r f o r e c a s t i s t h e weakening of housing. A c t i v i t y i n t h i s s e c t o r h a s s o f a r remained - 2 s u r p r i s i n g l y s t r o n g , r e f l e c t i n g i n no small measure t h e s u p p o r t t o d e p o s i t growth a t t h r i f t i n s t i t u t i o n s p r o v i d e d by t h e money m a r k e t c e r t i f i c a t e s i n t r o d u c e d l a s t June. But,as i s i l l u s t r a t e d in the t o p panel of t h e n e x t c h a r t , growth of s a v i n g s inflows h a s slowed i n r e c e n t months. As i n d i c a t e d i n t h e middle p s n e l , o u t s t a n d i n g mortgage commit- ments may have topped o u t , and t h i s month's Redbook confirms o t h e r of t i g h t e n i n g mortgsge markets. reports 1.10reover, it i s o u r judgment t h a t d e s p i t e t h e a t t r a c t i v e n e s s of homeownership a s a hedge a g a i n s t i n f l a t i o n , t h e s u b s t a n t i a l l y i n c r e a s e d c o s t s of t a k i n g on l a r g e r mortgages a t h i g h e r i n t e r e s t r a t e s w i l l i n c r e a s i n g l y p u t a damper o l housing demand i t h i s year. A s t h e bottom p a n e l d r a m a t i c a l l y p o r t r a y s , t h e monthly c a r r y i n g c o s t f o r an average new c o n v e n t i o n a l mortgage r o s e t o $500 by t h e end of 197S--a 50 p e r cent i n c r e a s e over t h e p a s t 3 y e a r s . The n e s t c h a r t p r e s e n t s i n t h e t o p p a n e l o u r p r o j e c t i o n o f housing s t a r t s . lie now a n t i c i p a t e t h a t s t a r t s w i l l bottom o u t a t a b o u t 1,650,000, a n n u a l r a t e a t t h e end o f t h i s y e a r and t h e n edge up d u r i n g 1980 a s somewhat z a s i e r f i n a n c i a l c o n d i t i o n s p e r m i t s a reemergence of t h e s t r o n g u n d e r l y i n g demand a s s o c i a t e d w i t h a h i g h r a t e o f f a m i l y f o r m a t i o n . - 3 - The key p o i n t made i n t h e bottom p a n e l i s t h a t w h i l e housing s t a r t s remained a t a high l e v e l f o r much of 1978, r e a l housing e x p e n d i t u r e s were no longer c o n t r i b u t i n g t o economic growth. And r e s i d e n t i a l c o n s t r u c t i o n i s expected t o be a n o t i c e a b l e drag on r e a l a c t i v i t y through most of t h i s year. Turning to t h e b u s i n e s s s e c t o r , t h e top tvo p a n e l s of t h e n e s t c h a r t i n d i c a t e r e c e n t t r e n d s i n r e a l o r d e r s f a r c a p i t a l equipment and c o n s t r u c t i o n c o n t r a c t s . They suggest s u b s t a n t i a l upward momentum f o r c a p i t a l spending i n t h e s h o r t term. However, t h e r e a r e i n d i c a t i c n s t h a t t h i s may be temporary ; both s e r i e s appear to be e i t h e r l e v e l i n g o f f or t u r n i n g doxm. I n a d d i t i o n , a slower pace of c a p i t a l spending over t h e b a l a n c e of 1979 i s i n d i c a t e d by t h e l a t e s t Commerce Department survey of p l a n t and equipment o u t l a y s , i l l u s t r a t e d i n t h e bottom panel. The outlook f o r c a p i t a l spending i n 1980 i s o b v i o u s l y more speculatiuc. A s i n d i c a t e d i n t h e n e s t c h a r t , o u r p r o j e c t i o n s of o v e r - a l l activity are consistent w i t h a decline i n capacity u t i l i z a t i o n r a t e s i n manufacturing from t h e p r e s e n t 86 p e r c e n t t o a b o u t 8 3 p e r cent - 4 toward t h e end of 1980. I n t h i s environment t h e r e should be l e s s p r e s s u r e f o r expansion of c a p i t a l s t o c k , and g i v e n a n expected weakening of p r o f i t s , we a r e f o r e c a s t i n g a v i r t u a l l e v e l i n g o u t of t h e s e o u t l a y s i n r e a l terms over t h e c o u r s e of 1980. The n e x t c h a r t i l l u s t r a t e s t h e diminished c o n t r i b u t i o n t o o v e r - a l l expansion expected from government spending d u r i n g t h e n e x t two y e a r s . As t h e top p a n e l shows, t h e annual growth of t o t a l government purchases--Federal, S t a t e and l o c a l - - i n r e a l terms i s expected t o average l i t t l e above 1 p e r c e n t d u r i n g 1979 and l9EO; t h i s r e f l e c t s an a c t u a l d e c l i n e of such F e d e r a l f i n a n c i n g programs as c o u n t e r c y c l i c a l revenue s h a r i n g and p u b l i c s e r v i c e employment, and a more moderate r i s e i n o u t l a y s f o r a wide r a n g e of o t h e r governmental programs. A s t h e bottom p a n e l shows, t h e F e d e r a l Government h i g h emp1o)rment budget s u r p l u s i s p r o j e c t e d t o show o n l y a modest change between 1978 and 1979 s i n c e p e r s o n a l and b u s i n e s s tax c u t s a r e a b o u t o f f s e t by mandated p a y r o l l t a x i n c r e a s e s and t h e impact of i n f l a t i o n i n r a i s i n g income t a x r e c e i p t s . However, w i t h no new t a x c u t i n i t i a t i v e s - 5 i n 1980--but w i t h the e f f e c t s of i n f l a t i o n and t h e scheduled p a y r o l l t a x i n c r e a s e s - - t h e high employment budget moves f u r t h e r i n t o s u r p l u s n e x t year. O r p r o j e c t i o n s of i n v e s t m e n t and government a c t i v i t y a r e u r e f l e c t e d i n a s u b s t a n t i a l f u r t h e r moderation of d i s p o s a b l e income growth, a s shown i n t h e t o p p a n e l o f t h e n e x t c h a r t . does n o t bode w e l l f o r consuner spending p r o s p e c t s . This slowing Growth of c o n s u n e r s o u t l a y s ~ 2 a l s o s u s t a i n e d i n t h e r e c e n t p a s t by a s u b s t a n t i a l r i s e i n consumer c r e d i t . A s i n d i c a t e d i n t h e second p a n e l , t h e r a t i o of t o t a l household d e b t t o d i s p o s a b l e income h a s r e a c h e d r e c o r d l e v e l s , i n c r e a s i n g t h e v u l n e r a b i l i t y of consumer o u t l a y s , p a r t i c u l a r l y f o r d u r a b l e s , t o any weakening i n t h e r i s e of d i s p o s a b l e income. Further- more, w i t h t h e s a v i n g s r a t e a l r e a d y a t t h e lower end of h i s t o r i c a l experience--the third panel--it seems u n l i k e l y t h a t growth of r e a l consumer o u t l a y s w i l l o u t p a c e income. Consequently, a s t h e bottom panel shows, w e have p r o j e c t e d a r i s e i n r e a l consumer s p e n d i n g of o n l y about 2 p e r c e n t , a n n u a l r a t e , o v e r t h e n e s t two y e a r s - - a b o u t l i n e w i t h t h e r i s e o f r e a l d i s p o s a b l e income. in - 6 W do e x p e c t a f u r t h e r improvement i n t h e t r a d e d e f i c i t e d u r i n g t h e p r o j e c t i o n p e r i o d which w i l l h e l p t o s u s t a i n o v e r - a l l economic a c t i v i t y . But on b a l a n c e , as shown i n t h e n e x t c h a r t , w e a n t i c i p a t e r e a l GNP growth to moderate d u r i n g t h i s y e a r , a v e r a g i n g a b o u t a 2 p e r c e n t annual r a t e of growth over t h e f o u r q u a r t e r s , and t h e n t o l e v e l o f f a t about a 1-1/2 p e r c e n t r a t e i n 1980. C o n s i s t e n t w i t h t h e slower pace of o v e r - a l l a c t i v i t y , w e a n t i c i p a t e s m l l e r employment g a i n s over t h e p r o j e c t i o n p e r i o d - - a s i n the top panel of t h e next chart. shown Although w are a l s o p r o j e c t i n g e slower l a b o r f o r c e growth than i n t h e p a s t few y e a r s , r e f l e c t i n g b o t h poorer j o b p r o s p e c t s and smaller p o p u l a t i o n g a i n s , t h e unemployment rate--shown i n t h e bottom p a n e l - - i s p r o j e c t e d t o move up s t e a d i l y begin- ning t h i s s p r i n g , r e a c h i n g a l e v e l o f a b o u t 7 p e r c e n t toward t h e end of 1960. D e s p i t e growing l a b o r market s l a c k , i n f l a t i o n i s e x p e c t e d t o c o n t i n u e t o be a c r i t i c a l problem f o r t h e economy. I n the next chart a r e p o r t r a y e d t h e c o r e e l e m e n t s o f t h e p e r s i s t e n t i n f l a t i o n problem--the - 7 c o n t i n u i n g r i s e i n wages and t h e poor p r o d u c t i v i t y performance o f t h e economy. As t h e t o p p a n e l shows, we e x p e c t t h a t h o u r l y compensa- t i o n w i l l r i s e about a s r a p i d l y on average i n 1979 a s i n 1978, r e f l e c t i n g t h e lagged i n f l u e n c e of r e c e n t c o s t of l i v i n g i n c r e a s e s , t h e r e s u l t s of t h e heavy round of c o n t r a c t n e g o t i a t i o n s and t h e h i k e s i n minimum wage and i n s o c i a l s e c u r i t y t a x e s t h a t went i n t o e f f e c t on January 1. Some modest e a s i n g of compensation i n c r e s s e s i s e x p e c t e j i n 1980, i n response t o s m a l l e r p a y r o l l t a x i n c r e a s e s , t h e c o n t i n u e d s l a c k f i l i n g o f l a b o r market p r e s s u r e s and some impact of t h e g u i d e l i n e s program. As t h e middle p a n e l i n d i c a t e s , w e e x p e c t l i t t l e h e l p from improved p r o d u c t i v i t y performance i n damping t h e impact of r i s i n g wages on l a b o r c o s t s and p r i c e s . d u c t i v i t y remains b a f f l i n g . The c o n t i n u e d abysmal performance of p r o - Eut i n any e v e n t , only modest p r o d u c t i x - i t y growth i s t o be e s p e c t e d i n an environment of such s m a l l g a i n s i n o v e r - a l l output. A s a r e s u l t , we a r e p r o j e c t i n g c o n t i n u e d r a p i d i n c r e a s e s i n u n i t l a b o r c o s t s , t o t a l i n g a b o u t S-1/2 p e r c e n t d u r i n g 1979 and 7-1:2 p c r c e n t i n 1980, p a r a l l e l i n g t h e p a t t e r n o f wage movements. - 8 - The top panel of t h e n e x t c h a r t i l l u s t r a t e s GNP p r i c e s excluding food and energy, which a r e p r o j e c t e d t o move g e n e r a l l y i n l i n e with u n i t l a b o r c o s t s . W e remain moderately o p t i m i s t i c i n r e g a r d t o food s u p p l i e s and p r i c e s l a t e r t h i s y e a r and i n 1980, r e f l e c t i n g p r o s p e c t s f o r good g r a i n crops and some improvement i n pork s u p p l i e s . Our p r o j e c t i o n s c a l l f o r a 9-114 p e r c e n t food p r i c e i n c r e a s e t h i s y e a r a s opposed t o t h e 12-112 p e r c e n t r i s e d u r i n g 1078. an 8 p e r c e n t i n c r e a s e in 1980. W are projecting e Energy p r i c e s a r e p r o j e c t e d t o a c c e l e r a t e i n response t o t h e 14-112 p e r c e n t OPEC p r i c e i n c r e a s e d u r i n g e 1979; f o r 1980 w a r e assuming a r i s e i n o i l import p r i c e s of 7-112 p e r cent--about equal t o average i n f l a t i o n . Over-all, w a r e pro j e c t i n g e a modest d e c e l e r a t i o n i n GNP p r i c e i n c r e a s e s , from 8-314 p e r c e n t d u r i n g 1978 t o 8 p e r c e n t t h i s y e a r , and a b o u t 7-112 p e r c e n t i n 1980. Mr. Truman w i l l now review t h e i n t e r n a t i o n a l s i t u a t i o n . FOMC PRESENTATION E.M. Truman February 6, 1979 The upper left-hand panel of the f i r s t international c h a r t shows the decline i n the weighted-average foreign exchange value of the d o l l a r since the middle of 1976. The decline began t o accelerate i n the fourth quarter of 1977 and was only p a r t i a l l y reversed follow- i n g the November 1 i n i t i a t i v e s . has been r e l a t i v e l y stable. Over the past two months the d o l l a r The foreign exchange value of the d o l l a r , in nominal terms, i s now about 17 per cent below i t s level i n mid-1976 a n d about 15 per cent below i t s level in September 1977. As i s shown i n the lower left-hand panel, i n the f i r s t quarter of l a s t year the average price level i n foreign industrial countries began t o f a l l r e l a t i v e t o the U.S. price level. This deterioration i n the r e l a t i v e price performance of the United S t a t e s has o f f s e t some of the competitive advantage resulting from the decline i n t h e d o l l a r ' s nominal value. As i s shown in the c h a r t , w expect e t h a t , over the projection period, the U.S. i n f l a t i o n r a t e will remain r e l a t i v e l y h i g h , b u t the d i f f e r e n t i a l should narrow t o about 1% per cent per year--compared with almost 3 per cent over the past year. The upper r i g h t - h a n d panel of the chart shows the s t a f f ' s outlook f o r real economic a c t i v i t y abroad. Average growth i n real GNP i n foreign i n d u s t r i a l countries picked u p somewhat i n 1978, and r e a l growth i s expected t o continue a t an average annual r a t e of about 3%per cent over the projection period, while growth in the United -2- S t a t e s slows. The expected r e l a t i v e r i s e i n the level of economic a c t i v i t y abroad i s summarized i n the l a s t panel. The factors I have just reviewed a r e among the major determinants of t h e s t a f f ' s outlook f o r U.S. t h a t i s presented i n the next chart. international transactions A depicted i n the upper l e f t s hand panel, the value and volume of non-agricultural exports a r e expected t o increase briskly over the next two years, though not a s rapidly a s i n recent quarters. The volume of such exports i s expected t o increase a t an a n n u a l r a t e of around 9 per cent and the value a t a r a t e of about 18 per cent. A t the same time, a s shown i n the lower left-hand panel, the volume of non-oil imports i s expected t o expand r e l a t i v e l y slowly reflecting the slower growth of the U.S. e f f e c t s of the d o l l a r ' s depreciation. economy as well a s the lagged Even w i t h substantial price increases, the value of these imports should increase over the next two years a t an average r a t e of l e s s than 9 per cent per year. The upper right-hand panel i l l u s t r a t e s the e r r a t i c upward trend of U.S. o i l imports. In our forecast w have t r i e d t o take e account of recently announced, and prospective, OPEC price increases and t o make some guesses about the e f f e c t s of the Iranian production situation--which we have assumed will mainly a f f e c t the time pattern of o i l imports i n 1979. On t h i s b a s i s , we expect t h a t the U.S. oil import b i l l will r i s e $5-6 b i l l i o n per year in both 1979 and 1980. Most of the increase will r e s u l t from higher prices. -3As shown in the f i n a l panel, the net e f f e c t of the components t h a t I have just reviewed, together w i t h l i t t l e expected change in our a g r i c u l t u r a l exports, yields an improvement in the trade balance i n 1979 and 1980. The top l i n e in the c h a r t depicts the gradual r i s e over the projection period in net exports of goods and services as measured i n the GNP accounts. The f i n a l international chart summarizes U S . international transactions over the past three years. The left-hand column shows the current account balance f o r these years as well a s the s t a f f ' s projection f o r 1979 and 1980. You will note t h a t w expect the e United S t a t e s will record i t s f i r s t current account surplus i n 4 years i n 198U. The middle column indicates t h a t i n 1977 and 1978 capital inflows i n the form o f increases i n foreign o f f i c i a l reserve a s s e t s held i n the United S t a t e s were about twice as l a r g e a s our current account d e f i c i t s . However, t h e pattern of these increases has been e r r a t i c ; the l a r g e s t inflows have roughly corresponded t o periods of sharp downward pressure on the d o l l a r i n exchange markets d u r i n g the l a s t quarter of 1977 and the f i r s t and f o u r t h quarters of 1978. The t h i r d column shows other t r a n s a c t i o n s , derived e s s e n t i a l l y as a residual. These a r e mostly p r i v a t e c a p i t a l transactions. Such transactions a t times a r e a source of downward pressure on the d o l l a r . However, the s i z e o f any actual net outflow i s inversely r e l a t e d t o the volume of o f f i c i a l purchases of d o l l a r s . Given the improved outlook for the U.S. c u r r e n t account t h a t I have presented, the s t a f f expects l i t t l e further change in the -4- average nominal foreign exchange value of the d o l l a r over the projection period, a l t h o u g h w i t h the expected r e l a t i v e l y high U.S. t h i s implies a small real appreciation of the d o l l a r . i n f l a t i o n rate I would draw two inferences from this outlook f o r a stable d o l l a r and a d e c l i n i n g U.S. current account d e f i c i t . F i r s t , foreign monetary a u t h o r i t i e s will have less inducement t o purchase d o l l a r s t o add t o t h e i r holdings of reserve a s s e t s in the United S t a t e s . Second, the lower current account d e f i c i t i n 1979 should be accompanied by a s u b s t a n t i a l l y reduced net private c a p i t a l outflow o r , even, by a modest net inflow. Mr. Kichline will now conclude our presentation. James L. K i c h l i n e February 6 , 1979 C!JNCLUSION -- FOMC CHART SHOW Total c r e d i t flows c o n s i s t e n t w i t h t h e s t a f f ' s economic f o r e c a s t a r e shown i n t h e f i r s t c h a r t of t h e l a s t s e c t i o n of y o u r packet. Funds r a i s e d by n o n f i n a n c i a l s e c t o r s i n 1979 a r e p r o j e c t e d t o recede from the high l e v e l s of l a s t year. The htlk of t h e d e c l i n e i s a t t r i b u t a b l e t o reduced demands by t h e F e d e r a l Government, which i s expected t o f i n a n c e a p o r t i o n o f t h e d e f i c i t t h i s y e a r by drawing down i t s cash b a l a n c e s . T o t a l borrowing by o t h e r s e c t o r s i s n o t expected t o grow i n 1979 and 1980, r e f l e c t i n g t h e e f f e c t s of f i n a n c i a l r e s t r a i n t s and d e c e l e r a t i n g growth of economic a c t i v i t y . As shown i n t h e bottom p a n e l , commercial banks and t h r i f t i n s t i t u t i o n s a r e expected t o s u p p l y a somewhat s m a l l e r volume of c r e d i t i n t h e n e x t two y e a r s than i n 1978. These i n s t i t u t i o n s w i l l l i k e l y be l e s s w i l l i n g l e n d e r s t h i s y e a r i n l i g h t of reduced l i q u i d i t y p o s i t i o n s and a n expected f u r t h e r need t o r e l y upon borrowed f u n d s r a t h e r t h a n d e p o s i t flows t o meet c r e d i t demands. Other s u p p l i e r s of c r e d i t , p a r t i c u l a r l y i n s u r a n c e companies and pension funds, are expected t o be i n a more comfortable p o s i t i o n t o f i n a n c e economic a c t i v i t y . T o t a l borrowing by n o n f i n a n c i a l c o r p o r a t i o n s , shown i n t h e next c h a r t , i s p r o j e c t e d t o r i s e a p p r e c i a b l y i n both 1979 and 19SO from the a l r e a d y high l e v e l s reached l a s t year. Although t h e economic f o r e c a s t p r o j e c t s a slowing of growth i n c a p i t a l e x p e n d i t u r e s , e s p a n s i o n o f i n t e r n a l l y g e n e r a t e d funds i s a l s o expected t o moderate, t h e r e b y maint a i n i n g p r e s s u r e s on e x t e r n a l f i n a n c i n g . The i n c r e a s e d volume o f funds -2r a i s e d i s expected t o come from long-term s o u r c e s , where funds s h o u l d be a v a i l a b l e . Short-term markets seem l i k e l y t o be r e l a t i v e l y t i g h t e r , p a r t l y because o f t h e p r e s s u r e s on banks. In a d d i t i o n , however, t h e bottom panel shows t h a t heavy s h o r t - t e r m borrowing i n t h e p a s t two y e a r s h a s pushed t h e r a t i o of s h o r t - t e r m t o t o t a l d e b t o u t s t a n d i n g t o f a i r l y high levels. L a t e r t h i s y e a r and i n 1980 t h e r e p r o b a b l y w i l l be s t r o n g p r e s s u r e s t o begin funding such d e b t i n long markets t o r e l i e v e b a l a n c e sheet distortions. I n c o n t r a s t t o t h e c o r p o r a t e s e c t o r , t h e next c h a r t shows t h a t household s e c t o r borrowing i s p r o j e c t e d t o d e c l i n e somewhat t h i s y e a r and n e x t from t h e e x t r a o r d i n a r y l e v e l i n 1978. Despite expected f u r t h e r r a p i d growth of house p r i c e s , mortgage borrowing i n 1979 and 1980 i s e s p e c t e d t o remain around t h e l e v e l of t h e p a s t two y e a r s , which r e f l e c t s t h e e f f e c t s of f i n a n c i a l r e s t r a i n t . The s h a r p con- t r a c t i o n of mortgage borrowing t h a t h a s o c c u r r e d d u r i n g p a s t p e r i o d s of monetary r e s t r a i n t is p r o j e c t e d t o be a v o i d e d , a s a r e s u l t of b o t h t h e p a r t i a l i n s u l a t i o n of t h e mortgage market from t h e d i r e c t e f f e c t s of monetary r e s t r a i n t and s u s t a i n e d demands f o r h o u s i n g . Consumer i n s t a l m e n t and o t h e r borrowing i s p r o j e c t e d t o d i m i n i s h l a t e r t h i s y e a r and i n 19S0, given p r o j e c t e d s l o w e r growth of d u r a b l e goods p u r c h a s e s . R e l a t i v e t o income, however, consumer borrowing i s p r o j e c t e d t o remain q u i t e high. The economic f o r e c a s t and a s s o c i a t e d c r e d i t : f l o w s assume growth of E l - 1 a v e r a g i n g 6-1/’4 p e r c e n t i n 1979 and 19SO. t h e n e x t & a r t , nominal GNP expandcd a t d A s shown i n f a s t pace i n t h e l a s t q u a r t e r - 3o f 1978 while M - 1 growth a d j u s t e d f o r the e f f e c t s of ATS slowed. nus t h e income v e l o c i t y of money r o s e s u b s t a n t i a l l y and a s t r o n g v e l o c i t y i n c r e a s e i s a l s o expected t h i s q u a r t e r . L a t e r t h i s y e a r and i n 1980 t h e f o r e c a s t assumes t h a t s t r o n g e r demands for money r e l a t i v e t o GNp w i l l be e v i d e n t . I n o r d e r t o hold money growth t o 6-114 p e r c e n t t h e 3-month b i l l r a t e i s expected t o d e c l i n e o n l y a l i t t l e t h i s y e a r and n e x t , sho1.m i n t h e bottom panel. The A d m i n i s t r a t i o n i n i t s f o r e c a s t assumes 3-month b i l l r a t e s about 1/2 p e r c e n t a g e p o i n t lower on average t h i s y e a r than shown on t h e c h a r t and more t h a n a percentage p o i n t lower i n 1980. The economic f o r e c a s t of t h e A d m i n i s t r a t i o n and t h a t o f t h e s t a f f a l s o d i f f e r i n a number o f ways, a s shown on t h e n e x t c h a r t . Growth of nominal GXP expected i n 1979 i s q u i t e c l o s e , b u t i n 1980 t h e s t a f f f o r e c a s t i s s i g n i f i c a n t l y below t h a t of t h e Administration. N The d i f f e r e n c e i s even g r e a t e r f o r r e a l G P i n 19SO when t h e Administ r a t i o n p r o j e c t s growth of 3-114 p e r c e n t , o r more than twice t h e s t a f f ' s f o r e c a s t e d r a t e of growth; b u s i n e s s f i s e d i n v e s t m e n t , r e s i d e n t i a l c o n s t r u c t i o n o u t l a y s and consumption e x p e n d i t u r e s a r e a l l growing a t a p p r e c i a b l y f a s t e r r a t e s i n 1980 t h a n i n o u r own f o r e c a s t . The Adminis- t r a t i o n a l s o e x p e c t s c o n s i d e r a b l e improvement i n i n f l a t i o n t h i s y e a r and n e x t w i t h t h e GNP i m p l i c i t d e f l a t o r i n 1980 p r o j e c t e d t o r i s e a b o u t 6-112 p e r c e n t compared t o 7-112 p e r c e n t i n t h e s t a f f f o r e c a s t . Pre- sumably t h e l e s s r a p i d p r i c e i n c r e a s e s s t e m from t h e assumed g r e a t e r e f f e c t i v e n e s s o f t h e wage-price r e s t r a i n t program, s i n c e t h e p r i c e deceleration occurs w i t h l i t t l e a d d i t i o n a l slack i n resource u t i l i z a t i o n -4t h a n now e x i s t s , a s i l l u s t r a t e d by maintenance of a 6-114 p e r c e n t unemployment r a t e i n 1979 and 1980 i n t h e i r p r o j e c t i o n . M-1 growth assumed i n t h e s t a f f ' s f o r e c a s t i s 6-114 p e r c e n t a d j u s t e d t o t a k e account of t h e e f f e c t s of ATS. Judging from t h e econometric e x e r c i s e s w e have u n d e r t a k e n , nominal GNP growth a s i n t h e Administration f o r e c a s t could a l s o be f i n a n c e d by r o u g h l y s i m i l a r monetary growth. The model s i m u l a t i o n s , however, s u g g e s t v e r y low p r o b a b i l i t i e s of j o i n t l y a c h i e v i n g t h e lower i n f l a t i o n and lower unemployment f o r e c a s t s by t h e A d m i n i s t r a t i o n . The f i n a l c h a r t i n t h e package d i s p l a y s t h e r e s u l t s o b t a i n e d from model s i m u l a t i o n s employing 1 p e r c e n t a g e p o i n t slower and f a s t e r r a t e s of M1 growth t h a n i n t h e 6 - 1 / 4 p e r c e n t b a s e f o r e c a s t . - Each of t h e f o r e c a s t s p r e s e n t s a p i c t u r e of slow or moderate economic growth accompanied by s t i l l h i g h r s t e s o f i n f l a t i o n even i n t o 1 9 S l . There seems t o be l i t t l e i n t h e way of a t t r a c t i v e o p t i o n s f o r monetary p o l i c y . Tightening f u r t h e r would b r i n g on t h e l i k e l i h o o d of a r e c e s s i o n l a t e r t h i s y e a r o r n e x t w h i l e an e a s i e r p o l i c y would p r o b a b l y produce h i g h e r r a t e s o f i n f l a t i o n o v e r t h e l o n g e r run. CONFIDENTIAL (FR) CLASS 11-FOMC Material for Staff Presentation to the Federal Open Market Committee February 6, 1979 PRINCIPAL ASSUMPTIONS MONETARY POLICY Interest rates little changed in 1979H1; move lower through 1980 Growth of M-1 averages 6% per cent (adjusting for impact of ATS) in 1979 and 1980 FISCAL POLICY m Unified budget expenditures of $493 billion in FY 1979 Unified budget expenditures of $538 billion in FY 1980 FEDERAL BUDGET* Billions of r ars 500 400 300 r Billions of irs Receipts 00 100 300 Billions of dollars Admin. 1979 37% FRB 60 40 20 1976 *Fiscal years 1978 1980 ECONOMIC ACTIVITY Industrial Production r '77 Index, 1967=100 Nonfarm Employment 1 1978 '79 1 '77 :ail Sales 1978 Billions o 1972 f irs month Moving Average 44 43 42 '77 1978 Millions o workers f '79 '79 Real GNP and Major Sectors 1 - 1976--Q4 1978 4 - Percentage change, annual r e Business Fixed investment - 8 Personal Consumption Government Expenditures 4 - 1978--Q4 1980 4 0 t D - 4 DEPOSIT GROWTH AT THRIFT INSTITUTIONS Change from previous period, annual rate, per cent r 1 20 10 1976 1977 1978 OUTSTANDING COMMITMENTS AT SAVINGS AND LOAN ASSOCIATIONS - Billions of dollars - - - I I 1976 20 1977 1978 - - 500 - 450 - 400 - 350 I I - HOUSING STARTS :v 1974 1976 REAL HOUSING EXPENDITURES r Millions of u 1978 1980 Change from previous period, annual rate, per c - - 7 Nondefense Capital Goods 3-Month Moving Average - - - 3.0 PLANT AND EQUIPMENT Change from previous period, annual rate, per cent 1 rENDlTUREs I Nominal 1976 1977 1979 CAPACITY UTILIZATION Manufacturing - Pei ent r Pre-Recession Peak '73Q3=87.8% 85 80 1976 1978 1980 REAL BUSINESS FIXED INVESTMENT Billions of 197: r--- L ars I50 I30 I- 110 I I 1976 I I 1978 I 1980 REAL GOVERNMENT* PURCHASES OF GOODS AND SERVICES change from previous period, r annual rate, percenl 1 5.0 2.5 + 0 - I - I - 2.5 *Federal and State 8 Local I I I I CHANGE IN HIGH EMPLOYMENT SURPLUS OR DEFICIT I I - Billions of dollars 1 7 Calendar Years kalendar Years 20 .-' + 0 - 20 - 40 I I I I I I 1980 $ 1974 1976 1978 1980 REAL DISPOSABLE PERSONAL INCOME Change from previous period, annual rate, per cent r 1 5 + 0 - 5 - - 23 - - 22 - 21 - 20 I I I REAL PERSONAL CONSUMPTION EXPENDITURES r I I I I I Change from previous period, annual rate, per cent 1 I I I I I I 5 Change from previous period, annual rate. per cent 5 EAL GNP - 1972 Dollars 0 5 + 0 - I I 1974 I I 1976 I I 1978 I 5 1980 I W CIVILIAN LABOR FORCE EMPLOYMENT ,... " r'i I 1 I 1 I I u - 1 -a --- e//-- e- -7 - 6 cc--- - 5 - I I I I I I UNIT COST INDICATORS Nonfarm Business Sector Change from year earlier, annual rate, per cent - Compensation per hour 10 8 1974 1976 1978 1980 4 2 + 0 - 2 I I 1974 I I I 1976 198C - 1978 f 2 8 r \ I 1974 I 4 I 1976 I 1978 I 1980 LABOR COSTS AND PRICES Chanoes from Year Earlier Annual rate, per cent r- 1 15 Nonfarm Unit Labor Costs -----_ --------___. 10 **---- 5 Total GNP Prices Excluding Food and Energy Annual rate, per cent 1 Annual rate, per cent 1 - 30 10 **----------- I I Annual rate, per c 'nt - 12 9 6 - t1974 1976 1978 1980 IEIGHTED AVG. EXCHANGE VALUE I THE U.S. DOLLAR* F March 197 - 00 EAL GNP - 1975=100 Weighted Average of Ten Foreign Countries 05 1 95 85 I L 1976 1978 :ONSUMER PRICES 198( 1976 March 1973=100 .CTIVITY RATIO 1978 1980 1975=100 ---7 Ratio of Foreign Prices* to U.S. Prices Ratio of Foreign Real GNP* - US. Real GNP to -4112 - 1 1976 1978 1980 - 1 w 1976 *Weighted average against G-10 Countries plus Switzerland using total 1972-76 average trade 1978 Of these Countries. 1980 NON-AGRICULTURAL EXPORTS Rat billi scale, 16 of 1912 dollars 1€0 OIL IMPORTS Ratio scale, billions of dollars - - - Mi 3ns of barrels per day Billions of dollars 1 160 - - i 20 100 100 TO ao - 80 SO 40 1976 1978 1980 NET EXPORTS NON-OIL IMPORTS Rat! scale. biili IS of ?972 do:lars Ratio scale, billions of dollars - 1 Billions of 1972 do!lars Billions of dollars 160 120 100 80 60 40 1976 1978 1980 1976 1978 1980 SUMMARY OF U.S. INTERNATIONAL TRANSACTIONS llions of dollars - Current Account Balance --$Deficit Surplus 1976 1977 1980 * L_i -15.3 P Unstly net private capital transactions. Change in Foreign Reserve Assets in the U.S. Other Transaction: Inflow Outflow 1-17.4 13.11 35.2 I 1-19.9 FUNDS RAISED BY NONFINANCIAL SECTORS Billions of dollars r 1 - - 400 Total - - 300 Other Federal Government - - 200 - - 100 I I 1974 I I 1976 I I I 1978 1980 FUNDS SUPPLIED TO NONFINANCIAL SECTORS Billions of d - r am a00 c 300 200 I00 I I 1974 1976 ! I 1978 I 1980 FUNDS RAISED BY NONFINANCIAL CORPORATIONS 11974 I I I Billions of dollars I I 1976 I 1980 1978 NONFINANCIAL CORPORATIONS Short-term to Total Debt Outstanding - I ent 26 22 I 1974 I I 1976 I I 1978 I 18 98 Billions of dollars 1 Home Mortgages Other - ~ il uR 1974 1976 Change from previous period, annual rate, per c - IROWTH IN MONEY AND GNP I 5 0 5 JTEREST RATES - Pe I 9 6 I 1974 * Adjusted for A.T.S I I 1976 I I 1978 I 1980 Change from previous period, annual rate, per cenl NOMINAL GNP r - /<: 1 - 12 . --- - '&----Administration - I Change from previous period, annual rate, per cent 1 - REAL GNP I- I /-\.... I - 8 I I - 10 - 4 I 1975 -- I I 1977 - 2 1979 Change from previous period, annual rate. Der cent GNP DEFLATOR 1 - - -\ -0- / C C /*-=----- - - - - 5 I I I I I 7 IONETARY POLICY ALTERNATIVES REAL GNP ( % ) * 1979 1980 5% per cent M-1 1.6 .4 .7 6% per cent M-1 2.1 1.4 1.4 7% per cent M-1 2.8 2.5 2.4 5% per cent M-1 8.0 7.1 6.6 6% per cent M-1 8.1 7.4 7.4 7% per cent M-1 8.1 8.0 8.3 5% per cent M-1 6.5 7.7 9.4 6% per cent M-1 6.3 7.1 8.2 7% per cent M-1 6.1 6.3 6.8 5% per cent M-1 10% 9% 8% 6% per cent M-1 9 J/e 8% 8 7% Der cent M-1 8% 8 '/s 7% 1981 PRICES ( % ) UNEMPLOYMENT RATE (%) 3 MONTH TREASURY BILL RATE ( % ) ' M1 growth rates equivalent to those in the absence of ATS. Measured from fourth quarter to fourth quarter. Level end quarter of each year. B r i e f i n n f o r Lonn-run Aggregates FOMC meeting of 2/6/79 S . H. Axilrod A s background t o t h e d i s c u s s i o n of t h e longer-run ranges, i t might f i r s t be u s e f u l t o review b r i e f l y r e c e n t t r e n d s i n t h e a g g r e g a t e s and t h e i r r e l a t i o n s h i p t o t h e r a n g e s t h e Committee h a s been s e t t i n g : Ranges f o r t h e y e a r j u s t past--QLV '77-QIV '78--were 4 t o 6-112 p e r c e n t f o r M-1, 6-112 t o 9 per c e n t f o r M-2, and 7-112 t o 10 per c e n t f o r M-3. These r a n g e s were s e t last February and w e r e held e s s e n t i a l l y unchanged i n t h e c o u r s e of t h e year--except t h e ATS effects on M-1. f o r t h e adjustment made in October f o r For that p e r i o d , Q I V '77-QIV '78, M-1 came i n above t h e range a g a i n , but less so than i t had i n t h e p r e v i o u s y e a r . It grew a t a rate of 7.3 p e r c e n t ; w i t h o u t ATS effects t h a t r a t e would have been 7.5 p e r c e n t . M-2 and M-3 were w e l l w i t h i n t h e ranges set by t h e C o m m i t t e e , a t 8.5 and 9.4 p e r c e n t , r e s p e c t i v e l y . The i n t e r e s t i n g development is t h a t growth rates of a l l these a g g r e g a t e s have been v e e r i n g s h a r p l y downwards i n t h e l a s t f e w months of 1978 and e a r l y 1979, and a l l t h e aggregates have been g r a v i n g w e l l below t h e long-run ranges set by t h e FOMC. In t h e 3 months ending J a n u a r y 1979 M-1 growth w a s -1.8 p e r c e n t fW.5 p e r c e n t w i t h o u t ATS e f f e c t s ) ; M-2 growth was about 2 p e r c e n t and M-3 growth around 5.4 p e r c e n t . M-l+ d e c l i n e d 4.6 p e r cent--such a r a p i d r a t e of d e c l i n e it s o r t of j u s t d r i f t e d out of t h e b l u e book i n t h e p r o c e s s . Three r e a s o n s might b e advanced f o r t h e in t h e s e growth rates. sharp downward veer The f i r s t and v e r y u s u a l r e a s o n i s t h a t t h e cumulative impact of t h e 2-1/2 p e r c e n t a g e p o i n t rise i n s h o r t rates s i n c e -2- mid-year i s a f f e c t i n g t h e a g g r e g a t e s w i t h t h e u s u a l l a g . That would n o t , o f c o u r s e , cause t h e “veer” but i t would c a u s e some d e c l i n e i n growth from what i t had been before. More p a r t i c u l a r l y , I should p o i n t _- o u t t h a t t h e s t r e n g t h i n spending i n t h e l a s t few months h a s been r e f l e c t e d , I b e l i e v e , i n a n i n c r e a s e d w i l l i n g n e s s of t h e p u b l i c t e m p o r a r i l y t o draw down t h e i r l i q u i d i t y . Now t h i s may sound somewhat h y p o t h e t i c a l , but i f one l o o k s back over t h e p a s t s e v e r a l y e a r s i n t h e q u a r t e r s i n which t h e r e w a s s h a r p growth i n real GNP--that i s , a growth i n real GNP s h a r p e r than t h e s u r r o u n d i n g q u a r t e r s , i r r e s p e c t i v e o f t r e n d (QIV ’ 7 8 , QII ‘78, Q I ’77, Q I ‘76, and QIII ‘ 7 5 ) - - v e l o c i t y of M - 1 w a s c o n s i d e r a b l y h i g h e r t h a n i n t h e surrounding quarters. For example, i n t h e t h i r d q u a r t e r of 1978 even though M - 1 growth w a s sharp M-1 v e l o c i t y w a s about 9 . 1 p e r c e n t . Finally, t h e reassessment by t h e p u b l i c of p o r t f o l i o p o s i t i o n s , e s p e c i a l l y t h e i r t r a n s a c t i o n s and p r e c a u t i o n a r y balances f o l l o w i n g t h e ATS i n n o v a t i o n , and t h e r e a l i z a t i o n t h a t i n t e r e s t r a t e s and i n f l a t i o n may be a t h i g h l e v e l s f o r a s u s t a i n e d p e r i o d , h a s undoubtedly caused p e o p l e t o s h i f t money out of demand and s a v i n g s d e p o s i t s i n t o i n s t r u m e n t s o t h e r t h a n ATS accounts-- i n c l u d i n g money market funds, which as noted i n t h e b l u e book have grown v e r y s h a r p l y in t h e p a s t 2 months, and o t h e r s i m i l a r i n s t r u m e n t s . The s t a f f e x p e c t s growth i n M - 1 to resume o v e r t h e y e a r ahead as t h e u s u a l lagged e f f e c t s of i n t e r e s t r a t e i n c r e a s e s w e a r out and as t h e p u b l i c a t t e m p t s t o r e s t o r e b a l a n c e s d e p l e t e d by t h e r e c e n t s u r g e i n spending. The evidence I p o i n t e d o u t earlier shows t h a t t h e s e v e l o c i t y increases - __ - -c - -3- a r e n ' t s u s t a i n e d ; v e l o c i t y r e t u r n s t o more normal levels. d o e s e x p e c t t h e underlying growth rate of M-1--apart The s t a f f from ATS effects-- t o be s l o w e r i n 1979 than over t h e p a s t two y e a r s f o r two reasons: the slower nominal GNP growth, and our assumption of a downward s h i f t i n demand f o r M-1 of about two p e r c e n t a g e p o i n t s ( a g a i n a p a r t from ATS effects). Such a downward s h i f t h a s been assumed t o occur when i n t e r e s t rates moved t o high ground, and t h a t has been b u i l t i n t o our f o r e c a s t of t h e i n t e r e s t rate-money r e l a t i o n s h i p f o r about t h e p a s t year, and was e s s e n t i a l l y t h e reason why we d i d n o t f o r e c a s t h i g h e r F e d e r a l funds rates o t h e r t h a n t h e 9 - 1 / 2 t o 10 p e r c e n t r a n g e a t t h e C o m i t t e e ' s t a r g e t level. n e t h e r our l u c k w i l l c o n t i n u e i n t h i s , I d o n ' t know, but t h u s far i t has. If such a s h i f t does not develop, h i g h e r i n t e r e s t rates would be needed t o r e s t r a i n M-1 growth i f t h e Committee wanted t o s t a y w i t h t h a t p a r t i c u l a r M - 1 t a r g e t rate. O r t o p u t i t t h e o t h e r way, more growth i n M - 1 would b e needed, given c u r r e n t i n t e r e s t r a t e s . On t h e o t h e r hand-- and t h i s is a l s o a p o s s i b i l i t y - - a g r e a t e r s h i f t may develop. In t h e f i r s t q u a r t e r we have e v i d e n c e of a g r e a t e r s h i f t ; we j u s t d o n ' t b e l i e v e t h a t that w i l l be s u s t a i n e d . If a g r e a t e r downward s h i f t d e v e l o p s t h e Committee would need t o p e r m i t lower M-1 growth f o r any g i v e n i n t e r e s t rate level. The staff a l s o e x p e c t s a pick-up i n growth of M-2 and M-3 as t h e y e a r p r o g r e s s e s , as t h e s h i f t o u t of time and s a v i n g s d e p o s i t s of h i g h l y i n t e r e s t - s e n s i t i v e funds a b a t e s . But, s t i l l , recent e x p e r i e n c e s u g g e s t s -4 t h a t t h e p u b l i c i s l i k e l y t o remain q u i t e i n t e r e s t s e n s i t i v e . Thus, growth i n broader a g g r e g a t e s , t o o , i s l i k e l y t o b e much slower i n 1979 t h a n i n t h e l a s t two y e a r s . That i s t h e r e a s o n f o r t h e lower ranges of b r o a d e r a g g r e g a t e s i n t h e b l u e book a l t e r n a t i v e s . The Committee's d e c i s i o n today i s probably e s s e n t i a l l y whether t o lower t h e a g g r e g a t e s r a n g e s o r t o leave them unchanged. There i s some d i f f e r e n c e from r e c e n t Cotmnittee d e c i s i o n s i n t h i s regard i n t h a t account needs t o be taken of t h e A d m i n i s t r a t i o n ' s s h o r t - r u n g o a l s and t h e relat i o n s h i p o f t h e Committee's ranges f o r t h e a g g r e g a t e s t o t h e s e goals-that i s , under t h e procedures s e t f o r t h i n t h e Humphrey-Hawkins Act, t h a t r e l a t i o n s h i p has t o be e x p l a i n e d , a t least. There are some arguments, of course, f o r lowering t h e ranges and I would l i k e t o p r e s e n t a f e w t o t h e Committee f o r c o n s i d e r a t i o n . F i r s t , a s t e p needs t o be t a k e n t h a t w i l l move i n t h e d i r e c t i o n of reduci n g t h e rate of i n f l a t i o n over t h e l o n g run. I t h a s been a y e a r , a s I mentioned e a r l i e r , s i n c e any r a n g e h a s been lowered. Meanwhile, i n f l a - t i o n and t h e p u b l i c ' s p e r c e p t i o n of i n f l a t i o n have worsened. With r e g a r d t o t h e broader a g g r e g a t e s , a l o w e r i n g of t h e ranges would b e c o n s i s t e n t w i t h t h e apparent r e c e n t downward s h i f t i n t h e demand f o r them, and if t h e ranges a r e n ' t lowered, t h e r e i s a great danger t h a t a c t u a l growth w i l l be below t h e ranges set by t h e C o m i t t e e . F i n a l l y , lower r a n g e s may, over t h e near term, enhance confidence t h a t t h e slowing of p r i c e i n f l a t i o n can be achieved i n 1979 and t h u s w i l l h e l p i n c r e a s e t h e odds t h a t t h e A d m i n i s t r a t i o n ' s a n t i - i n f l a t i o n a r y program w i l l succeed. -5There a r e a l s o , of course, reasons f o r not lowering t h e ranges, o r f o r l o w e r i n g them w i t h caution. With r e g a r d t o M - 1 , the earlier r a n g e had been u n r e a l i s t i c ; e v e n t s seem t o b e making i t r e a l i s t i c , though b a r e l y s o , and w i t h t h e requirement t h a t we c o n t i n u e t o have c o n s i d e r a b l e luck. So t h e Committee may a c h i e v e more c r e d i b i l i t y by l e a v i n g t h e range unchanged and l e t t i n g a c t u a l growth come w i t h i n i t than by lowering t h e r a n g e and s t i l l missing a c t u a l growth. Secondly, t h e broader aggregates are h i g h l y s e n s i t i v e t o i n t e r e s t r a t e f l u c t u a t i o n s , s o that i f t h e r e ' s any thought t h a t i n t e r e s t rates might d e c l i n e s u b s t a n t i a l l y over next year--say a couple o f percentage p o i n t s o r s o - - t h e Committee might want t o leave room f o r some g r e a t e r growth i n t h e s e aggregates t h a n t h e s t a f f has projected. And as a t h i r d p o i n t I should add t h a t i f s h a r p r e d u c t i o n s a r e made i n t h e M-2 and M-3 ranges even i f t h e y a r e c o r r e c t , they might b e p e r c e i v e d p u b l i c l y as a n advertisement of a crunch and have u n f o r t u n a t e psychological repercussions. Balancing t h e s e v a r i o u s arguments I would make t h e f o l l o w i n g recommendations f o r Committee c o n s i d e r a t i o n : With regard t o M-1, one might c o n s i d e r lowering t h e p r e s e n t 2 to 6 p e r c e n t range t o 2 t o 5 per c e n t , and c o n s t r u e t h e midpoint, r a t h e r than t h e upper p o i n t , a s t h e b a s i c assumption. I t h i n k t h i s would g e t r e p o r t i n g under t h e Humphrey- Hawkins A c t o f f on a more r e a s o n a b l e and less awkward b a s i s . Such a range would leave ample room f o r changing economic circumstances w i t h i n t h e year. It would be a r a n g e I b e l i e v e that i s more realistic and more l i k e l y t o be h i t . And f i n a l l y , I would p o i n t o u t t h a t t h i s would narrow -6- t h e w i d t h of t h e range from i t s p r e s e n t 4 p o i n t s t o 3, b u t t h e 3 i s a l i t t l e b i t wider than u s u a l . I b e l i e v e , however, t h a t t h e t h r e e p o i n t s are needed because of t h e c o n t i n u i n g u n c e r t a i n t y about ATS. Implicit i n such a range would be a d e c e l e r a t i o n of M - 1 a s s o c i a t e d w i t h ATS of around 3 p e r c e n t a g e p o i n t s . Second, I would suggest lowering t h e ranges f o r M-2 and M-3 but not q u i t e by t h e dimensions i n d i c a t e d i n t h e b l u e book. The Committee may wish to l e a v e room over t h e f u l l year ahead f o r t h e p o s s i b l e e f f e c t of s i g n i f i c a n t i n t e r e s t r a t e d e c l i n e s , should t h e y develop, o r f o r o t h e r a d j u s t m e n t s such as Regulation Q c e i l i n g rates. Moreover, t h e Committee might wish t o avoid g i v i n g t h e impres- s i o n of a p o t e n t i a l c r e d i t crunch by p u b l i c a t i o n of s h a r p l y lower ranges. Thus, I would suggest f o r t h e Committee's c o n s i d e r a t i o n a r a n g e f o r M-2 of 6 to 8-112 p e r c e n t and f o r M-3, 112 p o i n t lower than a t p r e s e n t on both ends. 7 t o 9-112 p e r c e n t - - If a wider range were p r a c t i c a l i n terms o f p u b l i c r e l a t i o n s , i t would probably b e d e s i r a b l e to p u t a 112 p o i n t f u r t h e r r e d u c t i o n on t h e bottom ends of t h o s e ranges-- t h a t i s , 5-112 t o 8-112 p e r c e n t f o r M-2 and 6-112 t o 9-1/2 p e r c e n t f o r M-3. That would i n c r e a s e t h e odds t h a t growth would be w i t h i n t h o s e r a n g e s ; b u t I t h i n k i n terms of p u b l i c r e l a t i o n s i t might b e b e s t t o s t a y w i t h t h e somewhat narrower r a n g e s suggested f i r s t . Briefing f o r short-run operating decision FOMC o f 2/6/79 S. H. Axilrod Basic t o t h e a l t e r n a t i v e s the s t a f f has presented in the gluebook i s an expectation of a very considerable rebound of growth i n t h e aggregates--particularly M-1 and t h u s r e f l e c t e d i n M-2 and M-3--in February and March. Often a t the time of the Committee meeting w have some data f o r the month i n w h i c h the Comnittee e meeting i s held and have some s t a t i s t i c a l basis f o r speculation. W have none a t t h i s meeting, of course, w i t h no evidence a t a l l e about February. Our expectation i s based on the f a c t t h a t i f w e d o n ' t have a very s i z a b l e rebound, we're not even going t o have a p o s i t i v e r a t e of growth f o r M-1 f o r the f i r s t quarter on average, and we're going t o have a velocity f a r l a r g e r than w think i s e explainable, o r sustainable--given the projection of about a 13 per cent increase i n nominal GNP. Thus w r e a l l y do believe e t h a t we will have a rebound i n February and March; a 7 per cent r a t e o f growth, which is the c e n t e r o f the various a l t e r n a t i v e s , i s what we projected. I f you p u t t h e ATS e f f e c t s back i n , in e f f e c t t h a t ' s a 10 per cent r a t e o f growth on average f o r the 2 months which means we're going t o have t o have a very b i g month-- t h a t one of those months i s probably going t o be very l a r g e . Now I would l i k e t o c a l l the Committee's a t t e n t i o n again t o the t a b l e on page 14 which we p u t i n the Bluebook i n response t o the discussion o f t h e subcommittee report l a s t time and a l s o i n response t o other requests t h a t w r e l a t e the short-run a l t e r n a t i v e s e -2- more s p e c i f i c a l l y t o the long-run a l t e r n a t i v e s . Based on the midpoint of the 1-1/2 t o 4-1/2 per cent range f o r M1 shown - under a l t e r n a t i v e B, t h a t t a b l e shows t h a t from January you would . - have t o have growth in M-1 of 5.3 per cent and i n M-2 of 7.8 per cent, t o reach the low end of the range by March. And t h e range is defined as the cone based on the f o u r t h quarter of 1978. So a sharp rebound i n the coming 2 months would be consistent w i t h moving back i n t o the range t h a t the Committee has j u s t adopted i n view of t h e s h o r t f a l l s t h a t have been experienced already. I t ' s of course quite possible t h a t the aggregates will remain unexpectedly weak i n the f i r s t quarter i f the s h i f t out of money i n t o other competing a s s e t s i s even stronger than w e have allowed for. In the f i r s t quarter, we've allowed for a s h i f t not of 2 per cent b u t of 3-1/2 per cent in addition t o the ATS. So our f i r s t - q u a r t e r allowance i s much larger than we're expecting for the year as a whole. A t the same time, of course, you could get even more strength than we've projected i f the economy i s q u i t e a l o t stronger than the s t a f f projection o r i f this s h i f t d o e s n ' t develop. I t h i n k the Committee may wish t o consider whether i t ' s more important a t t h i s p a r t i c u l a r time--in the 6 weeks ahead--to guard against an excessive rebound i n the aggregates o r against continued weakness. The i n f l a t i o n problem would tend t o argue f o r guarding a g a i n s t an excessive rebound and p e r m i t t i n g some - 3continued weakness in the aggregates f o r a l i t t l e while more or a t l e a s t until signs of weakness in economic a c t i v i t y are much clearer. W have proposed an optional d i r e c t i v e paragraph e structured with a proviso clause t h a t would stress money market conditions and suggest no easing a t a l l . I t provides an option f o r t i g h t e n i n g i f the aggregates a r e r u n n i n g high, b u t no option for easing i f the aggregates are r u n n i n g weak. You could have the same e f f e c t without using t h a t optional paragraph by u s i n g the language adopted a t the l a s t meeting which would permit some t i g h t e n i n g if the aggregates were r u n n i n g strong b u t would limit the easing t o the point where the aggregates are r u n n i n g very weak--that i s , the tightening would occur i f you're rncving above the midpoint of whatever ranges a r e adopted by the Committee b u t the easing would not occur u n t i l you reach the bottom of the ranges. That may be a more preferable approach a t t h i s time since the Committee has already had 3 months o f weakness and i t may n o t wish t o have 2 more months without taking any action. Thus, the operational point becomes what ranges should be adopted both f o r the money market conditions and the aggregates i f you want t o have such an asymmetrical approach. r Therefore, M. Chairman. I would say t h a t the Committee probably might w a n t t o consider permitting a p r e t t y sharp increase i n M-2 in view of the weakness t h a t we've had and the s t r a i n s t h a t ' s -4p u t t i n g on credit conditions a t banks and a t thrifts. From t h a t p o i n t o f view, the a l t e r n a t i v e 2 range of 5 t o 9 per cent for M-2 may be quite desirable. An M-1 range somewhat lower than the associated 4-1/2 t o 9-1/2 per cent m i g h t be considered i f the Committee wants t o respond more promptly t o a rise i n the monetary aggregates. As f o r the Federal funds r a t e , s i n c e there has been no change i n t h a t r a t e since the l a s t meeting, a range such a s t h a t i n a l t e r n a t i v e 2 s t i l l permits the degree of tightening or easing t h a t t h e Cornittee was willing t o contempjate a t the l a s t meeting and I don't think conditions have changed such as t o require an adjustment i n t h a t range. Alan R. Holmes Notes For Meeting Of FOMC February 6,1979 Scott has already reported on our substantial progress in repaying swap debt. Since year-end, we have paid off Net no less than $ 1.1 billion of our Deutsche mark debt, bringing it $591 million below the level outstanding at the December Committee meeting. We have made steady progress on our repayment of current Swiss franc swap debt bringing the total outstanding down to the equivalent of $423 million a reduction of $344 million from the level outstanding at the last Committee meeting. And, of course, we have completely paid off our Japanese yen swap debt. I should note that repayment of yen debt resulted in a profit of $8.5 million, of which the System gets half. To date, repayment of current Swiss franc swap debt has resulted in a profit of $36million, shared equally with the Swiss National Bank. We have of course suffered substantial losses in our operation in Deutsch marks. As of today, our losses total $ 7 1 million, equally shared with the Bundesbank. Should we able to acquire DM at current rates to repay our outstanding debt of $3.4 billion, we would cut those losses by almost $ 2 7 million. As for our current situation, the System has about 41.7 billion in DM swaps maturing before the end of March that are not covered by previous committee decisions. All of these are fist renewals and I recommend that they be rolled over on maturity, if that should prove necessary. As far as out Swiss franc position is concerned, we have ten swaps totaling about $350 million maturing before the end of March that are not already covered by a Committee decision. I recommend that, if necessary, these swaps be renewed. They are 2 all first renewals. I should note that we acquired this morning $107 million in Swiss Planes directly from the Swiss National Bank for debt repayment. As already noted, we have repaid our yen swap debt, and have accumulated about $50 million in yen over the past few days as the dollar appreciated sharply against the yen. That acquisition was in the New York market. This acquisition, together with possibility that intervention in the market may from time to time be required to prevent too rapid appreciation of the dollar, raises the question of the System’s position with respect to the acquisition of foreign exchange assets, In my view the System would be wise to acquire a substantial amount of foreign currency under appropriate market conditions, giving us ammunition to defend the dollar later on if necessary and avoiding exclusive reliance on the swap network. This is a matter that needs solid study of the exchange risks involved, the appropriate size and composition of a foreign currency asset portfolio, and of Federal Reserve - Treasury relations in this area. We are preparing a memorandum on this subject. We plan to have it ready in time for Board staff review and submission to the Committee well before the next meeting. Meantime, however, I believe the System should be prepared to acquire yen and Swiss francs should we be able to pay off our current Swiss franc swap debt before the next Committee meeting. Acquisitions would be made only if market conditions so dictate and with the full concurrence of the Treasury and the foreign central banks concerned. I would suggest that we not exceed $500 million, with the probability that the 3 amount may be substantially less. Acquisition of Deutsche marks-except temporarjly pending repayment of swap debt-would not seem likely for some time to come. As I understand, the Committee has not established a formal limit on the amount of foreign exchange that can be acquired or held. Hood lings would be subject to the general limitations of the Committee’s limit on the System’s overall open position, but that is not much of a limitation at the moment. At the Desk, however, we have always felt constrained by the Committee discussions of fo1-eignexchange holdings way back at its December 1975 meeting. At that meeting, I proposed, and the Committee concurred, that we try to build up our foreign exchange holdings to $150 million, with the expectation that the Committee would review the situation should we reach that amount. In the event we never reached even that modest target, given the general pressure on the dollar that existed over much of the period. Last week, however, as we began to acquire yen-acquisition that seemed reasonable and desirable, and informally assented to by members of the System’s foreign exchange subcommittee and the Treasury-it appeared that we might approach the $150 million figure by the time of this meeting. He we done so, I would have felt obliged to put the matter before the Committee. On Friday, however the Bank of Japan decided to take all of our yen purchases in New York for their own account, so that our yen holdings held steady at just under $50 million. Other holdings, apart from Deutsche marks and Swiss francs which are earmarked to repay debt, amount to only $13million equivalent at the moment. It is my understanding that no formal vote is needed on the suggestions that the informal limit on the foreign currency acquisition be raised from $150 million to $500 4 million if the Committee is in general agreement. I would, however, like to have the Committee’s views. The larger amount may be needed to meet System commitments in the foreign exchange market and, I hope, can be reviewed in depth at the next Committee meeting.
@FedFRASER