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CONFIDENTIAL (FR) ALTERNATIVE OPERATING PARAGRAPHS FOR THE DIRECTIVE, AND BACKGROUND INFORMATION January 7, 1972 Recent developments (1) Since the last meeting of the Committee money market con- ditions have been eased substantially as growth in M 1 continued to fall below desired rates, as shown in the attached Table 1. of M 2 Meanwhile growth and the bank credit proxy was somewhat more rapid than anticipated as banks obtained more time and savings and U.S. Government deposits than expected. (2) In the two weeks immediately after the mid-December meeting, given preliminary evidence of weakness in M1, reserves were provided through open market operations to reduce the funds rate to around 3-7/8--4 per cent from the 4-1/4--4-5/8 per cent range of the previous two weeks. In recent days open market operations have become more aggressive, and the System Account Manager has been aiming at a Federal funds rate around 3-5/8 per cent, the minimum level discussed by the Committee at its last meeting. Since mid-December, the 3-month Treasury bill rate has dropped about 70 basis points, most recently trading around 3.35 per cent; and other shortterm rates, as well as bank prime rates, have also been reduced. With the general lowering of the short-term rate structure, System repurchase agreements have been made at 3-5/8 and 3-3/4 per cent, following suspension on December 23 of previous operating rules constraining the rate on these instruments. (3) Over the three weeks ending January 5 nonborrowed reserves of member banks (not seasonally adjusted) rose $1.7 billion, as shown in the last column of the table below, reflecting about $2 billion of System reserve supplying operations. About half of the provision of nonborrowed reserves represented normal seasonal needs. In addition, more reserves -2than earlier anticipated were absorbed by U.S. Government deposits, interbank deposits, and large CD's. Thus, despite a December seasonally adjusted increase in total reserves of 6 per cent--only slightly below expectations at the time of the last Committee meeting--achievement of the Committee's M 1 target would have required a still greater provision of reserves. Member Bank Reserves (Not seasonally adjusted, in million of dollars) Averages for weeks of Dec. 22, 29 and January 5 combined Difference: Bluebook actual less targets 1/ target Reserves supplied: Nonborrowed reserves Borrowing Total reserves Actual Cuc=clative changes for 3 weeks ending January 5 31,866 139 32,005 31,900 50 31,950 -34 89 55 1,706 30 1,736 260 275 -15 219 31 745 31 675 70 1,517 761 1,283 1,350 694 1,275 1,329 68 8 20 707 71 -2 M 2 - type deposits 28,351 28,377 -26 741 M1- 21,368 21,412 -51 641 Reserves absorbed by: Excess reserves Required--related to deposits 2 weeks earlier U. S. Gov't deposits Interbank deposits Large CD's 1/ type deposits December 10, Bluebook estimates that were considered to be consistent 5 per cent M 1 growth rate in December. (4) wi t h The following table shows changes in major financial aggregates for selected recent periods. 4th Qtr. '70 1st Qtr. '71 (March over Sept.) Total Reserves 2nd & 3rd Qtrs. '71 combined (Sept. over March) Fourth Quarter (Dec. over Sept.) 8.9 8.6 -0.8 10.3 8.1 3.1 6.5 7.2 1.1 13.6 8.5 7.9 14.5 11.2 9.5 9.4 8.1 9.5 10.7 10.2 8.7 Large CD's $ 6.8 $ 3.6 $ 2.3 Nonbank commercial paper - 0.4 - 1.0 Nonborrowed Reserves Concepts of Money M1 (Currency plus demand deposits 1/) (M1 plus time deposits at commercial banks other than large CD's) M2 M3 (M2 plus deposits at thrift institutions) Bank Credit Total member bank deposits (Bank credit proxy adj.) Loans and investments of Commercial banks 2/ Short-term market paper (Actual $ change in billions) 1/ 2/ n.a. Other than interbank and U.S. Government. Based on month-end figures. Includes loans sold to affiliates and branches. N.A. NOTE: - Not available. All items are based on averages of daily figures, except for data on total loans and investments of commercial banks, commercial paper, and thrift institutions--which are either end-of-month or last Wednesday of month figures. Proposed directives (5) Possible targets for the aggregates are shown in the table on the following page. These targets include a 6 per cent annual rate of growth for M 1 in both January and February (target I) and an 8 per cent rate in both months (target II). The first of these, if realized, would produce M1 growth for the three-month interval December-February of about 5 per cent, and the second would raise the average rate for that period to about 6 per cent. It has to be recognized that month-to-month M1 figures are variable and not subject to tight control, so that fluctuations around an average rate of growth are a reasonable expectation. (6) Presented below for Committee consideration are two alterna- tives for the second paragraph of the directive which differ with respect to the kinds of operating procedures they imply but not necessarily with respect to the monetary aggregate targets (whether I or II) the Committee may wish to adopt. As noted below, the language of alternative A is quite similar to that adopted by the Committee on December 14. Alternative B, on the other hand, places primary stress on bank reserves as the operating target variable, with a money market conditions constraint in a proviso clause. The choice of operating procedure depends in part on the Committee's relative confidence in reserves or money market conditions as bearing a more dependable relationship to bank deposit behavior. (7) The language proposed for alternative A is as follows: "To implement this policy, the Committee seeks to promote the degree of ease in bank reserve and money market conditions essential to greater growth in monetary aggregates over the [DEL: developinternational of account taking while ahead, months ments]." Possible Targets For Monetary Aggregates M1 M2 II 1971 1972 December January February 228.2 229.3 230.4 228.2 229.7 231. 2 I II 464.6 468.3 470.8 464.4 468.8 472.1 Per Cent Annual Rates of Growth 1971 1972 December January February 2.6 8.0 8.0 2.6 6.0 6.0 1971 1972 December January February 361.7 363.8 361.1 6.5 Total Reserves Credit Proxy I 9.9 11.0 8.5 II I II 361.7 364.2 362.4 32.0 32.7 32.3 32.0 32.7 32.3 Per Cent Annual Rates of Growth 1971 1972 December January February 12.4 7.0 -9.0 12.4 8. 5 -6.0 6.0 26.5 -13.0 6.0 27.0 -11.5 -6This language differs from that adopted at the last meeting (as amended on December 20) by omitting references international developments, and it money market specifications. ahead" is suggested if to the "months ahead" and to would be associated with different Omission of the reference to "months the Committee wishes to emphasize prompt attain- ment of a desired rate of growth for M 1 the aggregate hitherto lagging. The reference to international developments is omitted because reflows of funds from abroad have not been showing signs of becoming a disturbing influence on monetary policy. To the extent that pressures from this source do in fact develop, it is thought that past Committee discussion gives the Manager sufficient flexibility to cope with them. (8) A, If the Committee were to adopt the language of alternative it may wish to consider instructing the Manager to ease the Federal funds rate from the prevailing 3-5/8 per cent to the neighborhood of 3-1/4 per cent in the first week following the meeting and to the neighborhood of 3 per cent in the second week, unless a sudden surge of M1 growth were to appear. The purpose of such an instruction would be to stimulate more growth in M1 than has been apparent in the data thus far available. If such an approach were successful in moving M 1 onto the path specified by the Committee as desired, the staff believes that the odds are that the funds rate would need to be raised in the ensuing weeks in order to keep growth in M1 around the target rate, particularly if a 6 per cent target path for M1 is adopted but also perhaps under an 8 per cent target. -7- (9) The proposed language for alternative B follows: "To implement this policy, [DEL: to seeks Committee the promote market money and reserve bank in ease of degree the to] essential conditions SYSTEM OPEN MARKET OPERATIONS UNTIL THE NEXT MEETING OF THE COMMITTEE SHALL BE CONDUCTED WITH A VIEW TO SUPPLYING THE BANK RESERVES NEEDED TO SUPPORT greater growth in monetary aggregates; over while ahead, months the [DEL: developments] international of account taking PROVIDED THAT MONEY MARKET CONDITIONS DO NOT FLUCTUATE OVER AN UNDULY WIDE RANGE." If the Committee were to take this course in its operating instructions, the Manager would be guided initially in his reserve supplying operations by a target path for reserves thought to be consistent with whatever aggregate targets the Committee adopts. The estimates for total reserves, seasonally adjusted and rounded, consistent with the proposed targets I and II are shown in the table; and detailed weekly and monthly seasonally unadjusted figures have been prepared for use if this alternative procedure is adopted. (10) Operating on an aggregate reserve target would represent a departure from past Committee practice. With primary emphasis on a reserve target, the Manager would be guided in the amount of reserves he supplies during a week by the difference between the reserve target and the sum of other factors affecting reserves, and not primarily by the behavior of the Federal funds rate. The reserve target would, however, -8have to be adjusted week by week to take account of changes in the deposit mix--such as unexpected developments with respect to Treasury deposits, interbank deposits, and perhaps CD's--and also shifts in the demand for excess reserves. Such adjustments would tend to reduce the potential for day-to-day money market fluctuations, but money market conditions would still likely be more volatile than under present procedures. Since it will take time for the market and banks to adjust to the new procedures, with transitional uncertainties reflected in, for example, greater bank demand for excess reserves, reserve targets for the period immediately ahead would have to be flexible enough to allow for a potential enlargement of excess reserves. (11) Since effects on money market conditions would be a secondary consideration in the Manager's operations under alternative B, the Committee need not prejudge the direction of the funds rate, as would be the case under alternative A. Depending on developments affecting the demand for money, the funds rate under this procedure might rise or fall from currently prevailing levels, and the rate movements could be sub- stantial. Therefore, the Committee might wish to place a lower and upper limit on the funds rate, perhaps 2 and 5 per cent. These limits could apply to the weekly average, with somewhat more intra-weekly volatility permitted. In the period ahead--given past shortfalls in M1 and the announcement by the Treasury in late January of its mid-February refunding --the Committee might wish to instruct the Manager within the context of this directive to err on the side of ease, that is, to show greater resistance to interest rate increases than to declines. Table 1 STRICTLY CONFIDENTIAL PATHS OF KEY MONETARY AGGREGATES Period Path as of 1 2 Actuals& Path as of 3 Current Proj. Dec. 14 Adjusted Credit Proxy Broad Money Supply (M 2 ) 2/ Narrow Money Supply (M1 ) 1/ Dec. 14 Actuals & 4 January 5 Path as of Dec. 14 Current Proj. 6 7, 1972 Total Reserves Actuals & 7 Current Proj. Path as of Dec. 14 8 Actuals Current Proj Monthly Pattern In Billions of Dollars 1971: 1972: Sept. 227.6 45i5.6 353.3 32. 1 Oct. Nov. Dec. 228.8 227.7 227.7 228.2 464.3 4558.3 4( 60.8 4 64.6 360.9 351 .7 358.0 361.7 31.6 31.8 32.0 Jan. 229.8 (229.3) 467.6 (4 68.4) 363.0 (364.0) (32.7) 10.9 8.4 7.6 9.5 11.0 6,6 10.4 -0.8 2.9 7.9 15.8 9,0 4.8 11.2 12.4 -15.9 7.7 6.0 7.0 Annual Percentage Rates of Change-Quarterly and Monthly 1971: 1971: 1972: let 2nd 3rd 4th Qtr. Qtr. Qtt. Qtr. 9.1 18.1 10.6 12.4 4.4 7.9 3.7 2.0 1.1 7.5 -2.1 Sept. 0.5 Oct. Nov. Dec. 5.0 2.6 8.5 7.1 6.5 9.9 Jan. 5.0 ( 6.0) 8.5 10.0) 8.5 (26.0) ( 7.5) Weekly Pattern In Billions of Dollars 227.4 41 227.6 228.6 227.6 227.7 ?2l. 7 44 44 4 41 /14 228.4 228.6 779.7 NOT S:; imlIr ! i A 1) l1 a / I' tl., l h" i., tI ll .llv I tI/IM -liI f r i.i, Im i 111 11 |ll | lhlln I w ,h , Iia. .,l 'i 1l t4 .1 l. l l." lli Il i 11 i, n .I 463.4 464,1 /ih6 .O ,, II l I'"HI 1 1I. 11.i, 1 *'I- 0 p1.l 1Vun I . .iii.il l, l .,," ll 41 227.6 ,|l 1 n1 I't' i. li'.I mll rIn..tl l (1 ll1m a oir tl II I par calli , ie - l'orlI lly atlm1 t d , fl7I STRICTLY CONFIDENTAL (FR) Table l-A PATHS OF KEY MONETARY AGGREGATES Period Period Path as of Dec. 14 2Actuals& Path as of Current Proj. nec. 14 Actuals & Current Proj. 5 Path asof Dec. 14 6 Actuals & Current Proj. Nondeposit Sources of Funds C ia e N are Negotiable CDs Time Deposits other than largeCD's Total Time & Savings Deposits Deposits Govt..S. U U.S.Govt. Deposits January 7, 1972 7 Path as of Dec. 14 89 Actuals & Current Proj. Path as of Dec. 14 10 Actuals & Current Pro Monthly Pattern in Billions of Dollars Sept. 6.6 259.6 228.0 31.6 4.1 Oct. Nov. Dec. 4.7 5.4 5.8 268.4 263.3 265.3 269.9 235.5 230.6 233.1 236.4 32.7 32.2 33.5 4.8 5.4 4.0 1972: Jan. (6.0) 271.1 (273.5) 237.9 (239.1) (34.4) 1971: 1st 2nd 3rd 4th 1971: (3 Annual Percentage Rates of Change-Quarterly and Monthly 1971: 1972: 28.8 Qtr. Qtr. Qtr. Qtr. 13.0 27.5 14.0 5.3 14.7 20.8 (16.0) 14.7 8.2 15.9 Sept. 10.7 7.9 Oct. Nov. Dec. 17.1 9.1 12.0 13.7 13.0 17.0 12.0 (13.5) 12 Jan. Weekly Pattern In Billions of Dollars 1971: 1972: Nov. 17 24 5.5 5.0 265.2 266.3 233.1 234.0 32.1 32.3 5. 5.7 Dec. 1 8 15 22 29 5.1 267.1 267.9 32.6 33.2 33.0 33.6 34.0 5.4 4.7 3.8 3.9 3.8 34.1 (34.2) 5,3 6.4 5.7 5 pe 12 Jan. 267.9 268.5 269.3 269.1 270. 1 272.3 235.0 235.5 236.3 234.5 234.7 236.1 236.4 238.2 270.4 272.1 (273.1) 237.3 237.6 238.0 (238.')) 5.7 7.3 (7.1) 2 70.7 I- ___ NOTES: jIt i~ntolt It tny f I'timo)n ort r i oDwiinw Il1 |iateilntn - I'lr ll AIIIIHl Ihia illt.. otlit*r H nio 1 tIlh ll) IcIoHto m 1in0nl fi 1.1 'nJ J m nt ti tI ni , nre rmniihd to the neClre t lin 1 per cent. __ __ L- __ _ _ 3.5 (3.5) _ _I _ _ _ _ _I._ _ _ FR 712 e(v 2 / 16/7 CONFIDENTIAL (FR) Table 2 AGGREGATE RESERVES AND MONETARY VARIABLES RETROSPECTIVE CHANGES, SEASONALLY ADJUSTED (Annual rates in percent) Monetary Variables Reserve Aggregates 1 Period 3 2 Total Reserves Total Member Nonborrowed Period Reserves Bank Deposits 4 Addenda Money Supply Adjusted Credit Proxy 5 Total 8 7 6 Currency 7, 1972 January Private Demand Deposits Deposits Deposits Adjusted 9 10 Instit. Deposits Nonbank Commercial Paper Annually + 7.8 - 1.6 + 6.4 + 6.0 - 3.0 + 9.5 + 8.9 - 4.0 +11.8 + 9.7 + 0.4 + 8.3 + 7.8 - 0.2 +13.0 + 1.9 + 4.7 +17.1 +18.4 + 4.8, +11.4 + 5.6 2nd Half 1970 + 5.2 + 7.4 + 5.5 1st Half 1971 + 8.9 + 8.2 +14.6 + 9.7 +10.0 Quarterly 3rd Qtr. 1970 4th Qtr. 1970 +19.1 + 6.6 +24.4 + 9.4 +21.5 +14.6 +14.7 + 7.8 + 6.5 1stQtr. 1971 2nd Qtr. 1971 +11.0 + 6.6 +11.0 + 5.3 +16.9 +11.8 +10.9 + 8.4 + 9.1 1971 +10.4 +10.8 + 8.1 1970--Oct. Nov. Dec. - 1.9 + 3.6 +18.4 + 4.4 +22.8 1971--Jan. Feb. Mar. +12.2 +11.4 + 9.2 + 2.7 1968 1969 1970 Semi-annually 1st Half 1970 3rd Qtr. Apr. May June July Aug. Sept. Oct. Nov. NOTE: rs" rvi hAro.er al II) ilI t l n I1li l l lr +17.0 + 0.2 + 0.3 +14.7 +15.8 -15.9 + 7.7 + 7.4 + 6.0 + 6.5 +11.3 - 4.9 +17.9 + 6.3 + 3.4 + 7.8 n.a. + 7.3 + 5.1 + 5.1 + 8.4 +26.3 + 4.7 +10.6 +12.8 + 1.7 + 8.6 +10.5 +22.3 +20.9 -18.2 + 5.0 + 5.8 + 6.9 + 3.2 +30.4 +20.6 + 9.3 +11.6 -16.2 +20.4 +10.6 + 8.2 + 8.8 + 9.4 +11.3 +28.8 +14.7 +23.3 +17.4 -24.7 -12.5 + 7.6 + 3.7 + 6.3 + 2.8 + 8.2 +12.8 - +10.9 +12.4 +19.9 + 1.8 + 6.3 +15.1 + 1.7 + 2.8 + 6.7 + 5.0 + 4.9 + 7.4 + 0.7 + 2.2 + 6.5 +20.9 +14.6 +25.2 +10.6 + 9.4 +14.5 +32.4 -28.7 -58.1 + 8.8 +15.1 + 8.8 +16.2 +10.2 +11.9 +10.3 + 2.8 +13.4 +11.0 + 7.3 + 9.7 + 7.2 + 1.4 +14.5 +12.1 +28.8 +29.7 +26.0 +25.1 +18.5 +24 .9 - 9.0 -10.9 -55 .2 + 9.7 +12.4 - 6.2 +15.9 +12.5 + 8.2 +14.1 + 9.1 +12.0 + 7.1 + 7.1 + 7.1 +16.2 +10.4 +13.2 +15.5 +14.8 +21.8 + 4.4 + 6.7 + 8.5 + 8.8 + 7.7 +14.2 +15.4 -15 .8 -26.3 -13.1 +16.1 +29.6 +11.2 + 5.6 + 7.3 +10.7 + 4.1 + 7.9 +10.1 + 3.2 - 2.1 +11.7 + 2.3 + 4.6 + 8.9 + 3.4 - 4.1 + 9.4 + 4.2 +15.9 -32.1 + 8.5 - +10.7 +1 3.8 11.6 -13.0 + 5.6 + 2.1 4 9.9 + 4.8 +11.2 + 0.5 + 6.9 - 1.4 +17. 1 +11.8 *10.0 +30.1 -18.6 +17.8 +16.1 + 3.2 + 5.4 + 3.8 L It requIltreA t ntl a unt reerve e r ihtll ee Int pArca nli(ia to enll Iul,.l tsortes hivn 1, , ol nlllI I ,, , nllf0nl - | n.t l l ,1,| i I1 i1. 1t 1, I I ' 'l , ritid I 'lll n rl l llnl d I I 1, nI I u, I d,1l l iipn nil Irrl + 9.1 . t. rit det H 1in , ,lt i ...t ,r verr i.. l,' I i iI ,( h , 1m1I' |>i )Io r rlflI 1 "'It I1-1 n.. 1.0 1.7 Ffl '.n r 171-? 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