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MEMORANDUM OF DISCUSSION

A meeting of the Federal Open Market Committee was held in
the offices of the Board of Governors of the Federal Reserve System
in Washington, D.C., on Tuesday, January 14, 1969, at 9:30 a.m.
PRESENT:

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

Martin, Chairman
Brimmer
Daane
Galusha
Hickman
Kimbrel
Maisel
Mitchell
Morris
Robertson
Sherrill
Treiber, Alternate for Mr. Hayes

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

1/14/69
Mr. Wernick, Associate Adviser, Division
of Research and Statistics, Board of
Governors
Mr. Keir, Assistant Adviser, Division of
Research and Statistics, Board of
Governors
Mr. Bernard, Special Assistant, Office of
the Secretary, Board of Governors
Miss Eaton, Open Market Secretariat
Assistant, Office of the Secretary,
Board of Governors
Messrs. Eisenmenger, Eastburn, Snellings,
Baughman, Jones, Tow, Green, and
Craven, Vice Presidents of the Federal
Reserve Banks of Boston, Philadelphia,
Richmond, Chicago, St. Louis, Kansas
City, Dallas, and San Francisco,
respectively
Mr. Meek, Assistant Vice President, Federal
Reserve Bank of New York
By unanimous vote, the minutes of
actions taken at the meeting of the
Federal Open Market Committee held on
December 17, 1968, were approved.
The memorandum of discussion for
the meeting of the Federal Open Market
Committee held on December 17, 1968,
was accepted.
The reports of audit of the System
Open Market Account and of foreign cur
rency transactions, made by the Board's
Division of Federal Reserve Bank Operations
as at the close of business on October 18,
1968, and submitted by Mr. Schaeffer, Chief
Federal Reserve Examiner, were accepted.
Before this meeting there had been distributed to the members
of the Committee a report from the Special Manager of the System Open
Market Account on foreign exchange market conditions and on Open Market

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-3

Account and Treasury operations in foreign currencies for the period
December 17, 1968, through January 8, 1969, and a supplemental report
covering the period January 9 through 13, 1969.

Copies of these

reports have been placed in the files of the Committee.
In supplementation of the written reports, Mr. Coombs said
that the Treasury gold stock was unchanged again this week.

The Bank

of Italy had taken $76 million of gold last week and the Swiss wanted
$50 million, but there were no other orders in sight and the Stabili
zation Fund still had a balance of $450 million on hand.
On the London gold market, Mr. Coombs continued, the price
was up again this morning, to $42.40.

The recent increases reflected

the continuing uncertainty over U.S. gold policy, Middle East tensions,
and the progressive erosion of the overhang that had resulted from
last winter's official gold sales.

He expected further trouble from

the gold market in the months to come.
On the exchange markets, Mr. Coombs observed, sterling had
failed to show any improvement despite the fact that seasonally favor
able influences generally produced inflows to Britain at this time of
year.

The recent squeeze in the Euro-dollar market had been a handicap

in that it increased the disadvantage against sterling, and the Bank
of England might have to take some action to improve that relationship.
However, the basic difficulty lay in Britain's foreign trade balance.
Figures just released this morning showed that Britain had had a trade

1/14/69

-4

deficit of 55 million pounds in December, as compared with 17 million
pounds in November.

Market confidence in sterling remained at a low

ebb, and, as he had said on earlier occasions, he shared the market's
view that the present $2.40 parity might well prove untenable.

He

was afraid that most of the European central bankers felt the same way.
In his judgment, in the event of a new sterling crisis it probably
would not be possible for Britain to obtain new credits from those
European central banks that held substantial reserves.
In effect, Mr. Coombs said, the devaluation of November 1967
had proved to be a failure.

In the period of just over a year since

devaluation, the Bank of England had had to take additional credits of
$3.4 billion--more than ever before in a comparable period--with the
result that Britain's external debt burden had approached the point
of unmanageability.

While some progress in restructuring the debt had

been made last summer, heavy instalment payments on the British debt
to the International Monetary Fund and to others would fall due this
year.

Unless the scheduled payments to the Fund were deferred until

next year or later, the British might well be drawing on their swap
line with the System to pay the Fund.
a travesty.

That, in his judgment, would be

He gathered that the Fund was prepared to accept some

postponement of its claims and he hoped that the incoming officials of
the U.S. Treasury would press for early action on that matter.

Mean

while, the Bank of England still had available a little more than $200

1/14/69

-5

million under existing credit lines with European central banks.

He

had suggested that they might use those lines before drawing further
on the System.
Mr. Coombs remarked that the French franc had been stabilized
temporarily by unusually severe exchange controls, but the state of
market confidence was well reflected in discounts on forward francs
of 9 or 10 per cent.

The French trade figures for December showed a

further deterioration from the already poor figures for November and
wage negotiations scheduled for March were expected to cause further
dangerous strains.

The general view of the European central bankers

was that the French Government had succeeded only in postponing the
inevitable.
Mr. Coombs observed that the only bright spot in recent ex
change market developments had been the outflow of money from Germany,
the volume of which had been astonishing.

From the date of the Bonn

meeting through the end of December the net outflow had very nearly
equaled the massive inflow during the first three weeks of November.
Another $1 billion had moved out of Germany since the turn of the year,
providing a much-needed offset against the heavy demand for Euro-dollars
by U.S.

banks.

How long the outflow would continue was problematical.

The German economy was moving toward full capacity now, and if wage
and price pressures developed the German Federal Bank might conclude
that it could no longer maintain its present easy money posture.

-6

1/14/69

Moreover, German Government officials continued to hint at revaluation.
Mr. Schiller kept referring to the need for realignment of currency
parities, and as the Committee members might have noted, Dr. Blessing
recently acknowledged publicly that the German Federal Bank had recom
mended a revaluation of the mark at the time of the Bonn conference.
At the Basle meeting during the past weekend, Mr. Coombs con
tinued, some individual central bankers had expressed concern about
the impact on their money markets of the recent credit tightening in
the United States.

However, there was a general feeling that the

Federal Reserve's actions had been essential to break the wave of
inflationary psychology that was prevalent not just in the United States
but world-wide.
Much of the discussion at the Basle meeting, Mr. Coombs said,
was concerned with the subject of "recycling" speculative flows that
had first been broached in November and had subsequently been considered
in several meetings of technical advisers.

Three main approaches were

suggested of which the first, proposed by Governor Carli of the Bank
of Italy, would involve a fully automatic, open-end arrangement under
which flows of speculative funds would be rechanneled back by the central
bank of the recipient country.

That approach was flatly rejected by all

of the others, and even the Italians finally backed away from it.

The

second suggestion was advanced by the Belgians, who in the past had not
been overly sympathetic to the System's swap network.

It involved a

1/14/69

-7

grandiose plan for an intra-European swap network, in which each central
bank would have swap lines with all others.

The Belgian plan would have

led to large-scale pyramiding of commitments and was unanimously rejected
as simply unworkable.

The third suggestion had been advanced partly at

the instance of the U.S. representatives at the meeting.

It called for

a system of voluntary deposits in the Bank for International Settlements
by central banks of countries receiving speculative flows.

Those deposits

would then be relent to the central bank of the country losing funds,
with a collective guarantee on the loans by all participating central
banks.

That proposal also met with objections, mainly on the matter of

guarantees; few of the central bankers present thought they had legal
authority to provide such guarantees.

The fact that acts of parliament

would be needed in a number of countries appeared to present an insur
mountable obstacle to early--and perhaps even eventual--implementation
of such a plan.
Mr. Coombs noted that the governors of only two central banksO'Brien of England and Brunet of France--expressed any real sympathy for
going beyond the credit arrangements already in place, which consisted
of the Federal Reserve swap network and various ad hoc arrangements.
Mr. Hayes and he (Mr. Coombs) felt that something had to be done in
response to the statement in the Bonn communique that a study would be
made of means for alleviating the impact on reserves of speculative
movements.

In an effort to break the impasse at Basle they had suggested

-8

1/14/69

a fourth approach involving a single swap network.

In effect, each

participating central bank would extend a credit line to the BIS,
thus providing a pool of reserves that could be made available to a
central bank experiencing a speculative outflow.

Such an arrange

ment, in itself, would not be adequate to deal with a situation in
which the inflows of hot money were concentrated in a single central
bank; for example, if only the German Federal Bank were experiencing
inflows, other central banks might have insufficient funds to support
credits to the countries losing funds and the Germans presumably
would be unwilling to bear the entire credit risk.

Accordingly, the

plan had a second element under which the central bank gaining reserves
would rediscount credits extended by others to central banks losing
reserves.

For example, if there were a speculative flow from France

to Germany, the Netherlands might participate in extending credits
to France through the BIS, raising the funds by rediscounting the
credits with the Germans.

In effect, Germany would still be providing

the funds to France but their risk exposure would be minimized since
the paper would bear the names of the central banks of both France
and the Netherlands.

While there was more hope for that proposal than

for the other three, he could not say whether it would be considered
acceptable.

In light of the statement in the Bonn communique, the

market was likely to construe a failure of a recycling plan to emerge
as a breakdown in international cooperation.

1/14/69
Finally, Mr. Coombs said, he might refer briefly to the ques
tion Mr. Maisel had raised at the previous meeting of the Committee
relating to possible conflicts between the System's foreign currency
operations and domestic credit policy.

He (Mr. Coombs) thought that

Mr. MacLaury had given an excellent response at the meeting.

In

addition, Mr. MacLaury currently was preparing a memorandum on the
subject that Mr. Coombs thought would relieve any apprehensions in
that area that the members might have.

As that memorandum would

indicate, operations of the types Mr. Maisel had referred to had been
undertaken only at times, such as year-ends, when the domestic Desk
was also operating in the same direction.

In general, such foreign

currency transactions had in no way impeded domestic operations.
Mr. Daane asked whether there had been any evidence of
restiveness with respect to the gold situation at the Basle meeting.
Mr. Coombs replied that there had been a great deal of
restiveness on that subject in Basle.

The European central bankers

were being subjected to questions at home as to whether any change
in U.S. gold policy was likely and whether their countries were
adequately protected in the event of such a change.

It was their

hope that the new Administration would make a forthright statement
on gold soon.
By unanimous vote, the System open
market transactions in foreign currencies
during the period December 17, 1968,
through January 13, 1969, were approved,
ratified, and confirmed.

-10

1/14/69

Mr. Coombs reported that three drawings by the System on
the Swiss National Bank would reach the end of their current three
month terms soon.

They included drawings of $50 million and $30

million which would mature for the first time on January 28 and
February 4, 1969, respectively; and a drawing of $40 million, which
would mature for the second time on January 31.

The System had a

total of $320 million in drawings outstanding on the Swiss National
Bank, and he had talked with the Swiss officials during the weekend
about possible arrangements to permit the System to repay soon an
amount on the order of $200 million.

Any such arrangements probably

would include the issuance of a Swiss franc-denominated bond by the
U.S. Treasury as a major component.

If those arrangements were

completed it might prove possible to repay the three drawings in
question before their maturity dates.

Otherwise, however, he would

recommend their renewal for further periods of three months.
Renewal of the three drawings
on the Swiss National Bank was noted
without objection.
Mr. Coombs then reported that two drawings on the Federal
Reserve by the Bank of France would mature on February 13, 1969.
One, of $15 million, would be reaching the end of its first three
month term then; the other, of $50 million, already had been renewed
once.

As the Committee knew, the Bank of France had made a fair

amount of progress in paying down its swap debt to the System over
the past month.

However, they had managed to do so by using the

1/14/69

-11

exhaustible resource of dollars held by their commercial banks and
citizens.

He would recommend renewal of the two drawings in question

if the French were unable to repay them at maturity.
In reply to a question by Mr. Mitchell, Mr. Coombs said that
many drawings by the System and by other parties under the swap lines
had remained outstanding for periods of six to nine months, and some
had remained on the books for longer periods.

It was his recollection

that only a few had been outstanding for slightly more than a year.
Renewal of the two drawings by
the Bank of France was noted without
objection.
Before this meeting there had been distributed to the members
of the Committee a report from the Manager of the System Open Market
Account covering domestic open market operations for the period
December 17,

1968, through January 8, 1969, and a supplemental report

covering January 9 through 13, 1969.
been placed in
In

the files

Copies of both reports have

of the Committee.

supplementation of the written reports,

Mr.

Holmes commented

as follows:
As the written reports to the Committee indicate,
the financial markets reacted vigorously to the tight
ening of monetary policy voted by the Committee at
the last meeting. Most observers have interpreted
the System moves as a determined drive against the
forces of inflation. Currently, a debate is raging
as to whether the markets and the banking system
face a lengthy period of sustained pressure or a
shorter period of intense pressure that soon will be

1/14/69

-12-

reversed if and as the economy cools off. In this
atmosphere, I fear the System faces the delicate
task of letting the markets settle down after having
weathered the turbulence of year-end, while avoiding
any impression that we are loosening up on the policy
reins. Interest rate levels reached just before
Christmas were probably too high--if sustained--to
avoid an overly severe squeeze on bank CD's with
attendant problems in all financial markets. Current
rate levels are more consistent with a manageable
degree of pressure on the banks, provided that the
banks are not overwhelmed by a precautionary wave
of borrowing by business firms. Indications that a
major part of the money repatriated from abroad by
U.S. firms at the year-end may be used at home provides
at least a glimmer of hope on that score.
Interest rates in all maturity areas quickly
rose to new record highs following the System's dis
count rate and open market actions and the increase
in the prime rate, reaching their peaks just before
Christmas. Since then rates have tended to move
lower, with a temporary reversal of the movement
when the prime rate was raised once again on January 7.
The three-month Treasury bill rate--which touched a
peak of 6.29 per cent on December 24--closed last
night at 6.13 per cent, after broad-based demand at
the new rate levels before and after the year-end
had brought dealer positions down sharply. Trading
volume reached an all-time high during the period,
straining the facilities of the clearing banks and
causing for the first time some concern about fail
problems in the Government market. In yesterday's
regular Treasury bill auction average rates of 6.21
and 6.37 per cent were established respectively for
three- and six-month Treasury bills, up about 1/4
and 3/8 percentage points from the rates established
in the auction just preceding the last Committee
meeting.
Yields on intermediate- and long-term Government
securities followed roughly the same pattern as Treasury
bill rates--rising precipitously before Christmas
and declining thereafter--although there was a sharp
reaction to the January 7 prime rate increase. The
willingness of dealers to cut prices, despite the

1/14/69

-13capital losses involved, permitted sustained market
activity, with dealer positions in coupon issues of
over 1-year maturity declining by $347 million since
December 16 to $117 million by the close of business
last Friday. The market is thus getting into a good
technical position for the forthcoming Treasury re
funding, although whether much enthusiasm can be
generated remains to be seen. Dealers have been
generally hard hit by the price movements of the last
six weeks, but have been sustained by the hope that
a successful drive against inflation will mean better
days for the bond market in the months ahead.
Open market operations over the period were
directed first at moving decisively to firmer money
market conditions and then at maintaining pressure
while trying to prevent interest rates from going
through the roof. It was of considerable importance,
we felt, to signal to the market early that the change
in the discount rate was more than a technical reaction
to the already prevalent increases in market rates.
Thus, on the first day of the new statement week
following the last Committee meeting, with projections
indicating a possible need to absorb reserves, the
System sold Treasury bills in a market go-around
despite a somewhat shaky atmosphere in the market.
Although a total of only $187 million of bills was
sold the market got the message immediately. No
further outright sales were made in the market until
last Friday, although substantial sales on balance
for foreign account tended to put pressure on the
market from time to time. For much of the period,
of course, the System was meeting seasonal reserve
needs. Outright purchases amounted to $518 million
in the market and to nearly $800 million from foreign
accounts, while repurchase agreements were used quite
extensively.
Bank reaction to the tightening of monetary policy
was, of course, exacerbated by the usual year-end
turbulance which was strengthened by the fact that
holidays fell on the final day of the last two state
ment weeks of the year. Banks therefore tended to
manage their reserve positions cautiously. Money
market banks bid aggressively for Federal funds early

1/14/69

-14-

in the statement week--pushing rates into new high
ground and accumulating more reserves than they
really needed to meet their requirements. Thus, both
borrowings and excess reserves were unusually high in
the statement weeks ending December 25 and January 1,
with the Federal funds rate easing off on the final
day of each of the last three statement weeks. Looking
to the future, I have little to add to the discussion
of prospective developments in the blue book.1/ I
suspect that money center banks will make every effort
to avoid the capital losses involved in major adjust
ments of their investment portfolios by bidding aggres
sively for Federal funds, Euro-dollars, and foreign
official time deposits. Last week there was some
evidence that some of the non-money market banks, who
are the providers of Federal funds, were being lured
by attractive rates into Treasury bills and other
investments. If this development should proceed very
far, the Federal funds rate could settle at or above
the upper end of the range suggested in the blue book
as being consistent with an unchanged stance for mone
tary policy. The Euro-dollar market has also felt the
impact of the tighter situation--rates there rose to
8 per cent or more on up to three-month maturities as
the major banks built their holdings back to mid-December
levels after the seasonal decline at year-end. Euro
dollar rates normally decline in January; they have
recently come off their peaks but it is probably too
early to predict developments there with any certainty.
As far as foreign official deposits are concerned,
New York banks have paid as much as 7-1/2 per cent for
one-month money and 7-1/4 per cent for three-month
money, far above the Q ceiling for private deposits.
Basically, it seems to me, we are in a race between
a seasonal slackening of pressure on interest rates
and a counter-seasonal pressure on bank CD's arising
from the relation of market rates to the Q ceiling.
The outcome cannot be predicted with confidence and we
may have to put up with substantial variations in rate
and reserve relationships from those that seem most
likely at the present time.

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

1/14/69

-15-

As you know, the Treasury is auctioning today $1-3/4
billion of June tax bills, with banks permitted to pay
for their bills through credit to tax and loan accounts.
The banks were rather disappointed with the meager value
of the tax and loan account privilege at the last auction
of tax bills and are approaching the new auction with
some caution. Nevertheless, given the better technical
position of the bill market, adequate bank bidding is
anticipated and the market, which expects to have to take
on a large proportion of the bills awarded to banks over
a short period, seems to be taking the auction in stride.
As the blue book notes, the Treasury may still need $1-1/2
to $2 billion of new money by early March. Whether or
not a major part of this amount can be raised in conjunc
tion with the February 15 refunding remains to be seen.
The refunding, which should be announced on about January
29, involves a total of $14-1/2 billion of maturing issues,
of which $5.4 billion are held by the public. Banks hold
a rather large percentage of the public holdings, and there
may be a tendency for some of the larger banks to let
their holdings run off as part of their current portfolio
adjustment program. At current yield levels the Treasury
will have to offer an attractive coupon--perhaps 6-3/8
to 6-5/8 per cent, depending on maturity. And this in
turn may create new problems of disintermediation for
the banks and thrift institutions. The new Treasury debt
management team, whoever they may be, will thus be faced
with major decisions in their first ten days in office.
The System holds $1,140 million of the maturing 4
per cent bonds and $7,441 million of the maturing 5-5/8
per cent notes. It would appear likely--given the size
of the public holdings--that the Treasury might decide
to offer a short-term and a somewhat longer-term note.
In that event I would plan to distribute the System's
subscriptions between the two issues in accordance with
the amounts offered to the public if it is a cash
exchange, or in accordance with expected public sub
scriptions if the Treasury decides on a rights exchange.
Mr. Mitchell commented that growth in various aggregate
monetary measures--bank time deposits, the narrowly defined money
supply, and the bank credit proxy--had been disappointingly large
in December for reasons that were not wholly clear to him.

He

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noted, however, that the staff projected a decline in time deposits
and only a small increase in the credit proxy in January.

He wondered

if the Manager thought these projections were likely to be realized,
given the present posture of monetary policy, and how long credit
markets would be able to sustain the current degree of restraint.
Mr. Holmes replied that under the current interest rate re
lationships the annual rate of bank credit growth in January might
well be reduced to a figure in the neighborhood of 2 per cent, as
projected in the blue book.

He thought, however, that the impact of

such slower growth was likely to be tempered for a while by the fact
that expansion in bank credit had been rapid before the year-end and
also by the fact that growth of total credit probably was not being
curtailed as sharply as that of bank credit.
In response to further questions by Messrs. Mitchell and
Hickman, Mr. Holmes indicated that he found it difficult to explain
short-run movements in the money supply.

He did not think thatthe

relatively rapid growth projected for January--an annual rate of 7 to
10 per cent--was related to changes in Treasury cash balances at
commercial banks; it was his recollection that those balances were
expected to increase somewhat on average from their December level.
Mr. Keir confirmed that Treasury cash balances were projected
to rise slightly in January from their average December level.

The

relatively high growth rate projected for the money supply in January

1/14/69

-17

resulted from a bulge in demand deposits around the year-end.

That

bulge served to augment the average level of the money supply for
January as a whole even though sizable declines in money balances
were projected to occur over the course of the month.

He added that

he could offer no plausible explanation for the rapid expansion in
money supply at the year-end beyond the tentative reasons given in
the blue book.1/
Mr. Bopp remarked that he found it difficult to understand
one of the explanations for the year-end bulge in the money supply.
He did not see how payments by corporations into their pension funds
could occasion a change in demand deposits for the banking system as
a whole.
Mr. Keir said the staff presumed that holdings of temporary
cash balances had risen sharply around year-end partly because
investors holding liquidity balances earmarked for payment of commit
ments on long-term investments were unwilling to invest those balances
temporarily in short-term assets at a time when the risk of further
sharp increases in short-term rates appeared to be high.

In the case

of payments by corporations to their pension funds, an increase in idle

1/

The blue book passage referred to by Mr. Keir read as follows:

"No obvious explanation is at hand for the very recent money supply
growth, although it is possible that large transfers around year-ende.g., corporate payments to pension funds, repatriation of liquid
funds from abroad, and churning associated with switches from CD's to
market securities--may have led to some temporary accumulations of
cash in a period of uncertainty."

1/14/69

-18

cash balances could result because such funds were typically managed
by a separate trustee and the parent corporation usually had to sell
short-term securities from its own portfolio in order to allocate
funds--in the form of cash--to the trustee.
In answer to a question by Mr. Heflin, Mr. Holmes indicated
that while the prospective CD run-off in January would depend importantly
on the course of interest rates, he thought that under prevailing
market conditions CD losses could be as high as $2 billion in January.
He would expect the losses to continue largest at major New York banks.
Mr. Daane asked Mr. Holmes whether the market seemed convinced
of the System's determination to carry forward its policy of restraint
or whether the skepticism reported in some market letters was wide
spread.
Mr. Holmes replied that opinions on the matter were divided.
Some market participants were convinced that System policy would
continue on its present course, while others thought it likely that
signs of cooling in the economy would be followed by some reduction
in the present degree of restraint.

The market was watching the

System's actions closely for clues about the future direction of
policy.
By unanimous vote, the open
market transactions in Government
securities, agency obligations, and
bankers' acceptances during the
period December 17, 1968, through
January 13, 1969, were approved,
ratified, and confirmed.

-19-

1/14/69

The Chairman then called for the staff economic and financial
reports, supplementing the written reports that had been distributed
prior to the meeting, copies of which have been placed in the files of
the Committee.
Mr. Wernick made the following statement concerning economic
developments:
Recent thinking, which has emphasized the undiminished
upward momentum of the economy, may now have to face up
to the possibility of a change in the course of economic
events. Since the last meeting of the Committee, there
have been two significant developments which could well
alter businessmen's spending decisions. First, the
recent turn to tighter money markets has revived memories
of the 1966 credit crunch and its aftermath of slow eco
nomic growth and reduced profit margins. Second, the
apparent recent weakness in retail sales does not support
the much publicized notion that the affluent consumer
will continue to spend freely regardless of fiscal or other
restraints. In fact, the spurt in consumer spending after
midyear, following the passage of the tax surcharge, now
appears to have been relatively short-lived. While some
of the loss of sales at year-end--retail sales fell 2
per cent in December--must be credited to the flu and
erratic statistics, slackening nevertheless seems to have
begun much earlier in the fall.
In retrospect, anticipatory buying on the part of
consumers last summer appears to have been limited mainly
to the purchase of 1968-model cars prior to the introduc
tion of the higher priced new models. Not long after the
new models were introduced, automobile sales began to
edge off; they were down to an 8.5 million rate in December
compared to over 9 million in September and October, and
early January sales were not strong. Nondurable goods
sales were not much above midsummer levels even before
the slide-off in December.
The official GNP estimates made available today,
therefore, indicate that the rise in consumer expenditures
slowed dramatically in the fourth quarter to about $5
billion compared with more than $13 billion in the third
quarter.

1/14/69

-20-

In contrast to the caution in spending now being
indicated by the consumer, business optimism continues
strong. In December the production index rose another
one per cent, employment advanced rapidly, unemployment
remained at the 15-year low of 3.3 per cent, and indus
trial price increases were widespread.
And for the fourth quarter as a whole, a sharper
rise than anticipated in fixed investment expenditures
and a rapid step-up in inventory accumulation helped to
sustain current-dollar GNP growth at almost the previous
quarter's rate. But with the price deflator accelerating,
the annual rate of real growth declined significantly in
the fourth quarter to a 3.7 per cent rate, well below
the average of over 6 per cent in the first half of the
year and a 5 per cent rate in the third quarter.
Probably of most significance for the short-run
outlook has been the latent weakness in the economy in
herent in the sharp run-up in inventories starting in
late summer. Based mainly on October-November data,
inventory accumulation is estimated to have been at an
annual rate of $10 billion, on a GNP basis, a faster
pace of stockpiling than in the previous quarter despite
continued liquidation of steel stocks and a leveling
off in defense inventory growth. Moreover, the easing
of retail sales and the further large increase in indus
trial production in December suggest that the final
figures for inventory accumulation for the fourth quarter
as a whole could be even larger than the present Commerce
estimate. Thus, with stocks rising more rapidly than
sales, the stock-sales ratio for business inventories
as a whole at year-end was probably only slightly less
than it had been two years earlier, just prior to the
large inventory adjustment of 1967.
Looking to the future, it seems highly doubtful
that the recent rate of growth can long be sustained if
it stems primarily from excessive inventory accumulation

and rising investment expenditures in the face of the
increasing number of factors acting to limit over-all
demands. Slower growth in consumer spending has apparently
now been added to the leveling in Federal Government
expenditures as a source of reduced stimulus in the
economy. The Federal Budget will be moving strongly into
a large surplus in the second quarter. Market interest
rates have moved up sharply and reduced availability of
funds should begin, with a moderate lag, to curb construc
tion activity.

1/14/69

-21-

It is possible that consumer expenditure growth
could rebound somewhat in the next month or two, given
the special factors lowering December sales and the
volatile movements that have come to be expected in this
series. But there is little evidence pointing to any
sustained resurgence. The impact of the increase in
social security taxes and retroactive 1968 tax payments
on disposable income is a major consideration. Moreover,
special influences which sparked unusually large income
gains in 1968, such as the large minimum wage increase,
substantial hikes in social security benefits, and ex
tensive front-loading of first-year labor contracts,
should be less significant counters to income restraints
this year. And given further rapid consumer price in
creases, real after-tax wage gains will at best be minimal
this year. In any event, consumers will have to reduce
their saving rate further to maintain even the moderate
rate of growth in their spending we have assumed in our
projections.
On the other hand, expenditures for plant and
equipment will probably continue at a rapid pace. Stepped
up spending plans are unlikely to be quickly reduced or
abandoned as long as costs are rising and businessmen
hold to their longer-run fears concerning inflation.
Changes in investment outlays also tend to lag other
sectors; in the past they often have continued to rise
fairly rapidly even after over-all economic expansion
had moderated considerably. However, with the relatively
high inventory overhang, business efforts to stem a
growing imbalance between output and consumption may
become necessary before the quarter is over and industrial
production could begin to level off. Without the thrust
from inventory building we experienced last quarter, GNP
growth would moderate further this quarter.
By next quarter, the underlying factors slowing final
demands in the economy seem likely to become more pervasive
as stock building continues to ease and the impact of
credit restraint begins to limit construction activity.
However, with pressure on industrial prices still likely
to be widespread, and inflation continuing to be important
in business investment and spending decisions, it seems
unlikely that the rate of price rise will moderate signif
icantly so soon.

1/14/69

-22-

But if we make headway in moderating rates of ex
pansion in real growth to perhaps a 1-1/2 to 2 per
cent rate in the second quarter, pressure on resources
and prices should begin to ease somewhat and the rise
in the price deflator could be reduced to about a
3-1/2 per cent rate before midyear. Since costs would
still be under upward pressures--at least from decelera
ting productivity if not from accelerating wages--further
progress would probably require maintaining the surcharge
and other constraints on demands for a longer period of
time. But an evaluation of the second half of the year
will have to wait until the next meeting, when we have
had a chance to assess the new Federal Budget, which we
will receive in the next day or two.
In summary then, it appears that the real growth in
the economy has begun to moderate and that prospects for
slowing demands appreciably further before midyear seem
more realizable now than earlier. But at the same time,
the prospects for a gradual slowing in the pace of
economic growth which we have projected could be threatened
by persistent business expectations of further inflation
and their spending decisions based on these expectations.
Continued restraint in both monetary and fiscal policy
would seem to be called for in the present situation to
maintain pressure on demands in order to dampen unwanted
excesses.
Mr. Keir made the following statement regarding financial
developments:
The shift to a tighter monetary policy since the last
meeting of the Committee has pushed the CD accounts of
major money market banks well beyond the point of disin
termediation. Consequently, a sharp cut-back in bank
credit growth is now under way. With sizable further CD
attrition generally anticipated during the rest of January
and February, the principal financial question facing the
Committee this morning is whether a policy of maintaining
the tighter money and credit market conditions now prevailing
would risk a credit crunch--assuming no change in CD rate
ceilings.
The evidence available on CD attrition through early
January indicates that the run-off thus far has been heavily
centered on the relatively small number of major money market

1/14/69

-23-

banks that typically finance a sizable part of their
reserve needs in markets for interest-sensitive funds,
here and abroad. Smaller banks, that have less ready
access to Euro-dollars and concentrate more on CD sales
to less interest-sensitive regional customers, have not
as yet been subjected to very severe reserve drains.
Even so, CD run-off in December totaled about $1.5
billion and the estimate for January is roughly the same.
Since banks usually add to outstanding CD's in January,
this estimate is equivalent to about a $2 billion run
off, seasonally adjusted, or three times the comparable
figure for December. This suggests that reserve pressures
from CD attrition will cumulate further as January pro
gresses, unless yields on competing market securities
decline or Euro-dollars can be reasonably obtained to
provide an offset.
Most recently, yields on U.S. Government securities
have receded somewhat from their earlier record highs.
To some extent this has reflected special demands for
short-term securities--in part from the proceeds of
maturing CD's--at a time when dealers' positions have
been quite low. But the yield declines also seem to
have reflected a more fundamental change in market
judgment about the likely outcome of the CD squeeze.
Apparently, the relative absence of stepped-up bank
security liquidation has encouraged some market parti
cipants to believe that major banks can avoid large
security sales, at least for the time being, and continue
to cover the bulk of their CD run-off through short-term
borrowing from other sources. This judgment has probably
been reinforced by reports that the prime rate action
and some other credit rationing measures are now tending
to limit business loan volume. Moreover, while some
banks have reportedly become a bit restive because
seasonal business loan repayments have been sluggish,
the general impression received by the market is that
there is as yet little evidence of strong new pressures
from would-be corporate borrowers. There is a general
attitude of caution at banks regarding the sizable volume
of binding loan commitments that have been made to good
customers. But to some extent even these are read as a
moderating influence that may tend to keep corporate
customers from feeling compelled to anticipate future
financing needs by actually drawing on their credit lines.

1/14/69

-24-

This generally more relaxed market appraisal of the
chances for a credit crunch may, of course, be too relaxed,
since it seems to assume that all the pieces of the puzzle
will fall rather neatly into a reasonable equilibrium.
One major roadblock that could upset this equilibrium is
the large volume of Treasury borrowing operations due in
the market over the next few weeks.
As Mr. Holmes has noted, after today's tax-bill fi
nancing the Treasury must refinance sizable public holdings
of its maturing February securities and in addition raise
perhaps another $1.5 to $2 billion of new money by early
March. Since the banking system is already under general
pressure from CD attrition, large banks are not likely to
hold their underwriting acquisitions of tax bills very
long. Likewise, their participation in the refinancing
will very likely be minimal, unless market expectations
should suddenly change. With bank interest limited, the
new Treasury issues will have to be priced to attract
larger than usual participation by the non-bank public,
a requirement which past experience has shown often leads
to higher yields. This would be particularly so if dealers,
in the face of continued high financing costs, should be
come reluctant underwriters. On the other hand, the extent
of any yield advance in the Treasury financing period
should be limited by the prospect of $10.5 billion of net
Federal debt repayment starting in late March and running
through June.
Outside the market for U.S. Treasury securities, the
weight of CD attrition tends to center on the market for
municipal securities, where the forward calendar of new
offerings remains heavy. Experience with recent municipal
issues suggests that prevailing yield levels may not yet
be high enough in this market to overcome the withdrawal
of bank participation and attract needed funds from other
types of investors. Further strains may, therefore, be
in the offing for this market as well. In corporate bond
and stock markets, on the other hand, where bank portfolio
operations are not a factor, recent changes in quotations
seem to reflect some moderation of inflationary expecta
tions, brought on by the combination of tighter money and
the economic evidence reported by Mr. Wernick.
Thus far, my comments have focused on CD attrition
at major banks, where the bulk of the credit squeeze has
been occurring. Partial data indicate that flows to other

1/14/69

-25-

bank time and savings deposits have also slowed appreciably
during the January reinvestment period. And net flows to
non-bank depositary-type institutions have weakened signi
ficantly during this period too.
For the most part these
changes in other savings flows appear to have been about
in line with industry expectations. Consequently, although
the slowing does represent some added constraint on funds
available for housing, the industry seems to be taking the
change in stride, and there appears to be little risk of
an immediate abrupt curtailment of mortgage commitments
like the one that occurred in the spring of 1966.
This brief run-down of the cross-currents now present
in financial markets suggests that the forces that will
determine the actual outcome for interest rates, CD's, and
bank credit over the next few weeks are rather sensitively
balanced.
For this reason, the outcome can be significantly
influenced by any emerging news that affects market expec
tations about the economic outlook, including the full
details of the imminent budget and tax proposals.
This
suggests that a fairly wide range of possible outcomes
could emerge on CD's, creating possibilities for significant
deviation on either side from the blue-book forecast of
a 0 to 3 per cent annual rate of growth in the credit proxy
in January.
Given this rather delicate balance of market forces,
and the developing evidence that credit restraint is already
taking hold, there would seem to be no need for the Committee
to move toward further restraint at this time.
Indeed,
because the market is unusually sensitive to indicators of
System policy, particularly the Federal funds rate, it may
be important to guard against any unexpected sustained upward
pressure on that rate.
Such a change could trigger market
fears of worse disintermediation to come.
In short, it seems to me that the appropriate decision
for the Committee today is to adopt the draft directive
submitted by the staff.1/ If the associated money market
and reserve targets specified in the blue book are then
effectively realized, the odds of avoiding a credit crunch
in the weeks immediately ahead seem quite good--even without
a change in CD rate ceilings. The institutions being most
severely affected by the CD squeeze are those possessing the
greatest resources and know-how for making needed reserve

1/

Appended to this memorandum as Attachemnt A.

1/14/69

-26-

adjustments. However, this approach does put a special
premium on retaining the two-way bank credit proviso in
order to give the Account Manager leeway to respond to
possible deviations on either side of the credit proxy
projection.
Mr. Solomon said he would preface his prepared statement on
balance of payments developments with a few observations on the British
trade figures for December, the details of which he had just received.
As Mr. Coombs had indicated, Britain's foreign trade position had
worsened in December following a sharp improvement in November.

However,

it probably was not reasonable to expect that all of the November improve
ment would be retained.

Moreover, the worsening in December was due to

a decline in exports; imports, which had been the main source of diffi
culty all along, also declined slightly.

While the recent trade figures

did not offer grounds for cheery optimism, those for November and
December taken together did indicate improvement from the performance
earlier.
Mr. Solomon then presented the following statement:
The Committee already has the surprising news, as
reported in the green book,1/ that the U.S. balance of
payments will probably show a surplus on the liquidity
basis for the entire year 1968. This came about as a
consequence of some massive shifts of funds by corpora
tions and banks in the last week of the year. I shall
attempt today to explain this outcome and to place it
in perspective.
The Committee will recall that, until the end of
the year, we had been looking at a balance of payments
for 1968 that was in deficit on the liquidity basis by
about $1-1/2 billion and in surplus on the official

1/

The report, "Current Economic and Financial Conditions," prepared

for the Committee by the Board's staff.

1/14/69

-27-

settlements basis by about $1 billion. The liquidity
deficit was held down by a number of special governmental
transactions, including purchases of non-liquid Treasury
securities by foreign monetary authorities. The official
settlements surplus arose from the fact that U.S. banks
had borrowed about $4 billion of Euro-dollars from their
foreign branches, thereby absorbing dollars that would
otherwise have gone into foreign official reserves.
The payments position on both bases had been helped
significantly by a substantial inflow of foreign capital
into U.S. equities and by a net repayment of loans to
U.S. banks and other financial institutions under the
voluntary foreign credit restraint program. The Commerce
Department program had not, through the third quarter,
made its contribution to the balance of payments, in
terms of a reduction in net outflows of U.S. funds to
finance direct investment abroad. U.S. corporations had
borrowed heavily in Europe but had built up very large
deposits abroad with the proceeds of these borrowings.
Under the Commerce program, they were required to meet
their target only on a full-year basis, and could there
fore wait until year-end.
That brings us to the last week of 1968. During
that week U.S. banks sold some $300 million of assets to
their branches abroad. These sales improve the balance
of payments on the liquidity basis, since they reduce
U.S. liabilities to foreigners--in this case foreign
branches of U.S. banks. More important was the repatri
ation by U.S. corporations of a substantial sum--running
into hundreds of millions--to their home offices.
This
transfer not only fulfilled the obligations of corporations
under the Commerce program but probably over-fulfilled it.
As corporations shifted deposits they held abroad--perhaps
largely in U.S. bank branches--to the United States, U.S.
liabilities to banks abroad--including branches--declined
correspondingly, and this improved the balance on the
liquidity basis. In the last week of the year, liabilities
of U.S. banks to their branches fell by more than $900
million. Whereas normally such a drop would be associated
with a deficit on the official settlements basis as dollars
returned to branches were made available in Europe and
seeped into official reserves, this time there was a surplus
on the official settlements basis, for the drop in liabilities
to branches was the counterpart of net payments of dollars
to the United States.
To compound the story further, in
the latest week--ending January 8--there was a further
increase in U.S. head office liabilities to branches of

1/14/69

-28-

$1.4 billion, related to outflows from Germany, and
another surplus on the official settlements basis.
The question is, what are we to make of all this?
Is it all just window dressing and to be ignored or
did something significant happen? Although we have
only preliminary and scattered facts, I shall go out on
a limb and say that I think we should take seriously at
least a part of the apparent improvement in the balance
on the liquidity basis.
As noted earlier, the corporations under the Commerce
program borrowed heavily in the Euro-bond market earlier
in the year but kept much of the proceeds on deposit
abroad. These borrowings did not show up in the balance
on the liquidity basis until brought home at the end of
the year. But insofar as these liquid funds were depos
ited in U.S. bank branches abroad and loaned by them
to their head offices earlier in 1968, they contributed
to the surplus on the official settlements basis earlier
in the year. The end-of-year transactions by which U.S.
corporations switched deposits to home offices and thereby
switched deposits from banks abroad to banks at home
merely permitted the balance on the liquidity basis to
catch up, as it were, with the balance on the official
settlements basis. Another way to put this point is to
say that the official settlements surplus earlier in the
year represented not only the absorption by U.S. banks
of Euro-dollars stemming from reserve losses by France
and the United Kingdom but also dollars from Euro-bond
borrowings by U.S. corporations. If the proceeds of these
Euro-bond borrowings had been switched to head offices
immediately--or had substituted for direct investment
outflows immediately--the balance on the liquidity basis
would have looked better earlier in the year. As it
turned out, this effect was delayed until the last week
of the year.
Assuming I haven't lost you, let me now ask whether
all these transactions are likely to be reversed early
in 1969. Some of them have been. Banks bought back $100
million of the $300 million of the assets they sold to
branches in late December. The deficit in the first week
of the year was $400 million on the liquidity basis,
larger than usual. On the other hand, not all the end
December inflow will be reversed. A good part of it was
necessary in order that the corporations might meet their
targets under the Commerce program. To the extent that
the corporations repatriated more funds than required
under the Commerce program, they have the choice of putting
the funds abroad immediately or keeping them at home and

1/14/69

-29-

giving themselves more leeway for direct investment out
flows later in 1969. We can't predict what they will do
but surely tight money at home will have some influence
on their behavior.
From what has been said, I would not expect anything
like a complete reversal of the end-of-year inflows.
Now, what can we say more broadly about the status
of the U.S. balance of payments? Has equilibrium been
established now that we have had a surplus on both bases
of calculation in 1968?
There was certainly improvement in 1968 in the over-all
position. The Federal Reserve and Commerce programs
produced more than their intended results and the inflow
of foreign private funds to the U.S. stock market was an
unexpected bonus. Investment income and other non-mer
chandise accounts also showed a gain. These factors add
up to something like a $4-1/2 to $5 billion improvement,
against which must be set the $3 billion deterioration
in the trade surplus.
Another part of the apparent improvement from 1967
to 1968 comes in governmental transactions of various sorts:
purchases of long-term deposits and non-liquid Treasury
securities by foreign monetary authorities and advance
debt repayments. Although some of these transactions may
be regarded as window dressing, they can also in part be
viewed as the counterpart of political understandings
between the United States and other countries--for example,
as Germany's quid pro quo for U.S. military expenditures.
Insofar as these transactions have such a political basis
and can be expected to continue and to be renewed on
maturity, it is misleading to label them as pure window
dressing and ignore them. On the other hand, some of the
special transactions--for example, Canada's investment
of her liquid reserves in non-liquid Treasury securitiescannot be repeated.
The improvements in 1968 resulting from the Federal
Reserve and Commerce programs are unlikely to be repeated
in 1969. Certainly the Commerce program is unlikely to
yield another $1 or $1.5 billion. The outcome of the Fed
program, under which there is leeway for an outflow, will
no doubt depend largely on monetary policy here.
Investment income ought to rise again and hopefully
the trade surplus will increase significantly. Hopefully
the inflow of foreign equity capital will also continue

1/14/69

-30-

but here we have no bases for prediction. If one puts
all this together, there is the possibility that some
what larger outflows under the Commerce and Fed programsby more than $1 billion--and smaller special transactions
would be offset by larger earnings on trade and invisible
account. This might leave a relatively small liquidity
deficit and a tolerable balance of payments in 1969tolerable in the sense that the U.S. balance of payments
itself is unlikely to induce unrest in exchange or gold
markets or large foreign purchases of gold from the United
States. The official settlements basis is likely to stay
in surplus as long as tight money continues here and funds
are attracted from European reserves to the Euro-dollar
market. But a reversion to easy monetary conditions here
combined with tight money in Europe could lead to substantial
reflows of Euro-dollars from the United States. This
analysis does not take account of any possible benefits
from a cessation of hostilities in Vietnam.
The tolerable payments position I see for the period
ahead thus depends on the capital control programs and
on tight monetary conditions in the United States. A
more durable position depends on a sizable rebuilding of
the U.S. trade surplus.
Mr. Solomon added that the figures for U.S. international pay
ments in the fourth quarter and the full year 1968 were based on
preliminary calculations.

The official figures would not be released

for about a month if the regular publication schedule were followed.
Mr. Daane remarked that he would expect the figures in question
to be made public in advance of the regular schedule.
Mr. Brimmer agreed, noting that they might be mentioned by the
President in his State of the Union Message this evening.

If not, they

were likely to be reported shortly in some other connection.
Chairman Martin then called for the go-around of comments and
views on economic conditions and monetary policy, beginning with
Mr. Treiber, who commented as follows:

1/14/69

-31-

Inflationary forces are strong, and most sectors
of the economy are vigorous. Wholesale prices have
continued their renewed advance. Consumer prices have
been rising rapidly at the highest rate in more than
a decade and a half. The demand for labor is strong,
and unemployment is low. Residential construction and
business construction are vigorous. Industrial production
continues to advance strongly.
Retail sales have weakened, partly because of the
flu epidemic and perhaps also because the income tax
surcharge is beginning to have an impact. With retail
sales failing to maintain the high upward thrust to
which merchants had become accustomed through so much
of 1968, trade inventories have risen. Inventories are
a sensitive area and will have to be watched carefully.
An unprecedented inflow of capital in the closing
days of 1968 created a massive recorded liquidity surplus
in our international balance of payments for December,
resulting in a surplus of probably several hundred mil
lion dollars for the year 1968.
Altogether during December, United States corporations
appear to have repatriated as much as $1 billion of
balances borrowed during 1968 in foreign bond and loan
markets by their U.S.-incorporated investment financing
affiliates and their foreign-incorporated operating
affiliates. These funds, which presumably were expected
to be used in part for direct investment expenditures in
1969, have been used to refinance earlier direct invest
ment outflows and--at least for the time being--to improve
the cash position of their large American parent corporations.
An incidental effect of the large-scale shift of funds
was to escalate rates in the Euro-dollar market which
were under pressure from year-end adjustments and the
run-off of CD's. The return flow of corporate funds from
Europe, together with sales of loans by the head offices
of American banks to their foreign branches and sizable
special transactions negotiated by our Treasury, helped
to produce an estimated recorded liquidity surplus for
December of more than $2 billion.
Despite a surplus in the recorded liquidity balance
for 1968, and an even greater surplus in the official
settlements balance, we continue to have a severe balance
of payments problem. The underlying liquidity balance
for 1968 was in deficit by more than $2 billion. The
merchandise trade balance which deteriorated so greatly
in 1968 as imports burgeoned will still remain a problem

1/14/69

-32-

in the coming year. I hope that the recorded balance of
payments surplus in 1968 will not obscure our basic balance
of payments problem and create a euphoria which can only
worsen the long-run adjustment problem.
Analysis of the domestic financial data is unusually
difficult because of the turbulence in the markets resulting
from the recent tightening of monetary policy and year
end adjustments. Bank credit and deposit growth apparently
remained substantial in December, but a marked slowdown
now seems to be in progress. There was a big run-off
of large certificates of deposit in December, particularly
at the New York City banks, and there is widespread appre
hension that large-scale attrition will continue. Conceivably
a further large and rapid reduction in CD's could cause
the banks to panic, and to bid even more aggressively for
Euro-dollars, to dump municipal securities on the market,
and to cut loans sharply. But to date there is no evidence
of such a frantic search for liquidity. The limited
information available with respect to thrift institutions
indicates a somewhat weaker deposit experience in December.
A continued and sustained rise in market rates could make
their position increasingly difficult. Capital market
demands remain quite heavy despite the very high level of
interest rates. The Treasury is offering today $1-3/4
billion of June tax-anticipation bills to raise needed
cash, and will be announcing a major refunding at the end
of this month.
With two increases in the prime rate since the mid
December rise in the discount rate, some increases in
personal loan rates, and rapid increases in market rates,
there has been a great change in market psychology. The
markets have generally interpreted our actions as a
determined effort to break the back of inflationary expec
tations. This is all to the good. More time will be
needed for markets to stabilize and to permit a better
assessment of the impact of the sharp change in financial
conditions on business sentiment and bank lending.
It seems to me that, broadly speaking, credit policy
should continue its recent stance. With no change in policy
one might expect to see (a) Federal funds rates generally
in a 6-1/4 to 6-1/2 per cent range, probably more frequently
in the higher part of the range or even exceeding the
range; (b) member bank borrowings generally in a $550 to
$800 million range; and (c) net borrowed reserves generally
in a $250 to $600 million range.
Fortunately, the current credit proxy projections
for January show a lower rate of credit growth. Under

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1/14/69

such circumstances, the two-way proviso in the directive
suggested by the staff appears appropriate, with the expectation
that an upward deviation should be resisted sooner and
more vigorously than a downward deviation. The reference
to the Treasury refunding also is appropriate. Because
of sensitive market conditions it would also seem desirable
to keep open market operations flexible, particularly if
abnormal liquidity pressures develop. I would accept the
suggested directive.
It seems to me that a further increase in the dis
count rate would not be desirable at this time in the light
of the present sensitive market atmosphere and the reduced
credit availability that has developed in recent weeks.
Nor does it seem appropriate in these circumstances to
give an overt signal of further tightness in the form of
an increase in reserve requirements. On the other hand,
we should be careful not to let a seasonal decline in
market pressures, if it should develop, lead the market
to the conclusion that we are backtracking from a policy
of restraint. We have gotten a good reaction so far to
our policy moves, but there is still a long way to go before
we can be sure that inflation is under control.
It is clear that the maximum rate permitted under
Regulation Q for large certificates of deposit is creating
heavy market pressures. There have been large run-offs
of CD's and heavy pressure on the Euro-dollar market.
Continuation of the existing ceilings will restrict over
all deposit and credit growth in the coming months. Since
this goal is desirable, I would not recommend any change
in Regulation Q ceilings at this time. Of course, if
extreme liquidity pressuresshould develop, or if it became
clear that use of the Euro-dollar route by the banks to
offset these pressures were placing a severe strain on
foreign currencies, an increase in the ceilings might
be needed promptly. It would be preferable, however,
to make flexible use of open market operations to avoid
the need to raise Regulation Q ceilings, provided it could
be done without misleading the market.
Mr. Morris said that the blue book projections had given him
cause for concern, since they suggested that the monetary policy now
in force would be substantially more restrictive in January and
February than the policy he thought he was voting for at the last meeting
of the Committee.

The monetary policy he favored was one that would

1/14/69

-34

cut roughly in half the 13 per cent annual rate of growth of bank
credit recorded in the last half of 1968.

Given the fiscal

restraint at work in the economy, an annual rate of growth of 5 to
7 per cent in bank credit would seem to be an appropriate guideline
for the first half of 1969.
However, Mr. Morris continued, according to the blue book
projections current policy would be much more restrictive than
that.

A growth rate of 0 to 3 per cent in the proxy was forcast

for January and, although no specific forecast was presented for
February, the text suggested that growth in that month was likely
to be zero to negative.

That would constitute a severe swing from

the 13 per cent rate of growth of the proxy in the past six monthsin his judgment, an excessive swing.

The state of the economy

called for a substantially less expansionary policy than was follow
ed from July through December but it did not, in his opinion, warrant
the sort of policy described in the blue book.

The Committee should

give recognition to the fact that it was dealing with a decelerating
economy, even though the pace of deceleration had been rather dis
appointing during the past 6 months.
Mr. Morris remarked that the response of the market to the
change in monetary policy had been constructive thus far.

The

System had put a dent in inflationary expectations without, as yet,
generating any widespread fear that policy would be unduly restrictive.

1/14/69

-35

There was concern in the financial community but no sense of panic.
The major Boston banks with large CD positions were well aware of
the adjustment problem which they faced in the months ahead and
were in the process of tightening their lending and investment
policies.
The cutting edge of the new policy, Mr. Morris said, was
formed by the Regulation Q ceilings, and that was a very blunt and
unwieldy policy instrument.

It was a difficult instrument not only

for the Manager to deal with in fine-tuning the market, but also
for the Board's staff to deal with in forecasting monetary aggre
gates.

In wielding that blunt instrument, there was a clear risk

of producing an excessively restrictive policy, unless the Committee
made it clear to the Manager that it was seeking a slower rate of
growth of bank credit, not a leveling off or a contraction.

If that

was, in fact, the intention of the Committee, he thought it would
be desirable to change the language of the directive.

Specifically,

he would suggest replacing the proviso clause shown in the staff's
draft with the following language:

"provided, however, that opera

tions shall be modified to the extent necessary to assure a modest
rate of growth in bank credit."
Mr. Morris added that he was concerned with the suggestion
in Mr. Keir's statement that under current policy there was a
fairly good chance of a credit crunch in January.

It was clear

that the state of the economy did not call for a drastic monetary

1/14/69

-36

remedy of a kind that was likely to lead to disorganized markets
such as had developed in 1966.

Moreover, if there was a credit

crunch the System might have to take measures to deal with it that
would produce excessive rates of growth in bank credit.

Accordingly,

he would much prefer a more moderate degree of restraint at this
juncture than that indicated by the blue book figures.
Mr. Coldwell reported that the Eleventh District economy
was at a very high level.

There had been some industrial produc

tion declines, with strikes and reduced oil output largely respon
sible.

However, employment, construction, and retail sales had

reached new record levels.

Agricultural conditions reflected

seasonal slackness and a period of reappraisal of last year's
efforts.

Cotton continued to be held off the market in hopes of a

better price.
District financial conditions reflected seasonal factors
and a continued strong loan demand, Mr. Coldwell said.

Loans,

investments, and demand and time deposits all advanced through the
close of 1968.

CD runoffs had been largely those scheduled and in

total were relatively minor.
Bankers reported a continued availability of lendable funds
and a strong demand, Mr. Coldwell continued.

Customers had not yet

reduced their demands for credit and seemed unconvinced that the
inflation would be slowed markedly.

The banks were not under any

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real pressure for funds and, in fact, with a seasonal slack in agri
cultural demands, the small country banks were looking for partici
pations.

Failing to find such correspondent accommodation, the

small banks were enlarging their sales in the Federal funds market.
There were now about 240 District banks in the Federal funds marketmore than one-third of all member banks in the District.
Mr. Coldwell remarked that a review of the national economy
indicated to him that the forward momentum had not as yet been
materially checked by fiscal or monetary restraint.

In the financial

area, there had been a sharp run-up in yields and interest rates
with some pressure beginning to develop at large money-market banks.
However, the reduction in credit availability came primarily from
the run-off of large-denomination CD's which had been concentrated
at the large banks.

Even at those banks, though, pressures had been

moderated by access to the Euro-dollar market, and the restraint had
not yet been sufficient to force major changes in lending practices
nor to force major borrowers to reach down to interior banks.
Mr. Coldwell thought one had to admit that the higher rate
levels had not caused a significant reduction in credit demands.
Apparently, the inflation psychology was still strong.

Borrowers

were willing to pay the higher rates because they expected prices

and costs to increase.

There had been only a short time to measure

the impact of higher rates, especially as they might impinge upon
borrowers' demands or cause CD run-offs.

Nevertheless, whatever

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1/14/69

pressures on reserves had developed at the large banks had not yet
filtered down to the interior banks.
As to policy, Mr. Coldwell said, despite the apparently slow
impact of the fiscal and monetary restraints, he believed the Com
mittee could wait for a further period to see if the desired results
were forthcoming.

The problems of visibility in the present period

of seasonal change and the adjustments under way in the economic and
financial sectors argued for a policy of steadiness, holding the
degree of restraint at present levels.

He could not counsel too

strongly that the Committee hold to the present course of policy
until it could see that significant improvement had been achieved
in the fight to break the inflation psychology and reduce credit
demands to sustainable levels.

As he had indicated, he was not con

vinced that that had been accomplished, and he thought that further
tightening measures might well prove necessary.
Mr. Swan reported that the Twelfth District economy also
had continued strong.

In California, the unemployment rate had

declined from 4.4 per cent in November to 4.2 per cent in December.
There had been a slight reduction in the labor force; employment
had remained essentially unchanged.

In November seasonally adjusted

housing starts in the West were at their highest level in four
years.

Although the rise in the West was smaller than in the rest

of the country in November, it was substantially greater for the
first eleven months as a whole; through November, Western housing

1/14/69

-39

starts were up about 34 per cent from the comparable 1967 period,
compared with an increase of some 14 per cent in other areas.
Mr. Swan noted that in December business loans had expanded
considerably at District weekly reporting banks and there had been
a run-off of large-denomination CD's.

However, the CD run-off was

not as substantial as at weekly reporting banks elsewhere and it was
smaller than that experienced by District banks in the corresponding
period of 1967.

Similarly, expansion in total time and savings

deposits--including interest credited--was larger in December than
a year earlier.

Nevertheless, major banks in the District expected

deposit losses, including further CD run-offs, in January and Feb
ruary, and they thought their reserve positions would be under some
pressure.

As a consequence, there had been a substantial increase

in advertising of a wider variety of forms of "consumer" CD's, which
the banks described as a "defensive" measure.
The situation at District savings and loan associations was
not clear, Mr. Swan said.

While the green book reported the rather

unsatisfactory experience in the last few days of 1968, the San
Francisco Reserve Bank's limited sample of five large associations
indicated that there had been a small net inflow in the first ten
days of January.

The inflow was of about the same magnitude as in

the corresponding period a year ago, and the institutions had been
rather pleased by it.

The sample was, of course, very small and

any conclusions drawn from it were highly tentative.

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In addition to the prime rate increase, Mr. Swan continued,
there had been increases in interest rates on mortgage loans at some
of the larger District banks and there was talk about increases in
rates on consumer loans.

Those banks were now less interested in

acquisition loans and in business loan participations except for
their regular customers, but it appeared that they had taken few if
any steps to restrict loans to their customary business borrowers.
During the first week of the year, Mr. Swan observed, there
had been a considerable easing in the reserve positions of the major
District banks, and in the current week--at least as of last Thursdaythey expected to be net sellers of Federal funds.

Apparently, a

substantial volume of money was available to the banks through cor
porate repurchase agreements, perhaps involving funds repatriated
from Europe or raised in the commercial paper market and not im
mediately used.

Whatever the source of such funds, their availabil

ity might well be temporary.
Turning to policy, Mr. Swan said that in his judgment the
firmer money market conditions recently attained were desirable and
should be maintained for the time being.

He saw no reason for a

change in policy at this point even apart from the forthcoming Treasury
refunding.

The slackening in retail sales in December, the recent

rapid growth in inventories, seasonal factors, and the expected
continuing run-off of CD's all suggested some further significant
moderation in the rate of economic expansion.

However, he would be

willing to maintain the present posture of policy even though a low

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1/14/69

rate of bank credit growth was projected for January.

If one

considered December and January together, the current rate of bank
credit growth did not appear unduly low.

The Regulation Q ceilings

had a good deal of significance in terms of the market's evaluation
of the System's policy intentions, and he hoped they would be main
tained at their present levels if at all possible, even if liquidity
pressures proved to be somewhat greater than now expected.

If it

was necessary to relieve such pressures, he would prefer to see
additional reserves provided through the discount window or by open
market operations under the proviso clause, rather than to have the
Q ceilings raised.
On that basis, Mr. Swan concluded, he could accept the second
paragraph of the staff's draft directive as written.

With respect to

the first paragraph, he questioned one clause in the final sentence
containing the description of the Committee's general policy stancethe clause which described one of the Committee's objectives as that
of "attaining a reasonable equilibrium in the country's balance of
payments."

He did not want to exaggerate the importance of the sur

plus that had been recorded for the year 1968; from a longer-run
viewpoint, the payments balance was likely to continue to be a
serious problem.

But since there had, in fact, been a surplus last

year the language in question struck him as inappropriate.

Perhaps

it would be desirable at this point to replace it with a statement
of objectives in terms of the trade balance, such as, "enlarging
the favorable balance in the country's merchandise trade accounts."

1/14/69

-42
Mr. Galusha remarked that the pace of economic advance in

the Ninth District might well be slowing.

There had been a 25 per

cent decrease in prime defense contract awards in the third quarter
of last year.

That sharp decrease might explain the recent relatively

modest increases in District manufacturing employment.

Government

employment had also been increasing relatively modestly of late.
Mr. Galusha said that the Minneapolis Reserve Bank's most
recent survey of country banks, completed only a week or so ago, in
dicated that farm incomes had been increasing, but that there had
been no increase in the willingness of farmers to spend--whether for
consumer durable goods or for farm equipment.

The survey also indi

cated that, as a group, country bankers were expecting no trouble in
meeting what might be an unusually large early-spring loan demand.
Apparently, the weather was so bad last fall that farmers could not
prepare their fields, and so put off borrowing until spring.
Obviously, there could be trouble if the inflow of time and savings
deposits to the country banks decreased appreciably; but so far there
had been no hint of such a decrease.

In fact, their condition gen

erally paralleled that reported by Mr. Coldwell for the Eleventh
District.
Turning to Committee policy, Mr. Galusha commented that with
the bits of information which had come in recently, it was easy to
accept the Board staff's projection of some slowing in the national
economy's pace of advance.

Quarterly increases in current-dollar GNP

averaging $12 to $13 billion appeared quite reasonable for the first

1/14/69

-43

half of 1969.

He would not rule out smaller average increases.

He

had only his intuition to go on, but consumers might well do even
less buying--particularly in the first quarter of the year--than
Mr. Brill and his colleagues expected; and he (Mr. Galusha) had
not been persuaded by the latest OBE-SEC survey, even before talk
of another credit crunch had become widespread.
Accordingly, Mr. Galusha observed, things were looking up.
Of course, insofar as the Committee was concerned, the first half
of 1969 belonged more to the past than to the future.

The Committee

should be thinking about the second half of the year, and more
particularly about whether, with no further changes in monetary
policy, the pace of economic advance was going to increase again.
He had seen forecasts--authored, he should add, by respected fore
casters--of quarterly increases in current-dollar GNP of not $12 to
$13 billion but rather of $17 billion or so.

And those forecasts

were based on the assumption of a continuing 10 per cent tax sur
charge.
shade.

He believed they were too bullish, but perhaps by only a
Anyway, it was clear that the issue of the surcharge had

returned to plague the Committee.
In the fond hope that the issue would soon be resolved one way
or the other by the new Administration, Mr. Galusha remarked, he would
suggest that the Committee keep policy unchanged, and that the Manager
be directed to maintain the three-month bill rate within a narrow
range--from 6.00 to, say, 6.20 per cent--until the next meeting.

1/14/69

-44

If a real scarcity of three-month bills were to develop the rate
might be permitted to drop below 6.00 per cent, but not much below.
Mr. Galusha said he thought the Committee should recognize
that it was presently playing a dangerous game.

Squeezing the

money market banks--and, to a lesser extent, the other banks and
nonbank thrift institutions as well--against unchanged Regulation Q
ceilings might be an effective way of curbing the growth of bank
credit, at least in the short-run; but depending on what money mar
ket rates averaged over coming weeks, disintermediation would be
slight or considerable.

And, as he was sure everyone would agree,

how much disintermediation there was made a difference.
To Mr. Galusha's mind, the implication was that the Com
mittee should take the three-month bill rate as its operating target.
Certainly now was not the time for turning to bank reserves or some
other quantity target.

He would remind the Committee that Professor

Milton Friedman had on occasion--not always, but on occasion--acknow
ledged the impracticability of following a bank reserves or money
supply rule so long as Regulation Q ceilings were, as at present,
effective.

And in the short run it was no answer to say "get rid of

Regulation Q."
Mr. Galusha commented that over coming weeks expectations
could be quite volatile.

With the present Regulation Q ceilings,

the Committee could not really afford to let a change in expectations
carry the three-month bill rate above 6.20 or 6.25 per cent, even for

1/14/69

-45

several days running.

Nor could it afford to let an opposite change

carry that rate below 6 per cent or thereabouts unless, of course,
a severe scarcity of three-month bills developed.
In concluding, Mr. Galusha said he favored the draft direc
tive submitted by the Board's staff, and he would urge that the
two-way proviso clause shown in the draft be included.

In the

present circumstances, such a clause was essential; and it was
essential that the Manager respond promptly, particularly to signs
that bank credit was going to increase less than expected.

If the

feel of crisis developed, the Federal Reserve could be forced to
come to the rescue of markets; and in that event it would have lost
a great deal in its struggle to change inflationary expectationsno one would believe in monetary restraint.
Mr. Scanlon reported that the economic picture in the Seventh
District continued to be characterized by low unemployment, wide
spread price increases, better than expected orders for various
manufactured goods, and heavy demands for credit.

That view of the

economy appeared to be somewhat different from the description of
the outlook given in the first few pages of the green book.

The

language used in the front of the green book seemed to go further in
suggesting the development of restraint than did either the green
book figures on recent and projected GNP or the evidence available
to date on Seventh District developments.
There was some concern in the District that monetary policy
would swing too vigorously toward restraint, Mr. Scanlon observed.

1/14/69

-46

However, the predominant view of economists in the area appeared to
be that the stringencies associated with the 1966 experience would
not be repeated.

Although quarterly projections of total spending

through 1969 showed diverse patterns, the consensus looked to another
year of inflation with continued pressures on labor resources.
Mr. Scanlon said that increases in prices in recent weeks
had been more numerous than that at any turn-of-the-year period in
the 1960's, and had affected a wide variety of materials and finished
goods.

District companies expected to pay higher prices, and to

charge higher prices, in the months ahead.
The green book suggested that business capital expenditures
were likely to be reduced from planned levels, Mr. Scanlon observed.
That would be a desirable development and he hoped it occurred.

How

ever, there was no evidence of it as yet in his District.
Mr. Scanlon remarked that farm machinery output, the weakest
of the major District industries, was not expected to improve in 1969
and, according to one producer, it might decline further on a year-to
year basis.

On the other hand, prospects for construction machinery

sales appeared excellent.

Demand for heavy trucks continued strong.

Orders had increased recently for railroad equipment, nuclear power
apparatus, air conditioning equipment, machine tools, and components
for capital goods.
The dollar volume of construction contracts had been large
and a substantial amount of new work was in the planning stages,

1/14/69

-47

Mr. Scanlon said.

Increasingly, reports were heard of limited

availability of construction materials and components in addition
to labor shortages.
rising sharply.

Rents for both dwellings and office space were

Multi-family units had accounted for most of the

increase in housing permits in the District in 1968, and the increase
in starts projected for 1969 also was expected to occur in the
multi-family sector.

Insurance companies were pushing a variety

of plans for financing residential construction, mainly multi
family projects, that included some kind of equity interest.
Mr. Scanlon noted that steel orders--looked upon as a
trouble area--had increased each month, and by more than expected,
since the late summer low.
into January.

That trend appeared to have continued

Steel consumption was expected to be slightly higher

in 1969 than in 1968 despite an anticipated decline in steel used
in autos and pipelines.

Although steel companies apparently had under

estimated consumption and overestimated customer inventories in
recent months, excess steel inventories were still being liquidated.
As a result, according to the Reserve Bank's contacts, shipments
and output of steel were expected to be about 4 per cent less in
1969 than in 1968.

Steel prices appeared to be stabilizing--and

firming--after the most chaotic period since the 1930's.
Reports to the Reserve Bank from Detroit indicated that auto
assemblies would be at 806,000 in January, about the same as the
year-earlier level of 808,000, Mr. Scanlon said.

First-quarter auto

1/14/69

-48

sales were forecast at two million units, about the same as in the
first quarter of 1968.
In the financial area, Mr. Scanlon continued, it was difficult
to sort out the effects of year-end pressures and reactions to the
discount and prime rate changes from more basic trends.

Bank loan

figures continued to reflect strong credit demand and loan officers
did not appear to expect demand to abate in the near future.

On the

other hand, their reluctance to acquire funds at today's costs for a
period of more than two or three months ahead suggested they did
expect some weakening in the second quarter.

The same could have been

said, of course, during most of the second half of last year.

Business

loans had risen very fast at the large District banks in the past two
months.

Much of the increase had gone to public utilities and, to

some extent, might reflect postponement of capital market financing.
But loans to other business borrowers looked quite strong also.
At current market interest rates, Mr. Scanlon remarked, rapid
attrition of CD funds was taking place and was beginning to produce
fairly strong offsetting action by the banks.

There was considerable

evidence that some large banks were becoming more restrictive in their
lending policies.

They were already liquidating investments and

reactivating committees of senior officers to review applications for
credit.

District banks showed a decline in Euro-dollar borrowings

and were reluctant to bid for them at current rates.

It did not appear

1/14/69

-49

that the Euro-dollar market had much potential as an offset.

Borrowing

at the discount window had been intermittent so far but was likely to
increase, as it had in 1966, if the squeeze intensfied.
Assuming that credit demands would not decline abruptly in the
next few months, Mr. Scanlon continued, it seemed to him that bank
credit could be adversely affected considerably more than in 1966 and
with even greater psychological ramifications.

In contrast to 1966,

all market rates were above CD ceilings on like maturities, with the
widest spreads existing at the shorter maturities.

Since early December

CD's at weekly reporting banks had declined by almost $2 billion, or
by two-thirds of the amount of the 1966 decline, although from a level
one-third greater.

The Euro-dollar market today appeared tighter and

probably less readily accessible than in 1966 as a source of funds to
offset the decline in CD's.
Mr. Scanlon said he favored continuing a substantially restric
tive policy.

He recognized, however, that the Committee also had to

guard against large, abrupt, or long-continued credit contractions.
In the absence of an increase in the Regulation Q ceilings, a slow growth
of bank credit could be achieved only through a relatively rapid growth in
total reserves and demand deposits.

While that might be an acceptable

development for a few weeks, it was not a happy prospect if it were to
continue for several months, since it would tend to cause an inefficient
allocation of credit and would further confuse the interpretation of
policy indicators.

1/14/69

-50
The staff's draft directive was acceptable, Mr. Scanlon said,

except that he would favor deleting the word "real" from the statement
in the first sentence that ". . .expansion in real economic activity
has been moderating.

..

."

The introduction of "real" at the point

where the term "over-all" had previously been used suggested that the
Committee was now giving real GNP a priority in its thinking that it
had not given it in the past.

That was the kind of change he would

like to avoid when the Committee was not changing policy.
Mr. Clay remarked that adoption of a monetary policy of re
straint at the last Committee meeting had been a good beginning in the
effort to fight price inflation and to produce a more sustainable pace
of economic growth.

That policy would have to be maintained if the

System's efforts were to be successful.
Price inflation continued to be very strong and the intense
inflationary expectations of recent months showed no signs of abatement,
Mr. Clay continued.

Considerable time and effort, buttressed by

evidence of persistence and positive results, would be required to
restore relative price stability and to dispel price inflation expec
tations.

A slower pace of economic expansion had to be part of the

process by which the necessary results were attained.
It did not seem necessary to Mr. Clay to move beyond the
current degree of monetary restraint at present, but it also was very
important that monetary policy not be relaxed.

The money market

-51

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conditions specified in the blue book as likely to be associated with
an unchanged policy in open market operations appeared to be reasonable.
Those conditions included a Federal funds rate frequently around 6-3/8
to 6-1/2 per cent, member bank borrowings in a range of $550 to $800
million, and net borrowed reserves of $250 to $600 million.
Mr. Clay thought that more importance should be attached to
preventing undue expansion of member bank reserves and bank credit.
The suggested range of 0 to 3 per cent for the annual rate of growth
in the bank credit proxy, apart from some added allowance for Euro
dollar borrowings, appeared to be in order for January.

The System

should stand ready to accept substantial attrition of CD's.
The Federal Reserve discount rate should be left unchanged,
Mr. Clay said.

Admittedly, it was out of line with money market rates,

and thus it was not entirely appropriate for discount window adminis
tration.

On the other hand, the announcement effect of such Federal

Reserve action did not seem to be necessary, and the interest rate
repercussions of the announcement probably would be more detrimental
than helpful.

The principal need was to limit the amount of credit

availability.
The staff's draft of the directive appeared to Mr. Clay to
be satisfactory.
Mr. Heflin reported that the latest information on the Fifth
District showed some signs of a slackening in the pace of expansion

-52

1/14/69

in recent weeks, although the evidence was far from conclusive.

The

Richmond Reserve Bank's early-January survey indicated some disappoint
ment with Christmas retail sales and a dimmer outlook in residential
construction.

Manufacturers covered in the survey also reported a

tapering off in both new orders and backlogs.

On the other hand,

most of the Reserve Bank's area contacts reported a continuing boom
in business expenditures for new and expanded plant capacity.

Banks

in the District apparently had not yet begun to feel any tight money
squeeze and while most had followed the latest prime rate hike, some
did so reluctantly.
At the national level, Mr. Heflin continued, upward price
pressures persisted but excess demand in the economy seemed to be
associated mainly with expenditures in the business sector.

Consumer

outlays appeared to have moderated and prospects were that they would
continue to do so.

Under the circumstances the recent spurt in

inventory spending was likely to be transitory and there was at least
a possibility of some scaling down of business capital investment plans.
Considering the budgetary changes now in process, and the System's
recent tightening moves, it seemed to him that there almost certainly
would be a significant moderation in the business expansion in the
months ahead.

It might be that there would be more moderation than

bargained for, but he believed that that was a risk that had to be
taken if the inflationary climate was to be dissipated.

-53

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Mr. Heflin noted that there seemed to be some doubt that the
System's latest moves had convinced the market of its determination
to contain inflation.

Nonetheless, rate increases since the Committee's

last meeting, and especially the two rapid-fire prime rate hikes, had
rather clearly produced an impact on market expectations patterns.
Recent movements of bond and stock prices suggested growing doubts
about the continued buoyancy of the business advance.

Such expecta

tions should, of course, strengthen the tone of credit markets generally.
Yet it seemed to him that at the moment markets were still in a nervous
and uncertain state.

In the light of the likely CD situation over the

next two weeks, he thought the System would still have to face up to
the possibility of a credit crunch that might make it difficult for
borrowers to raise funds even at high rates.
As for current policy, Mr. Heflin felt that there was no room
for further tightening at this time.

Accordingly, he favored the

draft directive submitted by the staff.

But he wanted to say that it

would be a mistake, in his judgment, to back away from the current
posture of policy at the first sign of a break in the boom.

Even in

the face of a crunch created by large CD run-offs, he believed he
would be inclined to move with caution and to avoid any major effort
to compensate reserve losses through large open market purchases.
It might be better to encourage banks to use the discount window to
make up any losses that might occur, even if that might involve a
large increase in borrowings.

-54

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Mr. Mitchell said he agreed with the views expressed today
by the staff and by Mr. Treiber.

Unlike Mr. Morris, he would not

be concerned if the bank credit proxy increased only slightly or
not at all for a month or two, following the 13 per cent annual rate
of growth experienced over the second half of 1968.

He would not

want to see bank credit growth sharply curtailed for an extended
time, but under current circumstances he would be inclined to assess
its performance in terms of the average rate of growth over a period
such as the four months from November through February.

If the

11-1/2 per cent growth rate of November and December--allowing for
Euro-dollars--were averaged with projections for January and February,
the average rate of expansion would be found to be about 6 or 7 per
cent, and that seemed appropriate in the present environment.
Mr. Mitchell noted that the liquidity positions of various
sectors of the economy--including banks, corporations, and consumerswere very good at present, and far better than they had been in 1966.
It seemed, therefore, that the System would have to maintain a policy
of substantial restraint for some period of time if it were going to
accomplish its objectives.

He wanted to avoid a credit crunch, and

although he did not think the current degree of restraint would produce
one, he would urge the Manager to watch developments carefully.

At

the same time, he would emphasize the need to guard against an undue
increase in the bank credit proxy.

-55-

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Mr. Mitchell added that he was somewhat disturbed by the
recent movements in the money supply.

The reasons for the sharp

increase around the turn of the year were not wholly clear, but
he was satisfied that the staff's explanations were the best that
could be made.

In any case, he would focus on bank credit rather

than on the money supply.

With respect to the policy statement

about the balance of payments in the first paragraph of the directive,
he agreed with Mr. Swan that recent developments made the present
language obsolete, but was not sure what alternative language would
be desirable.
Mr. Daane remarked that Mr. Solomon's statement on the
balance of payments had been thoughtful and lucid, and offered a
realistic appraisal of the outlook for 1969.

He accepted Mr. Solomon's

conclusion that there had been a significant improvement in the
balance, and that not all of the massive inflow before the end of
the year would be quickly reversed.

But he also shared the view-

which Mr. Treiber and others had underscored--that a serious pay
ments problem remained.

The fact that there had been large inflows

of funds just before the year-end did not justify the conclusion
that the objective of a sustainable equilibrium in the payments
balance had been achieved.

Accordingly, he would not favor changing

the policy statement on the balance of payments in the directive.
Mr. Daane said he thought the comments by Mr. Morris con
cerning prospective bank credit developments had been helpful in

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sharpening the issue.
conclusion.

However, he (Mr. Daane) had come to an opposite

In Mr. Morris' judgment there was nothing in the economic

outlook that justified risking a credit crunch or that warranted
accepting bank credit behavior in January and February of the kind
projected in the blue book.

He (Mr. Daane) thought the risks with

which Mr. Morris was concerned were far less important than the opposing
risk that the Committee might contribute further to the inflationary
expectations that were currently prevailing.

He was concerned by the

Manager's suggestion that there was still a good deal of skepticism
in financial markets regarding the System's determination to hold to
its present policy course as long as necessary.

He joined those who

hoped that the System would continue to indicate by its actions that
it had the courage to stand fast.

While he decried the clumsiness of

Regulation Q ceilings as a policy device and had no desire to produce
a credit crunch, he thought the Committee presently was on the right
course in its efforts to dampen inflationary expectations, and he
would not want to see it deviate from that course.

He favored adopting

the directive as drafted by the staff.
Mr. Maisel said he would make only two brief observations.
First, he thought the Manager should be prepared to react rapidly
if bank credit developments called for implementation of the proviso
clause.

Secondly, be believed the second paragraph of the draft

directive gave undue prominence to the Treasury's February refunding,
since operations in a large part of the forthcoming policy period

1/14/69

-57

would not be subject to even keel constraints.

To avoid confusing

the historical record, he would prefer to excise the two references
to the refunding from the draft, and add a statement at the end of
the paragraph to the effect that the refunding should be taken into
account when it became imminent.
Mr. Brimmer said he wanted to join in complimenting
Mr. Solomon for an effective job of unraveling the complex balance
of payments figures.

He (Mr. Brimmer) would add that apart from

uncertainties with respect to the basic economic developments that
would affect the payments balance in 1969, there was also considerable
uncertainty regarding the life expectancy of the Government's balance
of payments programs.

At this stage no one could say with confidence

whether, or in what form, the Commerce program--which had made the main
contribution to the improvement in 1968--would be continued.

There

was also some uncertainty about the views of the new Administration
concerning the voluntary foreign credit restraint program administered
by the Federal Reserve.

In connection with that program, as the members

knew he had sent out letters to all the Reserve Bank Presidents announc
ing a series of meetings with Federal Reserve Bank officers and with
representatives of the banks and of other institutions participating in
the program.

The information gathered at those meetings would help

the Board in carrying out an evaluation of its guidelines and would
provide the Administration with an essential basis for its basic policy

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decisions.

He would represent the Board tomorrow (January 15) in

hearings on the voluntary foreign credit restraint program before
the Subcommittee on International Exchange and Payments of the
Joint Economic Committee.
Turning to the directive, Mr. Brimmer indicated that he did
not agree with the language change proposed by Mr. Swan in the policy
statement about the balance of payments.

There was no assurance

that equilibrium had been achieved in the country's external accounts.
Even apart from doubts about the duration of the surplus, he saw
no reason to change the statement since reasonable equilibrium in
the balance of payments remained the Committee's objective.
Mr. Brimmer said the directive as drafted by the staff was
acceptable to him.

Unlike Mr. Morris, he would not be particularly

disturbed if the rate of growth in bank credit over the near term
were to drop substantially below the average rate of the fourth
quarter.

He was prepared to see the money market banks lose a sub

stantial portion of their CD's.

He hoped that such losses would

lead banks to curtail loans to business customers, since the investment
outlays currently planned by businessmen were too large, and that
the rate of growth in the monetary aggregates would slow.
he would favor a determined policy of credit restraint.

In short,

Such a

course seemed particularly necessary to him in light of the doubts
reported this morning concerning the System's determination.

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Mr. Sherrill said that he too wanted to commend Mr. Solomon
on his presentation.

It was one of the few appraisals of the balance

of payments he had heard recently in which positive accomplishments
were not described as unreal and negative developments as the tip
of an iceberg.

However, nothing in Mr. Solomon's analysis offered

grounds for great optimism or suggested the need to change the policy
statement on the payments balance in the directive.
In the domestic area, Mr. Sherrill continued, the key economic
problem was that of dealing with bullish business expectations.

Such

expectations might well lead to an undue expansion in capital outlays
and inventories, and to subsequent problems associated with the un
winding of such investments.

Recent developments provided strong evidence

that high interest rates alone were not the solution to the problem.
Businessmen were so optimistic about economic prospects that they were
willing to borrow at very high interest rates.

Tight control over

the availability of credit was likely to be the most effective approach;
growth in bank credit had to be curbed.
Accordingly, Mr. Sherrill observed, he favored maintaining
the current policy of restraint.

He recognized that there were risks

in such a course and that the present degree of restraint was essentially
a policy for the short run.

He would want to be alert to any tendencies

toward changing expectations in order to prevent an over-reaction.

For

the present, however, he would have the Manager watch developments
carefully and avoid signaling easing of any kind through his operations.
He would accept the directive as drafted by the staff.

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Mr. Hickman commented that although economic activity
continued to expand rapidly, there were scattered indications of
easing, especially in the consumer sector.

Retail sales had

rebounded in November but had failed to return to the August high,
and then had dipped significantly in December.

The extent to which

that dip was related to the Hong Kong flu was debatable.

Sales of

new domestic cars in November and December were considerably less
than the 9 million annual rate that had been a floor since last
spring, and January sales would probably hold at the reduced level.
Latest surveys of consumer sentiment and buying plans also appeared
to rule out renewed vigor in that sector.

If consumers behaved as

now seemed likely, the growth of GNP this quarter, and perhaps next
quarter, would depend largely upon inventory investment.

Nevertheless,

the recent acceleration of wholesale prices for industrial commodities
and the continued sharp advance in consumer prices were likely fur
ther to fan inflationary psychology.
In that environment, the current objective of monetary policy
appeared to Mr. Hickman to be about right, providing the Desk held to
a fairly firm and narrow course without major deviations in either
direction.

As he had stated at the last meeting, the appropriate

policy in the present situation seemed to him to be "credit restraint,
not a crunch."

In that regard, he had to admit to a few moments of

doubt since the last meeting, when intermittent run-ups in bill rates
appeared to be leading to excessively large run-offs of CD's.

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It seemed to him, Mr. Hickman continued, that in the period
immediately ahead the System should strive for a rate of bank credit
growth just a shade less restrictive than that outlined in the blue
book.

The blue book projected a rate of credit growth in January,

excluding Euro-dollars, of zero to 3 per cent, augmented to 2 to 5
per cent when Euro-dollars were included, and a 91-day bill rate in
a range of 6 to 6-1/4 per cent.

In his opinion, it would be slightly

more desirable to keep the bill rate in a 5.90 to 6.15 per cent range,
which would perhaps permit bank credit growth in a range of 4 to 6
per cent.

That policy would lessen the likelihood of a sharp CD

run-off and would reduce dependence on Euro-dollars.
In any event, Mr. Hickman said, the difference between his
prescription and the staff's was not large and he was prepared to
vote for the staff's draft directive.

He would prefer, however,

either to delete the references to the Treasury refunding or to make
a modified reference along the lines of that suggested by Mr. Maisel,
since the terms of the refunding would not be announced until shortly
before the Committee's next meeting.

Since the present was a period

in which minor differences in market conditions could have major
effects on market expectations and the flow of funds, the Manager
should be given more than usual latitude to achieve the Committee's
objectives.
Mr. Bopp observed that, as usual, the choice today involved
a comparison of the costs and benefits attached to the various policy

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alternatives.

But the choice was unusually difficult because the

alternatives had potentially heavy and immediate costs attached to
them against which uncertain benefits had to be weighed.
Arguing for further restraint, Mr. Bopp said, was the dearth
of signs that excessive growth in the economy had yet been brought
under control.

Locally, the Philadelphia Bank's December business

outlook survey showed that two-thirds of the executives polled
expected a more buoyant economy by mid-1969.
cator had been rising since last September.

That confidence indi
In addition, inflationary

sentiments had increased.
As for the national economy, Mr. Bopp continued, in spite
of the December decline in retail sales, it was still far from
certain that the pressures from excessive growth were subsiding.
Moreover, policy decision made now would have much of their impact
in the second half of the year when some of the restraining influ
ences on consumers would be appreciably less,
proxy during December had again been large.

Growth in the credit
Although a slowdown was

forecast for January, that forecast had to be interpreted in the
light of excessive growth of bank credit since midyear and its
persistent tendency to grow faster than expected.
All of those facts pointed to the need for some further
restraint, Mr. Bopp said.

On the other hand, a strong case could be

made for not rocking the boat.

Banks were tightening lending policies

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as their supply of CD money had become uncertain.
tightened since the increase in discount rates.

Money markets had
Further restraint

would make an already nervous money market still tighter.
disintermediation could turn into a rout.

Orderly

Nevertheless, in his

judgment the potential costs of inaction were so great that the risks
attached to a policy of more restraint had to be taken.

He was all

the more persuaded of that in view of the approaching period of even
keel in February which would probably preclude

any policy move until

some time in March.
However, in view of the risks attached to further restraint,
Mr. Bopp thought the choice of policy tools was particularly important.
Any overt change in policy was inappropriate now.

Expectations were

currently of critical importance to short-term stability in the
money markets.

They were likely to continue to be so.

Because of

the difficulty of judging the impacts of policy changes on those
expectations, the System had to test and probe their impacts.

The

flexibility and reversibility of open market operations made them the
ideal tool for that approach.
Mr. Bopp's recommendation was for some additional restraint,
with bill rates and Federal funds rates at the upper end of the
ranges projected in the blue book.

He would, however, give the Desk

discretion to use the tactics it thought appropriate in achieving that
restraint, including freedom to offset any overreaction of money market

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rates.

With that qualification, he could accept the directive

proposed by the staff.
Mr. Kimbrel observed that a review of the latest economic and
financial data strongly suggested to him that the somewhat firmer
policy adopted by the Committee at its last meeting had not yet
achieved the desired slowing in the growth of bank credit and in
the economic expansion.

One could hardly expect that in so short a

time.
The original green book estimates of commercial bank loan
and investment growth at a seasonally adjusted annual rate of
around 6 per cent in November and December had given him some com
fort, Mr. Kimbrel said, by suggesting that the Committee might be
approaching its goal.

However, the later revised estimate of a

10.1 per cent growth rate for December had had the opposite effect.
The revised December estimate for the nation, incidentally, more
nearly conformed to the Atlanta Bank's estimates of a continued
strong growth in loans and investments at Sixth District banks.
Preliminary estimates showed a seasonally adjusted annual rate of
growth of over 20 per cent at the large banks in December.

That rise

was not explained by security loans and loans to non-bank financial
institutions.

Consumer and real estate lending was strong despite

a slowdown in business lending.

The banks also added to their

Government security holdings, especially Treasury bills.
large-denomination CD's were relatively small.

Losses of

1/14/69

-65
One could not be very certain, Mr.

Kimbrel remarked,

that the

sharp rise in money market rates could be attributed primarily to the
change in monetary policy rather than to expectational factors and
technical forces.

There were some grounds, of course, for assuming

that the economic slowdown was just over the horizon.

If

consumers

continued to slow down their spending as they had in December, one
should expect eventually to see some cut in

inventory growth followed

by production cutbacks and reduced credit demands.
happened yet.

Moreover,

But that had not

the consumer had not been too consistent

during the last few months; and with businessmen's behavior influenced
unduly by expectational factors rather than by a cold, calculating
look at the economic statistics, he thought caution was needed in
assuming that a slowdown in credit demand was imminent.
That there had been no dramatic changes in over-all reserve
positions despite the churning around of rates and other forces in
the money and capital markets was well and good, Mr. Kimbrel continued.
A gradual firming rather than a sudden and drastic action was desirable.
For that reason he had told the Executive Committee of the Board of
Directors at the Atlanta Bank last week that he thought raising the
discount rate at this time was inadvisable since it

might be inter

preted as pushing the panic button rather than an implementation of
gradual firming.
The past record showed that there was more danger that the
System would be too accommodative rather than too restrictive, Mr.

Kimbrel

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said.

Therefore, he hoped that the Committee would not find at its

next meeting that substantially more reserves had been supplied than
had been intended in connection with the move toward a moderately
restrictive policy.

He thought there were three possible ways in which

that accommodation could occur:

the squeeze on the large banks could

be relieved by raising the Regulation Q ceilings; the System could
become frightened by temporarily high short-term rates into supplying
reserves to offset pressures created by expectational and technical
factors; and the System could be tempted into supplying all the
reserves needed for Treasury financing.
Therefore, Mr. Kimbrel concluded, he could support the staff's
draft directive calling for maintaining the prevailing firm conditions
in money and short-term credit markets on the understandings that
primary attention was to be given to the behavior of the bank credit
proxy; that the Desk would not be too disturbed by high short-term
bill

rates,

under the assumption that an increase in

the Regulation Q

ceilings was to be avoided if at all possible; and that any necessary
assistance to Treasury financing would be kept minimal.
Mr. Francis commented that the economy's most serious problem
continued to be excessive total spending.

Output had been going up

as rapidly as labor capacity permitted, and prices had been rising at
about a 4 per cent annual rate.

The demand for goods and services had

been stimulated by a rapid 7 per cent annual rate of growth of M1 over

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the past two years,

a 10 per cent rate for M2 , and an 11 per cent rate

for bank credit.
At its last meeting the Committee had decided to move toward
monetary restraint, Mr. Francis noted.

As of December 18, discount

rates were partially adjusted to market rates, which had been rising
rapidly.
ment,

Those market rates had continued their previous upward move

although at a decelerated pace.

While the period was too short

for conclusive analysis, he noted continued net expansion in most
monetary aggregates since the last meeting.

He saw no net evidence

that the System had exercised a restrictive monetary influence.

In

the week ending January 8 Federal Reserve credit, member bank reserves,
and the monetary base all were higher than in
18.

the week ending December

The money stock was $1 billion higher in the week ending January 1

than two weeks earlier.

Even M2, bank credit at large commercial banks,

and the credit proxy had increased in spite of the disintermediation
facilitated by Regulation Q.

He continued to hope that the growth

rates of member bank reserves, the monetary base, and the money supply
would soon begin to show solid evidence of slowing.
Mr. Francis felt that for the foreseeable future the System
should restrain the growth rates of monetary aggregates even at the
cost of still higher interest rates.

As a target for the next several

months, it would seem desirable for the money stock to increase at no
more than a 4 per cent annual rate and at no less than a 2 per cent
rate.

Temporarily, that might contribute to relatively high interest

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rates by limiting one source of available funds.

As the demand for

goods and services and inflationary expectations gradually diminished,
however, the huge demand for funds was likely to contract, causing
interest rates to move lower.
In evaluating the behavior of monetary aggregates in
future, Mr.

Francis remarked,

the near

the Committee should give less weight

than usual to commercial bank credit and the measure of money which
included time deposits.

With the recent increase in market interest

rates relative to Regulation Q ceilings, banks would be less successful
in acquiring or holding time deposits, particularly large-denomination
CD's.

As a result, some funds that normally flowed through commercial

banks were likely to move directly from source to borrower without
passing through a bank.

Hence, changes in bank credit and time deposits

might be a misleading indicator of total credit expansion in the economy,
tending to understate actual growth.

The re-directing of funds away

from local financial institutions and into the money markets might
discriminate against consumers, home buyers, and small businesses, if
Regulation Q ceilings remained at present levels.
With market rates substantially higher than the discount rate,
Mr. Francis observed, there would probably be a tendency for member
banks to do more of their reserve adjusting by borrowing from Reserve
Banks.

A rise in the volume of those loans outstanding should not be

considered as monetary restraint.

In fact,

the Committee should give

quite the opposite interpretation to such a development.

Loans

1/14/69

-69-

outstanding from the Federal Reserve should be considered as substi
tutes for System holdings of Government securities.
Mr. Robertson made the following statement:
Since our mid-December meeting, monetary restraint
has caught the attention of the country--partly because
of the conduct of open market operations, partly because
of the discount rate action, but importantly, too, because
of the contents of the press announcement of the latter.
While, with the benefit of hindsight, I think that the
results would have been even better if, instead, we had
raised reserve requirements--either alone or in conjunc
tion with the discount rate action--there are clear signs
of some dampening effects on particular banks and on some
elements in other financial sectors.
But the toughest part of our job lies ahead. That
consists of sticking to a tight policy with determination
until the economy has been set decisively on the track
of a slower and noninflationary expansion. Assuming that
we have the wisdom and the courage to stick to our guns,
we should be successful eventually--perhaps sooner than
most people think--in getting on top of the inflationary
problem. We will be receiving plenty of advice to let
up on the pressure--from people afraid of the effects of
tight money on the banks, on the savings institutions
and the housing industry, on the economy in general, and
perhaps on some of our closest friends abroad as well.
Many of these reasons will sound plausible, I am sure,
but I am also sure that any easing up on our part--whether
by providing more reserves or by raising Q ceilingswould loosen our restraint on inflationary expectations
and reinforce a complacent feeling in some quarters that
the Fed will relax its pressures in the pinch and that
therefore no cutbacks in financing and spending decisions
really have to be made. This is the most pernicious
attitude we face, and we have to be very careful not to
foster it by being too quick to moderate our restraint.
For now I am in favor of holding as tightly as we
can to the firmer conditions introduced since the last
meeting. I would urge the Manager to guard against even
any temporary easing of the money market, so long as
bank credit does not falter so much as to trigger the
proviso clause on the downside. And I would like him to
be assiduous in activating the proviso clause on the upside.

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Beyond attention to the bank credit aggregate as a
whole, I think we also need to keep an eye on major move
ments in the money supply. We may argue about the extent
of causal power in the money supply, but its influence as
a symbol in the current climate is undeniable. I do not
mean to advocate using "money supply" as a primary target
for day-to-day open market operations, or as a substitute
target for the proviso clause. But I do mean that exces
sive rates of money supply growth, if persisting, should
lead us to consider reinforcing the speed and vigor of our
tightening operations.
Finally, if our present restraining posture should
prove to be inadequate, we should keep an increase in
reserve requirements at the ready. We may very well need
to use this kind of an overt System action in order to
drive home our basic policy thrust against inflationary
credit availability.
Mr. Robertson added that he agreed with those who thought the
wording of the policy statement on the balance of payments in the
first paragraph of the directive was no longer appropriate in light of
the information now available to the Committee.

Retention of the

present language might leave the impression, when the directive was
made public in a few months, that the Committee had been unaware today
that there had been a surplus in the payments balance for 1968.

He

would propose replacing the clause "and attaining reasonable equilibrium
in the country's balance of payments" with "and improving the country's
balance of payments position."
With respect to the second paragraph of the draft directive,
Mr. Robertson thought the word "prevailing" was superfluous in the
expression "maintaining the prevailing firm conditions."

He also had

some question about the form of the references to the Treasury refunding

-71

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since only part of the forthcoming policy period would be subject
to even keel constraints.

However, he did not have strong feelings

about either of those matters.
Chairman Martin remarked that he would report briefly to the
Committee on how he had been discharging his responsibility, as
Chairman, for maintaining the System's relations with the outgoing
and incoming Administrations during the current period of transition.
In recent weeks, he had been in communication by telephone and other
wise with President Johnson and President-elect Nixon and appropriate
associates of both.

He had informed them prior to mid-December of

the general view within the Federal Reserve that the reduction of
the discount rate to 5-1/4 per cent in August had turned out to have
been based on a miscalculation, and that the rate should shortly be
increased to the previous level of 5-1/2 per cent or perhaps to 5-3/4
per cent.

He had advised them that in his judgment the choice between

an increase of 1/4 and 1/2 point was not crucial, since the primary
problem was not one of rate relationships but rather one of dealing
with the prevailing inflationary psychology.
The Chairman said he thought the System's relations with the
outgoing Administration were ending on a good note and that early
contacts with the incoming Administration were proceeding harmoniously.
Both he and Mr. Brill had participated to some extent in the recent
discussions between the two Administrations on the status of the income

-72

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tax surcharge, and he personally was gratified at the outcome of
those discussions.

He had reviewed the structure and workings of

the Federal Reserve and the problems it faced with people who would
have responsibilities in the economic policy area in the new Admin
istration, and they appeared to have a generally good understanding
of the System and a cooperative attitude.

To Mr. Nixon he had

expressed his view that inflation was the primary economic problem
now facing the nation, and that the new Administration would have to
deal with it effectively from the beginning if inflation were not to
get out of control.

He had done his best to emphasize the seriousness

of the problem and had left for Mr. Nixon a memorandum on the subject
prepared by Mr. Brill.
On the whole, Chairman Martin continued, he thought that from
the standpoint of the Federal Reserve the transition was going well,
and he was rather optimistic about the System's relations with the
new Administration.

Continued close relations and policy coordination

would be important, particularly since monetary policy would need the
help of fiscal policy in coping with inflation.
Turning to the question of current monetary policy, the
Chairman remarked that the System continued to face the problem of
dealing with the "heritage of errors" from past economic policies.
That problem was not new; the System had faced similar difficulties
from time to time in the past.

It was true that the Federal Reserve

had been widely criticized in recent months on the grounds that it

-73

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had vitiated the effects of fiscal restraint by an unwarranted easing
of monetary policy last summer.

He did not think such criticism was

wholly justified since much of the prevailing inflationary psychology
was a consequence of the long delay in getting fiscal legislation.
That psychology--which, as Mr. Coombs had noted earlier, was part of
a world-wide phenomenon--appeared to have outrun the underlying eco
nomic realities since last summer.
In any case, Chairman Martin observed, he thought monetary
policy was now on the right track.

In his judgment it would be better

at this juncture to risk overstaying, rather than understaying, a
policy of restraint, and he certainly would not want to relax policy
now.

The staff's draft directive seemed to him essentially appropriate,

although the Committee might want to adopt some of the language changes
that had been suggested in the go-around, such as the change Mr.
Robertson had proposed in the policy statement on the balance of pay
ments.

He had no strong feelings about the proposal to delete the

word "real" before "economic activity" in the first sentence, since
the word would be implied in any case.
Mr. Maisel remarked that preferences with respect to the form
of the balance of payments statement seemed to be a matter of taste.
Personally, his reaction was just the reverse of Mr. Robertson's; he
thought that the statement of the objective proposed by the latterin terms of "improving" the balance of payments--would suggest to

1/14/69

-74

readers that the Committee had been unaware today that there had been
a surplus in 1968.

The language of the staff's draft appeared pref

erable since it was clear that the Government's programs had both
produced large inflows and halted other outflows.

Therefore, given

the existence of those programs, most observers would agree that rea
sonable equilibrium had not been attained.
Mr. Daane said he also continued to favor the language of the
staff's draft.

The facts concerning the year-end inflows were set

forth in the next-to-last sentence of the first paragraph.

Since

those inflows did not mean that reasonable equilibrium had been
achieved, he saw no reason for changing the statement of the Committee's
objective from the form that had been used for some time.
Mr. Brimmer noted that the sentence involved--the last of the
first paragraph--differed in content from the preceding sentences.
Whereas the bulk of the first paragraph contained a summary descrip
tion of economic and financial developments, the last sentence specified
the Committee's general policy stance and broad objectives.

Perhaps

it would be desirable to set off that sentence in a separate paragraph.
In any case, as he had indicated earlier he favored the staff's draft
language.
After further discussion, the Committee decided to accept the
language of the staff's draft for the balance of payments statement.
It also agreed to retain the word "real" in the statement of the first

1/14/69

-75

sentence to the effect that "real economic activity has been moder
ating."

In that connection, Mr. Brill noted that in submitting past

directive drafts the staff customarily had used the term "over-all"
economic activity as a synonym for "real" activity.

Ordinarily,

however, the statements in which the term occurred had been accurate
whether one had real or dollar-volume GNP in mind.

That was not the

case now, since there had been a significant decline in real, but not
in dollar, GNP growth in the fourth quarter.

The staff therefore had

proposed the use of the word "real" to avoid possible misunderstanding.
In the discussion of the changes proposed in the draft of the
second paragraph, it was agreed that the reference to the Treasury
refunding should be deleted from the primary instruction but retained
in modified form in the proviso clause.

Mr. Mitchell remarked that

he would prefer to retain the word "prevailing" in the primary instruc
tion since it served to define the following phrase, "firm conditions
in the money and short-term credit markets."
Mr. Hickman said that while he had some sympathy for the
substitute language for the proviso clause that Mr. Morris had proposed,
he would not favor its adoption since it would involve a change in
policy.

At the same time, he thought it was desirable not to press

monetary restraint so far that it would become necessary to back off.
He asked Mr. Holmes how the Desk would react if the bill rate rose to
the upper limit of the range given in the blue book--6.25 per cent--and
a sharper than expected run-off of CD's ensued.

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Mr. Holmes replied that the Desk's reaction would depend
mainly on the effect such a development had on the bank credit proxy,
assuming the directive contained the two-way proviso shown in the
staff's draft.

If there were a significant short-fall in bank credit

from the projection, the Desk would modify its operations.
Chairman Martin then suggested that the Committee vote on a
directive consisting of the staff's draft with the references to the
Treasury refunding modified in the manner discussed earlier.
Mr. Morris said he would find it necessary to dissent from
such a directive since in his judgment it could be compatible with
an unduly restrictive monetary policy.

He thought his position today

was consistent with the position he had taken at other recent meetings
when he had spoken in favor of a substantial slowing in the rate of
bank credit growth.

As he recalled the discussion at the previous

meeting, the Committee had not sought money market conditions that
would be compatible with an actual contraction in bank credit.
With Mr. Morris dissenting, the
Federal Reserve Bank of New York was
authorized and directed, until other
wise directed by the Committee, to
execute transactions in the System
Account in accordance with the follow
ing current economic policy directive:
The information reviewed at this meeting suggests
that expansion in real economic activity has been mod
erating, with slower growth in consumer outlays but
higher rates of business inventory accumulation and
capital expenditures. Upward pressures on prices and

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costs, however, are persisting. Since the mid-December
firming of monetary policy, most interest rates have
risen further and, with the outstanding volume of large
denomination CD's declining sharply, bank credit expan
sion has slowed. Growth in the money supply moderated
somewhat on average in December from its rapid November
pace. The U.S. foreign trade surplus remains very small
but near the end of the year unusual capital inflows had
a markedly favorable effect on the over-all balance of
payments. In this situation, it is the policy of the
Federal Open Market Committee to foster financial
conditions conducive to the reduction of inflationary
pressures, with a view to encouraging a more sustainable
rate of economic growth and attaining reasonable equilibrium
in the country's balance of payments.
To implement this policy, System open market operations
until the next meeting of the Committee shall be conducted
with a view to maintaining the prevailing firm conditions
in money and short-term credit markets; provided, however,
that operations shall be modified, to the extent permitted
by the forthcoming Treasury refunding, if bank credit
expansion appears to be deviating significantly from
current projections.
It was agreed the next meeting of the Committee would be held
on Tuesday, February 4, 1969, at 9:30 a.m.
At this point, all members of the staff withdrew from the
meeting except Messrs. Holland, Kenyon, Broida, Hackley, Brill,
Axilrod, and Holmes; and Mr. Molony, Assistant Secretary, and Mr.
Harris, Coordinator of Defense Planning, Board of Governors, entered
the room.

Mr. Holmes reported to the Committee with respect to the

latest developments in connection with the Government's investigation
of the leak of information on the Treasury refunding of August 1967,

1/14/69

-78

and in the course of the ensuing discussion he responded to ques
tions .
Thereupon the meeting adjourned.

Secretary

ATTACHMENT A
CONFIDENTIAL (FR)

January 13, 1969

Draft of Current Economic Policy Directive for Consideration by the
Federal Open Market Committee at its meeting on January 14, 1969
The information reviewed at this meeting suggests that ex
pansion in real economic activity has been moderating, with slower
growth in consumer outlays but higher rates of business inventory
accumulation and capital expenditures. Upward pressures on prices
and costs, however, are persisting. Since the mid-December firming
of monetary policy, most interest rates have risen further and, with
the outstanding volume of large-denomination CD's declining sharply,
bank credit expansion has slowed. Growth in the money supply mod
erated somewhat on average in December from its rapid November pace.
The U.S. foreign trade surplus remains very small but near the end
of the year unusual capital inflows had a markedly favorable effect
on the over-all balance of payments.
In this situation, it is the
policy of the Federal Open Market Committee to foster financial
conditions conducive to the reduction of inflationary pressures,
with a view to encouraging a more sustainable rate of economic growth
and attaining reasonable equilibrium in the country's balance of
payments.
To implement this policy, while taking account of the
forthcoming Treasury refunding operation, System open market oper
ations until the next meeting of the Committee shall be conducted
with a view to maintaining the prevailing firm conditions in money
and short-term credit markets; provided, however, that operations
shall be modified, to the extent permitted by the Treasury refunding,
if bank credit expansion appears to be deviating significantly from
current projections.


Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102