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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 20, 1976, at
9:00 a.m.
PRESENT:

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

Burns, Chairman
Volcker, Vice Chairman
Baughman
Coldwell
Eastburn
Holland
Jackson
MacLaury
Mayo
Mitchell
Partee
Wallich

Messrs. Balles, Black, and Winn, Alternate
Members of the Federal Open Market
Committee
Messrs. Clay, Kimbrel, and Morris, Presidents
of the Federal Reserve Banks of Kansas City,
Atlanta, and Boston, respectively
Mr. Broida, Secretary
Mr. Altmann, Deputy Secretary
Mr. Bernard, Assistant Secretary
Mr. O'Connell, General Counsel
Mr. Axilrod, Economist (Domestic Finance)
Mr. Gramley, Economist (Domestic Business)
Mr. Solomon, Economist (International Finance)
Messrs. Boehne, Davis, Green, Kareken,
Reynolds, and Scheld, Associate Economists

1/20/76

Mr. Holmes, Manager, System Open Market Account
Mr. Pardee, Deputy Manager for Foreign
Operations
Mr. Sternlight, Deputy Manager for Domestic
Operations
Mr. Coyne, Assistant to the Board of
Governors
Messrs. Kichline and Zeisel, Associate
Directors, Division of Research and
Statistics, Board of Governors
Mr. Keir, Adviser, Division of Research
and Statistics, Board of Governors
Mr. Gemmill, Adviser, Division of International
Finance, Board of Governors
Mrs. Farar, Economist, Open Market Secretariat,
Board of Governors
Mrs. Ferrell, Open Market Secretariat
Assistant, Board of Governors
Mr. Leonard, First Vice President, Federal
Reserve Bank of St. Louis
Messrs. Eisenmenger, Parthemos, Balbach, and
Doll, Senior Vice Presidents, Federal
Reserve Banks of Boston, Richmond, St. Louis,
and Kansas City, respectively
Messrs. Hocter, Brandt, and Keran, Vice
Presidents, Federal Reserve Banks of
Cleveland, Atlanta, and San Francisco,
respectively
Mr. Meek, Monetary Adviser, 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 16, 1975, were approved.
By unanimous vote, the memoranda
of discussion for the meetings of the
Federal Open Market Committee held on
November 18 and December 16, 1975, were
accepted.

1/20/76

Before this meeting there had been distributed to the
members of the Committee a report from the Manager of the System
Open Market Account on foreign exchange market conditions and
on Open Market Account and Treasury operations in foreign cur
rencies for the period December 16, 1975, through January 14,
1976, and a supplemental report covering the period January 15
through 19, 1976.

Copies of these reports have been placed in

the files of the Committee.
In supplementation of the written reports, Mr. Holmes
made the following statement:
Since the December meeting of the Committee
the dollar has eased by roughly 1 per cent against
major currencies. This easing has mainly reflected
the recent decline of interest rates here and in
the Euro-dollar market. In addition, renewed
heavy buying of Swiss francs, partly speculative,
has contributed to the strength of that currency
and of other European currencies against the
dollar. The Swiss National Bank intervened
heavily, however, taking in some $650 million,
and thereby helping to calm the market. We inter
vened in a very modest way on four occasions,
selling a total of $47 million worth of marks out
of our balances, which we have largely been able
to recoup. On occasion, in addition to offering
marks in New York, we have been able to intervene
simultaneously in Swiss francs, using francs sup
plied by the Swiss National Bank for its own
account.
In contrast with earlier periods of falling
U.S. interest rates, the decline in the exchange
rate for the dollar has been rather modest. In
part this has reflected the market's recognition
of the fundamental strength of the dollar, with

1/20/76

the U.S. trade account remaining in solid surplus.
In addition, as compared with last year at this
time, many market participants see the decline of
U.S. interest rates as probably being temporary,
rather than as a continuous slide. Finally,
against the background of the various international
agreements over the past year--in London last
February, in Rambouillet in November, and in Jamaica
most recently--the market has responded favorably
to central bank intervention, which has been quite
quick and forceful. In fact, traders in the market
place are beginning to complain that intervention
has left exchange rates so stable that it has be
come hard to trade for profits.
Turning to operations, I have circulated to
the Committee a report on the loss-sharing agree
ment that we reached in Basle with officials of the
Swiss National Bank.1/ The agreement is subject
to the Committee's approval, which I recommend, and
to approval by the Board of Directors of the Swiss
National Bank. At current very high rates for the
franc, some SF 2.60 to the dollar, neither we nor
the Swiss are eager to go into the market. Never
theless, there are opportunities to acquire francs
in modest volume outside the market. At current
exchange rates the System's share of losses would
be 56 per cent to the Swiss National Bank's 44 per
cent on any swap repayments that we might make. If
the dollar should rise to SF 2.70 and beyond, the
Swiss National Bank is prepared to sell dollars in
the market, and the losses on any swap repayments
would be shared equally. We have no illusions about
an early repayment of the Swiss swap debt, but we
can at least show some progress.
Turning to the Belgian franc, our program of
modest daily purchases is about on schedule and we
have repaid a further $30.1 million of debt. The
Belgians hope, as do we, to accelerate the pace of
repayment, but that largely depends on market develop
ments.
Finally, at last week's Basle meeting, Governor
Baffi and Deputy Governor Ossola of the Bank of Italy
met with us to request a $500 million drawing under
1/ A copy of this report, dated January 15, 1976, and entitled,
"Loss-sharing agreement with the Swiss National Bank," has been
placed in the Committee's files.

-5

1/20/76

the Federal Reserve swap line. Italy has had an
impressive turnaround in its current account--from
a deficit of $7.5 billion in 1974 to flat last yearbut the turnaround has been at the expense of a severe
recession. More recently, with the resignation of
the Italian cabinet, there have been heavy outflows
of funds.
An added feature in the situation is market
reaction to press reports suggesting that U.S. bank
examination authorities are looking askance at loans
to Italy, and the Bank of Italy believes this has
been quite damaging to confidence in the lira at
the present time. Governor Baffi argues that any
further depreciation of the lira would only exac
erbate domestic inflation, through escalators and
other automatic mechanisms built into the Italian
price and wage structure.
Moreover, he feels that
the lira is quite competitive in international markets
at the present time. Consequently, he believes that
the exchange rate should not be allowed to decline
very far under pressure of speculative outflows.
Nevertheless, Italy's usable cash reserves are lowunder $500 million--and they need more resources in
hand. At the time of the request to us, they also had
rounded up $1 billion of additional credits from
Germany, Switzerland, and the Bank for International
Settlements. They are also applying for an SDR $450
million borrowing from the International Monetary
Fund, which they have pledged to repay the System
swap drawing, if that should prove necessary.
In response to questions by Mr. Coldwell about Italy's
plans to borrow foreign currencies, Mr. Holmes indicated that
the Italians were sending a delegation this week to the Inter
national Monetary Fund in Washington.

No formal application

for an IMF loan had been made thus far, but he understood that
the Italians had some assurance of sympathetic consideration
by the IMF.

It might take some time for the loan arrangements

1/20/76

to be completed, however, and for that reason the Italians
viewed the swap drawing on the System as a sort of bridge
loan.

Italy might also be able to borrow a substantial amount

from the EEC oil facility, once that facility was put into
place, but again such a loan was down the road a bit.
Mr. Holmes added that Italy's total foreign debt was
around $14 billion, including that of the various governmental
agencies, but fortunately the maturity structure of that debt
was favorable in that only $300 million of the total would be
up for renewal in 1976.

The amount of foreign currencies

that the Italians would need to borrow would therefore depend
on the size of their intervention in support of the lira.

The

$1 billion in new credits, to which he had referred in his
statement, included a $500 million loan from the Germans.

As

the Committee members would recall, the Italians had repaid
a $500 million gold collateral loan from West Germany in 1975.
In addition, the Swiss had agreed to make a $250 million gold
collateral loan and the BIS had agreed to a $250 million direct
swap.

Accordingly, if the Italians drew $500 million on the

System, they would have total new credits of $1.5 million plus
whatever they might obtain from the IMF and the EEC oil facility.

1/20/76

In reply to questions by the Chairman about the EEC
oil facility, Mr. Holmes said that it had been set up by the
EEC countries some time ago, but it had not yet been put into
operation.

The total resources of the facility would be

$1 billion,which--on the basis of tentative plans--would be
borrowed in the market.

Of the $1 billion total, he believed

as much as $700 million might be available to Italy.
In response to a question by Mr. Holland, Mr. Holmes
indicated that the Italians had exhausted their borrowing
facilities at the IMF except for the additional leeway that
was made available at the recent meeting in Jamaica.

As a

result of that meeting the Italians could now borrow a further
$450 million in SDR's.
The Chairman inquired about the performance of the lira
in recent days, and Mr. Holmes said that the lira was off about
one-half per cent against the dollar and somewhat more against
some of the European currencies.

The Italian authorities were,

therefore,letting the lira slide a bit, but they did not want
the decline to go too far.

He thought they were probably

right in their view that substantial further deterioration
in the lira would worsen wage and price problems in Italy.

1/20/76

In response to a further question by the Chairman,
Mr. Holmes said the Italians had lost some $400 million in
reserves since the fall of the Italian government on January 7,
including about $180 million in the last 2 days.

The lira

had declined further today, but no information was available
so far concerning any intervention by the Italians.
Mr. Holland asked Mr. Holmes whether he expected the
Italians to make a stand at a level close to the current
exchange rate and whether the drawing on the System might
have to be followed by additional borrowings if Italian re
serve drains proved to be heavier than anticipated.
Mr. Holmes said he thought the Italian authorities
wanted to make a stand at a level close to the current rate
in light of their concern about the inflationary impact of a
further substantial depreciation of the lira.

If a new infla

tionary spiral were triggered by such a depreciation, the
competitive position of the lira could be seriously eroded.
As he had noted in his statement, he thought the lira's position
was quite good at the present time.
Mr. Solomon commented in reference to Italy's debtor
position that so long as the OPEC countries continued to run
a large surplus, other countries as a group would experience

-9-

1/20/76

a deficit in their current account.

In these circumstances

one could not judge the normal position of a country like
Italy on the basis of whether or not its current account was
close to zero or in surplus.

Someone had to hold the "hot

potato" and it happened to rest rather heavily now with Italy
and the United Kingdom.

On the other hand, the United States

and Germany had current account surpluses that were really
too large for the health of the world economy.

This did

not mean that the System rather than someone else should
lend to the Italians.

That was a separate, if related,

question.
In reply to a question by Mr. Partee, Mr. Solomon
noted that the improvement in Italy's current account position
last year had been at the cost of a severe recession.
Mr. Pardee added that GNP in Italy had fallen 4-1/2
per cent in 1975 and industrial production about 12 per cent.
Mr. Wallich commented that, cyclically adjusted, the
Italian balance of payments on current account was probably
in deficit.
Mr. Mayo referred to the System's debt in Swiss francs
and observed that the franc had appreciated considerably in
recent months--indeed, it was now trading on a par with the

-10-

1/20/76

German mark.

To an important extent, inflows of funds to

Switzerland were induced by a desire for a haven that offered
privacy, and he suspected that some of those inflows could
prove to be temporary.

He wondered, therefore, whether it

might not be preferable for the System to try to minimize its
losses by delaying repayment of its franc debt until the market
was more favorable.
Mr. Holmes said he thought it would be highly desirable
to reach agreement with the Swiss now on a rate at which loss
sharing would be 50-50, and he believed the proposed rate of
2.70 francs to the dollar was fair.

The System would not incur

any losses until swap drawings were actually repaid, and he
did not envision the acquisition of very many Swiss francs at
a rate less favorable than 2.70.

However, he saw some advantages

in making some small progress in reducing the Swiss debt through
off-market transactions.

As he had noted in his statement, the

Federal Reserve would have to absorb 56 per cent of the losses
at current exchange rates.

Since the best that could be hoped

for would be a 50-50 sharing of losses, it was his personal
view that the System should be willing to take the extra losseswhich would be quite small in light of the small size of the
contemplated transactions--so as to show at least token progress
in repaying the System's debt.

-11-

1/20/76

Mr. Mayo indicated that he had a somewhat different
view.

He was not raising any objection to going ahead with

the loss-sharing agreement outlined by Mr. Holmes.

However,

he did question the desirability of incurring losses at cur
rent exchange rates.

If the Swiss franc

was indeed close to

peaking--and he could be wrong in his assessment of where the
franc was going--a delay would mean that the System would have
to absorb only half the losses, and that was preferable to
More importantly, the

absorbing, say, 56 per cent of them.

Swiss franc might weaken to a rate above 2.70 per dollar, so
that the losses to be shared on a 50-50 basis would be smaller.
Mr. Holmes remarked that the Swiss had been very con
structive in devising various ways for the System to acquire
francs in off-market transactions.

For example, the Swiss

would be putting up dollars in connection with an upcoming
drawing on the IMF oil facility by another country, and they
were willing to share their lessened dollar exposure by selling
some Swiss francs to the System.

He thought such access to

Swiss francs outside the market was very useful to the System,
and he believed it was desirable for the System to help get
this sort of mechanism well established.
Replying to a question by Mr. Holland, Mr. Holmes
indicated that the Swiss authorities had been very cooperative.

1/20/76

-12-

They recognized that the Swiss franc was a special case and
that it was strong against all currencies.

In that connection,

they apparently felt that they had some moral, if not legal,
responsibility to be accommodating.
Mr. Pardee observed that the Belgians, unlike the Swiss,
had been unwilling to accept any responsibility for the appre
ciation of their currency relative to the dollar.
In response to a question by Mr. Coldwell, Mr. Holmes
said that losses on any new System drawings of Swiss francs
would be shared on a 50-50 basis.

In the unlikely event that

the Swiss should draw on the System, they would absorb 100 per
cent of any losses, but he believed that that part of the agree
ment might have to be renegotiated at a later date.
By unanimous vote, the System
open market transactions in foreign
currencies during the period Decem
ber 16, 1975, through January 19,
1976, were approved, ratified, and
confirmed.
Mr. Holmes reported that $1,167.2 million of System
drawings in Swiss francs would mature prior to the next meeting
of the Committee and would be up for their eighteenth renewals.
He recommended that the Committee approve the renewals.

He

added that $600 million of the maturing drawings were on the
Bank for International Settlements.

The Swiss National Bank,

-13-

1/20/76

which had originally advanced the francs, now wanted to have
the drawings transferred to its account, apparently to avoid
paying the BIS a commission for its services.

He saw no

objection to the transfer from the System's standpoint, since
only a change in creditors was involved and no change in the
amount or terms of the drawings was in question.
In reply to a question by the Chairman, Mr. Holmes
It

said he saw no real alternative to renewing the drawings.
might prove feasible to repay $20 million or $30 million of
the total, but that was about all that could be hoped for.

Replying to a question by Mr. Holland about the $600
million drawing on the BIS, Mr. Pardee recalled that the Swiss
National Bank had found it desirable to minimize the extension
of credit to the System in its own name.

It had therefore made

arrangements to extend credit through the BIS.
Mr. MacLaury said that was also his recollection.
The decision to use the BIS was made by the Swiss National Bank
and not by the System.
Mr. Holmes then noted that all of the System's drawings
on the Belgian National Bank, totaling $277.5 million, would
mature before the next Committee meeting.

The Desk would pay

-14-

1/20/76

off any amounts that it could, but he recommended that the
Committee approve renewal of the remaining balances.
By unanimous vote, renewal
for further periods of 3 months
of System drawings on the National
Bank of Belgium, the Swiss National
Bank, and the Bank for International
Settlements, maturing in the period
January 30 through February 28,
1976, was authorized. It was under
stood that the System's outstanding
drawing of $600 million on the Bank
for International Settlements,
maturing on February 13, 1976, would
be transferred on that date to the
Swiss National Bank under arrange
ments made between those two insti
tutions.
Turning to the loss-sharing agreement with the Swiss,
Mr. Holmes recommended approval of the proposal he had nego
tiated with the Swiss authorities, subject to final approval
by Chairman Burns following favorable action by the Directors
of the Swiss National Bank.
By unanimous vote, the Com
mittee approved an agreement with
the Swiss National Bank for the
sharing of losses incurred in the
repayment of the System's swap
liability to that Bank on the
basis recommended by the Manager
in his memorandum to the Committee
dated January 15, 1976, subject
to final approval by the Chairman

-15-

1/20/76

on receipt of advice that the
agreement was acceptable to the
Board of Directors of the Swiss
National Bank.
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 op
erations for the period December 16, 1975, through January 14,
1976, and a supplemental report covering the period January 15
through 19, 1976.

Copies of both reports have been placed in

the files of the Committee.
In supplementation of the written reports, Mr. Sternlight
made the following statement:
The period since the last meeting of the Com
mittee has been marked by gradually easing money
market conditions and declining interest rates
against a background of sluggish growth in money
and credit aggregates. As the period began, the
Account Management sought money market conditions
about unchanged from those prevailing prior to
mid-December--that is, a Federal funds rate
around 5-1/4 per cent. Within a few days after
the meeting, incoming evidence suggested a
significantly weaker picture than was expected
at mid-December and embodied in the Committee's
indicated growth ranges.
Given the Committee's preference at the last
meeting for a money-market-oriented directive,
and in light of skepticism about the monetary
growth data in the year-end period, the Desk
responded quite cautiously to the weak aggre
gates. Thus, no change in stance was made
until the final days of December, and then

1/20/76

-16-

in successive weeks the funds rate objective was
edged down in steps of 1/8 per cent, to 4-7/8 per
cent by January 9. By that time, with the market
sensing the System's thrust, actual trading in
funds was at 4-3/4 per cent, with some market
participants anticipating that a continued decline
was likely. Since the agreement by a majority
of the Committee with the Chairman's recommendation
of January 12, the Desk has aimed at a continuation
of the 4-3/4 per cent funds rate until today's
meeting.
Following the typical intra-monthly pattern,
the Desk supplied reserves early in the period
through outright purchases of $297 million of
Treasury coupon issues and $675 million of bills
in the market, and about $1.1 billion of bills
from foreign accounts, along with sizable day-to
day repurchase agreements. Substantial repurchase
agreements were required, particularly in the days
surrounding the turn of the year, to avoid undesired
firmness during this period of uncertainty and of
sizable financial flows that were partly related
to statement-date adjustments. Early in the new
year, with Treasury balances dropping sharply,
the Desk absorbed reserves through a market sale
of $506 million in bills, sales of about $733 mil
lion of bills to foreign accounts, and a redemption
of $600 million of maturing bills. There were also
day-to-day matched sale-purchase transactions with
foreign accounts and occasionally in the market.
In the last few days, with market factors turning
around again, the Desk has moved to provide re
serves, including the purchase of $240 million
of Federal agency securities to be delivered
today.
Encouraged by the Desk's easier stance, weak
ness in the money supply, the December 24 reduction
in reserve requirements, a decline in wholesale

prices, and anticipation that credit demands would
be moderate in the months ahead, interest rates
have declined across the board in the past few
weeks. Some short-term rates, in fact, have
reached their lowest point since late 1972. In
yesterday's auction, 3- and 6-month bills went

1/20/76

-17-

at 4.78 and 5.05 per cent, compared with 5.49
and 5.91 per cent just before the last meeting.
Rates on commercial paper and bank CD's are
down by roughly a full percentage point. On
the day of the last meeting the Treasury sold a
2-year note to yield 7.28 per cent, while last
Wednesday a similar issue was sold at a yield
of 6.49 per cent. At the longer end, the yield
decline was around 30 basis points.
Toward the close of the period, the rally
was running out of steam, and it appeared that
dealers felt uncomfortable with their sizable
takings of 2- and 5-year notes last week. Over
the whole interval, dealer holdings of over-l
year maturities increased by about $1.2 billion,
to $1.6 billion. While Friday's discount rate
reduction tended to bolster confidence, the market
is also keenly aware of the approaching Treasury
financing to be announced a week from today. With
respect to that financing, the System holds $3.7
billion of the maturing issues, which we would
plan to exchange for new issues in approximately
the proportions that such issues are offered to
the public.
Rates in the corporate bond market also
declined in the past month, on the order of 10 to
25 basis points for seasoned issues. As with
Treasury issues, the rally lost strength in the
latter part of the period, partly because under
writers became too enthusiastic and priced new
issues ahead of investor willingness to buy.
Moreover, the strength of the market around the
turn of the year has encouraged an increase in
the calendar of offerings, including the resched
uling of issues postponed a month or two ago--in
some cases with sizes enlarged.
The tax-exempt market also strengthened over
the past several weeks, with yield declines on
the order of 20 to 40 basis points. This market
appears to be learning to live with more complete
disclosure requirements for new issues--imposed
both by law and by the increased wariness of in
vestors after the events of the past year. Pros
pects for several major issuers, including New York

1/20/76

-18-

State and its agencies, remain clouded as regards
any near-term return to normal marketing channels,
although plans are under consideration to seek
temporary off-market solutions.
Mr. Baughman said he thought the lag between incoming
evidence on growth in the aggregates and the subsequent
response of open market operations tended to be too long.

He

realized that the evidence concerning the aggregates was gen
erally tenuous and that frequent changes in interest rates
were regarded as costly.

In the previous inter-meeting period,

however, operations to move the Federal funds rate might have
been initiated earlier, although he believed that the level
reached toward the end of the interval was appropriate.

If

they had, the record--in retrospect--might look better.
Chairman Burns commented that the issue Mr. Baughman
had raised was one on which more than one opinion could be,
in some indefinable sense, correct.

Certainly, differences

of opinion on the subject were thoroughly understandable.
With respect to the past month's operations, he had two
observations to make.

First, the Desk had followed--in his

judgment, wisely--the rule that operations not be directed
at moving the Federal funds rate in the period immediately
following a meeting of the Committee, so as to avoid giving
the market an immediate signal of the Committee's decision.

-19-

1/20/76

Second, the Committee had adopted a money market directive
at its last meeting, and that factor alone would prompt the
Desk to move more slowly than it otherwise would with regard
to influencing the level of the Federal funds rate.

He

asked Mr. Sternlight and Mr. Holmes whether they had any
additional comments.
Mr. Sternlight said he would add only that--as had
been noted at the last meeting and in the Chairman's telegram
of January 12--there was considerable uncertainty surrounding
the data on the aggregates for the December-January period.
That was another factor that had prompted caution in the
timing of operations.
Mr. Holmes remarked that the Chairman and Mr. Sternlight
had aptly described the circumstances that had caused the
Desk to respond slowly to incoming data.

He would note that,

despite the cautious response, the decline in interest rates
over the period had been fairly pronounced.

While the decline

might have begun a little later than some would have preferred,
he was not sure that a week's difference in timing was
crucial in terms of achieving the over-all objectives of the
Committee.

Moreover, he thought it was preferable to be

relatively certain of the facts before acting rather than

-20-

1/20/76

to have to reverse an action shortly after

taking

it.
Mr. Baughman commented that, by the nature of the
environment in which open market operations were carried
out, one could never be very sure of the facts.
Chairman Burns agreed that there was always an element
of uncertainty, but that the uncertainty was greater around the
year-end than at other times.

Moreover, recent innovations in the

payments mechanism had further complicated the interpretation
of money supply figures.

He was not certain whether that had

influenced operations at the Desk, but it had generated
considerable staff study here at the Board.

The staff also

had done a great deal of new work in connection with the
problems of seasonal adjustment and had arrived at resultswhich he had reviewed rather carefully--that provided some
insight into the importance of seasonal adjustment and its
implication for the Committee's decisions on policy.

He

planned to discuss the matter more fully in connection with
the Committee's deliberations on the policy directive.

By unanimous vote, the open
market transactions in Government
securities, agency obligations,
and bankers' acceptances during
the period December 16, 1975,
through January 19, 1976, were
approved, ratified, and confirmed.

-21-

1/20/76

Chairman Burns then called for the staff report
on the domestic economic and financial situation, supple
menting the written reports that had been distributed
prior to the meeting.

Copies of the written reports have

been placed in the files of the Committee.
Mr. Zeisel made the following statement:
Over this past month incoming evidence has
indicated resumption of a faster pace of economic
expansion, following a brief slowdown in the late
autumn. In December industrial production, employ
ment, and retail trade were all up strongly, and
the economy seems to have sustained this momentum
going into the new year.
Industrial production rose by 1 per cent
last month, and the November index was revised
up to show an increase of one-half per cent.
Gains were widespread in December, with much of
the acceleration in durable goods production,
where the recovery has lagged. Output of con
sumer goods rose strongly, and so did produc
tion of business equipment. In this latter sec
tor, however, the level of output remains only
modestly above its early-summer low.
The rise in production in December was
accompanied by a renewed growth in employment,
but since the labor force increased strongly,
the unemployment rate remained unchanged at
8.3 per cent. Nonfarm payroll jobs rose by
nearly a quarter million, almost as much as
the average increase during the initial cy
clical rebound. In manufacturing, the length
of the workweek jumped by four-tenths of an
hour--although this rise in hours may be over
stated somewhat as a result of seasonal
adjustment problems.

1/20/76

-22-

A most heartening bit of news was the
strength of Christmas sales. Increased consumer
spending in December was particularly evident
for autos, furniture and appliances, and general
merchandise--the more discretionary goods. Frag
mentary evidence suggests, moreover, that total
retail sales are continuing strong into early
January. There had been some concern earlier
about the trend of consumer buying, as retail
sales in constant dollars leveled out for a time
after a strong rise last spring. This period of
sluggishness in consumer markets probably rein
forced the disposition of retailers to continue
very cautious inventory policies. Excluding
autos, inventory/sales ratios at retail are un
usually low. Thus, the strong sales rise in
December should be reflected in a further gain
of industrial output in the months ahead and,
even more important, may encourage some change
in attitudes on the desired level of trade stocks.
Activity in the housing industry also con
tinues to look better. Starts edged off slightly
in December, but the level in the fourth quarter
is still nearly one-tenth above the third-quarter
average. Sales of new houses have resumed an
upward course in recent months, and with flows
of savings to thrift institutions continuing to
be very ample and mortgage interest rates edging
down, the outlook for housing in 1976 seems a
good bit brighter now than it did several months
ago.
The strength of the recovery later this year,
however, will depend fundamentally on the rate of
recovery in business capital spending. The past
month has brought some disappointing news in this
regard. New orders for nondefense capital goods
in November now show a small decline, and in real
terms, there has been very little increase in these
orders since last spring. In addition, there was
a sharp drop-back in November in contracts for
commercial and industrial building; this series,

1/20/76

-23-

too, has shown no tendency yet to move much above
its low point of last spring.
The most recent Commerce Department survey
of anticipated business plant and equipment spend
ing for 1976, moreover, indicates a year-to-year
increase of only 5-1/2 per cent in nominal terms
and a 9-1/2 per cent expected price rise for
capital goods--in effect a year-to-year decline
in real capital outlays of about 4 per cent.
These results are weaker than indicated by either
the earlier Commerce survey for the first half of
this year or by most private survey results.
Our staff view is that these recent indicators
of capital spending all point to the continuance
of unusually cautious policies by business firms.
But we believe the 5-1/2 per cent figure in the
recent Commerce survey will prove to be too low.
In a period of expanding activity, businessmen
typically understate their planned capital outlays
as the length of their forecasting horizon increases.
And of course, since the survey was taken in late
November and December there have been some encour
aging developments--such as the renewed strength in
consumer markets, the decline in interest rates,
and the upward movement in the stock market--which
should improve expectations. Investment spending
tends to lag in the recovery, and spending is not
at this time significantly out of line with the
1957-58 experience.
On balance, these recent developments have
not caused the staff to alter materially its view
on the strength of expansionary forces. With the
acceleration of activity in December, real growth
in the fourth quarter of last year was slightly
stronger than we had expected last month--although,
of course, it was substantially under the double
digit pace of last summer. Commerce Department
figures for the fourth quarter will be available
later today; we have estimated a rise in real GNP
of about 6 per cent at an annual rate.
For the coming year, we have raised somewhat our
projections of personal consumption expenditures, on the
basis of the recent improvements in retail markets.
Upward revisions were also made in our projections of net

1/20/76

*24-

exports--mainly reflecting larger expected sales
of military hardware--and in residential con
struction--in response to the financial factors
mentioned earlier. We have, however, cut our
projected increase in business fixed investment
spending by enough to outweigh these additional
elements of strength, so that we are now project
ing a slightly weaker over-all rate of expansion
during 1976--an annual growth rate of about 4-1/4 per
cent for the four quarters, about 0.3 percentage point
less than last month. As a result, the unemploy
ment rate is projected to edge off only slightly,
to around an 8 per cent rate in the second half.
Our price projections have also been revised
slightly, partly to reflect a small reduction in
prices of fuel in the first half of 1976 as a
consequence of the rollback called for in the
Energy Policy and Conservation Act. A small
increase in these prices later in the year is
anticipated, however, reflecting provisions in
the Act which permit gradual decontrol. The
dominant new factor affecting our price projection
is a further upward adjustment in projected wage
rate increases. The rate of rise of compensation
per manhour declined in late 1974 and early 1975,
but there has been no further improvement such as
we had been expecting. Given the continued rise
in prices and the heavy schedule of bargaining
this year, we are now projecting that the recent
annual rate of increase in compensation--in excess
of 8 per cent--will persist through 1976. With
productivity gains likely to moderate to the 3 per
cent range, in line with the slower growth of real
output expected, and with no particular shocks
anticipated from energy or food prices, we are
projecting the over-all fixed-weighted price
index to move about in line with unit labor costsshowing about a 5-1/2 per cent rate of rise during
the four quarters of 1976, about 1 percentage point
less than the price rise last year.
Chairman Burns remarked that before opening the dis
cussion of the economic situation and outlook, he would again

1/20/76

-25-

call on Mr. Holmes, who now had some additional information
for the Committee.
Mr. Holmes said he had just been advised that the
Board of Directors of the Swiss National Bank had agreed in
principle to the proposed loss-sharing arrangement, although
it had yet taken no formal action.

He had also been advised

that the Bank of Italy was preparing to draw $250 million on
the swap line, for value on Thursday, January 22.
Chairman Burns then called for the discussion of the
domestic economic situation, suggesting that the members
concentrate their remarks on any differences between their
views and those of the staff.
Mr. Black commented that he continued to believe that
the staff analysis underestimated the strength of the recovery.
So far, the recovery had been similar to earlier postwar
swings.

up

The staff projection for the period ahead, however,

suggested weaker expansion than in the earlier upswings.

In

his view, there had been a marked and highly significant improve
ment in consumer and business confidence over the past month.
The red book 1/and other sources of information on regional
developments suggested that some involuntary liquidation of
1/ The report, "Current Economic Comment by District," prepared
for the Committee by the staff.

1/20/76

-26-

inventories in the trade sector might have occurred toward the
end of 1975, which might well lead to inventory investment
early this year at a higher rate than that projected by the
staff.

In addition, the Bicentennial year was creating a

completely new industry and new outlets for spending.

Finally,

1976 was a Presidential election year, and it was not certain
that the general population would assume that fiscal policy
would be more prudent than it traditionally had been in election
years.
In response, Mr. Gramley observed that at present he
personally believed that expansion in activity in 1976 was
more likely to exceed than to fall short of the rate projected
by the staff.

He too thought that over the past month the state

of confidence had improved, and he felt reasonably sure that
when the staff took account of recent sales and inventory
developments in preparing its projections for the February
meeting, it would raise the rate of growth for the first quarter.
However, the cautious attitudes of businessmen in planning
expenditures for fixed capital were still a source of concern.
Revival of expenditures in that sector was essential if over-all
activity were to grow in 1976 at a faster rate than that projected by
the staff.

In making its projection for today's meeting, the

1/20/76

-27-

staff had been faced with a set of bearish indicators of
activity in that sector.

Its projection of the 1975 to 1976

increase in business fixed investment--which was somewhat
larger than the 5-1/2 per cent rise based on the Department
of Commerce survey--was stronger than could be justified by
the behavior of the indicators.
Mr. Black then noted that the president of a large
construction company had said many building plans had been
completed and could be activated quickly in the event that
businessmen revised their spending plans upward, and he asked
whether the staff saw any evidence of such an accumulation of
plans on the shelf.
Mr. Gramley replied that the staff also had heard
reports of an accumulation of building plans ready for acti
vation

and that such an accumulation was consistent with the

widespread cancellation of industrial construction projects
during 1974.

As yet there were no signs that the plans were

being taken off the shelf and activated.

When that occurred, it

would presumably be reflected in new orders for equipment and in
other indicators of business capital expenditures.
Mr. MacLaury noted that, as shown in the green book,
the staff projection of growth in real GNP over the period
1/ The report, "Current Economic and Financial Conditions,"
prepared for the Committee by the Board's staff.

-28-

1/20/76

from the fourth quarter of 1975 to the fourth quarter of 1976
had been reduced to 4.3 per cent from 4.7 per cent at the time
of the December meeting--a reduction that was not consistent
with his sense of the developing situation.

While the staff

had raised projected growth in consumption expenditures, it
had substantially lowered projected expansion in business
fixed investment.

Even though the latter expansion exceeded

that implied by the Commerce Department survey, the resurgence
of confidence led him to think that the staff projection under
stated the rise that would occur.

From the vantage point of

the Minneapolis District, he had for some months viewed the
outlook as stronger than indicated by the staff projection,
and he felt now that his view was being confirmed.
Chairman Burns remarked that he agreed with the staff
analysis and also with the views expressed by Messrs. Black
and MacLaury.

In explanation of that seeming inconsistency,

he would say that it was good for the staff to follow the
evidence very closely and not to place too much reliance on
judgment.

An element of judgment did and should enter into

projections, but the staff had a laudable tendency not to
give too much weight to the judgmental factor.

Viewing the

data that had recently become available regarding anticipations
of business capital investment, new orders for capital equipment,

1/20/76

-29-

and contract awards, the staff had made a reasonable projection
of business fixed investment.

At the same time, his own judg

ment on the outlook for that sector of the economy was much
the same as that expressed by Messrs. Black and MacLaury.
The Chairman added that recently he had had conversations
concerning the Commerce Department survey of business capital
expenditures with several individuals connected with a reputable
economic counseling agency.

From talks with people who had

responded to the Commerce survey, they had concluded that
responses to the latest survey had not been prepared so care
fully as responses to the survey of 6 weeks earlier.

In

their view, businessmen had been too busy to consider the
question carefully and to update their reports.
Mr. Kimbrel observed that the calendar of labor con
tracts up for renegotiation this year was large, so that
interruptions to production for some significant periods of
time were at least possible and could harm the recovery process.
He asked whether the staff had taken account of that possibility
in making its projections.
Mr. Zeisel replied that because of the substantial rise
in prices that had occurred since contracts were last signed in
the industries coming up for negotiations this year, the atmos
phere was conducive to strikes.

However, the staff did not feel

-30-

1/20/76

that strikes would be so severe as to affect economic activity
significantly.
In response to questions, Mr. Zeisel observed that the
greatest impact on wages was likely to come from developments in
Since

the trucking industry, where the contract expired in March.

the current contract had taken effect, wage rates had fallen about
75 cents per hour below the level they would have reached had they
kept pace with the rise in the consumer price index.

In addition

to their impact on the 400,000 workers covered, the terms of the
new contract would have widespread effects throughout the economy.
Wages had fallen badly behind in the rubber industry as well, and
it was expected that the union would make a strong effort to win
a substantial increase and a cost-of-living clause.

In the

electrical industry, where the contracts expired in June and
July, the advance in wage rates had fallen behind the rise in
prices by about 35 cents per hour.

The automobile industry also

would negotiate a new contract this year, but it was not likely
to encounter severe problems.

The present contract contained an

effective cost-of-living clause, and the advance in wages had
about kept up with the rise in the cost of living.

The settlement

was likely to be a traditional one for the industry, containing an
over-all increase of about 3 per cent in addition to the cost-of
living adjustments.

-31-

1/20/76

Mr. Gramley remarked that the indicators suggested
that the recovery was sufficiently strong to withstand a
major labor dispute this year.

Should there be an extended

dispute in the trucking industry, for example, it probably
would change the pattern of developments through the year
without materially altering the over-all strength of the
recovery.
Mr. Partee, referring to the earlier comments on the
outlook for business fixed investment, said he believed that
the current indicators of such investment were not indicative
of what would develop.

The recovery in economic activity had

passed through a lull last autumn and early winter, and the
current indicators of business investment might be reflecting
that lull; the indicators, in effect, were lagging behind the
improvement in final sales and the improvement in confidence
that had occurred over the past month.

He would guess that

the 10 to 12 per cent rise in the stock market since the first
of the year had added $100 billion to equity values.

In the

past such a rise had been regarded as a very good bull market.
Altogether, he was inclined to the view that the rise in real
GNP this year would be larger than that projected by the staff.
It would not be a great deal larger, however, because some
economic problems--such as those of State and local governmentspersisted.

-32-

1/20/76

Chairman Burns remarked that recent forecasts of revenues
of State and local governments looked much better than earlier
ones and that over-all finances of those governments had improved
greatly.

He asked Mr. Gramley to comment.

Mr. Gramley observed that the position of State and
local governments had been improving since the first quarter
of 1975, when their over-all deficit had reached a high.

In

the fourth quarter of last year, on the basis of the newly
revised GNP figures, those governments had a surplus at an
annual rate of $13.6 billion.

In its Annual Report, the

Council of Economic Advisers projected substantial further
improvement during 1976, on the basis that State and local
governments would continue to follow cautious expenditure
policies at the same time that their revenues would be raised
by continued recovery in economic activity.
Mr. Partee remarked that his main point was that the
State and local governments would remain cautious in planning
expenditures.

New York State continued to face serious problems;

he hoped that Mr. Volcker would comment on that situation.

The

commercial and multi-family sectors of the construction industry
still had problems that would limit the recovery in building.
On the other hand, as he had indicated, he believed that business
fixed investment would be stronger than suggested by the latest
survey of the Commerce Department.

-33-

1/20/76

Chairman Burns remarked that the view had become wide
spread among businessmen, bankers, economists, and others that
the world had entered a new era--that economists had learned
how to fine-tune the economy and that the business cycle was
dead.

Given the belief that we would have mild recessions, at

worst, the depth of this recession must have come as a shock.
The effects of that shock had been underestimated, but now there
were signs that confidence was being restored to a significant
degree.
The Chairman then asked Mr. Volcker if he would comment
on the financial situation of New York State.
Mr. Volcker said New York State and its agencies still
had great financial difficulties.

Earlier this month a financing

by a small agency had been handled fairly well, with the help of
some banks that rolled over their holdings.

From here on, however,

financings would become larger and would be more difficult to manage.
Under consideration was an effort to put together a comprehensive
program to deal with agency financing needs--which totaled more than
$2 billion.

The program would rely on public funds for about

two-thirds or three-fourths of the required amount.

However, there

were grave doubts that even the remainder would be forthcoming from
private sources.

-34-

1/20/76

At about the time of the agency financing during the spring,
Mr. Volcker continued, the State would need to borrow $4 billion.
It was thought that the State's financing could not be accomplished
in the market, and some kind of nationwide syndicate of banks was
being considered.

More detailed discussion to determine the

plan's feasibility would be premature, however, because the
budget program had not yet been presented.

Altogether, the

very large financing problem ahead for both the State and its
agencies was unresolved.
Mr. Eastburn remarked that he would comment first on
the state of confidence.

Because it had often been said that

consumer spending would be the key to developments in 1976,
he had talked with a number of retailers in his District
during the past week.

One retailer had pointed out that the

current behavior of consumers, which was preventing the recovery
from being aborted, could be viewed--using an old analogy--as
a half-full glass; on the other hand, projections of a
rate of unemployment as high as 8 per cent at the end of this
year could be viewed as the half-empty glass.

Retailers were

being encouraged by strong Christmas sales and by continuation
of strength into January, with sales considerably above year
earlier levels.

Moreover, there was a feeling that psychology

had changed--that consumers had abandoned the excessive caution

-35-

1/20/76

that had been evident earlier; they were spending not only for
quality goods but also for such frivolous items as "pet rocks,"
which had been a popular item this Christmas season.
Continuing, Mr. Eastburn observed that when pressed
further, retailers seemed more realistic in their optimism;
they anticipated a slow, unexciting uptrend over the next 6
to 9 months.

Consequently, their inventory policies remained

relatively cautious.

One expressed the view that inventories

would be kept in line even if that resulted in some loss of
sales.

Such a prospect, along with other aspects of the out

look, was consistent with an 8 per cent unemployment rate at
the end of the year and led him to emphasize the empty rather
than the full half of the glass.
With respect to the position of State and local govern
ments, Mr. Eastburn said the Mayor and the Finance Director
of Philadelphia were now indicating that the city faced a
deficit of $80 million in the fiscal year ending July 1.
Apparently, that prospect had not been evident to the public
earlier because projected revenues had been based on unrealistic
assumptions.

As a result, substantial emergency increases in

property and other taxes now were required.

And reflecting the

school budget, the over-all budget probably would still be in
deficit in the next fiscal year.

In his view, the situation in

-36-

1/20/76

Philadelphia was illustrative of the problems facing many
local governments outside of New York.
Chairman Burns commented that for some time the bond
market had been sensitive to the financial problems of
Philadelphia.
Mr. Morris remarked that even from the vantage point
of Boston the staff projection of 4.3 per cent growth in real
GNP from the fourth quarter of 1975 to the fourth quarter of
1976 appeared conservative.

He had been thinking in terms of

growth in a range of 5 to 5-1/2 per cent.

During the past few

weeks, evidence of a basic change in the psychology of consumers
and investors had been impressive, and the outlook was stronger
now than it had been 5 weeks ago.

He was surprised that the staff

had revised downward its projection of growth in real GNP.
Chairman Burns asked Mr. Morris if he would comment on
the unemployment situation in New England.
Mr. Morris remarked that actual unemployment rates in
New England, although above the national average, were not
so high as the reported figures, which were based on a faulty
formula.

In Massachusetts, for example, the reported rate

was 13 to 14 per cent, but he believed that the actual rate
was 10 or 11 per cent.

In the BLS formula for calculating

State unemployment rates, a number of adjustments were made

1/20/76

-37-

to the figures for insured unemployment.

Consequently, the

more generous a State's unemployment compensation program and
the more people collecting benefits, the higher that State's
unemployment rate.

New Hampshire, for example, followed a tighter

policy with respect to unemployment benefits, and the State's
reported unemployment rate typically was below the national average.
In January Massachusetts tightened up the eligibility requirements
for unemployment compensation by making ineligible anyone who
had voluntarily left a job, with the results that insured
unemployment would be reduced and the reported unemployment
rate would decline dramatically.

Actually, the Governor had

been urged to publish figures based on an alternative formula,
because the figures that had been published gave a faulty
image of the State.
Chairman Burns remarked that the problem had political
implications, because certain special benefits--such as extended
unemployment compensation--were related to a State's unemploy
ment rate.
Mr. Zeisel commented that recently the Labor Department
had changed the formula for estimating State unemployment rates
and had provoked considerable controversy.

In fact, the State

of New Jersey had sued the Department in an effort to block the
change, because it would result in a reduction in Federal grants
to the State.

-38-

1/20/76

In response to questions, Mr. Morris observed that in
the 1960's the unemployment rate in Massachusetts had been
close to the national average.

In the recession of 1969-70,

however, the State's economy had been hit hard by cutbacks in
military research and development and by curtailments in the
electronics industry, from which it had not fully recovered by
the onset of the more recent recession.

Even before that reces

sion, therefore, the State's unemployment rate had been higher
than the national average.
Mr. Morris then reported that Massachusetts faced a
potential problem in turning over its short-term debt, even
though it had a balanced budget.

The scale of the problem

was small, involving $300 million in the March-April period
and $200 million in June.

Over the past few months, the

State had been buying its own obligations by mobilizing and
drawing down cash balances; because of inefficient financial
management, various agencies

balances.

had had scattered bank

But the State could not obtain another $500 million

in that way, and at present there was no public market for
its obligations.

The State's problems in raising funds in

the spring could well be compounded if, as seemed likely,
New York State faced a severe problem at the same time.

In

-39-

1/20/76

his opinion, Massachusetts had no hope of selling securities
in the public market until New York's problem was resolved.
A plan to sell $500 million of securities to the mutual savings
banks was under consideration.
Mr. Mayo remarked that unemployment rates in New York,
California, Illinois, and Michigan--as well as those in New
England States--exceeded the national average, and staff
investigation of the causes would be worthwhile.
Mr. Winn observed that industrialists in his District
had a strong preference for paying overtime rather than in
creasing employment.
Chairman Burns commented that the preference Mr. Winn
had noted was a general phenomenon.

When sales first began to

improve, producers tended to react cautiously because the
improvement could prove transitory.

As the improvement

continued, however, their confidence grew.

In time, a

boundary line was crossed, and employment had to be increased.
That was one of the hopeful factors in the present situation.
Mr. Winn said industrialists preferred not to increase
employment because of the possibility that subsequent layoffs
would have an adverse effect on their tax rating for purposes
of the unemployment insurance fund.

Moreover, the cost of

fringe benefits had become quite high.

However, he agreed

-40-

1/20/76

that the process of increasing hours without increasing employ
ment could not go on for long.
With respect to the situation of local governments,
Mr. Winn remarked that labor in the public sector was more
He believed that

militant than he had ever seen it before.

more public employees were on strike at present in the Fourth
District than in any other, and upward pressures on the cost of
public services were strong.
Mr. Winn observed that he was concerned about a number
of other elements in the situation.

First, the current indicators

of business fixed investment, as compared with the past,
overstated capacity-raising

expenditures because of

the importance now of outlays for environmental purposes.

In

his District, the major part of the rise in investment expen
ditures so far appeared to be of the latter sort.

Second,

General Motors was planning large investment expenditures and
a major model change-over for next autumn.

Other auto manufac

turers were not doing so, however, and he wondered about the
implications for the industry's future.

Third, speculation in

options might cause problems among dealers in options; a speculative
blow-off would be unfortunate.

Finally, he was concerned that events

abroad--involving, in particular, Syria and Angola--might develop
in a way that would have a significant impact on the course of the

-41-

1/20/76

U.S. economy this year, but such possibilities were not taken
into account in the projections.
Mr. Jackson noted that near the end of December, he and
Mr. Partee had met with leaders of the real estate investment
trust industry, and he thought that it would be useful to sum
marize the latters' views.

Last autumn people in the industry

had thought that their situation was improving, but now they
were less optimistic.

Legal and accounting problems had arisen in

connection with swaps of assets with commercial banks, and prospects for
more of them had deteriorated.

Although such swaps had attracted

considerable attention, they had amounted

to only about $450

million--of which $160 million had been accounted for by a single
transaction.
Continuing, Mr. Jackson observed that some of the industry's
assets had begun to be self-sustaining.

Shopping centers were

probably the strongest investments, despite the adverse impact
of the bankruptcy of the W.T. Grant Company.
apartments, occupancy rates had stabilized.

In garden-type
However, net rents

had continued to decline because of the sustained surge in costs
of operation, and the representatives felt that nothing should
be done to encourage the building of more apartment units.

The

condominium situation seemed to be mixed; some units had been
converted into rental apartments and were encountering a better

-42-

1/20/76

market.

Altogether, he would characterize as modest, if not poor,

the industry members' view of prospects for construction of commercial
buildings and of multi-family residential units.
Mr. Jackson reported that the industry people were not
optimistic about vacant land ventures, which he believed accounted
for about 20 per cent of the loans that were on a non-accrual basis.
More defaults were expected, and at present there was no market
for the land.

In addition, the representatives remained apprehen

sive that some major REIT's would go into bankruptcy, bringing on
a new crisis.
Mr. Partee said he would add only that the industry
people felt there was a glut of office buildings.

Houston and

Kansas City were the only centers mentioned that might not have
a surplus.
Mr. Clay remarked that several office buildings were
under construction in Kansas City, including a large one down
town and a large one just north of the city.
Mr. Winn asked whether it was true that the moratorium
on delinquent loans had ended and that foreclosures were forcing
many builders into bankruptcy.
Mr. Jackson replied that he did not have any recent
reports.

The situation had improved somewhat in September and

October, but the lull in the economic recovery in the autumn
might have brought on some additional failures.

-43-

1/20/76

In response to a question by Chairman Burns, Mr. Gramley
reported that the rate of failures in the construction industry
had been quite high through the first 6 or 7 months of last year
but had declined appreciably since then.
Mr. Mayo observed that he supported the staff analysis
of the economic outlook, although he agreed that one might have
reservations about the validity of the latest Commerce Department
survey of business capital spending.

In his view, the optimism

expressed by some participants in today's meeting was not inconsis
tent with the outlook suggested by the staff projections of the
past couple of months.
Continuing, Mr. Mayo commented that State and local
governments would contribute less to recovery this time than
they typically had before.

Apart from the effects of the finan

cial problems of some units, voters had been reluctant to approve
new projects, and retrenchment programs were being implemented
in some areas and contemplated in others.

The housing industry

also was not making its customary contribution to the recovery.
With respect to the REIT's, the overhang of uncompleted projects
was serious, and in the Chicago District one also heard the
warning that construction of more apartments should not be
encouraged.

With respect to fixed investment, businessmen in

his District appeared to remain very cautious, despite the

-44-

1/20/76

strength in retail sales and other bullish elements in the
situation.

Altogether, he thought there was more than an even

chance that the staff projection would prove to be an overestimate
rather than an underestimate of the course of economic activity
this year.
Mr. Wallich observed that the slack in the expansion of
business fixed investment had two possible explanations.

One was

that the high level of excess capacity at present did not justify a
higher rate of investment; in

effect, the existing capital

stock was consistent with the desired capital stock.

Alterna

tively, fixed investment was being limited by business efforts
to improve liquidity.

Should the latter be the case, business

investment at some point in the future might be higher for a
time than under the first premise, as businesses tried to get
back on track with respect to the level of the capital stock.
Which of the alternative explanations one thought was correct
depended upon one's estimate of the desired capital stock.

He

asked whether the staff had a view concerning the question.
In response, Mr. Gramley said it was very difficult to
determine the factors affecting business fixed investment at any
particular time.

He would note that the staff's judgmental projec

tion for such investment did not differ a great deal from the
econometric model's projection.

In the model, a heavy weight was

-45-

1/20/76

given to the relationship between estimates of the desired and
the actual capital stock.

The model also gave substantial

weight to real interest rates, but uncertainties about
the actual level of real interest rates were great enough to
limit one's confidence in that source of influence on the
model's projection of business fixed investment.
Mr. Gramley added that in his opinion businessmen's
attitudes toward fixed investment at present were influenced
by a deep concern about the state of profits.

That concern was

evident also in the cautious inventory policies being followed
and in the preference for lengthening the workweek rather than
adding to employment.

He believed--as had been suggested by

Mr. Partee earlier--that the recent upturn in retail sales might
provide the business community with convincing evidence that a
really good recovery was under way and thereby lead to a marked
improvement in business capital investment in the near future.
Chairman Burns commented that the Board's index of
capacity utilization for major materials provided impressive
evidence of a good recovery in activity.

The rate of utiliza

tion had risen from 70 per cent in the first quarter of 1975 to
just over 80 per cent in the fourth quarter, and only a small
further rise could bring on shortages of particular materials.

1/20/76
Mr. Gramley remarked that there was considerable
dispersion in the capacity utilization rates by industry.
Production

of nondurable materials had recovered rapidly,

and utilization rates for broadwoven fabrics had almost
returned to the quarterly peaks reached in the 1972-74 period.
However, considerable slack existed in a number of industriesparticularly metals.
Mr. Wallich then asked how the staff projection of real
GNP compared with the many published forecasts.
In reply, Mr. Gramley noted that the average forecast
suggested growth of 5 to 5-1/2 per cent over the four quarters
of 1976 and an increase of about 6 per cent from 1975 to 1976;
the staff projections of the past 4 or 5 months had been at the
low end of the range of the forecasts.

As he had suggested earlier,

the staff projection might well be raised by the time of the next
meeting of the Committee, in light of the latest developments in
sales and inventories.

Nevertheless, he would stress that

forecasters should not give a great deal of weight to the
statistics for a single month.

The figures for the latest

month looked fairly good, but he would remind the Committee
that only a month ago the statistical evidence had suggested
that the recovery in activity had slowed.

-47-

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Mr. Volcker remarked that, like Mr. Gramley, he would
not be quick to change his view of the outlook, but he also
agreed with those who felt that the atmosphere had improved
So far, the recovery had been con

over the past month or two.

fined largely to consumption expenditures, and that sectoralong with inventory investment--could continue to stimulate
over-all activity for a while.

He was concerned, however, about

other sectors of the economy.
With reference to earlier comments on the condition of
the REIT's and prospects for the construction industry, Mr. Volcker
observed that a tremendous volume of construction activity in
New York was directly or indirectly sponsored by the State, and
he was sure that was true in other States as well, if on a smaller
scale.

In New York no new State-sponsored projects were being

started, and while a lot of activity remained in the pipeline,
nothing would be left by the end of the year.

That had great

significance for the construction industry.
Mr. Volcker said he was concerned about the behavior of
business fixed investment.

The lag in recovery in that sector

was real, and he did not expect the situation to change quickly.
Like Mr. Mayo, he believed that businessmen remained very cautious;
they were concerned about the state of profits in relation to the
high cost of new capital equipment.

And as Mr. Winn had suggested,

-48-

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a significant part of capital expenditures was to meet environ
mental requirements rather than to modernize or to increase
capacity.

Consequently, there was some danger that a fairly

good recovery--an even better one, perhaps, than projected by
the staff--would continue to be based largely on consumption
expenditures, provoking shortages of certain types of capacity
before expansion in business fixed investment had gained much
momentum.

Such developments would aggravate the problem of infla

tion and would tend to shorten the recovery.
While he did not now see an early end to the recovery,
Mr. Volcker said the sort of developments he had outlined posed
a policy problem.

The question, to which he did not have an

answer at present, was whether monetary policy--or more appro
priately, perhaps, tax policy--could stimulate a more vigorous
expansion in investment outlays.

If that could be done, he

would feel more optimistic about the longer-term prospects for
the recovery in activity and for reduction in the rate of
inflation.
Mr. Balles commented that at the January meeting of the
directors of his Bank, the only major disagreement that the
business directors had had with the Bank's research staff had
been over the latter's forecast for the rate of increase in
prices this year--which was close to that in the projection of the

1/20/76

-49-

Board's staff.

The views of the business directors seemed to be

based mainly on strong expressions of intent by company after
company to take the earliest possible opportunity

to raise

prices in order to restore profit margins that had been reduced
during the recession.

Their minimum expectations for price

increases in particular industries were on the order of 7, 8,
and 9 per cent, compared with the staff's projected over-all
rate of about 5-1/2 per cent during 1976.

Against that back

ground, he asked Mr. Gramley whether the staff's current pro
jection--if it was in fact underestimating growth in real GNPwas likely to be underestimating the rate of inflation as well.
Mr. Gramley replied that, in his view, it was more likely
that the staff projection underestimated than overestimated the
rate of price increase in 1976.

However, the rate of increase in

prices in the short-run--as in the past--would not be affected
very much if real GNP expanded at a faster rate than projected.
The principal effect on prices would occur after 1976.

In those

circumstances, increases in wage rates could be somewhat larger,
but productivity gains also would be greater.

Barring unfore

seen developments--having to do, for example, with the cost of
energy--he felt that a rise in the general price level in a
range of 5-1/2 to 7 per cent was a reasonable expectation.

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Chairman Burns observed that over time the staff projec
tion of the rate of increase in prices in 1976 had undergone
considerable change.

Earlier, the projection had been for a

significant reduction in the rate during the course of the year.
According to the latest projection, however, the rate throughout
the year--at about 5-1/2 per cent--would remain close to that in
the fourth quarter of last year.

And Mr. Gramley's expectation

was for a still higher rate--one between 5-1/2 and 7 per cent.
Personally, he had felt all along that the staff had been under
estimating the pace of inflation; he would guess that it would
be between 6-1/2 and 8 per cent.
The Chairman added that the Department of Commerce GNP
figures, on the revised basis, indicated that inflation was at
an annual rate of just over 7 per cent in the third quarter of
last year, and no figure was yet available for the fourth quarter.
In his judgment, the current rate was in a 7 to 7-1/2 per cent
range, and although he hoped events would prove him wrong, he
did not expect significant improvement this year.
Mr. Baughman noted that by historical standards the
projected rise in unit labor costs was large, given the amount
of unemployment.

He asked whether the staff felt that the

actual increase was more likely to exceed than to fall short of
the projected increase and whether the rise was likely to have an

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adverse effect on businessmen's decisions concerning fixed invest
ment and exert a drag on the recovery during the course of this
year.
In response, Mr. Gramley observed that in developing its
projection the staff had struggled more with compensation per
manhour, and its implications for unit labor costs, than with
any other element.

In the projection, hourly compensation in

the nonfarm economy rose about 8-1/2 per cent from the fourth
quarter of 1975 to the fourth quarter of 1976; and productivity
advanced about 3 per cent, resulting in a rise in unit labor costs
of about 5-1/2 per cent.

The argument could be made--and, in

fact, had been made by the Board's labor economists--that the
reduction in the rate of increase in consumer prices in 1975
would have an important impact this year on the course of wage
rates in many activities, even if it had little effect on the
major settlements, and that the staff projection for compensation
per manhour was too high.

However, he had been reluctant to

reduce the projected rate of increase in the face of evidence
that the rise in wage rates had not slowed over recent months.
With respect to Mr. Baughman's second question, Mr. Gramley
commented that businessmen appeared to anticipate faster rates of
increase in wages and unit labor costs--and also in prices--than
those projected by the staff, and they were not likely to find it

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discouraging if events more or less conformed to the staff
projections.
favorable.

Moreover, the outlook for profits was quite
In the staff projection, corporate profits rose

21 per cent from the fourth quarter of 1975 to the fourth
quarter of 1976, even though profit margins changed little.
Mr. Baughman then observed, first, that the geophysical
work preparatory to exploration for oil and gas in his District
was reported to be at a low level, and presumably, some change
in expectations would be required to raise it.

Second, activity

of architectural firms also seemed to be down.

Third, prospec

tive employees for both farm and household work reportedly
pressed vigorously to be paid in cash and without deductions
for social security and income taxes.
In response to questions by the Chairman, Mr. Baughman
added that it was difficult to judge whether the recently
enacted Energy Policy and Conservation Act was having a dis
couraging effect on exploration for oil and gas, but he thought
that it probably was.

Most comments on the Act had a critical

tone, and while it was said that no drilling rigs were idle, it
was also said that use of a rig could be obtained at a consid
erably lower price than earlier.

In explanation of the attitude

attributed to prospective household workers, he suspected that
they generally had another wage-earner in the family, who was

-53-

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covered under social security and they were attempting to evade

taxes.

In the case of farm workers, he would guess that the attitude

reflected a preference for income now rather than later.
Finally, Mr. Baughman remarked that during the past
week he had encountered a banker who had said if money market
interest rates fell any lower, he would have to begin to seek

new loans.
Mr. Mayo observed that the Committee was about to begin
a discussion of its longer-run targets for growth in the mone
tary aggregates during 1976, and although the first month of
the year was almost over, no staff projections of economic
activity beyond the fourth quarter were available.

Despite all

the qualifications concerning projections for so far into the
future, he would find it useful to have some staff impression
concerning, at least, the first half of 1977.
Mr. Gramley remarked that the staff had not carried its
projections into 1977 for two reasons.

First, data just now

becoming available for the fiscal 1977 Federal budget suggested
that fiscal stimulus would be substantially less than the staff
had been assuming would be the case.

Having anticipated that

possibility, the staff had wanted to have an opportunity to
appraise the budget more fully before developing projections for
the first half of 1977.

Second, business and consumer confidence

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appeared to have been undergoing a change over recent weeks,
and he wanted to see another month's data before attempting to
judge the implications that the confidence factor might have
for 1977.

The staff planned to present projections for the

first half of 1977 in the next green book.
The Chairman said the Committee now needed to consider
and extend its longer-run targets for the monetary aggregates.
He was scheduled to testify on this subject at a hearing on
February 3 before the House Committee on Banking, Currency,
and Housing.

In keeping with the usual practice, he planned

to announce at that hearing the growth ranges for the monetary
aggregates that the Committee anticipated over the updated
period from the fourth quarter of 1975 to the fourth quarter
of 1976.

Before turning to the discussion of those targets,

he would ask Mr. Gramley to report on some staff studies that
had a bearing on the general question before the Committee.
Mr. Gramley made the following statement.
I will be referring in my remarks to some
charts and a table that are entitled "Policy
Alternatives.".1/ Our staff projection of real
GNP growth in 1976 has not changed a great deal
over the past several months, but the risks
associated with it have, in my judgment, changed
significantly. In particular, I am less worried
now than I was last fall that financial constraints
1/ Copies of these materials are appended to this memorandum
as Attachment A.

1/20/76

-55-

will interfere seriously with the course of recovery
during 1976. Something of fundamental importance
has been happening, I believe, to reduce the amount
of money needed to finance economic expansion.
Obviously, this is a critical issue for the Com
mittee's consideration in setting its longer-range
monetary targets.
The first chart shows the income velocity of
M1 in this and past cycles. M1 velocity usually is
relatively flat, or declines somewhat, during a reces
sion--and its behavior during the recent recession
differed only a little from historical experience.
In the past two quarters, however, income velocity
of M1 has risen twice as fast as the average for
the previous 4 recoveries--actually, as fast as in
the 1949-50 upswing, when the economy was awash with
liquidity.
This behavior of velocity is all the more puzzling
when account is taken of short-term interest rates,
which usually rise rather sharply in the early stages
of a business expansion. We are presently in the
ninth month of recovery in industrial output, and
yields on most short-term market instruments are
below their cyclical lows of last June.
This behavior of interest rates in a strongly
expanding economy argues convincingly that the recent
weakness of money growth does not result from a re
striction of supply relative to demand. Instead,
it appears to reflect a failure of the demand for
M1 --given income and interest rates--to grow along
the path indicated by historical relationships.
The quarterly econometric model used by the
Board's staff has in it a money demand equation
that can be used to estimate how much the growth
of money demand has fallen behind expectations.
In the past the model's money-demand function has
been reasonably reliable--in the sense that errors
of prediction did not tend to cumulate. Since the
third quarter of 1974, however, the model's pre
dictions have gotten progressively worse, as is
indicated in chart II.
All of the shortfall has been in the demand
deposit component of M1. By the fourth quarter of

1/20/76

-56-

1975, the error had grown to $18.7 billion--about
6-1/4 per cent of the actual stock of money. Trans
lated to growth rate terms, this means that if past
relationships had held, growth of M 1 at an annual
rate of around 8-1/2 per cent would have been required
since mid-1974 to finance the expansion of GNP that
has occurred--while still keeping interest rates
where they are. The actual growth rate of M 1 over
those 6 quarters was only 4-1/4 per cent.
If money is defined more broadly, the discrepancy
between recent and past experience diminishes, but
it does not vanish. For example, the income velocity
of M2, which is shown in chart III, has also risen
quite rapidly relative to past experience. This is
true for M 3 velocity as well. I should note, in
this connection, that growth rates of the time and
savings deposit components of M 2 and M 3 do not seem
materially out of line with recent cyclical experience.
As you are well aware, there are numerous finan
cial innovations under way that may have contributed
to increased efficiency of money use. The shift of
funds to corporate savings accounts since mid-November
has been a significant factor recently. As for the
trend since mid-1974, the Board staff has been seeking
intensively--but so far with only limited successto find the explanation for the weakness of money
demand. We believe the shock effect of record-high
interest rates in 1974 may have awakened many indi
viduals and small businesses to the benefits of
economizing on cash. And a number of other develop
ments--such as the growth of NOW accounts, increased
use of telephonic transfers of funds from savings
accounts to demand balances, the spread of overdraft
privileges in the banking system, and the increase
of third-party payments from savings accounts--have
probably each played a small but significant role.
Yet, all of these developments taken together do
not seem to explain adequately the ability of the
economy to get along with the recent modest increases
in money balances.
The staff is therefore in a quandary. Since we
are not sure why demand for money has been so weak,
we cannot be sure when the period of weakness will
end. In our current GNP projection, as in earlier

1/20/76

-57-

ones, we have assumed that there will soon be a
reversion to historical relationships between growth
rates of nominal GNP and growth rates of M1, taking
interest rates into account. But we also assume
that the level of money demand has been permanently
lowered, relative to the level of GNP, by the in
creased efficiencies of money use adopted to date.
These are the assumptions that underlie the
figures in the table showing the effects of alter
native monetary policies on key economic and finan
cial variables. If the long-run course of policy
provides for a 6-1/4 per cent rate of increase in
M1, as the green book projection assumes, we would
expect pressures to begin developing in financial
markets later this quarter and to continue through
out 1976. With Treasury bill rates under this
alternative projected to rise to a little above 7
per cent by year-end, savings flows to thrift
institutions would taper off as the year progressed.
But the effects of financial restraint on housing
and on other sectors would be relatively modestmuch less than we expected 6 months ago, when we
first extended our projection through all of 1976.
Given this base projection, raising or lowering
the target growth rate of M 1 by 1 percentage point
would, we believe, have the effects on key economic
and financial variables shown in the table. Thus,
we estimate that an additional 1 per cent added to
M 1 growth would, by the close of 1976, raise the
level of real GNP by about a half a percentage
point, reduce the unemployment rate by a couple of
of tenths, and add a couple of tenths to the rate
of inflation--with larger effects on prices later
on. We estimate that 1 percentage point less in
M 1 growth would, under present circumstances, have
effects of roughly equal magnitude, but of opposite
sign.
The principal thought I would like to leave
with the Committee, however, is that there are much
greater uncertainties now than is usually the case
about the economic and financial effects likely to
be associated with any given growth rate of narrowly
defined money. Therefore, a wider range of evidence
than just the behavior of M1 needs to be weighed in

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assessing the degree of monetary stimulus or restraint.
Assigning greater importance to broader monetary aggre
gates will be of some help. However, careful atten
tion will also have to be given, for a while at least,
to movements of interest rates and other indicators
of financial market conditions to judge the thrust
of monetary policy on real economic activity and
prices.
The Chairman then called on Mr. Axilrod to comment on
the longer-run targets.
Mr. Axilrod observed that in anticipation of today's
discussion the staff had followed its usual practice in the
1/
blue book 1/ of presenting alternative longer-run growth ranges
for the monetary aggregates and moving the 1-year period for the
proposed ranges ahead by one quarter.

Three alternative sets

of ranges were shown in the blue book and, of course, retention
of the current ranges would represent a fourth alternative.

The

alternative B ranges included a range of 5 to 7-1/2 per cent
for M 1 , the same as that adopted by the Committee at its October
meeting for the period ending with the third quarter of 1976.
Alternative A contained an M 1 range that was 1 percentage point
higher, and alternative C an M 1 range that was 1 percentage
point lower, than the alternative B range.

As it had in other

recent blue books, the staff was projecting somewhat slower
rates of growth in time and savings deposits relative to M 1
1/ The report, "Monetary Aggregates and Money Market Conditions,"
prepared for the Committee by the Board's staff.

-59-

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than were implicit in the Committee's current ranges, and that
projection was reflected in each of the three alternatives.

He

would add, however, that the early January experience pointed
to very strong growth in time and savings deposits.

That

experience had not been given full weight in the projections
because of its limited duration and its occurrence in a period
when short-term interest rates had fallen to new cyclical lows.
Continuing, Mr. Axilrod said that alternative A made
up in an arithmetic sense for the shortfall in M1 growth in the
fourth quarter.

More specifically, alternative A incorporated

a level for M1 in the third quarter of 1976 that was the same
as the level implied in the Committee's current growth target
for that quarter. However, that arithmetic relationship did
not take into account the economic implications of shifts of
funds into savings accounts by business firms nor the implications
of other factors that could be changing the demand for money.
By way of brief background, he would note that in the 2 months
since businesses were first authorized to hold savings accounts,
the staff estimated that roughly $1-1/2 billion of the increase
in such accounts represented business funds that were substitut
able for demand deposits.

According to staff projections, such

substitutable funds might grow by an additional $1 billion or
so over the next 9 months.

Thus, over the period from the fourth

quarter of 1975 to the third quarter of 1976, the increase would

1/20/76

-60-

be on the order of $2-1/2 billion.

Taking such deposit shifts into

account, alternative B appeared on economic grounds to be more nearly
consistent with the Committee's current longer-run growth range for
M1 .

More specifically, if the shifts in question were deducted from

the level implied by the current target range for the third quarter
of 1976, the result was a level for M1 that was virtually the same
as the third-quarter level shown under alternative B.
Mr. Axilrod added that the Committee might also wish to
consider where the aggregates were currently in relation to the bases
adopted by the Committee at various times during 1975.

As the members

would recall, the growth range for M1 had remained unchanged at 5 to
7-1/2 per cent, but the base was raised in effect each time the
Committee extended the 1-year period for its target range following
the selection of March 1975 as the original base.

In other words,

each new base was set a bit above the one implied by the underlying
6-1/4 per cent midpoint of the growth range extended from the previous
base.

This in effect allowed some scope for a fourth-quarter short

fall in growth relative to the longer-run range.

Thus, growth in

M1 from the March base to the fourth-quarter average, or from the
second-quarter average to the fourth-quarter average, was still
within the Committee's longer-run range, although it was at the
lower end of it.

Over the same periods, growth in M-2 was close to

the midpoint of its range and growth in M 3 came out at the higher end
of its range.

-61-

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In the context of the shifts of funds by corporations
that he had just reviewed, Mr. Axilrod continued, a 6-1/4 per
cent growth rate for M 1 from a fourth quarter base would tend
to overstate the degree of monetary stimulus in relation to
that provided by the same growth rate in earlier periods.
The staff estimated that such shifts would require--to achieve
a neutral result, so to speak--a reduction on the order of
1/4 to 1/2 percentage point in the 6-1/4 per cent growth rate.
Accordingly, an alternative somewhere between B and C would
have the same economic meaning as the Committee's current
longer-run range for M1 with its 6-1/4 per cent midpoint.
Chairman Burns observed that the Committee had a
choice at this point.

It could devote some time to a dis

cussion of technical issues or it could move directly to the
policy questions involved in reaching a decision on the longer
run growth ranges.
A majority of the Committee members indicated a
preference for proceeding immediately to the policy issues.
The Chairman said he would be governed by the majority's
preference, but he would make special provision for a systematic
discussion of technical matters at a later meeting.

He thought

such a discussion should include a review of seasonal adjustment

-62-

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techniques, which he felt were of great importance for the
proper conduct of open market operations.

Indeed, he had

reached the conclusion that the Committee's short-run instruc
tions to the Manager often caused the Desk to chase
shadows.

In his judgment those instructions needed to be

reformed.
Turning to the policy issues relating to the longer
run growth ranges, the Chairman said he wanted to make a few
comments before the Committee began its discussion.

As he

judged the outlook for economic activity, and indeed as the
majority of the members appeared to view that outlook and the
prospects for continued inflation, he thought there was little
reason for the Committee to raise the growth ranges from their
current levels.

He therefore wanted to make the case, first,

for lowering the ranges, and next, the case against lowering
them.

He would then put forward a suggestion for Committee

consideration.
Several arguments could reasonably be advanced for
lowering the growth ranges at the present time, the Chairman
said.

First, the money-demand function appeared to have shifted

downward in relation to GNP; currency and demand deposits were
doing more work than in the past.

That development definitely

-63-

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argued for lowering the growth ranges.

Second, the current

business recovery had been under way since around April 1975,
and a reduction in monetary stimulation would be consistent
with the moderately advanced age of the economic upturn.
Third, one could argue that the adoption of lower growth
ranges now would be a timely step toward what had been, and
should remain, the Committee's longer-run goal of reattaining
a stable

general price level.
The Chairman added that those arguments were by no

means conclusive, and indeed there were powerful arguments
against lowering the growth ranges.

First, while there had

been a downward shift in the demand function for money over
the past 1-1/2 years or so, the staff's studies were incon
clusive on the question of whether that trend was likely to
continue, and the possibility that it might not continue had
to be respected.

Second, while most Committee members appeared

to believe that the recovery had developed a certain momentum,
some members questioned the strength of the recovery.

Moreover,

their view was shared by many businessmen and economists outside
the Committee.

Third, the shortfall in the growth of the mone

tary aggregates during the fourth quarter could not be ignored
completely.

While it could be argued that the ranges need not

-64-

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be raised, or should not be raised, to compensate for the
shortfall, one could also argue that they should not be lowered,
considering that there had been a shortfall.
After taking these various arguments into account,
the Chairman continued, he was inclined to the view that it
would be desirable for the Committee to reduce the lower limit
of its range for M 1 by 1/2 percentage point.

That would mean

moving from the current range of 5 to 7-1/2 per cent to 4-1/2
to 7-1/2 per cent.

A wider range was indicated in his judgment

by the increased uncertainty about M1 that had emerged from the
Committee's experience over the past year and especially in
recent months.

Moreover, a small reduction in the lower limit

of the M 1 range was certainly suggested by the evidence--which
could no longer be neglected--that the money-demand function
had shifted downward.

On the other hand, he would be inclined

to leave the ranges for M2 and M3 unchanged.

In part, he had

in mind the fact that those aggregates had compensated in a
sense for the weakness in M1; in addition, the Committee had
reduced the lower limits of the ranges for M 2 and M3 by one
percentage point at its meeting in October 1975 when it last
considered the longer-run ranges.

-65-

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The Chairman remarked that he would not make any sug
gestion with respect to the credit proxy beyond recommending
that for now it be retained among the aggregates specified by
the Committee.

The Committee would have an opportunity to

decide whether it wanted to continue using the credit proxy
when it turned its attention to technical issues at a later
meeting.

The credit proxy had been a source of some incon

venience and embarrassment, but it would take the Committee
a good deal of time to unravel the factors that were involved.
Mr. Coldwell said he came out close to the Chairman
in his preferences for the longer-run ranges, but he arrived
at his position by a somewhat different route.

It seemed to

him that the Committee's many problems with M1--including
problems of definition, seasonal adjustment, shifts to time
deposits, and inadequacies in the data--argued strongly for
downgrading that aggregate in the Committee's forecasts and
in its testimony to Congressional committees.

In the latter

connection, he recognized that the Congress would continue to
demand some accounting for M1.

He hoped that the Committee

would devote more attention to M3 while paying less to M1.
For him that meant specification of a wider range for M

in

order to accommodate the uncertainties concerning the figures.
And perhaps increased attention might be given to market

-66-

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conditions and other factors in the Chairman's testimony
before the Senate and House Banking Committees.

Therefore,

he agreed with the Chairman's proposal for widening the M1
range to 4-1/2 to 7-1/2 per cent.

He differed on the ranges

for M2 and M3, however; for M 2 his preference would be a range
of 7 to 10 per cent and for M 3 a range of 8 to 11 per cent.
Those preferences would imply reductions of 1/2 percentage
point and 1 percentage point, respectively, from the Com
mittee's current ranges.
Mr. Coldwell added that, while he was a little unsure
about the economic outlook, he sensed that the economy would
continue to strengthen, and he believed that lower growth
ranges were called for in light of that outlook.

On the

other hand, if the Committee decided to maintain its current
ranges, he believed that, in effect, it would be telling the
Congress that it was going to adhere to previously set ranges
despite changes in economic conditions.

He doubted that such

a position was a good one for the Committee to take.
Mr. Mitchell indicated that his preference would be
to retain the current ranges for the monetary aggregates, but
he would not be disturbed by a reduction in the lower limit
of the M1 growth range to 4-1/2 per cent.

In his view the

-67-

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weakness in M1 was related in part to real structural changes
in the financial system, but it was also accounted for in large
measure by weakness in business loan demand.

As business loans

were repaid, compensating balances were reduced.

In its GNP

projection, the staff was assuming that historical relation
ships between growth rates of nominal GNP and growth rates
of ML would be reestablished.

He agreed that such a develop

ment would occur, and in his judgment, it would be associated
with a pick-up in business loan demand.

In these circumstances

he would not want to lower the growth range for M 1 to any
significant extent.
Mr. Mitchell observed that the Committee's current
range for M2 appeared to be realistic, judging by the recent
performance of time and savings accounts at banks and nonbank
thrift institutions.

As for the credit proxy, he hoped the

Committee would not discontinue its use, because it was the
only aggregate that was really understood and subject to
relatively direct control by the Committee.

For that aggre

gate, he thought a growth range of 6 to 9 per cent was about
right for the year ahead.

The bank credit proxy had been weak

because of weakness in business loan demand; when a loan was
repaid, the compensating balance disappeared.

As he had sug

gested, however, he expected business loan demand to strengthen
considerably, possibly by the end of the first quarter.

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The Chairman inquired whether the staff was aware of
any change in practices affecting compensating balances.
Mr. Gramley said that the staff was not aware of any
major changes.

In reference to Mr. Mitchell's hypothesis,

the staff had done one study that might have a bearing on the
issue.

The staff had tried to determine the influence that

changes in expenditure components of GNP might have on the
rate of growth in the quantity of money.

The results sug

gested that inventory liquidation--which led to declines in
bank loans and, therefore, in compensating balances--did have
some effect on the rate of growth in the money stock.

However,

the contribution that inventory liquidation made to an expla
nation of the recent weakness in the demand for money was minor.
Mr. MacLaury remarked that he could accept the Chairman's
suggested ranges for longer-run rates of growth in the aggre
gates.

A technical case could be made for lowering the range

for M 1 at this time, and also, it would be desirable to make some
change to avoid giving the impression that the Committee would
retain the original range forever.
range of 4-1/2 to 7 per cent.

His preference was for an M 1

He recognized, however, that some

unexplained change in the demand for money had occurred, and he
could accept the 4-1/2 to 7-1/2 per cent range even though he
ordinarily favored either narrow ranges or point targets.

-69-

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He would not change the ranges for M2 and M3 .

Rates of growth

within the existing ranges appeared consistent with some
further drop in longer-term interest rates, which he would like
to see as an incentive to investment outlays.

While his con

fidence in the strength of the recovery had increased, he
believed that there was still a long way to go.
Mr. Balles said the question of whether or not there
had been a downward shift in the demand for money was crucial.
If such a shift had occurred, the Committee should provide for
less monetary growth, but if it had not, the System ran the
risk of under-financing the economic recovery.

He was as per

plexed as the Board's staff in trying to explain the weakness in
monetary growth, and his staff had been investigating the hypothesis
that the money-demand equation was now misspecified and that the demand
for money possibly had not decreased.

Underlying this line of

reasoning was the fact that banker attitudes toward risk had
undergone a major shift and had turned definitely more con
servative.

To illustrate that point, he had been surprised

to hear the head of a major West Coast bank give an extremely
gloomy report on the outlook for bank profits in 1976.

Indeed,

the banker in question thought 1976 would be the worst year

-70-

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for bank profits since the depression, and he expected a wave
of dividend cuts.

In fact, one major bank in California

would be announcing a dividend reduction later today.

What

this gloomy outlook added up to was the lagged impact of
inflation and the recession on the quality of bank assets
and on bank earnings.

The banker expected that many more

loan losses would be reported this year and that they could
be even larger than those reported in 1975.
It remained to be seen, Mr. Balles continued, whether
this dire forecast would be realized, but it underscored the
proposition that banks, especially the larger ones, were now
stressing the quality of assets and earnings; they were much
more in the mood to emphasize the rate of return on investments
and were paying much less attention to growth or to maintenance
of a market share for their own sake.

A result of that attitude

had been a significant widening in the spread between the prime
rate and both the CD and the commercial paper rates since late 1974.
With the prime rate so much above the other rates, the demand
for business loans at banks had lessened and banks were less
interested in selling CD's.

Reduced market interest rates,

therefore, had not triggered the money-demand response that
would have been anticipated on the basis of the present money
demand equation.

-71-

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Chairman Burns observed that Mr. Balles' alternative
hypothesis might provide an explanation of the weakness in
bank credit and a partial explanation of the weakness in M
and M5, which were defined to include large-denomination CD's.
However, he did not see how it could be an alternative expla
nation of the weakness in M1 or even in M 2 or M3.
Mr. Gramley commented that, unless the money-demand
function had been mis-specified over the years, the hypothesis
outlined by Mr. Balles would explain the weakness in bank
credit but it would not account for that in M
of rising income and declining interest rates.

in a period
He added that

the Board's staff had devoted a great deal of effort to
investigating whether anything on the supply side
might help to explain the behavior of M., and the staff
could not find any significant evidence to support the supply
hypothesis.
Mr. Balles remarked that if the alternative explanation
he was advancing was correct--and he recognized that it was
as yet unproven--it suggested that the roughly parallel move
ment in the demand for money and the demand for bank credit had
been broken by the recent behavior of banks.

It would seem to follow

that the demand for money by households and firms had not nec
essarily shifted downward.

If it was true that banker attitudes

-72-

4/20/76

toward risk had contributed to the fall in interest ratesas reflected in greater selectivity in bank lending activities
and smaller bank sales of CD's--market interest rates might well
decline without inducing the enlarged demand for money that would
otherwise be expected from the money-demand equation.
Mr. Balles said he had another reason for being
cautious about accepting the hypothesis of a decline in the
demand for money.

His staff had done research on earlier

periods when the question had been raised about a possible
shift in money demand.

It had been argued, for example,

that the demand for money had shifted upward in 1966 and
1971.

However, his staff was of the opinion--on the basis

of subsequent evidence--that no shifts had occurred in those
periods.

He was, therefore, led to approach this question very

cautiously, and his preference was not to form a firm opinion
until he saw more evidence.

In terms of the Committee's long

term ranges, that preference led him to the conclusion that
some consideration should be given to making up for the short
fall in the fourth quarter.

One way of accomplishing that

objective would be to retain the Committee's current ranges,
but to use the third rather than the fourth quarter as the
base for the ranges.

-73-

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Chairman Burns said he had serious reservations
about that procedure because of the communications problem
that would be created.

He believed that if the Committee

started to vary its procedures--if it did not stay with moving
1-year periods based on quarterly averages--it would have great
difficulty in attaining even a modicum of understanding from
members of Congress and from the business and financial communitie
He did not mean to imply that the current procedure was ideal, and
he was not addressing the intrinsic merits of Mr. Balles' proposal
Mr. Balles commented that in view of the problem

of

communications, the Committee might be well advised to go one
step beyond its present practice and publish not only the ranges
of growth rates it decided upon for the monetary aggregates, but
also the dollar levels implied by the upper and lower limits of
the range.

The Federal Reserve had been the object of a good

deal of sharp--in his view, unjustified--criticism to the effect
that it was playing games by maintaining its growth ranges while
shifting the base for those ranges.

If the Committee decided

to retain the current ranges, he believed such criticism could
be defused by indicating clearly any differences in levels that
given growth rates might produce by the end of 1976 due to a

1/20/76

-74-

shift in the base from the third to the fourth quarter of
1975.

And if the Committee decided to reduce its growth

ranges because it accepted the hypothesis of a downward shift
in the demand for money, the problem of possible public mis
understanding might be attenuated by the explanation that the
Committee did not think the economy needed as much monetary
growth because of the shift.
Chairman Burns recalled that the Committee had pre
viously rejected a recommendation to publish levels
because doing so would tend to complicate communications with
Congress and the public.
reconsidered.

Perhaps the matter needed to be

A separate question was the desirability of

taking levels into account in the Committee's internal
deliberations, and Committee members seemed to be agreed on
the usefulness of levels for that purpose.
Mr. Balles observed that if the Committee did not
publish the levels associated with its longer-run growth
ranges, analysts would be quick to calculate them and make
their own interpretations.
The Chairman commented that all sorts of inter
pretations could be anticipated in any event, and he suspected
that the Committee's problems of communications would not be

4/20/76

-75-

eased as the year progressed.

He thought the Committee had

been handling those problems reasonably well, but he respected
Mr. Balles' opinion and agreed that a good case could be made
for publishing levels.

It was a matter the Committee would

need to return to at a later meeting.
Mr. Holland said that the Committee now had
about as good a set of reasons for changing the longer
run growth ranges as it was likely to encounter.

As a matter

of personal philosophy he believed it was desirable for the
Committee to alter those ranges from time to time.

There

had been significant changes in economic and financial con
ditions, and he thought it made sense to let those changes
be reflected in the longer-run ranges.
Mr. Holland added that there was a reasonable amount
of evidence to support the view that the demand for money
had fallen.

He understood the staff's quandary in not being

able to explain that decline, and its decision to project
some snapback.
some.

The Committee itself had to be more adventure

He agreed with the Chairman's recommendation for reducing

the lower end of the M1 range by 1/2 percentage point.

Indeed,

his first preference would be to reduce the entire M1 range
by that amount.

If later in the year the staff assumption

-76-

4/20/76

of a snapback in the demand for money should prove to be
correct, the Committee could decide then whether or not to
make an adjustment.

An upward shift in the demand for money

would not necessarily argue, of course, for raising the range
at that time since the economy would be further into the
business recovery.
Mr. Holland said he would also lower the ranges for
M2

M3 , and the credit proxy by 1/2 or 1 percentage point.

With one exception, the reductions would be less than those
the staff had proposed for the alternative B ranges, but they
would be consistent with his view that the demand for M 1 was
likely to continue weaker than the staff anticipated.

He

also believed that the ranges he had in mind would be con
sistent with a generous availability of funds during the
business recovery.
Chairman Burns then asked Mr. Gramley to summarize
information on fourth-quarter GNP developments that had just
been received.
Mr. Gramley commented that the newly available figures
from the Department of Commerce did not deviate greatly from
the estimates in the green book.

The new data indicated that

real GNP had increased at a 5.4 per cent annual rate in

-77-

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the fourth quarter; the staff had estimated a 6.2 per cent rate
of growth.

The rise in the deflator of around 6-1/2 per cent was
The major deviation

about the same as the staff had anticipated.

was in the inventory investment figures, which were considerably
lower than Board staff estimates; actually, the Department of
Commerce figures were slightly negative.

Final sales were stronger,

and that strength showed up partly in residential construction,
partly in business fixed investment, and partly in net exports.
him, the data suggested that there would be room for inventory
investment to provide more thrust in the first quarter than
the staff had incorporated in its projection.
The Chairman then called for a resumption of the
discussion of the longer-run ranges.
Mr. Wallich commented that at a time of unusual
uncertainty with regard to the monetary aggregates one rule
of thumb for policy was to make no change.

A second rule was

to take into account in choosing among operating targets a
disturbance that had the effect of unsettling the demand for
money; that would lead him to lean more on interest rates
than on the monetary aggregates.

The implications of those

To

-78-

1/20/76

two rules of thumb, as he reviewed them, was that the Committee
should aim at very little change in interest rates for now.

That

conclusion led him logically to favor a widening of the longer-run
ranges for the aggregates, so that operations would not be likely to
interfere with a reasonable degree of stability in interest rates.
In stating his policy preference, he realized that real interest
rates might well have undergone an unobservable change in
recent days.

Expectations of inflation appeared to have di

minished, and although nominal interest rates had declined
recently, real rates quite possibly had remained constant
or might even have increased somewhat.

One could not tell

for sure.
Mr. Wallich added that he shared Mr. Balles' concern
with regard to the Committee's problems of communications.
He too found troublesome the fact that the published ranges,
which had not changed for M1, were related to shifting bases.
Fortunately, the rate of growth in M 1 from the March base that had
originally been set at the April 1975 meeting was still within the
5 to 7-1/2 per cent range.

The same was not true, however, when

the growth rate was related to the latest base used by the

-79-

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Committee--the third quarter of 1975.

An attenuating con

sideration was, of course, that only a relatively brief period
had elapsed since the latest base had been established.
Mr. Wallich noted that the ranges were acquiring a
certain strategic--or perhaps tactical--property, particularly
in light of the prevailing uncertainties about the demand for
money.

He agreed with Mr. Holland's view that it was desirable

to introduce some flexibility in setting those ranges.

His

own preference would be to change one side of the ranges at
a time, thereby introducing a degree of flexibility while
permitting the change either to be reversed or to be confirmed
by a similar change on the other side of the ranges at a subse
quent meeting.

In keeping with this approach and with

his current preference for widening the ranges, he would reduce
the lower limit of the range for M 1 by 1/2 percentage point
and the lower limits of the ranges for M 2 and M3 by 1 percent
age point.

For M3, he would argue that the 8 to 12 per cent

range was not unreasonable.

However, a 12 per cent rate of

growth might seem rather high, and he was not wedded to that
range for M3.
The Chairman said he would add two footnotes to
Mr. Wallich's comments.

First, there had been an undershoot

-80-

1/20/76

in the fourth quarter and that undershoot had a bearing on
the range to be set for the year ahead, since the latter would
have a fourth-quarter base.

Nevertheless, the Committee should

not lose sight of the fact that there had been overshoots in
the two previous quarters.

Second, the Committee had never

committed itself to staying within the ranges that it specified.
On the contrary, the Concurrent Resolution itself recognized
that the Committee had considerable freedom to change its views
with regard to appropriate rates of growth.
Mr. Black remarked that he agreed with the Chairman's
views on the proper range for M . He believed that the demand
for money had probably shifted downward, as evidenced by the
fairly good pickup in economic activity despite a shortfall
in M1.

He saw no reason to try to compensate for that

shortfall.

It was also his view that M 2 and M 3 had

assumed relatively more importance.

He would lower the ranges

for those aggregates in light of the fact that the economic
recovery had now been under way for some 9 months and in view
of the desirability of moving toward noninflationary growth
rates in the aggregates over the longer run.

The ranges for

M 2 and M 3 associated with alternative B seemed about right to
him.

1/20/76

-81-

Mr. Leonard indicated that his personal preference
would be to change the longer-run growth ranges only infre
quently, and he also favored relatively narrow ranges for
the aggregates.

It seemed to him that such an approach would

tend to validate the concept of longer-run targets.

However,

he could also appreciate the points made by the Chairman, and
in any event, he regarded the change in the M1 range proposed
by the Chairman as relatively minor in view of the uncertainties
that were associated with that aggregate.

Moreover, while he

had not done the arithmetic, the proposed 4-1/2 to 7-1/2 per
cent range on a new fourth-quarter base might well be encom
passed later this year by the current 5 to 7-1/2 per cent range
on a third-quarter base; what he had in mind was the megaphone
shaped or expanding range of levels that was traced by extend
ing a given set of growth rates out over time.
Mr. Leonard added that the green book projections
assumed a 6-1/4 per cent growth path for M 1 .

Since the alter

native B ranges appeared to be consistent with such a path,
they would be his preference.

Mr. Mayo said he supported the Chairman's recommendations for
the growth ranges.

Broadening the M1 range would provide an opportunity

to call attention publicly to the Committee's uncertainty about a possible

1/20/76

-82-

shift in the demand for money.

The announcement of the new M1

range could also furnish the occasion to explain that M2 and
M3 were now felt to be more relevant aggregates than they
used to be.

Moreover, it could be argued that the new range

for M1 was not meant to indicate that the Committee had lowered
its target, but that it had made a technical adjustment in
recognition of the changing relationship between M1 and the
other aggregates.

In that connection, he would retain the

current ranges for the other aggregates, since to reduce them
would destroy the basic argument that no real change had been
made in the ranges.

Finally, the wider range for M

would

give the Committee a little more flexibility in meeting the
needs of the economy as the recovery unfolded.
Mr. Eastburn commented that his preference would be
to retain the current ranges for the monetary aggregates.
His view was based on three considerations.

First, he felt

that the recovery projected by the staff was inadequate, and he
was especially concerned about the unemployment rate associated
with the staff projection.

Second, the fourth-quarter shortfall

in monetary growth was also a matter of concern to him.

And

third, he regarded the evidence of a downward shift in the
demand for money as inconclusive.

-83-

1/20/76

Mr. Eastburn added that these considerations led him
to prefer the current ranges, but he could accept the modified
M 1 range proposed by Chairman Burns.

The Committee--as the

Chairman had emphasized at a number of meetings--was not
wedded to particular growth rates, and he agreed that some
flexibility in setting those rates was desirable.

Nonetheless,

he foresaw a major problem of communications for the Committee
if it did adopt the Chairman's proposed change.

It would be

difficult to explain the technical basis for the change, and
many observers in Congress and elsewhere were likely to con
clude that the Committee had made a restrictive move.
Mr. Mayo observed that the proposed retention of
the 7-1/2 per cent upper limit of the M 1 range would tend to
mitigate the expected criticism.
The Chairman said he had intended to mention earlier
that Mr. Partee was attending his first meeting as a member
of the Committee.

He was sure he spoke on behalf of all the

members in expressing a warm welcome to Mr. Partee and in wishing
him well in his new duties.

He asked Mr. Partee to comment on

the growth ranges.
Mr. Partee said he saw no basis in the economic outlook
for reducing the rate of monetary expansion.

Indeed, if he

-84-

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were to accept the staff projection of economic growth over the
next four quarters, he would have to urge an increase in the
growth ranges.

However, as he had already observed, he

thought the recovery was likely to be more vigorous, perhaps
appreciably so, than the staff anticipated.

A rate of eco

nomic expansion from the fourth quarter of last year to the
fourth quarter of this year in the 5 to 6 per cent rangerather than the 4.3 per cent rate projected by the staffwould not surprise him.

In light of the recovery that he

foresaw, he would retain the current growth ranges for the
monetary aggregates.
Mr. Partee added that he could accept the reduction
to 4-1/2 per cent in the lower limit of the M 1 range proposed
by the Chairman.

In his judgment there was a sound technical

reason for such a reduction.

In particular, he found quite

persuasive the argument relating to a shift of funds by cor
porations to passbook accounts.
was still occurring and

The one-time stock adjustment

was expected to continue for some

time, thereby permitting a lower growth rate for M1 .

The

move to a fourth-quarter base also made sense, because the
shift of corporate funds had had its first effects on M 1
during that quarter and had helped to account for much of the
shortfall in M 1 occurring at that time.

-85-

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Mr. Partee said the technical argument did not extend
to M2 or M3, and since he expected the economy to meet only
the minimum standards of a recovery, he would not be able to
participate in a decision to reduce growth ranges for those
aggregates.

Also, he did not regard M 2 and M 3 as cosmetic

type objectives, but wanted to pay a good deal of attention
to them.

Since growth in those aggregates would depend

importantly on the level of market interest rates in relation
to Regulation Q ceilings, it followed that movements in interest
rates would require close attention, especially when market
rates reached so-called threshold levels.

Market rates were

currently below such levels, but he suspected that the question
of threshold levels would come to the fore by the spring.
The meeting then recessed.

It reconvened at 3:05 p.m.

with the same attendance as at the morning session.
Mr. Kimbrel said he appreciated the difficulty of
communicating the technical reasons for a reduction in the
Committee's longer-run growth ranges.

However, possibly

because he was not a technician, he had always felt that the
Committee should focus upon total economic behavior and not
necessarily upon some particular monetary behavior.

He was

concerned about the possibility of an escalation in the rate

1/20/76

-86-

of inflation, especially in light of the major wage negotiations
that were scheduled during 1976.

For that reason, and in rec

ognition of the technical considerations outlined in the blue
book, his preference would be to reduce the current M1 and M
2
ranges by perhaps 1/2 percentage point and the M3 range by 1
percentage point.

He realized that such reductions could be

misinterpreted, but unless there were risks that had not been
brought to his attention, he would favor such reduced ranges.
Mr. Volcker commented that current Committee procedures
in setting

longer-run growth ranges gave rise to all sorts

of technical problems.

He was glad that the Committee would

have an opportunity to examine such problems at a later meet
ing since he did not think the Committee's present procedures
always had the most felicitous results.

Fortunately, the

technical problems were not fully exposed because the perfor
mance of the aggregates had been reasonably within the ranges
specified by the Committee, at least with respect to the base
periods established in the spring of last year.
Turning to the substance of the Committee's decision
today, Mr. Volcker said he was delighted to see some sentiment
in favor of reducing the lower limit of the M1 range, and he
himself would have no concern about lowering the upper limit

-87-

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However, he could tolerate a growth rate as high as

as well.

7-1/2 per cent for now in light of the recent shortfall in M1
On the other hand, the proposed reduction in the

growth.

lower limit to 4-1/2 per cent was a step in the right direction
and he would be prepared to approve an even larger reduction.
Mr. Volcker said that some reduction in the M 2 and M3
ranges seemed to be called for on grounds of technical con
sistency.

The staff had reached a similar conclusion.

He

did not think that the Committee had to lower those ranges
as much as the staff had suggested under alternative B in
the blue book, and he rather liked the ranges that Mr. Coldwell
had proposed.
Mr. Volcker added that Mr. Partee's remarks seemed
to imply a somewhat easier monetary policy than the one the
staff suggested would be consistent with its view of the
business outlook.

He himself was reasonably satisfied with

recent developments.

Finally, he agreed with Mr. Wallich's

views regarding the desirability of specifying somewhat wider
ranges for the aggregates and not making interest rates overly
sensitive to movements of the aggregates within those ranges.
Mr. Winn said he was more concerned about the problem
of communications than some of his colleagues.

He appreciated

-88-

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the argument that could be made regarding a downward shift
in the demand for money, but he had strong reservations
about lowering the growth ranges following a period of
shortfalls.

Under the circumstances, a reduction was al

most sure to be interpreted as an adjustment in the range
to accommodate actual results rather than an adjustment made
on policy grounds.

In short, the problem of public understanding

troubled him considerably.
The Chairman remarked that growth of the aggregates
had been within the target ranges in relation to the original
March and second-quarter bases that had been specified by
the Committee.

It was true that a shortfall had occurred

in growth from the third-quarter base, but an interval of
only 3 months was involved and that was not sufficient for
judging a 12-month growth target.

Mr. Winn might well be

right with regard to the problem of communications.

He

himself was especially sensitive to that problem since he
had to live with it from day to day. There would be crit
icism and misinterpretations regardless of what the Com
mittee did.

The subject of monetary policy was inherently

difficult and poorly understood.

However, he did not think

there would be any great problem of communications if the

-89-

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Committee adopted his recommendations to leave the ranges
for M2 and M3 unchanged and to reduce only the lower limit
of the M1 range.

The case for doing the latter was clear

in terms of measurable factors that could be cited, to say
nothing of additional factors whose quantitative magnitude
could not be appraised.

Moreover, questions of communi

cations alone could never be decisive;

facts had

to be respected insofar as they were known.

The recent

shortfall in M, growth could be explained in large measure
by technological changes, including the Board's new regulation
permitting corporate savings accounts.

In these circumstances

he would not feel uneasy about reducing the lower limit of the
M1 range.
Mr. Winn observed that his main concern was to assure
somewhat greater growth in the monetary aggregates during the
current stage of the business recovery.

More moderate growth

might be appropriate later during the year.

In a word, he

regarded the timing of the monetary stimulus as critical.

The Chairman remarked that the Committee's ability
to control short-run movements in the monetary aggregates was very

limited, and problems with seasonal factors further complicated
the Committee's task.

The difficulty of seasonal adjustments

-90-

1/20/76

was highlighted by a staff finding that a monthly growth
rate of 4 per cent might well be equivalent to a growth
rate of 8 or 9 per cent on the basis of reasonable
alternative seasonal factors.

The evidence for such a

statement would be presented to the Committee--and, he
believed, in decisive fashion--at a future meeting when
consideration was to be given to technical problems.
Mr. Jackson observed that the Committee's efforts
to control the monetary aggregates sometimes seemed like
a game of basketball played on a skateboard with the op
posing team having the right to move the basket.

Where

communications were concerned, the world unfortunately
thought of the Committee's growth ranges as straight
lines, when very often they were curved lines to which
adjustments had to be made.

He shared Mr. Partee's in

terest in trying to focus on M2 and M3, although he found
it very difficult to concentrate on measures that were
subject to such effects as those produced by the Regulation Q
ceilings.

In some circumstances, those ceilings could completely

distort the performance of the broader measures of money
in relation to the Committee's objectives.

From an oper

ational point of view, moreover, it was extremely difficult

-91-

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to focus on a measure like M3, because estimates were avail
able only once each month and were subject to a sizable margin
of error.

His conclusion would be to widen the growth ranges.

Specifically, he would adopt a 4-1/2 to 7-1/2 per cent range
for M1 and drop the lower limit of the ranges for M

and M

slightly.
Mr. Baughman said he would advise the Committee not
to set in concrete any conclusions about a downward shift in
the demand for money.

In his judgment, the evidence was still

sufficiently uncertain that any reference to such a shift
should not imply that it was permanent.
Chairman Burns indicated his agreement and noted
that his Congressional testimony would have to be along the
lines recommended by Mr. Baughman.

He would be able to

speak with some definiteness about what had happened over
the past four to six quarters, but he would have to be very
cautious in his testimony about what might happen in the
future.
Mr. Baughman added that despite his uncertainty
about the future performance of M1, he still felt there was
sufficient evidence to justify reducing the M1 range at this

-92-

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time.

However, he found himself in the same corner as

Mr. Partee with regard to a reduction in the M

2

range.

It seemed to him that the technical arguments relating
to M1 did not carry through to the broader measure, un
less one was prepared to take a fairly unequivocable
position with respect to a change in the demand for money.

On the issue of broadening the ranges, it was his view
that the present ranges were already rather wide, and
apart from reducing the lower limit of the M1 range, he
would be inclined to make no changes.
Mr. Morris said that he would subscribe to the
views stated by Mr. Partee.
Mr. Clay observed that the Committee's job was one
of encouraging a sustainable economic expansion and a con
current reduction in the rate of inflation.

To accomplish

the first objective, he thought the Committee should foster
somewhat faster growth over the period immediately ahead
than had occurred recently in the monetary aggregates.

How

ever, to promote a deceleration in the rate of inflation,
he believed the aggregates should not grow as rapidly in
1976 as would be permitted by the Committee's current ranges.
Accordingly, he would set ranges of 4-1/2 to 7 per cent for

1/20/76

-93-

M1, 6-1/2 to 9-1/2 per cent for M 2 , and 7-1/2 to 10-1/2 per
cent for M 3 ; the latter two ranges were those associated
with alternative B in the blue book.
The Chairman remarked that it was clear that the
Committee accepted his recommendation to reduce the lower
limit of the M 1 range to 4-1/2 per cent.

It was equally

clear that the Committee wished to retain the 7-1/2 per cent
upper limit of that range.

A majority of the Committee members,

but only a thin majority, was in favor of leaving the M 2 and
M 3 ranges unchanged.

He inquired whether the Committee wanted

to discuss the latter ranges further.
Mr. Coldwell commented that according to data in the
blue book the growth rates of M2 and M3 had exceeded 10 per
cent in only a few quarters over the 1973-1975 period.

That

evidence supported his preference for reducing the M2 and M
3
ranges.
Mr. Partee suggested that the years 1971-1972 would
be a better period to use for comparative purposes, since the
economy was then also coming out of a recession.

As he recalled,

growth in M2 and M3 during that period had generally been much
higher than the current ranges.

-94-

1/20/76

Mr. Coldwell said he was not sure the two recovery
periods were comparable.

In any event, he believed the

present outlook called for a slight reduction in the M2
and M

ranges.
Mr. Volcker said he shared Mr. Coldwell's view; a

possible compromise would be to reduce only the lower limits
of the M2 and M3 ranges.
Mr. Mayo observed that such a reduction would
destroy the argument that the proposed change in the M1
range was based on technical considerations.

The latter

related in part to shifts of funds by corporations into
savings accounts and also to other changes in the demand
for money.

To the extent that corporate deposit shifts

were involved, M2 would not be affected; to the extent that
a reduced demand for M1

balances was caused by other factors,

growth in M2 would be affected much less than growth in
M1.

Moreover, the retention of the upper limit for M 1 and

of the current ranges for M2 and M 3 could be justified as
an opportunity to make up for the recent shortfall in mone
tary growth, although the Committee might not want to make use
of that opportunity.

That course could also be justified as a

-95-

1/20/76

relatively modest contribution to the current economic re
covery.

In his view it would be preferable to hold off

signaling a more restrictive policy until later.
The Chairman noted that the Committee had not been
standing still:

When the longer-run ranges had last been

reviewed at the October meeting, the lower limits of the
ranges for M 2 and M3 had been reduced by 1 percentage
point.
The Chairman added that according to the notes
he had taken during the discussion, seven members of the
Committee had indicated a preference for not changing
the current

M2

and M3 ranges.

He asked whether any mem

ber had altered his views during the discussion, and no
member indicated a change in his thinking.
The Chairman observed that the majority favored reducing
the lower limit of the range for M1 by one-half of a percentage
point and retaining the present ranges for M 2 and M 3 . He then recom
mended that the Committee accept a growth range calculated by the
staff for the credit proxy, the procedure it had also followed at
the October meeting.

It would not be desirable to continue such

a procedure indefinitely, and the Committee would need to discuss
this matter at a later meeting.
No objection to the Chairman's recommendation was heard.

-96-

1/20/76

Mr. Axilrod then made the following statement on prospective
financial relationships:
In the blue book for this meeting, we have
presented for your consideration short-run ranges
for the monetary aggregates that are wider than
usual. There are three reasons for this:
First, it follows recent Committee practice.
Second, we are quite uncertain about the
demand for money, particularly for M1, in this
transitional period.
Third, in view of the growing dissatisfaction
with money supply seasonal adjustments, we have
undertaken a very careful review of the implications
of applying alternative techniques. We have not
changed our basic methodology as a result, but it
is clear that alternative, reasonable methods of
seasonal adjustment will produce noticeably dif
ferent seasonal factors for any individual month.
A wider band for the aggregates would recognize
that uncertainty as to the seasonal factors limits
the significance that can be attributed to short
run variations in monetary growth.
Apart from these somewhat technical consider
ations, the basic outlook in the blue book once
again reflects a lowering of expected interest rate
levels for any particular rate of monetary growth,
given the staff's GNP projection. As noted in the
blue book, our expectation of resumed growth in the
monetary aggregates is based essentially on the view
that such large increases in velocity as occurred in
the third and fourth quarters simply cannot persist,
given past historical experience. It is difficult
to find special factors that held growth in money
down in the fourth quarter at the interest rates
then prevailing, apart from business savings accounts.
But it is possible that exceptionally large loan re
payments in December provided banks with considerable
liquidity that was in effect mopped up by the System.
If the liquidity had not been absorbed, bank
placement of the proceeds of loan repayments would
have lowered the Federal funds rate and other short
term rates by more than actually occurred. Such an

1/20/76

-97-

absorption of bank liquidity by the Federal Reserve
may have caused the stock of money in the hands of
the public temporarily to fall below the demand for
money, given GNP. But if the demand is there, such
a shortfall cannot long persist, and M1 growth is
likely to be resumed as the reserves are supplied
to accommodate the public's efforts to obtain addi
tional cash in the months ahead, whether these
efforts take the form of increased borrowing or
of asset sales.
Chairman Burns then called for a discussion of current
monetary policy and the directive.

He believed that agreement

on ranges of tolerance for the monetary aggregates could be
achieved quickly and that the basic issues to be decided were
the range

for the Federal funds rate and the form of the

directive.1/ In order to expedite the proceedings, he would
begin by proposing that the Committee adopt a money market
directive again this time.

He asked the members to indicate

informally whether they preferred that to the monetary aggre
gates formulation of the directive.
The poll indicated that the members were evenly divided
on the question.
Mr. Holland observed that, in his view, the present
was one of those occasions when it was reasonable to adopt a
money market directive and to specify relatively wide ranges

of tolerance for the aggregates.

However, he had not indicated

1/ The alternative draft directives submitted by the staff
for Committee consideration are appended to this memorandum as
Attachment B.

-98-

1/20/76

a preference for the money market directive because he was
concerned that the Committee might be sliding away from the
practice of formulating its directive in terms of the monetary
aggregates.

He would be able to accept a money market directive

this time if he felt that the Committee would soon return to
a monetary aggregates formulation for the directive.
Chairman Burns remarked that he intended to advocate
a return to a monetary aggregates directive.

At present, however,

the meaning of the money supply figures was quite uncertain.

As

he had indicated earlier, he planned to call for a thorough
discussion at the next meeting of the Committee.
Mr. Holland commented that under the circumstances he
could accept a money market directive and its implicit policy
stance that the Federal funds rate be maintained at about its
current level unless growth in the aggregates appeared to be
deviating substantially from current expectations.
In another informal poll, a majority of the members
indicated that a money market directive was acceptable.
Turning to the question of the Federal funds rate
range, Chairman Burns said he had serious reservations about
the desirability of any further significant decline in the
funds rate.

Given the decline in that rate and in the whole

interest rate structure in recent weeks and given the economic

-99-

1/20/76

outlook, it seemed likely that any further decline in the
funds rate would have to be reversed rather soon.
such a reversal was not easy to accomplish.

At times

Accordingly,

he would not like to see the funds rate drop below 4-1/2 per
cent during the coming inter-meeting interval unless new
developments suggested that such a decline was desirable.
Mr. Mitchell remarked that he would like to see the
funds rate drift down to the 4-1/2 per cent area--not in the
current week but as soon afterward as feasible.

At the moment

he saw no need for subsequent reductions in the rate.

Believing,

however, that it would be incongruous to plan to move the rate
down to the bottom of its range, he favored a range of 4 to 5-1/4
per cent.

He had no great objection to the 4-1/4 to 5-1/4 per cent

range shown under alternative B in the blue book, but he would like
to see the rate move down a little from its current level of about
4-3/4 per cent.
Mr. Coldwell observed that he would not want the Federal
funds rate to go above 5 per cent.

With a money market directive

he would be willing to accept a 4-1/4 to 5 per cent range for
the funds rate.
Mr. Mitchell remarked that he would not mind that

range.

His objective for policy at this time had been largely

met by the reduction in the discount rate to 5-1/2 per cent,

-100-

1/20/76

announced 4 days earlier.

In his opinion, that was inducing

a change in psychology with respect to long-term interest
rates.

It was important to

reinforce that change, and

consequently he favored the further downward drift in the
funds rate.
Mr. Mitchell said the past year had been an extremely
difficult one--particularly for the Chairman, who had carried
the responsibility for publicly explaining the Federal Reserve's
goals and the reasons for its various policy actions.

In the

process, however, he seemed to have convinced most people that
the Federal Reserve was dead set against an inflationary mone
tary policy.

Reflecting the persistence of that conviction,

long-term interest rates had begun to decline, and he viewed
the reinforcement of that trend as a vitally important objective
of policy.

In his judgment, the economy could not recover if

long-term interest rates remained as high as 10 per cent.

And

such a level would not put an end to inflation.
Mr. Partee remarked that he had initially preferred
a funds rate range of 4 to 5 per cent, but he recognized that
a rate of 4 per cent might have an undesired signal effect.
Accordingly, he could accept a range of 4-1/4 to 5 per cent.
Mr. Eastburn commented that even under a money market
directive the behavior of the monetary aggregates was taken

1/20/76

-101-

into account.

Therefore, he thought the Committee ought to

allow enough leeway for some decline in the funds rate in
case growth in the aggregates fell short of rates currently
expected.
Chairman Burns asked the Committee members to indicate
whether the 4-1/4 to 5 per cent funds rate range suggested by
Mr. Coldwell would be acceptable.
A majority of the Committee responded affirmatively.
In response to questions, Chairman Burns observed that
he would address himself to the issue of the way in which the
Desk's objective for the Federal funds rate should be adjusted
in light of the behavior of the monetary aggregates.

Bearing

in mind that in recent months many members of the Committee
had expressed a preference for attaching more importance to
the broader measures of the money supply than had been the
case in the past, he would focus on M1

as symbolic of the

entire family of monetary aggregates.

Quite some time ago the

Committee had interpreted the range it set for M1 as a zone of
tolerance or of indifference; in fact, the language used to
describe the short-run constraints was "range of tolerance."
The Committee's interpretation of that language had changed
gradually,

almost imperceptibly,

inadvertently.

and--in his view--largely

Over time, however,

the result was an

1/20/76

-102-

interpretation entirely different from the original one.

Adjust

ments in the funds rate objective were now made in response to
projections of the 2-month growth rates in M 1 within the range
specified as well as to movements that carried the projections to
or beyond the limits of the range.

The Committee had drifted

into a procedure which was, in his judgment, an exercise in fine
tuning that had involved the Desk and the Committee in chasing
shadows.
Therefore, the Chairman said, he would recommend that
operations be conducted in the manner originally intended--that
the ranges be viewed as zones of indifference and that operations
not be directed at moving the funds rate unless the projections of the
aggregates were virtually at or outside the upper or lower limits of
their specified ranges.

For example, if the Committee agreed upon

the 4 to 8 per cent M1 range shown under alternative B, which
was associated with prevailing money market conditions, a 4
per cent rate of growth would be viewed as about equal to an
8 per cent rate; on the basis of uncertainties regarding the
accuracy of seasonal measures alone, that would be reasonable.
The funds rate would be maintained near its current 4-3/4 per
cent level unless the aggregates approached or went outside
the limits of their ranges.

The one change from earlier practice that

-103-

1/20/76

he would recommend to the Committee was the specification of
slightly wider short-run ranges for the aggregates--as shown
under all three alternatives in the blue book--which was
justified on the basis of the seasonal problems alone.

If

that was acceptable to the Committee he would suggest adoption
of the specifications for the aggregates shown under alter
native B.
In response to questions on the specifics of operations
contemplated in his recommendation, the Chairman said he had in
mind maintaining the current funds rate level--not moving to
the midpoint of the 4-1/4 to 5 per cent range--as long as esti
mates indicated that the aggregates were growing at rates within
their specified ranges.

He would deviate from that only if the

growth rates were close to their limits; in that case he would
want to allow the Desk some discretion as to the timing of
operations directed at moving the funds rate.

He would suggest

that the full width of the Federal funds rate range be available
for use should the aggregates

appear to be growing at rates

outside their specified ranges.
Mr. Coldwell remarked that he was not sure whether the
procedure the Chairman had suggested was a return to one previously
employed by the Committee or was a shift to an entirely new one.
It was his understanding that, in the past, open market operations

1/20/76

-104-

had been guided by the Committee's desire to effect changes in
the Federal funds rate in an orderly and gradual fashion within
its specified range.

If the Desk saw growth in the aggregates

moving toward the bottom of their ranges, it would begin gently
to move the funds rate down within its range.
Chairman Burns agreed that that had been the standard
procedure for some time.

However, that practice represented

a departure from the interpretation originally attached to the
ranges of tolerance adopted by the Committee, which were regarded
as zones of indifference.

He remembered vividly a discussion

that had taken place in which he had interpreted the ranges
as such zones, and Mr. Holmes had asked if the Desk should not
begin to move the Federal funds rate as growth in the aggregates
approached the limits of their ranges.

He had agreed, and that

had been the sentiment of the Committee at that time.
Mr. Wallich commented that in the present situation
pursuit of the procedure advocated by the Chairman would result
in a lag of 2 weeks after obtaining an estimate that M

was

growing at a rate below its range before the Desk aimed for a
Federal funds rate at the lower limit of its range.

That would

be quite a long time between the recognition of weakness in the
aggregates, however indefinite, and the full response to that
weakness.

1/20/76

-105-

Chairman Burns remarked that by late Wednesday of this
week the Desk would have a new estimate of money supply growth
in the January-February period, and it would be able to take
that data into account in operations beginning on Thursday.

If

the estimate indicated that M1 was growing at about a 4 per cent
annual rate or less--and the Committee had adopted a 4 to 8 per
cent range of tolerance for M --the Desk would begin immediately
to direct operations toward reducing the funds rate gradually.

If

a shortfall first began to appear a week or two later, Desk operations
to reduce the funds rate would begin then.

However, there could

be a problem of sorts if the shortfall began to appear as late
as 3 weeks from this Wednesday.

In that case the Desk would

not have quite enough time before the next meeting to achieve
the desired result of a gradual reduction in the funds rate to
the lower limit of its range.
Mr. Wallich commented that--for the coming period--he
would not object to the procedure the Chairman had described,
because he viewed interest rates as a key factor at this time.
However, he thought such a procedure would result in more
rigidity in the funds rate than he would ordinarily find
acceptable.
Chairman Burns agreed that the funds rate would tend
to be more stable under the proposed procedure.

In his judgment,

1/20/76

-106-

however, the procedure that the Committee was using resulted
in fluctuations in the funds rate that were not justified on
economic or financial grounds.

Small variations in the rates

of growth of the money supply had been viewed as having signif
icance when, in fact, they did not.

Such variations were random

rather than systematic.
Mr. Wallich remarked that while the level of the money
stock figures might be uncertain due to seasonal adjustment
problems, the estimated rate of growth relative to the expected
rate was probably meaningful.
Chairman Burns observed that the procedure he had pro
posed was a change from recent practice, as Mr. Coldwell had
noted.

It was, however, a return to an operating rule that

the Committee had followed previously.

The Committee might

decide today to continue its recent practice pending a more
thorough discussion of operating techniques at the next meeting,
but in his judgment a change in operating techniques was
inevitable.
Mr. MacLaury said he would not describe the Committee's
procedures as shadow-chasing.

To his mind, the Federal funds

rate had moved in a rather systematic--not erratic--fashion
over recent months.

He did not believe that the Committee had

drifted into the practice of attaching significance to the

1/20/76

-107-

midpoints--and not just to the limits--of the tolerance ranges
it set for the aggregates.

On his part, at least, that had

been a conscious decision, and he would not want to revert to
the procedure the Chairman had described as the Committee's
method of operation a few years ago.
Continuing, Mr. MacLaury remarked that, while he was
not opposed to allowing the Desk some discretion in its operations,
he would argue that such discretion should be exercised along the
following lines.

First, the Desk should take a movement in

the projections of the aggregates as an indication of the
direction in which the funds rate ought to be moved.

If the

Desk--in its discretion--felt that sufficient reasons existed
for not following the direction indicated by the behavior of the
aggregates--which admittedly was erratic-- he would be prepared to
abide by its view.

It was his feeling that at times--especially

under a money market directive--the possibility of a change in the
funds rate in response to movements in the aggregates had been too
severely limited by the Committee.

For example, the Committee had

ruled out the possibility of a funds rate response in the first and
last weeks of the previous inter-meeting interval, leaving only
2 weeks in which the funds rate could be moved in response to the
behavior of the aggregates.

He found that unsatisfactory.

1/20/76

-108-

Chairman Burns said he did not think the characterization
of the Committee's targets as "zones of indifference" or "ranges
of tolerance" could be dismissed lightly.

The Board staff had

done a great deal of research on seasonal adjustment procedures,
which he had followed very closely.

The staff's investigation of

nine alternative seasonal adjustment procedures for M --all
judged to be more or less equally valid--suggested that the
annual rate of growth for any particular month might vary within
a range of about 7 percentage points depending on the procedure
used.

For a 2-month period the range of variation would be less,

but still on the order of 4-1/2 percentage points.
Mr. Mitchell said the Committee was debating an issue
that he thought it could not resolve and that, in any case,
probably was not very important.

At times, either because of

past behavior of the aggregates or for other reasons, the Com
mittee had directed the Desk to move the funds rate at some
specific time.
With respect to the behavior of the aggregates, Mr. Mitchell
said

one needed to bear in mind that judgments during the inter

meeting periods were made on the basis of preliminary and un
certain weekly figures.

He would agree, therefore, that there

was some zone in which differences in growth rates were not signif
icant.

In considering a 4 to 8 per cent range for M1 , for example,

1/20/76

-109-

he saw no difference between rates of 4 and 5 per cent or
between rates of 3 and 4 per cent.

However, he did see some

difference between rates of 4 and 8 per cent.

In his judgment,

if the data becoming available week by week during the inter
meeting interval cumulated toward the lower or upper limit of
the range, operations should be directed toward moving the
funds rate in the appropriate direction.

But if the weekly

figures suggested that the growth rate was not far from the
midpoint--5, 6, or 7 per cent--he would not be inclined to move
the funds rate.
Chairman Burns commented that Mr. Mitchell's observations
added force to his own views.

The tests of seasonal adjustment

techniques that he had referred to were based on monthly statistics.
However, open market operations were guided by the much more
wobbly weekly figures.
Mr. Holland said he agreed with the Chairman's reading
of history concerning interpretation of the specifications, and
he also agreed that the earlier approach was preferable.

However,

it had one shortcoming, which Committee members might bear in mind
in the more extended discussion of operating procedures at the
next meeting.

At times, for example, the data becoming available

during an inter-meeting period had suggested that growth in the
aggregates would be in the lower part of the range but not low

1/20/76

-110-

enough to trigger a reduction in the funds rate.

Then for

the next meeting, growth rates had been projected from levels
that were somewhat lower than those the Committee had con
templated earlier.

In that manner, cumulative shortfalls

sometimes had occurred.

As Mr. Mitchell had suggested, the

Committee had dealt with those situations by instructing the
Desk to move the funds rate down.

However, it should be pos

sible to devise a better means of dealing with such developments.
Mr. Partee said he agreed that there should be zones of
indifference within the ranges of tolerance specified for the
aggregates.

Like Mr. Holland, however, he was concerned about

the potential for cumulative deviations from the midpoints that
did not trigger changes in the funds rate.

For that reason,

he believed that ordinarily, in due course,the funds rate should
be moved to the midpoint of its specified range, unless the
behavior of the aggregates or developments in financial markets
indicated otherwise.

In the present case, however, the difference

between the midpoint of the 4-1/4 to 5 per cent range and the
current level--that is, 4-5/8 versus 4-3/4 per cent--was almost
insignificant.
Chairman Burns commented that he could accept the inter
pretation of operating techniques suggested by Messrs. Mitchell
and Holland; it was close to his own view and, in his opinion,

-111-

1/20/76

represented an improvement over recent practice.

As he under

stood it, no distinction would be made among growth rates of
5, 6, and 7 per cent within the 4 to 8 per cent short-run
range of tolerance for M .
Mr. Volcker observed that he fully supported the
Chairman's view on operating procedures, and he could accept
the specific prescription just indicated.

But in light of his

objectives for the long-term securities market, he would be
reluctant to move the funds rate up from its current 4-3/4
per cent level even if growth in M 1 appeared to be near the
8 per cent upper limit of the proposed range.

Accordingly,

he would prefer a somewhat higher upper limit for M1 in order
to avoid the possibility of disturbing the market atmosphere
the Committee was seeking to achieve.
Mr. Mitchell remarked that it was important to keep
that market atmosphere in mind and not let basic objectives
be disturbed because of short-run behavior of the aggregates.
Mr. Coldwell remarked that, as he had stated earlier,
he would not like to see the funds rate move up to 5 per cent.
He suggested that the Committee consider an M1 range of 4 to
9 per cent, with a zone of indifference around the midpoint.
Chairman Burns remarked that, in view of the position
he had emphasized today, a range of 4 to 9 per cent might be

1/20/76

-112-

preferable.

He asked the members to indicate informally whether

that range and the mode of operation that had been outlined
would be acceptable.
A majority of the members indicated acceptance.
The Chairman then suggested that the Committee ask the
staff to determine the consistent ranges of tolerance for the
remaining aggregates.
Mr. Coldwell remarked that, because of the importance
of M 2 in the current environment, the Committee might wish to
comment on the staff judgment concerning the range that was
consistent.
Mr. Holland said he thought an M

range of 7 to 12

per cent would be appropriate.
In response to a question by the Chairman, Mr. Axilrod
remarked that the demand deposits were the most volatile com
ponent of M2 . He would assume that the Committee had raised
the upper limit of the M 1 range in order to accommodate an
erratic movement in demand deposits on the high side, should
that develop, but that it was not necessarily contemplating
faster growth in time deposits as well.

Consequently, he would

adjust the M 2 range to 7 to 11-1/2 per cent.
The Chairman then proposed that the Committee vote on
a directive consisting of the general paragraphs as drafted

1/20/76

-113-

by the staff and the money market proposal for the operational
paragraph.

It would be understood that the directive would be

interpreted in accordance with the following short-run specifi
cations.

The ranges of tolerance for growth rates in the

January-February period would be 4 to 9 per cent for M , 7 to
11-1/2 per cent for M2, and whatever the staff determined would
be consistent for RPD's.

The range of tolerance for the weekly

average Federal funds rate in the inter-meeting period would be
4-1/4 to 5 per cent.

It would be further understood that Desk

operations would be conducted in the manner described earliernamely, that the ranges for the aggregates be interpreted as includ
ing zones of indifference and that the Desk maintain the Federal
funds rate at about its current level unless incoming data
suggested that the monetary aggregates were growing at rates
approaching the limits of their specified ranges.
By unanimous vote, the Federal
Reserve Bank of New York was autho
rized and directed, until otherwise
directed by the Committee, to execute
transactions for the System Account
in accordance with the following
domestic policy directive:
The information reviewed at this meeting sug
gests that output of goods and services--which had
increased very sharply in the third quarter of
1975--expanded more moderately in the fourth quar
ter. In December retail sales rose sharply, but
the increase in the fourth quarter as a whole was

1/20/76

-114-

less than that in the third quarter. After
having slowed over the preceding 2 months,
the rise in industrial production and in non
farm payroll employment accelerated in Dec
ember. However, the unemployment rate remained
at 8.3 per cent, as the civilian labor force
grew about as much as total employment. The
increase in average wholesale prices of indus
trial commodities was again relatively large,
but average prices of farm products and foods
declined sharply further. The index of average
wage rates was unchanged in December, following
2 months of large increases.
The exchange value of the dollar against
leading foreign currencies held steady in
December but eased somewhat in early January.
Another sizable foreign trade surplus was
registered in November.
M1 declined in December, and growth in M2
and M3 slowed considerably. At commercial banks,
inflows of time and savings deposits other than
large-denomination CD's slowed, despite a con
tinuing build-up of business savings accounts,
while inflows of deposits to nonbank thrift
institutions were relatively well maintained.
In terms of quarterly averages, growth in M
from the third to the fourth quarter was modest,
while growth in M2 and M3 was more substantial.
In recent weeks interest rates on both short
and long-term securities have declined appre
ciably. In mid-January Federal Reserve discount
rates were reduced from 6 to 5-1/2 per cent.
In light of the foregoing developments, it
the
policy of the Federal Open Market Com
is
mittee to foster financial conditions that will
encourage continued economic recovery, while
resisting inflationary pressures and contribut
ing to a sustainable pattern of international
transactions.

1/20/76

-115-

To implement this policy, while taking
account of developments in domestic and inter
national financial markets, the Committee seeks
to maintain prevailing bank reserve and money
market conditions over the period immediately
ahead, provided that monetary aggregates appear
to be growing at about the rates currently
expected.
Secretary's note: The specifications
agreed upon by the Committee, in the
form distributed after the meeting, are
appended to this memorandum as Attach
ment C.
It was agreed that the next meeting of the Committee
would be held on February 18, 1976.
Thereupon the meeting adjourned.

Secretary

ATTACHMENT A

POLICY ALTERNATIVES
January 20, 1976

STRICTLY CONFIDENTIAL (FR)
CLASS II FOMC

INCOME VELOCITY OF M1

INDEX, TROUGH

120

50

-115

-110

-105
r
n

100

-4

-2

Trough

+2

3-MO. TREASURY BILL RATE
-

220

-200

180

160

-

140

-

120

-50

-100
-4

-2

Trough

+2

+4

ACTUAL & PREDICTED LEVELS OF M 1
BILLIONS OF

PREDICTED
$18 7 Billion

1-3
291
ACI UAL

S28C

Q2

03
1974

Q4

01

Q2

Q3
1975

Q4

INCOME VELOCITY OF M 2
INDEX, TROUGH QUARTER = 100

1949-50

-120

115

-110

-105°

1 75-7

Average of four
rncovprips

-4

-2

Trough

from

-100

Monetary Policy Alternatives
Effects on Key Economic and Financial Variables

1976
I

II

III

IV

Treasury Bill Rate, Per Cent
1.
6-1/4% M1 Growth*

6-7/8

7-1/4

2.

7-1/4% M1 Growth*

4-3/4

6-3/4

3.

5-1/4% M1 Growth*

7-1/8

8

Real GNP, Per cent Increase
at Annual Rates
1. 6-1/4% M Growth*

4.5

4.3

4.0

2.

7-1/4% M

Growth*

4.5

4.7

4.9

5.0

3.

5-1/4% M1 Growth*

4.5

4.3

3.7

3.0

1232.8

1246.6

1259.9

1272.2

Real GNP Level, Billions
of 1972 Dollars
1.
6-1/4% M 1 Growth*
2.

7-1/4% M1 Growth*

1232.8

1247.3

1262.6

1278.4

3.

5-1/4% M1 Growth*

1232.8

1246.0

1257.5

1266.9

8.2

8.1

7.9

7.9

Unemployment Rate, Per Cent
1.
6-1/4% M 1 Growth*
2.

7-1/4% M1 Growth*

8.2

8.1

7.9

7.7

3.

5-1/4% M1 Growth*

8.2

8.1

8.0

8.1

5.6

5.6

5.6

5.5

Fixed Weight Price Index
for Gross Private Product
1.
6-1/4% M1 Growth*

*

4.5

2.

7-1/4% M1 Growth*

5.6

5.6

5.7

5.7

3.

5-1/4% M 1 Growth*

5.6

5.6

5.5

5.3

QIII 1975 through QIII 1976,
no account is taken of shifts

extended through the fourth quarter of 1976;
of funds to savings accounts by corporations.

ATTACHMENT B

January 19, 1976
Drafts of Domestic Policy Directive for Consideration by the
Federal Open Market Committee at its Meeting on January 20, 1976

GENERAL PARAGRAPHS
The information reviewed at this meeting suggests that
output of goods and services--which had increased very sharply
in the third quarter of 1975--expanded more moderately in the
fourth quarter. In December retail sales rose sharply, but the

increase in the fourth quarter as a whole was less than that in
the third quarter. After having slowed over the preceding 2
months, the rise in industrial production and in nonfarm payroll
employment accelerated in December. However, the unemployment
rate remained at 8.3 per cent, as the civilian labor force grew
about as much as total employment. The increase in average
wholesale prices of industrial commodities was again relatively
large, but average prices of farm products and foods declined
sharply further. The index of average wage rates was unchanged
in December, following 2 months of large increases.
The exchange value of the dollar against leading foreign
currencies held steady in December but eased somewhat in early
January. Another sizable foreign trade surplus was registered
in November.
M 1 declined in December, and growth in M2 and M3 slowed
considerably. At commercial banks, inflows of time and savings
deposits other than large-denomination CD's slowed, despite a
continuing build-up of business savings accounts, while inflows
of deposits to nonbank thrift institutions were relatively well
maintained. In terms of quarterly averages, growth in M 1 from
the third to the fourth quarter was modest, while growth in M2
and M 3 was more substantial. In recent weeks interest rates on
both short- and long-term securities have declined appreciably.
In mid-January Federal Reserve discount rates were reduced from
6 to 5-1/2 per cent.
In light of the foregoing developments, it is the policy
of the Federal Open Market Committee to foster financial conditions
that will encourage continued economic recovery, while resisting
inflationary pressures and contributing to a sustainable pattern
of international transactions.

OPERATIONAL PARAGRAPH
Alternative "Monetary Aggregate" Proposals
Alternative A
To implement this policy, while taking account of develop
ments in domestic and international financial markets, the Committee
seeks to achieve bank reserve and money market conditions consistent
with substantial growth in monetary aggregates over the months ahead.
Alternative B
To implement this policy, while taking account of develop
ments in domestic and international financial markets, the Committee
seeks to achieve bank reserve and money market conditions consistent
with moderate growth in monetary aggregates over the months ahead.
Alternative C
To implement this policy, while taking account of develop
ments in domestic and international financial markets, the Committee
seeks to achieve bank reserve and money market conditions consistent
with modest growth in monetary aggregates over the months ahead.
"Money Market" Proposal
To implement this policy, while taking account of develop
ments in domestic and international financial markets, the Committee
seeks to maintain prevailing bank reserve and money market conditions
over the period immediately ahead, provided that monetary aggregates
appear to be growing at about the rates currently expected.

ATTACHMENT C

January 20, 1976
Points for FOMC guidance to Manager
in implementation of directive

A.

Specifications

Desired longer-run growth rate ranges (as agreed 1/20/76):
4-1/2 to 7-1/2%
M1
(QIV '75 to QIV '76)

7-1/2 to 10-1/2%
M3
Proxy
B.

9 to 12%
6 to 9%

Short-run operating constraints (as agreed 1/20/76):
1.

2.

Range of tolerance for RPD growth
rate (January-February average):
Ranges of tolerance for monetary
aggregates (January-February average):

-7 to -2%
4 to 9%
7 to 11-1/2%

3.

C.

Range of tolerance for Federal funds
rate (daily average in statement weeks
between meetings):

4-1/4 to 5%

4.

Federal funds rate to be moved in an
orderly way within range of toleration.

5.

Other considerations: Account to be taken of developments in domestic
and international financial markets.

If it appears that the Committee's various operating constraints are proving
be significantly inconsistent in the period between meetings, the Manager is
promptly to notify the Chairman, who will then promptly decide whether the
situation calls for special Committee action to give supplementary instructions