The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
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,,
197
4,
beginning at
PRESENT:
4
on Monday and Tuesday, March 18-19,
:00 p.m . on Monday.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Burns,
Chairman
Hayes, Vice Chairman
Black
Brimmer
Bucher
Clay
Holland
Kimbrel
Mitchell
Sheehan
Wallich
Winn
Messrs. Coldwell, MacLaury, Mayo, and Morris,
Alternate Members of the Federal Open
Market Committee
Messrs. Eastburn, Francis, and Balles, Presidents
of the Federal Reserve Banks of Philadelphia,
St. Louis, and San Francisco, respectively
Mr. Broida, Secretary
Mr. Altmann, Deputy Secretary
Mr. Bernard, Assistant Secretary
Mr. O'Connell, General Counsel
Mr. Partee, Senior Economist
Mr. Axilrod, Economist (Domestic Finance)
Messrs. Bryant, Davis, Doll, Hocter, and
Parthemos, Associate Economists
3/18/74
Mr. Holmes, Manager, System Open Market
Account
Mr. Coombs, Special Manager, System Open
Market Account
Mr. Sternlight, Deputy Manager, System
Open Market Account
Mr. Coyne, Assistant to the Board of
Governors
Messrs. Keir and Williams, Advisers,
Division of Research and Statistics,
Board of Governors
Mr. Wendel, Assistant Adviser, Division of
Research and Statistics, Board of
Governors
Miss Pruitt, Economist, Open Market
Secretariat, Board of Governors
Mrs. Ferrell,
Open Market Secretariat
Assistant, Board of Governors
Messrs. Boehne and Scheld, Senior Vice
Presidents, Federal Reserve Banks of
Philadelphia and Chicago, respectively
Messrs. Green and Sims, Vice Presidents,
Federal Reserve Banks of Dallas and
San Francisco, respectively
Chairman Burns welcomed Mr. Henry C. Wallich, recently
appointed to the Board of Governors, to his first meeting of the
Federal Open Market Committee.
1/
The Secretary reported that advices had been received of
the election by the Federal Reserve Banks of members and alternate
members of the Federal Open Market Committee for the term of one
year beginning March 1, 1974; that it appeared that such persons
were legally qualified to serve; and that they had executed their
oaths of office.
1/ Mr. Wallich had executed his oath of office as a member of the
Committee prior to this meeting.
3/18/74
The elected
members and alternates were as follows:
Robert P. Black, President of the Federal Reserve Bank of
Richmond, with Frank E. Morris, President of the
Federal Reserve Bank of Boston, as alternate;
Alfred Hayes, President of the Federal Reserve Bank of
New York, with Richard A. Debs, First Vice President
of the Federal Reserve Bank of New York, as alternate;
Willis J. Winn, President of the Federal Reserve Bank of
Cleveland, with Robert P. Mayo, President of the
Federal Reserve Bank of Chicago, as alternate;
Monroe Kimorel, President of the Federal Reserve Bank of
Atlanta, with Philip E. Coldwell, President of the
Federal Reserve Bank of Dallas, as alternate;
George H. Clay, President of the Federal Reserve Bank of
Kansas City, with Bruce K. MacLaury, President of the
Federal Reserve Bank of Minneapolis, as alternate.
By unanimous vote, the following
officers of the Federal Open Market
Committee were elected to serve until
the election of their successors at
the first meeting of the Committee
after February 28, 1975, with the
understanding that in the event of the
discontinuance of their official con
nection with the Board of Governors
or with a Federal Reserve Bank, as the
case might be, they would cease to
have any official connection with
the Federal Open Market Committee:
Arthur F. Burns
Alfred Hayes
Arthur L. Broida
Murray Altmann
Normand R.V. Bernard
Thomas J. O'Connell
Edward G. Guy
John Nicoll
Chairman
Vice Chairman
Secretary
Deputy Secretary
Assistant Secretary
General Counsel
Deputy General Counsel
Assistant General Counsel
3/18/74
J. Charles Partee
Stephen H. Axilrod
Robert Solomon 1/
Senior Economist
Economist (Domestic Finance)
Economist (International Finance)
Harry Brandt, Ralph C. Bryant,
Richard G. Davis, Raymond J.
Doll, Lyle E. Gramley,
William J. Hocter, James
Parthemos, James L. Pierce,
Associate Economists
and John E. Reynolds
By unanimous vote, the Federal
Reserve Bank of New York was selected
to execute transactions for the System
Open Market Account until the adjourn
meeting of the Federal
ment of the first
Open Market Committee after February 28,
1975.
By unanimous vote, Alan R. Holmes,
Peter D. Sternlight, and Charles A. Coombs
were selected to serve at the pleasure of
the Federal Open Market Committee as
Manager, Deputy Manager, and Special
Manager for foreign currency operations,
respectively, of the System Open Market
Account, it being understood that their
selection was subject to their being
satisfactory to the Board of Directors
of the Federal Reserve Bank of New York.
Secretary's Note: Advice subsequently was
received that Messrs. Holmes, Sternlight,
and Coombs were satisfactory to the Board
of Directors of the Federal Reserve Bank
of New York for service in the respective
capacities indicated.
Consideration was then given to the continuing authorizations
of the Committee, in accordance with the customary practice of
reviewing such matters at the first meeting in March of every year.
1/ On leave of absence,
3/18/74
Secretary's Note: On February 26, 1974, certain
continuing authorizations of the Committee, listed
below, had been distributed by the Secretary with the
advice that, in accordance with past practice, they
would remain effective until otherwise directed by
the Committee.
Members were asked to so indicate if
they wished to have any of the authorizations in
question placed on the agenda for consideration at
this meeting, and no such requests were received.
The authorizations in question were as follows:
1.
2.
3.
4.
5.
6.
7.
8.
Procedures for allocation of securities in the
System Open Market Account.
Distribution list for periodic reports prepared
by Federal Reserve Bank of New York.
Authority for the Chairman to appoint a Federal
Reserve Bank as agent to operate the System
Account in case the New York Bank is unable
to function.
Resolutions providing for continued operation
of the Committee and for certain actions by
the Reserve Banks during an emergency.1 /
Resolution relating to examinations of the System
Open Market Account.
Guidelines for the conduct of System operations
in Federal Agency issues.
Regulation relating to Open Market Operations
of Federal Reserve Banks.
Rules of Organization, Rules Regarding Availability
of Information, and Rules of Procedure.
Reference was made to the procedure authorized at the meeting
of the Committee on March 2,
9,
1955 (and most recently amended on March
1971, to authorize the Secretary to act on the Chairman's behalf
1/ With respect to the second of these resolutions, a final
(unnumbered) paragraph had been inadvertently omitted from the text
shown in the memorandum of discussion for the meeting of the Committee
on September 21, 1971 (the date of the latest revision) and in copies
distributed subsequently. The full text of the resolution was shown
in an attachment to the memorandum of February 26, 1974, and is
reproduced in Attachment A to this memorandum.
3/18/74
in considering proposals for the addition of members of the
Board's staff to the list) whereby, in addition to members and
officers of the Committee, minutes and other records could be
made available to any other employee of the Board of Governors
or of a Federal Reserve Bank with the approval of a member of
the Committee or another Reserve Bank President, with notice to
the Secretary.
It was stated that lists of currently authorized persons
at the Board and at each Federal Reserve Bank (excluding secretaries
and records and duplicating personnel) had recently been confirmed
by the Secretary of the Committee.
The current lists were reported
to be in the custody of the Secretary, and it was noted that
revisions could be sent to the Secretary at any time.
It was agreed to retain the existing
procedure for making minutes and other
records of the Committee available to
employees of the Board of Governors and
the Federal Reserve Banks, including
authorization to the Secretary to act on
the Chairman's behalf in considering
proposals for the addition of members of
the Board's staff to the list
of those
having access to Committee minutes and
other records.
In connection with the Committee's review of its authori
zation for domestic open market operations, Chairman Burns noted
that the report of the staff committee on bankers' acceptances,
3/18/74
dated January 29,
1974, and entitled "Recommendations on Desk
Operations in Bankers' Acceptances,"1/ included recommendations
for revisions in paragraphs 1(b) and 1(c) of the authorization.
He asked Mr. Sternlight, chairman of the staff committee, to
comment.
Mr. Sternlight remarked that, in response to the FOMC's
request at its meeting on September 18, 1973, the staff committee
had considered what changes might be made in the form and substance
of the FOMC's rules governing System operations in bankers' accep
tances in light of the decision by the Board of Governors to revoke
Regulations B and C.
A new form for the rules was needed because
the Board's Regulation B had constituted part of the chain of refer
ences underlying the present rules.
The FOMC also had asked the
staff committee to consider possible changes in the substance of
the rules.
In its report, Mr. Sternlight continued, the staff committee
had recommended that the elimination of reference to the Board's
Regulation B from the FOMC's Regulation should be accompanied by a
revision in the FOMC's authorization for domestic open market opera
tions to incorporate a description of the types of acceptances
suitable for System operations.
1/
The standards proposed in the
A copy of this report has been placed in the Committee's files.
3/18/74
report were designed to ensure that System operations were confined
to liquid, readily marketable acceptances.
The standards involved
certain modifications in the traditional "eligible" acceptance con
cept which were modest in nature and mostly in a liberalizing and
modernizing direction.
They would leave intact the basic trade
related nature of the acceptances that the Federal Reserve would
purchase.
Mr. Sternlight observed that the staff committee had con
sidered at some length the possibility of dealing in non-trade
related acceptances, or finance bills.
While most members would
lean toward recommending System operations in finance bills, the
staff committee concluded that the subject deserved further study,
which it was prepared to undertake if the FOMC so directed.
The aim
of such study would be to see whether System participation in the
market for finance bills would add significantly to the scope of
open market operations, and what effects such participation might
have on the market for either finance bills or trade-related
acceptances.
Mr. Sternlight added that the proposed language revisions
in the
FOMC authorization, shown in attachment A to the staff
committee report, affected paragraph 1(b), relating to outright
purchases and sales of acceptances, and paragraph 1(c),
relating
3/18/74
to repurchase agreements.
The changes suggested in paragraph 1(b)
were intended mainly to incorporate the description of acceptances
the Desk would be authorized to trade in.
However, two of the
changes were suggested simply to eliminate wording which appeared
unnecessary.
The language indicating that the Desk could buy or
sell acceptances "on a cash, regular, or deferred delivery basis,"
seemed superfluous because that list exhausted the delivery bases
which might be used.
Secondly, the statement that aggregate hold
ings of bankers' acceptances should not exceed the lower of two
figures--$125 million or 10 per cent of the total volume of accep
tances outstanding--could be replaced by language specifying a
single limit of $125 million; the 10 per cent limitation served no
useful purpose since the volume of outstanding acceptances was
currently in excess of $8 billion.
Mr. Mitchell noted that the Board had placed reserve require
ments on finance bills but not on eligible acceptances.
Assuming
that the Committee, after reviewing the results of the proposed
study, decided to authorize an expansion of the scope of open
market operations to cover finance bills as well as eligible
acceptances, he wondered whether there would be grounds for argu
ing that the Board also should treat the two types of paper alike
by placing reserve requirements on eligible acceptances.
3/18/74
-10-
Mr. Sternlight replied that he saw no reason why Committee
action to expand the scope of open market operations in acceptances
should necessitate Board action with respect to reserve requirements.
Mr. Mitchell then said he had had the impression at one
time that a substantial volume of staff resources at the New York
Reserve Bank was devoted to examining the acceptances proposed for
purchase to determine whether the documentation was complete and
whether they were satisfactory in other respects.
He asked if that
was the case at present.
Mr. Sternlight replied in the negative, adding that the
Reserve Bank relied primarily on the commercial banks whose names
appeared on the acceptances for such purposes.
Mr. Holmes noted that the Acceptance Department at the
New York Bank handled purchases and sales for foreign central banks
in addition to carrying out operations under the Committee's direc
tives.
The Bank guaranteed the acceptances it bought for foreign
official accounts for a fee of 1/8 per cent, and the income it earned
through such fees exceeded the Department's costs of operation,
including overhead, by about $420,000 in 1973.
Earnings on the
guarantee fee were participated among all Reserve Banks,
3/18/74
In reply to a further question by Mr. Mitchell, Mr. holmes
remarked that the housekeeping operations involved in repurchase
agreements on bankers' acceptances were limited to such routine
actions as arranging for the delivery of the paper by the other
party and for its subsequent return.
Mr. Holland said he was prepared to approve all of the
recommendations of the staff committee except that relating to the
deletion of the phrase "on a cash, regular, or deferred delivery
basis"
from paragraph 1(b) of the authorization.
He agreed that the
phrase was not essential, since the list of delivery bases mentioned
was exhaustive.
Nevertheless, the phrase did serve a useful pur
pose in making explicit the Desk's authority to buy and sell accep
tances on a deferred basis as well as for cash and regular delivery.
After further discussion, the Committee agreed that it
would be desirable to make the amendments to paragraphs 1(b) and
1c) of the authorization recommended by the staff committee, except
that involving the deletion of the phrase "on a cash, regular, or
deferred delivery basis," and to direct the staff committee to make
further studies of the desirability of expanding the scope of System
operations in bankers' acceptances to include finance bills.
Mr. Broida noted that in its discussion last September the
Committee had agreed in principle to delete the reference to the
3/18/74
-12-
Board's Regulation B from Section 270.4(c)(2) of the FOMC Regulation
as soon as rules governing operations in bankers' acceptances had
been incorporated in its authorization for domestic open market
operations.
He suggested that the Committee make both actions
effective as of April 1, 1974, in order to provide time for the
preparation of Federal Register notices relating to those actions
and to the Board's revocation of Regulations B and C, which would
be effective on the same date, and for the preparation of a press
release describing the realignment and modernization of the System's
rules relating to open market operations in bankers' acceptances.
By unanimous vote, Section 270.4(c)(2)
of the Regulation Relating to Open Market
Operations of Federal Reserve Banks was
amended, effective April 1, 1974, to read
as follows:
ยง 270.4 Transactions in Obligations.
(c)
In accordance with such limitations, terms, and
conditions as are prescribed by law and in authorizations and
directives issued by the Committee, the Reserve Bank selected by
the Committee is authorized and directed-
(2)
To buy and sell bankers' acceptances in the open
market for its own account; . . . .
3/18/74
-13-
By unanimous vote, paragraphs 1(b)
and 1(c) of the Authorization for Domestic
Open Market Operations were amended,
effective April 1, 1974, to read as
follows:
(b) To buy or sell in the open market, from or to
acceptance dealers and foreign accounts maintained at the
Federal Reserve Bank of New York, on a cash, regular, or deferred
delivery basis, for the account of the Federal Reserve Bank of
New York at market discount rates, prime bankers' acceptances
with maturities of up to nine months at the time of acceptance
that (1) arise out of the current shipment of goods between
countries or within the United States, or (2) arise out of the
storage within the United States of goods under contract of sale
of expected to move into the channels of trade within a reasonable
time and that are secured throughout their life by a warehouse
receipt or similar document conveying title to the underlying
goods; provided that the aggregate amount of bankers' acceptances
held at any one time shall not exceed $125 million.
(c)
To buy U.S. Government securities, obligations that
are direct obligations of, or fully guaranteed as to principal and
interest by, any agency of the United States, and prime bankers'
acceptances of the types authorized for purchase under 1(b) above,
from nonbank dealers for the account of the Federal Reserve Bank of
New York under agreements for repurchase of such securities, obliga
tions, or acceptances in 15 calendar days or less, at rates that,
unless otherwise expressly authorized by the Committee, shall be
determined by competitive bidding, after applying reasonable limita
tions on the volume of agreements with individual dealers; provided
that in the event Government securities or agency issues covered
by any such agreement are not repurchased by the dealer pursuant
to the agreement or a renewal thereof, they shall be sold in the
market or transferred to the System Open Market Account; and provided
further that in the event bankers' acceptances covered by any such
agreement are not repurchased by the seller, they shall continue to
be held by the Federal Reserve Bank or shall be sold in the open
market.
By unanimous vote, the staff
committee on bankers' acceptances
was directed to conduct further
studies of the desirability of
expanding Federal Reserve open
market operations in bankers'
acceptances to encompass all types
of prime acceptances, including
finance bills.
3/18/74
-14-
The Chairman then noted that a memorandum from Mr. Holmes,
dated March 11, 1974, and entitled "System Purchases of Federal
Financing Bank Securities,"
1/
had been distributed to the Committee.
He asked Mr. Holmes to comment.
Mr. Holmes said he thought it would be desirable and appro
priate for the Federal Reserve to support the Treasury's effort to
consolidate the financing of Federal agencies to the largest extent
feasible through the Federal Financing Bank, which had been estab
lished by legislation enacted in late 1973 and was expected to begin
operations soon.
As his memorandum indicated, unless the Committee
directed otherwise the Desk would plan to treat FFB securities in
the same manner as Treasury obligations in the conduct of open
market operations.
That would mean, of course, that the Committee's
guidelines for System operations in Federal agency issues would not
apply to FFB securities.
The Desk would, however, take care to avoid
becoming a dominant factor in the market for such obligations.
After
some supply of FFB securities had accumulated the Desk would consider
lending them to dealers on the same basis as it lent other obliga
tions, assuming that lending continued to be authorized by the
Committee.
1/ A copy of this memorandum has been placed in the Committee's
files.
3/18/74
-15-
Mr. Holmes observed that he planned to recommend adding a
reference to Federal Financing Bank securities to paragraph 1(a) of
the Committee's authorization for domestic open market operations,
to make it clear that the Desk was authorized to trade in such securi
ties under the authority to buy and sell U.S. Government securities.
However, the Committee might want to consider that recommendation in
conjunction with certain other recommendations of his relating to
paragraph 1(a).
Mr. Mitchell asked whether Federal Financing Bank securities
would be classified with U.S. Government securities or with Federal
agency obligations in Federal statistical reports.
Mr. Axilrod replied that, while that question was still being
discussed by the agencies involved, it was hoped to treat FFB obliga
tions in a fashion similar to U.S. Government securities.
In the Federal
Reserve weekly statement it was likely that FFB obligations would be
shown separately under the heading of U.S. Government securities, and
not grouped with agency obligations.
Mr. Mitchell then asked whether the Federal Financing Bank
was expected to take over all agency financing, so that the categories
for agency obligations might eventually be phased out.
Mr. Holmes replied in the negative, noting that under the
terms of the new law a number of agencies--including the Federal
National Mortgage Association, Federal Home Loan Banks, Federal
3/18/74
-16-
Land Banks, Federal Intermediate Credit Banks, and the Bank for
Cooperatives--were not authorized to finance through the Federal
Financing Bank.
In reply to a question by Mr. Kimbrel, Mr. Holmes said he
would not plan to bid for new issues of the Federal Financing Bank
except in exchange for maturing issues.
In his judgment, System
acquisitions of securities from the FFB for cash, like such acquisi
tions from the Treasury of present Government obligations, would be
considered direct lending to the Treasury, and thus subject to the
provisions of paragraph 2 of the Committee's authorization.
Chairman Burns asked whether there were any objections to
Mr. Holmes' recommendations with respect to System operations in
Federal Financing Bank securities, and none was heard.
The Chairman then asked Mr. Holmes to comment on his
memorandum dated March 11, 1974, entitled "Recommended changes in
paragraph 1(a) of authorization
for domestic open market operations."1/
Mr. Holmes observed that one of the four changes in para
graph 1(a) suggested in his memorandum was to delete the phrase "on
a cash, regular, or deferred delivery basis."
He would now like to
withdraw that recommendation, in view of the Committee's decision to
1/ A copy of this memorandum has been placed in the Committee's
files.
-17-
3/18/74
retain the same phrase in paragraph 1(b).
Of the remaining changes
proposed, he had already referred to one--the addition of the words
"including the securities of the Federal Financing Bank" after the
opening phrase authorizing the Desk "To buy and sell U.S. Government
securities."
Another proposal was to add a parenthesis containing
the phrase "including forward commitments" following the reference
to System Account holdings of securities in the statement relating
to the leeway for changes in holdings between meetings of the
Committee, in order to make it clear that the leeway calculations
were made on a commitment basis,
Such a phrase had been included
in the leeway clause prior to March 1964, but it had been inadver
tently omitted when new language approved then to clarify the clause
in certain other respects was transcribed.
Mr. Holmes observed that his remaining recommendation with
respect to paragraph 1(a) was a substantive one--to increase the
dollar amount of the leeway from $2 billion to $3 billion.
As
indicated in his memorandum, there had been a marked increase in
recent years in the variation in System Account holdings between
meetings, and during the past year he had found it necessary on
three occasions to ask for a temporary increase in the leeway to
$3 billion.
While the Committee had approved those recommendations
promptly, it seemed to him that a permanent increase to $3 billion
would be reasonable now.
-18-
3/18/74
In response to questions by the Chairman, Messrs. Partee
and Axilrod said they concurred in Mr. Holmes' recommendations with
respect to paragraph 1(a), and Mr. O'Connell indicated that he found
no legal objections to them.
After discussion, the Committee agreed that the revisions
proposed by Mr. Holmes were appropriate.
By unanimous vote, paragraph 1(a)
of the Authorization for Domestic Open
Market Operations was amended, effec
tive immediately, to read as follows:
(a) To buy or sell U.S. Government securities, including
securities of the Federal Financing Bank, and securities that are
direct obligations of, or fully guaranteed as to principal and
interest by, any agency of the United States in the open market,
from or to securities dealers and foreign and international accounts
maintained at the Federal Reserve Bank of New York, on a cash, regular,
or deferred delivery basis, for the System Open Market Account at
market prices, and, for such Account, to exchange maturing U.S.
Government and Federal agency securities with the Treasury or the
individual agencies or to allow them to mature without replacement;
provided that the aggregate amount of U.S. Government and Federal
agency securities held in such Account (including forward commit
ments) at the close of business on the day of a meeting of the
Committee at which action is taken with respect to a domestic
policy directive shall not be increased or decreased by more than
$3.0 billion during the period commencing with the opening of
business on the day following such meeting and ending with the
close of business on the day of the next such meeting.
Chairman Burns observed that a memorandum from the Committee's
General Counsel, dated March 8, 1974, and entitled "Status of paragraph 2
of authorization for domestic open market operations,"1/ had been
distributed.
He asked Mr. O'Connell to comment.
1/ A copy of this memorandum has been placed in the Committee's
files.
3/18/74
-19-
Mr. O'Connell noted that paragraph 2 of the authorization,
which authorized the Federal Reserve Banks to purchase short-term
certificates of indebtedness directly from the Treasury, had been
in a state of de facto suspension since November 1, 1973, when the
underlying statutory authority--contained in a provision of Section 14(b)
of the Federal Reserve Act--had expired.
Accordingly, question might
be raised as to whether paragraph 2 should be retained in the authori
zation.
In his opinion, there was no legal impediment to the reten
tion of that paragraph, and retention could be justified on the
grounds of administrative convenience, looking forward to the time
at which new statutory authority would be enacted.
If, as he would
recommend, the Committee decided to retain paragraph 2 in the autho
rization, he would suggest that it direct the staff to include in
the policy record for today's meeting a statement to the effect
that the Committee had taken note of its present state of de facto
suspension.
Mr. Holland said he thought a case could be made for keeping
the Committee's various authorizations current by removing provisions
that were inapplicable even temporarily, thus avoiding the
false impression that the Committee could not act in timely fashion
to adapt its instruments to changes in circumstances.
Moreover,
there was some uncertainty at present about the date at which new
3/18/74
-20-
legislation regarding direct lending to the Treasury would be
enacted.
For those reasons he would prefer to delete paragraph 2
from the authorization now and plan on restoring it when the new
legislation was in place.
However, he did not feel strongly about
the matter.
Chairman Burns said he thought it was generally expectedwithin the Congress and the Administration, and among Committee
members--that new legislation would be enacted relatively soon.
As far as he was concerned, the decision with respect to paragraph 2
could go either way; however, he had a slight inclination toward
retaining the paragraph.
Mr. Hayes said he also would be inclined to retain the
paragraph, to avoid the need for special action to restore it in
the near future.
Mr. Brimmer expressed a similar view, on the understanding
that the policy record for this meeting would include a statement
regarding the de facto suspension of the paragraph along the lines
recommended by Mr. O'Connell.
The Chairman asked whether there was any objection to
retaining the paragraph for the present on that understanding,
and none was heard.
3/18/74
-21-
The Committee took note of the
present state of de facto suspension
of paragraph 2 of the Authorization
for Domestic Open Market Operations
as a consequence of the expiration,
on November 1, 1973, of the underlying
statutory authority contained in a
provision of Section 14(b) of the
Federal Reserve Act.
Chairman
Burns then referred to memoranda from the
Manager, dated March 11, 1974, and from the General Counsel, dated
March 13,
1974, both of which were entitled "Review of System
Lending of Government Securities."1
/
He asked Mr. Holmes to
comment.
Mr. Holmes said that, as indicated in his memorandum, he
thought there continued to be a need for the authority for the
Desk to lend securities to help cope with the problem of delivery
failures.
He might call the Committee's
particular attention to
the increased use of the lending facility by New York City banks
participating in the Government Securities Clearing Arrangement.
That was an important factor in the growing use of the book entry
system.
With respect to the lending operation as a whole, repay
ments remained prompt and the operation continued
itable to the System.
1/
files.
to be quite prof
He recommended that the Committee find System
Copies of these memoranda have been placed in the Committee's
3/18/74
-22-
lending of securities to be reasonably necessary to the effective
conduct of open market operations, and that it renew the authority,
which was contained in paragraph 3 of the authorization for domestic
open market operations, subject to periodic review.
Mr. Holmes added that such reviews had been made at semi
annual intervals in the past.
In light of the prospects that lending
would continue to be necessary for some time to come, he recommended
that the Committee shift to annual reviews, to be made at the time
of the organization meeting in March of each year.
If there were
any significant change in the need for lending between the annual
reviews he would, of course, inform the Committee promptly.
Mr. Brimmer observed that the Committee's General Counsel
had consistently taken the view that the lending of securities in
the System Account was legally authorized if the Committee found it
to be reasonably necessary to the effective conduct of open market
operations.
On the basis of such opinions, the Committee had deemed
it desirable in the past to review the authority at semi-annual
intervals.
He noted that in his present memorandum, Mr. O'Connell
expressed the opinion that "there is no legal objection" to shifting
to an annual review.
He wondered, however, whether Mr. O'Connell
would recommend such a shift.
3/18/74
-23
Mr. O'Connell said he thought the question of the frequency
of the review was a policy matter for decision by the Committee.
Mr. Brimmer then observed that he was prepared to support
the Manager's recommendations that the authority be renewed at this
time, subject to annual review in the future.
Chairman Burns asked whether there was any objection to the
Manager's recommendations, and none was heard.
It was agreed that the author
ization for the lending of Government
securities from the System Open Market
Account, contained in paragraph 3 of
the Authorization for Domestic Open
Market Operations, should be retained
at this time, subject to annual review.
The Chairman then noted that three memoranda concerning
a proposed expansion of the lending authority 1/ had been distributed
to the Committee.
He asked Mr. Holmes and Mr. Axilrod to comment.
Mr. Holmes noted that the proposal, which had originated in
a suggestion by the Association of Primary Dealers in Government
Securities, was that the System lend securities to dealers not only
1/ The memoranda referred to were (1) from the System Account
Manager, dated February 5, 1974, and entitled "Proposed expansion
of authority to lend securities from System Open Market Account;"
(2) from the Board Staff, dated October 3, 1973, and entitled
"Dealer Association request for a broadening of System security
lending;" and (3) from the General Counsel, dated March 8, 1974,
and entitled "Loan of System Account securities to cover dealer
short sales."
3/18/74
-24-
to avoid delivery failures--the sole basis on which such lending
was now authorized--but also to permit dealers to sell securities
that were in demand in the market but which they did not own.
Dealers would thus be enabled to establish short positions in
individual issues; however, since the loans by the System would
be made against the collateral of other securities of comparable
maturity held by dealers in their portfolios, they would not be
enabled through such loans to establish a net short position in any
given maturity area.
As the memoranda indicated, Mr. Holmes continued, he would
be prepared to recommend such an expansion of the lending authority,
provided that adequate safeguards were established to avoid abuse.
The Board staff was inclined to take a negative view of the proposal.
The General Counsel had expressed the opinion that the same legal
test applied to lending for this purpose as to lending for the
purpose of coping with delivery failures; i.e., the activity in
question was legally authorized provided that the Committee found
it to be reasonably necessary to the effective conduct of open
market operations.
Mr. Holmes observed that developments in the market today
could be used to illustrate one important merit of the proposal.
Because dealers were trying to lighten their inventories of one of
3/18/74
-25-
the new issues in the Treasury's February financing--the 7 per cent
notes of 1981--the price of that issue was off by a full point in
today's trading.
If dealers had been able to borrow and sell
securities of nearby maturity against the collateral of those notes,
the impact of their desire to go short would have been spread among
several issues rather than concentrated on one.
There was no way
to prevent dealers from going short when they wanted to, but it seemed
useful to have some device that would spread out the market effects.
In general, he thought the proposed expansion of lending would make
for a more fluid and stable market, and thus would provide a better
base for System open market operations.
Mr. Axilrod said the Board's staff leaned toward a negative
view of the proposal for several reasons.
First, the staff was con
cerned about the potential for public misunderstanding.
It was true
that, because of the requirement for collateral, the System would
not be enabling dealers to take a net short position in a particular
maturity area.
Because short sales would be involved, however,
misinterpretations to the effect that the System was helping dealers
"bear" the market for U.S. Government securities were likely to arise.
Secondly, questions of equity would be involved in any arrangement
that permitted dealers, but no other groups of market participants,
to make portfolio adjustments of the kind contemplated.
In his view,
-26-
equity questions did not arise in System lending to dealers to
prevent delivery failures, because of the central role of dealers
in the market mechanism, as intermediaries between buyers and sellers.
Such considerations in themselves would not necessarily be overrid
ing if there were strong offsetting advantages to the proposal, but
the Board staff was not persuaded that the advantages would be that
strong.
He did not mean to suggest that the development of better
lending facilities would not be helpful to the market; he did, how
ever, have some doubts about the necessity for the Federal Reserve to
offer the proposed facilities at this time.
Mr. Hayes asked whether it might be desirable to have a
subcommittee of the FOMC designated to review the considerations
involved.
Chairman Burns expressed the view that, since the opportu
nities for misunderstanding were so great, very clear advantages
would have to be demonstrated before the proposal was considered
seriously by the Committee.
While the proposed expansion of lend
ing might enable the market to function somewhat more smoothly, in
his judgment a decisive case in its favor had not been made.
Mr. Hayes said the argument
in favor of the proposal--that
it would contribute to a better-functioning market for Government
securities--seemed to him to have somewhat more substance than
-27-
3/18/74
those against, the most important of which appeared to be the risk of
misunderstandings of the short selling involved.
It should be possi
ble to deal with any misunderstandings on that score by demonstrat
ing that the System was not facilitating net short positions on the
part of dealers.
Mr. Black remarked that that position rested on the premisewhich was not necessarily warranted--that critics would take a
rational view of the matter.
Mr. Mayo noted that the Treasury was, of course, concerned
about the functioning of the Government securities market.
He
asked whether the Treasury was willing to lend securities from the
trust accounts for the purpose proposed.
Mr. Holmes observed that the Treasury had never been willing
to join with the System in lending securities to avoid delivery
failures, despite some favorable sentiment within the Department.
Accordingly, it was highly unlikely that the Treasury would partici
pate in lending for the present purpose.
He thought it would have
no objections to the System's doing so, however.
Mr. Morris said that if the Committee were inclined to
undertake lending operations of the type proposed--and he thought
it probably would be desirable to do so--it might be best first to
ask the Treasury for a letter expressing the view that such a course
was in the public interest.
3/18/74
-28-
In reply to a question by Mr. Mayo, Mr. Holmes
commented
that it would be necessary to give careful thought to the width of
the maturity ranges that were used in determining whether the
collateral offered was "in the same maturity area" as the securities
borrowed.
The ranges proposed by the Dealer's Association--which
were shown in one of the attachments to his memorandum--struck him
as rather broad.
Mr. Holland observed that there were two considerations,
in addition to the potential for misunderstanding, that led him to
take a negative view of the proposal.
First, there would be con
siderably more risk than in the case of lending to cover delivery
failures that the dealer would not be able to repay the loan by its
due date, so that the System would be forced either to extend the
period of the loan or sell off the collateral.
Where the problem
was a delivery failure, the dealer already owned securities identi
cal to those he borrowed, and had only to wait for the delayed
delivery to be effectuated in order to be able to repay the loan.
In borrowing for short sales, the dealer would ordinarily plan on
making repayment by buying the needed securities in the market or
by borrowing them from someone else, which was a much more uncertain
process.
As a result, the record of repayment performance would not
be nearly as clean as in the case of fails.
3/18/74
Secondly, Mr. Holland continued, while the proposal was
intended to deal with a deficiency in the market, that deficiency
was a consequence of Treasury debt management techniques.
Accord
ingly, responsibility for finding a solution lay more with the
Treasury than with the Federal Reserve.
One possibility would be
for the Treasury to offer a "maturity exchange service,"
to its present denominational exchange service.
comparable
If the maturity
exchange service were available to all holders of marketable Govern
ments, the equity problem inherent in the present proposal could be
avoided.
Mr. Eastburn asked what the consequences would be if the
Committee did not approve the Manager's proposal.
Mr. Holmes replied that they would not be serious.
The
proposed expansion of lending would improve the performance of the
market and make it easier for the System to conduct its open market
operations, but he did not view the issue as a life-or-death matter.
Mr. Mitchell said he thought Mr. Holland's suggestion for a
maturity exchange service had more merit than the proposed lending
operation as a possible means of resolving the problem, and should
be pursued with the Treasury.
He would be interested in having the
Manager's opinion of the suggestion.
Mr. Holmes expressed the view that a maturity exchange
service offered a potential solution.
It might pose a problem,
3/18/74
however, in that the market would not be sure of the size of an
issue that would be outstanding at any particular time.
Mr, Mayo said he would consider that problem to be a serious
one; if the outstanding volume of individual issues could fluctuate
from day to day, holders of those issues might feel discriminated
against and the freedom of the market could be significantly impaired.
Mr. Brimmer observed that since the summer of 1972, when the
dealer's association had first advanced the suggestion for an expansion
of System lending operations, the staff had done a great deal of work
on it.
On the basis of the memoranda that had been distributed, he
would favor turning the proposal down.
He would strongly urge that
other possibilities be pursued--including that suggested by Mr. Holland,
which struck him as promising.
However, he would not want to postpone
a decision on the particular proposal before the Committee while those
studies were being carried out.
Mr. Black remarked that he would have some difficulty in con
cluding that the proposed new lending authority was reasonably necessary
to the effective conduct of open market operations, particularly in
light of Mr. Holmes' response to Mr. Eastburn's question.
Mr. O'Connell noted that he had had the same reaction when
he heard Mr. Holmes' response to that question.
The Chairman said it appeared that the Committee did not
favor the proposed expansion of the lending authority, but that it
3/18/74
-31-
would like to have the Manager and Board staff members explore
alternative means of dealing with the problem at which the pro
posal was directed, including discussions with the Treasury.
He
asked whether there were any objections to that course, and none
was heard.
Mr. Hayes observed that in conversations with the Treasury
the staff might find greater backing for an expansion of the lending
authority than had been evidenced to date.
In that event, he assumed
it would be agreeable to the Committee for the staff to submit a new
proposal along those lines.
There was no disagreement with Mr. Hayes' suggestion.
Chairman Burns then noted that a memorandum from the Manager,
dated March 15,
1974, and entitled "Proposal to bid for Treasury
bills on a noncompetitive basis"1 / had been distributed.
He asked
Mr. Holmes to comment.
Mr. Holmes noted that in the weekly and monthly auctions
of Treasury bills it had been the Desk's practice to bid on a com
petitive basis in rolling over maturing bills held by the System
Open Market Account, Treasury investment accounts, and foreign
official accounts.
1/
In order to be reasonably sure of securing the
A copy of this report has been placed in the Committee's files.
3/18/74
-32-
desired bill,
the Desk obtained information from dealers just
before the bidding deadline regarding their likely bids.
Because
System and foreign central bank holdings of Treasury bills had
been growing relative to the total volume outstanding, the Desk
was now bidding for 50 to 60 per cent of the bills offered in an
auction, compared to about 10 or 15 per cent a few years ago, and
was encountering more problems.
As a result of the increased
volatility of interest rates, it was more common now for rate
ideas to change in the last minute or two before the auction dead
line and hence for the Desk to miss in the auction or receive only
a partial award on its bid.
In such cases, the bills inadvertently
run off had to be replaced through purchases in the market--a dif
ficult process and one potentially disruptive to System policy
objectives.
And, with the growing size of the Desk's bids, the
consequences of an unintentional miss had become more serious.
Also, Mr. Holmes observed, the dealers were dissatisfied
with the present bidding arrangements.
Not knowing the size of
official holdings of maturing bills in an auction, they did not
know the amounts available to the rest of the market.
They were
aware that misses by the System could suddenly supply the market
with a much larger volume of bills than otherwise.
And they were
reluctant to give the Desk information about their own bids
3/18/74
-33-
which was then used to outbid them in acquiring bills for foreign
official accounts.
As noted in his memorandum, Mr. Holmes continued, the
Treasury had agreed to a procedure designed to cope with those
problems.
Under the proposal, the Desk would submit bids on behalf
of official holders of maturing bills on a noncompetitive basisthat is, it would receive awards at the average price established
by the competitive bidders.
In addition, the Treasury would
announce in advance of each bill auction the total amount of
official holdings of maturing bills that would be eligible for
noncompetitive rollover.
It would be understood that, as in the
past, the Desk would not necessarily roll over its total holdings;
it would reserve the right to submit competitive bids when it
wanted to run off bills or bid "on the margin."
The procedure
would be similar to that now followed in auctions of coupon issues
in quarterly refundings, except that in the bill auctions it would
be followed for foreign official accounts as well as for System
and Treasury accounts.
In his judgment, the average price at which
the System acquired bills over time would be the same on the new
basis as it had been on the old.
In reply to questions, Mr. Holmes said that the Treasury
announcement regarding official account holdings of maturing bills
-34-
3/18/74
would disclose the total of such holdings, without breakdowns for
the three types of official holders.
At present, noncompetitive
bids were permitted only for small bids--up to $200,000--and the
aggregate volume of such bids ranged in individual auctions from
10 to 15 per cent.
Mr. Brimmer observed that about 12 years ago he had done
some research on the question of whether the average price received
by the Treasury in a securities auction tended to rise or fall when
the proportion of bidders placing competitive bids increased.
He
had not reviewed that work recently, but according to his recollec
tion it would support the position that the Government would tend
to be better off if a large participant, like the System, placed
its bids on a competitive basis.
Mr. Holmes expressed the view that allowance had to be
made for the special characteristics of the System's bids.
First,
the amount bid for never exceeded the holdings of maturing bills.
Second, the price at which the bid was submitted was based on
information regarding the probable bids of dealers.
He thought
the record would demonstrate that on the average the Desk had been
successful in its effort to bid at the market consensus; it was not
a market maker.
3/18/74
-35-
Mr. Coldwell asked whether a discontinuation of competitive
bidding by a bidder receiving roughly half of the bills auctioned
would not have an impact on the tail of the bidding.
In reply, Mr. Holmes said he thought the average price
received by the Treasury in individual auctions might be affected
to some extent, depending on the relative size of official account
holdings.
At times when the Treasury's announcement revealed that
official holdings were relatively large, other participants might
compete more intensively for the remaining supply, thereby tending
to raise the average price; when official holdings were small, the
average might be reduced.
Over time, however, the two types of
situations would balance out.
Mr. Holland noted that he had first heard of the proposal
under discussion when it was advanced by Government securities
dealers at a recent meeting with Treasury officials, in which he
had participated as a representative of the Board of Governors.
Until that time, he had not appreciated how disadvantaged the
dealers felt by their lack of information on the size of official
account holdings of maturing bills.
The dealers also observed
that they were providing the Desk with information regarding their
bidding ideas which the Desk then used for the purpose of outbidding
them in the auction.
He had the feeling that the dealers' concerns
-36-
3/18/74
were legitimate and that the proposed change in procedure was a
reasonable means for dealing with them.
Mr. Brimmer asked about the basis for Mr. Holmes' conclusion
that the new procedure would not have an appreciable effect on
average auction prices over time.
Mr. Holmes replied that that conclusion reflected his best
judgment, supported by some review of the record; it was not based
on a formal scientific analysis.
Mr. Axilrod expressed the view that a detailed analysis
would bear out the Manager's impression that the Desk's bids were
very close to the auction average, so that on balance that
average would not be significantly affected by the proposed change
in procedure.
As Mr. Holmes had noted, the Desk would retain its
present options of bidding to run off maturing holdings and of
placing supporting bids at the margin, and thus it would lose none
of its present ability to meet its reserve objectives,
Under the
present procedure, the Desk sought to insure that its bid was at or
close to the auction average by soliciting last-minute bidding infor
mation from dealers that they gave to no one else; under the proposed
procedure, it would achieve the same end by placing a noncompetitive
bid.
In effect, the objective now achieved by indirect means would
be accomplished directly.
The new procedure also would have the
3/18/74
-37-
advantage of avoiding the present risk of unintentional misses.
Finally, he thought it would be desirable for market participants
to know the size of official account holdings and, therefore, the
volume of bills available to the public in the auction.
Mr. Brimmer noted that market participants could not be
sure about the volume of bills available to the public so long as
the System reserved the option of placing a competitive bid.
Mr. Axilrod added that under the proposed procedure, as well
as under present practice, market participants would have to make a
judgment as to whether the System's reserve objectives would lead it
Thus, all the pro
to run off some or all of its maturing holdings.
posal really would do was remove the additional uncertainty for dealers
relating to the size of official account holdings.
Mr. Mitchell said he did not believe a conclusive case had
been made that the change in procedure would have no significant
effect on the prices received by the Treasury.
He would favor some
additional research on that point.
Mr. Mayo remarked that if the System did not bid competitively
it might be easier for a few dealers to dominate a particular auction.
In response, Mr. Holmes noted that the Treasury now employed
a rule of thumb under which no one dealer could be awarded more than
25 per cent of the issues offered in an auction.
That rule might be
modified to deal with the possibility Mr. Mayo had mentioned.
-38-
3/18/74
Mr. Holland expressed the view that the reduction of
uncertainty with respect to official holdings would make for a
better market.
Under the present procedure, an individual dealer
might bid to acquire a large proportion of the supply of bills
available to the public partly because he believed he could make
a better guess than the market as a whole of the size of official
holdings; under the proposed procedure, all participants would have
precise information on the matter.
And he was inclined to agree
with the dealers' view that there was an element of unfairness in
an arrangement under which the System solicited information on
bidding ideas which the dealers felt they could not withhold from
the central bank, and then used that information to the disadvantage
of the dealers.
Mr. Brimmer remarked that he did not understand how dealers
were disadvantaged if the System's objective was simply to enter
a bid close to the average.
Mr. Axilrod observed that the dealers' concern related
primarily to the use of the information in question for the purpose
of placing bids for foreign accounts.
In reply to questions by Mr. Black, Mr. Holmes said he
thought foreign central banks would have no objections to the change
in procedure.
He would, of course, inform them in advance if the
-39-
3/18/74
change were made.
On the whole, he thought the System would derive
greater benefits from the new procedure than the dealers would.
Mr. Brimmer observed that because of the late date at which
Mr. Holmes' memorandum had been distributed, he had not yet had
time to give adequate consideration to the proposal.
Accordingly,
he hoped the Committee would not dispose of it today.
Mr. Coldwell said he also would favor postponing a decision,
in order to give the staff time to develop additional information
regarding the likely effects of the proposed change on the tail of
the bidding.
Mr. Holmes observed he would be happy to have some work
done in that area.
He would hope, however, that a decision would
not be deferred unduly long.
Mr. Holland remarked that he also saw advantages in acting
on the matter reasonably promptly, and Mr. Hayes expressed similar
sentiments.
Mr. Mitchell commented that the kind of research he personally
had in mind would involve an analysis of a sample of bill auctions
over the past 3 or 4 years, and should not prove to be time-consuming.
Mr. Axilrod observed that the staff might include in its study
for selected auctions, the total size of the issue, the proportions
3/18/74
taken by the several official accounts, the nature of the bidding,
and perhaps a rough judgment as to the effect on the outcome that
the use of the proposed new procedure might have had.
Mr. MacLaury noted that the open questions related mainly
to the effect of the proposed procedure on the prices paid for the
bills auctioned, a matter that was of more direct concern to the
Treasury than to the System.
If after due consideration the Treasury
had agreed to the proposal, he wondered whether the System could
not rely on their judgment.
The Chairman remarked that there was much force in
Mr. MacLaury's observation.
At the same time, since some members
were interested in obtaining more information, he would suggest
that the matter be deferred until the next meeting.
There was general agreement with the Chairman's suggestion.
In response to a question by the Chairman, Mr. Broida
reported that the staff committee that had been designated to make
recommendations for any needed changes in the Committee's foreign
currency instruments hoped to complete its report following the
April meeting, for consideration by the Committee in May.
He sug
gested that at today's meeting the Committee might want to reaffirm
those instruments in their existing form,
3/18/74
-41-
By unanimous vote, the
Authorization for Foreign
Currency Operations shown
below was reaffirmed:
1. The Federal Open Market Committee authorizes and directs
the Federal Reserve Bank of New York, for System Open Market Account,
to the extent necessary to carry out the Committee's foreign currency
directive and express authorizations by the Committee pursuant thereto:
A. To purchase and sell the following foreign currencies
in the form of cable transfers through spot or forward transactions
on the open market at home and abroad, including transactions with
the U.S. Stabilization Fund established by Section 10 of the Gold
Reserve Act of 1934, with foreign monetary authorities, and with the
Bank for International Settlements:
Austrian schillings
Belgian francs
Canadian dollars
Danish kroner
Pounds sterling
French francs
German marks
Italian lire
Japanese yen
Mexican pesos
Netherlands guilders
Norwegian kroner
Swedish kronor
Swiss francs
B. To hold foreign currencies listed in paragraph A
above, up to the following limits:
(1) Currencies purchased spot, including currencies
purchased from the Stabilization Fund, and sold forward to the Stabili
zation Fund, up to $1 billion equivalent;
(2) Currencies purchased spot or forward, up to the
amounts necessary to fulfill other forward commitments;
(3) Additional currencies purchased spot or forward,
up to the amount necessary for System operations to exert a market
influence but not exceeding $250 million equivalent; and
3/18/74
(4) Sterling purchased on a covered or guaranteed
basis in terms of the dollar, under agreement with the Bank of England,
up to $200 million equivalent.
C. To have outstanding forward commitments undertaken
under paragraph A above to deliver foreign currencies, up to the
following limits:
(1) Commitments to deliver foreign currencies to
the Stabilization Fund, up to the limit specified in paragraph 1B(1)
above; and
(2) Other forward commitments to deliver foreign
currencies, up to $550 million equivalent.
D. To draw foreign currencies and to permit foreign
banks to draw dollars under the reciprocal currency arrangements
listed in paragraph 2 below, provided that drawings by either party
to any such arrangement shall be fully liquidated within 12 months
after any amount outstanding at that time was first drawn, unless
the Committee, because of exceptional circumstances, specifically
authorizes a delay.
2. The Federal Open Market Committee directs the Federal
Reserve Bank of New York to maintain reciprocal currency arrange
ments ("swap" arrangements) for the System Open Market Account for
periods up to a maximum of 12 months with the following foreign
banks, which are among those designated by the Board of Governors
of the Federal Reserve System under Section 214.5 of Regulation N,
Relations with Foreign Banks and Bankers, and with the approval of
the Committee to renew such arrangements on maturity:
Foreign bank
Austrian National Bank
National Bank of Belgium
Bank of Canada
National Bank of Denmark
Bank of England
Amount of
arrangement
(millions of
dollars equivalent)
250
1,000
2,000
250
2,000
-43-
3/18/74
Foreign bank
Bank of France
German Federal Bank
Bank of Italy
Bank of Japan
Bank of Mexico
Netherlands Bank
Bank of Norway
Bank of Sweden
Swiss National Bank
Bank for International Settlements:
Dollars against Swiss francs
Dollars against authorized European
currencies other than Swiss francs
Amount of
arrangement
(millions of
dollars equivalent)
2,000
2,000
3,000
2,000
180
500
250
300
1,400
600
1,250
3. Currencies to be used for liquidation of System swap
commitments may be purchased from the foreign central bank drawn
on, at the same exchange rate as that employed in the drawing to
be liquidated. Apart from any such purchases at the rate of the
drawing, all transactions in foreign currencies undertaken under
paragraph 1(A) above shall, unless otherwise expressly authorized
by the Committee, be at prevailing market rates and no attempt
shall be made to establish rates that appear to be out of line
with underlying market forces.
4. It shall be the practice to arrange with foreign central
banks for the coordination of foreign currency transactions. In
making operating arrangements with foreign central banks on System
holdings of foreign currencies, the Federal Reserve Bank of New York
shall not commit itself to maintain any specific balance, unless
authorized by the Federal Open Market Committee. Any agreements or
understandings concerning the administration of the accounts main
tained by the Federal Reserve Bank of New York with the foreign
banks designated by the Board of Governors under Section 214.5 of
Regulation N shall be referred for review and approval to the
Committee.
5. Foreign currency holdings shall be invested insofar as
practicable, considering needs for minimum working balances. Such
investments shall be in accordance with Section 14(e) of the Federal
Reserve Act.
3/18/74
-44-
6. The Subcommittee named in Section 272.4(c) of the
Committee's rules of procedure is authorized to act on behalf of
the Committee when it is necessary to enable the Federal Reserve
Bank of New York to engage in foreign currency operations before
the Committee can be consulted. All actions taken by the Sub
committee under this paragraph shall be reported promptly to the
Committee.
7. The Chairman (and in his absence the Vice Chairman of
the Committee, and in the absence of both, the Vice Chairman of the
Board of Governors) is authorized:
A. With the approval of the Committee, to enter into
any needed agreement or understanding with the Secretary of the
Treasury about the division of responsibility for foreign currency
operations between the System and the Secretary;
B. To keep the Secretary of the Treasury fully advised
concerning System foreign currency operations, and to consult with
the Secretary on such policy matters as may relate to the Secretary's
responsibilities; and
C. From time to time, to transmit appropriate reports
and information to the National Advisory Council on International
Monetary and Financial Policies.
8. Staff officers of the Committee are authorized to
transmit pertinent information on System foreign currency opera
tions to appropriate officials of the Treasury Department.
9. All Federal Reserve Banks shall participate in the
foreign currency operations for System Account in accordance with
of the Board of Governors' Statement of Procedure
paragraph 3G(1)
with Respect to Foreign Relationships of Federal Reserve Banks
dated January 1, 1944.
By unanimous vote, the
Foreign Currency Directive
shown below was reaffirmed:
1. The basic purposes of System operations in foreign
currencies are:
3/18/74
-45-
A. To help safeguard the value of the dollar in
international exchange markets;
B. To aid in making the system of international
payments more efficient;
C. To further monetary cooperation with central banks
of other countries having convertible currencies, with the Inter
national Monetary Fund, and with other international payments
institutions;
D. To help insure that market movements in exchange
rates, within the limits stated in the International Monetary Fund
Agreement or established by central bank practices, reflect the
interaction of underlying economic forces and thus serve as efficient
guides to current financial decisions, private and public; and
E. To facilitate growth in international liquidity in
accordance with the needs of an expanding world economy.
2. Unless otherwise expressly authorized by the Federal
Open Market Committee, System operations in foreign currencies
shall be undertaken only when necessary:
A. To cushion or moderate fluctuations in the flows
of international payments, if such fluctuations (1) are deemed
to reflect transitional market unsettlement or other temporary
forces and therefore are expected to be reversed in the foresee
able future; and (2) are deemed to be disequilibrating or other
wise to have potentially destabilizing effects on U.S. or foreign
official reserves or on exchange markets, for example, by occasion
ing market anxieties, undesirable speculative activity, or excessive
leads and lags in international payments;
B. To temper and smooth out abrupt changes in spot
exchange rates, and to moderate forward premiums and discounts
judged to be disequilibrating. Whenever supply or demand persists
in influencing exchange rates in one direction, System transactions
should be modified or curtailed unless upon review and reassessment
of the situation the Committee directs otherwise;
C. To aid in avoiding disorderly conditions in exchange
markets. Special factors that might make for exchange market insta
bilities include (1) responses to short-run increases in international
3/18/74
-46-
political tension, (2) differences in phasing of international
economic activity that give rise to unusually large interest rate
differentials between major markets, and (3) market rumors of a
character likely to stimulate speculative transactions. Whenever
exchange market instability threatens to produce disorderly con
ditions, System transactions may be undertaken if the Special
Manager reaches a judgment that they may help to reestablish
supply and demand balance at a level more consistent with the
prevailing flow of underlying payments.
In such cases, the
Special Manager shall consult as soon as practicable with the
Committee or, in an emergency, with the members of the Subcommittee
designated for that purpose in paragraph 6 of the Authorization for
Foreign Currency Operations; and
D. To adjust System balances within the limits
established in the Authorization for Foreign Currency Operations
in light of probable future needs for currencies.
3. System drawings under the swap arrangements are appro
priate when necessary to obtain foreign currencies for the purposes
stated in paragraph 2 above.
4. Unless otherwise expressly authorized by the Committee,
transactions in forward exchange, either outright or in conjunction
with spot transactions, may be undertaken only (i) to prevent for
ward premiums or discounts from giving rise to disequilibrating
movements of short-term funds; (ii) to minimize speculative distur
bances; (iii) to supplement existing market supplies of forward
cover, directly or indirectly, as a means of encouraging the reten
tion or accumulation of dollar holdings by private foreign holders;
(iv) to allow greater flexibility in covering System or Treasury
commitments, including commitments under swap arrangements, and
to facilitate operations of the Stabilization Fund; (v) to facilitate
the use of one currency for the settlement of System or Treasury
commitments denominated in other currencies; and (vi) to provide
cover for System holdings of foreign currencies.
By unanimous vote, the minutes
of actions taken at the meeting of
the Federal Open Market Committee
held on February 20, 1974, were
approved.
3/18/74
The memoranda of discussion for
the meetings of the Federal Open Market
Committee held on January 21-22 and
February 20, 1974, were accepted.
Before this meeting there had been distributed to the
members of the Committee a report from the Special Manager of the
System
Open Market Account on foreign exchange market conditions
and on Open Market Account and Treasury operations in foreign cur
rencies for the period February 20 through March 13, 1974, and a
supplemental report covering the period March 14 through 18, 1974.
Copies of these reports have been placed in the files of the Committee.
In supplementation of the written reports, Mr. Coombs made
the following statement:
Since the previous Committee meeting, we have
intervened in the exchange markets for a total of $155
million equivalent in marks, French francs, and Belgian
francs. The French francs were supplied from Treasury
balances; the Belgian francs from our own holdings.
Much of the intervention--$133 million--was done in
German marks, of which $9 million was supplied from
Treasury balances and the remaining $124 million
by Federal Reserve drawings on our swap line with the
German Federal Bank. Of these swap drawings, $4
million have been repaid, leaving $120 million out
standing. The 50-50 sharing of risks and losses on
drawings under the swap line with the German Federal
Bank remains in force.
The main purpose of our intervention was to
check an accelerating erosion of dollar rates across
the board. By February 22, the dollar had fallen
about 10 per cent from its January highs, market
traders had repeatedly suffered losses on their
dollar positions, and the risk of a new speculative
3/18/74
-48-
attack was mounting. We were particularly concerned
about the erroneous but recurrent market rumors that
the Federal Reserve was secretly intervening to push
down dollar rates in an effort to improve the U.S.
export trading position. Our appearance as sellers
of marks, French francs, and Belgian francs helped to
reassure the market, I think, particularly on February 27
when we conducted our largest operation so far, $100
million in a single day. Since then, dollar rates have
held steady, although they have been depressed a bit
from time to time by temporary liquidity squeezes in
the Swiss and German money markets. And last Monday
we had to contend with misinterpretations of a state
ment by the German Finance Minister which the market
erroneously viewed as a possible prelude to a new
revaluation of the mark.
At the present, on an uncovered basis European
short-term rates are running 1 to 3 percentage points
above U.S. and Euro-dollar rates. For the time being,
however, forward discounts on even the strong European
currencies are roughly compensating for these interest
rate differentials, leaving little or no interest
arbitrage margin. Nevertheless, so far as the dollar
is concerned, the situation is vulnerable; any revival
of speculation against the dollar could quickly erase
the forward discounts on such inherently strong Euro
pean currencies as the mark and the Swiss franc. And
this could quickly recreate the old, familiar vicious
circle in which speculation against the dollar opens
up an adverse interest arbitrage incentive, and that in
turn leads to more speculation against the dollar. I
think we have been helped on this score in recent
weeks not only by the stiffening of U.S. rates but
also by the fact that there has been a great deal of
anticipatory borrowing in the Euro-dollar market, at
a time when the inflows of funds to that market from
the oil-producing countries have not yet attained the
volume they will reach later on. On the basis of
information that we have been collecting from the
oil companies--and I must add that those companies
have been quite forthcoming--it now appears that the
major buildup in payments to the oil-producing countries
will occur in April. If,as expected, the bulk of those
3/18/74
-49-
funds flow to the Euro-dollar market in the form of
short-term placements, Euro-dollar rates will be
severely depressed and the whole situation with
respect to interest rate relationships will be even
more vulnerable.
I might mention two other points. At the last
BIS meeting the Bank of Italy succeeded in getting
an agreement from its Common Market partners on
credits of $l.9 billion, in addition to the $3 billion
line they have with the Federal Reserve. This is indi
cative of the continuing strong pressures on the lira;
in recent months intervention by the Bank of Italy has
been at a rate close to $1 billion per month. The
other point, which might have a considerable bearing
on the developments in the exchange markets and in the
Euro-dollar market, is the recent decision of the
British government to offer guarantees to official
holders of sterling balances. The guarantees will
not be in terms of dollars, as in the past, but in
terms of about 10 currencies weighted by their share
in British trade. I think there is a fair chance that
these guarantees, in combination with the high short
term rates available in London, will be effective in
inducing countries acquiring sterling to hold on to
that currency; if so, it could very well mean that a
large part of sterling payments for oil--the sums
involved are substantial--might remain fairly well
immobilized, thereby safeguarding the markets from
the unfortunate consequences of constant shifts of
funds in response to interest rate differentials.
Mr. Eastburn recalled that at the previous meeting he had
asked whether the Special Manager thought the Committee should
attempt to influence international interest rate differentials as
a matter of policy.
Mr. Coombs had responded in the negative,
suggesting only that the Committee keep a close watch on those
rate relationships.
the same view today.
He wondered whether the Special Manager held
3/18/74
-50-
Mr. Coombs replied that he did.
It would be especially
important to remain alert to the differentials in April, when heavy
flows of oil money to the Euro-dollar market could depress short
term Euro-dollar rates
and enlarge the differentials against
short-term rates in, say, Switzerland, Germany, Belgium, and the
Netherlands,
As he had indicated, he was particularly worried
about the possibility that the effects on arbitrage incentives
would be magnified by speculative flows, which could eliminate
the existing forward discounts on strong European currencies and
perhaps convert them to premiums.
many times in the past.
That kind of pattern had developed
Foreign exchange operations could prove
helpful in forestalling its development now, insofar as they helped
to prevent speculative flows from gaining strength.
In his opinion,
however, the most useful single step would be a strong official
expression of the view that it was necessary to avoid an external
depreciation of the dollar--barring some change in the fundamentalsbecause of the consequences it would have for domestic inflation.
The German Finance Minister had made such a statement with respect
to the mark a few days ago.
Chairman Burns asked about the force such a statement would
carry and the nature of the commitment it might imply.
3/18/74
-51-
Mr. Coombs responded that a statement along those lines
could be quite helpful to market psychology.
In particular, an
indication that the U.S. Government was determined to defend the
dollar at current exchange rates for the purpose of avoiding the
inflationary consequences of depreciation could provide a highly
useful counterforce to the market's present belief that the Germans
were determined to prevent the mark from going down.
The commit
ment implied by the statement would depend on its specific phrasing,
which would, of course, have to be considered carefully.
In reply to a further question by the Chairman, Mr. Coombs
said that any further rise in domestic U.S. interest rates would
tend to ameliorate the external problem of the dollar, which
threatened to become increasingly difficult.
Conversely, a slippage
in U.S. interest rates could greatly complicate the problem.
Mr. Brimmer asked whether the heavy oil payments anticipated
for April were likely to occur in the first or second half of the
month.
That question might be relevant to the policy decisions the
Committee took today, since its next meeting was tentatively scheduled
for mid-April.
Mr. Coombs replied that the figures he was getting from oil
companies did not provide information on intra-monthly payments.
He
might note, however, that in terms of monthly totals the increase in
-52-
3/18/74
oil payments from March to April was expected to be substantial.
For the five largest U.S. oil companies alone, dollar payments
were scheduled to more than double--from $1.3 billion in March to
$2.8 billion in April.
On a worldwide basis, dollar payments were
expected to rise from $3.3 billion to $6.5 billion.
Sterling pay
ments also would increase substantially, by the equivalent of
several billion dollars.
In response to questions by Chairman Burns, Mr. Coombs
said he expected European interest rates to remain high; he had
seen no evidence whatsoever of official intentions to bring them
down.
As he understood it, the European monetary authorities were
maintaining tight monetary policies primarily to counter inflation.
Countries such as Britain that were experiencing large balance of
payments deficits also were naturally interested in attracting Arab
oil money by direct or indirect means.
That, however, would not
be damaging to the position of the dollar;
the risk that concerned
him was of flows of oil money to countries in strong balance of
payments positions.
He had no reason to believe that the monetary
policies of the latter countries were being influenced by the
desire to attract oil money.
Mr. Holland referred to the Special Manager's comments
regarding forward discounts and premiums.
He asked whether
-53-
3/18/74
Mr. Coombs thought that Federal Reserve operations in the forward
market might be more useful than a corresponding volume of spot
market operations in forestalling undesirable speculative flows,
In reply, Mr. Coombs remarked that he had not been thinking
in terms of forward operations; he thought the spot market would be
the main area of concern.
In his view, the System should be prepared
to intervene in that market, perhaps forcefully, if the situation
appeared to call for it.
Mr. Wallich asked whether Mr. Coombs, in his comments on a
possible depreciation of the dollar, was thinking primarily in terms
of the exchange rate for the dollar against the German mark or
against all foreign currencies taken together.
Mr. Coombs observed that certain currencies, such as the
mark and the Swiss franc, tended to act as bellwethers; if the
dollar were to encounter difficulties, it was likely that the
signs would appear first in the markets for those currencies and
then would spread to others.
By unanimous vote, the System
open market transactions in foreign
currencies during the period February 20
through March 18, 1974, were approved,
ratified and confirmed.
Mr. Coombs noted that two System swap drawings on the
National Bank of Belgium, totaling $31.8 million, would mature
3/18/74
-54-
for the eleventh time on April 18 and 25, respectively.
Since the
swap line had been in continuous use for more than a year, specific
authorization by the Committee was required for their renewal.
The
Treasury's negotiations with the Belgians concerning the terms of
repayment of the swap drawings were still uncompleted, and he saw
no alternative to renewing the drawings at maturity.
He might
note that the System had paid as much in interest on the drawings
as the Treasury had hoped to save through the negotiations.
By unanimous vote, renewal for
further periods of 3 months of System
drawings on the National Bank of Belgium
maturing on April 18 and 25, 1974, was
authorized.
Mr. Coombs then reported that, following advance notice by
telephone last Friday, the New York Bank today had received a
formal request from the Bank of England for an increase in their
swap line with the System from $2 billion to $3 billion.
members knew, there had been extensive discussions
As the
in the press
and elsewhere of the difficulties facing the British, and it was
clear that their needs for additional financing were real.
In his
judgment, the British might be considered somewhat more creditworthy
than certain other central banks in the System's swap network, for
two reasons.
The first was a factor he had mentioned earlier--the
likelihood that funds accruing to oil-producing countries in the
3/18/74
-55-
form of sterling would be kept in London.
That would provide a
source of credit, and perhaps a fairly stable one.
was a longer-run factor:
The second
the North Sea oil resources now
under development were expected to begin having significant
effects on Britain's external position by 1980.
The British were
attempting to put together a combination of short-, medium-, and
long-term financing that would carry them through the intervening
period.
Mr. Coombs added that if the Committee approved the proposed
swap line increase, the British would like to have it made effective
and announced in about a week, when their new budget would be pub
lished.
In connection with the statement on the budget, they
expected to disclose their complete financing plan, covering the
period until about 1980; and they would like to include information
on the swap line increase in the more general announcement.
Mr. Brimmer said he assumed the British did not want to
increase the swap line solely for the sake of the psychological
effect of the announcement.
On a visit to the Bank of England in
January, he had received the impression that they might be interested
in drawing on the line.
He asked whether the Special Manager had
reason to believe they might want to draw now.
3/18/74
,56-
Mr. Coombs replied that in the preliminary discussions
the British authorities had asked about the possibilities of drawings.
After consulting with Chairman Burns, he had advised them that
drawings of moderate size--measured in hundreds of millions of
dollars rather than billions--would be agreeable, on the under
standing that the Bank of England would bear the full risk of
exchange rate fluctuations; i.e., that they would repay the same
number of dollars they had borrowed.
As usual for such drawings,
the interest rate would be equal to the U.S. Treasury bill rate.
Mr. Brimmer asked whether it would be correct to view the
proposed increase in the swap line essentially as an increase in
British reserves that would enable them to avoid borrowing from the
International Monetary Fund or other sources where discipline would
be applied; and whether it would mean, in effect, that the Federal
Reserve would finance a good part of the deficit of the United Kingdom
for the next several years.
Mr. Coombs replied that he would not be inclined to interpret
the proposal in that way.
He thought the British would be negotiat
ing with the IMF for a standby credit facility that would provide
a means for repaying any short-term debts they might incur.
The
main advantage of the swap line, from their point of view, was that
3/18/74
-57-
it provided a means for raising amounts on the order of $200 million
or $300 million on very short notice, when needed to deal with
exchange market problems that might arise from one day to the next.
In his judgment, the British had demonstrated during the 1960's
that they would take advantage of all reasonable opportunities to
pay down swap debts to the System by means of drawings on the IMF.
Mr. Brimmer said it was also the case in the 1960's that
the System had been unwilling to extend credits to the British
unless there were arrangements to insure that they would not run
on for long periods.
He personally would not want the System to
get into a position now which led to its financing long-term credits
to the British.
Mr. Mitchell remarked that he shared Mr. Brimmer's concern.
The North Sea oil development program might make the British credit
worthy over the longer run, but he would not like to have the Federal
Reserve wait until 1980 for repayment of any drawings made now.
Before the System agreed to permit the British to draw on the swap
line, he would want to reach highly specific understandings with
them that the drawings would be repaid within a reasonable period.
Mr. Coombs agreed.
In the event that either the British
or the Italians proposed to draw on the swap lines, he thought the
System should raise questions on such matters as the backstop
3/18/74
-58-
facilities available to them, the order in which they proposed to
repay various creditors by drawings on standby facilities in the
Fund, the plans they might have for raising medium-term funds in
the Euro-dollar market, and so forth.
In referring to the North
Sea oil program he had not meant to suggest that the System might
have
to wait until 1980 for repayment, but only that the British
were relying on that program to provide means for repaying any
medium-term debt they might incur.
In the interim, however, they
might have need from time to time for immediately available funds,
in order to cope with speculative flows.
Mr. Coombs added that the British--and, incidentally, the
French also--appeared to have better opportunities for raising
medium-term money than the Italians did.
The Italian balance of
payments deficit was deeper and there was less light at the end
of the tunnel for them.
Chairman Burns asked Mr. Bryant for his views regarding
the proposed increase in the swap line with the Bank of England.
Mr. Bryant said he agreed with Mr. Coombs that the dif
ficulties facing the United Kindgom this year were somewhat less
marked than those facing Italy.
culties could well be serious.
Nevertheless, Britain's diffi
For that reason, he would
feel more comfortable about the proposed increase if more
3/18/74
information were available about British policy, particularly
with respect to their plans for medium-term borrowing.
1/
paper assessing the economic situation in Britain
A staff
had recently
been distributed to the Committee, but it contained little informa
tion about medium-term borrowing prospects.
He understood, however,
that pursuit of those questions might be inconsistent with the need
for an early response to the Bank of England.
Mr. Coombs observed that the increase that had been proposed
in the swap line would imply no commitment with respect to the terms
on which drawings might be made.
One possibility that might be
pursued in subsequent negotiations would be for the British to
make pro rata drawings on the Federal Reserve and on Common Market
central banks.
As he had mentioned earlier, the Italians had just
arranged for credits from those central banks totaling nearly $2 billion.
Mr. Wallich remarked that the proposal to increase the
British swap line with the System, like the scheme recently advanced
by the IMF, was characteristic of a general tendency
to employ
short-term means for financing payments deficits arising out of
the oil situation.
It was possible to go along with such proposals,
1/ A copy of this memorandum, dated March 1, 1974, and entitled
"The Economic Situation in the United Kingdom," has been placed in
the Committee's files.
3/18/74
since up to a point the tendency to rely initially on short-term
means for financing medium- or long-term needs was understandable.
It was clear, however, that short-term credits were basically
inappropriate for dealing with the oil problem--unless, of course,
one expected some substantial change such as a large decline in
oil prices.
For some countries, the only ultimate solution might
be a change in exchange rates.
In any case, when short-term
credit facilities were employed, it was important to place them
in the context of some more general financing scheme.
Mr. Hayes said he did not disagree with Mr. Wallich's
observations.
He would like to stress, however, that the main
gain from swap line increases in the past had often taken the form
of a favorable psychological effect from the announcement of the
increase; time and again, such announcements had been effective
preventive measures against the kind of speculation that created
major problems.
If the proper timing were to be achieved, however,
it was not always possible to reach firm advance understandings
about the size of any drawings and about specific means for financ
ing repayments.
While he agreed that any actual drawings by the
Bank of England should be based on clear understandings regarding
repayments, he thought an increase in the British line now, like
3/18/74
the recent increase in the Italian line, would be a constructive
step.
Mr. Holland said he thought all members of the Committee
would agree that the swap lines were not an appropriate means for
permanent financing of deficits created by the oil situation.
They
might also agree, however, that the potential for large swings in
short-term capital flows had been heightened by various circumstances
relating to actual and prospective oil payments, and that the London
money market was among those most likely to be affected by such swings.
In his judgment, an increase in the System's swap line with the Bank
of England would be warranted as providing better facilities for
coping with such swings, which might be marked to some extent by
speculative overtones.
However, he would favor holding discussions
with the British for the purpose of making it clear that the swap
line was intended for use only in dealing with short-run problems,
and that they were expected to use other means for financing longer
term needs.
Mr. Holland asked Messrs. Coombs and Bryant whether they
concurred in his comment.
Mr. Coombs said he did.
He added that he thought Mr. Holland's
reasoning was wholly consistent with the views of the Bank of England.
-62-
3/18/74
It would, of course, take some time for them to work out the needed
arrangements for longer-term financing.
Mr. Bryant said he also concurred.
that he still had some residual concerns.
He might note, however,
For one thing, an increase
in the size of the British swap line, as in the case of the recent
increase in the Italian line, was likely to create a presumption
that the line was available for use.
For another, it was quite
difficult in practice to distinguish between short- and long-term
flows; a capital flow this week that appeared to be of a short-term
nature might well prove nine months hence to require long-term
financing.
Mr. Hayes remarked that that risk had always been present
in drawings under the System's swap network.
Nevertheless, over
the years the record indicated that most drawings had been repaid
within an acceptable period, either as a result of a reversal of
the underlying flows or by being funded.
Chairman Burns observed that the Federal Reserve itself
had been mainly responsible for drawings that proved to be long
term in nature.
Mr. Brimmer agreed, noting that the System's current debt
to the National Bank of Belgium was a case in point.
He thought
however, that there was a qualitative difference in the present
3/18/74
-63-
case, in that it was known in advance that the British needed
medium- or long-term funds.
He would see nothing objectionable
in the extension of long-term credits to the British by the U.S.
Government.
However, he would consider it improper for the Open
Market Committee to decide on its own to extend credit to another
central bank when that credit was being sought on behalf of a
government that needed long-term financing.
The problem would be
resolved in his own mind if the U.S. Treasury were prepared to take
over the debt at some point.
In that connection, he asked whether
the Treasury had expressed a view on the proposed swap line increase.
Chairman Burns said he had not yet discussed the matter
with Treasury officials.
However, he was confident that they would
strongly approve the proposal.
His confidence was based partly on
a thorough-going discussion he had held with the Secretary of the
Treasury before the enlargement of the Italian swap line had
been approved.
The Secretary of State also had been consulted at
that time with respect to the general policy; as the members would
recall, it had been decided to include a statement in the press
announcement of the enlargement of the Italian swap line to the
effect that "the Federal Reserve will consider possible increases
in its other swap lines, as needed."
Various considerations argued
strongly for the proposed increase in the British swap line--
3/18/74
-64-
particularly at present, when there was a new Government in Britain
that was beset with difficulties and faced with many uncertainties.
At the same time, the Chairman continued, he agreed entirely
with Mr. Brimmer that the System should not undertake to extend
long-term credits to the British.
When the Italian swap line had
been enlarged the Committee had agreed that it should be made clear
to the Italians that any drawings would be for 3-month terms, and
that if the drawings were renewed it would be on the understanding
that full repayment would be made by the end of a year.
He thought
a similar explicit understanding should be reached with the British.
In
both cases, of course, there would remain some possibility that
the debts would run on for more than a year.
Nevertheless, the
System should remind all of its swap partners as the need arose
that they were expected to use avenues other than the swap network
for permanent financing.
It could also offer to help the central
banks involved to arrange for permanent financing, through the IMF
or other sources.
Mr. Wallich observed that it was useful to bear in mind
that in the bargaining process now under way with oil-producing
countries, the consuming countries would tend to weaken their
bargaining positions if they rushed to finance high-priced oil
imports by any available means, however inappropriate; in effect,
3/18-19/74
-65-
they would appear to be validating the present level of oil prices.
He was not suggesting that the consuming countries should incur
the risks that would be involved in demonstrating an inability to pay
for oil imports unless prices were reduced.
Nevertheless, an
indication of somewhat less than full readiness to employ short
term facilities for financing oil imports would be desirable.
Chairman Burns concurred in Mr. Wallich's comment, adding
that the United States was moving slowly with respect to the IMF
scheme for just that reason.
The Chairman then said he would determine the Treasury's
attitude with respect to the proposed increase in the swap line
with the Bank of England.
Assuming the Treasury was favorably
inclined, he asked whether the members would be agreeable to the
increase.
No views to the contrary were expressed.
Thereupon the meeting recessed until 9:30 a.m. the follow
ing morning, Tuesday, March 19, 1974.
the same as on Monday afternoon.
Committee attendance was
Staff attendance was the same as
on Monday except that the following also were present:
Messrs. Gramley, Pierce, and Reynolds,
Associate Economists
3/19/74
-66-
Mr. Melnicoff, Managing Director for
Operations and Supervision, Board
of Governors
Messrs. Eisenmenger, Taylor, and
Andersen, Senior Vice Presidents,
Federal Reserve Banks of Boston,
Atlanta, and St. Louis, respectively
Mr. Kareken, Economic Adviser, Federal
Reserve Bank of Minneapolis
Chairman Burns observed that he had discussed the proposed
enlargement of the System's swap line with the Secretary of the
Treasury last evening, and the latter had consulted about the
matter with the Secretary of State.
Both officials were favorably
inclined toward the action.
Mr. Coombs said he understood that the Bank of England
would like to have the increase made effective as of Monday,
March 26.
By unanimous vote, the
Committee authorized an increase
from $2 billion to $3 billion in
the System's swap line with the
Bank of England, and the corres
ponding amendment to paragraph 2
of the Authorization for Foreign
Currency Operations, effective
March 26, 1974.
Secretary's Note: Prior to this meeting notes by
Governor Wallich summarizing developments at the
March Basle meeting were distributed to the Committee.
A copy of these notes is appended to this memorandum
as Attachment B.
-67-
3/19/74
Chairman Burns then called for the staff report on the
domestic economic and financial situation, supplementing 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. Partee made the following statement:
The economic news of the past month, on balance,
has been on the encouraging side. To be sure, over
all activity has continued to decline, with industrial
production off another 0.6 per cent last month, retail
sales soft--especially in real terms--and new car
sales down further to their lowest point thus far.
But manufacturers' new orders rebounded in January,
and the decline reported earlier for January in non
farm employment was revised upward, with an appre
ciable rise in nonmanufacturing jobs reported for
February. Moreover, there was fresh survey evidence
that business plant and equipment spending plans con
tinue strong, and the February upturn in housing
starts, though probably temporary, serves as a har
binger of the possibilities for recovery in this
sector as the year progresses.
Our economic projection, as presented in the green
book,1/ shows a little deeper decline than before in
real GNP over the first half, reflecting mainly the
apparent softness in consumer spending. But second
half prospects appear to be a little stronger than
before, and the projection for the year as a whole
is little changed. Basically, the evidence continues,
in our view, to support the expectation that weakness
is not likely to spread importantly beyond the
industries most directly affected by the fuel short
age, and that recovery later in the year will be
supported by some upturn in housing, a significant
1/ The report, "Current Economic and Financial Conditions," prepared
for the Committee by the Board's staff.
3/19/74
-68-
increase in domestic small car output and sales, and
continued expansion in business fixed investment.
Our GNP projection, as you know, had assumed a
continuing oil embargo and a consequent shortfall in
oil supplies throughout 1974. This assumption now
is incorrect, since an ending of the embargo for at
least a limited period was announced yesterday. We
have been working on the implications for the economy
of an improvement in oil supply, assuming further that
there will be some increase in the flow of Arab oil
but that imported oil prices will remain high. Our
conclusions are still quite preliminary, since the
supply and real income effects of this new development
are diverse and partly offsetting, but I have asked
Mr. Gramley to discuss briefly our initial estimates
with you today.
Mr. Gramley made the following statement:
At the outset I want to emphasize what Mr. Partee
has just said--that my remarks represent very preliminary
staff judgments on the probable effects of the lift
ing of the embargo. Let me begin by listing the
assumptions underlying the exercise.
First, we assume no change in the posted price of
Arabian oil over the remainder of this year. As you
know, a freeze on the posted price for the 3 months
beginning April 1 has already been announced.
Second, we assume a moderate recovery in Arabian oil
production--one that would not put much downward pres
sure on the market price of imported crude over the
remainder of this year. Any increase in world supply
of oil would obviously act as a depressing force on
market prices. But we believe that there would also
be a substantial rise in U.S. demands for oil if
restrictions on sale and use of gasoline, heating
fuel, and other petroleum products were lifted.
Higher prices for petroleum since last fall have
fostered economies in the use of this energy source.
But price elasticities of demand are relatively low
in the short run, and we believe that, at the present
price of imported crude, imports might rise by up to
2 million barrels per day if supplies became readily
available.
3/19/74
-69-
Third, we assume that 80 per cent of the increase
in domestic expenditures for gas and oil would take
place in the consumer sector, and would in the main
represent a rise in the consumption of gasoline for
passenger car use. The remaining 20 per cent would
reflect a rise in industrial uses of gasoline and
other petroleum products.
Our preliminary staff judgments on the probable
effects of an ending of the embargo, in terms of the
changes we would make in the current green book pro
jection, are set forth in the two-page table 1/ that
you have before you. As shown at the top of the first
page, we would add an additional half million units
to our projection of domestic-type auto sales. A
pickup in auto sales compared with our earlier pro
jection could begin rather promptly, we think, probably
in the second quarter. We would also look for a stronger
rebound in residential construction over the remainder
of 1974, and a somewhat higher rate of business fixed
investment in the second half.
The crucial issue, however, will be the willingness
of consumers to maintain their spending on goods and
services other than gas and oil in the face of a large
increase in their outlays for petroleum products. Our
assumption in this regard is perhaps best illustrated
by what happens to the personal saving rate. In our
green book projection, the saving rate over the next
three quarters was projected to be in the range of
6-1/2 to 7 per cent.
In the alternative, the saving
rate is projected to be about a full percentage point
lower. This is quite an optimistic assumption about
how consumers might respond to the increased avail
ability of gas and oil. Even so, as the data on the
next page show, the result would still be to encourage
only a relatively moderate improvement in over-all
economic activity.
Thus, the growth rate of real GNP in the third
and fourth quarters might rise to about 3-3/4 per cent,
instead of the 2.7 per cent average rate for the two
1/ A copy of the table referred to is appended to this memorandum
as Attachment C.
-70-
3/19/74
quarters projected in the current green book. By the
fourth quarter, the unemployment rate might be around
5.8 per cent, instead of the 6.2 per cent in our cur
rent projection. This may seem, at first blush, a
rather weak economic response to a major change in
energy supplies. We believe, however, that there are
reasons for expecting only a moderate response if the
price of imported crude stays at about its current
level of $10 a barrel.
Increased imports of 2 million barrels of oil per
day at current prices would raise the average price of
domestic and imported crude by about 7 per cent, and
would increase the retail price of gasoline by 1 to 2
cents per gallon.
As shown in the table, we estimate
that the fixed-weight price index for private product
would increase in the second half by 3 to 5 tenths
more, at annual rates, than we had projected in the
green book. This is not an alarming increase. But
the implications for consumer budgets of a 2 million
barrel per day rise in imports at today's prices are
disturbing.
If the increase in domestic expenditures for
petroleum products were distributed by sectors as we
have assumed--with 80 per cent in the consumer sectorconsumer expenditures for fuels would rise by something
like $12 billion at annual rates. About half of this
amount would go for imports; about one-fourth would go
for increased excise taxes; and a good part of the
remainder would take the form of higher corporate
profits in the petroleum industry. Only a small por
tion would end up as increased wage and salary payments
in petroleum refining and distribution, and so the
secondary effects on employment, income,and consump
tion in other sectors would be quite small. The rise
in imports would thus act like an increased tax on
consumers--a tax imposed at a time when consumer
markets are already weak.
The outcome would, of course, be more favorable
if the increase in Arabian oil supplies were large
enough to depress world oil prices, and even more so
if posted prices of Arabian crude were lowered.
But
unless such developments occur, the improvement in
economic activity we can realistically expect with the
-71-
3/19/74
ending of the embargo will leave us short of full
recovery from the effects on activity that imposition
of the embargo has brought since last fall. In this
connection, I would remind you that staff projections
before the oil crisis developed were for a slowing of
real growth this year. The oil crisis has altered the
profile of cyclical developments in 1974, but the
effects of inflation on the real income of urban
workers, and the prospects for a significant slowing
in the pace of business inventory accumulation, are
still likely to limit the rate of growth over the
remainder of the year.
Mr. Winn said he would like to get the staff's reactions to
the likelihood of a scenario somewhat different from the one they
had presented today.
Suppose that there were price increases as a
result of the removal of controls; that rapidly spreading labor unrest,
such as was reflected in the recent strikes by San Francisco municipal
employees, led to an acceleration of increases in wages and costs; that
the changes in prices and costs produced economic distortions which in
turn resulted in some modifications in expectations; and, in the inter
national area, that the cost of imports rose as a result of a depre
ciating dollar.
Under such conditions he wondered whether the more
rapid inflation and greater economic distortions might not lead to
greater strength in the second and third quarters than the staff had
projected, and then to a rather sharp curtailment of activity in the
fourth quarter.
Mr. Partee replied that, in his view, most of the factors
that Mr. Winn had mentioned would be likely to have a depressing
-72-
3/19/74
effect on economic activity in the short run.
case in point.
Labor unrest was a
He might note that the staff had not allowed
for any unusual incidence of work stoppage in its projections,
partly because the contract negotiations in the aluminum industry,
which usually set the pattern for other bargaining agree
ments, had been concluded successfully.
While labor discontent,
which certainly was widespread, was likely to result in demands for
larger wage increases and thus add to upward pressure on prices,
those effects might be offset to some extent by weakness in commodity
prices; futures prices in both domestic and international agricultural
commodity markets had been declining for the past 3 weeks.
The staff
projections might not have made enough allowance for lower commodity
prices, which would, of course, reduce desired rates of inventory
accumulation.
Mr. Partee said he agreed that there were a great many
uncertainties in the outlook.
In the staff's judgment, however,
the ending of the oil embargo would have only a modest stimulative
effect on the economy because of the income redistribution effects
Mr. Gramley had mentioned.
In 1973, growth in economic activity
had been held down by a large-scale transfer of income from urban
workers to farmers.
Farm income was not likely to increase so
rapidly in 1974, although it was expected to remain high.
However,
-73-
3/19/74
the rising share of income accruing to the oil industry was likely
to have a similar effect, since the recipients probably had a lower
than-average marginal propensity to spend.
Thus, while the ending
of the embargo would no doubt result in a pick-up in new car sales and
improvement in the housing market, on balance it was not expected
to produce a substantial gain in economic activity.
Mr. MacLaury noted that Mr. Gramley had described the
lower personal saving rate incorporated in the revised projection
as an optimistic assumption.
He (Mr. MacLaury) inferred that,
Mr. Gramley thought consumers might be induced by the prevailing
uncertainties to try to maintain higher levels of savings, rather
than reducing savings in the effort to maintain expenditures on
goods and services other than oil products.
Mr. Gramley said that Mr. MacLaury's inference was correct.
While the increased availability of petroleum products at current
high price levels would probably result in some reduction in the
personal saving rate, it was possible that consumers might curtail
other expenditures more and savings less than the projections
allowed for.
Mr. MacLaury then asked if the staff had any new thoughts
on the possible effects that sustained high prices of oil might
have on demands in other developed countries and therefore on
U.S. net exports.
3/19/74
-74-
In response, Mr. Bryant said there was no significant
difference between the staff's current assessment of the situation
and that made a month ago.
Some participants in recent European meet
ings, however, appeared to have shifted their concern a bit away from
the contractionary effects of the oil situation on real activity to its
inflationary impacts on prices. Thus far, data on U.S. exports suggested
no diminution in foreign demand; exports had been very high in January.
Mr. Partee commented that one important effect of the
termination of the oil embargo was to add the United States to the
list of countries which would have a balance of payments deficit.
If oil prices remained at current levels, the increment in payments
for oil imports would be very large.
The Chairman said it was worth noting that the major impact
of the oil embargo had been on the United States; supplies of oil
and gasoline in other developed countries recently had been ample.
In both Europe and Japan, inventories had risen to comfortable
levels and the conservation measures that had been adopted earlier
had now been almost entirely eliminated.
The major question con
cerned the degree to which existing conservation measures in the
United States would be retained, now that the embargo had been
lifted.
He would hazard the guess that efforts to conserve fuels
would continue, but on a reduced scale.
3/19/74
Mr. Hayes observed that the Board staff's appraisal of the
economic outlook was quite similar to that developed at the Federal
Reserve Bank of New York.
There was, however, some difference with
respect to the outlook for automobile sales.
The green book indi
cated that sales would decline to an annual rate of 7-1/4 million
units in the second quarter from 7-1/2 million units in the first
quarter.
Had it been the view of the Board staff that shortages
of small cars and concern about the availability of gasoline would
cut more deeply into auto sales in the second quarter than in the
first?
He would have been somewhat more optimistic about second
quarter sales even if the embargo had continued.
In response, Mr. Partee noted that seasonally adjusted auto
sales had drifted down over the course of the first quarter.
The
green book projection had been based on the assumption that
sales would be maintained in the second quarter at roughly the
average levels reached in February and early March.
Surprisingly,
the data suggested that the decline in sales in January and February
had been in small cars--at least if the seasonal adjustments were
accurate.
Although that development had appeared temporary, it had
seemed likely that total new car sales would be poor if the embargo
continued.
As Mr. Gramley had noted, the projected rate of sales
had been increased by a half million units to allow for the lifting
-76-
3/19/74
of the embargo.
Because production of small cars was already
running at capacity levels, the increase in sales would necessarily
be accounted for mainly by large cars.
Mr. Hayes then asked about the interest rate assumptions
underlying the staff projection of a recovery in housing
starts.
Mr. Partee replied that, although the staff had not worked
out detailed projections of interest rate relationships, it had
assumed that mortgage credit would be reasonably available.
Because
the demand for mortgage credit was relatively low at present, it
would not be necessary for inflows to thrift institutions to be on
the scale reached in 1972 and 1973, when a record level of housing
activity had been financed.
While it was anticipated that mortgage
rates would drift downward over the first half of 1974, the avail
ability of mortgage credit might be reflected somewhat more in a
liberalization of non-rate terms than in declining rates.
Mr. Hayes asked whether the assumption of a downdrift in
mortgage rates was consistent with the recent updrift in short-term
rates.
Mr. Partee agreed that that assumption would have to be
reviewed carefully in view of recent developments in short-term
credit markets.
-77-
3/19/74
In conclusion, Mr. Hayes asked whether the staff would agree
that the official estimate of a $9.4 billion Federal budget deficit
in fiscal 1975 was optimistic.
Mr. Partee replied that, while he had no firm evidence on
the point, he thought the risk was that expenditures in fiscal 1975
would exceed rather than fall short of the level projected in the
budget.
In reply to a question by Mr. Brimmer, Mr. Gramley said the
assumption regarding the growth rate of money was the same in the
revised projection presented today as in the original green book
projection.
Mr. Brimmer then noted that revised projections had been
presented for real GNP but not for nominal GNP.
The latter were
of interest because upward revisions would imply an increase in the
transactions demand for money, which in turn would have consequences
for interest rates.
In response, Mr. Gramley said it was assumed in the revised
projection that the increase in interest rates during the latter half
of 1974 would be shifted up somewhat by the larger rise now expected
in nominal GNP and thus in the transactions demand for money, but that
the principal effects, in terms of restraint on economic activity, would
not be felt until some time in 1975.
He added that in developing
-78-
3/19/74
the projections to be presented at the next FOMC meeting the staff
would work through the implications of increased transactions demands
more carefully than had been possible in today's projections.
Mr. Coldwell expressed surprise at Mr. Partee's comments
about softness in consumer spending.
The staff of the Federal
Reserve Bank of Dallas had just completed a rather large survey of
retailers in the Eleventh District, covering sales of durable and
nondurable goods and services.
The retailers surveyed were quite
optimistic, although sales were off slightly in real terms and
shifts in buying patterns indicated cost consciousness on the part
of consumers. -For example, consumers had adapted to beef short
ages by buying less, and they had not returned to their earlier
scale of purchases even when beef had become more readily available.
However, retailers had managed to keep their inventories at rea
sonable levels; their main concern was that they had run down
stocks they had acquired earlier at lower prices than they now had
to pay.
On the whole, given the optimism of survey respondents,
ne wondered whether it was not a mistake to regard the recent
behavior of retail sales as disappointing.
Mr. Partee noted that the tone of the remarks on retail
sales in the Dallas Bank's contribution to the red book 1/ differed
1/ The report, "Current Economic Comment by District," prepared
for the Committee by the staff.
-79-
3/19/74
from that in most other District reports which included comments
on such sales, suggesting that the situation in the Eleventh
District was not typical of the nation as a whole.
His own obser
vations had been based on national data which indicated an irregular
downward movement in retail sales in real terms since April 1973.
Over recent months total retail sales exclusive of automobile sales,
which had been notably weak, had about leveled off; they had drifted
up a little in nominal terms and perhaps drifted down a little in
real terms.
In relation to previous cyclical experience, such
behavior represented softness in the consumer sector.
Mr. Coldwell remarked that the developments Mr. Partee had
described could be regarded as a relatively good performance, in
light of the uncertainties faced by consumers over the past 9
months.
Mr. Hayes commented that, excluding automobiles, the down
trend in the physical volume of retail sales had been only slight.
The Chairman observed that the heavy indebtedness of
American households was an important factor in the downtrend in the
physical volume of retail sales since last spring.
Currently, one
out of every six dollars of disposable personal income was used
for repayment of instalment debt.
on consumer buying power.
That represented a sizable drain
Purchases of "big ticket" items in
3/19/74
general, not only autos but also mobile homes and appliances, had
been weak.
The slackness of demand for conventional new homes
might also be cited.
Consumer debt had risen rapidly in late 1972
and in 1973, and delinquency rates also had increased sharply.
The
economy appeared to be suffering from an over-extension of consumer
credit, along with credit generally.
Mr. Coldwell then observed that Elventh District builders
found themselves with a growing inventory of unsold homes because
of buyer resistance to high prices.
Although financing costs also
were fairly high, mortgage credit was available.
However, down
payment requirements appeared to be a major constraint on sales.
He asked whether the staff believed that that situation prevailed
nationally.
Mr. Partee responded that, for the nation as a whole,
inventories of unsold single family homes held by merchant builders
still represented almost a year's supply--an historically high
ratio.
There appeared to be several contributing factors, of which
one certainly was the sharp increase in home prices over the last
year or two.
Uncertainty about fuel supplies probably also had
been an important factor in recent months.
A third factor was credit
terms--including down-payment ratios and standards of creditworthiness,
as well as rates--which evidently had become more restrictive since the
3/19/74
-81-
summer of 1973.
If growing competition for mortgages were to
induce lenders to relax non-rate credit terms, that should help
home sales.
Mr. Balles noted that while the revised projection contained
good news
with respect to the rate of increase in real output and
the level of unemployment, it also contained some bad news in the
form of a higher estimate for the rate of increase in the GNP
deflator.
He wondered whether the staff shared his concern that
a wage explosion might follow the price and profits explosions that
had already occurred.
San Francisco municipal
Perhaps he was too much influenced by the
strikes to which Mr.
Winn had referred;
by virtually shutting the city down last week, the municipal workers
had achieved some large wage gains.
The increase in basic pay was
about 6 per cent; including special supplemental increases, fringe
benefits, and the effects of numerous prospective job reclassifi
cations, the over-all increase might approach 10 per cent. He asked
about the staff's assumptions with respect to potential wage
increases in 1974 and their impact on costs and prices.
Mr. Partee replied that for some time the staff's 1974
projection had incorporated about an 8 per cent increase in com
pensation rates, somewhat higher than the 1973 rate.
Furthermore,
-82-
3/19/74
it was expected that slowing productivity gains would result in
a large advance in unit labor costs.
Mr. Partee went on to note that the rate of increase in
the index of average hourly earnings had shown a distinct modera
tion over the past 5 months.
He found the slowdown inexplicable,
and he certainly anticipated that it would be reversed soon; as the
year progressed, he expected demands for higher wages to be strong
and urgent.
Thus far this year, contract negotiations in the basic
industries had been settled quickly, with fairly moderate wage
increases accompanied by full cost-of-living protection through
escalator clauses.
If, as he expected, that pattern continued,
actual wage increases would be determined more by the future
rate of price advance than had been the case in the past.
Mr. Eastburn observed that before this meeting his staff
had worked out two possible patterns for the growth rate of real
GNP in 1974, assuming in both cases that the oil embargo would
continue.
The first pattern, which was based on the assumption
that the slowdown in economic activity was primarily a result of
demand deficiencies, was saucer shaped;
the second, which involved
the assumption that the slowdown was largely shortage-induced,
indicated a more rapid upturn in the second and third quartersand in one version even suggested a sizable rise in real GNP in
3/19/74
the second quarter.
Now that the oil embargo had been terminated,
those results made him wonder whether the recovery in GNP might be
more rapid than suggested by the Board staff's revised projectionat least if the slowdown had been more a consequence of supply
shortages than of demand deficiencies.
Mr. Partee responded that in any projection there was, of
course, the possibility of erring in one direction or the other.
If
sales of automobiles or houses should now pick up faster than antici
pated, however, the major effect in the short run would not be on the
over-all growth rate of GNP but on the distribution of the change
between inventory accumulation and final expenditures.
He was not
aware of any evidence that the weakness in consumer spending was
attributable to shortages to any great extent.
There were, of
course, shortages of some particular consumer goods, such as com
pact cars, but by and large retail stores had been offering fairly
wide selections of clothing, furniture, appliances, and other goods.
In his judgment, the sluggishness of consumer spending was attribut
able mainly to the decline in real income, and as mentioned earlier
by the Chairman, to the burden of consumer debt.
Mr. Partee remarked that business spending for plant and
equipment probably had been held down by shortages, so that an
improvement in deliveries might result in a faster rise in business
-84-
3/19/74
fixed investment than projected.
It should be noted, however, that
the staff's plant and equipment projection was consistent with the
latest Commerce Department survey of business investment plans,
with no allowance for shortfalls of actual from planned spending
such as had occurred in other recent quarters.
Finally, Mr. Partee noted, there was the question of inven
tory accumulation.
It was obvious, both from the red book and from
the recent purchasing agents' report, that businessmen were still
concerned about shortages of strategic materials and would probably
continue to accumulate substantial inventories of such materials,
at least in the short run.
The staff's projections for the near term
were consistent with a substantial buildup in inventories of strategic
materials; they allowed for a continued high level of over-all inventory
investment, even
though stocks of automobiles--which had been an
important factor in the accumulation of the fourth quarter of 1973were not expected to rise further.
Mr. Gramley said he might add a few comments.
The available
evidence did not support the view that the decline in economic
activity had been induced by a lack of petroleum products for use
in industrial processing.
The December and January declines in
industrial production had been primarily a function of slowdowns
in auto assemblies, and the further decline of February was
-85-
3/19/74
concentrated mainly in the industries supplying automotive parts
and materials.
It appeared likely, therefore, that a substantial
part of the drop in real GNP between the fourth quarter of 1973 and
the first quarter of 1974 would be found to be attributable to autos
and parts, and that the extent of the recovery in the second quarter
would depend on the magnitude of the rebound in auto sales.
In
his opinion the half-million increase in unit sales of domestic
autos now projected by the staff for the second quarter was on the
optimistic side.
As for the latter half of the year, Mr. Gramley continued,
the key question, in his judgment, was whether the price of imported
crude oil would decline.
In the absence of good evidence to the
contrary, the staff had assumed that imported crude prices would
remain at present levels.
The increased availability of petroleum
products at current high prices would have the same economic effect
as the imposition of a substantial tax on consumers,
Mr. Eastburn referred to Mr. Partee's comment that the
production of small cars was already close to capacity, and asked
whether the producers' shift from large to small cars was about on
schedule or was proceeding more rapidly than expected.
Mr. Gramley replied that recent production rates appeared
consistent with the information on conversion plans the staff had
3/19/74
-86-
obtained around the first of the year through telephone conversa
tions with economists of the major automobile companies.
The
production of small cars had risen to an annual rate of about 3
million units, suggesting a modest increase in small-car capacity
since the fourth quarter.
The expected large increase in capacity
was yet to come; one major producer did not anticipate much increase
in small car output prior to the 1975 model year.
Mr. Francis commented that at least in some cases the auto
mobile companies appeared to be making the shift to small cars very
rapidly.
He had heard from one informed observer that some assembly
lines would be changed over in 2 months and that many of them would
be shifted within 3 to 6 months.
Mr. Gramley noted that the responses in the staff's telephone
inquiries suggested that production of compacts and subcompacts might
reach an annual rate close to 5 million units by the fourth quarter
of 1974.
Thus, the survey results were not inconsistent with an
expectation of a substantial conversion to small-car production over
the course of the next few months.
Mr. Mitchell said it was not clear to him whether the staff
expected the oil shortage to be dealt with by price rationing, by ration
ing through queues, or by shifts in production and consumption patterns.
If the price of gasoline were to settle at a level 50 per cent above
-87-
3/19/74
the pre-embargo level, the impact on the housing and recreation
industries over the next few years might be larger than envisioned
by the staff.
If the price increase were on the order of 20 per
cent, the impact would probably not be great.
Mr. Partee observed that the average price of gasoline had
gone up by about 50 per cent, from around 35 cents per gallon to a
range of 50 to 55 cents.
The price of home heating oil had risen
by an even larger percentage.
Mr. Gramley added that the staff projection assumed that,
with an additional supply of 2 million barrels of oil per day, going
mainly into gasoline most of the existing non-price rationing mecha
nisms would be eliminated--that is, sales would be permitted on
Sundays, the long queues would disappear, and consumers would, in
effect, be able to buy all the gasoline they wanted at prevailing
prices.
Even with the 2 million barrel per day increase in supplies,
however, the share of petroleum products as a percentage of total
energy sources in the United States would be lower than originally
projected by the staff in November 1973, prior to the oil crisis.
Mr. Morris remarked that he was somewhat concerned about
the availability of financing for the projected volume of housing
starts.
The econometric model of Data Resources Incorporated pro
jected a volume of housing starts only slightly higher than that
3/19/74
-88-
called for in the staff's revised projection.
model indicated that thrift institution
However, the DRI
deposits would have to
grow at a 12 to 14 per cent rate in order to finance that level
of activity.
In contrast, the Board staff's projections indicated
that thrift institution deposits would grow at a rate of only 6 to
7 per cent.
Mr. Partee responded that there were other factors which
had to be taken into account.
For one thing, thrift institutions
could borrow from the Federal Home Loan Banks.
Secondly, in
recent years commercial banks had become increasingly important
as a source of funds to the mortgage market.
If, as anticipated,
the current bulge in short-term business credit demands subsided,
banks might well continue to be major suppliers of mortgage credit.
Furthermore, arrangements for bond sales and tandem mortgage sales
by GNMA and FNMA represented another potential supplement to the
mortgage market.
Simulations run with the flow-of-funds model
late last year had not suggested any difficulties in the financing
of the projected volume of residential construction activity.
While
the outlook for savings inflows had worsened somewhat since then, in
view of the structural shifts that had occurred he did not believe it
would be necessary for thrift institution deposits to grow at a rate
as high as 12 to 14 per cent.
3/19/74
-89-
Chairman Burns observed that the sizable tandem mortgage
plan now under serious consideration by GNMA could change the
financing outlook considerably.
He added that in the recent past
the financing of residential construction had been carried on
primarily by governmentally sponsored agencies.
The economy now
had resources for mortgage financing that did not exist 10 or 20
years ago.
Mr. Clay noted that there were mixed signs of strength
and weakness in the economy.
with manufacturers
On the one hand, new orders placed
rose in January and the strength in planned
capital outlays for the year was reconfirmed by the McGraw-Hill
and Commerce Department surveys.
At the same time, retail sales
declined in February and the January gain had been revised downward.
It was not clear to him, however, that a fall-off in consumer
demand at this point was necessarily undesirable.
The combina
tion of a reduction in consumer spending and an increase in capital
spending could serve to slow the rate of inflation.
Mr. Partee agreed that that would be true in the long run;
in the short run, an increase in spending on plant and equipment
presumably would be even more inflationary than an equivalent
increase in consumption spending, given the capacity situation.
Furthermore, a shift from consumption to investment might well
be associated with a net softening in the economy, if the former
fell more than the latter rose.
-90-
3/19/74
Mr. Clay said he would not want to see the reduction in
consumer demand persist indefinitely.
consumer resistance to higher
However, he considered
prices an indication of intelligent
behavior that would offer a wholesome restraint on inflationary
pressures.
The Chairman remarked that the recent change in the real
terms of trade resulting from the rising price of imported oil
might well result in a standard of living somewhat lower than
would have prevailed otherwise.
Mr. Clay observed that the new, higher price of oil might
very well represent its true economic value.
It was conceivable
that energy in general had been underpriced for some time, and
that the whole economy would now have to adjust to the real price.
Chairman Burns then said he would like to call to the
attention of the Committee some simple but important facts concern
ing the current inflation.
While inflation was a worldwide
phenomenon, the U.S. record was becoming progressively poorer
relative to that in other nations.
He recently had some calcula
tions made for the 14 major OECD countries, in which the level of
the consumer price index in each month since January 1973 was
compared with the level in the same month of the preceding year.
The rise in consumer prices was smaller in the United States than
3/19/74
in any of the 13 other OECD countries for the year ending in January
1973.
The situation continued the same for the monthly comparisons
month from February through July 1973, but then the picture began
to change.
Over the year ending in August, consumer prices rose
more in the United States than in Austria, Belgium, Germany, Norway,
and Sweden.
By December the Netherlands had been added to the list
of OECD nations with smaller rises in consumer prices than the United
States, and incomplete data for January and February 1974 suggested
that the relative position of the United States had deteriorated further.
Calculations using the wholesale price index resulted in
a similar picture, the Chairman observed.
Over the year ending in
January 1973, wholesale prices had risen more in 9 of the other
countries than in the United States.
By August and September,
however, the rise in the U.S. wholesale price index exceeded that
in all but 2 or 3 of the other nations, and in subsequent months
the situation had remained much the same.
Although a great deal had been written about the rate of
inflation in Great Britain, Chairman Burns continued, the data showed
that the recent U.S. experience was worse.
Over the year end
ing in January 1974, wholesale prices rose at rates of 21 per cent
in the United States and 15 per cent in the United Kingdom.
In
February, the comparable year-over-year increases were 20 per cent
-92-
3/19/74
for the United States and 17 per cent for the United Kingdom.
A
year ago it was possible to say that inflation was less rapid in
the United States than in other countries and to draw the conclusion
that that would have a favorable influence on the U.S. balance of
payments.
It should be borne in mind that such statements could no
longer be made.
It should also be borne in mind that there had been
little or no relaxation of monetary policy in European countries or
in Japan in recent months.
Mr. Wallich remarked that he believed there were more elements
of strength in the economy than suggested by the staff projections,
but he was concerned about one potential element of weakness.
The
substantial bulge in inventory accumulation in the fourth quarter
had resulted mainly from the oil situation, and it seemed likely that
inventory investment would taper off, as it apparently had begun to
do in January.
He wondered if the staff thought such a development
would postpone the cyclical turning point and delay the economic
recovery.
In reply, Mr. Partee said he expected inventory behavior to
be a dampening influence on the economy for the remainder of 1974.
The staff projection called for a progressive reduction in the rate of
inventory accumulation from the $18
billion rate recorded in the fourth
quarter of 1973 to about $7 billion in the fourth quarter of 1974.
-93-
3/19/74
Of course, the change in business inventories was one of the most
difficult of the GNP categories to predict.
It was possible
that the change in inventories would become negative during the
year, but because businesses had kept their inventory-sales
ratios at moderate levels and had generally followed conservative
policies, the staff thought a classic cyclical decline in inventory
accumulation was unlikely.
It would be important, however, to
follow developments in that area closely as the year progressed.
He might note, Mr. Partee continued, that some business
analysts were forecasting a recession in 1975 rather than in 1974,
mainly on the basis of their expectations that a large inventory
correction would develop next year, concurrently with a stabiliza
tion or downturn in business capital spending.
In effect, they
considered the current decline in economic activity to be a minor
dip in advance of a general recession in 1975.
Mr. Brimmer observed that, despite the modest improvement
in the economic outlook described by Mr. Gramley, and despite the
current high rate of inflation, policy makers were still faced
this year with what essentially was a recession.
There was no
easy way out of the dilemma, but it was important to note that
there would be a great deal of misery in the country even if the
unemployment rate rose no higher than 5.8 per cent by the end of
the year.
-94-
3/19/74
Mr. Clay remarked that much of the recent inventory accumula
tion might reflect stocks acquired by users of oil products in an
effort to protect themselves against shortages.
If that were the
case, the process of running down stocks should be accomplished
without much negative impact on the economy.
The Chairman commented that the inventory situation was
distorted not only by the oil crisis but also by the price control
program, and it would not be possible to analyze it properly until
the controls were lifted.
That probably would occur soon.
In reply to a question by Mr. Bucher concerning the projected
reduction in the saving rate, Mr. Gramley said he should emphasize
that that projection reflected highly preliminary judgments.
It
seemed reasonable to assume that consumers would tend to maintain
their spending on other goods and services at a time when their
expenditures on gasoline and oil were rising because of increased
supplies at higher prices--a process that would result in some
decline in the personal saving rate.
He considered that relatively
optimistic assumption regarding consumer behavior useful in making
a first approximation to the likely extent of the economic recovery.
However, he had some doubts as to whether the actual decline in per
sonal saving would be as large as he had indicated.
Indeed a smaller
decline was likely to be shown in the projections prepared for the
3/19/74
-95-
next meeting, which would be based on a more elaborate and careful
analysis of the various relevant considerations than that under
lying today's projections.
Mr. Bucher then noted that in the revision of the projec
tions the rise in the fixed-weight deflator for the third and
fourth quarters of 1974 had been increased by 0.3 and 0.5 percentage
points, respectively, to 6.1 and 6.2 per cent.
He understood that
the increase was attributable primarily to upward revisions in the
projections of petroleum prices.
He wondered, however, about the
extent to which food prices contributed to the anticipated rise in
the deflator.
Mr. Gramley replied that the rate of increase in food prices
was expected to taper off in the latter half of 1974.
That was one
factor accounting for the projected slowing of the rise in the
deflator in the second half.
In response to a question by the Chairman about the likely
trend of meat prices, Mr. Gramley noted that any projections of
agricultural prices were highly uncertain; indeed, recent forecasts
had involved some phenomenally large errors.
However, the large
supplies of cattle now on the range at least gave one reason to
hope that meat prices would decline over the course of the year.
-96-
3/19/74
The Chairman observed that slaughter rates were currently
high because of the unfavorable relationship between prices of
cattle and prices of feed grains.
He wondered if that would not
have adverse effects on meat prices later in 1974.
In reply, Mr. Gramley said he thought the high slaughter
rate would have unfavorable implications for beef supplies and prices
mainly beginning in 1975.
In the short run, of course, high slaughter
rates tended to reduce meat prices.
staff's agricultural economist
It was the opinion of the
that the slaughter rate might
increase in coming months, although there was some uncertainty on
that point.
Mr. Clay expressed the view that the decline in food prices
was a temporary aberration and that rising food prices might again
be a contributor to inflation by the end of the year.
The
cattle marketing situation had been distorted by controls, and
cattle had been fattened too long.
That was undesirable from the
viewpoints of both producers and consumers because production costs
tended to rise substantially in the later stages of preparing cattle
for market.
It was his opinion that high production costs--includ
ing grain prics--would keep the cost of beef high, and might result
in increased production of lower-quality, grass-fed beef.
3/19/74
-97-
Mr. Partee noted that the staff projection allowed for a
4 to 5 per cent rate of increase in food prices in the latter half
of 1974.
That was less rapid than the rise in the over-all deflator
for the second half of the year because it was anticipated that prices
of manufactured goods in that period would begin to reflect rapidly
rising unit labor costs.
Mr. Clay observed that his staff's expectations for food
prices were about the same as those of the Board staff.
However, his
staff believed that meat prices would fluctuate but average
prices would be relatively stable in the last half of 1974.
Mr. Coldwell remarked that feedlot operators in the Eleventh
District reported a large overhang of cattle ready for slaughter,
which would have an impact on prices.
However, the operators also
expected the slaughter rate to drop back in August and September to
levels well below current market demands.
Any near-term drop in
prices was therefore likely to be temporary.
Mr. Francis commented that a number of commercial feeding
operations were reported to be in financial difficulties because
they were taking losses of $125 to $200 a head on cattle currently
being slaughtered.
It
was possible that some feedlots might go
out of business, and there was some question about the willingness
or ability of feedlot operators in general to maintain the volume
of operations.
The outlook was uncertain, but it was clear that the
3/19/74
-98-
industry had problems which were likely to affect meat prices for
some time to come.
Mr. Holland remarked that the revision in the staff's GNP
projection described this morning had implications for the expected
relationships between growth rates in monetary aggregates and interest
rates, and therefore for the specifications associated with the
alternative policy courses discussed in the blue book.1/
If one
were not a strict monetarist--and he was not--and if one felt that
the degree of pressure presently being exerted by monetary policy
was appropriate for dealing with inflation, he would conclude that
the 6-month targets for the monetary aggregates, and possibly also
the 2-month ranges of tolerance, should be recalculated.
Perhaps
that could be done before the end of today's meeting, so that the
information on which the Committee based its policy decision would
be as current as possible.
In reply, Mr. Partee noted that the staff seemed to be
having greater difficulties than usual in maintaining consistency
in the assumptions incorporated in various parts of the documenta
tion it prepared.
The analysis in the blue book reflected expecta
tions of more upward pressure on interest rates than had been
1/ The report, "Monetary Aggregates and Money Market Conditions,"
prepared for the Committee by the Board's staff.
-99-
3/19/74
anticipated only a few days earlier, when the green book was pre
pared; and,as Mr. Holland had suggested, the revision of the GNP
projections presented today would imply somewhat different rela
tionships between monetary growth rates and interest rates than
were set forth in the blue book.
He did not think the relationships
involving the March-April ranges of tolerance for the aggregates
would be significantly different, since the growth rates for that
period were already determined to a large extent.
As to the rela
tionships involving the longer-run targets for the aggregates, he
would hesitate to offer the Committee hastily prepared revisions;
the implications of the change in GNP projections for the rela
tionships in question had to be worked through carefully, sector
by sector.
In reply to a question by Mr. Sheehan, Mr. Gramley said
that, as Mr. Partee had noted earlier, the staff had not yet
worked out the mortgage rates and fund flows likely to be
associated with its revised projection of housing starts.
earlier projection,
shown in the green book,
tions of some easing in mortgage credit terms.
The
was based on expecta
Personally, he
thought it was reasonable to expect the ending of the embargo to
call for some increase in the projected level of housing starts
over the rest of 1974; he did not expect mortgage terms to tighten
-100-
3/19/7
enough in that period to choke off the expected rise.
In 1975,
however, the story might well be different.
Before this meeting there had been distributed to the members
of the Committee a report from the Manager of the System Open Market
Account covering domestic open market operations for the period
February 20 through March 13, 1974, and a supplemental report
covering the period March 14 through 18, 1974.
Copies of both
reports have been placed in the files of the Committee.
In supplementation of the written reports, Mr. Holmes made
the following statement:
Open market operations over the period since the
Committee last met gradually turned toward a more
restrictive stance as the aggregates, particularly M1,
exhibited more strength than had been anticipated.
Early in the period, when financial markets were react
ing rather strongly to the failure of open market opera
tions to validate market expectations of a continued
easing of policy, the Federal funds rate was kept steady
at around 9 per cent, in accordance with the Committee's
wire agreement of March 1. After the restoration of
the 8-1/4 to 9-1/2 per cent range of tolerance by wire
agreement on March 11, and with M1 stronger than desired,
the Desk aimed for a more restrictive supply of reserves,
expecting initially that Federal funds would trade in a
9-1/8 to 9-1/4 per cent range. And, last Friday, when
new data further confirmed the stronger-than-desired
growth in M1, the Desk became an even more reluctant
supplier of reserves, anticipating that the funds rate
would move to the 9-1/2 per cent top of the Committee's
range, which it did yesterday.
As noted in the blue book, both short- and long
term rates moved significantly higher. Market expecta
tions of an easier monetary policy were frustrated, and
3/19/74
-101-
a mood of pessimism enveloped the markets when economic
news turned out to be somewhat better than expected
and published M 1 data exhibited explosive growth.
Government dealers entered the period with heavy
inventories--over $1.6 billion--of Treasury securities
maturing in more than one year, mainly stemming from
their underwriting of the February Treasury refunding.
Reduction of those inventories to about $400 million
in a declining market involved them in heavy financial
losses. Some dealers are quite bitter, feeling that
the Federal Reserve led them down the primrose path.
Others--a little more honestly--bemoan their own lack
of judgment in acting so strongly on the belief that
the System had embarked on a policy of continuous
easing.
Yesterday's regular Treasury bill auction illus
trates the rise in short-term rates over the period.
Average rates of 8.04 and 7.88 per cent were set for
3- and 6-month bills, up 103 and 110 basis points from
the rates established in the auction just preceding the
last meeting of the Committee. While the rise was
sharp, it should be noted that there had been about
as large a decline in short-term rates between the
January and February meetings of the Committee. The
extreme volatility of interest rates in recent months,
while a sign of these times of uncertainty, is a
matter of some concern with respect to the longer-run
orderly functioning of the financial markets. In this
connection, the Joint Federal Reserve-Treasury Study
Group of the Government Securities Market has stepped
up its activity and is acting on a number of sugges
tions made in a meeting with dealers a short time
ago. As part of that effort I have asked dealers to
submit, on a voluntary basis, monthly profit and loss
statements so that we can have a more current view of
the financial health of the market.
The Treasury is planning to announce shortlyperhaps this week--a $4 billion cash offering, which
probably will involve tax-anticipation bills and short
term notes. Given the short maturities and the use of
the auction technique, even keel considerations would
not appear to be of much importance. The amount is
larger than the market expects, however, and given the
-102-
3/19/74
gloomy atmosphere, it may not all be smooth sailing.
Should the Committee decide today on a policy that
would involve a rise in the Federal funds rate, I
think it would be important to make that quite clear
in the market before the first stage of the Treasury
financing.
Finally, I should note that despite the recent
poor profit performance, there is still an interest
in getting into the Government securities business.
A week ago Friday, we added two names to our list of
reporting dealers--First Pennco and Donaldson, Lufkin
and Jenrette. After a further period of surveillance,
we would expect to start doing business with both
firms. This will bring us to a new high of 25 dealer
firms.
By unanimous vote, the open
market transactions in Government
securities, agency obligations, and
bankers' acceptances during the
period February 20 through March 18,
1974, were approved, ratified, and
confirmed.
Mr. Axilrod made the following statement on prospective
financial relationships:
The unexpectedly large rise in M1 in early March
brings the level of the series somewhat above the
Committee's long-run, 5-3/4 per cent growth path that
starts in December 1973. If our estimate for the
month of March as a whole holds up, M1 growth for the
first quarter will be at a 6.7 per cent annual rate.
Growth was also relatively rapid in the last few
months of 1973. But taking a 15-month time framefrom the end of 1972 to date--the annual rate of
growth in M1 would be a shade under 6 per cent--5.9
per cent, to be specific.
With expansion of nominal GNP projected to pick
up in the spring and summer from the low first-quarter
pace, the staff expects that further increases in
interest rates would probably result from efforts to
3/19/74
-103-
keep M 1 to the path indicated by the Committee at its
last two meetings. Alternative B 1/ represents a pattern
of interest rates and aggregates which the staff believes
will bring M1 back to path by September. Alternative C
encompasses a more rapid move back to path for M 1 and,
hence, would appear to involve a sharper rise in interest
rates in the short run. This alternative involves the
risk, however, of M 1 falling well below path by summer
from the cumulative impact of the restraint that is
set in motion. Alternative A can be interpreted as
accepting a new and somewhat faster growth path for M 1
and would not be expected to involve any further tight
ening of money market conditions and possibly some
easing.
These relationships are, as the Committee well
knows, subject to great uncertainty, particularly in
a period such as now when the basic projections of
GNP may be subject to larger-than-usual margins of
error and when inflation seems to have led to shift
ing and unpredictable attitudes toward interest rates,
credit, and money demand on the part of borrowers,
lenders, and savers. This would suggest that the
Committee may wish to consider expressing its short
run operating guides in terms of rather wider ranges
of tolerance for aggregates and/or interest rates.
Under current circumstances, for example, the 2-month
range for the monetary growth rates might be at least
three percentage points.
If such a widening of the
blue book ranges were accomplished by lowering the
bottom of the range, this would, for example, enable
the Committee to express its willingness under current
circumstances to accept a prompter return of M 1 to
the long-run path, if that turns out to be possible,
without requiring any significant deviation of money
market conditions from the ranges the Committee specifies.
On the other hand, with the potential pull on
money demand from large price increases apparently
great, the Committee would probably also want to keep
adequate leeway for interest rate flexibility--to avert
1/ The alternative draft directives submitted by the staff for
Committee consideration are appended to this memorandum as Attachment D.
3/19/74
-104-
the risk, for instance, of fostering an excessively
low real rate of interest in a period of continuing,
strong expectations of rising prices.
On the other
hand, the Committee may also wish to have flexibility
on the downside because of the risk of maintaining
high market rates should money and credit growth
suddenly weaken. In that context, it might be pointed
out that the recent rise in short-term market rates
has brought them close to their January 1974 highs; bill
rates are there, and other short-term rates are within
25 to 50 basis points of those highs.
Long-term rates
have moved somewhat above the levels of January 1974.
As compared with the highs of the summer of 1973, short
term rates are currently 1 to 2 percentage points below
those peaks, while long-term market rates are only 20
to 40 basis points below.
If interest rates do have to rise further in the
weeks ahead in pursuance of the Committee's policy
toward reserves and aggregates, we will be moving back
toward the establishment of short-term rate levels
that may begin to threaten savings flows to inter
mediaries and to tighten mortgage market conditions.
In bond markets, rates will probably rise above their
summer of 1973 levels, and some upward pressure on
mortgage rates may be exerted from that quarter also.
This type of pressure might be eased to some degree
if the Desk purchased coupon issues in the market more
frequently and in larger volume in the months ahead
than has been the case in the past.
Monetary policy in the period ahead will have to
be conducted in the face of the $4 billion Treasury
cash financing. Since this financing will most likely
be in the bill and short-term coupon area, it would
not ordinarily require a significant degree of even
keel. However, the recent adverse market experience
with the mid-February refunding raises the possibility
of stronger-than-usual over-all market interest rate
repercussions from signs of a tighter money market.
This suggests the need for a little more even keel
than such a financing would usually require, partic
ularly in light of possible adverse implications for
intermediaries and the mortgage market of rising
short-term rates.
3/19/74
-105-
Mr. Bucher referred to Mr. Axilrod's comment that alternative A
would be expected to involve no further tightening of money market
conditions and might lead to some easing.
According to the blue
book, maintenance of the funds rate at around its recent level of
9-1/4 to 9-1/2 per cent might be accompanied by some further upward
adjustment in short-term rates, particularly as the forthcoming
Treasury financing was absorbed.
Some market observers appeared to
be interpreting the recent rise in the funds rate as
an aberration,
which also suggested that some further market adjustments lay ahead.
He asked how the staff would assess the prospects for increases in
short-term rates even if the funds rate remained at its current
level.
Mr. Axilrod responded that the Federal funds rate had just
reached 9-1/2 per cent, which he would now interpret as the "current"
level.
He would expect the persistence of that level, and of the
effects it implied for dealer financing costs, to be associated
with at least some further upward adjustments in short-term market
rates.
Moreover, the $4 billion Treasury financing in prospect
probably was at least $500 million higher than market participants
generally were expecting.
Mr. Holmes remarked that he agreed with Mr. Axilrod.
Although a substantial adjustment had occurred yesterday, when
-106-
3/19/74
Treasury bill
rates had risen by almost one-quarter of a percentage
point, some further adjustment could occur--particularly in view of
the $4 billion of short-term Treasury securities that the market
would have to absorb.
Mr. Black asked whether a further significant increase in
the funds rate might risk creating disorderly market conditions.
In response, Mr. Holmes observed that the recent rapid
adjustment in rates, while producing difficulties for the dealers
holding large inventories of securities, had not led to disorderly
conditions.
In his view, a further rise in the funds rate would
result in a repetition of that experience, and would not generate
disorderly conditions; short-term rates would again adjust upward,
and the higher rates would bring investors back into the market.
As he had noted in his statement, however, any upward adjustment
in the funds rate that might be called for by today's policy
decision should be brought about quickly, before the financing.
Mr. Holland asked whether it was correct to infer from
Mr. Holmes' remarks that he, like Mr. Axilrod, believed that the
Committee would be well advised to instruct the Desk to give a
little more weight to even keel considerations during the forth
coming financing than it had in connection with the previous
3/19/74
-107-
financing.
In any case, he (Mr. Holland) wondered why the staff
had proposed to put parentheses around the reference to the financ
ing in alternatives B and C for the directive.
Mr. Holmes replied that even though the prospective financing
was of a kind that ordinarily had not called for even keel, he
thought the Desk should pay more attention to it than it had to
short-term financings in the past.
Mr. Axilrod remarked that the parentheses--which could
easily be deleted--had been suggested to avoid giving the degree
of prominence to the forthcoming short-term financing that was
customarily given to large coupon financings.
With the exception
of a $4 billion bill financing several years ago, the Committee
had not applied even keel to short-term financings.
Mr. Mayo observed that in the past he had advocated ranges
of tolerance of more than two percentage points for the short-run
growth rates in the aggregates.
Consequently, he was happy to
endorse Mr. Axilrod's suggestion today for a widening of the ranges
to three percentage points.
He noted, however, that a range of
6 to 9 per cent for M 1 would encompass all three alternatives pre
sented in the blue book; the alternatives did not appear'to be
significantly different from one another.
-108-
3/19/74
In response, Mr. Axilrod observed that the 2-month ranges
of tolerance for both M 1 and M 2 shown for the three alternatives
in the blue book did not differ much from one another because a
move toward restraint, for example, would have relatively little
effect on deposits during the first 4 weeks.
When the Desk held
back on the provision of reserves and the Federal funds rate rose
as a consequence, member banks initially tended to borrow more from
the Reserve Banks, partly offsetting the effects of the Desk's
operations on total reserves.
In the very short run, therefore,
the effects on the rate of growth in deposits was small.
Growth
in deposits was retarded over succeeding months, however, in
response to the rise in the general level of short-term interest
rates.
As he had noted in his statement, Mr. Axilrod added, he
thought the Committee might want to reduce the lower limit of the
short-run ranges by one percentage point in order to reflect a
willingness to accept a more prompt return of M
to the long-run
growth path, if that turned out to be possible
without requiring
any significant deviation of money market conditions from the
specified range.
Mr. Brimmer said he would like to pursue the question of
even keel in connection with the forthcoming short-term financing.
3/19/74
-109-
He was concerned about the possibility that market conditions
might develop in which some assistance was needed from monetary
policy instruments other than open market operations.
If, for
example, the Board concluded in the near future that a change in
reserve requirements was appropriate, he questioned whether it
should feel bound by even keel constraints.
He had understood
even keel to mean that the System normally would not change the
stance of monetary policy while a Treasury financing was in process,
but that it was not bound by that constraint.
He was troubled by a
conjuncture of circumstances at the present time which might pose
severe conflicts for monetary policy, and he would not want to
have inhibitions placed on the conduct of policy.
Mr. Axilrod commented that his remarks
with respect to
the forthcoming Treasury financing were not intended to suggest
that a decline in the Federal funds rate from its current 9-1/2
per cent level would be desirable.
His point was that, since the
market had not yet fully adjusted to the recent rise in the funds
rate, considerable caution should be exercized with regard to the tim
ing and magnitude of any further rate increases in view of the prospec
tive financing--even though the System ordinarily had applied even keel
only to longer-term issues.
Chairman Burns remarked that, in view of the shift to the
auction technique in selling Treasury securities, even keel con
siderations should be less important than in the past.
3/19/74
-110-
Mr. Holland observed that over recent years the Committee
had been moving in the direction of attaching less importance to
even keel considerations, and he would not suggest any reversal
of that trend.
He would suggest, however, that somewhat more
attention be given to even keel in the forthcoming financing than
had been given in the February refunding.
In that instance, the
Committee's instructions to the Manager had resulted in operations
conducted a little too late, relative to the timing of the financ
ing, that had led the market to misinterpret the stance of policy.
Chairman Burns commented that, while that interpretation
might be correct, he nevertheless felt that the System should not
take too seriously the expectations of Government securities dealers
regarding monetary policy.
The dealers were businessmen undertak
ing risks, and the Federal Reserve did not have a responsibility
to assure their success and their profits.
Because of the huge
Federal deficit and the frequency of Treasury financings, the
Committee would run the risk of frustrating the goals of monetary
policy if it gave too much attention to even keel considerations.
Mr. Brimmer noted that, particularly because the goals of
monetary policy were complex and often conflicting, he shared the
Chairman's concern about the possibility that policy might be
frustrated.
Recently, one goal had been to assure an availability
3/19/74
-111-
of funds consistent with a structure of interest rates over the
rest of the year that would bring about a revival in the housing
sector.
If interest rates rose much beyond the levels they had
attained recently, that goal would be called into question.
Mr. Mayo remarked that, as long as the Treasury employed
its present procedures for financing the national debt, the Federal
Reserve did have a responsibility to assist in creating a fairly
calm atmosphere in the market in order to help in the secondary
distribution of Treasury issues, whether the yield was fixed or
was determined by an auction.
If the Treasury were to shift to a
commission system in issuing securities, the situation could be
quite different.
Chairman Burns observed in that connection that he was much
impressed by the size of the Federal deficit in the five fiscal years
1970 through 1974.
Taking into account off-budget outlays and out
lays by Government-sponsored enterprises, as well as the outlays re
ported under the unified budget, the cumulative deficit in that period
amounted to $110 billion, rather than the published total of $68 bil
lion.
While the Federal Reserve always would accommodate the Treasury
up to a point, the charge could be made--and was being made--that the
System had accommodated the Treasury to an excessive degree.
Although
he was not a monetarist, he found a basic and inescapable truth in
the monetarist position that inflation could not have persisted
3/19/74
-112-
over a long period of time without a highly accommodative monetary
policy.
Mr. Sheehan asked Mr. Holmes about the profits experience
of the Government securities dealers in recent years.
Mr. Holmes replied that more than half of the dealers had
lost money in 1973, and during the past month their realized and
unrealized losses probably had been in the neighborhood of $25
$30 million.
to
On the other hand, profits had been remarkably good
in 1971 and 1972.
He did not have information at hand on total
industry profits by years, but would supply such information after
the meeting for inclusion in the record.1/
Mr. Axilrod said he might add a comment to clarify his own
position with respect to even keel in the period ahead.
The issue,
as he saw it, was not so much a matter of the state of the Government
securities market itself; rather, it involved a possible conflict of
objectives, along the lines of Mr. Brimmer's observation.
In partic
ular, the interaction of a possible tightening of money market condi
tions and a large Treasury financing could lead to greater upward
adjustments of interest rates than the Committee might wish to contem
plate in the very short run, before it had been able to evaluate fully
the implications of rising rates for residential construction activity.
1/ The tabulation Mr. Holmes supplied is appended to this memorandum
as Attachment E.
-113-
3/19/74
Mr. Wallich remarked that, granting the objective of keeping
the distribution system for Government securities intact, there must
be ways, other than generous even keeling, of accomplishing that
objective.
For instance, the Treasury might issue public statements
putting market participants on notice that in future there would be
less support to the market.
Chairman Burns observed that the Committee was ready for
its deliberations concerning monetary policy.
Mr. Eastburn commented that he would support Mr. Axilrod's
suggestion to widen the March-April ranges of tolerance for the
aggregates.
He believed that the longer-run path of 5-3/4
per cent growth in M was a desirable objective of policy,
1
and the important issue, therefore, was the strategy that would
return growth to that path.
Recent experience suggested that it
was important to focus more on the longer-run path than the short
run projections
a return to path.
in the event that developments were favorable to
Accordingly, whatever short-run rate of growth
would be consistent with a return to path should be encompassed
by the 2-month range of tolerance.
With respect to the March
April period, a 6-1/2 per cent rate of growth would return M
1
to
the 5-3/4 per cent path by April, and that rate should be encom
passed by the short-run range adopted by the Committee.
Under
3/19/74
-114-
alternative B, therefore, he would drop the lower limit of the M 1
range to 5-1/2 per cent.
Continuing, Mr. Eastburn said he thought the Committee
should reconsider its recent decision against publishing the
longer-run targets or suggesting them by reference to past rates
of growth in the operational paragraph of the directive.
Over the
last 3 years more than half the directives compared the targets
with behavior of the aggregates in a past period.
The directive
issued in August, for example, called for "slower growth in
monetary aggregates over the months immediately ahead than has
occurred on average thus far this year."
With respect to the
drafts of the operational paragraph before the Committee today,
alternatives A and C contained a reference to behavior of the aggre
gates in a past period, but alternative B did not.
He favored
alternative B, and preferred that the language suggest a more
specific reference point in the fashion of alternatives A and C.
He proposed the following substitute language for alternative B:
". . .the Committee seeks to achieve bank reserve and money market
conditions that will foster growth in the monetary aggregates over
the quarters ahead at a somewhat slower rate than achieved over the
past year."
3/19/74
-115-
Chairman
Burns observed that after deliberation at the
December meeting the Committee had decided not to publish its
longer-run targets.
That decision could be reconsidered at any
time, and in view of Mr. Eastburn's comments, such reconsideration
should be undertaken promptly.
However, the issue required care
ful study and debate, and it could not be dealt with today.
Mr. Eastburn might distribute to the Committee the results of his
review of directive language over the past 3 years, and the staff
would prepare some additional background materials, so that the
Committee could reconsider its decision at a Monday afternoon
session of the April meeting.
believed
Pending such reconsideration, he
the language of the operational paragraph of the direc
tive should not implicitly disclose the longer-run targets.
Mr. Eastburn remarked that while he favored publication
of the longer-run targets, he was not pressing for reconsideration
of the issue at this meeting; he agreed that it was an important
question that should be discussed carefully.
Therefore, he also
agreed that, in the event the Committee favored either alterna
tive A or alternative C, the language for the operational paragraph
should be altered to remove the reference to growth in the aggre
gates over recent months.
3/19/74
-116-
Mr. Hayes commented that in assessing policy objectives
today, he believed that the Committee must again give primary
weight to bringing inflation under control.
Up to this point,
he saw no reason to alter the view that the current decline in
activity would prove to be relatively mild and brief and that it
reflected in large part the effects of the energy crisis and other
shortages of various types.
The easing of the oil embargo should
prove to be a significant plus within a reasonable period of time.
Despite such a development, some further period of weak output and
rising unemployment seemed likely.
Nevertheless,an effort to pre
vent that would surely bring about what the Chairman had referred
to as "two-digit" inflation.
The consequences of that, in turn,
could well be substantially increased social strains and, ultimately,
a far sharper economic reaction.
In other words, he believed
the
Committee simply had to allow time for some breathing space to open
up in the economy or face even more serious problems later on.
In framing objectives at this time, Mr. Hayes said, the
Committee should certainly take account of the fact that for
reasons that were, as usual, rather mysterious, M 1 growth in the
first quarter now appeared likely to seriously overrun the roughly
4-1/2 per cent growth rate anticipated a month ago.
Thus the Board
staff's current projection was for about a 6-3/4 per cent growth
3/19/74
-117-
rate, following on the heels of a 7-1/2 per cent rate in the
previous quarter.
With that in mind, he thought the 5-1/4 per
cent growth in M1 for the second and third quarters combined pro
jected by the staff under alternative B represented the outside
limit of what the Committee should aim for over this period.
Mr. Hayes observed that under those circumstances, and in
view of the staff projections, he thought the Committee would have
to be prepared to see some further rise in the Federal funds rate
duringtheperiod ahead from the current level of around 9-1/2 per
cent.
On balance, he would prefer a range along the lines of
alternative B, with the Manager moving promptly to a firm 9-3/4
to 10 per cent, and subsequently probing higher--with due regard
to Treasury financing operations--if the aggregates were close
to or above the top of their 2-month tolerance ranges.
He would
both widen and lower the ranges under alternative B, preferring
4 to 8 per cent for M1 and 5 to 9 per cent for M2.
He realized
that a further rise in the funds rate could, in the current market
atmosphere, produce a sharp rise in both short- and long-term
interest rates.
The Committee should take that risk, recognizing
that it could relax its reserve stance once the aggregates were
under control.
He would also note that the rise in rates in
recent weeks had been helpful on the international side.
Needless
-118-
3/19/74
to say, the Committee had to remain very alert to capital flows in
the weeks and months ahead.
With regard to the directive, the
language of alternative B with its reference to maintaining bank
reserve and money market conditions "consistent with moderate growth
in monetary aggregates over the months ahead" continued to be
satisfactory.
Mr. Eastburn's proposed substitute also would have
been satisfactory, but he agreed that it raised issues that it
would be better to defer.
Mr. Morris remarked that the facts that had become avail
able during the past 4 weeks had led to a modest shift in his
position.
He was more cautious now than earlier both because the
economic statistics were of a more mixed character than he had
expected and because the bulge in M 1 growth--which earlier was
suspect because of its association with the large decline in
Treasury balances--no longer could be explained away.
As a con
sequence, he would not advocate, as he had in recent months, that
the Federal funds rate be moved down--at least not until the
situation became more clear.
On the other hand, Mr. Morris said, he still believed that
the economy was in the early to middle stages of a recession.
Although the staff projected an upturn at midyear--and he saw no
reason to quarrel with the projections--the indicators offered no
3/19/74
-119
clear evidence of an upturn.
Therefore, it was a little too early
to move toward a more restrictive policy; he would prefer that
such a policy move be delayed until the evidence clearly indicated
that economic activity had turned up.
Thus there were risks in
both alternatives B and C, and although he had modified his posi
tion, he favored alternative A.
If the projections were correct,
that policy course would result in a 6-1/2 per cent rate of growth
in M1 over the second and third quarters combined.
While he would
not be too happy about such a rate of growth, it would not be
alarming for a period of recession.
In those circumstances, he
favored the suggestion to widen the short-run ranges for the
aggregates.
Mr. Mayo observed that economic prospects appeared to be a
little better now than a month ago, and he would not want to do
anything that would inhibit improvement.
Like Mr. Morris, he did
not believe that there was evidence pointing to an upturn in
activity--although the prospective lifting of the oil embargo was
bound to be beneficial--and he would want to proceed cautiously.
As he had pointed out at the February meeting, a 6 per cent growth
path for M1 in the first and second quarters combined had merit.
In effect, alternative B represented such a path; the indicated
3/19/74
-120-
rate of 6.7 per cent in the first quarter combined with the second
quarter rate of 5.7 per cent projected under alternative B, yielded
a rate of 6.2 per cent for the two quarters combined.
In general,
he favored alternative B--with the wider, three percentage point
short-run ranges for the aggregates--and believed it to be consis
tent with the longer-run objective of a 5-3/4 per cent path.
The
5 per cent rate of growth for the third quarter projected under
alternative B might be a little too restrictive, but the Committee
would have an opportunity to consider that prospect again at its
next meeting.
Specifically, Mr. Mayo continued, he would suggest ranges
of 6 to 9 per cent for M1 in the March-April period and the appro
priate three percentage point ranges for RPD's and for M2.
favored a range of 9 to 10-1/2 per cent for the funds rate.
He
He
would not object if the rate moved up a little from its recent
level, which was near the mid-point of that range, although he
hoped that it would not go over 10 per cent.
In line with
Mr. Axilrod's suggestion, he would encourage the Desk to watch,
for opportunities to buy coupon issues so that further increases
in long-term rates might be inhibited.
Chairman Burns remarked that total employment was at a
peak--that there had been a leveling off rather than a decline.
3/19/74
-121-
While a slowdown or recession in economic activity clearly had
occurred, it was confined almost entirely to the automobile industry
and residential construction.
Real consumer spending had declined,
but business fixed investment had risen.
The reduction in real
consumer purchases had been caused by the inflation-induced erosion
in real income of the average wage earner--which had declined 4 per
cent over the year to January 1974--and by the large increase in
consumer debt that had occurred during the upsurge in consumer buy
ing of autos and household goods in late 1972 and the first half
of 1973.
Although the reaction in consumer buying could go too
far and last too long, it probably was healthy.
Monetary stimula
tion at present could lead to further increases in consumer debt
that would be undesirable.
Mr. Bucher commented that the current economic situation
was aptly characterized by the remark an economic consultant was
said to have made to a client:
"Be sure to keep in touch as I
intend to make frequent forecasts."
He agreed that the rates of
growth of the monetary aggregates in February and those forecast
for March appeared to be disturbingly high, and continuation of
relatively high rates of growth could lead over the longer run to
intensification of inflationary pressures.
The prospect of "double
digit" inflation was frightening, but even with further increases
3/19/74
-122-
in prices of petroleum products, the GNP deflator was projected
to rise at rates of 6.1 and 6.2 per cent in the third and fourth
quarters of this year.
However, the question was whether it would
be appropriate to move in the near term to correct for the excessively
high growth in M
1
relative to the Committee's longer-run target path
or to pause, pending a better reading on both the money stock and
the effect the lifting of the oil embargo would have on the economy.
To an unknown extent, Mr. Bucher continued, the growth rate
of M 1 in the February-March period might be associated with special
factors.
Private deposit balances were probably enlarged by the
unusually sharp decline in U.S. Government deposits, related in
part to tax refunds.
In addition, some of the growth might be
explained by a rebuilding of cash balances following the decline
in M 1 in January.
Moreover, currency growth was quite large in
February; the behavior of currencywas difficult to explain and such
sizable changes often had been erratic and generally had been transi
tory.
If such special factors had increased demands for cash
balances, it could be that their diminution or disappearance would
lead to more moderate growth in M1 in coming months.
Under alterna
tive A--as Mr. Axilrod had indicated, and Mr. Holmes had agreedincreases in market rates of interest already in process could well
continue.
That would help to slow growth in M1, even though the
3/19/74
-123-
projections did not indicate a return to the target path.
In any
event, projections of M1 growth in the present environment seemed
particularly subject to uncertainty.
Mr. Bucher observed that since the last FOMC meeting, market
interest rates had risen substantially, and as indicated, current
rate levels might not fully reflect the recent upward adjustment in
the Federal funds rate.
Moreover, some upward interest rate pres
sure might result from the upcoming large Treasury financing.
Thus,
in his view, it would be desirable to permit those adjustments to
occur without additional pressures that would emanate from a funds
rate above 9-1/2 per cent.
Given the current and prospective
weakness in economic activity and the importance of providing an
environment for a recovery in the credit-sensitive housing sectorand the large increase in housing starts in January was widely viewed
as an aberration--this was an appropriate time to pause and await
additional information with regard to the course of the monetary
aggregates and the direction of the economy.
If developments over
the next month suggested the need to tighten, the April Committee
meeting would appear to be soon enough. At this time, he could
accept alternative A, and like Mr. Morris, he would widen the
short-run ranges of tolerance for the aggregates.
The language
of the operational paragraph, including the reference to growth
over the past 6 months, was acceptable to him.
3/19/74
-124-
Mr. Black remarked that the Committee was confronted with
an unusually difficult problem.
Most members no doubt would agree
that inflation was the major problem.
But the rapid rate of growth
in M1 --which was somewhat unexpected--was occurring at a time when
the market for short-term securities was unsettled.
It might be,
as Mr. Bucher had suggested, that the high rate of monetary growth
was an aberration; at a time of large changes in Treasury balances,
it might be better to pay more attention to the bank credit proxy,
which had been growing moderately.
Because of the current sensitivity
of the markets--owing to the rapid rise in short-term rates and
market expectations that the System would push rates up furtherand because of the forthcoming Treasury financing, there were con
straints on what the Committee could do.
He would be concerned
that further increases in rates would abort the budding recovery
in the mortgage market.
It also needed to be borne in mind that
the economy was suffering from built-in inflation--resulting from
the fuel problem, from shortages of other materials, and from wage
pressures--that monetary policy could not dissipate; it was a
problem that, unfortunately, had to be dealt with over a longer
period, perhaps a year.
Consequently, Mr. Black said, he would not reduce the
longer-run target for M
below 5-1/2 per cent.
Although generally
3/19/74
,125-
favoring a wide range for the funds rate, at this time he would
establish a relatively narrow range of 9 to 10 per cent because
of the current market situation.
of alternative B.
And he would adopt the language
If growth in the aggregates proved to be lower
than the rates projected, the System would have avoided upsetting
the market.
However, if the aggregates continued to grow rapidly,
he would be prepared at the April meeting--or in consultation
before that meeting--to move the funds rate up a notch further.
Mr. Balles observed that, compared with some others, he
had more confidence in the projections which suggested that the
economic outlook had been strengthened by the lifting of the oil
embargo.
Unfortunately, however, a higher rate of inflation also
appeared likely.
In view of the changed economic outlook, he
believed that Chairman Burns' statements on appropriate monetary
and fiscal policy in his recent testimony before the Joint
Economic Committee were especially relevant.
Continuing, Mr. Balles remarked that while participating
in the daily call during the past month, he had expressed his con
cern and apprehension about the overshoots in the aggregates in
view of the problem of "two-digit" inflation.
While recognizing
that Desk operations had been constrained by the upper limit of
the range of tolerance for the Federal funds rate, he nevertheless
-126-
3/19/74
was reminded of the Chairman's observation concerning the overshoot
in the first quarter of 1973, to the effect that the System had
been providing too many reserves.
He was beginning to feel at
this time that growth in reserves was excessive.
Consequently,
he leaned more toward alternative C than alternative B in order
to return monetary growth to the 5-3/4 per cent path--which the
Committee had agreed upon at its last two meetings--by June rather
than September.
Measured on a quarterly average basis, which he
believed was the best method, M1
was indicated to grow over the
first half of 1974 at an annual rate of 6.2 per cent under alterna
tive C, compared with 6.5 per cent under alternative B and 6.9 per
cent under alternative A.
In his view, growth at the 6.2 per cent
rate would be quite adequate if an effort was to be made to reduce
inflationary pressures and growing inflationary expectations.
For
the language of the operational paragraph, however, he favored
alternative B.
Chairman Burns remarked that it might be helpful if the
Committee's Senior Economist gave his policy recommendations at
this point.
Mr. Partee said he would like to make a few points about
the thrust of Committee policy.
First, he believed that the objec
tive of holding down on the rate of monetary growth should be
3/19/74
-127-
continued in order to dampen inflationary pressures.
Second, the
pursuit of such a policy objective at this time, as always,
involved the danger of precipitating a cumulative decline in
economic activity that subsequently would require remedial fiscal
and monetary policies of an inflationary character.
Third, the
termination of the oil embargo had reduced the risk of a cumulative
decline in activity; while the specific quantitative impact of the
embargo's end might be debatable, the direction of its impact was
not.
And as Chairman Burns had noted, up to this point there was
very little evidence that a cumulative decline had in fact been
developing.
Finally, therefore, the Committee was now in a better
position to run the risk of higher interest rates in pursuit of a
moderate rate of monetary growth, even though higher interest rates
might dampen the projected recovery in residential construction;
the recovery in housing no longer appeared to be as crucial an
element as before in the projected expansion in economic activity
in the second half of the year.
While such a policy course clearly
would not maximize real output and employment, it represented a
reasonable compromise between the objectives for output and prices.
In that light, he could support alternative B.
Mr. MacLaury commented that he had found helpful the device
used in the blue book of differentiating the alternatives for policy
3/19/74
-128-
in terms of the time period required to return M1 to its longer
run growth path.
On the other hand, he would urge that throughout
the blue book quarterly averages be used in measuring rates of
growth in the aggregates.
Like
Mr. Balles, he found the quarterly
averages a more satisfactory method of measurement.
With respect to the economic outlook, Mr. MacLaury said,
he was in agreement with those who interpreted the developments
of the past month as lessening the risks of a cumulative downturn
and improving prospects for an upturn later in the year.
Accord
ingly, like Mr. Morris, he had modified his policy position some
what.
The most important decision the Committee made, in his
view, was its choice of a longer-run path for monetary growth,
and he would now be content with the growth path of 5-3/4 per cent
rather than the 6 per cent path that he had advocated at the last
meeting.
Having some skepticism about the recent data and the
indicated strength in the aggregates, however, he did not see a
need to pursue a return to the 5-3/4 per cent path by June, as
called for under alternative C, especially because of the staff's
judgment that such a course would lead to a shortfall from path
later on.
He would be happy with alternative B, modified to
reduce the lower limits of the short-run ranges of tolerance for
the aggregates.
Because of his skepticism about the recent strength
3/19/74
-129-
in the aggregates, he would set an upper limit of 10 per cent for
the funds rate, specifying a range of 8-3/4 to 10 per cent.
While
some might view alternative B as a restrictive policy because of
its implications for money market conditions and interest rates,
he would not consider it as such because it represented an effort
to return monetary growth to the longer-run path at a time when
growth had been well above path.
Finally, Mr. MacLaury observed, he had not interpreted the
language that Mr. Eastburn had proposed for the operational para
graph of the directive as precedent-setting; he considered it a
matter of preference whether, as often in the past, the Committee's
longer-run targets were referred to in relation to rates of growth
in some past period.
However, he agreed that it would be desirable
to consider the whole subject at another time.
Mr. Mitchell remarked that from time to time in the past the
Committee had debated the question of how specific the language of
the directive should be, and more recently the adoption of longer
run targets for the aggregates had raised the additional issue of
whether to disclose those targets in the policy record.
His own
view was that the Committee ought to be more specific in describ
ing what it was doing, but he agreed that the issue should be debated
and resolved at another time.
3/19/74
-130-
Mr. Clay observed that most interest rates had reversed
their downward slide and had advanced strongly since the last
Committee meeting.
Those advancing rates could not be attributed
to a tightening in monetary policy, with virtually all the aggre
gates either piercing or being near the upper ranges of tolerance
specified by the Committee.
Neither could those advancing rates
be attributed to increased demand for loans because of expected
sharp increases in economic activity.
The most logical explana
tion was that they were inflation oriented.
Since both monetary
and fiscal policy had been highly expansive, the recent weaknesses
in the economy and increasing interest rates must be attributed to
something other than failure to follow expansive monetary and fiscal
policies.
Mr. Clay remarked that failure to recognize the impact of
expansive policies probably was largely responsible for much
confusion in economic analysis.
The blue book forecasted rather
sharply increasing short-term rates unless monetary policy followed
a substantially easier stance than had been prescribed by the
Committee for some time.
In his view, however, there was a
strong probability that an easier monetary policy now might
increase rather than alleviate the problems associated with
increasing short-term interest rates.
Increases in interest
3/19/74
-131-
rates were provoked by inflation as well as, in the short run, by
a tightening of policy; the economy had reached the point where
increases in interest rates were likely to occur with almost any
monetary policy.
Recent growth of M1 and M2, Mr. Clay continued, would
provide plenty of liquidity to fuel a recovery later this year
if the rate of inflation could be retarded.
Indeed, given the
rapid rate of monetary growth already experienced in the first
quarter, aggregate growth rates indexed by M
growth of less than
5 per cent over the second and third quarters now seemed to be
necessary to insure a recovery without accelerating inflationary
problems.
As he had indicated, achieving lower monetary growth
rates probably would mean increasing short-term rates.
In the
next few weeks, the funds rate likely would rise above the 9-1/2
per cent area.
Given current market sensitivity to System actions,
that increase was likely to cause further rises in other rates.
In
a period in which inflation rates would indicate negative real costs
for short-term borrowing, increases in interest rates to bring infla
tion under control likely would not discourage recovery in the
latter part of the year.
Therefore, Mr. Clay said, his preference would be
to use
the language of alternative C and the long-term targets somewhat
-132-
3/19/74
above those of alternative C, as indexed by an M1 growth rate of
4-3/4 per cent.
In his judgment, such a specification would be
compatible with the Federal funds and associated short-term
ranges of alternative B.
Mr. Kimbrel remarked that inflation continued to be the
primary concern, and the rate of increase in prices in the United
States relative to that in other countries raised questions about
the creditability of Federal Reserve policies to deal with it.
In
the Atlanta District, as in the country as a whole, economic weakness
was localized.
Nonfarm employment had declined only in Florida
of the six states in the District, and there the reductions
had been localized.
Florida bankers had reported that they
understood their own problem and ultimately would be able to deal
with it.
However, they were much more concerned about inflation
than about the energy crisis or their immediate difficulties.
Unemployment seemed to be confined mainly to the automobile industry,
and reports suggested that the unemployed were drawing from 90 to
95 per cent of their normal pay; consequently they were not
experiencing substantial income losses at the moment.
Mr. Kimbrel observed that, because of the need to deal
with inflation, he would hope that the rate of monetary growth
could be returned to the longer-run path by June while avoiding
3/19/74
-133-
unreasonable disruption.
Accordingly, he favored the specifications
of alternative C, although he preferred the language of alternative B.
He would be inclined to take into consideration near-term develop
ments in the money market, shading a little on the downside, but
somewhat higher levels of the funds rate would be required; a price
had to be paid sooner or later.
He hoped that flows to thrift
institutions would not be unnecessarily disrupted, but in any case
flows had improved and the institutions were beginning to seek
outlets for funds.
And while having an orderly Treasury financing
was an important objective, it could not be the main determinant
of policy.
Mr. Wallich remarked that he was impressed with the emphasis
placed on monetary aggregates in the discussion.
He was concerned
that the interest rate which figured most prominently in the
discussion--the funds rate--was not really the one most relevant
for development of the economy; long-term bond and mortgage rates
were the relevant rates.
The funds rate, he recognized, was an
operating target because short-term rates were the only ones the
Committee could control, but he wanted to consider what open
market policy would do to long-term as well as to short-term
rates.
3/19/74
-134-
Mr. Wallich observed that what the Committee did at this
point would have its principal impact 6 to 9 months from now; in
the shorter run, only such financial variables as interest rates
and capital flows would be affected.
Looking ahead 6 to 9 months,
he was inclined to believe that the cyclical turning point would have
been left well behind by then.
The economy clearly was a lot stronger
than it had seemed a month or two ago, and it would
strength if, indeed, the embargo had ended.
gain further
From a cyclical stand
point, therefore, the economy was moving into a new expansion.
It
was doing so under conditions of inflation at a rate of from 5 to
10 per cent; a rate of unemployment only about one percentage point
above what passed for full employment nowadays;
real shortages of
industrial capacity and materials; a large budget deficit; and
interest rates close to 10 per cent.
If policies adopted now
brought about an acceleration of the expansion, they would lead
to a rapid resumption of capacity pressures, a faster rate of
increase in prices, and still higher interest rates.
In the next
boom, then, prices might be rising in a range of 10 to 15 per cent.
That had been the experience in some European countries.
At this point, Mr. Wallich remarked, it would be a mistake
to accelerate the recovery; the objective should be to pursue
a path of monetary growth such that economic activity continued to
3/19/74
-135-
expand, but at a rate not necessarily much faster than its potential
and perhaps even below.
Although that might lead to political
problems, real GNP would be rising and the economy would not be
going into recession.
At the same time, excess capacity would
be increasing somewhat, providing some possibility of a gradual
reduction in the rate of inflation.
He would reject as both sub
stantively and politically unsound a policy of so tight a rein
that economic activity failed to recover at all and excess capacity
built up rapidly.
In terms of immediate action, Mr. Wallich said, he did
not believe sufficiently in the importance of M 1 or any of the
aggregates to argue for returning to a particular path very
rapidly if that would bring about a jump in interest rates.
Over
time, a return to path was desirable, and he would not quarrel
with an M1 growth rate of 5 to 6 per cent.
After allowance for the
upward trend in the income velocity of money and the effects of
very high interest rates, such a rate of growth in M1 would
support growth in nominal GNP at a rate on the order of 7 to 9
per cent.
Thus he was among those who favored alternative C,
but with a proviso that he would not be eager to return M1
growth path by June.
to its
3/19/74
-136-
Mr. Holland observed that the outlook for real GNP was
stronger now than a month ago for a number of reasons, some of
which had traditional cyclical significance and others of which
did not.
He was, however, skeptical of the estimate of the size
of the fillip to GNP growth provided by termination of the oil em
bargo.
In large part because of the oil situation, the outlook also
was for a faster rise in prices.
Although skeptical of the validity
and persistence of the recent acceleration in growth in the mone
tary aggregates, he believed that the present stage in the formu
lation of economic policy was serious enough that it would be
prudent to move in the direction of resisting the developments
that those admittedly imperfect indicators were suggesting.
Thus,
he wanted monetary policy to be supplying somewhat more resistance
to inflationary developments than he favored a month ago.
In
talking about increased resistance to inflationary pressures,
however, it was necessary to recognize that there was an adjust
ment process involved.
The process of resisting a strengthening
in GNP-related and other demands for money involved allow
ing some bulge in monetary growth to develop and then squeezing
it out.
That sort of development was the most reasonable prospect
and was the one the Committee should be trying to attune its policy
prescription and specifications to.
3/19/74
-137-
While attracted to alternative B, Mr. Holland said, he believed
that the longer-run targets should be adjusted.
If there were inade
quate analytical support for adjusting them, he would prefer to drop
them altogether; adoption of the targets specified under alternative B
represented, to him, a hope more than an analytical decision.
He would
suggest raising the targets for M, and the credit proxy to 6 per cent.
It was consistent not to raise the target for M 2 because interest rates
would rise sufficiently to slow down inflows of time and savings
deposits to banks and nonbank thrift institutions.
Such a policy
would not add to inflationary pressures; rather, it would be a realistic
approach to a process of working down the growth rates in the aggre
gates and of working down the inflationary steam in interest rates and
credit conditions over a longer period of time than the next 6 months.
Such a policy would be likely to involve some rise in interest rates,
which he was prepared to accept.
However, the Committee should be
careful to avoid acting so abruptly as to produce a sharp jump in
rates, which would be counter-productive.
In the current environ
ment, the possibility of such a jump could not be excluded.
Mr. Holland said he would widen the short-run ranges of
tolerance for the aggregates by one-half of a percentage point in
both directions.
For the funds rate, a range of 9 to 10-1/2 per cent
3/19/74
-138-
was reasonable, given the interval of modest but nevertheless real
even keel in the period ahead.
For reasons that were stated in
Part I of the Manager's annual report for 1973, it was important
to instruct the Manager to move the funds rate promptly rather than
to wait until the aggregates approached the upper limits of their
ranges.
He wanted the System to be niggardly in supplying reserves
in the near term so that the funds rate would move up to around
9-3/4 per cent before the Treasury financing; even keel would then
unfold against that greater degree of reserve restraint and
pressure on the price of reserves.
Mr. Holland added that the Manager would need to remain
in close touch with the Chairman as money market conditions
tightened so that a pause could be called for in the event of
undue market reactions.
On the other hand, should growth in the
aggregates be revised downward--and the chances of that happening
were not insignificant--he would like the Manager to so inform the
Chairman before undertaking any easing actions.
In such an event,
as he had said before, he would like the Board to have an opportunity
to consider a realignment of reserve requirements as an alternative.
Finally, he endorsed the suggestion that the Manager might con
structively buy coupon issues as part of his reserve-supplying
operations in the period ahead, with due regard for even keel.
3/19/74
-139-
Chairman Burns remarked that governments were weak in all
of the democratic countries of Europe--indeed, in virtually all
countries of the world except for a few of the totalitarian regimes.
Because weak governments could not cope with the problem of infla
tion, the task had become the inevitable responsibility of central
banks.
Although their ability to deal with inflation was limited,
central banks were discharging that responsibility at present.
How long they could continue to do so was uncertain, since apart
from the Federal Reserve--and, to a degree, the German Federal
Bank--central banks were no longer independent.
Because the System had substantial independence, the Chairman
observed, it could resist political pressures to pursue inflationary
policies, and it should do so.
Moreover, at the present time
neither the Administration nor the Congress was urging the Federal
Reserve to pursue a more expansionary course.
One of the distin
guished liberal members of the Congress recently had commented to
him that the System was not exercising with sufficient determina
tion the independent power that the Congress had deliberately
granted to it.
There was no question in his mind, the Chairman continued,
that inflation was the major economic problem facing the nation,
as well as the world.
However, he would not favor adopting the
-140-
3/19/74
specifications of alternative C today; the Committee should avoid
abrupt shifts in its policy stance, and in his opinion a rise in the
Federal funds rate of the magnitude likely under that alternative
would be unduly sharp in the short run.
Although his views were
subject to change as the Committee's deliberations proceeded, at
the moment he was inclined toward the B specifications, perhaps
with some reduction in the 10-3/4 per cent upper limit shown for
the funds rate.
He also favored the suggestion to reduce the
lower limits of the 2-month ranges for growth rates in the
aggregates.
Mr. Francis remarked that the developments with regard to
the monetary aggregates over the past couple of months were dis
concerting, but not altogether surprising.
noteworthy.
Several points appeared
Even though the Committee had not adopted the alterna
tive A specifications in January, the level of M1 now indicated for
March was $300 million greater than
called for by those specifica
tions and the Federal funds rate had moved to the upper end of the
range shown under A in the January blue book.
The directive had
called for slower growth in aggregates than actually occurred.
In the February blue book, Mr. Francis continued, levels
of the aggregates specified under all alternatives for both March
and June were reduced considerably, and the ranges of the funds rate
-141
3/19/74
constraint were lowered significantly.
In the past month growth of
M1 had been greater than called for under the February alterna
tive A,
even though the Federal funds
rate exceeded the A range.
But last month the Committee again had issued a directive, based
on blue book specifications, calling for much slower growth of M1
than indicated under alternative A.
belief
At that
time, it was his
that there would be more upward pressure on rates and
greater growth in the aggregates.
Mr. Francis noted that the growth of M1 specified under
alternative C in the current blue book was at the upper end of
what he would like.
concerned
calling
Given past operating strategy, he was again
that even if the Committee were to adopt a directive
for growth
of aggregates
on the order of the B or C alterna
tives,
the actual outcome again might be somethimg more like A.
If so,
then the growth of M1 through the
first two, and possibly
three, quarters of this year would be at a 7 per cent rate--the
same as
the average of the past 3 years.
He continued to believe
that the dangers for error were on the side of greater monetary
growth than desired.
To minimize that risk, he would suggest rais
ing the upper end of the Federal funds
rate range sufficiently to give
the Desk latitude to slow the growth of reserves and
the monetary base.
-142-
3/19/74
Mr. Francis urged that the Committee adopt the C alternative
for M1 through June, but not accept the suggestion that a sharp
drop in M
growth in the third quarter would be inevitable.
He
might add that, when he observed that over the last year the
monetary base had continued to grow at the previous year's rate
of 7.7 per cent, and when he noted the deviation of growth in
money from growth in the base, he felt considerable concern,
based on historical experience, that there still might be pressure
for the money growth rate to move back to that of the base.
Mr. Coldwell commented that he had not advocated easing
actions at recent meetings because he considered inflation to be
the nation's main economic problem.
He still held that view.
The lifting of the oil embargo added another element to the
picture, if only in that it would tend to raise some expectations
and to improve consumer psychology.
He thought the end of the
embargo would help clarify the underlying situation, but the situa
tion would not become really clear until wage and price controls
were removed.
He suspected that problems arising in the interna
tional area were likely to be especially important in the next
few months; in particular, he was worried that the dollar might
come under additional downward pressure as a consequence of the
embargo's end.
-143-
3/19/74
Mr. Coldwell went on to say he shared the view that the
Committee tended to focus too closely on the growth rate in M1.
It would be well, in his judgment, to pay more attention to
interest rate relationships over the longer run; he was especially
concerned about the prospect of entering a new period of expansion
with the Federal funds rate in the neighborhood of 10 per cent
and other key interest rates in an 8 to 10 per cent range.
With respect to the directive, Mr. Coldwell continued,
he would favor making one revision in the staff's draft of the
paragraph describing the Committee's general policy stance.
In
the list of objectives shown in the draft, one was given as
"cushioning weakness in economic activity."
He would prefer to
describe the objective in terms of "supporting a resumption of
real economic growth."
Chairman Burns remarked that that proposal was acceptable
to him.
He asked whether there were any objections to it, and
none was heard.
As to the operational paragraph, Mr. Coldwell continued,
he was disturbed by the variety of historical time periods that had
been suggested at various points as a basis for describing the monetary
growth rates desired by the Committee.
For example, in the language
suggested for alternatives A and C in the blue book, the desired
3/19/74
-144-
growth rates were expressed relative to the rates that had occurred
over the past 3 months.
In the draft directives distributed sub
sequently, the past 6 months was used as the time reference; and
in his proposal today, Mr. Eastburn had suggested using the past
year.
If the Committee were going to use such constructions, he
thought it should be consistent with respect to the length of the
period cited; he would favor 6 months.
operational paragraph was as follows:
His own preference for the
". . .the Committee seeks
to achieve bank reserve and money market conditions consistent
with about the same rate of growth in monetary aggregates as over
the past 6 months."
Mr. Coldwell said he agreed that the short-run ranges for
the monetary aggregates should be widened to 3 percentage points.
He would favor ranges of 5 to 8 per cent for M
for M 2 for the March-April period.
and 6 to 9 per cent
With respect to the funds rate,
he would set the range at 9-1/4 to 10-3/4 per cent.
He hoped that the
Desk would act promptly to achieve a rate around 9-3/4 per cent, and
would then await new information on the aggregates before seeking
further changes.
Mr. Brimmer referred to the Chairman's comment that total
employment had leveled off but not declined, and remarked that that
should not be surprising; total employment tended to decline in a
substantial recession, but in a mild recession unemployment increases
3/19/74
-145-
usually were a consequence of faster growth in the labor force
than in employment.
This year, with the civilian labor force
growing to about 91 million persons, an unemployment rate of
5-1/2 per cent would mean over 5 million people out of worknearly a million more than in 1973.
cern to the Committee.
That fact should be of con
He also did not share Mr. Wallich's view
that the unemployment rate equivalent to full employment was only
1 percentage point below the present rate.
However, Mr. Brimmer continued, he thought a policy course
similar to that the Chairman had suggested would be appropriate.
The unemployment rate was higher than might have been expected,
and certainly higher than he would have desired; he did not think
it should be tolerated for an extended period.
For the time being,
however, it might have to be accepted if the desired results with
respect to inflation were to be achieved.
He believed the Committee
should neither tighten nor ease at this point, and that any errors
made should be in the direction of accepting somewhat higher
interest rates.
Although he was not persuaded that a turnaround
in the economy was assured, he concurred in Mr. Partee's analysis
and conclusions; in particular, he agreed that the risks of a cumula
tive downturn were now reduced.
The course he favored was consistent
with the alternative B specifications with the 2-month ranges for
the aggregates widened from those shown in the blue book.
-146-
3/19/74
Mr. Brimmer said he agreed that any firming actions that
might be required should be taken before the Treasury financing;
he certainly would not want to firm in the midst of the financing.
He would, however, repeat his earlier observation that even keel
considerations should not prevent the Board from taking other policy
actions it might decide were appropriate, such as an adjustment
with respect to reserve requirements.
He would favor purchases of
coupon issues, although he would attach less importance to that
type of operation than some others might.
Chairman Burns observed that, details of language aside,
he could accept virtually every statement Mr. Brimmer had made.
Mr. Sheehan remarked that the information that had become
available since the Committee's previous meeting lent more support
to the position on policy the Chairman had taken in recent months
than to the position he (Mr. Sheehan) had taken.
He was not per
suaded, however, that all signs of weakness in the economy would
evaporate now that the oil embargo had been lifted.
He believed
that the economic outlook would be clearer in a month or two; at
this point, he would agree with Mr. Brimmer that policy should be
neither tightened nor eased.
Mr. Winn said he felt uneasy about a number of possible
developments, including international flows and possible shifts
3/19/74
-147-
of funds from nonbank thrift institutions to banks, and he
considered it important that the Desk have adequate flexibility
to deal with the kinds of flows it might be faced with in the
coming month.
Because of his concern about inflation, and partic
ularly in light of the wage-cost pressures that lay ahead, he
would favor maintaining a posture of restraint.
While he could
accept an outcome anywhere within the range covered by the blue
book alternatives, he would lean toward C.
Mr. Mitchell observed that some of the preceding speakers
evidently were much more confident about where the economy was
headed than he was.
His intuition suggested that the outlook was
more bearish than the data suggested or others seemed to believe.
Interest rates recently had fallen further than the Committee had
expected or desired as a result of market misinterpretations of the
stance of policy, and now, he thought, they were likely to increase
further than they should.
If the Desk acted to raise the Federal
funds rate to 9-3/4 per cent within the next few days, the market
would interpret that development as a signal of the Committee's
response to high growth rates in the aggregates, and expectations
of further upward pressure on interest rates would spread.
He
doubted that any useful policy purpose would be served by the
fears of disintermediation that would result.
An increase in the
3/19/74
-148-
funds rate would be particularly unfortunate if it coincided with
the prospective Treasury financing.
Mr. Brimmer remarked that he also would not advocate an
immediate increase in the funds rate.
In response to a question by the Chairman, Mr. Holmes said
the Treasury was likely to announce the financing some time this
week.
However from the point of view of even keel considerations,
the significant date was not that of the announcement but of the
auction;
that was likely to be within a period of 6 to 9 days.
Chairman Burns observed that there evidently would be
adequate time for the Desk to achieve a higher funds rate before
the financing if the Committee so desired.
that such
He believed, however,
a move should not be made immediately.
In general,
he would consider it a mistake for the Desk to give the market
signals about the Committee's policy decision the day after a
meeting.
At present, moreover, it should be recognized that the
funds rate had risen substantially in just the last few days.
If
a further increase were to be sought, he would favor waiting until
new data on the aggregates were available later in the week
before acting.
But the move could not be delayed too long if it
was to be accomplished before the auction date for the financing.
-149-
3/19/74
Mr. Holmes said it appeared likely at the moment that
there would be a need to supply reserves in the near term.
If
so, an increase in the funds rate could be achieved by supplying
fewer reserves than otherwise.
That process tended to produce
less of a reaction in the market than the process of actually
withdrawing reserves.
In a concluding observation, Mr. Mitchell said he would
be inclined to dissent from the consensus that appeared to have
emerged from the Committee's discussion if he felt more strongly
than he in fact did.
He did not expect to dissent so long
as the final decision was about what he now expected it to be.
Chairman Burns then remarked that he would offer a few
brief comments on the economic outlook before turning to the
directive and specifications.
First, it was evident that the
economy was going to be sluggish this year.
Secondly, a signifi
cant amount of unemployment was unavoidable at a time when the
economy was undergoing structural shifts.
Third, while he saw
no evidence of a cumulative decline in activity and doubted that
one would occur, he was aware from close study of past experience
that once a slowdown was under way it could turn out to be much
larger than anyone might anticipate on the basis of current infor
mation.
3/19/74
-150The Chairman then asked the members to express their
preference between alternative B, as drafted by the staff, and
the following language:
"To implement this policy, while taking
account of international and domestic financial market develop
ments, including the prospective Treasury financing, the Committee
seeks to achieve bank reserve and money market conditions that
would moderate growth in monetary aggregates over the months ahead."
Mr. Mitchell asked whether the proposed new language would
not be subject to the same objection as that suggested earlier by
Mr. Eastburn.
Chairman Burns said he thought it would not, because no
reference period was specified.
A majority of members expressed a preference for the
language read by the Chairman.
Chairman Burns then referred to Mr. Mitchell's earlier
comment about the degree of confidence with which some views on
the outlook had been expressed.
The manner in which people spoke
in meetings such as this was influenced by the need for brevity.
He was sure that, however
they may have formulated their state
ments, all participants in today's meeting approached the problem
of economic forecasting in a spirit of true humility.
He also believed
that the differences of view today were narrower than particular
3/19/74
-151-
terms used in the discussion might suggest.
No one had proposed
that the economy should be put through the wringer; no one had
suggested that monetary growth should come to an end; and no one
had indicated that the Committee could ignore interest rates entirely.
The Chairman then said he would offer certain suggestions
for the specifications and ask whether they met with the general
approval of the members even though they might not agree precisely
with the preferences originally expressed.
His suggestions, briefly,
were to adopt the longer-run targets shown under alternative B; the
short-run ranges of tolerance for the aggregates shown under B,
except that the lower limit of each range would be reduced by one
percentage point; and a range of 9 to 10-1/2 per cent for the
Federal funds rate.
Mr. Holland observed that, for reasons he had indicated
earlier, he would have preferred modifications in the longer-run
targets shown in the blue book to allow for the latest revisions
of the GNP projections.
However, he could accept the Chairman's
proposal.
Mr. Black asked whether the proposal would contemplate
having the Desk seek a higher funds rate late this week, along the
lines the Chairman had suggested earlier.
3/19/74
-152-
Mr. Holland said he would like in that connection to ask
a question of the Manager.
If the data becoming available on
Wednesday and Thursday indicated that the aggregates were at least
as strong as now projected, suggesting the desirability of raising
the funds rate to about 9-3/4 per cent, would there be sufficient
time before the auction date to do so?
In reply, Mr, Holmes noted that the auction date had not
yet been established.
If, as he thought likely, the auction would
be in 6 to 9 days, there should be adequate time for the purpose.
A discussion ensued of the various considerations likely
to affect the timing of the auction and the degree of flexibility
the Treasury might have with respect to the specific date.
Mr. Hayes said he would be inclined to begin moving toward
a higher funds rate immediately.
The advantages of acting well
ahead of the auction date seemed to him to outweigh
any risks of
giving market participants clues to the Committee's policy decision.
Chairman Burns asked whether there would be any objections
to delaying any change in the objective for the funds rate until
late in the week unless conversations with the Treasury about the
timing of the auction indicated that an earlier move would be
desirable.
No objections were raised.
-153-
3/19/74
The Chairman then proposed that the Committee vote on a
directive consisting of the staff's draft
of the general paragraphs,
with theamendment Mr. Coldwell had suggested earlier in the state
ment of general policy, and the language for the operational para
graph he (the Chairman) had read.
It would be understood that the
directive would be interpreted in accordance with the following
specifications.
The longer-run targets--namely, annual rates of
growth for the second and third quarters combined--would be 5-1/4,
7-3/4, and 5-1/2 per cent for M1 , M2, and the bank credit proxy,
respectively.
The associated ranges of tolerance for growth rates
in the March-April period would be 4 to 7 per cent for RPD's, 5-1/2
to 8-1/2 per cent for M1, and 6-3/4 to 9-3/4 per cent for M2.
The
range for the weekly average Federal funds rate in the inter-meeting
period would be 9 to 10-1/2 per cent.
By unanimous vote, the Federal
Reserve Bank of New York was authorized
and directed, until otherwise directed
by the Committee, to execute trans
actions for the System Account in
accordance with the following domestic
policy directive:
The information reviewed at this meeting suggests that
real output of goods and services is declining in the
current quarter, in large part because of the oil situa
tion, and that prices are continuing to rise rapidly. In
February industrial production and manufacturing employ
ment declined again, while total nonfarm payroll employ
ment recovered, and the unemployment rate was unchanged at
3/19/74
-154-
5.2 per cent. Prices of farm and food products and
industrial commodities increased sharply, although
less so than in the preceding 2 months.
Increases
in wage rates appear to have moderated in recent
months.
After depreciating during the first 3 weeks of
February, the dollar has since shown little net change
against leading foreign currencies. The U.S. trade
surplus remained large in January, despite a further
sharp rise in the cost of petroleum imports.
The narrowly defined money stock, after having
declined in January, increased sharply in February
and early March. Broader measures of the money stock
rose substantially in February, as net inflows of
consumer-type time deposits remained relatively strong.
Business short-term borrowing at banks and in the open
market has continued at a rapid pace. Following earlier
declines, both short- and long-term market interest
rates have risen appreciably in recent weeks.
In light of the foregoing developments, it is the
policy of the Federal Open Market Committee to foster
financial conditions conducive to resisting inflationary
pressures, supporting a resumption of real economic
growth, and maintaining equilibrium in the country's
balance of payments.
To implement this policy, while taking account of
international and domestic financial market developments,
including the prospective Treasury financing, the
Committee seeks to achieve bank reserve and money
market conditions that would moderate growth in mone
tary aggregates over the months ahead.
The specifications agreed upon by the
Secretary's Note:
Committee, in the form distributed following the meeting,
are appended to this memorandum as Attachment F.
3/19/74
-155
It
was agreed that the next meeting of the Committee would
be held on Monday and Tuesday, April 15 and 16, 1974, beginning on
Monday afternoon.
Thereupon the meeting adjourned.
Secretary
ATTACHMENT A
RESOLUTION OF FEDERAL OPEN MARKET COMMITTEE AUTHORIZING
CERTAIN ACTIONS BY FEDERAL RESERVE BANKS DURING AN EMERGENCY
(As last revised September 21, 1971)
The Federal Open Market Committee hereby authorizes each
Federal Reserve Bank to take any or all
of the actions set forth
below during war or defense emergency when such Federal Reserve
Bank finds itself unable after reasonable efforts to be in com
munication with the Federal Open Market Committee (or with the
Interim Committee acting in lieu of the Federal Open Market Com
mittee) or when the Federal Open Market Committee (or such
Interim Committee) is unable to function.
(1) Whenever it deems it necessary in the light of
economic conditions and the general credit situation then prevail
ing (after taking into account the possibility of providing
necessary credit through advances secured by direct obligations
of the United States under the last paragraph of section 13 of
the Federal Reserve Act), such Federal Reserve Bank may purchase
and sell obligations of the United States for its own account,
either outright or under repurchase agreement, from and to banks,
dealers or other holders of such obligations.
(2)
Such Federal Reserve Bank may in its discretion
purchase special certificates of indebtedness directly from the
United States in such amounts as may be needed to cover over
drafts in the general account of the Treasurer of the United
States on the books of such Bank or for the temporary accommoda
tion of the Treasury, but such Bank shall take all steps practi
cable at the time to insure as far as possible that the amount
of obligations acquired directly from the United States and held
by it, together with the amount of such obligations so acquired
and held by all other Federal Reserve Banks, does not exceed
$5 billion at any one time.
(3) Such Federal Reserve Bank may engage in operations
of the types specified in the Committee's authorization for
System foreign currency operations when requested to do so by
an authorized official of the U.S. Treasury Department; provided,
however, that such Bank shall take all steps practicable at the
time to insure as far as possible that, in light of the informa
tion available on other System foreign currency operations, its
own operations do not result in the aggregate in breaching any
of the several dollar limits specified in the authorization.
-2
Authority to take the actions set forth shall be effective
only until such time as the Federal Reserve Bank is able again to
establish communications with the Federal Open Market Committee (or
the Interim Committee), and such Committee is then functioning.
ATTACHMENT B
Henry C. Wallich
March 18, 1974
Notes on BIS Meeting of March 11-12, 1974
The discussion at the BIS meeting in Basle on March 11 and
12, 1974 focussed on the problems of the Euro-currency market, in
addition to the usual discussion of country conditions.
The magnitude of the capital flows back from the OPEC
countries continues to be estimated in the $25-50 billion range at
an annual rate.
It was pointed out by Christopher Dow and others
that this is the order of magnitude by which the Euro-currency
market has been increasing annually so far and that nothing alto
gether unusual or unmanageable seemed to be ahead.
Despite the general expectation of a massive inflow into
the Euro-currency market, very little OPEC money seems actually to
have been seen.
A possible explanation given by McDonald is that
the oil companies pay the OPEC countries with a three-month delay,
and that an additional two months or so is absorbed in computing
the amounts due; the big flows therefore might not begin until some
time during the summer.
It seemed generally to be assumed that the OPEC countries
would aim to invest their money with high liquidity and as high a
rate of return as possible.
Longer term commitments, concessionary
terms, equity or direct investment, and especially investment in the
United States seemed to be regarded as having low probability.
The question whether the borrowing needs of oil importing
countries would create excess demand in the Euro-currency markets
or whether the investments by the OPEC countries would on the
contrary generate an excess supply of funds was not treated in
details on these terms.
structure effects.
Instead, the discussion turned on term
Emminger especially argued that the demand of
the borrowers was of a medium-term nature and would be satisfied
by roll-over credits.
short-term funds.
The supply from the OPEC countries would be
This was likely to lead to a drop in short-term
rates and a rise in longer term rates.
That would be a desirable
development, he argued, because it would tend to drive borrowers
to sources other than the Euro-currency market while also inducing
lenders to seek other outlets.
Some concern was expressed about the tendency of the OPEC
countries to concentrate their deposits in a few well known banks.
This condition was already leading to congestion, with the maximum
capital on deposit ratios in London (1:18) being approached in some
cases.
The BIS, which is seeking to play a role in directing Arab
funds, believes that it can do a better job than the Arabs in
spreading the money more widely among depositary banks.
The possible need for lenders of last resort was discussed.
In case of a need to come to the aid of a Euro-currency bank in
difficulties, which central bank would have the responsibility?
The central bank in whose market the difficulties occurred?
The
central bank in whose currency the liabilities in question were
denominated?
If the bank in question were the branch of a foreign
bank, this presumably would throw the responsibility upon the head
office of the branch in the first place and upon the central bank
of the country of the head office in the last resort.
The need for more detailed statistical information was
stressed and the type of information that could feasibly be collected
was turned over for examination to the technical level.
The Euro
currency markets will be on the agenda once more for the April 8
meeting.
The discussion of country conditions showed a more optimistic
picture than the gloomy one that had prevailed a month previously.
Only a few countries may need to borrow in 1974 to cover their oil
deficit.
Some of these, such as France, have already completed much
of their borrowing.
Italy and secondarily the U.K. present the
main problem cases.
Italy has tried to diversify its borrowing away from the
Eurodollar market, where it may be approaching its credit ceiling.
The IMF, and swap lines with the Federal Reserve and with Common
Market countries, were referred to by Governor Carli as additional
sources.
The standby agreement with the IMF specified elimination
of the non-oil current account deficit in 1975, and limited the
amount of credit expansion.
limiting the budget deficits.
This in turn goes some way toward
For the United Kingdom, Gordon Richardson conveyed a
picture of severe inflationary pressures emanating in part from
the 36 per cent settlement of the mineworkers.
He thought, however,
that the deflationary effects of the oil deficit would provide all
the anti-inflationary monetary and fiscal action that seemed
appropriate at this time.
With respect to Germany, as well as in general, Otmar
Emminger questioned the contractive effect of the oil deficit.
The
resulting flow of funds into the Eurodollar market, the prospective
decline of short-term rates in that market as a result, together
with higher wage demands resulting in part from higher living costs
based on higher oil prices, all would combine to make the net effect
of the oil situation expansionary.
He foresaw no balance-of-payments
problems for Germany, at most a small current account deficit, but
massive cost-push pressure from a public service wage increase of
about 13 per cent in the face of a previously expected 10 per cent.
Before 1975 and after, the picture becomes more clouded.
It is unlikely that continued borrowing in the Euro-market by the
countries now heavily in deficit will be possible.
For some 30
developing countries that are not oil producers moreover the situation
is very serious as of now.
ATTACHMENT C
Effects of a Lifting of the Oil Embargo
on Key Economic Variables
1974
Q II
Q III
Q IV
Domestic-type auto sales
(Annual rate, millions of units)
1.
2.
Green book projection
Alternative
Difference
8-1/4
8-3/4
7-3/4
7-1/2
8
+1/2
+1/2
1,500
1,575
1,650
1,750
1,750
1,850
+ 75
+100
+100
95.6
95.6
96.5
97.5
97.2
98.2
+1.0
+1.0
7.0
6.2
6.9
5.9
6.6
-0.8
-1.0
-1.2
-1.5
-0.9
1.9
3.7
3.5
3.7
+0.6
+1.8
+0.2
7-1/4
+1/2
Housing starts
(Annual rates, thousands of units)
1.
2.
Green book projection
Alternative
Difference
Business Fixed Investment
(Billions of 1958$)
1.
2.
Green book projection
Alternative
Difference
Personal saving rate
(Per cent of disposable income)
1.
2.
Green book projection
Alternative
Difference
5.4
Growth in real GNP
(Per cent annual rate)
1.
2.
Green book projection
Alternative
Difference
~2
Q II
1974
Q III
Q IV
Increase in fixed-weight
(Deflator for private GNP)
1.
Green book projection
7.3
5.8
5.7
2.
Alternative
7.5
6.1
6.2
+0.2
+0.3
+0.5
5.8
5.7
6.0
5.7
6,2
5,8
-0.1
-0.3
-0.4
Difference
Unemployment rate (per cent)
1.
2.
Green book projection
Alternative
Difference
ATTACHMENT D
Drafts of Domestic Policy Directive for Consideration by the
Federal Open Market Committee at its Meeting on March 18-19, 1974
GENERAL PARAGRAPHS
The information reviewed at this meeting suggests that
real output of goods and services is declining in the current
quarter, in large part because of the oil situation, and that
prices are continuing to rise rapidly. In February industrial
production and manufacturing employment declined again, while
total nonfarm payroll employment recovered, and the unemployment
rate was unchanged at 5.2 per cent. Prices of farm and food
products and industrial commodities increased sharply, although
less so than in the preceding 2 months. Increases in wage rates
appear to have moderated in recent months.
After depreciating during the first 3 weeks of February,
the dollar has since shown little net change against leading
foreign currencies. The U.S. trade surplus remained large in
January, despite a further sharp rise in the cost of petroleum
imports.
The narrowly defined money stock, after having declined
in January, increased sharply in February and early March. Broader
measures of the money stock rose substantially in February, as net
inflows of consumer-type time deposits remained relatively strong.
Business short-term borrowing at banks and in the open market has
continued at a rapid pace. Following earlier declines, both short
and long-term market interest rates have risen appreciably in
recent weeks.
In light of the foregoing developments, it is the policy
of the Federal Open Market Committee to foster financial conditions
conducive to resisting inflationary pressures, cushioning weakness
in economic activity, and maintaining equilibrium in the country's
balance of payments.
OPERATIONAL PARAGRAPH
Alternative A
To implement this policy, while taking account of interna
tional and domestic financial market developments, the Committee seeks
to achieve bank reserve and money market conditions consistent with
moderately greater growth in monetary aggregates over the months
ahead than has occurred over the past 6 months.
-2
Alternative B
To implement this policy, while taking account of interna
tional and domestic financial market developments (including the
prospective Treasury financing), 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 interna
tional and domestic financial market developments (including the
prospective Treasury financing), the Committee seeks to achieve bank
reserve and money market conditions consistent with somewhat less
growth in monetary aggregates over the months ahead than has occurred
over the past 6 months.
ATTACHMENT E
DEALERS' NET INCOME FROM GOVERNMENTS BEFORE TAXES
1965
1966
1967
1968
1969
1970
1971
1972
1973
9-Year
Average
Dealer Banks' Profits
-4.5
8.5
1.4
-3.1
2.2
71.9
18.0
10.3
-0.3
+11.6
Nonbank Dealers' Profits
-8.3
23.3
25.3
-3.4
-0.-
114.9
120.2
28.8
-18.1
+31.4
Dealer Banks and Nonbank
Dealers' Profits
-12.8
31.8
26.7
-6.5
2.2
186.8
138.2
39.1
-18.4
+43.0
Note:
These data may not reflect consistent cost allocations by the dealers over time and may
not be comparable for the different dealers. The numbers are preliminary. The number
of dealers included has increased steadily over the period shown from 17 to 25.
ATTACHMENT F
March 19,
Points for FOMC guidance to Manager
in implementation of directive
A.
1974
Specifications
(As agreed, 3/19/74)
Longer-run targets (SAAR):
(second and third quarters combined)
5-1/4%
7-3/4%
Proxy
B.
5-1/2%
Short-run operating constraints:
1.
2.
Range of tolerance for RPD growth
rate (March-April average):
4 to 7%
Ranges of tolerance for monetary
aggregates (March-April average):
5-1/2 to 8-1/2%
6-3/4 to 9-3/4%
3.
Range of tolerance for Federal funds
rate (daily average in statement
weeks between meetings):
9 to 10-1/2%
4. Federal funds rate to be moved in an
orderly way within range of toleration.
5. Other considerations: account to be taken of international and domestic
financial market developments, including the prospective Treasury financing.
C. If it appears that the Committee's various operating constraints are
proving to 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.
@FedFRASER