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FIFTY SECOND
Annuaf Report
OF THE
BOARD OF GOVERNORS
OF THE FEDERAL RESERVE SYSTEM
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COVERING OPERATIONS FOR THE YEAR
1965
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DIGEST OF PRINCIPAL FEDERAL
Period
Action
RESERVE
I
POLICY ACTIONS IN 1965
Purpose
January
Reduced System holdings of U.S. Government secu
rities by about $500 million. Member bank borrow
ings averaged $300 million.
To absorb seasonal reflow of bank reserves while maintaining about
the same firmness in the money market as had prevailed in earlier
weeks.
February
Introduced a program, at the request of the President
and in cooperation with the Treasury, under which
financial institutions were asked to limit voluntarily
their expansion of foreign loans and investments.
To reduce the outflow of private capital and thus improve the U.S.
balance of payments and strengthen the international position of
the dollar.
FebruaryMarch
Limited the increase in System holdings of U.S. Gov
ernment securities to about $1.0 billion, nearly one
fifth of which were securities maturing in over 1
year. Member bank borrowings rose to an average
of nearly $500 million in late March.
To move toward firmer conditions in the money market, while off
setting a $600 million gold outflow, and to encourage more mod
erate growth in the reserve base, bank credit, and the money
supply--in an effort to reinforce the voluntary foreign credit
restraint program and avoid the emergence of inflationary
pressures.
April
Limited the increase in System holdings of U.S. Gov
ernment securities to about $2.4 billion, nearly one
third of which were securities maturing in over 1
year. Member bank borrowings averaged $500
million.
To offset a drain on bank reserves from market factors-as outflows
of $2.5 billion in currency and $700 million in gold were only
partly offset by reserves supplied from other technical factors
while attempting to maintain firm conditions in the money market
in a period of rising credit demands and shifting expectations
and at the same time accommodating no more than moderate
growth in bank reserves, bank credit, and money.
Early
December
(1) Raised the discount rate from 4 to 4
per cent
and (2) raised maximum interest rates payable by
member banks on time deposits (other than savings
deposits) from 4 to 5 2 per cent for maturities
of 30-89 days and from 4
to 5
per cent for
longer maturities.
(1) To moderate additional bank reliance on short-term borrowings
from the Federal Reserve to meet intensifying loan demand and
(2) to enable banks to attract and retain time deposits of busi
nesses and individuals and thus to assure an adequate flow of funds.
December
Increased System holdings of U.S. Government secu
rities by about $1.1 billion, one-fifth of which repre
sented securities acquired under repurchase agree
ments. Member bank borrowings averaged about
$450 million.
To moderate adjustments in money and credit markets following
the December discount rate increase and to offset part of the
seasonal drain on bank reserves.
November
L
ANNUAL REPORT OF BOARD OF GOVERNORS
members thought that a slight reduction in monetary ease also
was appropriate on domestic grounds in view of the latent in
flationary pressures they saw, and some expressed the view that
it would tend to sustain the current expansion by helping to
avoid speculative excesses.
The following current economic policy directive was issued
to the Federal Reserve Bank of New York:
In light of the economic and financial developments reviewed at this
meeting, including the generally strong and continuing expansion of the
domestic economy and the continuing adverse position of our interna
tional balance of payments, it remains the Federal Open Market Com
mittee's current policy to accommodate growth in the reserve base, bank
credit, and the money supply but at a more moderate pace than in recent
months. This policy seeks to avoid the emergence of inflationary pres
sures and to support other measures that may be taken to strengthen the
international position of the dollar.
To implement this policy, while taking into account Treasury financing,
System open market operations over the next 4 weeks shall be conducted
with a view to moving toward slightly firmer conditions in the money
market than have prevailed in recent weeks.
Votes for this action: Messrs. Martin, Hayes,
Balderston, Daane, Hickman, Mills, Shepardson,
Shuford, Swan, and Wayne. Votes against this
action: Messrs. Mitchell and Robertson.
Messrs. Mitchell and Robertson dissented from this action be
cause they believed that additional monetary restraint was not
warranted either by present domestic conditions or by the bal
ance of payments situation. They noted that the present high
levels of demand for steel and automobiles were likely to be
only temporary, and that any expansive effects of the Federal
fiscal program would not be felt until the second half of the
year. As to the balance of payments, they thought that-in
view of the large differentials existing between interest rates in
the United States and abroad-a policy change large enough
to reduce capital outflows significantly would have severe de
flationary effects on the economy. For this reason, Mr. Robert-
FEDERAL RESERVE SYSTEM
son felt that the appropriate remedy for the international pay
ments problem lay elsewhere than in the area of monetary
policy, and Mr. Mitchell thought it lay in specific measures to
remove the disequilibrating effect of international interest rate
differentials. Mr. Robertson added that in his judgment Treas
ury financing operations and the recent weakness in security
markets also argued for keeping policy on a steady course at
present.
March 2, 1965
1. Authority to effect transactions in System Account.
Economic activity was continuing to advance after four con
secutive years of expansion. In January, steel and automobile
production remained at high levels, and output gains in a broad
variety of other industries carried total industrial production to
a new peak. Retail sales continued strong in January and early
February; sales of new domestic cars were at a record annual
rate of 9.7 million units in the first month of the year. Although
stock-sales ratios remained low, rough estimates suggested that
the rate of inventory accumulation continued high in early 1965
after turning up sharply in the closing months of 1964. Much
of the accumulation still was related to strikes-both the pos
sible strike in steel and the earlier strike in automobiles-but
stocks of other commodities apparently also were growing
rapidly. Labor markets were strong in January: nonfarm em
ployment increased further; the average manufacturing work
week was extended to the longest period since World War II; and
the unemployment rate declined to 4.8 per cent from 5 per cent
in December.
Average industrial commodity prices, which had risen six
tenths of 1 per cent in the fourth quarter of 1964, edged up
one-tenth of a per cent in January. Weekly estimates through
mid-February suggested no further change, and the average re
mained within the broad range of recent years.
ANNUAL REPORT OF BOARD OF GOVERNORS
Growth in commercial bank credit accelerated in January
and early February, and banks reduced their holdings of Gov
ernment securities to help accommodate record demands for
business loans. Part of the exceptional rise in business loan
volume reflected various temporary factors, but part was due
to the general strength of business activity. Time and savings
deposits at commercial banks continued to expand rapidly in
response to the higher interest rates now being paid on such
deposits. The money supply rose at a reduced rate in both
December and January and declined in the first half of February.
Recent money supply performance no doubt was affected by
some transfers of funds from demand into time and savings de
posits and, in early February, by a larger than usual rise in
U.S. Government deposits. Member bank borrowings rose in
February, and free reserves were estimated to have averaged
about $30 million compared with a revised figure of $114 mil
lion in January.
Yields on U.S. Government securities had advanced recently,
partly as a result of the somewhat reduced level of reserve avail
ability and of market interpretations of that development as
reflecting a mild shift in monetary policy. Rates on 3-month
Treasury bills rose about 10 basis points in February to about
the 4 per cent discount rate, and Government bond yields also
increased slightly. Average prices of common stocks declined
in early February but more recently returned to levels near
their earlier highs.
In a message to the Congress on February 10, the President
had set forth a program to improve the nation's balance of pay
ments position. Steps subsequently were taken by the Federal
Reserve System and the Department of Commerce, in coopera
tion with the Treasury Department, to implement the part of the
program that called for voluntary efforts by banks, other finan
cial institutions, and nonfinancial businesses to restrain foreign
lending and investment. In January and early February, prior
FEDERAL RESERVE SYSTEM
to the Presidential message, the U.S. payments deficit had con
tinued large, according to tentative data. Long-term bank loans
to foreigners were particularly heavy, perhaps partly because of
expectations that the interest equalization tax soon would be
extended to such loans.
In the Committee's discussion of prospective business condi
tions, it was noted that the current high output rates for steel
and automobiles probably were unsustainable-declines ap
peared likely in steel if and when the threat of a strike was re
moved and in automobiles after previous strike losses were made
up-and that downturns in those industries might check the
rate of over-all expansion. On the other hand, some members
thought that the widespread nature of recent production gains
suggested sufficient underlying strength in the economy to cush
ion the expected readjustments in steel and autos, and that
prospects for sustained growth now appeared brighter than
earlier.
The Committee concluded that over the next 3 weeks, while
the President's balance of payments program was getting un
derway, it would be appropriate to maintain the slightly firmer
money market conditions that had been achieved under the
policy adopted at the meeting a month earlier. Some members,
although not advocating a policy change at present, expressed
concern about the recent high rate of growth in bank credit and
indicated that a somewhat more restrictive policy might be
necessary in coming months to achieve a reduction in that rate.
The following current economic policy directive was issued
to the Federal Reserve Bank of New York:
In light of the economic and financial developments reviewed at this
meeting, including the generally strong and continuing expansion of the
domestic economy and the continuing adverse position of our interna
tional balance of payments, it remains the Federal Open Market Com
mittee's current policy to accommodate growth in the reserve base, bank
credit, and the money supply but at a more moderate pace than in recent
months. This policy seeks to support fully the national program to
93
ANNUAL REPORT OF BOARD OF GOVERNORS
strengthen the international position of the dollar, and to avoid the
emergence of inflationary pressures.
To implement this policy, System open market operations over the
next 3 weeks shall be conducted with a view to maintaining the slightly
firmer conditions in the money market that have prevailed in recent
weeks.
Votes for this action: Messrs. Martin, Hayes,
Bryan, Daane, Mitchell, Robertson, Scanlon, and
Clay. Votes against this action: Messrs. Balderston,
Ellis, and Shepardson.
Messrs. Balderston, Ellis, and Shepardson dissented from this
action because they favored a further slight firming of money
market conditions. Mr. Balderston noted that bank credit had
expanded at a considerably higher rate than GNP throughout
the current business expansion. This, in his judgment, had
added to the volume of funds seeking investment abroad and
might have created potentially inflationary pools of liquidity.
Messrs. Ellis and Shepardson observed that if the program to
restrain foreign lending by U.S. banks was effective, more funds
presumably would be available for domestic loans, thus adding
to what they considered to be an undesirably high rate of do
mestic bank lending. Mr. Ellis thought that a firmer monetary
policy might result, beneficially, in the deferral of some current
domestic demands and indicated that he also favored such a
policy for balance of payments reasons.
2. Amendment of continuing authority directive.
The Committee amended Section 1(c) of the continuing
authority directive to the Federal Reserve Bank of New York
relating to transactions in U.S. Government securities and bank
ers' acceptances to remove the maturity limitation on Govern
ment securities that might be held under repurchase agreements
with nonbank dealers during Treasury refunding operations.
The directive previously in effect, as set forth in the preface to
this record of Federal Open Market Committee policy actions
for 1965, limited Government securities acquired under repur-
FEDERAL RESERVE SYSTEM
chase agreements to those having maturities of 24 months or
less at the time of purchase. The new directive authorized re
purchase agreements involving Government securities of any
maturity during any period beginning the day after the Treasury
had announced a refunding operation and ending on the settle
ment date for the exchange. As amended, Section 1(c) of the
continuing authority directive read as follows:
To buy U.S. Government securities with maturities as indicated below,
and prime bankers' acceptances with maturities of 6 months or less at
the time of purchase, from nonbank dealers for the account of the
Federal Reserve Bank of New York under agreements for repurchase
of such securities or acceptances in 15 calendar days or less, at rates not
less than (1) the discount rate of the Federal Reserve Bank of New York
at the time such agreement is entered into, or (2) the average issuing
rate on the most recent issue of 3-month Treasury bills, whichever is the
lower; provided that in the event Government securities covered by any
such agreement are not repurchased by the dealer pursuant to the agree
ment 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 re
purchased by the seller, they shall continue to be held by the Federal
Reserve Bank or shall be sold in the open market. U.S. Government
securities bought under the provisions of this section shall have maturi
ties of 24 months or less at the time of purchase, except that, during any
period beginning with the day after the Treasury has announced a refund
ing operation and ending on the day designated as the settlement date
for the exchange, the U.S. Government securities bought may be of any
maturity.
Except for the change resulting from this amendment the
directive was renewed in its existing form.
Votes for this action: Messrs. Martin, Hayes,
Balderston, Bryan, Daane, Ellis, Mitchell, Scanlon,
Shepardson, and Clay. Votes against this action:
None.
Under the provisions of the previous directive it had been the
practice of the Account Management to terminate any repur
chase agreements against "rights" (securities eligible for ex-
ANNUAL REPORT OF BOARD OF GOVERNORS
change in a Treasury refunding) when the dealer by whom they
were to be repurchased entered a subscription to exchange the
rights in question for new securities offered by the Treasury
with maturities of 24 months or more. During some Treasury
refundings such terminations had proved to be inconvenient
from the point of view of efficient market operations. Accord
ingly, the Committee decided to amend the directive so that
they would no longer be required.
3. Authority to purchase and sell foreign currencies.
The Committee approved a number of revisions in the guide
lines for System foreign currency operations, the purposes of
which were (1) to delete passages relating to the original
launching of operations in foreign currencies in 1962 and
passages that had been found by experience to be unnecessarily
detailed; (2) to consolidate certain provisions that had been
incorporated into the guidelines at different times into a form
that lent itself more readily to operational requirements; and
(3)
to clarify the language at a number of points. The guide
lines previously in effect are shown in the preface to this record
of policy actions. As amended, the guidelines read as follows:
1. Holdings of Foreign Currencies
Until otherwise authorized, the System will limit its holdings of foreign
currencies to that amount necessary to enable its operations to exert a
market influence. Holdings of larger amounts will be authorized only
when the U.S. balance of international payments attains a sufficient sur
plus to permit the ready accumulation of holdings of major convertible
currencies.
Foreign currency holdings shall be invested as far as practicable in
conformity with Section 14(e) of the Federal Reserve Act.
2. Exchange Transactions
System exchange transactions shall be geared to pressures of payments
flows so as to cushion or moderate disequilibrating movements of funds
and their destabilizing effects on U.S. and foreign official reserves and
on exchange markets.
In general, these transactions shall be geared to pressures connected
with movements that are expected to be reversed in the foreseeable future;
FEDERAL RESERVE SYSTEM
when expressly authorized by the Federal Open Market Committee, they
may also be geared on a short-term basis to pressures connected with
other movements.
Subject to express authorization of the Committee, the Federal Reserve
Bank of New York may enter into reciprocal arrangements with foreign
central banks on exchange transactions ("swap" arrangements), which
arrangements may be wholly or in part on a standby basis.
Drawings made by either party under a reciprocal 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.
The New York Bank shall, as a usual practice, purchase and sell
authorized currencies at prevailing market rates without trying to estab
lish rates that appear to be out of line with underlying market forces.
If market offers to sell or buy intensify as System holdings increase
or decline, this shall be regarded as a clear signal for a review of the
System's evaluation of international payments flows.
It shall be the practice to arrange with foreign central banks for the
coordination of foreign currency transactions in order that System trans
actions do not conflict with those being undertaken by foreign monetary
authorities.
3. Transactions in Spot Exchange
The guiding principle for transactions in spot exchange shall be that,
in general, market movements in exchange rates, within the limits estab
lished in the International Monetary Fund Agreement or by central bank
practices, index affirmatively the interaction of underlying economic
forces and thus serve as efficient guides to current financial decisions,
private and public.
Temporary or transitional fluctuations in payments flows may be
cushioned or moderated whenever they occasion market anxieties, or
undesirable speculative activity in foreign exchange transactions, or ex
cessive leads and lags in international payments.
Special factors making for exchange market instabilities include (i)
responses to short-run increases in international political tension, (ii)
differences in phasing of international economic activity that give rise
to unusually large interest rate differentials between major markets, or
(iii) market rumors of a character likely to stimulate speculative trans
actions.
Whenever exchange market instability threatens to produce disorderly
conditions, System transactions are appropriate if the Special Manager,
ANNUAL REPORT OF BOARD OF GOVERNORS
in consultation with the Federal Open Market Committee, or in an
emergency with the members of the Committee designated for that
purpose, reaches a judgment that they may help to re-establish supply
and demand balance at a level more consistent with the prevailing flow
of underlying payments. Whenever supply or demand persists in influenc
ing exchange rates in one direction, System transactions should be modi
fied, curtailed, or eventually discontinued pending a reassessment by the
Committee of supply and demand forces.
Insofar as is practicable, the New York Bank shall purchase a currency
through spot transactions at or below its par value, and sell a currency
through spot transactions at rates at or above its par value.
Spot transactions at rates other than those set forth in the preceding
paragraph shall be specially authorized by the Committee or by the
members of the Committee designated in Section VIII of the Authoriza
tion for Open Market Transactions in Foreign Currencies, except that
purchases of exchange to meet System commitments may be executed
without special authorization at rates above par when necessary.
4. Transactions in Forward Exchange
Transactions in forward exchange, either outright or in conjunction
with spot transactions, may prove desirable:
(1) When forward premiums or discounts are inconsistent with in
terest rate differentials and are giving rise to disequilibrating
movements of short-term funds;
(2) When it is deemed appropriate to supplement existing market
supplies of forward cover, as a means of encouraging the reten
tion or accumulation of dollar holdings by private foreign holders;
(3) To allow greater flexibility in covering System commitments,
including those under swap arrangements;
(4) To facilitate the use of holdings of one currency for the settle
ment of commitments denominated in other currencies.
Forward sales of authorized currencies to the U.S. Stabilization Fund
out of existing System holdings or in conjunction with spot purchases of
such currencies may also prove desirable in order to allow greater
flexibility in covering commitments of the U.S. Treasury.
In all other cases, proposals of the Special Manager to initiate for
ward operations shall be submitted to the Committee for advance
approval.
FEDERAL RESERVE SYSTEM
Votes for this action: Messrs. Martin, Hayes,
Balderston, Bryan, Daane, Ellis, Mitchell, Scanlon,
Shepardson, and Clay. Votes against this action:
None.
4. Review of continuing authorizations.
This being the first meeting of the Federal Open Market Com
mittee following the election of new members from the Federal
Reserve Banks to serve for the year beginning March 1, 1965,
and their assumption of duties, the Committee followed its cus
tomary practice of reviewing all of its continuing authorizations
and directives. The actions taken with respect to the continuing
authority directive for domestic open market operations and the
guidelines for System foreign currency operations have been
described in the preceding portions of the entry for this date.
The Committee reaffirmed its authorization regarding open
market transactions in foreign currencies and its continuing
authority directive on foreign currency operations, in the form
in which they were outstanding at the beginning of the year
1965, as set forth in the preface to this record of policy actions.
Votes for these actions: Messrs. Martin, Hayes,
Balderston, Bryan, Daane, Ellis, Mitchell, Scanlon,
Shepardson, and Clay. Votes against these actions:
None.
March 23, 1965
1. Authority to effect transactions in System Account.
The domestic business situation continued strong, according
to reports at this meeting. Industrial production, retail sales,
and nonfarm employment all rose to new record levels in Feb
ruary, although the unemployment rate returned to 5.0 per
cent after dipping to 4.8 per cent in January. Weekly estimates
suggested that average industrial commodity prices remained
stable from mid-January through early March at a level less
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