View original document

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., on Tuesday, May 15, 1973, at
9:30 a.m.
PRESENT:

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

Burns, Chairman
Hayes, Vice Chairman
Balles
Brimmer
Bucher
Daane
Francis
Mayo
Morris
Sheehan

Messrs. Clay, Eastburn, Kimbrel, and Winn,
Alternate Members of the Federal Open

Market Committee
Messrs. MacLaury and Coldwell, Presidents
of the Federal Reserve Banks of
Minneapolis and Dallas, respectively
Mr. Holland, Secretary
Mr. Broida, Deputy Secretary
Messrs. Altmann and Bernard, Assistant
Secretaries
Mr. Hackley, General Counsel
Mr. O'Connell, Assistant General Counsel
Mr. Partee, Senior Economist
Mr. Axilrod, Economist (Domestic Finance)
Messrs. Andersen, Bryant, Eisenmenger,
Hersey, Reynolds, Scheld, and Sims,
Associate Economists
Mr. Holmes, Manager, System Open Market Account
Mr. Coombs, Special Manager, System Open Market
Account

5/15/73

Mr. Melnicoff, Deputy Executive Director,
Board of Governors
Mr. Coyne, Assistant to the Board of Governors

Mr. O'Brien, Special Assistant to the Board
of Governors
Messrs. Keir, Pierce, Wernick, and Williams,
Advisers, Division of Research and
Statistics, Board of Governors
Mr. Gemmill, Adviser, Division of International
Finance, Board of Governors
Mr. Ettin, Assistant Adviser, Division of
Research and Statistics, Board of Governors
Mr. Wendel, Chief, Government Finance Section,
Division of Research and Statistics,
Board of Governors
Mrs. Peters, Secretary, Office of the
Secretary, Board of Governors
Mrs. Stanier, Secretary, Office of the
Secretary, Board of Governors
Mr. Black, First Vice President, Federal
Reserve Bank of Richmond
Messrs. Link, Boehne, Parthemos, Taylor, and
Doll, Senior Vice Presidents, Federal
Reserve Banks of New York, Philadelphia,
Richmond, Atlanta, and Kansas City,
respectively
Messrs. Hocter and Green, Vice Presidents,
Federal Reserve Banks of Cleveland and
Dallas, respectively
Mr. Kareken, Economic Adviser, Federal Reserve

Bank of Minneapolis
Mr. Sandberg, Manager, Acceptance and Securities
Departments, Federal Reserve Bank of
New York
Chairman Burns noted that the number of Committee members
present was smaller than usual because of Mr. Robertson's resignation
on April 30 and Mr. Mitchell's illness.

Although Mr. Mitchell was

still in the hospital, he was making good progress towards recovery.

5/15/73

By unanimous vote, the
minutes of actions taken at the
meetings of the Federal Open
Market Committee on March 19-20
and April 17, 1973, were approved.
The memoranda of discussion

for the meetings of the Federal
Open Market Committee on March 19-20
and April 17, 1973, were accepted.

The Chairman then noted that a number of Committee members
had recently returned from foreign meetings.

He invited Mr. Daane

to report on the Basle meeting held during the past weekend.
Mr. Daane observed that he had attended the Basle meeting along
with Messrs. Hayes, Coombs, and Bodner from the System.

The discussion

at the Sunday afternoon session of the governors was concerned wholly
with a progress report by the Standing Committee on the Euro-currency
Market, of which he had been a member since its inception several
years ago.

No recommendations were included in the Standing

Committee's report because of differences of view among the members
with respect to both the seriousness of the problems associated with
the Euro-currency market and the appropriate policies for dealing
with those problems.

On the former question, some members of the

Standing Committee thought that the market simply offered borrowers
an alternative facility for credit that could be obtained elsewhere.
The key policy issue was whether national controls of inflows and
outflows would be effective or whether a multinational approach was

5/15/73

required because the imposition of controls by an individual country
would result simply in a shift of transactions to another country.
At the outset of the discussion, Mr. Daane continued,
Chairman Zijlstra observed that the first question facing the
governors concerned the significance of the Euro-currency marketspecifically, whether flows in that market could have a sufficiently
important effect on financial conditions, monetary policies, and so
forth in individual countries to warrant efforts to influence or
limit such flows.

He indicated that his (Zijlstra's) own philosophy

could be expressed by a statement in a document of the Standing
Committee reading as follows:

"In the absence of international

controls, the Euro-dollar would seem to resemble a currency working
under a system of inconvertibility and according to criteria set by
the commercial banks themselves.

The banking school, driven out by

the currency school in 1844, could thus come in again through the
back-way more than a century later."

That philosophy led Mr.

Zijlstra to the conclusion that the Euro-currency market did have
significant effects on national economies and therefore should be
subject to limitations.

His conclusion was echoed by most of the

others in the subsequent discussion.

However, two governors indi

cated that they would share that view in connection with a stable
exchange rate system, but that they had some question about it when
considering a system of floating rates.

He (Mr. Daane) had noted

5/15/73

-5-

that, while the possible availability of other credit sources as a
substitute for the Euro-currency market made it impossible to quantify
the credit-creating potential of that market, it was clear that
central bank placements in the Euro-currency market were a more
certain source of the credit creation that had proved troublesome
to some.

In any event, it was the consensus of the group that

limitations on the market were warranted.
With that issue resolved, Mr. Daane continued, Mr. Zijlstra
turned to the questions of what could or should be done to influence
the supply of funds to the Euro-currency market; the demand for
funds in the market; and, more directly, what he termed the "meeting
place"--the banks participating in the market.

On the question of

supply, he agreed with a view Mr. Daane had expressed, that parti
cular attention should be given to the placement of central bank
funds in the market.

He divided the central banks involved into

three categories--those in G-10 countries, in non-G-10 countries
other than oil-producing countries, and in oil-producing countriesand then he further subdivided them according to whether or not they
could be drawn into special arrangements affecting their supply of
funds to the market.

In the course of the ensuing discussion there

was a great deal of comment about the need for rules of behavior
governing central bank investments of reserves and about diversifi
cation of such investments--matters which were increasingly becoming a
source of concern to the Basle group.

There also was comment about the

5/15/73

desirability of exploring anew the possibility of joint action to
absorb some of those reserve funds or divert them from the Euro
market, in the first instance involving possible issuance of special
securities by the U.S. Treasury which could be attractive to foreign
central banks.
Mr. Daane noted that the first conclusion reached on the
subject of supply related to action regarding central bank placements
of the Basle countries themselves.

The governors reaffirmed the

agreement--first reached in the summer of 1971, rescinded in letter
although not in spirit in the fall of that year, and then renewed in
the Paris meetings of March 1973--not to place additional funds of
their own central banks in the Euro-currency market, and to gradually
and prudently withdraw their earlier placements.

One governor

indicated that since March his central bank had shifted more than
half of its Euro-currency placements to the United States and that
it planned to do the same with 50 per cent of the proceeds of matur
ing contracts.

Another governor, while not providing quantitative

information, indicated that his bank was following a roughly similar
course, and the remaining governors expressed intentions of making
such transfers.

The second conclusion was that the possibility

should be explored of--to use Mr. Zijlstra's terminology--"draining
the market a bit through open market operations."

That was translated-

initially, at least--into reviving discussions between the BIS and

5/15/73
the U.S. Treasury of the possibility of tailoring U.S. security
issues to the needs of other countries, particularly those in the
non-G-10 group, and of using the BIS as an intermediary for channel
ing funds.

While it was agreed that those discussions should be

revived, there was no agreement as to where they should lead.

As he

(Mr. Daane) had noted during the Sunday afternoon session, the U.S.
Treasury had been reviewing all possibilities, even including that
of offering a public issue which could be subscribed to by non
governmental investors in the Euro-currency market.

The British

representative at the meeting reported that public corporations in
the United Kingdom, such as the Greater London Council, were now
being "permitted" to borrow funds in the Euro-currency market and
to invest them until needed in the United States, so that those
corporations were, in effect, carrying out the kind of open market
operation being discussed at Basle.

Such transactions had a number

of advantages from the British viewpoint:

they enabled the public

corporations to borrow at rates lower than those available to them
in domestic markets; they avoided the additional undesired upward
pressure on domestic U.K. interest rates that such borrowing would
create; and they resulted in an increase in the reserves of the
Bank of England.
As to what might be done to influence demand in the Euro
currency market, Mr. Daane observed that the governors discussed

5/15/73

various national policies--such as the German "bardepot" deposit

requirement on foreign borrowings by nonbanks, and the outright
prohibition of outside borrowing in the Netherlands.

While there

were no specific undertakings, Chairman Zijlstra concluded it was
clear that the countries represented at Basle would "not be reluctant"
to put controls on borrowings from outside.

Finally, the governors

turned to the "meeting place" issue, a subject to which the major
part of the Standing Committee's report had been devoted.

There was

a great deal of discussion--but no resolution--of the question of
whether reserve requirements were desirable and, if so, whether they
should be applied to assets or liabilities.

The group recognized,

but tended to discount,the argument that the imposition of controls
by an individual country would result in a shift in transactions to
other countries; they felt that such shifts could be limited by
national policies affecting the home offices of domestic banks and,
in turn, the branches and subsidiaries of those banks.

The governors

agreed to return to the meeting place question at the July Basle
meeting.
In response to questions about the status of the Federal
Reserve's marginal reserve requirements on Euro-dollar borrowings
of U.S. banks, Mr. Daane continued, he had noted that the Board
had published a proposal to reduce the requirement from 20 to 10
per cent and had asked for opinions on that proposal.

It was the

-9-

5/15/73

consensus of the governors that it would be desirable to reduce the
requirement "as much as possible."

Subsequently, however, in con

versation following the meeting one of the deputy governors expressed
great reservations about such advice; he was concerned about the risk
of a repetition of the 1969-71 experience, in which there were large
flows from the Euro-dollar market to U.S. banks and then back again.
Mr. Daane said he might also comment on certain conversations
that occurred outside the formal sessions.

As to the very recent

unsettlement in the exchange markets, one governor in conversation
expressed the view that last week's developments, if they had
occurred under a system of fixed parities, would have culminated
in a crisis; and that, more generally, the present regional system
of exchange rates with particular floats was more resilient than
the fixed-rate system.

Several governors noted that it was necessary

to think in terms of adapting and reinforcing the exchange rate
system now existing, and they thought that a substantial increase in
the official price of gold would be helpful in that connection.
In concluding, Mr. Daane observed that Mr. Hayes might have
some additional comments on the Basle meeting.
Mr. Hayes remarked that he had only one comment to addnamely, that there was a general feeling of unease, uncertainty,
and unhappiness about the existing situation in exchange markets.
Mr. Daane agreed, and added that he had not meant to imply
the contrary.

5/15/73

-10-

In reply to a question by Chairman Burns, Mr. Daane said the
discussions with the Treasury about possible means of channeling Euro
currency funds into U.S. securities would move forward promptly.
Mr. Coombs added that certain suggestions regarding such means had
been transmitted to the Treasury several months ago.
Mr. Morris referred to Mr. Daane's comment regarding the con
cern expressed privately by one participant in the Basle meeting about
a sharp reduction in U.S. reserve requirements on Euro-dollar borrow
ings, and asked for amplification of the reasoning underlying that
concern.
Mr. Daane said he thought the argument was that a sharp
reduction in the reserve requirement might lead to a large flow of
funds into the United States, and that that might be followed--should
monetary conditions subsequently change--by a large reverse flow.
In the ensuing discussion several members, including Mr. Daane,
agreed that, in light of the recent enormous outflows of funds from
the United States, some reflow at this point would be welcome.
Chairman Burns also agreed with that view, but he added that
a succession of large flows in opposite directions, such as had
occurred in 1969-71, would not be a happy outcome.
tion was one that frequently faced policy-makers:

The basic ques
whether to focus

today on means for dealing with an immediate problem, or whether to
take account also of the spill-over effects that would be felt
tomorrow.

5/15/73

-11Mr. Daane remarked that he might add a postscript with respect

to a conversation in Basle with Mr. Morse, Chairman of the Deputies of
the Committee of Twenty, and with a few other C-20 Deputies present
there, concerning a first very preliminary draft outline of reform

looking toward eventual presentation to the governors at the annual
meeting of the International Monetary Fund in Nairobi in September.
The preliminary draft was designed to provide a framework for dis
cussion by Deputies rather than a cohesive plan.

Although the

Europeans seemed to consider the draft reasonable, it appeared to be
inadequate from the U.S. viewpoint.

One problem revolved around the

manner in which one of the issues was formulated--the issue of
whether reserve indicators should trigger action, as suggested by the
United States, or simply consultation, as favored by the Europeans.
A second problem was posed by the presumption in the outline that the
Fund would be deeply involved in all aspects of the new international
monetary system, i.e., that everything would be referred to the Fund
for ad hoc decision. At one extreme, that could suggest an unrealistic
transfer of authority to the Fund.

At the other extreme, it could

imply that efforts to enforce any new rules of behavior in the
monetary area would be limited to "consultations" with the Fund
along the lines of present Article 8 consultations which were largely
ineffective in producing action.

In any case, the Deputies would be

discussing the draft outline at their next meeting, after initial
discussion of the problems of concern to the less developed countries

-12-

5/15/73

such as the link between SDR's and development aid.

The meeting,

which would be held in Washington, would extend over the week May 21-25.
Chairman Burns noted that Mr. Brimmer had headed the Federal
Reserve delegation to the Tenth Meeting of the Governors of Central
Banks of the American Continent, held from April 30 to May 2 in Curacao.
He invited Mr. Brimmer to comment on developments at that meeting.
Mr. Brimmer observed that the System's delegation to the
meeting included Mr. Coldwell, Messrs. Debs, Lang, and Pardee of the
New York Bank, and Mr. Maroni of the Board's staff.

He had had the

privilege of serving as delegation head only because Chairman Burns
had found that he was unable to attend the meeting, and the Chairman's
presence had been missed.

He planned to distribute to the Reserve

Banks and to the Board a written report on the meeting--and also on a
subsequent meeting of the Assembly of Members of the Center for Latin
American Monetary Studies (CEMLA).

So he would limit his oral comments

to a few points of particular interest to the Committee.
Mr. Brimmer noted that the first session of the meeting of
Western Hemisphere governors was concerned with issues related to
the reform of the international monetary system.

A second session,

which he would pass over today, was devoted to the role of central
banks in channeling internal bank credit flows in desired directions.
The basic paper at the first session was presented by Deputy Governor
Mancera of the Bank of Mexico.

Mr. Mancera addressed, among other

matters, the question of controls over the Euro-currency market.

5/15/73

-13-

He noted that such regulation would be a cause of serious concern
to the developing countries which depended heavily on those markets
for large amounts of development capital.

He added that regulation

of the Euro-currency markets would not lead to the disappearance
of the destabilizing capital flows since the elements contributing
to such flows would continue to exist--the leads and lags and the
large working balances of powerful companies and wealthy individuals.
He also remarked that, while there might be good reasons to suggest
that monetary authorities should refrain from placing funds in the
Euro-currency markets, for the developing countries the funds so
placed often constituted the compensating balances required by the
Euro-banks which extended credit to them.

For that reason, he

thought that the placement of funds in the Euro-currency markets
by the central banks of the developing countries should not be
viewed in the same way as placements by the central banks of the
industrialized countries.
Mr. Brimmer said he had cited Mr. Mancera's comments on the
subject because they reflected a viewpoint that diverged sharply
from that of the Basle group of governors which Mr. Daane had
described.

In his own comments following Mr. Mancera's statement,

he (Mr. Brimmer) had focused on the U.S. proposal for using reserves
as an indicator of the need for balance of payments adjustment.
presentation was well received.

His

However, one point of particular

5/15/73

-14-

interest was made in the subsequent discussion:

that if the U.S.

proposal were adopted it would be crucial for the large countries
to submit themselves to the same kind of discipline as applied to
small countries.

One speaker commented that the willingness of the

United States and other large countries to do so remained to be
demonstrated, and that it could not be predicted on the basis of

their past behavior.
At the CEMLA meeting which followed, Mr. Brimmer continued,
one of the subjects discussed was the plan developed earlier for cen

tral bank assistance to the Central Bank of Nicaragua to meet needs
arising out of the earthquake of last December.

There was con

siderable criticism of the Federal Reserve for declining to parti

cipate in the plan.

In an effort to clarify the System's position,

he had asked for the floor to read a substantial part of the text
of the Chairman's letter setting forth the System's reasons for
not participating.

Those reasons involved questions not only of

legal authority but also of policy, given that assistance of the
type in question--which was essentially of a foreign aid naturewas the responsibility of the Agency for International Development.
However, the explanation was not well received.
Mr. Brimmer said he might also mention that, following his
departure from Curacao, the governors of the Latin American central
banks held their Sixteenth Meeting.

He was informed by System

-15-

5/15/73

staff members, who attended the meeting as observers, that one of
the sessions was concerned with the question of whether and how the
Latin American central banks might diversify their reserves.
Several Latin American central banks made it clear that they had
moved out of dollars in the latter part of 1972 and at least one
explicitly stated that it had made a profit from the devaluation
of the dollar last February.

The central banks of the five Central

American countries jointly proposed that a study be made of the
possibility of diversifying reserves--including the possibility of
having exports paid for in the currencies of the markets in which
they are sold.

The Central Bank of Argentina had already put such

a requirement into effect.

The Latin American Governors agreed

that a study would be worthwhile, and they instructed CEMLA to
prepare a report with the help of central bank personnel and
technical experts of its choosing.
In response to the Chairman's request for his comments on
the Curacao meetings, Mr. Coldwell said he would report a few
general impressions.

The Latin American central bankers still

appeared to be mainly concerned with the problems of obtaining
sufficient development capital at low interest rates and with
getting access to the capital markets of developed countries.
Inflation remained a major concern to all of them.
Mr. Coldwell added that he had been interested in the
governors' reactions to the international monetary unrest of the

-16-

5/15/73

last few years.

That unrest apparently had had a significant impact

on the less developed countries, both in raising prices of their
imports and in producing new trade barriers to their exports.

Also,

the exchange controls imposed in some countries were a matter of
deep concern to them.

From his conversations with a number of

governors he concluded that their preferred approach to inter
national monetary reform would involve a better distribution of
available reserves.

They were fearful that international bodies

such as the IMF or the Committee of Twenty might decide on reform
measures predicated on the view that aggregate reserves were exces
sive.

They noted that reserves were heavily concentrated in the

hands of a few countries, and that from their viewpoint reserves
were far from excessive.
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 currencies
for the period April 17 through May 9, 1973, and a supplemental
report covering the period May 10 through 14, 1973.

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:

5/15/73

-17-

At the last Committee meeting I questioned the
general assumption in the press and elsewhere that the
world had moved onto a floating rate system, and I
pointed to the emerging efforts by most of the G-10
central banks to stabilize their currencies either
against one another, as in the European "snake in the
tunnel," against SDR parities, or as a temporary
measure against the dollar. Since then, this de facto
system of fixed rates outside of the Western Hemisphere
has hardened into a reality. We now have rather good
figures on foreign central bank intervention over the
seven weeks since the markets reopened on March 19,
and those figures show a total of roughly $4.5 billion
equivalent in central bank exchange operations. I
don't think one could have expected a much bigger
volume under a formal fixed rate system.
In some cases--notably, Germany, Japan, and the
Netherlands--such intervention has taken the form of
heavy sales of dollars and other currencies to prevent
an abnormal depreciation by temporary factors of
essentially strong currencies such as the mark, the
yen, and the guilder. Within the European snake, the
French franc, the Belgian franc, and the Scandinavian
currencies have been restrained by intervention from
appreciating further. By varying domestic liquidity,
the Swiss National Bank has succeeded in stabilizing
the Swiss franc in terms of the German mark.
Perhaps the most interesting policy development,
however, has been the shift in the British approach
to market intervention. Only a few months ago the
British government was more or less openly espousing
a clean float for sterling. Since then they have
apparently concluded that a further depreciation of
sterling, which the big trade deficit expected this
year has threatened to bring about, would probably
wreck their efforts to restore some measure of price
and wage stability. Consequently, the British govern
ment has authorized its nationalized industries and
local authorities to borrow between now and year-end
up to roughly $2 billion of medium-term money in the
Euro-dollar market on the condition that the dollars
be sold to the Bank of England, which will use them
to stabilize the sterling rate. This operation is
reminiscent of the central bank credit packages pro
vided to the Bank of England during the 1960's and

5/15/73

-18-

the market results have been much the same. Sensing a
commitment by the Bank of England to defend the sterling
rate at least for the rest of this year, those with
money to invest are now encouraged to move uncovered
funds into London to take advantage of the high short
term rates prevailing there. Middle East oil money
is well represented in these inflows. In effect,
therefore, by last week a pattern had emerged in which
nearly every major foreign currency was being firmly
defended, either on the upside or the downside, while
the dollar was floating in isolation without any
evidence of intervention by the Federal Reserve. This
did not help to restore confidence in the dollar.
I was interested in Mr. Brimmer's report regarding
the efforts of Latin American central banks to diversify
their reserves by shifting out of dollars. That is a
world-wide phenomenon; it is natural for any central
banker responsible for protecting his country's reserves
to seek to hold them in currencies whose value will be
defended rather than in dollars, for which no such
commitment is apparent.
Meanwhile, the exchange markets for the dollar
remained quiet as profit-taking on earlier speculation
served to counterbalance more or less evenly our con
tinuing balance of payments deficit. This tranquility
has been abruptly shattered yesterday and today, unfor
tunately, by a new run on the dollar which has driven
up the major European currencies by as much as 3 per
cent above last Friday's levels--with forwards out to
7 or 8 per cent--while the gold price has rocketed
up to a new peak of $116 this morning in London.
There are a number of reasons for this flare up,
not the least of which is Watergate. I am persuaded,
however, that one fundamental factor has been the
growing feeling in the market that the dollar would
not be defended against new speculative attacks,
either by the European central banks or by the Federal
Reserve. If one were to ask exchange market partici
pants or officials of foreign central banks what event
had triggered the explosion, most probably would refer
to the statement attributed last week to Mr. Flanigan
of the White House staff that the United States might
have to devalue the dollar once more to deal with the
oil import problem. If Mr. Flanigan did not make that

5/15/73

-19-

statement, it would be desirable to have a correction
issued as soon as possible. Meanwhile, the increases
in the System swap lines which the Committee has dis
cussed at recent meetings have become a matter of some
urgency.
By unanimous vote, the
System open market transactions
in foreign currencies during the
period April 17 through May 14,
1973, were approved, ratified,
and confirmed.
The Chairman 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:
Very little has happened since the last meeting of
the Committee to change one's view of the economic situ
ation and outlook. Current trends in orders and output
continue very strong. Industrial production in April
is estimated to have risen at a 12 per cent annual
rate, while new orders received by durable goods manu
facturers increased in the first quarter at a spectacu
lar 32 per cent annual rate. The job market also looks
strong; the rise in nonfarm employment slowed in April
to 110,000, but there was a large gain in manufacturing
and a substantial increase in the length of the work
week. Price increases continue very large, with an
extraordinarily sharp increase last month for indus
trial commodities at wholesale and a further substantial
advance for wholesale foods. And, as before, we are
still witnessing the dichotomy between the strong near

term optimism of businessmen, on the one hand, and a
notably weak stock market, on the other.
Our projections of GNP and related measures are
little changed from 4 weeks ago, except for a further

boost in the expected rate of inflation.

This occurs

5/15/73

-20-

mainly in the second quarter, and is necessitated
by the recent performance of the monthly price indexes,
but we have also stepped up slightly the second-half
price projection in reflection of the deterioration in
the farm production outlook. Growth in real GNP is
projected to moderate beginning this quarter, and to
be down to an annual rate of about 4 per cent by the
final quarter of the year. The principal forces
dampening real growth are expected to be a slowing
in the growth of consumption, especially for durables,
and a declining trend in residential construction. The
principal forces tending to fuel the economic expansion
are expected to be a continued rapid increase in busi
ness capital investment and a sharp acceleration in
inventory accumulation. Today I would like to comment
briefly on each of these four major influences.
The expansion in consumption, which has been so
marked a feature of the economic resurgence this past
winter, appears to have been slowed or reversed in
April. The dollar volume of retail sales declined
1-1/2 per cent, according to the advance report, and
total new car deliveries dropped to an annual rate of
11.6 million units, from a 12.2 million rate in the
first quarter. This obviously is too limited a reading
on which to base a judgment, but yet I am confident
that the major part of the consumer boom is behind us.
Consumer opinion surveys continue to show a deteriora
tion in sentiment, and the latest quarterly Census
survey also indicates a decline in buying plans for both
new cars and household appliances. Consumer credit
has been growing at an extraordinary pace, and this is
unlikely to be sustained. The payment of the tax
refunds will be largely completed this month and will
be replaced, in the second half of the year, by a sub
stantially longer period than in the past during which
social security taxes represent a drain on spendable
income. Adding this all together, and making allow
ance for the likelihood that anticipatory buying in
the first quarter borrowed to some degree from future
purchases, I think that the prospects for the months
ahead point clearly in the direction of less ebullient
consumer product markets generally.
Residential building activity appears also to
be in a declining trend. Housing starts declined
appreciably in March, and we anticipate another drop

5/15/73

-21-

in April, although the figures will not be available

until later today or tomorrow.

More importantly, signs

of a weakening in the housing boom are growing more

numerous. Rental vacancies were up appreciably from
a year ago in the first quarter, with increases in all
sections of the country except the North Central States.
Completions of new units, which have been delayed during

the past year or more by materials and labor scarcities,
are likely now to be on the rise. New home sales by
merchant builders have shown a declining tendency over
recent months, after seasonal adjustment, while the
number of homes for sale has increased to a new high.
Finally, reports from around the country in recent
weeks indicate a tightening in the availability of
mortgage credit, involving not only an upward notching
of interest rates but often also the imposition of
more restrictive lending terms. We have been expecting
a downturn in housing for some time, and now it finally
seems to be in progress.
Information on business capital spending, on the
other hand, points in a strengthening direction. Quan
titatively, the recent McGraw-Hill survey represents
a substantial step-up in business plans for 1973, and
the strength in new orders for business capital goods
certainly is supportive of a sharp upward movement.
Qualitatively, also, the impression gained from the
red book1/ and from other reports citing capacity
shortages in various strategic areas is suggestive
of a major boom in capital spending. The staff had
already been projecting more strength in this area
than indicated by the official reports, but the incoming
information has led us to revise our projections up
somewhat further. Most of the revision is in the
second half, so that there is now relatively little
slowing in the upsurge as the year progresses.
The outlook for inventory investment also grows
more robust with the passage of time. Partly this is
a matter of shortfalls in realized inventory accumu
lation thus far this year. The book value of business
stocks rose at a $21-1/2 billion rate in the first
quarter, but most of this was accounted for by higher
prices; inventory accumulation, after valuation adjustment,
1/ The report, "Current Economic Comment by District,"
prepared for the Committee by the staff.

5/15/73

-22-

appears to have dropped substantially below the fourth
quarter pace. Partly, also, the strengthening inven
tory outlook is influenced by the marked increase
that has occurred in final sales. Inventory-sales
ratios have dropped progressively over recent months
and are now generally at the lowest levels in a good
many years. In addition, businessmen continue to
complain of slower deliveries, materials shortages,
and inadequate stocks to service customer demands.
It seems to me obvious that a rather major restoration
of inventory positions lies ahead of us. How large
it will prove to be, at this point, is a matter of
conjecture.
In sum, I feel confident that we have the direc
tion of change right in these four major economic
variables for the months ahead. The basic tendencies
will be for residential construction to decline, growth
in consumption to slow, business capital spending to
continue strongly upward, and inventory investment to
accelerate substantially. The specific amounts to be
attached to these projected changes are much harder
to gauge, but the odds still strongly favor moderation
in the over-all rate of economic expansion. Even with
such moderation, however, inflationary pressures are
likely to remain substantial. There are apt to be
continuing scarcities in some markets; wages and
salaries will be under upward pressure from higher
consumer prices and a strong demand for labor; and
growth in productivity is likely to be slowing along
I do not have much
with slower growth in output.
hope that these underlying inflationary forces can
be dampened appreciably without profoundly adverse
consequences for the economy later on.
Another disturbing aspect of the economic out
look is that the forces of expansion appear likely
to shift markedly, away from demands that are consumer
oriented to demands based on rising business outlays.
Comparing our projection for the next three quarters
with actual results over the past three quarters,
growth in consumption and housing combined is expected
to slacken by more than $20 billion, while investment
in business fixed capital and inventory is projected
to accelerate by more than $15 billion. This projected
shift would give the economy a markedly more cyclical

-23-

5/15/73

configuration by year-end. It would also be likely
to produce substantially larger business demands for
external finance. The projected increase in business
investment over the next three quarters amounts to
$30 billion. As a rough and ready--though imprecisecomparison, the internal generation of funds by
corporations is projected to rise by only $7 billion
over the same period. If the increase in corporate
financing that this implies could be moderated without
at the same time devastating the mortgage and muni
cipal markets, the prospects for stretching out the
upsurge in business investment--and hence the economic
expansion--would, I believe, be considerably better
than they appear at the moment.
Mr. Winn noted that one of the tax reform proposals sub
mitted to Congress by the Secretary of the Treasury on April 30
would limit the extent to which taxpayers could charge off losses
on construction projects begun after that date.

It appeared to him

that the Secretary had instituted a highly effective control device
simply by submitting that legislation.

He understood that about

90 per cent of commercial construction and a substantial part of
apartment building had been financed under partnership arrangements
developed to take advantage of the provision it was now proposed
to eliminate, and that since April 30 such construction had dropped
off sharply.

Some people with whom he had checked expected the

proposal to have a dramatic effect on construction activity as long
as it was under consideration.

Evidently an industry already plagued

with sharply rising materials and labor costs was now to experience
new difficulties in connection with its financing arrangements.

-24-

5/15/73

Moreover, the financial health of speculative builders, many of whom
apparently were in a highly exposed position, might now be called
into question; he had already heard of a number of cases of bankruptcy.
Mr. Partee observed that the matter to which Mr. Winn refer
red had escaped his notice; he had concluded from a review of the
Secretary's tax reform proposals that they would not have a signi
ficant impact on economic activity.
Chairman Burns remarked that the matter was new to him also.
He asked that a staff report be prepared and distributed to the
Committee later in today's meeting.

1/

Mr. Partee added that it would be helpful if any Reserve
Bank in a position to assess the impact of the tax proposal in its
District would include some comments on its findings in the next
issue of the red book.
Mr. MacLaury noted that the GNP projections and analysis
prepared by the staff for this meeting extended only through the end
of the year.

In his judgment the Committee also needed some informed

insights into likely developments in the first half of 1974, following
the slowdown in growth anticipated over the remainder of 1973.
the lags of monetary policy, whatever actions the Committee took

1/ A copy of the report subsequently distributed is appended
to this memorandum as Attachment A.

Given

-25-

5/15/73

today would have important effects in early 1974.

Moreover, the

current debate among economic forecasters focused primarily on the
probable course of developments after the turn of the year.

The

staff had commented on prospects for 1974 in its chart presentation
at the March meeting of the Committee, but he understood that that
analysis had been invalidated to an important extent by subsequent
events.
More generally, Mr. MacLaury continued, he would urge that
the staff regularly present GNP projections extending for a period
at least four quarters into the future.

As he had reported at

previous meetings, from time to time the staff at the Minneapolis
Bank attempted to employ the Board's econometric model to make four
quarter projections, and he might note today that their latest pro
jections suggested approximately zero growth in the first quarter
of next year and very little growth in the second quarter.

Despite

the difficulties of projecting for so long a period ahead, he
thought it was highly important for the Committee to know whether
the Board's staff also held such expectations.
Mr. Partee remarked that if his recollection was correct
Mr. MacLaury had made a similar request for four-quarter projections
at the Committee meeting one year ago.

His response today would be

the same as that given a year ago--namely, that the projection period
would be extended in the course of a chart presentation planned for
the June meeting.

-26-

5/15/73

Mr. Partee added that the staff was reluctant to extend its
projections into 1974 until the likely pattern of developments in
1973 had become somewhat clearer.

There still was a great deal of

uncertainty about the probable profile of activity in the second
half of 1973; certainly, developments in the last few months had
required a modification of earlier judgments about the strength of
inflationary pressures.

In general, the staff had tried to extend

its projections at those points in time at which it thought doing
so would be of most help to the Committee.

Late April and early

May--the period since the previous meeting--happened to be the thin
nest period of the year as far as significant new information was
concerned.

By the time of the June meeting there should be a much

better basis for extending the projections.

For example, the results

would be available of the latest Commerce Department survey of
business fixed investment spending intentions, and it would be known
whether the weakness in retail sales evident in April had continued
in May.
Mr. Eastburn said he had planned to ask a question similar
to Mr. MacLaury's.

His own view about the outlook was affected by

some new calculations his staff had developed with the aid of the
Board's econometric model.

As he had indicated to the Committee a

few months ago, the Philadelphia Bank staff had concluded that an
M1 growth rate of 3-1/2 per cent would produce a decline in real GNP

-27-

5/15/73

by the fourth quarter of 1974.

However, their latest calculations

suggested that even if M1 were to grow at a 5-1/2 per cent rate
economic activity would be rather sluggish in 1974.

Despite the

prevailing uncertainties, it seemed clear that the Committee was
approaching the point at which it would have to face a difficult
trade-off between inflation and risks of recession.
Mr. Morris said he also had intended to ask Mr. MacLaury's
question, and had found Mr. Partee's response to be highly interest
ing.

At times in the future when the staff was reluctant to present

projections for four quarters ahead to the Committee, it would be
helpful if they would explain their reasons--as Mr. Partee had done
today--in the green book.1 /
Mr. Morris went on to say that he concurred in Mr. Partee's
view that the pattern of activity over the rest of 1973 was still
highly uncertain.

While econometric projections for that period

were nearly unanimous in anticipating a slowdown, current business
indicators had offered no support for such an expectation until this
past month--and even the latest figures offered only fragmentary
support.

Thus, the outlook for the second half of the year seemed

quite as cloudy as Mr. Partee had suggested.

The uncertainty was

reflected by the disparate views of Professors Samuelson and Eckstein,

1/ The report, "Current Economic and Financial Conditions,"
prepared for the Committee by the Board's staff.

-28-

5/15/73

as cited in the current red book; Professor Samuelson tended to
discount the projections and to stress the current indicators,
whereas Professor Eckstein leaned the other way.

In his (Mr. Morris')

judgment, a "middle of the road" approach to monetary policy was
appropriate at a time like the present, when it was difficult to
determine the direction of the winds to lean against.
Mr. Partee noted that in preparing for today's meeting he
had reviewed roughly a dozen econometric projections for the second
half of 1973.

All but one foresaw a definite moderation in the growth

of GNP, most to a rate of roughly 4 per cent by the fourth quarter.
The key question, as he saw it, was whether growth would moderate
gradually to a subnormal rate or whether there would be a specu
lative boom in the second half of 1973 that culminated in a major
recession next year.

He was not yet prepared to offer a judgment

on that question.
Chairman Burns remarked that, while he recognized the force
of Mr. MacLaury's observations, he thought the staff had demonstrated
good judgment in limiting the period for which it presented GNP
projections at this time of great uncertainty.

It was important

not to expect more from the staff than they could supply, and not
to put excessive faith in longer-run projections--particularly in
view of their unhappy history.

Like other Committee members, he had

great respect for the staff's views, but given the existing margins of

5/15/73

-29-

uncertainty he had even more respect for the humility Mr. Partee
had expressed today.
Mr. Brimmer observed that he had asked the staff before
today's meeting to update its longer-run econometric projections for

his personal information, not for incorporation in the green book.
The results conformed roughly to what might have been expected on
the basis of judgment--they suggested that the GNP growth rate would
slow progressively through the rest of 1973 and well into 1974.

He

agreed, however, that the Committee had to be particularly cautious
at this point in reaching conclusions about the longer-run outlook
and that the staff should await the information that would become
available during the next month before presenting its considered

assessment of that outlook.
Mr. Brimmer added that there were certain judgments which he
thought the Committee could appropriately make at this time.

In

particular, he believed it was correct to say that the main destabi
lizing force in the outlook was the boom that was developing in the
business investment sector, and that it would be helpful to develop
some means of moderating that boom.

At his request the staff had

employed its econometric model to investigate the possibility of
using a reduction in the investment tax credit for that purpose.
He concluded that such an action--if instituted promptly--would

-30-

5/15/73

reduce the demand for capital equipment somewhat and thus might have
some beneficial effect.
Mr. Hayes indicated that, while it was important to consider
questions concerning the longer-run economic outlook of the sort
that had been raised today, he subscribed fully to the Chairman's
words of caution about the value of projections for extended periods
into the future.

The economy was distinctly overheated and the

acceleration of inflationary tendencies and expectations was very
worrisome.

It seemed likely that the economic expansion would slow

in the current period, but it was still too early to be sure, and
he was fearful that there might be no slowing unless the System did
its part in bringing it about.
Chairman Burns asked whether Mr. Hayes was thinking in terms
of physical or dollar-value measures of economic activity.

If the

former, he (the Chairman) thought there was little doubt that a
slowing would occur, if only because available resources would not
permit the expansion to continue at its recent rate.
In reply, Mr. Hayes agreed that the existence of severe
bottlenecks would affect the rate at which output could expand in
physical terms.

It was clear, however, that the pressures against

limited resources were strong and persistent.

In his judgment, it

was incumbent on the Federal Reserve to try to reduce those pressures
rather than to wait for them to slacken of their own accord.

-31-

5/15/73

Mr. Hayes went on to say that the price outlook was highly
unsatisfactory.

Farm prices had apparently stopped rising, at least

for the time being, but there were factors in the picture that could
push them up further.

With regard to industrial prices, the situation

now was even more unsatisfactory than it had been a month ago.

It

was very hard to know how much of the recent acceleration reflected
a one-shot adjustment to the shift from Phase II to Phase III, and
how much reflected the increasing demand pressures that were evident
everywhere.

The wage performance had been moderate so far this year,

but the reaction of wages to the price explosion remained to be
tested.

In sum, he believed that the weight of the evidence continued

to indicate the need for monetary restraint.
Mr. Francis noted that in recent weeks officials of the
St. Louis Reserve Bank had held a series of meetings with business
people, culminating last Thursday in a meeting at which reports
were presented by the Chairmen of the Bank's branches.

From those

discussions there had emerged a rather uniform description of the
business situation as involving tremendous pressures on labor resources
and plant capacity and growing shortages of certain raw materials.
The business people consulted were deeply concerned about the
problem of inflation, Mr. Francis observed.

In general, they appeared

to be more optimistic about demands for their products and less optimis
tic about their ability to meet those demands than they had been, say,

-32-

5/15/73

6 months earlier.

Their attitudes appeared consistent with the view

that physical output was approaching capacity limits, but not with
projections suggesting that demands would ease off in the latter
part of the year.
Mr. Kimbrel remarked that attitudes in the Sixth District
were generally similar to those Mr. Francis had described.

Business

men with whom he had talked recently did not seem to share the doubts
about the continuation of demand pressures that were being expressed
in some quarters--at least not to the extent of limiting their
willingness to undertake capital outlays or incur additional debt.
As in the St. Louis District, their worries appeared to center more
on their ability to meet the demands of their customers.

He might

add that recently prevailing weather conditions did not lend much
encouragement to the hope that the rise in food prices would level
off; on the contrary, there was a widespread feeling in the District
that pressures on food prices would remain strong and might even
increase.
In short, Mr. Kimbrel continued, the sentiment in the Sixth
District was that some further overheating might lie ahead.

He hoped

the staff's view--that the odds strongly favored moderation in the
over-all rate of expansion--was representative of conditions in the
country as a whole.

Frankly, he drew encouragement from the projection

in the green book that there would be at least some slowing in the
average rate of price advance over the rest of the year.

-33-

5/15/73

Mr. Black observed that, like others, he was concerned about
the mounting fears of inflation on the part of the general public.
It was important, however, not to lose sight of the world-wide
character of the current upsurge of prices.

Indeed, after allowing

for the effects of the devaluation of the dollar and the removal of
Phase II controls, the performance of prices in the United States
might well be found to be better than that in most other countries.
While the U.S. price performance, considered alone, certainly had not
been satisfactory, it was clear that the System could not expect to
eliminate domestic inflation by monetary policy means, and that if it

aimed at too low a growth rate it was likely to create a recession.
Mr. Mayo said he was at least as skeptical of longer-run

GNP projections as any member of the Committee, particularly after
having prepared them for many years during his service at the
Treasury Department.

Nevertheless, in view of the lags of monetary

policy, he was as eager as any member to have the best insights
available at this point into the likely pattern of developments in
1974.

Accordingly, he had asked his staff to extend the Board

staff's judgmental projections through that year by use of the
econometric model.

The results were highly disturbing; they suggested

that a 1 per cent increase in real GNP would be associated with a
5 per cent unemployment rate and a 5 per cent rate of inflation.

He

hoped that a more sophisticated analysis would yield more encouraging
results.

-34-

5/15/73

In any case, Mr. Mayo continued, it was important that the
Committee have the best judgments that could be developed about the
longer-run outlook.

There was no question that the economy

was overheated at the moment.

And there was no question that

the rate of expansion in constant-dollar GNP would slow; the recent
rate could not possibly be maintained for long.

Such observations,

however, did not provide an adequate basis for making monetary
policy.

While he appreciated the problems faced by the staff in

making longer-run projections under present circumstances, he would
encourage them to do their best with the evidence available.

And

perhaps next year it would prove possible to extend the projections
into additional quarters during May rather than June.
Mr. Coldwell remarked that his own views on the economy were
similar to those already expressed, and he would confine himself at
this point to a comment on certain observations made last week by two
businessmen

directors of the Dallas Reserve Bank.

Both directors,

who happened to be heads of subsidiaries of large conglomerates,
had indicated that the chief executive officer of their conglomerates
had ordered a cutback in the rate of capital spending.

The decisions,

which in one case called for a 25 per cent reduction in capital
spending over the next 9 months, apparently were taken in light of
economic projections indicating a slowdown in growth in 1974.

It

-35-

5/15/73

was interesting to note that at least some large corporations were
now thinking in terms of retrenchment from the very high recent
rates of investment rather than further increases.
Mr. Balles noted that his staff also had been getting unsatis
factory results from longer-run econometric projections--unsatis
factory in the sense that various policy assumptions led to undesirably
high rates of inflation and unemployment.

In addition, he was con

cerned about the possibility that the recent explosions of prices and
of profits would be followed by an explosion of wages--a development
that could upset the conclusions that might be drawn from projections,
particularly with respect to the likely rate of inflation.

He asked

Mr. Partee about the staff's current thinking with respect to the
outcome of the forthcoming wage settlements.
In reply, Mr. Partee noted that for a number of months the
staff's projections had allowed for a substantial rate of wage
increase; the latest projections implied a rise of about 6-1/2 per
cent in the average hourly earnings index over the remainder of 1973.
If any revision were to be made in that figure now, he suspected
that it would be upward.

It had appeared for a while that a moderate

settlement would be reached in the rubber industry but now the
nature of the final settlement was very much up in the air, and
the initial demands of the Teamsters' union reportedly were for
very large increases.

It was reasonable to suppose that workers

--nonunion as well as union, and salaried employees as well

-36-

5/15/73

as wage earners--would be quite insistent on being compensated for
the tremendous increases that had occurred in the cost of living.
Mr. Partee observed that that prospect served to illustrate
the problems facing economic forecasters at the present time.

It

had been suggested by a number of speakers today that the Board's
econometric model could be used to extend the staff's GNP pro
jections through 1974.

It was important to recognize, however,

that the model incorporated relationships based on the economic
experience of the post-war period, and that the present situation
was sharply different from earlier experience in many respectsincluding the rate of inflation, the level of confidence, the scale
of international capital flows, and the concurrence of a business
boom with stock market prices so low as to be bordering on the point
of massive margin calls.

With circumstances so vastly different

from that of other recent years it was extremely difficult to make
economic projections, and he viewed the task of developing projections
for 1974 with trepidation.
Mr. Bucher remarked that one aspect of the present uncer
tainty involved the question of where buyers might be found for all
of the goods that industry was likely to be producing.

Noting that

there had been no reference in the discussion thus far to exports, he
asked whether they might play a significant role in that connection.
Mr. Partee replied that the staff anticipated large increases
in exports over coming quarters as a result of the devaluation of

-37-

5/15/73
the dollar.

He had no reason to disagree with that expectation,

although export growth might be held down in the short run by
supply limitations.

In reviewing prospects for the remainder of

1973 he had not mentioned exports--or, for that matter, Government
purchases--because the changes expected in those sectors were minor
in comparison with the very large changes anticipated in consumer
expenditures, residential construction, business fixed investment,
and inventories.
Mr. Eastburn noted that about a year ago the Board had
submitted a proposal to Congress for a variable investment tax
credit.

He asked about the current status of that proposal.
Chairman Burns replied that he had been working, with the

assistance of Mr. Cardon of the Board's staff, to develop modifi
cations in certain details of the original proposal in order to make
it more congenial to Congress and the business community.

He had

not pushed the proposal as energetically as he might have, partly
because of the pressure of other business and partly because of his
belief that, since it was a tax measure, its advocacy should be left

mainly to the Administration. Administration officials considered
the plan acceptable.

However, they thought it was likely to be

viewed as a device for raising revenue, and since the Administration
was committed to a policy of not increasing taxes, they had declined to
press it.

Revenue effects were, of course, implicit in the proposal,

-38

5/15/73

and they would tend to be in the cyclically desirable direction.
However, he had never considered the variable tax credit to be
primarily a revenue device; he had thought of it mainly as a measure
to stabilize business capital investment with spill-over effects
on the home building industry, and he had focused on the stabili
zation aspect in conversations about the plan.
The Chairman observed that a further difficulty had arisen
when Mr. Mills, a key member of Congress, had taken a public stand
against the Board's proposal.

It turned out that the Congressman's

opposition was based on an imperfect understanding of its elements
and, of course, he did not have knowledge about the modifications that
were being developed.
fresh consideration.

The Congressman was now giving the proposal
While he (Chairman Burns) was not optimistic

that the Congressman would take the lead in pressing the matter--or
that the Administration would do so--he planned to pursue those
possibilities.
The Chairman added that he might comment briefly on the
modifications he had mentioned.

First, if Congress were to consider

the proposal in the form in which it was originally recommended by
the Board, a bunching of investment orders--and thus an intensifi
cation of the capital spending boom--might occur.

Such a

development could be prevented by writing the legislation in two

5/15/73

-39-

parts, of which the first would provide for a reduction in the credit
from the present 7 per cent to some lower level--say 3-1/2 or 4 per
cent; and the second would provide for a variable credit at some
subsequent time.

A second modification was designed to give Congress

an active rather than a passive role in decisions on variations in
the level of the tax credit.

In the original proposal the Board had

attempted to take account of the traditional reluctance of Congress
to give the President discretionary authority in the area of taxation.
Specifically, a provision patterned after one in the Reorganization
Act had been included under which either House of Congress would
override a Presidential decision to modify the level of the credit
by voting it down within a certain period.

Under the modified ver

sion, Congress would have the additional power of modifying the level
of the tax credit decided upon by the President within specified
limits; for example, if the President proposed to set the tax credit
at 10 per cent, Congress could raise or lower that percentageperhaps within a range of 8 to 12 per cent.
With respect to attitudes in the business community, Chairman
Burns continued, the original proposal was defective with regard to
the possible range suggested for the tax credit--"from zero to 10 or
perhaps 15 per cent."

Businessmen, having had some experience

with the tax credit in the past, were disturbed by the reference to

5/15/73

-40-

a zero level since it raised the possibility of complete termination.
Had the range been specified as, say, 3-1/2 or 4 up to 15 or 18 per
cent, more support from business undoubtedly would have been forth
coming, and he believed that such support could still be obtained
when the matter was clarified.
Chairman Burns expressed the view that the proposal for a
variable investment tax credit made very good sense.

Better stabili

zation tools were needed; the reliance on monetary policy should
not be as great as it had to be under present circumstances.

The

modifications he had described should make the proposal more accept
able to Congress and the business community.

What was needed now

was some political push of a kind not yet in being.
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
April 17 through May 9, 1973, and a supplemental report covering the
period May 10 through 14, 1973.

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:
The period since the Committee last met was one of
considerable confusion. RPD's were running below the
lower end of the Committee's desired range while M1 and
M2 were running above the upper end of their ranges;

5/15/73

-41-

computer breakdowns made reserve figures and forecasts
more uncertain than ever; and the persisting shortage
of collateral in the Government securities market ham
pered the Desk's efforts to supply reserves needed by the
banking system. With the aggregates exhibiting stronger
growth than the Committee desired, despite the RPD per
formance which is described in some detail in the blue
book,1/ the Desk supplied reserves with increasing

reluctance. And with the Treasury financing going
smoothly, the Federal funds rate was allowed to move to
the upper limit of 7-1/2 per cent specified by the

Committee. In the statement week ended last Wednesdayand subsequently also--the funds rate has been above
the 7-1/2 per cent level despite rather strenuous
efforts by the Desk to supply reserves. In general,
the tightness of the money market did not appear to have
much effect on the general market atmosphere nor did it
interfere with the success of the Treasury's May refunding.
There was a substantial need for the System to
supply reserves over the period as the Treasury kept
its balance at the Federal Reserve Banks at a high level
and other market factors absorbed reserves on balance.
We were fortunate enough to be able to buy $1-1/4 billion
of Treasury bills directly from foreign accounts over
the period. Otherwise, given the market shortages of
Government securities, we had to rely heavily on repur
chase agreements to supply reserves, making a total of
more than $7 billion of such agreements. As mentioned
earlier, shortages of collateral in the market hampered
our efforts to supply reserves, as has occasionally
been the case in recent months. I trust that this is
only a temporary phenomenon, brought about in part by
the Treasury's unusual cash position which should be
straightened out shortly. Should the phenomenon persist,
however, we might well have to give some serious thought
to new methods of reserve management.
The Treasury's May refunding, which involved a
paydown of $1.65 billion of the maturing issues, went
quite smoothly with good secondary market demand develop
ing for both the 7-year note and the long bond. The
Dutch auction technique--under which all bonds are

1/ The report, "Monetary Aggregates and Money Market
Conditions," prepared for the Committee by the Board's staff.

5/15/73

-42-

awarded at the lowest acceptable price--was used in the
bond offering and again failed to attract the widespread
investor response which, in theory at least, it is
supposed to do. While some further experimentation with
the technique will probably be considered, experience to
date has not been encouraging, and I believe that the
technique has raised the Treasury's borrowing costs
somewhat.
Treasury bill rates backed and filled during the
period, with last week's increase in the discount rate
tending to push the 3-month bill back above the 6 per
cent level to which it had declined. In yesterday's
regular Treasury bill offering, average rates of 6.18
and 6.46 per cent were established for 3- and 6-month
bills, little changed from the 6.19 and 6.39 per cent
rates in the auction just preceding the last Committee
meeting.
Although there was a substantial firming of the
money market, longer-term markets remained reasonably
stable. The Government, corporate, and municipal
markets are all in good technical position, and new
issues of corporate and municipal bonds have continued
to be on the light side. The Federal agency market has
been more active, but most new issues, including a
three-pronged $2 billion Federal Home Loan Bank
offering, were well received.
I should note that the Desk has started doing
business with a new firm--Lehman Government Securities,
Inc.--bringing the number of firms with which we do
business to 25. Since 1965 we have added eight new
names to the list, while three firms have been dropped.
A substantial number of other firms have expressed an
interest in becoming Government dealers and are in
various stages of development. As, if, and when they
demonstrate their ability to make markets in Government
and agency securities, we will consider adding them
to our dealer list.
Chairman Burns asked the Manager to indicate how a firm's
"ability to make markets" was determined by the Desk.

5/15/73

-43-

In reply, Mr. Holmes said the key question was whether the
firm stood ready to operate on both sides of the market at all
times.

Many firms operating in Government securities were essen

tially speculators; they were willing to buy only when they expected
prices to rise and to sell only when they expected prices to decline.
Since the Desk itself was on both sides of the market, it preferred
not to deal with such firms.
The Chairman remarked that he would find some discussion
of that procedure helpful.

He invited comments from Messrs. Daane

and MacLaury.
Mr.

Daane observed that the procedure was of long standing

and in his judgment entirely appropriate.

He noted that the "quote

sheets"--lists of bids and offers for various Treasury issuesissued by some firms had little meaning, since the firms were not
in fact prepared to either buy or sell all of the issues listed.
Mr. MacLaury agreed that the System should deal only with
firms that made markets in the sense Mr. Holmes had described.

He

also considered appropriate the Desk's procedures of reviewing the
financial responsibility and capital adequacy of would-be dealer
firms and of observing their actual transactions during a trial
period before deciding whether to add them to its dealer list.

5/15/73

-44-

Mr. Brimmer asked about the range of transactions engaged
in by the firms that had most recently been added to the list.

He

wondered, for example, whether those firms were participating in
System repurchase agreements, and whether they took positions in
coupon-bearing and agency issues as well as Treasury bills.
Mr. Holmes replied that the new firms were participating
in both RP's and matched sale-purchase transactions with the System.
There were, of course, differences among dealers in the scale of
their operations and in their emphasis on particular maturity
ranges.

As to scale, the firms were expected to be reasonably

active but not necessarily to engage in a very large volume of
transactions.

The performance of one of the new firms was better

in the note and bond area than in bills--which was atypical, since
the bulk of most dealers' operations was in bills.

The Desk had

advised that firm that it would be expected to expand its bill
activity.
In response to a question by Mr. Mayo, Mr. Holmes said that
one or two of the dealers on the Desk's list dealt almost exclu
sively in bills.
Mr. Daane noted that for many years some firms had con
centrated on the bill market, but had been extremely active in that
sector.

It was his impression that the Desk had traditionally

been quite sympathetic to firms interested in meeting the System's
qualifications, offering them encouragement and advice.

-45-

5/15/73

In reply to a question by the Chairman, Mr. Holmes said he
believed it was generally known in the market that the System would
welcome the participation of any firm that met the established
criteria.
In response to a question by Mr. Coldwell, Mr. Holmes said
that the newer dealers were not taking unusual advantage of the
securities-lending facilities made available by the System.

If

anything, they probably were taking less advantage of those
facilities than the older dealers.
Mr. Brimmer then asked the Manager to amplify his comments
on the Treasury's experience with the Dutch auction technique.
In reply, Mr. Holmes noted that dealers had been very
aggressive bidders in the first such auction, contrary to theoreti
cal predictions, and then had encountered difficulties in making
secondary market distribution.

Although the dealers bid more

cautiously in the second auction, they still acquired the bulk
of the securities issued.

Their experience in secondary market

distribution of both the bond and the note was, however, quite
good.

According to the theory, ultimate investors in Government

securities should find the Dutch auction technique particularly
attractive.

It appeared, however, that most such investors--many

of whom presumably were interested in swapping out of corporate
bonds or other securities--preferred to make their transactions in
the secondary market.

-46-

5/15/73

In response to a further question by Mr. Brimmer, Mr. Holmes
observed that the Dutch auction technique had not posed any parti
cular problems for the Desk in connection with the length of the
even keel period or in other ways.
Mr. Coldwell noted that dealers had sharply reduced their
over-all positions in Government securities for a time during the
recent inter-meeting period.

He wondered whether their behavior

reflected expectations for longer-run changes in securities prices.
Mr. Holmes replied that two factors seemed to account for
the development in question.

First, dealers built up large short

positions in coupon issues in advance of the May refunding.

Secondly,

the bond and note markets had performed rather well recently, with
evidence of new retail demand.

How long that situation would last

it was impossible to say.
By unanimous vote, the
open market transactions in
Government securities, agency
obligations, and bankers'
acceptances during the period
April 17 through May 14, 1973,
were approved, ratified, and
confirmed.
Mr. Axilrod made the following statement on the monetary
relationships discussed in the blue book:

-47-

5/15/73

As noted in the blue book, we expect that bank
reserve and money market conditions consistent with the
longer-run target for the aggregates adopted by the
Committee at its last two meetings will involve some
further rise in the Federal funds rate, perhaps up to
around the 7-7/8 to 8 per cent area. One might begin
to think a funds rate that high is approaching a
cyclical peak. Whether it is or not depends on the
extent to which the Committee wishes to restrict
growth rates in the aggregates and on the degree to
which GNP growth moderates from the recent rapid
pace.
In the last half of 1969, the funds rate was up
to around 9 per cent and the 3-month bill rate was
around 7 per cent most of the time, but growth in the
monetary aggregates in that period dropped to rates
much slower than so far contemplated by the Committee.
While GNP weakened in the last quarter of 1969, rising
interest rates indicated continued monetary restraint
at the time. And over the second half of 1969 as a
whole M1 slowed to a 1-1/2 per cent annual rate of
growth, M 2 was showing virtually no growth at all, and
the bank credit proxy declined by about 2 per cent.
In the third quarter of this year, by contrast, growth
rates around 4-1/2 per cent for M1 and 6-1/2 per cent
for bank credit seem consistent with the money market

conditions contemplated in alternative B.1/ Sharply
tighter money market conditions would appear to be

required in the summer and fall only if the Committee
wishes to clamp down significantly further on the
aggregates, assuming, of course, that GNP is no
stronger than projected.

In two previous periods of monetary restraint1966 and 1969--a large-scale rechanneling of credit
flows and an accompanying relatively sharp constraint

on the mortgage market developed as money market condi
tions approached cyclical peaks. The divergence of
funds away from thrift institutions to market instru
ments that was so prominent a feature of the two

earlier periods has only just begun to appear in a
significant way. In April net savings inflows to
nonbank savings institutions dropped to a 5 per cent

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

5/15/73

-48-

annual rate, and Federal agencies have begun to provide
sizable support to the mortgage market. We do not think
that May will be as bad as April, but with some further
rise in market interest rates in prospect, the weeks
around the mid-year interest-crediting period may well
see further diminished savings flows. At banks, too, we
would expect the summer months to see a further scaling
down of net inflows of consumer-type time deposits at
current Regulation Q ceilings.
These developments are tending once again to focus
restraint on the mortgage market. Some restraint is,
of course, required in that market to help cool down
the economy. But it would seem desirable to attempt
to spread the effects of monetary restraint more widely,
particularly since business spending is becoming the
main propulsive force behind economic expansion and the
demand for funds.
The proposed marginal reserve requirement on large
CD's and similar instrumentsl/ would contribute to focus
ing restraint on business spending by increasing the
marginal costs to large banks of the money market funds
that are the typical means by which banks accommodate
expanding loan demand. As noted in the blue book, we
would expect this proposal to cut back some on CD
issuance and to tighten bank lending terms to business
somewhat further. Thus, if such a proposal were adopted,
we might see a little less expansion in bank credit
than we have assumed. There would probably, as a result,
be spill-over effects tending to raise interest rates
marginally in other markets. And announcement of the
action might well be taken--against the background of
the recent discount rate hike and tightening of the
funds market--as signaling a further stage of restraint,
thereby leading to some anticipatory interest rate
increases. The proposal is basically a modest step,
though, and would appear to affect the distribution
more than the volume of credit and the structure more
than the level of interest rates. In that context, I
would not expect any significant near-term effect on
M1 or M 2 for a given Federal funds rate.
1/ The proposals referred to were described in a staff memo
randum to the Board, dated May 10, 1973, and entitled "Reserve
Copies
Requirements on CD's, Euro-dollars, and related proposals."
of the memorandum were distributed to the Reserve Bank Presidents
on that date, with advice that the Board planned to act on the
approach described on May 16, 1973.

-49-

5/15/73

In closing, I would mention that we have not
presented an alternative that shows the aggregates
that might accompany unchanged money market condi
tions. It is not that the staff thinks it necessarily
illogical for the Committee to seek unchanged money
market conditions at this juncture. Rather, it is
more of a technical problem. If one takes the longer
run aggregate path adopted by the Committee as a start
ing point, the tightening that seems implied is not
really a very marked change from the money market
conditions that most recently have come to prevail. In
other words, if prevailing money market conditions were
maintained, we would not expect aggregates far off the
alternative B path. A result somewhere between A and
B would be a good approximation, though if one were to
utilize a straight average of the two alternatives, the
associated Federal funds rate would be a little below
the 7-5/8 to 7-7/8 per cent range of most recent days.
Mr. Daane noted that the operational paragraph of the
directive issued at the previous meeting had called for "moderate"
growth in monetary aggregates over the months ahead.

In contrast,

all three of the alternatives presented for consideration today
described the growth desired over coming months relative to average
rates in some past period.

For example, alternative B called for

"somewhat slower growth in monetary aggregates over the months
ahead than occurred on average in the past 12 months."

He was not

sure what was gained by such a modification, and he wondered
whether the same outcome could be achieved by retaining the previous
language.
Mr. Axilrod observed that the staff had used past growth
rates as reference points in the draft directives in response to

-50-

5/15/73

comments on the subject of directive language by a number of
Committee members at the previous meeting.

In his view, the term

"moderate" would be consistent with the aggregate growth rates
shown under either B or C in the blue book.
Mr. MacLaury noted that the M1 growth rate for the second
and third quarters combined shown under alternative B--5-1/4 per
cent--could be achieved, according to a blue book table, as the
average of a 6 per cent rate in the second quarter and a 4-1/2 per
cent rate in the third.

He asked about the likely implications for

interest rates of open market operations designed to reduce the
M1 growth to 4-1/2 per cent in the third quarter.
Mr. Axilrod replied that the Federal funds rate probably
would have to move up to the neighborhood of 8 per cent--the top
of the range shown under alternative B--by the next meeting of
the Committee if the second-quarter M1 growth rate was to be held
to 6 per cent.

In the staff's judgment, a funds rate of 8 per cent

was likely to be consistent with a 4-1/2 per cent M1 growth rate in
the third quarter, so that no further money market firming would be
required.

The rise in the funds rate to 8 per cent over coming

weeks probably would be associated with an increase in bill rates,
and some further bill rate advance was likely in the summer when
the Treasury was expected to come back into the market.

5/15/73

-51-

Mr. Coldwell asked whether the staff's projections incor
porated an allowance for a near-term decline in the Treasury balance.
In reply, Mr. Axilrod said the staff anticipated a rather
sharp drop in the Treasury balance at both commercial banks and
Federal Reserve Banks between now and mid-June.

In fact, one

reason for the expectation that bill rates would be under upward
pressure in coming weeks was the prospect that the System would be
selling bills to absorb the reserves released by the anticipated
decline in the balance at the Federal Reserve.

According to Board

staff projections, that balance would drop by roughly $1 or $1-1/2
billion by mid-June; according to Treasury projections, the decline
would be larger.

He might add that those projections had been

made before the most recent wave of speculative pressures in
foreign exchange markets.

The impact of those pressures on the

Treasury balance was anybody's guess at this point.
Chairman Burns then called for a general discussion of
monetary policy, including comments on any aspect of the subject
that the members deemed important.
Mr. Brimmer said he thought that at this point the Committee
should look to the Board of Governors for further steps with respect
to monetary policy.

On the assumption that the Board would adopt

the marginal reserve requirement measures to which Mr. Axilrod
had referred, the Committee should avoid innovation in open

-52-

5/15/73

market policy and limit itself to preventing slippage.

While he

would not comment on specifications in detail, he thought those
associated with alternative B were in the right general neighborhood.
Mr. Brimmer added that he would avoid innovation at this
time even with respect to the language of the operational para
graph of the directive.

In that connection he noted that the

alternative B language mentioned by Mr. Daane differed from the
tentative draft included in the blue book.1/

The new version was

better than the tentative draft, but he would still prefer to use
language like that of the directive adopted at the previous meeting.
Mr. Hayes observed that, as he had indicated earlier, the
economy was in a real boom and the slower pace that was generally
expected for the second quarter was not a certainty.

Inflationary

pressures were, if anything, more severe today than they had been
when the Committee last met.
In that context, Mr. Hayes remarked, he would like to see
the longer-run target for M 1 edged down to a 4-1/2 to 5 per cent
range.

That, it seemed to him, would provide some recognition of

the fact that present estimates of the M1 growth rate in April-May
were running 2 percentage points above the midpoint of the 4 to 6
per cent range adopted by the Committee at its previous meeting.
1/ The draft of alternative B shown in the blue book called for
"...growth in the narrowly defined money stock over the months ahead
at about the average rates of the past 6 months and slower growth in
other key monetary aggregates."

-53-

5/15/73

As to the funds rate, he thought the lower limit should be set at
7-1/2 per cent, only very slightly below the level of the past 2
weeks.

He felt that any significant easing in the money market

might, in the present environment, create the misleading impression
that the System was backing away from a firm stance.

Also, he

would raise the upper limit to 8-1/4 per cent, and he would expect
the Manager to move the funds rate up gradually from its present
level if the aggregates appeared to be running on the high side.
In general, Mr. Hayes observed, the specifications he favored
were between those of alternatives B and C.

He liked the kind of

operational paragraphs the staff had proposed for consideration
today, and among the several alternatives he preferred C.
With respect to the Board staff's proposals, Mr. Hayes said
he would favor the imposition of marginal reserve requirements
provided that it was linked with the suspension of the remaining
Regulation Q ceilings on large-denomination CD's.

He would cer

tainly favor the extension of reserve requirements to cover inelig
ible acceptances.

Those measures might well encourage the use of

documented discount notes as an alternative method of raising
funds, and he would urge that administrative action be taken to
close off that potential loophole.

Whether a 3 per cent marginal

reserve requirement would exert sufficient restraint was debatable,
but he believed it was a good starting point.

It should be kept in

5/15/73

-54-

mind that, if the contemplated measures tended to push interest
rates somewhat higher, the Committee should not use open market
policy to nullify that effect.

That was one consideration under

lying his preference for a somewhat higher range of tolerance for
the Federal funds rate.

As to Euro-dollar borrowings, he agreed

that the treatment should be kept separate from that accorded
domestic liabilities.

He preferred the procedure under which the

reserve-free base would be phased out and a uniform 8 per cent
requirement applied to all Euro-dollar borrowings--although he
believed a good case could be made for a 5 rather than 8 per cent
requirement.
Mr. Hayes went on to say that the proposed letter asking
for voluntary compliance by nonmember banks might be a useful way
of dramatizing one of the problems arising from the absence of
uniform reserve requirements for all commercial banks.

As to

restraint on the use of funds obtained from U.S. branches and
agencies of foreign banks, he would favor the guideline approach
along the lines adopted in 1969.
In concluding, Mr. Hayes said he would submit for the
Committee's records a number of memoranda dealing with the matters
under discussion that had been prepared at the New York Bank.1/

1/

files.

Copies of these memoranda have been placed in the Committee's

-55-

5/15/73

Mr. Balles remarked that the comments Chairman Burns had
made from time to time concerning the importance of confidence as a
determinant of the economic outlook appeared to be especially rele
vant at this point.

Evidence that confidence was in a rather peri

lous state could be found in various indicators, of which he would
mention only three:

the stock market, surveys of consumer expecta

tions, and markets for gold.

In his judgment, a good part of the

recent deterioration in confidence could be attributed to fear that
inflation would not be brought under a reasonable degree of control.
He was disturbed by the inflammatory nature of some of the comments
by responsible parties that were appearing in the business and
financial press.

For example, the recently published April survey

of the National Association of Purchasing Management referred to
fears that the current boom might be headed toward a condition
described as "running wild."

And, as he had indicated earlier, he

was concerned about a possible explosion in wages following on the
heels of the very sharp rise in prices and profits.

The April

increase in wholesale prices of industrial commodities, the largest
in 22 years, certainly did not offer any comfort about the prospects

for prices at the retail level.
In short, Mr. Balles continued, he considered inflation
to be the clear and present danger, and he believed it was crucial
for the System to give overt signals to the public and to the

-56-

5/15/73

financial markets that monetary policy was leaning against the winds
of inflation.

Partly by accident, the first-quarter growth rates

of M1 and M2 were considerably below the fourth-quarters rates,
and a strong rebound in the second quarter would have highly unfor
tunate effects on public and market attitudes.

Whatever the course

of Committee policy, both the rate of inflation and the rate of unemploy
ment would be higher than desirable.

In his judgment, however, the B

specifications were likely to represent the least destructive of
the unpleasant alternatives available.

As to the operational para

graph of the directive, he favored the language of the tentative
draft of alternative B that had been shown in the blue book.

The

problem with the revised version of B, which called for "somewhat
slower" growth in monetary aggregates than over the past 12 months,
was that the 12-month growth rates referred to were rather high:
6.3, 9.0, and 9.7 per cent for M1, M2 , and RPD's, respectively.
He would like to see the aggregates grow at rates much lower than
those.
Mr. Balles said he would make two observations regarding
the marginal reserve requirement proposals.

First, the measures

were not likely to have much restraining effect unless banks were
able to pass through the higher cost of funds in the prices they
charged their customers.

The measures should be expected, therefore,

to give further upward impetus to the prime rate.

Secondly, he was

5/15/73

-57-

highly skeptical that nonmember banks would comply with the request
that they voluntarily observe the marginal reserve requirements
to be imposed on member banks.

Indeed, they probably would be urged

not to comply by their State supervisors.

On the other hand,

he

thought the request would do little harm, and as Mr. Hayes had
suggested,it might serve a useful purpose by dramatizing the
inequities in the existing differences between reserve require
ments applicable to member and nonmember banks.
Mr. Mayo agreed that it was important for the Committee to
take account of the existing overheating of the economy and to do
its best to deal with the problem of inflationary psychology.
However, it was necessary also to recognize that the policy decision
taken today would have important effects not only on the present
situation but on that prevailing a year from now and perhaps even
later.

With those considerations in mind, he had a rather strong

preference for most of the specifications shown under alternative B,
including the retention of the existing 5 to 5-1/2 per cent longer
run target rate for growth in M1 .

The one exception he would make

related to the range of tolerance for the funds rate.

If the Board

should approve the marginal reserve requirement proposals, he would
expect some ratcheting up of CD rates with spill-over effects on
other rates.

Accordingly, like Mr. Hayes,he thought it would be

desirable to raise the funds rate specification by a quarter of a
point, to a range of 7-1/2 to 8-1/4 per cent.

5/15/73

-58-

With respect to the directive language, Mr. Mayo said he
felt quite strongly that the Committee would be ill-advised to move
in the direction suggested in the drafts the staff had submitted
for consideration today.

He noted that in both alternatives A

and C the desired growth rates of the aggregates were expressed
relative to the actual growth over the past 6 months, whereas in the
revised version of alternative B the past 12 months were used as a
reference period.

Perhaps at the next meeting it would be found

necessary to use the past 8 months, or some other interval, as a
reference for expressing the objectives associated with one or
more of the alternatives.
that path.

It would be unfortunate to start down

Personally, he thought the term "moderate growth" was

quite acceptable as a description of the Committee's objectives
for the aggregates.
Mr. Mayo remarked that he would heartily applaud a suspen
sion of the remaining ceilings on large-denomination CD's, should
that move be associated with the adoption of the marginal reserve
requirement proposals.
excellent.

He thought those proposals themselves were

In particular, he considered the technique of applying

a marginal requirement to a combination of items on the liability
side far more acceptable than the alternative--which might otherwise
have to be faced later on--of applying reserve requirements to
categories of assets.

He suspected that it was not necessary at

-59-

5/15/73

this point to include finance bills among the liabilities covered;
while the use of finance bills could expand rapidly under tight
credit conditions, he would not expect such expansion if the
ceilings on large-denomination CD's were removed.

However, no

particular harm would be done by including finance bills.
As to Euro-dollar borrowings, Mr. Mayo continued, he favored
phasing out the existing reserve-free bases and making reserve
requirements on such borrowings conform to those on other non
deposit liabilities.

One possibility would be to have the banks

pool all of their nondeposit liabilities, including Euro-dollar
borrowings, for purposes of reserve requirement calculations.

Such

a procedure need not mean giving up the opportunity to apply
differential reserve requirements to Euro-dollar borrowings, should
that prove desirable later, and it might have some advantages.
However, equivalent results could be obtained without pooling
liabilities.
Mr. Mayo noted that implementation of the marginal reserve
requirement proposals could lead to a further advance in the prime
rate, and it might also militate in favor of another increase in
the discount rate following the rise to 6 per cent that became
effective last Friday.

Indeed, it was quite possible that the

directors of the Chicago Reserve Bank would vote for another dis
count rate increase before the next meeting of the Committee.

He

-60-

5/15/73

thought the prospect of further upward pressure on the prime and
discount rates should not deter the Board from implementing the
proposals.
Mr. Morris remarked that, as he had indicated earlier, he
considered it advisable for the Committee to follow a middle course
on policy at this juncture in view of the uncertainties in the
economic outlook.

Accordingly, he favored alternative B. He

hoped it would not prove necessary to let the Federal funds rate
rise to the upper limit of 8 per cent shown under that alternative,
but he would certainly not object to such a funds rate if it should

prove necessary in order to dampen excessive growth in the monetary
aggregates.
Mr. Morris said his general reaction to the marginal reserve
requirement proposals was that they would represent a great step
forward.

To implement them would, in effect, be to announce that the

System intended to control bank credit expansion through the use
of reserves rather than interest rate ceilings; such an announce
ment would clear the air in a positive and constructive way.

Like

Mr. Hayes, he was concerned about the loophole represented by
documented discount notes, and he hoped high priority would be
given to developing means for closing that loophole.

Also, it was

important not to raise reserve requirements so high as to create
incentives for banks to spin off part of their lending activities

-61-

5/15/73

to affiliates.

Although he did not think the level now under con

sideration was high enough to have such an effect, he was not sure
where the threshhold might be.

If further increases were con

templated, it would be necessary to remain alert to signs that the
threshhold was being reached.
Mr. Morris added that he considered it highly desirable to
make a sharp distinction between Euro-dollar borrowings and funds
obtained from domestic sources.

It should be clear that System

actions affecting reserve requirements on domestic funds would be
governed by domestic economic considerations alone, but that actions
affecting Euro-dollar borrowings would also be influenced by bal
ance of payments and other international financial considerations.
He would favor introducing a differentiation at the outset, by
setting a lower requirement on Euro-dollar borrowings, so as to
avoid giving observers the impression that all sources of funds
would be dealt with on the same basis.
In reply to a question by Mr. Sheehan, Mr. Morris said he
thought changes in reserve requirements on Euro-dollar borrowings
would prove useful in the future as a means for influencing
international flows.
Chairman Burns observed that the establishment of uniform
requirements at the present time would not preclude the System
from varying the requirement on Euro-dollars separately in the
future.

-62-

5/15/73

Mr. Eastburn commented that the reasons for concern about
inflation had been amply described in the discussion thus far.

As

he had indicated earlier, however, he believed that the Committee
also had to take account of the increasing dangers of recession.
That led him to three conclusions.

First, it was important to

guard against overdoing restraint.

It appeared now that M1 would

expand in the first half of 1973 at a rate slightly below 4 per
cent.

In his judgment, growth at or below that rate in the second

half would be too slow, given the lags of policy.
favored a longer-run target range for M1

Accordingly, he

of 5 to 5.5 per cent, as

shown under alternative B.
Secondly, Mr. Eastburn continued, he thought the Committee
should not try to compensate for the overshoots in the monetary
aggregates that had occurred thus far in the second quarter.
That led him to favor the ranges shown under alternative B for
growth in the aggregates in the short run.

He preferred the

revised alternative B language the staff had proposed.

While he

recognized that there were some problems with that language, its
general thrust was in the direction of greater precision,and that,
in his view, was the direction in which the Committee should con
stantly seek to move.
precise.

Terms like "moderate growth" were not very

-63-

5/15/73

Mr. Eastburn observed that his third conclusion related to
the proposed marginal reserve requirement measures.

It was impor

tant for the System to remain alert to the risks of a credit crunch
and--since a crunch was essentially an availability phenomenon--to
work through credit cost rather than availability to the extent
possible.

That consideration argued for the adoption of the pro

posed measures.

In his judgment, however, it was essential that

those measures be accompanied by a suspension of Regulation Q
ceilings on large-denomination CD's.

Otherwise, the effects on

the market would be much too drastic.
Mr. Kimbrel remarked that observers in the Sixth District
had become increasingly anxious in recent weeks about the prospects
of getting assistance from fiscal policy in the economic stabili
zation effort.

Those anxieties, coupled with the sense of frus

tration arising from the latest disturbances in foreign exchange
markets, were certainly not contributing to the factor of confi

dence, which in his view was playing as important a role as any
other factor at the moment.

Against that background, he hoped the

Committee would be able to avoid unduly rapid growth in the monetary
aggregates.

He liked the language of alternative B and the speci

fications for longer-run targets shown under that alternative in
the blue book.

It might be desirable to give the Manager slightly

-64-

5/15/73

more latitude in his efforts to achieve those targets by raising
the upper limit of the range for the funds rate from 8 to 8-1/4
per cent.
Mr. Kimbrel noted that he had favored the imposition of
marginal reserve requirements in 1971.
latest proposals would be implemented

He certainly hoped that the
and that the Regulation Q

ceilings on large-denomination CD's would be suspended at the same
time.

One advantage of the proposals was that they would result

in more equitable treatment with respect to nondeposit sources of
funds that were used as substitutes for CD's.

He had wondered

whether a one percentage point increase in reserve requirements
might not be preferable to the introduction of marginal requirements,
but he did not feel strongly on that point.

As others had suggested,

implementing the proposals might strengthen the case for a further
increase in the discount rate.
Mr. Francis observed that both the long- and short-run
specifications for growth in the monetary aggregates shown under
alternative B seemed appropriate to him in the present situation.
There was some question in his mind as to whether it would be
possible for the Manager to achieve those growth rates if the upper
limit for the funds rate range were set at 8 per cent; he would
prefer to set that limit at 8-1/2 per cent, to give the Manager
more latitude in the case of need.

5/15/73

-65-

For the directive, Mr. Francis continued, he favored the
draft of alternative B shown in the blue book because, in calling
for a continuation of the M 1 growth of the past 6 months and some
slowing in growth of other key aggregates, it seemed to him to des
cribe accurately the needs of the present situation.

To illustrate his

point, he might note that Federal Reserve credit increased at annual
rates of 18 per cent in the 6 months ending in April, 11 per cent
in the 12 months ending then, and 8.5 per cent over the 5-year
period from early 1967 to early 1972.

Growth in the monetary base

also was faster in the last 6 months than in the other periods.
In contrast, growth in M , which was at a rate of 6.2 per cent in
the 1967-72 period and 6.3 per cent in the 12 months ending in
April, was at a rate of 5.3 per cent in the last 6 months and even
less--4.5 per cent--in the last 3 months.

He believed that the

recent deviation of the growth rate in M1 from that of the other
aggregates could be explained by the large build-up of Treasury
balances at commercial banks, and that M1 growth would tend to
deviate in the upward direction as those balances were reduced.
Under such circumstances, it would be correct to describe the
Committee's objective as that of keeping M1 growth close to the
rate of the past 6 months while slowing growth in other key
aggregates.

5/15/73

-66-

With respect to the marginal reserve requirement and
related proposals, Mr. Francis observed, he would be happy to see

the remaining Q ceilings on large-denomination CD's removed.
However, he had considerable doubts about the implications of the
proposals for monetary policy. He believed the record would indi
cate that when reserve requirements had been increased in the past
the Committee had usually sought to offset the effects temporarily

by open market operations, and the "temporary" offsets had fre
quently tended to be rather lasting.

Considering the proposals

from a cost-benefit viewpoint, he agreed that their direct costs
to the System would not be very great.

However, they might also

have an opportunity cost in the form of diverting System resources
from other uses.
Beyond those considerations, Mr. Francis continued, he
thought that with regard to controlling credit, the System's primary
emphasis should be on total credit.

He believed that the impact of

the proposals would be confined to bank loans and he doubted that they
would have any effects on total credit.

In his judgment the only way

the Federal Reserve could come to grips with total credit was by supplying
fewer reserves to the banking system.
Mr. Black remarked that he saw no good reason for the
Committee to change its longer-run targets for the monetary aggre
gates at this stage.

As others had noted, the economy was certainly

-67-

5/15/73

in a boom or near-boom situation and inflation was the most urgent
near-term problem.

Nevertheless, it was important not to allow

monetary policy to fall into the stop-go pattern that had character
ized it too frequently in the past, especially around cyclical
turning points.

The Federal Reserve had anticipated the present

boom--or near-boom--last fall and had undertaken a series of
restrictive moves which added up to an impressive package.

The

Committee's present longer-run target of a 5 to 5-1/2 per cent
growth rate in M1, which apparently would be undershot in the
first half of 1973, represented a substantial slowing from the
rate of more than 8 per cent recorded in the second half of 1972.
That amount of deceleration struck him as risky enough; he would be
reluctant to push further, especially in view of the pronounced
slowing in real GNP growth projected for the rest of the year.
With respect to the short run, Mr. Black observed, he
believed that a point had been reached at which caution was called
for in any further move toward tighter money market conditions.
Key money rates were now at or close to their 1966 and 1969 levels,
and the 6 per cent discount rate could prove to be an important
psychological barrier.

Also, the threshhold of disintermediation

might have been reached.

While he favored the specifications of

alternative B--and also the alternative B language, in the form
shown in the blue book--he would not like to see the Federal funds

-68-

5/15/73

rate move as high as 8 per cent unless it was clear that the
aggregates were growing at rates significantly above the upper
limits of their specified ranges.
Turning to the question of marginal reserve requirements,
Mr. Black said he would certainly prefer the staff's proposals to
the use of Regulation Q ceilings as a method of controlling bank
credit.

As Mr. Francis had pointed out, however, it was far from

clear that the proposed measures would prove to be an effective
device for controlling total credit.

It seemed entirely possible

that tighter control over bank credit would have interest rate
effects leading to more intensive use of demand deposits by non
bank lenders to satisfy credit demands not accommodated by banks.
One of the economists at the Richmond Bank had developed a theo
retical model for examining that question which appeared to be
quite useful.

Although his report was not yet in final form,

copies of a preliminary version were available to those interested.
Mr. Black went on to say that, despite his doubts about the
effectiveness of the proposed measures in controlling total credit,
he thought there were some important reasons for putting them
into effect.

In periods of tight money, the liquidity problems of

banks would be less acute if marginal reserve requirements were
substituted for Q ceilings on large-denomination CD's.
be a key factor at some later stage.

That could

Secondly, implementing the

5/15/73

-69-

proposals would put an end to the cat-and-mouse game the Federal
Reserve had played with banks in recent periods of tight money,
under which the System acted to limit bank access to particular
sources of funds and the banks reacted by developing new sources.
Third, reliance on marginal reserve requirements rather than Q
ceilings would insure that large banks, which were the principal
suppliers of business loans, would not be as effectively cut off
from money market sources of funds in tight money periods, and
therefore that there would be less tightness in business loan
markets in such periods.

Finally, marginal reserve requirements

would appear to be much more equitable than Q ceilings.

The

latter tended to undercut the competitive position of banks rela
tive to that of other lenders in tight money periods, and it seemed
only fair to permit banks to continue to engage in the process of
credit intermediation in such periods.
With respect to Euro-dollar borrowings, Mr. Black continued,
he agreed with Mr. Morris that the reserve requirements for them
should be kept distinct from those against domestic money market
instruments in order to facilitate their use as a means for influ
encing international flows of funds.

He would favor phasing out

the reserve-free base, ending up with a straight 8 per cent
requirement against Euro-dollar borrowings.

In view of the current

5/15/73

-70-

uncertainties in foreign exchange markets, he would prefer to use
one of the slower phase-out schedules mentioned in the staff
materials--5 or 7 per cent per computation period--rather than the
10 per cent schedule.

As to the proposed request for voluntary

compliance of nonmember banks, he shared Mr. Balles' skepticism
about its probable effectiveness.

Like Mr. Balles, however, he

thought that the request would be helpful in dramatizing the
inequities involved in the existing situation with respect to
reserve requirements for member and nonmember banks.
Mr. Coldwell remarked that for the short run inflation
was the major economic problem; for the longer run, there were
questions about the rate of growth of economic activity.

In his

view, the main source of difficulty related to the state of
confidence, and he could find little reassurance on that score
in light of recent developments in the stock market and in foreign
exchange markets.

He was especially disturbed by the latter; if

the international financial situation did not quiet down soon, he
would become concerned about the possible consequences for the
Committee's freedom of action with respect to monetary policy.
With respect to the alternatives before the Committee
today, Mr. Coldwell said he preferred the specifications of alter
native B and the revised language the staff had submitted for that
alternative.

In his opinion, however, the Committee had been

5/15/73

-71-

paying too much attention to M 1 , the movements of which had been
giving false signals.

He would favor putting more emphasis on

the objective of limiting growth in the bank credit proxy.

As to

the Federal funds rate, he thought a range of 1 percentage pointroughly from 7-3/8 to 8-3/8 per cent--would be appropriate.
Mr. Coldwell observed that there was much to attract him
in the package of proposals put forward by the Board's staff,
including the suggested removal of the remaining Regulation Q

ceilings on large-denomination CD's, the phasing out of the reserve
free Euro-dollar base, and the introduction of reserve requirements
against ineligible acceptances.

With respect to marginal reserve

requirements themselves, he had a number of reservations.

Before

mentioning them, however, he might note that the effects desired
from the marginal requirements would not be achieved unless the
Committee was prepared to validate the tendency toward higher
market interest rates that their imposition would produce.
Mr. Coldwell noted that one of his reservations related
to the complexity of the proposals.

He suspected that banks would

have some difficulty in adapting to another new arrangement for
calculating their reserve requirements and in understanding some
of the detailed provisions.

Partly because the proposals were

complex, banks were likely to seek ways of avoiding the marginal
requirements.

There would appear to be some good loopholes; for

5/15/73

-72-

example, the banks that made markets in Federal funds could absorb
into their own positions an increased proportion of the funds they
acquired, and banks in general could sell participations in their
loan portfolios to nonaffiliates.

Finally, he wondered whether

the effects of the proposals would be equitable, in view of past
differences among banks in the vigor with which they had acquired
CD funds.
Mr. Coldwell said he shared the skepticism others had
expressed about the extent to which nonmember banks were likely
to concur in the request that they comply voluntarily with the
marginal requirements imposed on member banks.

However, he had

long favored efforts to get nonmember banks to recognize their
responsibilities in the field of monetary policy, and accordingly
he thought there were good arguments for sending the proposed
letter.
In light of his reservations about the marginal reserve
requirements, Mr. Coldwell continued, he believed that the objec
tives sought might be better achieved by a simple increase in
existing reserve requirements, coupled with a further advance in
discount rates.

Like Mr. Francis, he thought the Committee itself

could best impose restraint by curtailing the rate at which it
injected reserves.

As he had indicated earlier, however, the

-73-

5/15/73

System's freedom of action in coming weeks might well be limited

by developments in the international financial area.

Both the

foreign exchange situation and the rapid waning of confidence in
the Government's ability to stabilize the economy and control
inflation offered real grounds for concern.
Mr. MacLaury said he did not sense any real disagreement
today with respect to the present state of the economy or the
prospects for the next 6 months, although--as several speakers had
noted--the outlook for the period thereafter was considerably
more cloudy.

Insofar as there was an open question, it related

to the extent to which monetary policy could be used to counter
the existing overheating without damaging the economy 6 months
hence.

With that question in mind, he found himself favoring the

specifications of alternative B.

Initially he had been inclined

to shade the upper limit of the funds rate down from 8 to 7-7/8
per cent, but he now thought that his objective could be accom
plished with the formulation suggested by Mr. Black, under which
the funds rate would be permitted to rise to 8 per cent only if
the monetary aggregates were significantly stronger than expected.
For the directive he favored the blue book version of alternative B.
Mr. MacLaury observed that he did not see a very close
relationship between the proposed marginal reserve requirement
measures and the question of the general credit policy stance to

5/15/73

-74-

be adopted by the Committee.

Like Messrs. Francis and Black, he

questioned the advisability of focusing restraint on bank credit,
given the ready access of large businesses to credit from other
sources.

In his judgment, special restraints on bank credit could

not be pushed very far.

The small size of the proposed marginal

reserve requirement--3 percentage points--was consistent with the
view that such a device could be expected to be only marginally
effective.

Indeed, he thought its main merit was as a substitute

for the Regulation Q ceilings on large-denomination CD's with
maturities of 90 days or more.

In that connection, a statement in

the staff memorandum reading "As part of the package of proposed
policy actions, the Board might wish to consider extending the
suspension of Regulation Q ceilings to such deposits" seemed to him
to put the cart before the horse; if the Q ceilings were not to
be suspended, he thought the other proposed actions also should
not be taken.
Mr. MacLaury noted that he agreed entirely with Mr. Morris'
view that a distinction should be preserved between reserve require
ments on Euro-dollar borrowings and on funds from domestic sources.
The staff memorandum included some well-taken observations on the
absence of significant advantage to an appearance of symmetry in
the treatment of funds from those two sources.

However, the memo

randum did not press that point to a conclusion he would consider

5/15/73

-75-

logical--that different percentage reserve requirements should be
set initially on the two types of funds.

Like Mr. Morris, he would

favor a lower initial requirement--specifically, 5 per cent--on
Euro-dollar borrowings.

He had no strong feelings about the

alternative means discussed for dealing with the existing reserve
free Euro-dollar bases.
In concluding, Mr. MacLaury asked whether any thought had
been given to the question of how and under what conditions the new
base that would be established for calculating marginal reserve
requirements might be phased out in the future.
Mr. Axilrod replied that the proposal had a "self-destructing"
aspect in the sense that the marginal reserve requirements on large
denomination CD's would become irrelevant to banks under the very
circumstances in which they might no longer be needed.

Specifi

cally, at some point on the road back to easy money market conditions,
market interest rates would drop to levels at which banks could sell
CD's in denominations of less than $100,000 at or below the ceiling
rates applicable to small CD's.

Thus, by issuing CD's in denomina

tions of, say, $90,000, banks could avoid the marginal requirement.
Chairman Burns remarked that, even apart from the feature
that Mr. Axilrod had mentioned, the Board of Governors presumably
would stand ready to eliminate marginal reserve requirements when
it concluded that they were longer needed.

-76-

5/15/73

Mr. Winn observed that the nation was experiencing one of
the biggest consumer spending booms in its history, fueled in large
part by expansion of consumer credit.

An aspect of the situation

which was not being widely discussed but which nevertheless worried
him deeply was the increasing tendency of lenders to lengthen maturi
ties on instalment loans.

He could not believe it was healthy for

banks, for example, to extend the maturities on new car loans to
48 months at the very peak of a boom in automobile sales.

He

understood that, under the provisions of the Credit Control Act
of 1969, the President could direct the Federal Reserve to issue
regulations controlling credit extensions, including terms on
consumer loans.

Enforcing limitations on consumer loan terms

could, of course, involve a tremendous administrative burden.
However, the experience under recent price control programs suggested
that such limitations could be made effective even if the enforce
ment apparatus consisted mainly of spot checks rather than of
efforts to police every individual retailer and lender.
With respect to the form of the directive, Mr. Winn said
that while he saw the advantages of greater precision in the des
cription of the Committee's objectives, he might note that increased
precision in that respect would not necessarily be matched by
increased precision in the degree to which the objectives were
met.

He meant no criticism of the Manager; indeed, he thought

5/15/73

-77-

the latter was doing an excellent job in his efforts to achieve
the results the Committee desired.

However, because of sudden

international flows, unexpected changes in the Treasury balance,
and similar developments, the outcome would often appear to be
wide of the mark at the time--90 days after the meeting--when the
directive was made public.

He was concerned that publication of

a highly precise description of the Committee's objectives at that
time might give a misleading impression of the System's ability to
achieve its goals.
Mr. Winn then noted that he was disturbed about the current
inflationary thrust.

He thought it was likely that during the

next 3 months or so there would be an explosion of wage rates
which, in turn, might have ramifications of a kind that could not
be foreseen now.

As to policy, he would want to hold "steady as

you go" to the extent possible.

Accordingly, he favored the

alternative B directive, and he hoped that it would be possible
to come reasonably close to the targets specified under that
alternative.
Mr. Winn remarked that he had nothing to add with respect
to the marginal reserve requirement proposals.

He would like to

second the view others had expressed that the implementation of
those proposals should be accompanied by a suspension of the
remaining Q ceilings on large-denomination CD's.

-78-

5/15/73

Mr. Clay observed that, with real economic growth projected
to slow and with the pace of the expansion generating demand pres
sures on prices, monetary policy should pursue a moderately restrain
ing course in order to avoid exaggerating either tendency.

He

shared the preference most others had expressed for alternative B.
Mr. Clay then noted that he had found the staff memorandum
on marginal reserve requirements to be highly interesting.

While

any reactions he might offer were necessarily tentative in view of
the limited time available to study the document, he did want to
express certain concerns.

First, he thought that the measures

proposed would place the major burden for reducing business loan
expansion on the large member banks, and that their implementation
would create additional pressures forcing such financing outside
of normal member bank channels.

Specifically, he believed that

the measures would accelerate efforts by banks to shift lending
activities to affiliates, and that they would encourage businesses
to do their financing outside of banking channels or go to nonmember
banks.

While it was proposed to ask nonmember banks to comply volun

tarily with the marginal reserve requirements, he would question
the effectiveness of such a request.

The staff memorandum suggested

that the request be directed only to the nonmember banks with a
large volume of money market-type borrowing outstanding, estimated
at less than 100.

Not only were those banks likely to complain, but

5/15/73

-79-

the many hundreds of smaller nonmember banks undoubtedly would
become concerned about the possibility that they might be brought
under the control of the Federal Reserve.
Secondly, Mr. Clay continued, member banks might attempt
to circumvent the marginal reserve requirements by issuing CD's
in denominations of less than $100,000.

As indicated in the staff

memorandum, however, the present relationship of market interest
rates to the ceiling rates on small-denomination CD's would prevent
any significant volume of such activity.

Finally, he continued

to be bothered by the fact that the retention of Regulation Q rate
restrictions on smaller-denomination CD's and their removal from
large-denomination paper would make it more difficult for small
rural banks to compete in financial markets.

To the extent that

the proposed measures would encourage the expansion of affiliates,
they would force many rural areas to turn increasingly to nonbank
sources of funds.

Despite all the platitudes pertaining to the

benefits of having large banking empires to finance rural areas,
research done on that subject continued to indicate that such
benefits did not accrue to rural communities.

Personally, he would

like to see the removal of Regulation Q ceilings from all types of
bank liabilities.
Mr. Daane remarked that it was probably too late in the
meeting and too late in the economic boom to say or do anything

-80-

5/15/73

very new.

In his view, both international and domestic consider

ations clearly called for a continuation of the present stance of
monetary policy.

Any overt actions that might be needed to under

score that stance should be taken in areas other than open market
operations.

At this time, the System should demonstrate steadiness

of purpose.

It should also recognize fully the limitations on

what could be achieved through monetary policy and on the feasible
types of policy actions.

He favored the specifications of alter

native B, and like Messrs. Brimmer, Mayo, and Winn, he would not
want to introduce additional quantification in the directive.
Having the staff's assurance that the B specifications were con
sistent with language like that of the previous directive, he would
prefer to retain such language.
Mr. Bucher observed that the case for moderation had been
eloquently made by others, and he had nothing to add on that score.
He, too, favored the specifications of alternative B, although like
Messrs. Black and MacLaury, he would be reluctant to see the funds
rate rise to the indicated upper limit of 8 per cent.

As far as

directive language was concerned, he should note that he had been
among those who had raised questions at the previous meeting about
the use of such terms as "moderate" and "modest" to describe the
rates of growth in the monetary aggregates sought by the Committee.
He believed, however, that the particular manner in which the staff

5/15/73

-81-

had formulated more specific language was likely to cause greater
difficulties than would the use of the term "moderate."

While it

might be possible to develop better means for making the directive
more specific, today he shared Mr. Daane's preference for retaining
language along the lines of that in the previous directive.
Mr. Sheehan said he concurred in Mr. Bucher's position.

He

added that he had been impressed by Mr. Black's comments on policy
today and would like to associate himself with those comments.
Chairman Burns remarked that a majority of the Committee
was clearly in favor of the specifications of alternative B and of
some version of the B language for the operational paragraph of the
directive.

He did not find the majority's position unacceptable,

but for reasons which he would not elaborate on at this point he
would prefer a somewhat different course.

Perhaps the best pro

cedure would be for him to describe the directive language and
specifications he favored and determine whether they would be
acceptable to the Committee.

If the members believed that further

deliberation would be useful, the meeting might be recessed for
luncheon and then continued in the afternoon.
With respect to the directive, the Chairman said, he would
prefer to use alternative C of the staff's drafts, with two modi
fications:

in the phrase "while taking account of credit market

developments," the words "credit market" would be replaced by

5/15/73

-82-

"international and domestic financial market"; and in the phrase
"somewhat slower growth in monetary aggregates over the months
ahead" the word "immediately" would be inserted before "ahead."
The paragraph would then read as follows:

"To implement this policy,

while taking account of international and domestic financial market
developments, the Committee seeks to achieve bank reserve and money
market conditions consistent with somewhat slower growth in mone
tary aggregates over the months immediately ahead than occurred on
average in the past 6 months."
As to specifications, the Chairman continued, he would
suggest adopting the longer-run targets of alternative B, which
would involve the retention of the present 5 to 5-1/2 per cent
target range for growth in M 1 over the second and third quarters
combined.

For the associated ranges of growth in the May-June

period, he would suggest those shown under alternative C:

7-1/2

to 9-1/2 per cent for RPD's, 3-1/2 to 5-1/2 per cent for M1, and
4-1/2 to 6-1/2 per cent for M2.

For the range of tolerance in the

Federal funds rate during the intermeeting period, he would suggest
7-1/4 to 7-7/8 per cent.

It would be understood, as in the past,

that it might prove necessary for the Committee to consult during
the intermeeting period about possible modifications in those
specifications.

In the present case, consultation might well be

required rather early in the period.

5/15/73

-83Following some discussion, Chairman Burns said he thought

it would be desirable to recess at this point and resume the
discussion after luncheon.
The meeting then recessed.

It resumed at 2:30 p.m., with

staff attendance limited to Messrs. Holland, Broida, Partee, and
Holmes.
The Chairman said he had asked that staff attendance be
limited at this afternoon session because he wanted to make certain
observations which he thought would best not be made in the presence
of a large group.

At the moment the country was passing through a

political crisis.

He personally could not say what effect that

crisis was having on domestic business and financial opinion,
although he had received some disturbing reports about the impact
on attitudes abroad.

He had noted at the previous meeting of the

Committee that consumers were becoming increasingly pessimistic
about the economic outlook, and in the month since then there had
been additional evidence to that effect.

Financial investors-

including investment bankers, managers of investment and pension
funds, stock exchange brokers, and individual traders--had been
in a depressed mood in recent months, and their depression had
deepened in recent weeks and days.

Businessmen remained highly

confident, but perhaps they were a shade less confident than a
month ago.

In view of all of the uncertainties prevailing at

-84-

5/15/73

present, and in view of the probability that the Board of Governors
would take certain important actions tomorrow with regard to member
bank reserve requirements, he thought it would be a serious mis
take for the Committee today to set the upper limit on the range of
tolerance for the Federal funds rate as high as 8 per cent.

A week

from now he personally might well be advocating an upper limit of
8-1/4 per cent; at the moment, however, he would not want to go
above 7-7/8 per cent.
With respect to directive language, Chairman Burns continued,
he thought there was good reason at this point for describing the
Committee's objectives for the aggregates in terms somewhat more
explicit than the phrase "moderate growth."

As had been noted in

the discussion this morning, real GNP was expanding at a dangerously
rapid rate, and the risk that inflation would continue, and possibly
accelerate, was very great.

Indeed, Mr. Partee had just advised

him that revised figures to be published by the Commerce Department
would show a substantially larger first-quarter increase in the
deflator than had been indicated by earlier estimates.

Under such

circumstances, he considered it important for the Committee to
record its desire not simply for "moderate" growth in the aggregates
but, for the months immediately ahead, for somewhat slower growth
than the average of the past 6 months.

-85-

5/15/73

In response to a question, the Chairman said he did not think
the language he had proposed would imply a narrower focus on M1 than
the Committee intended.

For one thing, it would include an instruc

tion to take account of international and financial developments;
for another, the term "monetary aggregates" was plural.
In reply to a further question, Chairman Burns remarked
that, if the term "monetary aggregates" were taken to cover
the credit proxy as well as RPD's, M1 , and M2, it would be correct
to say that the Committee sought "substantially" slower growth than
that of the past 6 months.

However, he did not consider it necessary

to spell out the objectives in such fine detail.
Mr. Francis observed that he preferred the Chairman's pro
posal for the operational paragraph to the type of language employed
in the previous directive.
Mr. Hayes said he also liked the Chairman's language pro
posal.

With respect to the suggested specifications, he wondered

whether it was reasonable to expect that the indicated growth rates
for the aggregates would prove consistent with a funds rate range
having an upper limit of 7-7/8 per cent.
The Chairman agreed that the several specifications might
well prove inconsistent.

It was with that thought in mind this

morning that he had mentioned the provisions for consultation in

-86-

5/15/73

the intermeeting period and had suggested that consultation might
be needed rather promptly after today's meeting.
In reply to a question by Mr. Francis, Chairman Burns said
he was not proposing any special commitment with respect to con
sultation.

His reference was simply to the understanding which, in

the recent past, had been regularly associated with the list of
specifications agreed upon by the Committee.
Mr. Brimmer noted that the understanding to which the
Chairman referred was set forth as item C on the specification
sheet captioned "Points for FOMC guidance to Manager in imple
mentation of directive."
After further discussion, Mr. Holland suggested that an
additional sentence, reading as follows, be added to that paragraph:
"It was understood that the chances are greater than usual that
consultation may be needed in the coming period because of incon
sistencies among the various operating constraints."
There was general agreement with that suggestion.
Mr. Daane said he could accept the directive language pro
posed by the Chairman if it was not necessarily to serve as a
prototype for future directives.
Chairman Burns remarked that he personally preferred more
general language under ordinary circumstances.

He believed, however,

5/15/73

-87-

that there were times when it was desirable to be a little more
specific

and that this was such a time.
Mr. Bucher commented that he would favor varying the format

of the operational paragraph with the needs of the occasion.

He

had objected earlier to the staff's draft of alternative B because
he was uncomfortable with the particular formulation, not because
he was opposed to more specific language in principle.
Mr. Hayes said he was prepared to accept both the language
and the specifications proposed by the Chairman.
Mr. Eastburn noted that most members had expressed a pre
ference for the short-run ranges for aggregate growth rates shown
under alternative B.

He asked if the Chairman would elaborate on

his reasons for suggesting that the Committee agree on the alternative
C ranges.
Chairman Burns replied that he felt less strongly about the
choice of short-run ranges for the aggregates than he did about either
the funds rate range or the language of the directive.

The C specifi

cations involved growth rates for the May-June period slightly
lower than those of B; specifically, they were 1/2 percentage point
lower for M1, 1 point lower for M 2 , and 1-1/2 points lower for RPD's.
He had thought that it might be well to lean toward the conservative
side at this point.

However, he would have no objection to using

-88-

5/15/73

the ranges of B, or ranges intermediate to those of B and C, if
that was the members' preference.
Mr.

Daane noted that the May-June range for M
1

B was 4 to 6 per cent.
to describe growth in

shown under

He questioned whether it would be correct
such a range as "somewhat slower" than the

average growth rate of the past 6 months, which was 5.3 per cent.
In

the ensuing discussion it

was suggested that the range

for M1 might be narrowed somewhat--perhaps to 4 to 5-1/2 per centor that some historical period other than the past 6 months be
used for reference purposes.
Chairman Burns expressed the view that neither of those
alternatives was desirable.
Mr.

Partee observed that for both RPD's and M2 the upper

limit of the alternative B ranges was below the average growth
rate of the past 6 months.

While that was not the case for M1,

the midpoint of the range for that variable--5 per cent--was below
the 6-month growth rate.
A number of members commented that they would not consider
the alternative B ranges to be inconsistent with the directive
language under consideration.
The Chairman then asked that the members indicate informally
their preferences for May-June growth rates in the monetary aggre
gates, first as between those of alternatives B and C, and second as
between those of alternative B and those intermediate to B and C.

5/15/73

-89-

In both polls, a majority of members expressed a preference
for the alternative B ranges.
The Chairman then proposed that the Committee vote on a
directive consisting of the staff's draft of the general paragraphsincluding the revised statement on foreign exchange market develop
ments that had been distributed today--and the language for the
operational paragraph that he had proposed.

It would be understood

that the directive would be interpreted in accordance with the
specifications shown under alternative B in the blue book, except
that the range of tolerance for the daily-average Federal funds
rate in the statement weeks until the next meeting would be 7-1/4
to 7-7/8 per cent; and that the usual understanding with respect
to intermeeting consultation would be amplified in the manner
that Mr. Holland had suggested.
By unanimous vote, the
Federal Reserve Bank of New York
was authorized and directed,
until otherwise directed by the
Committee, to execute transactions
for the System Account in accordance

with the following domestic policy
directive:
The information reviewed at this meeting suggests
that growth in real output of goods and services is likely
to moderate somewhat in the current quarter from an
exceptionally rapid pace in the two preceding quarters.
Over the first 4 months of this year, employment rose
considerably but the unemployment rate remained about 5
per cent. Retail prices of foods continued upward at

5/15/73

-90-

an extraordinary pace in March, and in April average
wholesale prices of consumer foods rose further.
Increases in wholesale prices of industrial commodi
ties were large and widespread in April, as in the two
preceding months. In foreign exchange markets, which
had been relatively quiet since mid-March, speculative
pressures have developed in recent days and exchange
rates for major European currencies have appreciated
against the dollar. The U.S. merchandise trade balance
improved considerably in the first quarter, reflecting
in part an especially large increase in agricultural
exports.
In April growth in the narrowly defined money
stock picked up from its low first-quarter rate, and
growth in the broadly defined money stock also increased.
Growth in business loans at banks slowed, and banks
reduced the pace at which they issued large-denomination
CD's; consequently, the bank credit proxy expanded some
what less than in other recent months. In recent weeks
Federal Reserve Bank discount rates have been increased
in two steps of one-quarter point to 6 per cent by
May 11. Most short-term market interest rates, which
had risen sharply earlier, have advanced slightly
further. Interest rates on long-term market securities
have been relatively stable.
In light of the foregoing developments, it is the
policy of the Federal Open Market Committee to foster
financial conditions conducive to abatement of infla
tionary pressures, a more sustainable rate of advance
in economic activity, and progress toward equilibrium
in the country's balance of payments.
To implement this policy, while taking account of
international and domestic financial market develop
ments, the Committee seeks to achieve bank reserve and
money market conditions consistent with somewhat slower
growth in monetary aggregates over the months immediately
ahead than occurred on average in the past 6 months.
Secretary's note: The specifications agreed
upon by the Committee, in the form distri
buted following the meeting, are appended
to this memorandum as Attachment C.

5/15/73

-91-

Mr. Hackley entered the meeting at this point.
Chairman Burns noted that a memorandum from the Secretary,
dated May 8, 1973, and entitled "FOMC Counsel positions," had been
distributed to the Committee.

He invited Mr. Holland to comment.

Mr. Holland observed that the several recommendations con
tained in his memorandum were occasioned by the fact that Mr. Hackley
planned to retire from the staff of the Board of Governors at the
end of this month, and that his service as General Counsel of the
Committee, which had extended over a period of 16 years, would
automatically terminate at the same time.

The purpose of the

recommended actions, all of which would be effective June 1, 1973,
was to provide for a better sharing of the prospective legal work
of the Committee and to achieve in the legal area the same kind of
coordinated staff support between the Board and New York Bank as
the Committee already had in the research and operational areas.
He recommended, first, that the Committee amend Section 4 of its
Rules of Organization in the manner indicated in the memorandum
to provide for the position of Deputy General Counsel in addition
to those of General Counsel and Assistant General Counsel.

Secondly,

he suggested that Thomas J. O'Connell, General Counsel of the
Board of Governors and presently Assistant General Counsel of
the Committee, be named to succeed Mr. Hackley as General
Counsel of the Committee; that Edward G. Guy, Vice President and

-92-

5/15/73

General Counsel of the Federal Reserve Bank of New York, be named
Deputy General Counsel of the Committee; and that John Nicoll,
Assistant General Counsel of the Board, be named Assistant General
Counsel of the Committee.
After discussion, it was agreed that the Committee should
act favorably on Mr. Holland's recommendations.
By unanimous vote, paragraphs (a)
and (d) of Section 4 of the Committee's
Rules of Organization were amended,

effective June 1, 1973, to read as
follows:
SEC. 4. Staff. (a) Selection of staff officers.
At its first meeting on or after March 1 of each year,
the Committee selects, from among the officers and
employees of the Board and the Federal Reserve Banks, the
following staff officers to serve until the first meeting
on or after March 1 of the next following year: Secretary,
Deputy Secretary, and one or more Assistant Secretaries;
General Counsel, Deputy General Counsel, and one or more
Assistant General Counsel; and Economists, one or more
of whom may be designated as Senior or Associate Economists
or given titles reflecting their areas of particular
specialization.
*

*

*

*

*

*

(d) General Counsel and Deputy
and Assistant General Counsel. The General Counsel fur
nishes such legal advice as the Committee may require. In
the absence of the General Counsel, the Deputy General
Counsel or an Assistant General Counsel acts as General
Counsel pro tem.

5/15/73

-93-

By unanimous vote, Thomas J.
O'Connell, Edward G. Guy, and John
Nicoll were elected General Counsel,
Deputy General Counsel, and Assistant
General Counsel, respectively, of the
Federal Open Market Committee, effective
June 1, 1973, to serve until the elec
tion of their successors at the first
meeting of the Committee after February 28,
1974, with the understanding that in the
event of the discontinuance of their
official connection 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.
Chairman Burns expressed the members' gratitude to
Mr. Hackley for his many years of outstanding service to the
Committee.

It was agreed that the Chairman should also write a

letter to Mr. Hackley on behalf of the Committee expressing
similar sentiments and extending the members' best wishes.
The Chairman then noted that the staff planned to make a
chart presentation on the economic outlook at the next meeting.
He suggested that, in order to provide adequate time for that
presentation and Committee discussion thereof, the meeting be
scheduled to begin on the afternoon of Monday, June 18, and to
continue on the morning of Tuesday, June 19.
No objections were offered to that suggestion.

5/15/73

-94

It was agreed that the next meeting of the Federal Open
Market Committee would be held on Monday and Tuesday, June 18-19,
1973, beginning on the afternoon of June 18.
Thereupon the meeting adjourned.

Deputy Secretary

ATTACHMENT A

(COPY)
BOARD OF GOVERNORS
OFTHE

FEDERAL RESERVE SYSTEM

Office Correspondence
To Chairman Burns
From

Date
Subject

May15,

1973

Tax Shelters in
Real Estate

Bob Fisher & Helmut Wendel

The Treasury proposals on limitations of artificial accounting
losses are designed to affect individuals who use initial losses incurred
in apartment construction and early apartment operation to offset net
income gained in other enterprises.

There is no change in the Treasury

proposals as regards people in the real estate business to the extent
that such individuals are receiving more income from ongoing real
estate operations than the losses involved in new projects.

The Treasury

proposals thus do not affect ongoing real estate businesses that are
in a net profit position.

They do affect, however, the ability of such

corporations to obtain outside funds from individuals who are engaged
in other business or professional pursuits.

Such individuals could no

longer find a tax shelter from artificial losses by investing funds
into the real estate business.

Construction firms have been getting

large portions of their initial capital for apartment building and
commercial construction from such outside individuals.

Hence the

proposal indicates a need to shift to other sources of capital or to
develop new financing techniques.

It is therefore quite possible that

the proposed rules affecting new projects to be started beginning
May 1, 1973, would be a pronounced short run deterrent on apartment
buildings and commercial construction.

For instance, the developers

Chairman Burns

-2-

of Columbia Maryland have told us that they have stopped new commitments
for rentals and commercial buildings until uncertainties regarding the
proposals can be clarified.

A similar report was obtained from a

leading real estate advisory firm in Chicago that felt that this
legislation would substantially halt speculative construction rental
housing and force new construction into condominium and cooperative
types of financial arrangements.
Many real estate experts have not yet had time to evaluate
the effects of the Treasury's proposals, so that our judgment now is
very tentative.

The Treasury's staff has told us informally that they

do not expect a major effect from these provisions.

Their argument

is that the estimated revenue effect of the proposed revenue amounts
to only a few $100 million.

They do not believe that such a small

tightening of tax provisions would have a pronounced impact on the
housing market.

They are working now with HUD on developing transi

tion rules such as to protect projects already in process.
rules would apply only to projects that have not yet begun.

The new

ATTACHMENT B

May 14, 1973
Drafts of Domestic Policy Directive for Consideration by the
Federal Open Market Committee at its Meeting on May 15, 1973
GENERAL PARAGRAPHS
The information reviewed at this meeting suggests that
growth in real output of goods and services is likely to moderate
somewhat in the current quarter from an exceptionally rapid pace
in the two preceding quarters. Over the first 4 months of this
year, employment rose considerably but the unemployment rate
remained about 5 per cent. Retail prices of foods continued
upward at an extraordinary pace in March, and in April average
wholesale prices of consumer foods rose further. Increases in
wholesale prices of industrial commodities were large and wide
spread in April, as in the two preceding months. In foreign
exchange markets, which had been relatively quiet since mid
March, speculative pressures have developed in recent days and
exchange rates for major European currencies have appreciated
The U.S. merchandise trade balance improved
against the dollar.1/
considerably in the first quarter, reflecting in part an especially
large increase in agricultural exports.
In April growth in the narrowly defined money stock picked
up from its low first-quarter rate, and growth in the broadly
defined money stock also increased. Growth in business loans at
banks slowed, and bank reduced the pace at which they issued large
denomination CD's; consequently, the bank credit proxy expanded
somewhat less than in other recent months. In recent weeks Federal
Reserve Bank discount rates have been increased in two steps of
one-quarter point to 6 per cent by May 11. Most short-term market
interest rates, which had risen sharply earlier, have advanced
slightly further. Interest rates on long-term market securities
have been relatively stable.
In light of the foregoing developments, it is the policy
of the Federal Open Market Committee to foster financial conditions
conducive to abatement of inflationary pressures, a more sustainable
rate of advance in economic activity, and progress toward equilib
rium in the country's balance of payments.
1/ This statement on foreign exchange market developments
incorporates the revisions suggested by the staff in a note
distributed to the Committee at the outset of the meeting.

OPERATIONAL PARAGRAPHS
Alternative A
To implement this policy, the Committee seeks to achieve
bank reserve and money market conditions consistent with somewhat
faster growth in the narrowly defined money stock over the months
ahead than occurred in the past 6 months on average but somewhat
slower growth in other key monetary aggregates than in that period.
Alternative B
To implement this policy, the Committee seeks to achieve
bank reserve and money market conditions consistent with somewhat
slower growth in monetary aggregates over the months ahead than
occurred on average in the past 12 months.
Alternative C
To implement this policy, while taking account of credit
market developments, the Committee seeks to achieve bank reserve
and money market conditions consistent with somewhat slower growth
in monetary aggregates over the months ahead than occurred on
average in the past 6 months.

ATTACHMENT C

May 15, 1973
Points for FOMC guidance to Manager
in implementation of directive
A.

Specifications
(As agreed, 5/15/73

Longer-run targets (SAAR):
(second and third quarters combined)

5 to 5-1/2%
M2

Proxy

6 to 6-1/2%
9 to 9-1/2%
7-1/2 to 8%

B. Short-run operating constraints:
1. Range of tolerance for RPD growth
rate (May-June average):

9 to 11%

2. Ranges of tolerance for monetary
aggregates (May-June average):

4 to 6%

5-1/2 to 7-1/2%
3. Range of tolerance for Federal funds
rate (daily average in statement
weeks between meetings):

7-1/4 to 7-7/8%

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.
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. It was understood that the chances are
greater than usual that consultation may be needed in the coming period
because of inconsistencies among the various operating constraints.