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APPENDIX Notes for FOMC Meeting May 20, 1980 Scott E. Pardee Since the last meeting of the FOMC the dollar has declined a net of 3 percent against the German mark, 2-3 percent against other European currencies, and 8 percent against the Japanese yen. Most of this decline was in the first week after the FOMC meeting, when interest rates were coming off sharply in the United States and when the Iranian situation was in the market's focus. Since then, and even though U.S. interest rates tailed off further, the dollar has held its own. Intervention has been relatively light. Most of us I guess would regard this more recent stability as a rather [remarkable] performance for the dollar. Most seasoned dealers with whom we have talked lately would agree. [Unintelligible] between the [unintelligible] interest rates and evidence of improvement in our trade account and inflation performance. By late April market participants began to respond to the growing signs that the U. S. economy has moved into recession and that the recession might be deeper than previously anticipated. Signs of a slowdown reinforced expectations that our trade and current account positions would improve and the trade figures for March--released in late April--did show a clear narrowing from the previous figures. In addition, expectations began to grow that our price performance would improve, again because of the domestic slowdown. Following earlier glimmers in individual price series released in late April, the market waited with bated breath, and with few long dollar positions, for the producer price index for April to be released on May 9. The result, 0.5 percent, or a 6 percent annual rate, was a welcome relief And although it did not set off a dollar rally, at least the possibility that the U.S. inflation rate might be easing over the next months took some of the bearishness out of the dollar market. Meanwhile, this somewhat improved sentiment toward the dollar from our side of the Atlantic helped the dollar weather any after-effects of the Bundesbank's action on April 30 to raise yet one more time its discount and Lombard rates. This action on official rates followed the previous rise in market rates in Germany and was accompanied by [steps] to release liquidity, with the result that market rates did not advance further there. [Unintelligible] around 10 percent. Only the Dutch followed, but other central banks that had been hoping to be able to ease up a bit had to stay firm. In explaining why the mark did not rise by more against the dollar, market participants cite Germany's own problems--a sizable current account deficit expected for this year, election uncertainties in Germany, and Germany's vulnerability to any exacerbation of East-West pressures. [Unintelligible.] [Contributing] to the relative stability of the dollar, at least against the mark and other continental European currencies, was the relatively close coordination of intervention we have been able to achieve with the Germans over the recent weeks. Both central banks have much to lose in terms of their domestic policy objectives if the exchange market suddenly becomes unsettled. So we have both been quick to step in to counter sudden bouts of selling pressure on the dollar. Market participants have sensed this, with the result that we have had to intervene less than at other times when the dollar was under a cloud. Mr. Chairman, I have done my best to provide perhaps the only bit of cheer the Committee may have at this meeting, but I would be remiss in not pointing out that market participants are seriously concerned that the interest differential between the United States and Germany, however measured among comparable short-term instruments, has virtually disappeared. [Bundesbank officials] stress that in view of inflation in their country they do not intend to ease [unintelligible] interest rates over the near term even though a substantial differential prevails in terms of relative rates of inflation. Foreign exchange traders and financial people generally believe that as long as the current interest rate constellation holds, it is only a matter of time before a major flow of funds develops out of dollars and into marks, particularly by OPEC diversifiers who are currently so flush with funds. To summarize our actions, the Desk sold a total of $377 million equivalent of marks for the U.S. authorities, of which $228 was for the System. Net of repayments, our swap drawings on the Bundesbank now amount to $331 million equivalent. The Desk also sold $25 million equivalent of Swiss francs from balances. Finally, our swap debt in French francs remains at $74 million, with no further operations during the period. F.O.M.C. MEETING MAY 20, 1980 Reporting on open market operations, Mr. Sternliqht made the following statement: In seeking to meet the reserve growth objectives associated with the Committee's desired monetary growth since the last meeting, the Desk encountered progressively slower monetary growth and weaker demand for reserves. Since we supplied nonborrowed reserves about in line with path, borrowings fell off sharply and money market conditions softened dramatically. The average Federal funds rate in the week of April 23, which included the last regular FOMC meeting, was about 17 1/2 percent-already a decline from the peak of 19 3/8 percent a few weeks earlier. In the week ended last Wednesday, the rate averaged 10 7/8 percent--down about 45 percent from the peak average week. Other rates also fell across a broad front. the funds rate has averaged a little percent, In the current week, higher so far--about 11 1/4 even though we have sought to provide sufficient non- borrowed reserves this week so that there should be virtually no need for adjustment borrowings at the discount window. comparison, By a $1.5 billion level of adjustment borrowing had been assumed in constructing the nonborrowed reserve path for the early part of the period. you know, In the course of the interval, as the Committee reduced the lower bound of the Federal funds rate to 10 1/2 percent, appeared to make it as the steep drop in market rates infeasible to meet nonborrowed reserve objectives and also stay within the earlier 13 percent lower bound. Reflecting the unusual decline looks at this point as though total in money supply, it reserves will average close to $850 million below their path average. Nonborrowed reserves, on the other hand, appear to be coming out about on path. In conducting operations over the period, we had a continuing concern that the seemingly generous provision of reserves and decline in market rates might be misread in the markets as denoting a lessened determination to deal with inflation, but I do not believe that our job of reserve provision was essentially impeded by this concern. On a few occasions, a desire to avoid over-stimulating the market affected somewhat the timing and manner chosen to provide reserves. Outright operations during the period included purchases of about $900 million of Treasury coupon issues and net purchases of nearly $300 million of bills from foreign accounts. The System arranged its own repurchase agreements on only one occasion during the interval, but some of the foreign account repurchase transactions were passed through to the market several times toward the end of the period. Matched sales transactions were employed at times to absorb reserves from the market and were arranged daily with foreign accounts as well. The most pronounced yield declines in the recent period were for shorter maturities. Treasury bill rates pushed down to about 8 percent last week before backing up to around 9 percent in the last few days. This compares with key bill rates in the 11 to 13 percent area at the time of the April Committee meeting and 14 to 16 percent a few weeks earlier. In yesterday's auctions, 3 3- and 6-month bills went at average rates of 8.92 and 8.95 percent, compared with 12.73 and 11.89 percent four weeks earlier. For intermediate term coupon issues maturing in 1 to 4 years, yield declines in about the recent period were largely in a range of 1 to 2 1/2 percentage points, while longer issues were mostly down about 1/8 to 1/2 percent in yield. issues had already undergone a substantial drop in March to late April. Coupon rates from late The further decline through about half of the most recent period continued to reflect reports of weakness in the economy, a view that inflation might tend to abate somewhat, declines in money and credit aggregates, and a sense that the Federal Reserve was at least tolerating if not promulgating a distinct easing in money market rates. In the final week or so of the period, rates have backed up, reversing a portion of the earlier declines. have stemmed from several factors, costs, This seems to including higher dealer financing a feeling that monetary growth might be resuming, and that earlier declines had been overdone at least for the time being. In the Treasury coupon sector, dealers managed to stock up on the new Treasury refunding issues when rates were at about their recent low point, and now the market has incurred some losses as prices have come down in the course of seeking to distribute the large takedowns, especially of the longer maturities. Market views seem to be mixed as to where rates go from here. Some see the very recent rate rise as a temporary setback, likely to be followed by renewed, if less spectacular declines, in coming months--essentially because of deepening recession. Others feel that rates may fluctuate close to current levels, as forces such as weakness in the economy, continuing inflation, and mixed credit demands from different sectors about offset one another. Indicative of dealer views, their positions in over-1-year maturities, which were around $1 billion a month ago, climbed above $3 billion as they took on supply in the refunding auctions. Subsequently, the over-1-year inventory has worked down closer to about $2 billion, but this is probably still higher than the dealers in the aggregate would prefer. Treasury financing demands should not be too great for the next month or so, as we come up to a period of seasonal surplus. There may have to be a cash management bill in early June, though, to get past a cash low point before the June tax receipts pour in. Also, there could be some difficulties in just the next few days as we face another cliff-hanger on the debt limit which drops precipitously at the end of May. Conceivably, the Treasury would want to accelerate a cash management bill month-end. to get payment before James L. Kichline May 20, 1980 FOMC Briefing Information on economic developments early in activity is contracting substantially. The staff has revised downward its fore- cast of real GNP for the second quarter, 6 percent at an annual rate. this quarter suggests and now anticipates a decline of around The available evidence indicates the economy during recent months has become widespread, that weakness in extending well beyond the auto and housing sectors. The nominal value of total retail sales dropped further in April, the third consecutive monthly decline. items, in Excluding autos, gasoline, and nonconsumption the fall in sales since January has been the weakest three-month performance the 13 year history of the series. Auto sales, too, have been weak and in April the annual sales pace of 8-1/4 million cars was nearly one-fourth below the first-quarter pace; sales of both foreign and domestic units, small-sized models, declined. including large and Available reports suggest tighter credit conditions following the March 14 policy actions have played some role in damping sales of durable goods, particularly autos. It is not possible to pinpoint how much of the most recent deterioration in sales can be traced to the credit restraint program or how long those impacts might last. But it real disposable income has been at work in does seem clear that the decline in depressing consumer outlays and this force is unlikely to turn around quickly. Personal income in April showed virtually no change in nominal terms, reflecting principally the adverse impact of labor market developments on wages and salaries. The average length of the workweek was shortened again in April and nonfarm employment fell by 1/2 million. The unemployment rate rose 3/4 percentage point to 7 percent and could show another sharp jump in May judging from the -2continued appreciable rise in the weekly unemployment insurance claims figures since the April labor market surveys were taken. The reduction in hours worked in April was associated with a substantial decline in industrial output. cent, The industrial production index fell about 2 per- the third consecutive monthly decline. and especially in April, Moreover, for the past few months, output declines have come increasingly to reflect weakness outside the sectors of motor vehicles and construction supplies. performance of output, Given this weak capacity utilization has continued downward and in April is estimated at 81 percent in manufacturing, nearly 6 percentage points below the recent peak utilization rates in the first quarter of 1979. The growth of unutilized capacity and weak sales should tend to depress business investment outlays in the months ahead. New orders, capital appropria- tions, and capital spending surveys have yet to pick up any sizable deterioration in planned spending. spending. But there are other signs pointing to a downturn in business Order backlogs for machinery have been moving lower, nonresidential construction activity has slowed, business purchases of autos and trucks have declined, and announced cutbacks in business capital investment plans have risen considerably during the past two months or so. The staff forecast contains a decline of fixed investment spending beginning this quarter and continuing through the projection period. In the housing market, bottom in in contrast, we expect housing starts to reach the current quarter and construction expenditures rising later this year. Housing starts in April fell a little in real terms to begin further to about 1 million units at an annual rate, while permits dropped 14 percent. recent easing of mortgage institutions, rates, and the reopening of commitment windows at some should help provide a foundation for an improvement in markets in coming months. But the The expected upturn in real estate housing starts, however, is -3likely to be limited by the level of mortgage rates--which this year may not move below the 12 to 13 percent range for primary conventional mortgages--and by concerns about job and income prospects. The staff's forecast of GNP still shows declining activity into early next year followed by a sluggish recovery. That outlook is also accompanied by a substantial rise of unemployment this year and a further drifting up of the unemployment rate to the 9 percent area in the latter part of next year. price side, we expect inflation to slow appreciably in On the the second half of this year and next in response to weak product and labor markets and the absence of another surge in oil prices. If judicial or Congressional developments preclude the imposition of the administration's oil import levy, that would reduce the projected rate of inflation by about 1/2 percentage point this year as well as add a little to real activity. In concluding, I might note that it is duration and depth of an economic contraction. to have their own special characteristics. difficult to judge the likely Most recessions in retrospect tend In the current environment one could argue that we will experience a sharp decline in and not severe measured from peak to trough. activity that will be short-lived Arguments supporting this view could include, for example, a belief that consumers were shocked by the March 14 actions and will soon return to their freer spending ways, that inventories have been kept under good control, that businesses have pressing capital expenditure plans and will generally try to hold to them, and that the drop in interest rates will be very supportive of a recovery in housing and consumer spending. to us unlikely that a combination of such developments will be sufficient the forces acting to depress activity, ing macroeconomic policies. Time, But it appears to outweigh including the impact of inflation and restrain- of course, will tell what will develop, but -4the assumptions underlying the forecast and the condition of various sectors of the economy at the start of the downturn, have led us to hold to the forecast of a fairly severe recession and one that is dominated by a drop of final sales. FOMC Briefing S. H. Axilrod May 20, 1980 As growth in explained April makes in it the blue book, highly improbable aggregates set by the Committee annual in around current rate of growth June). Even so, only about interest for the I rise longer-run range in large the second quarter for continue to fall is likely that the apparent continued and faster money growth projection the that nominal rate. and if that If real the projected May-June accompanied by a possibly not even then. decline in bank credit in loans by large banks showing large the possibility of continued deposit destruction interest rates and seems to lower the odds of money growth over the very near Given the recent weakness a bit In sizable that regard, early May--with outstanding suggests the blue book in leading to further weakness and consumer in more than for the period and business presented the growth the quantity of money demanded will short of expectations short rates, at about a 7 percent at a 4-1/2 percent annual money growth will not be attained except further drop in money for this aggregate. part on the GNP turns out to be even weaker than projected, it in (with most of objective that expectations GNP will nominal GNP, for the a rebound rate--which would be a little percent period are predicated in of money first half of the year M-1A would expand at May-June in project levels--perhaps points below the Committee's should stress shortfall the targets for M-1A over May and June the 3-1/2 to 6 well under does rate a 1-1/2 percent annual 3 percentage that large for the December-to June period can, at The staff this late date, be attained. growth at the very further drops-at current on a sustained rebound term. in monetary aggregates, focus on encouraging a rebound in the alternatives growth. They aim at relatively sizable growth rates in narrow money that get back to the middle of the longer-run ranges by either September or December. growth rates may appear tolerable, or even desirable, or two in view of the recent shortfall. throughout Such over the next month Whether they should be sustained the second half of the year of course need not be decided by the Committee today. That will depend in part on the Committee's attitude toward its longer-term ranges, or about where in to tolerate actual growth on the aggregates, formally reconsidered these ranges it is willing and longer-run ranges will be at the July meeting. But in setting short-term aggregate targets today for money growth, it also seems relevant to point out that in recent weeks we have had some signs of a bit more strength, relatively speaking, Since the beginning of the year, M-2 and M-3 have been running low relative to the Committee's annual target ranges, the beginning of May, growth has emerged, in broader aggregates. but not as low as M-1. And since a very substantial resurgence in money market fund following the cessation of expansion in March and April in the immediate aftermath of the Board's March 14 regulations. Some of the very recent strength may be temporary, but we do not expect growth over the near term to evaporate again. discussing broader money measures, for the behavior of L in March, I should also mention, while that we now have our first indication one month when money measures began In that month L remained relatively strong and weakening perceptibly. expanded at a 9 percent annual rate--compared rate of 10 percent in with an average growth the previous 2 months--as the public's acquisitions of short-term U.S. government securities increased sharply. In view of the small signs of life in M-l has been collapsing, it the broader aggregates, while may not be unreasonable to ask whether the weak- ness of narrow money at least in part reflects efforts by the public to -3- economize on cash at a faster rate than had been allowed narrow money very much supply target. in the second quarter is setting the running less than would be predicted by our econometric models, and interest rates. in M-1 demand, But for really convincing given GNP evidence of a downward shift one would be more comfortable with persistent, of M-1 growth relative fall if M-1 growth for in large shortfalls to model predictions--or with even a one-time short- were in combination with substantial growth observed in closely it related assets or new innovations in financial technology. Nonetheless, the possibility of such a shift--perhaps in delayed response to the unusual interest rate peaks of late March--might argue for a cautionary approach in attempting to bring M-1 back to the midpoint of the longer-run ranges. However, recognized if such a shift is not taking place, it should be that there are good odds that M-1 growth will rebound very rapidly sometime in the months ahead as the public seeks to rebuild excessively depleted cash balances. Permitting that to occur would not of course be inflationary under the circumstances, though there is the danger that any very sizable rebound might be so construed by domestic and international market participants. Given the uncertain state of our evidence about money demand relative to income, economy, it and also uncertainty about the resiliency of the may be just as well that the Committee today does not really need to resolve the very difficult question of what rate of monetary growth it might wish to encourage in the second half of the year. However, it may wish to consider the desirability of aiming at this time to bring M-1 back into its longer-run growth range, upper, middle, without prejudice as to whether or lower parts of the range represents Either alternative A or B before the the best long-run outcome. the Committee will start that process. -4- While differences between A and B are not large in the very short run, they can be associated and policy. the economy and that money is a significant not in process, the other hand, be in moderate interest control, alternative if that in downward shift alternative there in perception about you take the view that the economy longer-run On process or If with substantive differences is should be given to inflation the more attractive very weak for narrow appealing that such a money demand any event weight A may be the demand B may be the more a sense rate declines until in is alternative. shift the need may to more obviously comes under alternative.
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