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APPENDIX NOES FOR F.O.M.C. MEETING November 16, 1982 Sam Y. Cross Mr. Chairman: The theme of the exchange market continues to be the unremitting strength of the dollar. The dollar has edged higher against most other currencies to levels not recorded since 1976 or earlier; in terms of trade-weighted averages of all major currencies, it has reached peaks never attained since these calculations began in 1970. While there have to be very serious doubts about our competitiveness at present exchange rates, particularly once the world economy starts growing, market psychology toward the dollar is nonetheless exceedingly bullish, in part because traders who bet against the dollar at times this year have been burned repeatedly and are wary of taking short positions. In mid-October, when the announcement was made that less emphasis would be placed on M1 as an operating target of monetary policy, there were expectations of lower U.S. interest rates that would lead to a lower dollar. several factors. The failure of this to happen reflected First, the exchange market subsequently revised its view and decided that monetary policy had not been so fundamentally altered. Second, it was thought that foreign authorities, faced with weak econonies and record unemployment, would move quickly to relax their own monetary conditions any time exchange rate constraints permitted. Third, with our progress on inflation, it was felt that real interest rates in the U.S. were still very high, both absolutely and relative to other countries. Indeed, actual and expected declines in U.S. interest rates have fueled rallies in our financial markets that attract funds from foreign investors seeking capital appreciation. The dollar's strength continues to have many foundations other than interest rates. Also, the dollar continues to be attractive as a safe haven currency, with concerns over the future leadership of Russia and the future sovereignty of Hong Kong being the most recent additions to the list of things for international investors to worry about. The weaker than expected performance of our economy in the third quarter has, perhaps only temporarily but nonetheless effectively, upstaged concern about the fiscal deficit. The prospect that our economy may be closer than others to the forefront of recovery makes it attractive to investment. There is a continuing demand for dollar liquidity-indeed, there may be a build-up of dollar needs as those who postponed their dollar purchases on the expectation of lower exchange rates late in the year after interest rates fell are now confronted with a strong dollar and only a few weeks to meet their requirements before year-end. There were some worries before the November elections that U.S. policy making could become stalemated by conflicts between the White House and the Congress, but these were dispelled when the results proved less a setback for the Administration than expected, and the exchange market's confidence in the cohesion of U.S. policy was confirmed. The market's psychology is now such that almost any event can trigger dollar purchases. We had the experience last week when the playing of sad music on the Russian radio stations caused a rise in the dollar in the Far East, and the markets speculated for several hours on what was happening, until Brez hnev's death was subsequently announced. At the time of the last FOMC meeting, when the dollar was bid up sharply, the Trading Desk intervened in New York, on 3 days, on behalf of the Federal Reserve and the Treasury to purchase modest amounts of German marks and Japanese yen. These operations helped to slow the dollar's rise at that timeSince the Committee's last meeting, the Bank of Mexico drew $ 587 million on the combined U.S.-B.I.S. credit facility of $1.85 billion. In total, just over $1 billion has now been drawn, leaving nearly $850 million still available. Also, since the last meeting, the Bank of Mexico has been granted a three-month renewal of a $700 million drawing on its regular Federal Reserve swap line, separate from the U.S.-B.I.S. facility. Recommendations All of the Federal Reserve System's regular swap arrangements with foreign central banks and the BIS will mature in December. I recommend. Mr. Chairman, that the following arrangements be renewed with no changes in their terms for one more year: Maturing swap arrangements: Amount ($ millions) With Austrian National Bank Bank of England Bank of Japan Bank of Mexico Bank of Norway Bank of Sweden Swiss National Bank Bank for International 250.0 3,000.0 5,000.0 700.0 250.0 300.0 4,000.0 Term 12 mos. (fi i, Maturity Date 12/ 12/ 12/ 12/ 12/ 12/ 12/ 3/82 3/82 3/82 3/82 3/82 3/82 3/82 Settlements -- Swiss francs Other authorized European currencies National Bank of Belgium National Bank of Denmark German Federal Bank Bank of France Netherlands Bank Bank of Canada Bank of Italy 600.0 1,250.0 1I It 1,000.0 250.0 if 6,000.0 I, 2,000.0 500.0 2,000.0 II I, " 3,000.0 12/ 3/82 12/ 3/82 12/17/82 12/29/82 12/29/82 12/29/82 12/29/82 12/29/82 12/29/82 In addition, six swap drawings, totaling $46 million, by the Bank of Mexico under the $325 million special swap arrangement--extended as part of the $1.85 billion combined credit facility to Mexico--will mature between December 7, 1982 and December 21 1982. I recommend that these drawings, listed below, be extended for three more months. Maturing swap commitments: Line in continuous use since 9/7/82 Institution Bank of Mexico Total Amount ($ millions) Maturity 13.7 6.8 2.3 1.9 8.2 13.1 12/ 7/82 12/15/82 12/16/82 12/17/82 12/20/82 12/21/82 Current Term 3 mos. 11 It it it 11 it "( "( 46.0 This will represent the first renewal of the drawings. PETER D. STERNLIGHT NOTES FOR FOMC MEETING NOVEMBER 16, 1982 System open market operations since the last meeting of the Committee were conducted against a background of widespread market expectations of declining interest rates--but also of a strengthening in M2 growth which tended to limit the scope for accommodation of such declines. over the period, much of it Growth in M1 was quite rapid reaching a 20 percent annual rate in October, attributable to temporary holdings of transactions balances in the wake of heavy maturities of All-Savers Certificates. The rapid M1 growth was essentially accommodated through periodic adjustments of the reserve paths in line with the Committee's decisions at the last meeting. As for M2, in the early part of the period, it looked as though growth was proceeding at or even slightly below the modest pace anticipated at the time of the October meeting. late October, however, it By became clear that the month's growth was pushing ahead more strongly than expected earlier. The October growth rate of about 8 percent was still in line with the Committee's desired quarterly growth rate of 8 1/2 to 9 1/2 percent, but the late October information suggested levels exceeding a path consistent with the preferred growth rate for the quarter. In line with the Committee's admonition for flexibility in assessing the implications of substantial monetary growth that might be an outcome of increased precautionary demands for liquidity, part of the M2 strength was accommodated, but a portion also tended to show through as demand for reserves somewhat in desired path. excess of the Thus while reserves ran a shade below path in the first three-week subperiod, demand was perceived to be somewhat above path in the second three-week period. Consistent with this, adjustment and seasonal borrowing ran a little $300 million assumption in the second subperiod. the first below the initial three weeks, but above in In fact, because of a particular bulge in borrowing last Wednesday, November 10, which also carried over to the Veterans Day holiday on November 11, it looks as though borrowing in the second three-week subperiod could be on the order of $450 million or so. This margin above the initial $300 million borrowing level could be regarded as reflecting both a modest rise in demand for reserves above path, roughly on the order of $50 million, and the aforementioned November 10-11 bulge in borrowing. Because of the distortion to this current week's borrowing level due to the high figure on November 11, assumed path level of borrowing is this week's $550 million. Federal funds typically traded close to the 9 1/2 percent discount rate made effective early in the interval, compared with rates somewhat over 10 percent through much of September. While one might have expected the pervailing borrowing levels to be associated with funds trading, if anything, a little above the discount rate, the widespread anticipation of an early further reduction in that rate often tended to bias the day-to-day funds rate a bit lower. In the current week, however, affected in part by the tightness that carried over from the end of the November 10 week, funds have averaged about 9 5/8 percent so far. Outright transactions to affect reserves over the period were virtually all on the buy side, including about $1.2 billion of bill purchases from foreign accounts, and $1.3 billion of bill purchases in the market. On other occasions, reserve adjustments were made with short-term repurchase agreements, either passing through part of foreign account repos to the market or arranging the System's own repurchase transactions in the market. On a few occasions reserves were withdrawn through short-term matched sale-purchase transactions in the market, in addition to such transactions arranged routinely each day with foreign accounts. Most market interest rates declined since the early October meeting, especially in the days immediately after the meeting when the press focused on reports of Federal Reserve intentions to de-emphasize Ml for the time being and, by some accounts, to pursue a more accommodative course in weak economy. view of the Further along into the period, rates showed mixed movements, backing up on occasion in response to temporary indigestion and disappointment that a lower funds rate and further discount rate decline were not forthcoming more promptly, but also edging down further at other times in of weakness in response to signs the economy, moderation of inflation, renewal of hopes for an early discount rate cut. and periodic Those hopes are still there, although they have eroded in recent days, and yesterday's money numbers provided a further dampening. -4Among the more significant rate reductions since early October were those for private short-term debt instruments such as commercial paper and bank CDs. These rates fell about 1 1/2 to 1 5/8 percentage points, considerably narrowing the spread against short-term Treasury issues. Indeed, Treasury bills in the 3-month area actually rose about 1/2 percentage point over the period while 6- and 12-month bills were down about 1/2 to 1 percentage point. These differing trends reflected a narrowing of the unusually wide rate spreads between Treasury and private issues that had developed late in the summer in a significant flight to quality. As some of the market apprehensions abated, the spreads have narrowed to about the normal range. Also helping to narrow spreads were the sizable net sales of Treasury bills (about $15 billion over the period) and modest issuance of CDs and commercial paper. In turn, part of the weakness in commercial paper issuance reflected corporate moves to fund previous shortterm borrowings through sales of intermediate and longer issues. Another factor possibly retarding the decline in bill rates was the somewhat higher than usual cost of repo financing of Treasury issues in relation to the funds rate--which in turn may have stemmed in part from some narrowing in the repo market in the wake of concern over the legal status of repos. In yesterday's bill auctions, the 3- and 6-month issues went at about 8.45 and 8.54 percent, compared with about 8.10 and 9.23 percent just before the last meeting. -5The Treasury was also active in the coupon market, raising a net of about $12 billion, including some $8.8 billion in the quarterly refunding settling yesterday. Over the period, rates on 2 to 5 year issues came down about 1 to 1 1/4 percentage points, while longer issues came down by less--a little under one percentage point for the longest maturities. With the rate decline concentrated early in the period, the Treasury's refunding issues got the benefit of the lower rates, but ended the period somewhat below issue price. Dealer's holdings of over one year Treasury issues were up only moderately over the interval, considering the dealers' sizable stake in underwriting the issues just paid for. New issuance of both corporate and tax-exempt bonds was substantial over the period, with good receptions for the most part. Corporate yields came down about in parallel with Treasury issues, while the tax-exempt sector declined by less-apparently reflecting large recent and prospective supplies. There has been a particular push recently to issue tax-exempt securities in bearer form, as this won't be allowed after the turn of the year. Finally, I'd like to mention that today is the most logical day, in my judgment, to make a purchase of coupon issues in the market to meet seasonal reserve needs in coming weeks. Because of our purchases of bills since the last meeting, there is only about $500 million of leeway left for such purchases, -6and the new leeway following this meeting would not ordinarily take effect until tomorrow. I'd therefore like to request that the Committee enlarge the present leeway, running through today, by $1 billion. James L. Kichline November 16, 1982 FOMC BRIEFING The available evidence indicates the recession still has not ended. There are a few sectors of the economy evidencing growth, but there are also areas in the midst of traction. a little that the staff has reduced its this quarter to a recovery year. in On net, of forecast of real GNP show a small decline, and now expects activity will have to await the A delay in the expected recovery is about the forecast since the maintained substantial con- turn of the only last meeting of the Committee. the change We have the view that real GNP in 1983 will expand about 3 percent while additional progress will be experienced in bringing down the rate of inflation. In October both employment and production declined The midmonth further. labor market surveys showed a drop of million in payroll employment from the month earlier and a rise in the unemployment rate claims for unemployment remained to 10.4 percent. insurance in the Moreover, initial latter part of October in the 650 to 700 thousand area, indicating that ment was still being cut in the nonfarm sector. production employ- The industrial index, which was released this morning, dropped 0.8 percent in October, a tenth more than during the preceding month. autos was cut back once again, output of business Production of equipment fell substantially further, and the only - - products showing strength was major area of final space equipment. defense and 2 These latest production numbers will result in capacity utilization rates in manufacturing a bit below 69 percent which will be a new postwar producers new lows began being set during The general declines of of the summer. employment and production have been associated with a weak pattern of with low; at materials sales and orders, along lingering inventory problems in certain areas. course have been taking their toll on personal element in the performance of consumer spending. Job losses incomes, a key Retail sales excluding autos and nonconsumer items were flat in October, the third consecutive month of virtually no change or in nominal after terms. the staff small declines I might note that these data became available prepared its forecast, and although the October sales were only a little weaker than we expected, downward sions to the level of revi- sales in September suggest our current quar- ter forecast of consumption may be somewhat high. In the auto reflecting the clean up sales impact of various sales incentive programs; dropped in October smartly in market sales have been moving irregularly following the end of incentives but rose early November as new programs were introduced 1982 models. yet of a fundamental recent decline of On balance, to there haven't been any signs strengthening of demands for autos. The interest rates for consumer credit should, how- ever, be helpful in 3 stimulating - some pickup of buyer interest for autos and other durable goods in coming months. The rate decline in mortgage markets loan applications and commitment activity. has led to rising New home sales rose appreciably in September, the latest month for which we have data, and recovery starts and permits were of residential established, up as well. The cyclical construction seems quite well although mortgage rate levels are expected to remain high enough to hold the housing upturn to moderate proportions. to housing, there are In contrast the economy now in the midst of a major investment and exports, with until the second half of ing tors little next months, sector. and we have contraction, prospect year. international economic conditions of business capital two principal areas of further the be discuss- briefing. spending have been very weak revised down fixed for a turnaround Ted Truman will in his namely Indicain recent for projection Declines in long rates and higher stock prices are this pro- viding an opportunity for restructuring of corporate balance sheets, and this should be helpful over will take time the longer run. for financial and real side forces to But it exert appre- ciable positive influences on investment. For the near term the staff forecast of vides for a small upturn early next year flat second half of begin to 1982. see an improvement If real GNP pro- following an essentially our judgment is correct, we should in production, employment and sales within the next few months. drag on activity - However, given the fairly strong from the investment and export sectors, both of which have downside risks 4 potential, it would appear that the short-run for aggregate activity are weighted toward greater weakness than in the staff forecast. Finally, we have not changed in any significant way the wage/price portion of outlook still point This morning It shows the forecast. Incoming information and to further progress on the the producer price the inflation front. index for October was released. [an increase at an annual rate of 5-1/2 percent.] FOMC Briefing E.M. Truman November 16, International and International 1982 Economic Financial Conditions economic and financial developments continue to be a cause for concern, and the outlook is subject to substantial uncertainty. One bright spot that may be losing some of its shine is the external strength of the dollar. Combined with the generally bleak picture for world economic activity, the dollar's current high level means that U.S. decline in real exports are projected to continue to terms for most of the forecast period. The weakness in external demand is illustrated by the fact that September industrial production in foreign industrial countries averaged 3½ percent below the rate a year ago and 7 percent below the peak in early 1980. These countries are completing their third year in a row with real GNP, on average, inching up at less than one half of one percent. in the future, The recovery, which still is expected to be very moderate. forecast is for real percent during 1983. appears to lie The current staff growth to average somewhat less than two As a consequence, unemployment rates will continue to rise from current record levels. On the brighter side, countries has declined by about two percentage points on average during the past year. to inflation in the foreign industrial The continued slowing of inflation may lead somewhat lower savings rates and to tion, some stimulus to consump- in the context of slow growth in real disposable incomes. -2The easing of interest rates may also help to stimulate demand. In a few countries, residential construction has picked up and inventory decumulation has stopped. On the external side, current account positions -- with the important exception of France -- have moved this year toward surplus. We expect some further move in the same direction next year; however, the external sector is not likely to provide a significant net stimulus to real economic activity abroad. On the whole, the foreign industrial countries appear to be looking to the United States for lower real interest rates and for more real world economy. activity will growth, setting the tone for a general expansion in the Indeed, the staff forecast is that U.S. economic be expanding more rapidly next year than activity However, the staff forecast also implies a significantly abroad. less robust and more delayed U.S. recovery than appears to be embedded in forecasts of other countries, suggesting the risk that the forecasts may be too optimistic. Turning to the developing countries, it is apparent that many of these countries are facing severe adjustment problems. The sources of these problems include economic mismanagement, dramatic terms-of-trade deterioration causedby the global recession, high real interest rates and pure miscalculation. Regardless of the source of their economic problems, these countries'short-run prospects are constrained by their sharply reduced access to external financing. A few observations may provide some perspec- tive on the current situation. - The current staff forecast is that in an environment of forced adjustment the current account deficit of the non-OPEC developing countries will billion $75 - The be about $45 next year -- a significant reduction from billion in 1981. 1983 deficit will be more than accounted for by in 1980, the interest payments on external debt; interest contribution was less than 50 percent. A rule of thumb is that each percentage point change in the level of world interest rates implies a correspond- ing change of at least $2 billion in interest payments by these countries. - Net new borrowing from international banks by the non- OPEC developing countries was more than $40 billion A reduction in the flow to less than $20 in 1981. billion would be consistent with our current account estimates for next year. However, those estimates also assume a replacement, in 1983, of about $150 billion in maturing bank claims. - Next year these countries as a group will experience a third consecutive year of slow growth--- about 1½ percent or three percentage points less than the average for the 1973-1980 period. Real GNP will probably decline on average in Latin America. - We are forecasting that the volume of imports by the non-OPEC developing countries will decline again next -4year following a substantial general decline this year. (This pattern contrasts with the 1974-75 experience when these countries generally cushioned the recession in the industrial world.) Again, there are some bright spots. Lower interest rates already have eased the financing burden somewhat. It is encouraging that Mexico and Argentina -- two of the top three developing countries in terms of international ment with the bank claims IMF on stabilization programs. second largest borrower -- Brazil -- will also contribute to international financial -- have reached agree- The prospect that the soon follow suit should stability. adjustment measures put in place by individual However, countries are unlike- ly to yield a complete solution to their problems, especially in a stagnant world economy. not remove all Such measures are necessary but they do the economic and financial the rest of the world. risks for the countries or for The ability of Mexico, Brazil, Argentina, and countries in similar circumstances to follow through successfully on their IMF-approved, stabilization programs depends on some recovery in the industrial countries, adequate resources for the IMF to finance a part of these countries' needs, and continued lending by commercial banks to most of them -- albeit at a reduced pace. In the best of circumstances, significant real adjustments will be required by all. On the real and financial side, we have roughly calculated that the external component of the expected adjustment by developing countries next year will reduce U.S. -5- exports by at least five percent and lower U.S. real about 1/3 of a percentage point. larger. The financial GNP by These impacts could easily be implications are more difficult to and financial risks could be significant quantify. But the real especially if we have underestimated the negative real inter- actions among countries or miscalculated the capacity of the international financial disturbances. system to bridge over recent and potential FOMC Briefing S. H. Axilrod November 16, 1982 Behavior of the monetary aggregates in October and early November suggests that growth will again be on the strong side for the quarter as a whole, despite comparatively slow growth in nominal GNP. particularly large in October. M1 growth was It does not seem unreasonable--based on bits and pieces of evidence we have about behavior at banks--to attribute about half of the M1 expansion to maturing ASCs, but that would still leave a very substantial growth apart from ASCs. As you have seen from the blue book, we have assumed a deceleration of growth in narrow money over the balance of the year, but with the pace of advance still fairly strong in view of the evident sizable demands for liquidity relative to GNP. These demands have fallen as much, or more, on M2, and we have assumed that growth in M2 would accelerate somewhat from the measured October pace over the remainder of the year, given something like current levels of interest rates. For the year, growth rates for the monetary aggregates look as if they will be above the Committee's targets. Accompanying this above target growth for the year will be a substantial contraction in the income velocity of M1 and the broader aggregates over the four quarters of the year--about 3 percent for V1 and 5 percent for V2. (Velocity of the broader aggregates would decline even if these aggregates fell within their ranges). With regard to the velocity of M1, prior to this year there was only one other four quarter decline of any significance since 1960, and that was a 1 percent drop in the four quarters ending in the first quarter of 1961. More spectacularly, perhaps, V1 will also decline by about 3 percent at an annual rate for the five quarters ending in the fourth quarter, the only five quarter decline of significance prior to this year in the period since 1960. We have, of course, had substantial five quarter declines in the income velocity of M2 since 1960, given distortions generated by movements of market rates relative to fixed Regulation Q ceilings for the bulk of the period. But the five quarter decline ending with this quarter is the largest, even though M2 in the recent period was presumably less affected than in earlier years by the ceiling rate distortions, since key components of the M2 aggregate in this latest period bear a market-related interest rate. From all this I would draw the conclusion that demands for liquidity have been unusually strong. The econometric evidence is not totally clear for M1, though not in my view inconsistent. Our standard money demand equation has underpredicted M1 growth--given income and interest rates--over the past four quarters by about 1¾ percentage points, though by considerably less over the past five quarters. Buttressing the idea of an upward shift in money demand, though, the modified version of the standard model--modified to allow for so-called ratchet effects on money demand of significant new highs in interest rates--has underpredicted money growth by 2¾ to 2½ percentage points over the past 4 or 5 quarters. These strengthened money demands have been accommodated to a considerable extent by Federal Reserve policy, at least as might be judged from declines in short-term interest rates. The relative decline in the 3-month bill rate over the past five quarters--close to a 40 percent decline at an annual rate--would by a small margin be the largest in the whole period since 1960, assuming about the current rate level. Of course, it is difficult to evaluate how the decline stacks up in real terms, given difficulties in measuring inflationary expectations. The relative decline in inflation over the past five quarters varies with the measure of inflation that is used; the CPI has declined relatively more than the bill rate over the past five quarters but the GNP deflator has declined relatively less. It would not be far afield to think that the relative decline in short-term real interest rates has probably been about as much as the relative decline in nominal rates. Whether the relative drop in rates in nominal or real terms is sufficient to achieve the kind of economic performance satisfactory to the Committee is another matter. That depends in part on the confidence of business and consumers in face of current rate levels. While rates may have dropped, the resulting levels could still be restrictive if there were a substantial deterioration in confidence since last year--with confidence affecting the willingness to borrow and also to spend out of accumulated liquidity. Another way of putting it is that the demand for goods and services at any given level of real interest rates may have declined over the past year or so as confidence has waned. In other words, the drop in the income velocity of money over the past several quarters may reflect not only an outward shift in the money demand schedule but also what could be a fairly substantial backward shift in the demand schedule for goods and services of the private sector. An outward shift in the money demand schedule would mean that measured money is overstating the expansionary effect of monetary policy. and At the same time a backward shift in the goods services demand schedule would tend to imply the need for even more -4money and lower interest rates than might have otherwise been thought necessary to achieve any given level of GNP. The alternatives There would be a double bind. before the Committee might all be construed as accommodating stronger liquidity demands this year than were consistent with the Committee's original targets. lowering of interest rates. Only alternative A calls for a further The desirability of that alternative depends in part, given the preceding analysis, on assessment of the underlying strength of business and consumer confidence at this point.
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