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APPENDIX 11/19/79 AXILROD SEMINAR AXILROD'S REPORT I'll give a moderately lengthy presentation and Mr. Sternlight will follow with another presentation. The tables in front of you dated November 19 are based, given the paths that were derived from the Committee's decision last October 6 and put down in what we call working form. As you recall the Committee had a decision to accept monetary growth rates of M1 of 4-112 and M2 and M3 of about 7-112 or somewhat lower should they develop. We calculated the reserve increases that are consistent with the 4-112 percent M1 and the 7-112 percent M2 from September to December. The week, our estimate of the demand for money, the pattern of money demand was very close to a constant rate of growth of about 4-1/2 percent each month. That is, at the time of the October 6 meeting we were estimating a 4.8 percent for October. We had a lot of ups and downs in the course of the month, but that was the original estimate at the time of the Committee met, so we constructed the reserve path that was roughly consistent with this fairly steady 4-112 percent increase in M1 lacking any clear evidence at the time of the meeting that it should be 10, zero, or any kind of variation like that. Then we deseasonalized that and put it in the form that you see on the table in front of you. That is we developed a seasonally unadjusted 4 week average for the various reserve measures for the week ending October 10 to October 31 inclusive, that's a 4 week period. And then another series for the weeks ending, the 3 week period November 7 to 21. There was the 7 week interval between Committee meetings. It didn't seem reasonable to hit a 7 week average, and similarly it didn't seem reasonable to aim each week so we arrived at the thought that a 4-week--an initial 4 week and then a 3 week would he the most reasonable basis for preceding. So the, in a sense in the first 4 weeks Mr. Sternlight was aiming at 4-week average and the next 3 weeks at a succeeding 3-week average. And as you can see we have provided a monetary base level which in the week ending October 10 -2- through 31, not to read numbers on the table, but to be sure we are all on the same table as 150,943 in terms of millions and then was higher in the week ending the weeks of 7th to the 21st. We have provided the total reserve level, which is of course is the monetary base less currency and a nonborrowed reserve level. Now we took the Committee's assumption that borrowings ought to start out at $1,500 and that is shown in the next to the last panel, group, of member bank borrowings as our initial assumption of $,500. In the event, you will see that the demand for reserves ran much stronger than that. And excess reserves we assume at around $200 million which hadn't been far off the previous, what had previously occurred. The results--to focus for a minute on he column October l0-31--were that monetary base ran strong relative to path, total reserves ran strong by $390 million relative to path, and nonborrowed reserves as the Desk attempted to hold back in the face of this demand for reserves ran $231 million. In consequence, below path, in consequence borrowing ran $623 million above the path in that 4-week period and excess reserves in this kind of uncertainty that followed the Committee's actions ran high above path and continued to run high in the weeks of the 7th to 21st. In the weeks of 7th to 21st the monetary base again ran high relative to path, but came down. It was less high than in the preceding week. Total reserves was less high than in the preceding week and nonborrowed reserves appear to be on path. Now they were below path in the first 2 weeks, and this November 7th through 21st includes assumptions shown in footnote 2 about what the outcome for this week will be. A s the Committee knows that can't be entirely predictable because the factors affecting nonborrowed reserves other than Mr. Sternlight's operations, that is float, currency, and such items do vary quite widely, and so there can be misses because of that--substantial misses because of that. And finally excess reserves appear to be running above path. Now there ar some points that might be made about this, and 1 is how do these path levels of reserves relate to the multipliers that you were working with, and the deposits that -3- they supported or indeed caused. And there’s a summary of that on the 2nd table. Now I would like to stress that again that where we have M 1 type deposits this was calculated here in a sense as a residual. That doesn‘t mean it isn’t relevant but we haven’t broken it down by the distribution of deposits among large banks versus small banks and it’s noc in that fine a detail. And this shows for example on the first line, again it repeats the excess reserves running above path, which would be a factor increasing the demand for reserves relative to the path that the Committee wished and presumably the committee might want the excess reserves t3 be accommodated. Now, required reserves did turn out to be higher than we had estimated in our paths, but not because of required reserves against M1 type deposits, but because other deposits were growing stronger than had been originally estimated and were in a sense absorbing reserves from M1. Thus, time and savings deposits included in M2 looking to the 7th to 21st column were $10 million above. Again that#s a trivial amount and not really worth considering. But large negotiable CDs, required reserves against those items were running $270 million above path as banks were issuing many more large CDs than we had expected in view of the fact that they were losing a considerable amount of savings deposits and even indeed demand deposits and were trying to replace these funds in the way they could which was by issuing market instruments--large negotiable CDS as well as money market certificates. But these large negotiable CDs are not in any of our Ms, and they were absorbing reserves that would otherwise support M VOLCKER This doesn‘t include the marginal reserves. AXILROD No, this is abstracting for the marginal which we assume we just accomodate. This is the basic reserve and represents the distribution, the change in the distribution of those deposits. But the biggest factor was domestic net interbank demand deposits which from the 7th to the 21st had an increase that absorbed about $425 million more reserves than -4- we had allowed for. Now this factor fluctuated rather considerable in the course of the period. And $ 2 7 0 million you see from the 10th to the 31st kind of came toward the end of that period and the $ 4 2 5 million in the 7th to the 2 1 s t turned out by the time the period was over to be a fairly steady factor in the course of the period. If one had been certain about it in advance, one might have argued that the total reserve path should have been adjusted to, added to, to put those in but you would have wanted to provide the reserves needed to support those deposits rather than have those reserves dragged out away from money supply type deposits. Some such argument could have been made. We on the staff felt very reluctant to make changes, to make such changes until there was a very clear cause in view of the fact that it could all be reevaluated at the time of the next FOMC meeting. Skipping to the memorandum item, this is the implied impact of nonmember deposits on bank reserves. The negative sign there of minus 195, that reflects the strength in nonmember bank demand deposits. That is nonmember bank demand deposits were running stronger than had been built into the path--stronger than their usual relationship to member bank demand deposits. Given that strength, hat would have implied reducing member bank demand deposits, member bank required reserves behind member bank demand deposits by $195 million to offset that. A correction--that is to say you might have considered lowering the path by $195 million because you had to suppress member bank demand deposits, since nonmember bank demand deposits were running stronger than you had expected. In the event, you could see that the demand deposits in M 1 in that week were $ 4 3 4 million below path in any event, so you could say there was--it was $240 million more than you might have want for perfect MI-type 2 behavior. In fact M did turn out to come pretty close to path or right on path. M1 was below path. CDs were stronger, but that was financing a moderate expansion in bank credit, and as I say no adjustment was made to path because it was part of the Committee’s decision to restrain bank 2 credit as well as to restrain growth in M 1 and M or so we thought. Now 2 questions do come up in relation to this and Peter is going to describe what he did and when and how, but there are 2 more general questions that are continuously raised in relation to this procedure and system. And one is would the adjustment process have worked better if we didn't have lagged reserve accounting, and another is would it have worked better if the discount rate were more flexible. With regard to lagged reserve accounting, clearly that makes it almost impossible in the very short run to hit any total reserve type target. Hitting such a target may be impossible in any event in the short run, but the lagged reserve accounting certainly makes it very clear that it's impossible. For example, in the last 2 weeks of October the reason we came back, money supply came back under control was that demand deposits dropped very sharply in those 2 weeks, but we didn't get a drop in required reserves commensurate with that because the demand deposits had been strong in the previous 2 weeks and therefore the funds rate pressures emerged in the last part of October at a time when the money supply was already adjusting down, in lagged response really, to what had happened early. Moreover, the total reserves then were conditioned by the required reserves released in the last half of October to meet the demand deposits that were created in the first half of October. There was no way to reduce those total reserves because banks had to meet their reserve requirements. If Peter didn't provide the reserves at the Desk they would borrow them, and borrowings rose substantially as did the federal funds rate. If there hadn't' been lagged reserve accounting, the total reserves wouldn't have been as far off path in the first half of the month as they in fact were. That is, required reserves would have gone down in the last half of October and the total reserves would have gone down, maybe not to the full extent, but at least to a considerable degree. You did begin to get that adjustment that would have occurred in the last half of October in early November, and that's the essential reason why the total reserves in November, the actual total reserves are not as far above path as they were in the first half of -6- October. Banks had made the adjustments, demand deposits were weakening, and required reserves were coming down relative to the original path, and so the deviation of total reserves from path was only $303 million in the 3 weeks ending November 21 whereas it had been $390 million for October 10th through 31st. So what the lagged reserve accounting did, was in effect, delay the adjustment in total reserves and makes it more difficult to aim at a total reserve target over the very short run. In addition, it probably means that there would be a little more fluctuation in the federal funds rate from week to week than if you didn't have a lagged reserve, again because it delays the adjustment, it doesn't come quite as promptly as it otherwise would. In light of these possibilities, we are looking at the question of whether you shouldn't do away with lagged reserve accounting and with the aim of presenting the Board with memo in the not t o o distant future in that regard. I might say that I think it's not a simple question, and that the monetarists publicity in that respect is much overdone. Most of us have never believed that lagged reserve accounting should have been put in place to begin with but it's very hard to argue that its actually fatal to control of the aggregates over the length of run of 3 to 6 months when you consider you are dealing only with a 2 week lag. But it does have the deficiency I believe in any week, in any given week, of meaning that there's not a tight relationship between the reserves you supply and the deposits because in some theoretical sense deposits can be infinite or whatever you want because they don't relate to the reserves that are supplied in that week by the Desk. In turns out in practice of course they're not infinite because bank responds to the emerging federal funds rate and that's what determine in effect, their deposit and investment processes. But it is theoretically, a little bit odd to be on a reserve path and yet have in place a system which says in any given week there is the possibility that deposits can be almost anything the banking system wants although you recognize in practice that it's interest rates that determine the deposits from both and -7- the banks and the public's point of view. So its not the exactly the world's best public relations reserve structure if you are on a reserve target. But there are, there will be a number of practical problems should the Board want to do away with it, and there will be a difficult decision in terms of the careful assessment of benefits and costs. The other issue that gets raised is whether the borrowings has been a factor that has made a problem, that is in throwing us off path or whether it's a buffering factor in the adjustment process and what implications does this have for the discount rate. As you can see in the 4 weeks ending October borrowings were $2.1 billion, well above what we had originally put in there, and of course that was expected to happen if demand was strong. And the 3 weeks ending November they have dropped down to $1.8 indeed most recently or down to around $ 2 . 6 . The, I believe most of us would feel that the expansion borrowing most of which occurred in the second half of October when borrowing rose to $3 billion and the funds rate up to around 15 percent reflected the process by which banks were adjusting to the pressure being put on them by the Desk holding back on what the Desk can hold back on which is nonborrowed reserves. As the Desk held back not that because banks borrowed, were forced to borrow the required reserves hat had been created 2 weeks ago, and in that process the funds rate went up, market interest rates went up, and bank begin making the adjustments as did the public and indeed more rapidly than one could even have believed ahead of time in your optimistic frame of mind and perhaps coincidentally began making the adjustments that would bring them back to path. As I say the total reserves began coming back in the next 3 weeks. I have, if the $3 billion of borrowing had developed with a funds rate not rising to 15-1/2 but staying at 13 then it seemed to me there was clear evidence that the banks were not making those adjustments. That is they were simply borrowing and not doing the other things that might be required to get demand deposits back on path. However, when the funds rate went up 15, 15-1/2 percent, I believe that was evidence and we took -8- that view here even before we had the November results, that that was evidence that the banks were probably in fact making the adjustments that were likely to lead to slower money growth later, and therefore you did not have a clear reason at that high level of borrowing to raise the discount rate because you had adjustments in process as evidence by the behavior of the federal funds rate. That leads to the somewhat paradoxical conclusion that if borrowing had risen to $3 billion and the funds rate had stayed 13 percent and had a stronger reason to raise the discount rate than if the funds rate rose to 15 percent, because if the funds rate had stayed at 13 banks weren't making the adjustments and therefore you would have raised the discount rate and really make it expensive for them to borrow the amounts they had to borrow given the nonborrowed reserves that were being put in. Well be that as it may if banks had continued at that $3 billion level of borrowing for more than a couple of weeks and the funds rate had continued at 15, it might have been very clear that not enough adjustment had been in train in which case of course a rise in the discount rate given the nonborrowed reserves would put further upward adjustments on market rates and give banks further incentives to sell bills and do things like that, cut down loans and therefore lead to a slower money growth. So in this process the discount rate becomes a weapon which can be used in case the nonborrowed reserve path or whatever adjustments in that path are being made by the Manager aren't sufficient to cause money growth to slow down or speed up as the Committee might want. The discount rate can be used to reinforced. That is a rise in the discount rate would tend to reinforce upward pressures on market rates again unless the Committee asked the Manager to offset that by adjusting its nonborrowed up. And a decline in the discount rate can be used to reinforce pressures for lowering the funds rate. Now with that kind of background, that doesn't argue for a very different use o f the discount window than use of the discount rate than before. It still leaves it flexible and judgmental but adds a different wrinkle in its use. Really an economic wrinkle, it almost -9- says that that should only be adjusted more for long-term purposes and not for short run adjustment purpose. On the other hand, it does seem a little odd to have banks borrowing $3 billion at the basic discount rate if that's j - u s t short term adjustment borrowing, so we are trying to, we are considering for consideration by the Board and the Presidents a number of options in managing the discount window under this procedure. Now one of course is a perfectly flexible tied discount rate which has been discussed widely before. One of course is doing nothing any different from what you are doing now, but a third one, one which I think might have some interest is to have a second discount rate above the basic rate, but not like the, but available to banks for these kinds of buffering operations, that is they have a lot of required reserves, they are making adjustments that would bring money growth down, but to make these adjustments more orderly as was the case they are borrowing from the system. Now there is some possibility of developing a discount rate higher than the basic rate for that kind of borrowing, and there is the possibility in order for administration of the window to be the same district by district in that kind of circumstance to make that more or less automatic related to lines of credit of one sort of another with build-up incentives for them not to use them continuously, that is the rate goes up if you have used it more than one week, it goes up at 2 weeks, it goes up again etecera. Well I'm just mentioning these possibilities as the sorts of things that we are trying to consider and would like to when we have it worked out a little more have discussion with the discount conferent, the proper discount officers group, and of course bring it through the get comments, bring it through the Presidents Conference and what have you before it comes to a Board consideration. But there is nothing in the, this will sort of turning the basic borrowing privilege on its head, that is the basic borrowing privilege which for small banks, we are thinking also now of a kind of a money adjustment credit line for large banks with built in incentives such that you don't, its not a contribution to capital; it's -10- actually used for an adjustment and then goes away because price might go up to keep it. Well that kind of thing might have speeded up even further the response to, although its hard to conceive a response really being any faster than we seemed to have gotten here, but again I mention that could be coincidental. Well Mr. Chairman I have probably talked at too much length, but those are the, that concludes the comments I would have on this particular set of operations thus far. Notes for FOMC Meeting November 19. 1979 Scott E. Pardee Since the October 6 actions by the Federal Reserve, exchange market participants have had to contend with a string of bad news for the dollar: continuing poor price figures in the United States, another large trade deficit for the U S. in September, renewed leapfrogging of oil prices by individual OPEC members and threats of even greater increases in December, a further round of official interest rate hikes abroad, including a jump of Britain’s MLR to 17 percent last week, and the confrontation between the Iranian and the the United States governments in which a threat by the Iranians to pull their funds from U S. banks prompted the U. S. to freeze official Iranian funds in U.S. banks, including $1 3 billion on the books of the Federal Reserve Bank of New York. On balance the dollar has weathered all this fairly well. Against the German mark it is currently about 2% percent below its post-October 6 highs and about 2% percent above its pre-October 6 lows. Since October 6 we have managed to keep our intervention powder dry; over the past 7 weeks we have intervened only twice and that was in the past week and in the modest total of $14 million out of balances. The immediate uncertainties of the Iranian threat to pull their funds and the freeze of those funds by the United States can work for us as well as against us. Foreign exchange traders and brokers generally are being cautious themselves and it would be difficult to move large blocks of funds through the market in these circumstances. Moreover, dollar interest rates have been high enough to make it expensive for speculators to go short of dollars. But over time, as long as the standoff between the two governments remains unresolved the uncertainties can only work against us. We have made every effort to reassure central bankers in the Middle East and OPEC generally of the unique circumstances of the freeze, but the central banks are only the caretakers ofthe funds and must yield to government policy. Moreover, the central banks are not the only holders of funds in many ofthese countries. A long list of dollar holders in the Middle East and OPEC, while perhaps not supporting the present government in Iran. are wondering when their turn will come to have funds blocked by the U. S. government as a result of a political disagreement. Certainly the financial press has encouraged them to wonder, and diversification out of dollars is likely to continue What has protected the dollar up to this point has been the higher interest rates in the United States following the October 6 measures and the market’s positive attitude toward those measures. Even as the Federal funds rate has fallen back from its midOctober highs. the exchange market took this in stride in view of the evidence of slower growth for the aggregates and indications that the economy may be slowing down. Nevertheless, just about everybody in the market stresses to us that the only thing going for the dollar right now is monetary policy. 2 Since October 6 we have reduced our swap debt through operations with correspondents. In marks, we have repaid a total of $454 million equivalent, leaving $3,327 million. In Swiss francs, we repaid the full $44 million equivalent of drawings incurred in September-early October, at a modest profit to us. NOTES FOR SEMINAR 91; NEW APPROACH TO OPEN 1JARRZ:T 0PE:RATIcIPjS PETER D. STERPJLIGAT PJOVEMRER 1 9 , 1 9 7 9 Mr. A x i j r o d h a s d e s c r i b e d d e r i v a t i o r , of p a t h s f o r t o t a l and nonhorrowed r e s e r v e s . These have weekly v a l u e s , b u t a t t h e D e s k w look a t them i n b l o c k s of weeks ( e . g. e g r o u p of 4 and t h e n group of 3 ) which p e r m i t s us t o aim f o r r e a c h i n g p a t h for a m e a n i n g f u l b l o c k of t h e w h i l e a v o i d i n g some of t h e g y r a t i o n s i n market c o n d i t i o n s t h a t could follow from s e e k i n g a d h e r e n c e week-by-week to a p a t h t h a t m i q h t have been l a i . 5 o u t m d s r f a u l t y a s s u m p t i o n s scne w e e k s e a r l i e r . E a s i c a l : ~ , we've s o u g h t to a i m a t b r i n g i n g o u t nonbcrrowed t o it:; ~ a t h v e r a g e r b i l k a s i n t h e r'ctcber a F e r i o d we'd be srspars:! t o n m c l i f ? : . t h e r,c~r.br~rrov:ed b j e c t i v e o i ! o r d e r to pro~,ri-iec ; r e Z t E r ~.ss~::.a.>cs r.f hr.inqirz.? out t.-otal : xCs&rT.'es c s perhaps $500 m i l l i o n above p a t h , w e d e l i b e r a t e l y s o u g h t to u n d e r a c h i e v e nonborroved s o a s tc. p u t more s i r e i s on t h e b m k i n g sys.tem. to a d j u s t c r e d i t a d d e p o s i t q,rowth i n a wzy t h a t would b r i n g t o t a l r e s e r v e s closer t o p a t h clown the r o a d . T h i s i s r.ct an a u t o m a t i c a r ? j u s t m e n t , thouah. h a s a c c n s i d e r a h l c judcirnentil e l e z i e n t . It Thus i n November p a r t of p e r i o d , when it looked a2 though t o t a l was r u n n i n g - 2 - $200-$300 nillion above p a t h , we’ve been a i m i n g e s s e n t i a l l y t o r e a c h t h e nonborrowed p a t h , and n o t u n d e r s h o o t it. t h e difference? A t l e a s t part].’;, Wn ry t h i s i s b e c a u s e t h e over- age i n e x p e c t e d demmnd f o r t o t a l r e s e r v e s d o e s n o t r e a l i y r e f l e c t e x c e s s i v e growth i n monetary a g g r e g a t e s j u s t now. It’s b e e n m o r e a f u n c t i o n of s h i f t s i n t h e d e p o s i t mix, i n c l u d i n g greater t h a n e x p e c t e d CD growth -- and i n d e e d it c o u l d h a v e bem a r g u e d t h - l t t h e s e shifts i n t h e mix were a r e a s o n t o r a i s e t h e p a t h t o sme e x t e n t , so t h a t a c t u a l demand f o r t o t a l r e s e r v e s would n o t a p p e a r t o be so much above p a t h . Looking a t each p a r t i c u l a r xeek, w car, d e f i n e an e o ? , j i c t i v e f3r nonborrowed r a s e r v $ s , ai:r! t k s an i m p l i e d l e v e l f c r bGrrowiRgs since demand f c r tot31 rE?cSrves c a n be ass-ai€Z fron t h e known level of recpire2 r e s e r v e s a n 3 an ?szui?ed a l l o w a n c e f c r excess r e s e x v e s . V conpare the ncnborrowed e o b j e c t i v e w i t h t h e p r o j e c t e r ! snp~l..; of nocScrrowed, which w e d e r i v e f r o - d a L l ~ 7I r o j e c . k i c n s of inarket f a c t o r s s u c h as f l o a t , Treasury b a l a n c e , etc. T h i s q i v f s u s a rcuq’n idea of w h e t h e r reserves need to be .2dded o r < r a i n e d . Since t h i s s o m p a r i s c n i s s o d e p e n d e n t on p r o j e c t i o n s which c a n be p r e t t y f a r o f f b a s e , w a l s o look t o Fed f u n d s r a k e f o r e some d e g r e e c E q u i d a n c e i n the E ; ~ Y of c o n f i r m a t i o n o f t h e projections. The e x t e n t o f t h i s g?iidar.ce i s less t h a n hefore, when w e p r i m a r i l y fncuseri ~n t h e f u n d s r a t e , ,though. Th‘ils i f r e s e r v e p r o j e c t i o n s show a need t o add some r e s e r v e s , - 3 - w e p r o b a b l y would n o t , as w e might have b e f o r e , w a i t u n t i l Fed f u n d s were t e n d i n g t o push above t h e i r t a r g e t a r e a &fore a d d i n g t h e reserves. But w e m i g h t , u n d e r present p r o c e d x r e s , h e s i t a t e t o add t h e r e s e r v e s i f f u n z s were - a c t u a l l y t e n d i n g t o e'ase s i g n i f i c a n t l y i n manner t h a t c a s t d o u b t on t h e v a l i d i t y of t h e p r o j e c t i o n s . $Then w e view a p a r t i c u i a r week and compare o u r p r o j e c t i o n of t h e s u p p l y of nonborrowed reserves w i t h t h e d e s i r e d t a r g e t , i t i s n o t always 50 s i m p l e as m e r e l y a c t i n g t o aZd or drcliz tP.;us and s o many r e s e r v e s . Tc2r e x a n p l e , we c o u l d f i n d o u r s e l v e s i n a week where we aim for nonborrowed of $ 4 0 . 0 ' c i l l i o n , i n e x p e c t a t i o n t h a t t h e banks n e e 3 $11.5 3 F l i i o n of reserv*es and w i l l h a v e t o horrcw $1.5 billion. Suppose f u r t h e r t h s t o u r p r 3 j e c t i o n of s ~ p p l ya l s o shows $13.0 b i i l i o n of nonborrowed r e s e r v e s amcu:it. -- j u s t ths d e s i r e d Y e t f o r one r e a s o n oz a n c t h e r , i n e a r l y p a r t of w e e k t h e banks ha-.Te o n l y been bcrrowi-ng $700-$800 n i l l .;on ' e i t i l e r becazj,? t h e s-;pply of reserves is skewed i n t h > t veek o r b e c a u s e t h e b a n k s a r e w i l l i n s t o b u i l d up reseri'e deficiencies. 2 a t k r t h a n l e t an enormous r e s e r v e need e accxmulate t o be met a t v e r y en3 o E p e r i o d , w might w.int t o take same s t e p s e a r l ; i n x e e k t c m a t e t h e need f o r r e c c u r s e t o d i s c o u n t winSow more c l e a r -- d r z i n i n g sene r e s G r v e s e v e n t h o u g h w e ' d e x p e c k t o have t o add t h e 3 back l a t e r . Developments w i t h f u n d s r a t e rr,iqht p r o v i d e e guidance on e x t e n t t o which w would do t h i s . -- - 4 - Another k i n d of example: suppose wesre i n a week when w e p r o j e c t nonborroweii r e s e r v e s s u p p l y a t $ 4 0 . 0 b i l l i o n , zxd t h a t i s a l s o t h e t a r g e t l e v e l , w i t h banks e x p e c t e d t o Save t o borrow, s a y , $1.5 b i l l i o n t o r e a c h estimated demand f o r t o t a l rsser~resof $ 4 1 . 5 b i l l i o n . Now s u p p o s e t h a t banks on t h i s o c c a s i o n r?re borrowing 5 2 . 5 b i l l i o n i n e a r l y p a r t of week. We may want t o t a k e Desk a c t i o n t o ac‘d nonborrowec! r e s e r v e s j u s t t o relieve t h e demand f o r b o r r o w h g , even though our p r o j e c t i o n s s a y nonborrowed w i l l be j u s t r i g h t w i t h o u t action. I n . t h i s c a s e , we’d p r ~ ~ s b a b l q ‘ have t o t a k e o u t sono ncx- Lorrcwzc? r e s e r v e s l a t e r i n wee:<, i: t. r e a n h d e s i r e d nonborrowed average. I t c o u l d happen that %ward l i t t e r p x t of a week l i k e t h a t l a s t one, banks have alr-”-’ ’corrcwec: mere t h a n -..-.y FB I i n t e n d e d t h a t t h e y s h o u l d , and are i n i x o c e s s of b c i l d i n g up b i g reserve excesses. We coulr3- s t i c k wit4 o u r nonborrowec? o b j e c t i v e f o r ?‘he week and perstit a Treat abundanze of r e s e r v e ? at ertd of week -tc d r i v e dowa t k e .funds r a t e . Ai sam.e t i m e , we’d b e p e r n i t t i n g t o t a l r e s e r v i s i n t h a t week t o come o u t s u b s t a n t i a l l y above p a t h , s i n c e in t h e c a s e e n v i s a g e d h e r e t h e r e ’ s no x a y , m a t h e r n a t i c a l ? y , t h a t korrowing cc.ul(? cone down t o t h e d e s i r e d weekly a v e r a g e l e v e l once it had s t a y e d h i g h over t h e f i r s t 4 o r 5 days of t h e week. h e r e \iOclcl be t o t a k e a mid?!:? COCzSF) -- M own i n c l i n a t i o n y t a k i r . 9 o u t son- non- borrowed reser-ves arid t h i i s l c t t i n q nonborrowed t - r n o.~t - 5 - somewhat below t a r g e t , b u t l e a v i n g enough nonborrowed reserves t h e r e so t h a t s0T.e d i s t i n c t e a s i n g i n money m a r k e t o c c u r r e d and a t l e a s t t h e d a i l y l e v e l s of borrowing dropped down even i f w e c o u l d n o t p u l l down t h e weekly a v e r a g e borrowing a s f a r as d e s i r e d F M MEETING O C NOVEMBER 20, 1979 REPORT OF OPEN MARKET OPERATIONS Reporting on open market o p e r a t i o n s , M r . S t e r n l i g h t made t h e following statement. A review of domestic open market o p e r a t i o n s s i n c e t h e September meeting of t h e Committee n a t u r a l l y c e n t e r s on t h e Committee d e c i s i o n s reached a t t h e s p e c i a l October 6 meeting, Desk implementation of t h o s e d e c i s i o n s , and m a r k e t r e a c t i o n t h e r e t o . F i r s t , b r i e f l y reviewing o p e r a t i o n s from t h e t i m e of t h e September 18 meeting up t o October 5 t h e Desk focussed on a c h i e v i n g reserve . c o n d i t i o n s c o n s i s t e n t w i t h F e d e r a l f u n d s t r a d i n g around 1 1 / 2 1 percent. By O c t o b e r 5 , t h e funds o b j e c t i v e had been r a i s e d a b i t to 1 1 / 2 1 - 1 3/4 p e r c e n t , a g a i n s t a background of s t r o n g e r money 1 growth and a d e t e r i o r a t i n g atmosphere f o r t h e d o l l a r abroad. A s i z a b l e volume o f reserves was s u p p l i e d d u r i n g t h a t i n t e r v a l , e s p e c i a l l y i n the f i n a l d a y s of September. Despite repeated reserve i n j e c t i o n s F e d e r a l funds t r a d i n g moved up t o a b o u t 1 2 per- c e n t around t h e end o f September, r e f l e c t i n g t h e a l r g e a b s o r p t i o n of reserves from market f a c t o r s , e s p e c i a l l y a high Treasury b a l a n c e , as w e l l a s q u a r t e r - e n d s t a t e m e n t d a t e p r e s s u r e s . The funds r a t e receded t o a b o u t 1 5/8 percent by October 5. 1 Following t h e October 6 meeting, the f o c u s of o p e r a t i o n s s h i f t e d from achievement of a F e d e r a l f u n d s r a t e e x p e c t e d to be c o n s i s t e n t w i t h d e s i r e d growth of monetary a g g r e g a t e s , to t h e p r o v i s i o n of reserves deemed c o n s i s t e n t w i t h d e s i r e d monetary growth. The Board s t a f f developed p a t h s f o r t o t a l and nonborrowed reserves expected to b e s u p p o r t i v e of growth i n M i and M2 a t annual rates of about 4 1/2 and 7 1/2 percent, respectively, from September to December--the rates chosen by the Committee as acceptable upper bounds for fourth quarter performance. The basic nonborrowed reserve path assumed a $1.5 billion level of borrowing, a little above the averate level prevailing in recent previous weeks, in order to impart a somewhat greater measure of restraint on bank reserve positions at the outset of the new program. At the same time, it was anticipated that Federal funds trading, while free to move in the broad 11 1/2 - 15 1/2 percent band set by the Committee, might initially tend to be in the area of 13 to 13 1/2 percent. For about the first week of the new program, it seemed that monetary growth and reserve growth were about on track as the Desk aimed for path levels of nonborrowed reserves expected to be consistent with borrowings of around $1.5 billion. Federal funds in that period ranged fairly widely from day to day but tended to average in the area of 13 to 13 1/2 percent. By the second half of October, it appeared that growth in the monetary aggregates was substantially stronger than contemplated earlier, generating demands for reserves well above path levels. In response, the Desk sought to hold nonborrwed reserves down to, and even somewhat below path levels, thus forcing the banking system to meet demands for abovepath levels of total reserves through greater recourse to borrowings. In the process, borrowing rose for a time to the $3 billion area-actually a little higher than the Desk.intended, and the funds rate pushed to around the 15 1/2 percent top of the Committee's broad range--exceeding it on a few days and even slightly exceeding that level for one statement week on average. Toward the end of October it was learned that some of the excessive strength in the aggregates and in the above-path demand for total reserves -- had reflected reporting errors from a large New York bank but even after correcting for this it was still observed that demand for reserves was running well above path levels, so that the System's more restraining posture in the latter half of October was still appropriate for that period. For the four weeks ending October 31, total reserves averaged about $390 million above their path level, while nonborrowed reserves averaged about $230 million below their path. To obtain needed reserves, banks resorted to the discount window, so that borrowing averaged about $2.1 billion -- or about $ 6 0 0 million above the level initially assumed in constructing the nonbotrowed path. Coming into early November, it appeared that growth in the aggregates was abating considerably. Along with this, o expected demand for reserves has been closer t path -- although still somewhat above it because of various factors in the deposit mix including stronger qrowth in CDs than had been anticipated. In these circumstances, the Desk has been aiming essentially at the path levels for nonborrowed reserves, anticipating that borrowing would come down closer toward the $1.5 billion level and that funds would trade more in the middle of their broad range rather than near the Committee's upper bound. On the last available estimates, it looked as though, for the three weeks ending tomorrow, total reserves might average about $300 million above path, nonborrowed reserves might be close to path, with borrowing averaging in the area of $1.8 billion, and Federal funds averaging in the neighborhood of 13 1/2 percent. In terms of actual System operations during the period, the Desk was mainly on the reserve-supplying side. From September 18 to October 5, outright holdings of bills were increased by about $933 million, mainly reflecting purchases . from foreign accounts, while Treasury coupon holdings increased $634 million. From October 6 through November 19, bill holdings were up by $1,733 million, as purchases of nearly $2.7 billion from foreign accounts were partly offset by redemptions and sales in the market. The System also bought $63 million of coupon issues from foreign account. Matched sale-purchase transactions were arranged almost every day with foreign accounts, although on several occasions some of the foreign short-term investments were passed through to the market as repurchase agreements. The System also made short-term reserve adjustments through repurchqse agreements and matched sale-purchase transactions in the market. The use of these short-term reserve adjustments may have been somewhat less in the period since October 6 than it would have been under the old approach to reserve management, with its greater sensitivity to the funds rate, but it is too soon to reach a firm judgment on whether the new approach will make a significant difference in this regard. Market interest rates have risen sharply in the past . two months, with most of the rise coming since October 6 For a time, especially just after October 6 , the orderliness of the market was in question, and the whole period since early October has been marked by unusual price volatility as dealers have been less willing market makers and many institutional investors retreated to the sidelines. A greater measure of stability was beginning to return by early November, but the markets were still quite volatile and nervous by past standards. There was a fair sized rise in yields, by past standards, from the September meetinq date up to October 5 about 15-30 basis points for most Treasury issues -- -- as market concern grew over strengthening money growth, a weakening dollar internationally, continuing inflation, and an absence of signs of weakness in the economy. These moves were far overshadowed in the days after October 6 when rates jumped steeply in very thin markets. The initial impetus was the October 6 program, with its 1 percent discount rate increase, and firm message of restraint, highlighted by the System's departure from the traditional Federal funds anchor. After the initial vigorous upward rate reaction, rates pushed still higher in Late October following publication of higher money growth data along with a market sense that the System was encouraging still greater restraint. In the final weeks of the period many market rates came down somewhat, encouraged by the downward revisions and subsequent slower growth in money supply, and by a sense that the System was promoting a lesser degree of pressure on bank reserve positions and the money market. Developments related to Iran dented the recovery but have not distrubed the domestic markets greatly up to this point. On balance, for the period since October 5, Treasury bill rates have risen about 1 to 1 3/4 percentage points, although at their peak they were up more than 2 percentage points. At one point, the 3-month bill touched 13 percent, up from 10.70 on October 5 , while most recently that maturity has been around Yields on Treasury coupon issues out to about 10 12 percent. years are up around 1 1/4 to 1 1/2 percentage points while longer issues have risen roughly 1 percentage point -- equivalent to a price drop of 8 or 9 points on the longest issues. The yield rise at the long end is surprising against other recent experience when market participants seemed io welcome vigorous official action designed to curb inflation, feeling that the long-term effect should be toward lower rates. The reaction this time, in my view, reflects a sentiment that might be summarized: “I respect what the Fed is trying to do but I want to see some results before I become a believer.” Interestingly, the primary dealers with which the Desk trades did not on the whole fare too badly during this turbulent period. In the aggregate, they were positioned by October 5 to withstand restrictive moves which had been widely anticipated. We have surveyed profit results for October and found that gains outweighed losses both by number and dollar volume. profit -- a very rough estimate -- was on The net the order of $ 4 0 million. Still, it should be emphasized that the markets remain quite jittery -- and in a sense it is because of their skittishness that a number of firms managed to avoid losses. U n r e l a t e d t o r e c e n t p r o f i t developments, I might mention t w o p r o s p e c t i v e changes i n t h e Desk's d e a l e r r e l a t i o n ships. F i r s t , w e have e f f e c t i v e l y c e a s e d t r a d i n g w i t h B l y t h Eastman D i l l o n a s t h e y a r e i n p r o c e s s o f merging i n t o P a i n e Webber, which i s a n o t h e r d e a l e r on o u r l i s t . Second, w e are a b o u t t o t a k e a f u r t h e r step i n t h e p r o c e s s of d i s e n g a g i n g from t r a d i n g w i t h Second D i s t r i c t S e c u r i t i e s , a s t h e i r volume of a c t i v i t y h a s been f a l l i n g w e l l s h o r t of o u r s t a n d a r d s . YOMC P r e a c n t a t i o n E.M. Truman November 20, 1979 I n t h e course o f p r e p a r i n g t h i s month's p r o j e c t i o n , we have r e v i s e d our assumptions about world o i l p r i c e s . S p e c i f i c a l l y , w e a r e now assuming t h a t i n t h e f o u r t h q u a r t e r of t h i s y e a r t h e average p r i c e of o i l imported i n t o t h e United S t a t e s w i l l b e 73 p e r c e n t h i g h e r t h a n i n t h e f o u r t h q u a r t e r of 1978. I n a d d i t i o n , w e a r e assuming t h a t t h e p r i c e w i l l r i s e by a f u r t h e r 2 3 p e r c e n t by t h e f o u r t h q u a r t e r of 1980 t o more t h a n $28 per b a r r e l . W have assumed e t h a t OPEC o i l e x p o r t s w i l l c o n t i n u e a t about t h e 1979 r a t e . These r e v i s e d assumptions have b o t h d i r e c t i m p l i c a t i o n s f o r t h e U.S. economy, which M r . K i c h l i n e w i l l r e p o r t on i n a few m i n u t e s , and i n d i r e c t i m p l i c a t i o n s , through e f f e c t s on economic developments i n t h e r e s t o f t h e world. The s t a f f now e s t i m a t e s t h a t d u r i n g t h e f o u r q u a r t e r s of 1979 r e a l GNP i n t h e 10 major f o r e i g n i n d u s t r i a l c o u n t r i e s w i l l i n c r e a s e a t a n average r a t e of about 3 p e r c e n t compared w i t h almost 4 p e r c e n t i n 1978. Growth abroad t h i s y e a r has been supported by p e r s o n a l consumption e x p e n d i t u r e s and p r i v a t e f i x e d investment, e s p e c i a l l y i n Germany and Japan. T h i s expansion, coupled w i t h t h e lagged e f f e c t s of t h e d o l l a r ' s d e p r e c i a t i o n i n 1977 and 1978, has produced s t r o n g growth i n U . S . n o n - a g r i c u l t u r a l e x p o r t s . I n r e a l terms, G P N e x p o r t s of goods and s e r v i c e s a r e expected t o be 7 p e r c e n t h i g h e r t h i s q u a r t e r t h a n a y e a r ago. D e s p i t e a n o i l b i l l t h a t w i l l b e more t h a n $15 b i l l i o n h i g h e r i n 1979 t h a n i n 1978, our t r a d e d e f i c i t w i l l b e lower, a l t h o u g h r e c e n t l y it has been on a p l a t e a u in t h e $25-30 b i l l i o n r a n g e a t a n a n n u a l raLe. Lc now expecL J a c u r r e n t account p o s i t i o n of z e r o i n 1979, compared w i t h a d e f i c i t of $14 b i l l i o n i n 1978. Turning t o 1980, w e e x p e c t t h a t t h e r a t e 01 i n c r e a s e of r f d G P i n t h e major f o r e i g n i n d u s t r i a l c o u n t r i e s w i l l slow s i g n i f i c a n t l y t o N 1-112 p e r c e n t over t h e n e x t f o u r q u a r t e r s . The a v e r a g e r a t e of i n c r e a s e of - 2 - consumer p r i c e s i s expected t o d e c l i n e from about 9-1/4 p e r c e n t t h i s q u a r t e r t o about 7-1/2 p e r c e n t i n t h e f o u r t h q u a r t e r of 1980. The c a u s e of t h e expected slowdown i n growth abroad v a r i e s a c r o s s countries. The t r a n s f e r of w e a l t h i m p l i c i t i n t h e o i l p r i c e i n c r e a s e s and subsequent p o l i c y r e s p o n s e s t o h i g h i n f l a t i o n r a t e s a r e l a r g e l y r e s p o n s i b l e f o r t h e slowdowns i n Germany, Japan, France and I t a l y . On t h e o t h e r hand, t h e United Kingdom and Canada are roughly s e l f - s u f f i c i e n t i n energy and t h e d i r e c t impact on w e a l t h of t h e s o - c a l l e d o i l t a x -is a b s e n t . However, growth i n Canada w i l l be v e r y s l u g g i s h l a r g e l y because of weakening U.S. demand, and r e a l GNP i s expected a c t u a l l y t o d e c l i n e i n the United Kingdom due, i n p a r t , t o t h e l o s s i n U.K. p r i c e c o m p e t i t i v e n e s s and, i n p a r t , t o t h e s h o r t - r u n e f f e c t s of t h e p o l i c i e s of t h e Thatcher government. I would stress t h a t t h e r e are s i g n i f i c a n t r i s k s i n these f o r e c a s t s o f lower rates of growth abroad and h i g h e r rates of i n f l a t i o n : O i l s h o r t a g e s and more p e s s i m i s t i c o i l p r i c e s c e n a r i o s c o u l d develop. Policy responses t o high i n f l a t i o n r a t e s c o u l d be more v i g o r o u s t h a n w e now e x p e c t . The e f f e c t s of a simultaneous weakening of demand i n t h e i n d u s t r i a l c o u n t r i e s may have been underestimated. N e v e r t h e l e s s , b a s e d on our p r e s e n t o u t l o o k f o r growth and i n f l a t i o n h e r e and abroad and our r e v i s e d assumptions about o i l p r i c e s , w e expect a $10 b i l l i o n r e d u c t i o n i n t h e U.S. t r a d e d e f i c i t i n 1980 t o less t h a n $20 b i l l i o n . Another $15 b i l l i o n increase i n o u r o i l i m p o r t s i s expected t o b e more t h a n o f f s e t by somewhat h i g h e r a g r i c u l t u r a l and n o n - a g r i c u l t u r a l e x p o r t s , w h i l e U.S. demand f o r n o n - o i l i m p o r t s s t a g n a t e s . With some f u r t h e r i n c r e a s e i n o u r s u r p l u s i n o t h e r c u r r e n t a c c o u n t t r a n s a c t i o n s , we would e x p e c t a 1980 c u r r e n t account s u r p l u s o f about $14 b i l l i o n . James L. K i c h l i n e November 20, 1979 FOMC B R I E F I N G Domestic economic a c t i v i t y t h i s q u a r t e r a p p e a r s t o he d e c l i n i n g , j u d g i n g from t h e l i m i t e d s t a t i s t i c a l e v i d e n c e now a v a i l a b l e and b r o a d l y based q u a l i t a t i v e i n f o r m a t i o n . While t h e f o r e c a s t f o r t h e c u r - r e n t q u a r t e r i s l i t t l e d i f f e r e n t from t h a t p r e s e n t e d i n September, t h e s t a f f ' s p r o j e c t i o n f o r 1980 h a s d e t e r i o r a t e d a p p r e c i a b l y - - w i t h r e a l o u t p u t s i g n i f i c a n t l y lower and i n f l a t i o n h i g h e r . developments, The changed o u t l o o k r e f l e c t s o u r r e a d i n g of r e c e n t i n c l u d i n g t h e impact of t h e October 6 monetary p o l i c y a c t i o n s and t h e changed assumption of world o i l p r i c e s . The c u r r e n t q u a r t e r took o f f from a l e v e l of a c t i v i t y t h a t was q u i t e h i g h , and b o t h employment and p r o d u c t i o n h e l d up w e l l i n October. Non- farm employment i n October i n f a c t expanded by more t h a n 300,000, w e l l above t h e average monthly i n c r e a s e i n t h e p r e c e d i n g s e v e r a l m o n t h s . Most of the j o b g a i n o c c u r r e d i n t r a d e and s e r v i c e s w h i l e m a n u f a c t u r i n g employment i n c r e a s e d a little. The unemployment r a t e r o s e 0 . 2 p e r c e n t a g e p o i n t t o 6.0 p e r c e n t , t h e upper end of t h e narrow r a n g e t h a t h a s p r e v a i l e d all y e a r . Since the e a r l y 0 - t o b e r l a b o r m a r k e t s u r v e y t h e r e h a s n o t been an u p s u r g e i n unemployment i n s u r a n c e c l a i m s n o r any c o n s i s t e n t r e p o r t s of major l a y o f f s o u t s i d e t h e a u t o mobile i n d u s t r y . It seems a b i t e a r l y f o r s u b s t a n t i a l weakness i n demands f o r l a b o r t o have a p p e a r e d , p a r t i c u l a r l y g i v e n s t r o n g f i n a l s a l e s l a s t q u a r t e r and t i g h t markets f o r s k i l l e d l a b o r which may make f i r m s r e l u c t a n t t o g i v e up r e s o u r c e s u n t i l t h e y become more c e r t a i n of weakness i n s a l e s . S a b s a t t h e r e t a i l l e v e l a r e r e p o r t e d t o have d e c l i n e d markedly i n October, f o l l o w i n g r a p i d growth d u r i n g t h e t h i r d q u a r t e r . The drop was a t t r i b u t a b l e p r i n c i p a l l y t o developments i n consumer d u r a b l e s a s nondurable -2p u r c h a s e s changed l i t t l e i n nominal terms. F u r n i t u r e and a p p l i a n c e s a l e s moved lower w h i l e a u t o s a l e s t u r n e d i n an e s p e c i a l l y poor performance. Domestic a u t o s a l e s moved s t i l l lower i n t h e f i r s t 10 days of November, d e a l e r s t o c k s have remained uncomfortably h i g h f o r a number of models, and m a n u f a c t u r e r s r e c e n t l y r e i n s t i t u t e d d e a l e r d i s c o u n t programs. Even if r e t a i l p r i c e c u t t i n g f o r a u t o s s u c c e e d s i n b o o s t i n g d o m e s t i c a u t o s a l e s , t h i s seems l i k e l y t o be o n l y a t r a n s i t o r y f o r c e i n a n o t h e r w i s e weakening m a r k e t f o r consumer d u r a b l e s . The consumer d u r a b l e s and i n v e s t m e n t s e c t o r s a r e , of c o u r s e , t r a d i t i o n a l l y key c y c l i c a l e l e m e n t s and i n f a c t r e p r e s e n t t h e p r i n c i p a l s o u r c e s of weakness i n t h e s t a f f ' s p r o j e c t i o n . Although consumption spending g e n e r a l l y h e l d up w e l l t h i s y e a r i n t h e f a c e of d e c l i n i n g r e a l d i s p o s a b l e incomes, t h e f o r c e s a g a i n s t s u s t a i n e d e x p a n s i o n have been mounting. Developments o u t s i d e t h e consumer s e c t o r , such as a n o t h e r round of s i z a b l e i n c r e a s e s i n t h e p r i c e of imported o i l , imply f u r t h e r e r o s i o n of r e a l d i s p o s a b l e incomes and t h i s w i l l be o c c u r r i n g a t a time when t h e s a v i n g s r a t e i s a t h i s t o r i c a l l y v e r y low l e v e l s - - t h a t d e b t burdens a r e a t r e c o r d h i g h s . i s around 4 p e r c e n t l a s t q u a r t e r - - a n d On t h e f i n a n c i a l s i d e , consumer c r e d i t p r i c e and n o n p r i c e terms have t i g h t e n e d a p p r e c i a b l y i n r e c e n t weeks, and d u r a b l e s p u r c h a s e s a r e h e a v i l y dependent upon c r e d i t f i n a n c i n g . Should consumers t r y t o be p a r t i c u l a r l y generous t h i s C h r i s t m a s , i t would seem t h a t b a l a n c e s h e e t s t r a i n s c o u l d be i n t e n s e e a r l y n e x t y e a r and p o r t e n d a weaker o u t l o o k t h a n t h a t now i n p r o s p e c t . I n t h e i n v e s t m e n t s e c t o r , t o o , t h e s t a f f f o r e c a s t h a s been r e d u c e d . For r e s i d e n t i a l c o n s t r u c t i o n t h e o n l y immediate q u e s t i o n seems t o be how f a s t and how f a r s t a r t s w i l l f a l l . I n October, starts declined t o a 1-3/4 m i l l i o n u n i t r a t e from t h e i n f l a t e d September l e v e l , w h i l e p e r m i t s dropped a b i t more than s t a r t s . A v a i l a b l e r e p o r t s c l e a r l y i n d i c a t e consumers a r e backing away from t h e m a r k e t , l e n d i n g i n s t i t u t i o n s remain c a u t i o u s , and b u i l d e r s a r e s c a l i n g -3back t h e i r c o n s t r u c t i o n programs. The f o r e c a s t shows s t a r t s dropping t o t h e 1-1/4 m i l l i o n a r e a e a r l y n e x t y e a r and t u r n i n g up m o d e r a t e l y t h e r e a f t e r . For s t a r t s t o behave i n t h i s f a s h i o n we b e l i e v e i t i s n e c e s s a r y t h a t t h e u n c e r t a i n t i e s now p r e v a i l i n g i n t h e mortgage m a r k e t d i s s i p a t e a n d t h a t mortgage and c o n s t r u c t i o n l o a n r a t e s t u r n down over t h e n e x t few months. B u s i n e s s f i x e d investment p r o s p e c t s a l s o seem t o have weakened. New o r d e r s and c o n s t r u c t i o n c o n t r a c t awards i n re al terms g e n e r a l l y a p p e a r s l u g g i s h and a n t i c i p a t i o n s d a t a f o r 1980 s u g g e s t slowing of o u t l a y s . The McGraw-Hill s u r v e y , f o r example, shows no change i n real s p e n d i n g f o r n e x t y e a r , and 1980 seems t o b e shaping up a s a r e c e s s i o n a r y p e r i o d i n which s u c h s u r v e y s t y p i c a l l y overstate outlays. The h i g h e r i n t e r e s t r a t e s t r u c t u r e now p r e v a i l i n g and assumed i n t h e f o r e c a s t , a l o n g w i t h reduced b u s i n e s s s a l e s , seems l i k e l y t o prompt r e d u c t i o n s i n f i x e d investment p l a n s a s w e l l a s c u t b a c k s i n i n v e n t o r y accumulation. The f o r e c a s t e d b e h a v i o r of t h e b u s i n e s s and consumer s e c t o r s , t h e n e t e x p o r t p i c t u r e d i s c u s s e d by Mr. Truman, and s m a l l growth of government p u r c h a s e s adds up t o a p p r e c i a b l e d e c l i n e s i n a c t i v i t y t h i s q u a r t e r and d u r i n g t h e f i r s t h a l f of 1980. F o r t h e f o u r q u a r t e r s of 1980 r e a l GNP i s p r o j e c t e d t o d e c l i n e a b o u t 1 - 1 / 2 p e r c e n t , compared w i t h r o u g h l y no change e x p e c t e d a t t h e September meeting of t h e Conunittee. T h e unemployment r a t e i s p r o j e c t e d t o be a b o w 8 p e r c e n t i n t h e second h a l f of 1980. On t h e p r i c e s i d e t h e f i x e d - w e i g h t e d b u s i n e s s p r o d u c t d e f l a t o r h a s been i n c r e a s i n g around 10 p e r c e n t a l l y e a r and w e e x p e c t t h a t pace t o c o n t i n u e i n t o t h e f i r s t h a l f of n e x t y e a r . The changed o i l p r i c e assumptions and r e l a t e d e f f e c t s on domestic e n e r g y p r i c e s added n e t a b o u t 1 / 2 p e r c e n t a g e p o i n t t o t h e p r i c e f o r e c a s t t h i s month. Although weaker p r o d u c t and l a b o r m a r k e t s are expected t o g e n e r a t e improved p r i c e performance, t h a t e f f e c t w i l l be swamped -4i n t h e s h o r t e r . r u n by energy developments. A more f a v o r a b l e o u t l o o k would emerge if OPEC e x e r c i s e s moderation i n p r i c i n g o r i f i n f l a t i o n a r y e x p e c t a t i o n s improve and t h i s c a r r i e s i n t o wage and p r i c e b e h a v i o r . But f o r t h e n e a r term i t s e e m s most l i k e l y t o u s t h a t i n f l a t i o n w i l l remain i n t e n s e . FOMC B r i e f i n g S. H. A x i l r o d Nov. 2 0 , 1979 A s i n d i c a t e d i n t h e b l u e book, t h e b e h a v i o r o f t h e monetary a g g r e g a t e s t h u s f a r i n t h e f o u r t h q u a r t e r h a s n o t been f a r o f f o b j e c t i v e s i m p l i c i t i n t h e FOMC'S October 6 d e c i s i o n . Growth i n money s u p p l y measures, and i n hank c r e d i t , h a s d e c e l e r a t e d markedly. M - 1 expanded a t a s t r o n g pace i n t h e f i r s t h a l f o f O c t o b e r , b u t s u b s e q u e n t l y t h e o u t s t a n d i n g l e v e l c o n t r a c t e d , and through mid-November M - 1 h a s been r u n n i n g w e l l below p a t h - t h e p a t h b e i n g d e f i n e d a s a 4# p e r c e n t annual r a t e o f i n c r e a s e from September t o December. M-2, on t h e o t h e r hand, h a s been expanding a t a r a t e e q u a l t o p a t h , taken a s a 7% p e r c e n t annual r a t e o v e r t h e f o u r t h q u a r t e r . Given t h e weakness i n M - I , t h e r e l a t i v e s t r e n g t h o f M- 2 r e f l e c t s t h e a b i l i t y o f banks t o o f f e r money market c e r t i f i c a t e s and l a r g e time d e p o s i t s a t c o m p e t i t i v e r a t e s and t h e d e s i r e o f t h e p u b l i c t o p l a c e funds i n such d e p o s i t s a t t h e v e r y h i g h l e v e l of i n t e r e s t r a t e s p r e v a i l i n g . Of the t h r e e a l t e r n a t i v e s f o r t h e aggregates presented t o the Committee, a l t e r n a t i v e s B and C seem more c o n s i s t e n t w i t h t h e O c t o b e r 6 d e c i s i o n t h a n does a l t e r n a t i v e A. A t t h a t time t h e Conunittee i n d i c a t e d i t was w i l l i n g t o t o l e r a t e somewhat s l o w e r growth i n t h e a g g r e g a t e s t h a n s p e c i f i e d i n view o f t h e v e r y r a p i d growth t h a t had t a k e n p l a c e o v e r t h e summer. A l t e r n a t i v e C does c a l l f o r a slower growth i n M - 1 o v e r t h e f o u r t h q u a r t e r than t h e 4% p e r c e n t e a r l i e r s p e c i f i e d , b u t t h e M-2 growth accompanying i t would s t i l l b e expected t o b e a b i t above t h e C o p n i t t e e ' s o b j e c t i v e s f o r t h a t aggregate. A l t e r n a t i v e B c a l l s f o r a 4% p e r c e n t growth i n M - 1 over t h e q u a r t e r , t h e r e b y r e q u i r i n g a g r e a t e r a c c e l e r a t i o n o f M - 1 growth between now and year-end t h a n a l t e r n a t i v e C and implying somewhat g r e a t e r e x p a n s i o n of M-2. With regard to the probable course o f i n t e r e s t r a t e s , a l t e r n a t i v e B seems more l i k e l y t o i n v o l v e a d e c l i n e t h a n a l t e r n a t i v e C. Under a l t e r n a t i v e B , -2- M1 growth would have t o expand b y about a 9% p e r c e n t annual r a t e from - mid-November t o t h e end of December. i n nonborrowed reserves--needed The expansion i n r e s e r v e s - - p a r t i c u l a r l y t o s u p p o r t such M - 1 growth would probably l e a d t o a r e d u c t i o n o f i n t e r e s t r a t e s , s i n c e nominal GNP i s n o t expected t o be s t r o n g enough t o b r i n g f o r t h a commensurate demand f o r money and reserves a t prevailing i n t e r e s t rates. On t h e o t h e r hand, a l t e r n a t i v e C-- which i n v o l v e s a somewhat slower r a t e o f growth i n M - 1 between now and year-end--might be a s s o c i a t e d w i t h unchanged o r r i s i n g i n t e r e s t r a t e s . With t h i s background, v a r i o u s c o n s i d e r a t i o n s might be h i g h l i g h t e d t h a t t h e Committee may wish to t a k e i n t o account i n d e c i d i n g a t t h i s meeting upon s p e c i f i c a t i o n s f o r t h e a g g r e g a t e s , and a l s o t h e F e d e r a l f u n d s r a t e range. F i r s t , a l t e r n a t i v e A would n o t be a t t r a c t i v e u n l e s s t h e Committie wishes t o adopt a f a s t e r t r a c k f o r t h e a g g r e g a t e s t h a n was i m p l i c i t i n i t s October 6 d e c i s i o n . Second, between a l t e r n a t i v e s B and C, t h e c h o i c e depends i n p a r t on t h e e x t e n t t o which t h e Committee might wish t o t i l t t h e odds toward a d e c l i n e o f i n t e r e s t r a t e s i n t h e p e r i o d ahead, o r t i l t toward a s m a l l r a t h e r than a l a r g e d e c l i n e . There a r e r e a s o n s b o t h f o r and a g a i n s t such a t i l t . On t h e "pro" s i d e a r e : (a) The a p p a r e n t g a t h e r i n g weakness i n economic a c t i v i t y ; (b) An e f f o r t t o e a s e p r e s s u r e s i n t h e mortgage market, p a r t l y t o h e l p s u s t a i n economic a c t i v i t y and p a r t l y t o a v o i d b u i l d i n g any more upward p r e s s u r e s t h a n n e c e s s a r y i n t o t h e consumer p r i c e index; and (c) An e f f o r t t o e n s u r e t h a t t h e growth i n t h e a g g r e g a t e s would be w e l l s u s t a i n e d e a r l y n e x t y e a r , when economic a c t i v i t y i s p r o j e c t e d t o weaken more. -3On t h e o t h e r hand, r e a s o n s a g a i n s t a p o l i c y t h a t enhances t h e odds on a f a i r l y s u b s t a n t i a l d e c l i n e o f i n t e r e s t r a t e s o v e r t h e n e a r term would b e : (a) The need t o show c o n t i n u e d r e s t r a i n t a g a i n s t i n f l a t i o n a r y p r e s s u r e s , w i t h i n f l a t i o n a r y e x p e c t a t i o n s showing l i t t l e s i g n a s y e t o f abating; (b) A d e s i r e t o avoid a c t i o n s t h a t would tend t o undermine t h e exchange v a l u e of t h e d o l l a r i n t h e weeks immediately ahead, p a r t i c u l a r l y i n l i g h t of u n c e r t a i n t i e s i n t h e o i l market and t h e M i d d l e E a s t ; and (c) A d e s i r e t o e n s u r e t h a t t h e r e w i l l n o t be an e x c e s s i v e l y r a p i d expansion of t h e a g g r e g a t e s e a r l y n e x t y e a r t h a t might have t o b e c o u n t e r e d by a premature r i s e i n i n t e r e s t r a t e s i f t h e c r e d i b i l i t y of the S y s t e m ’ s program f o r l i m i t i n g money growth i s t o be m a i n t a i n e d . In addition, M r . Chairman, I might n o t e t h a t t h e Committee c a n , through i t s s p e c i f i c a t i o n s o f member bank b o r r o w i n g , a f f e c t t h e nonborrowed r e s e r v e p a t h t h a t i s i n i t i a l l y c o n s t r u c t e d and t h e r e f o r e a t l e a s t t h e s t a r t i n g l e v e l of t h e funds r a t e . The s t a f f h a s a s s o c i a t e d a borrowing l e v e l of about $ l f b i l l i o n w i t h a l t e r n a t i v e B s i n c e t h a t was t h e o r i g i n a l c h o i c e of t h e FOMC on October 6 ; t h i s l e v e l i s a b i t lower t h a n t h e borrowings o f r e c e n t days. a d i f f e r e n t choice. But t h e Committee c l e a r l y h a s t h e o p t i o n o f making For example, t h e Committee might a d o p t t h e a l t e r n a t i v e C p a t h f o r t h e a g g r e g a t e s b u t a s s o c i a t e w i t h i t n o t <he $ 2 b i l l i o n o f borrowing assumed by t h e s t a f f , b u t $ l f b i l l i o n . This would b e r e a s o n a b l e i f t h e Committee d i d n o t wish t o countenance t h e i n i t i a l b i a s toward t i g h t n e s s t h a t i s i m p l i c i t i n a l e v e l o f borrowing around $ 2 b i l l i o n . The t i g h t n e s s t h e n would n o t emerge u n l e s s money demand t u r n e d o u t t o b e s t r o n g e r t h a n t h e a l t e r n a t i v e C p a t h , i n which c a s e borrowing would o v e r a p e r i o d o f weeks -4 - tend t o r i s e up t o t h e $2 b i l l i o n a r e a , or even h i g h e r i n t h e p r o c e s s o f restraLn.ing t h a t demand. F i n a l l y , t h o Committee can a i s o n f c o u r s e a d j u s t t h e funds r a t e ranges themselves. I f t h e Coamittee wished t o b e r e a s o n a b l y c a t a i n t h a t i n t e r e s t r a t e s would n o t rebound s u b s t a n t i a l l y i n an upward d i r e c t i o n over t h 2 neax term, t h e upper l i m i t nf t h e funds r a t e range corild b e r d ~ i c e d - - ~ oerm m p l e , the t o p or t h e a l t e r n a t i v e 3 r a n g e c o u l d be reduced froin 15% pcx'cent t o 1' Tercen: 65 or SO. Such a policy would semn t o bi, most c . n n s i n r e n t w i t h t h e p a t h s o f the a g g r e g i t e s of e i t h e r a l t e r u a t i v e s R o r A , p a t h 6 t h a t seem m c z e l i ~ k e i yt h a n C t o be a s s o c i a t e d w i t h s t a ? > l e o r d2el.iniirg i n t e r e s t r a c e s .
@FedFRASER