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A meeting of the Federal Open Market Committee was held
in the offices of the Board of Governors of :he Federal Reserve
System in Washington, D. C., on Tuesday, October 12, 1965, at
9:30 a.m.
PRESENT:

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

Martin, Chairman
Hayes, Vice Chairman
Balderston
Daane
Ellis
Galusha
Maisel
Mitchell
Robertson
Scanlon
Shepardson
Irons, Alternate Member

Messrs. Hickman and Clay, Alternate Members
of the Federal Open Market Committee
Messrs. Wayne, Patterson, Shuford, and Swan, Presidents
of the Federal Reserve Banks of Richmond,
Atlanta, St. Louis, and San Francisco,
respectively
Mr. Young, Secretary
Mr. Sherman, Assistant Secretary
Mr. Kenyon, Assistant Secretary
Mr. Broida, Assistant Secretary
Mr. Hackley, General Counsel
Mr. Noyes, Economist
Messrs. Baughman, Brill, Garvy, Holland, Koch,
Taylor, and Willis, Associate Economists
Mr. Holmes, Manager, System Open Market Account
Mr. Coombs, Special Manager, System Open
Market Account
Mr. Molony, Assistant to the Board of Governors
Mr. Cardon, Legislative Counsel, Board of
Governors
Messrs. Partee and Williams, Advisers, Division
of Research and Statistics, Board of
Governors

10/12/65

-2
Mr. Hersey, Adviser, Division of International
Finance, Board cf Governors
Mr. Axilrod, Chief, Government Finance Section,
Division of Research and Statistics, Board
of Governors
Miss Eaton, General Assistant, Office of the
Secretary, Board of Governors
Messrs. Hilkert and Heflin, First Vice Presidents
of the Federal Reserve Banks of Philadelphia
and Richmond, respectively
Messrs. Eastburn, Mann, Jones, Tow, Green, and
Craven, Vice Presidents of the Federal Reserve
Banks of Philadelphia, Cleveland, St. Louis,
Kansas City, Dallas, and San Francisco,
respectively
Mr. Sternlight, Assistant Vice President, Federal
Reserve Bank of New York
Mr. Duprey, Economist, Federal Reserve Bank of
Minneapolis
Before this meeting there had been distributed to the members

of the Committee a report from the Special Manager of the System
Open Market Account on foreign exchange ma:ket conditions and on
Open Market Account and Treasury operations in foreign currencies
for the period September 28 through October 6, 1965, and a supplemental
report for October 7 through 11, 1965.

Copies of these reports have

been placed in the files of the Committee.
In comments supplementing the written reports, Mr. Coombs
said that the gold stock would remain unchanged again this week for
the eleventh week in a row.

On the London gold market, the price

had been allowed to move up to nearly $35.17 on September 30 in an
effort to delay or discourage Chinese buying.

Since then the Russians

had appeared as heavy sellers and the price had been marked down
sharply to $35.10 this morning.

10/12/65
As a result of Russian sales totaling $218 million last
week, Mr. Coombs continued, the Gold Pool had been able to liquidate
completely its deficit of $170 million and to retain another $47
million in reserve.

As the Pool had paid back gold previously

drawn from the various countries, the U.S. Stabilization Fund had
benefited to the extent of somewhat more than $84 million.

Unless

the United States received other gold orders in addition to a
prospective sale of $35 million to France, it should be able not
only to get through October without

having to show a reduction

in its gold stock, but might end the month with nearly $90 million
of gold in the Stabilization Fund.
On the exchange markets, Mr. Coombs said, sterling continued
to be the center of attention as it moved up above par for the first
time in more than two years.

That move through the parity level

was deliberately engineered by the Bank of

England, one day before

the scheduled announcement that the U.K. had run an actual balance
of payments surplus during the second quarter of this year.

That

favorable news had helped to sustain the rate above par since then,
although the inflow of dollars to the Bank of England had pretty
well dried up during the past five market days.

The market appeared

to have been awaiting the trade figures for September, which were
released this morning.

The new figures showed no gain in exports

but an appreciable dip in imports, with the result that the trade
deficit was reduced by $62 million.

Since the operation in support

10/12/65

-4

of sterling was launched on September 10, the Bank of England had
taken in a total of about $560 million, and further gains might well
be registered this week.
Mr. Mitchell asked whether the British had indicated their
intentions with respect to repayment of their drawings on the swap
line with the System. Mr. Coombs replied that the British plans
in this connection were not yet firm, but he assumed that they
would be punctilious about repayments, using a substantial part--perhaps
50 per cent or more--of their reserve gains each month to reduce
their debt to the System.

There was an important psychological

advantage to be gained from showing additions to reserves, of course,
and they would be balancing one objective against the other.
In response to a question, Mr. Coomos said that the British
had drawn the whole $750 million available under the swap with the
System, starting in June and making further drawings in July and
August.

Their first drawing, of $275 million, already had been

renewed and they were likely to renew all or part of the second
drawing of $250 million that would mature soon,
Mr. Mitchell then asked whether there was any way of knowing
the extent to which the earlier strength in the technical position
of sterling had already been dissipated.
Mr. Coombs said he thought that some of the technical
strength had been dissipated by the rise in the sterling exchange

10/12/65
rate.

-5

He personally would have preferred to see the rate move

up somewhat more slowly.

On the other hand, the short positions

in sterling had been so enormous--perhaps on the order of $2 or
$3 billion--that substantial further flows to Britain could be
expected if the British did not relax their efforts and if there
were no unfavorable developments in the news.
those flows could easily continue throug

With good luck

the year end.

Sterling

would then move into its seasonally strong period, so that the
flows might continue into the spring months.
In response to a question by Mr. Hickman, Mr. Coombs said
the British had been considering the advantages and disadvantages
of allowing the exchange rate to continue to rise.

Each rate

increase drew in additional funds but if they let rates continue
up they would soon run out of space and might suffer some reaction.
His own thinking was that for the time being they might hold the
rate somewhere between $2.8010 and $2.8040 and not try to ratchet
it up further.

It was important, he felt, to avoid pushing the

rate up to an artificial and unsustainable level.
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the System open market transactions in
foreign currencies during the period
September 28 through October 11, 1965,
were approved, ratified, and confirmed.

-6

10/12/65

Mr. Coombs then requested Committee approval of renewal
for another three months of the $100 million swap arrangement with
the Bank of France, which would mature on November 10, 1965.
Renewal for a further period of
three months of the $100 mi lion swap
arrangement with Bank of France, as
recommended by Mr. Coombs, was approved.
Mr. Coombs then noted that it might be necessary to renew
a $40 million equivalent swap drawing on the National Bank of
Belgium, maturing November 10, 1965; a $25 million equivalent
drawing on the Netherlands Bank, maturing November 12, 1965; and
a $7.5 million swap of guilders against marks, with the Bank for
International Settlements, maturing November 1, 1965.

In each

case these would be first renewals.
Renewal of the two drawings and of
the guilder-mark swap, each for a further
period of three months, was noted without

objection.
Mr. Coombs then remarked that a $250 million drawing by
the Bank of England on the System, to which he had referred earlier,
would mature on October 29, 1965, for the first time.

He hoped

the Committee would be prepared to approve its renewal, in whole or
in part, if the Bank of England should so request.
Possible renewal for a further period
of three months of part or all of the $250

million drawing by Bank of England under
its standby swap arrangement with the System
was noted without objection.

10/12/65
Before this meeting there had been distributed to the
members of the Committee the regular weekly report of open
market operations and money market conditions for the week ended
October 6, and a supplemental report summarizing highlights of the
entire period from September 28 through October 11, 1965.

Copies

of the reports have been placed in the files of the Committee.
In supplementation of the written reports, Mr. Holmes
commented as follows:
At the time of the Committee's last meeting two
weeks ago, the money market was in motion, with short
term interest rates pushing persistently higher despite
very sizeable System purchases of Treasury bills. In
sympathy with developments in the short end, longer-term
interest rates were also tending higher, following a
period around mid-September when longer markets had
regained some stability after an upward rate movement.
In pursuit of the Committee's objective to maintain
current money market conditions, the Account Management
continued its substantial purchases of Treasury bills
for several additional days, more than offsetting the
absorption of reserves through market factors and con
tributing significantly to the stabilizing of short rates
that has developed in about the past ten days.
The nigh point of bill rates came shortly after the
Committee's last meeting--around September 29-30--as the
market looked forward to the regular auction of three- and
six-month bills the following Monday and the auction of
$4 billion of tax anticipation bills the day after that.
By September 30, rates began edging down--but at first
this mainly reflected scarcities in the wake of heavy
System buying, while the underlying atmosphere continued
rather skittish. Thus, dealers bid quite cautiously in
the regular weekly auction on October 4, and were particularly
hesitant about taking on the six-month bill which is close
in maturity to the March tax bill.
Noticeably greater confidence returned to the
market by Tuesday, October 5, and there was fairly

10/12/65
good bidding for the tax bills at lower rates than
had been anticipated in the market a few days earlier.
With tax and loan deposits expected to be worth perhaps
40-45 basis points for the March bill and some 25 or
more basis points for the June issue, banks acquired
the bills at average rates of about 3.78 and 3.94 per cent
respectively, while trading in the secondary market began
in the 4 20 to 4.24 per cent area for each bill. Thus
far, secondary distribution of the bills has been
proceeding smoothly in the generally more stable market
atmosphere of recent days. Dealers' positions in bills,
which were sharply depleted in advance of the tax bill
auction, rose by about $1.1 billion last Wednesday
and Thursday as the dealers willingly absorbed a portion
of the tax bills taken by banks in Tuesday's auction.
As far as we can tell, banks still hold a large part of
their tax bill awards and there nay be additional efforts
to sell these into the market, particularly as the
Treasury calls on its tax and loan deposits. In turn,
the dealers' appetite for these and other bills will
depend inportantly on the course of corporate and other
demand for bills in ensuing weeks. While distribution
is thus proceeding well up to now, there is still some
distance to be traveled.
In yesterday's regular bill auction, the three- and
six-month issues were sold at average rates of about 4.01
and 4.18 per cent, respectively, up 3 and 5 basis points
from two weeks ago. I should mention with respect to the
six-month bill that yesterday's bidding was quite strong,
and we learned late yesterday afternoon that the System
received only a partial award on its tender to get those
bills. For the three-month bill the rate rise from two
weeks ago is quite modest considering that we are now
dealing with a January bill rather than a late December
issue. The upward rate adjustment in the six-month area
reflects the increased supply of bills in that maturity
area as a result of the tax bill sale. The outstanding
three- and six-month bills closed at bids of 3.98 and 4.17
per cent (bid) yesterday, down from highs of 4.05 and 4.21
per cent during the two-week period. The one-year bill,
which has become rather scarce in the past two weeks, was
bid at 4.15 per cent at the close yesterday, down from a
high of 4.24 per cent on September 29, and below the 4.20
per cent level of two weeks ago. In general, then, rates
are about back at the levels of two weeks ago, and in a

10/12/65
much steadier market atmosphere. The market remains
susceptible, however, to sudden snifts in sentiment,
in the event of new economic, financial, or other
developments.
Virtually all of the System's operations in the
past two weeks involved outright purchases or sales of
Treasury bills. While at the time of the last meeting
it appeared that some part of the current reserve need
could appropriately be met through purchases of coupon
issues and short-term repurchase agreements, it devel
oped as the period moved along that the Committee's
rate and reserve objectives could be best served by
concentrating on outright bill purchases. Toward the
end of the interval, unobtrusive outright sales or
redemptions of bills were arranged, to absorb currently
and prospectively redundant reserves.
In moving readily to supply reserves to the market
thrcugh substantial Treasury bill purchases, a somewhat
more comfortable tone has emerged in the money market.
The availability of Federal funds has increased and
some sizable trading has taken place at 4 per cent or
below, although most trading has continued at 4-1/8
per cent. Estimated net borrowed reserves in the week
ending October 6 were down very sharply--to only $40
million--but this would convey an exaggerated impression
of easing as an unusually high amount of excess reserves
was held at country banks and was inaccessible to the
central money market. Borrowing from the Reserve Banks,
in fact, was little changed from the preceding week when
net borrowed reserves were over $200 million. This week
borrowing appears to be running a little lighter.
Longer-term markets tended to move sympathetically
with the shorter area during the recent period--first
moving lower in price and then recovering to show little
net change for the period. Investor activity was light,
but with dealers seeking to keep positions fairly close
to "even" in a period of uncertainty over the likely
course of interest rates there was some tendency for
even modest investor interest to produce sizable day
to-day price changes. A case in point is the 4-1/4
per cent Treasury bond of 1992, which closed two weeks
ago at 99-2/32 bid, touched a low of 98-22/32 on
September 29, and closed yesterday at 99-12/32.

10/12/65

-10-

There was little net price change in the corporate
and tax-exempt bond markets during the period, but a
somewhat more confident atmosphere emerged in these
areas, too. The near-term supply of rew corporate
issues is now rather modest, but some sizable State and
local offerings will come in the next few weeks and the
extent of commercial bank appetite for additional tax
exempt holdings is something of a question mark.
The next item on the Treasury financing agenda is
the refunding of November 15 maturities--of which some
$3.3 billion is publicly held. Advisory groups will
meet with the Treasury on October 26 and 27, with terms
probably to be announced on the latter day. Current
market yields pretty much dictate an offering in the
shorter-term area. The Treasury may seek at the same
time to raise some additional cash--and in any case a
cash borrowing would be needed soon after the November 15
payment date for the refunding.
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the open market transactions in Govern
ment securities and bankers' acceptances
during the period September 28 through
October 11, 1965, were approved, ratified,
and confirmed.
Chairman Martin called at this point for the staff economic
and financial reports, supplementing the written reports that had
been distribu:ed prior to the meeting, copies of which have been
placed in the files of the Committee.
Mr. Noyes made the following statement on economic conditions:
The current performance of the economy continues to
be best characterized, it seems to me by the word "strong"without much qualification one way or the other. Both an
inflationary surge and an adjustment that would stall our
forward momentum remain possibilities for the future, but
it is very hard to show that either of these unpleasant
prospects is imminent.
A survey of recent movements in the broad aggregate
measures of output, production, employment, and prices

10/12/65

-11-

indicates that the situation leaves little to be desired.
In almost every case the figures have moved in accord
with the most optimistic expectations. GNP in the
third quarter will probably be up at least as much as
was generally anticipated--a $10 billion increase to
$675 or $676 billion seems as good a guess as any at
this point. The global unemployment figure confounded
the experts by breaking through the 4.5 per cent level
to 4.4 in September, and other labor market data generally
confirm this strong showing. Industrial production, in
the aggregate, seems to be about on track--with the
September figures moderately depressed by the combined
effects of the steel settlement and hurricane Betsy.
While the calculations have not been completed, it
appears likely that the production index will be down
about one percentage point. Retail sales were also off
a little, due mostly to a decline in seasonally-adjusted
auto sales that may well stem from the difficulty of making
precise seasonal adjustments during the model change-over
period. At the same time, the broad indexes of both
wholesale and retail prices have shown little net change.
With all the talk of inflation and of price advances,
it is important to remember that average prices of whole
sale industrial commodities are only about 1.5 per cent
above year-ago levels and non-food commodities at retail
are up only .5 per cent. This may be more than any of
us would like, but it is an enviable record against our
own historical experience or that of other countries.
As I have had occasion to say many times in the last
four years, it is hard to find much fault with the performance
of the economy--the question is how best to maintain that
performance. There was complete unanimity among the
distinguished academic consultant who were here last week
that this was the question, despite their differences as
to the answer.
For this Committee, essentially the same question can
be restated in more complex form. If we look behind these
broad aggregates which have moved in such a satisfactory
way, is there evidence that distortions or imbalances have
developed which could be halted or reversed by action on
the part of the Federal Reserve to attain money market
conditions different from those which have in fact come
about and now prevail? Would either firmer or less firm
money market conditions enhance the chances of prolonging,
and hopefully perpetuating, healthy expansion? And, if so,
how much of a change is appropriate?

10/12/65

-12-

The case for moving actively to ease some of the
pressure that has recently developed in money and
capital markets seems to me to be the hardest to
support. Granting that we still have some unemployed
and underemployed resources, it is doubtful that we
could reduce that margin more rapidly than we have
been, without serious danger to the price structure and
the sustainability of the expansion. Both business and
consumer expenditure plans are buoyant. Hence, the case
for easing seems to me to rest heavily on the possibility
of a fairly imminent unwinding of the inventory positions
that have been built up in the last twelve months or so.
As you all know, this has worried me for some time and
it still worries me, but I can find no convincing evidence
that the people who actually hold the inventory share
my concern.
Setting aside rates of expansion in financial
magnitudes themselves, as coming within the purview of
Mr. Brill's subsequent remarks, the case from the
nonEinancial side for a tighter policy also seems to me
to fall short of persuasiveness. There are unquestionably
imbalances in our present expansion, but it is hard to
demonstrate that they are more likely to be corrected if
credit is less readily available. Bear in mind that I
am not speaking here of financial markets themselves,
but of the basic relationships between production and
consumption of various types of goods and services. An
example is the disparity in the expansion of output as
between business equipment and consumer goods, which
shows up so dramatically on production index charts.
Some tempering of the rate of expansion in business
equipment production and some acceleration in production
of consumer goods would seem essential to balanced growth
in the period ahead. But it is not apparent, at least to
me, that tighter credit would contribute to this sort of
adjustment. I have also looked hard for some evidence
that the pattern of resource utilization is being
distorted by inflationary expectations. If this were
happening, it would, in my judgment, make the strongest
case for a more restrictive policy, but I am unable to
find any convincing evidence that it is happening now.
In fact, the results of a recent McGraw-Hill survey seem
to deny it explicitly.

10/12/65

-13-

Thus, I would conclude that recent developments in
the nonfinancial sectors do not in themselves provide
sufficient grounds for a change in policy, one way or the
other.
Mr. Brill made the following statement concerning financial
developments:
Over the past month or so market interest rates have
bounced around quite a bit, responding in part to seasonal
ebbs and flows of funds and in part to rumors, official
statements, semi-official interpretations of official
statements, and fears of new official actions or statements.

In this context, it has become fashionable for some observers
to describe the state of financial markets as nervous, and to
attribute the generally higher level of interest rates now
prevailing to "market expectations."
In the limited time
available this morning, I would like to present an altex
native interpretation.
Specifically, I would advance two
hypotheses:
(a) That a substantial degree of monetary restraint
already exists, and that the higher range within which
interest rates are now fluctuating is the result primarily
of recent and prospective supply-demand relationships, not
only or even mainly dependent on expectational factors;
(b) That even under the present stance of policy with
respect to availability of reserves, upward pressure on
rates is likely to persist, and probably to intensify.
Turning to the first of these hypotheses, that substan
tial restraint already exists, let me retrace a bit of
Earlier this year, the level and
financial history.
structure of interest rates was partially shielded from the
impact of burgeoning private credit demands by several
factors. The increases in time deposit rates following
the late 1964 increase in Q ceilings inundated banks with
two months of the year; even after
funds in the first
slipping a bit in the spring, time and savings deposit
inflows remained high. Second, banks accommodated their
private customers by consistent and large reductions in
Over the first
their holdings of Government securities.
half of the year, banks liquidated almost $4 billion of
Government securities--6 per cent of their portfolios of
Third, banks worked down their excess
these issues.
reserves a bit and went into debt to the Fed substantially,

10/12/65

-14-

with borrowings rising from $300 million in January to
about $500 million by mid-year.
In addition to these maneuvers to find the resources
to accommodate customer loan demands, banks were aided by
the System's expansion in nonborrowed reserves, which grew
over the first half of the year at about the same rate as
in 1964. And the Treasury helped moderate rate pressures
by reducing the marketable debt substantially; the nonbank
public didn't have to absorb many Government securities,
on net, over this period.
Even so, private credit demands outpaced supplies of
funds, and there was a gradual diffusion of restraint
through most financial markets. It showed up in rising
rates on Federal funds and CDs at the short end, and in
increases in corporate and municipal bond yields at the
long end. Increasingly as the year progressed, there were
reports of bank rationing of credit and of more restrictive
nonprice terms on bank loans.
Over the summer, supply-demand relationships tilted
further in the direction of restraint. Private credit
demands remained strong, partly because the steel wage
negotiation developments encouraged further inventory
accumulation and partly because of continued strength in
consumer spending and corporate capital investment. Banks
had to scramble for funds, and while they were able to
garner a larger share of the savings flow--at the expense
of other savings institutions--the Fed became a less
accommodating source of funds. Nonborrowed reserves
actually declined over the summer months. Borrowings
didn't rise much, as increasingly banks felt that they
had worn out their welcome at the discount window.
To accommodate customers, banks had to continue to
liquidate Governments, but now there was less of an offset
from Treasury operations. Expanding revenues permitted
the Treasury to stay away from the market for new money,
but it was not able to retire debt at the pace of the
first half year.
In this context, it is no wonder that interest rates
reacted strongly when the Treasury returned to the market
for its fall seasonal cash needs, with prospects of
additional financing requirements occasioned by military
developments in the Far East. And it is no wonder that
bank lending oFficers have been reporting to us significant
tightening in lending policies.

10/12/65

-15-

My second hypothesis is that the financial situation
is not likely to ease; if anything, upward rate pressures
are likely to intensify under present conditions of
reserve availability, even if economic activity continues
to expand at only a moderate pace. There is not a simple
relationship between GNP and financial flows, particularly
in the short run. Changing structure of expenditures and
the state of liquidity of spending sectors--as well as
shifts in expectations--can create financial pressures
that have no immediate counterpart in goods and services
markets. So far, business loan demand has been maintained
at surprising strength, rising about as rapidly in September
as in August, even with industrial production declining as
steel inventory liquidation got underway. Plant and
equipment expenditures are continuing to rise, while
internal generation of funds appears to be leveling off
and liquidity is already reduced. All in all, corporate
financing demands are likely to continue strong. Consumer
credit expansion should also continue if auto sales hold
their recent pace. And Federal financing demands over
the balance of the year will be substantial, even without
unexpected military drains, for the Treasury is now running
closer to the wind with its cash balance. A conservative
summing of prospective credit needs suggests that actual
supply-demand pressures in financial markets are likely
to be stroger over the next few months than they were this
summer and fall.
What would be the appropriate stance of policy, if the
above analysis of present and prospective financial
conditions is correct? Mr. Noyes' appraisal of prospects
for the real economy--in which I concur--suggests to me
that it would be reasonably safe to accommodate at current
rates the credit demands likely to accompany this sort of
activity outlook. The odds now favor some tranquility in
the real sector of the economy. We've gotten through a
period of extraordinary demands with nothing worse than
a price creep. Short of introduction of a major military
spending program, it's hard to see anything on the horizon
that would significantly accelerate this price creep.
Symptoms of over-ebullience may emerge--the stock market
shows signs of becoming one--but, by and large, business
and consumer spending plans seem predominantly on the strong
but cautious side.

10/12/65

-16

I agree also that there are some important elements
of imbalance in the economy, particularly as between
capacity and final demands, but I fail to see how a general
tool like monetary policy could correct these structural
imbalances without slowing an expansion that is not excessive
in the aggregate. Over the near cerm, considering the
favorable prospects for further noninflationary expansion,
the pressures already extant in financial markets, and the
financial pressures looming ahead, it would not seem
appropriate to me for the System to intensify financial
restraint,
Mr. Ellis asked Mr. Brill whether he thought the current level
of the prime rate was affecting the pattern of flows in credit markets.
Mr. Brill replied that it was quite likely that businesses
were favoring bank borrowing over capital market financing because
of the change
financing had
risen.

in rate relationships.

But the volume of capital market

increased recently and long-term rates had already

If business demands were diverted away from banks they were

not likely to be satisfied in the capital market at current rate
levels.
Mr. Daane asked whether Mr. Brll thought it would be possible
to maintain the current degree of rigidity and artificiality in the
interest rate structure in view of the financial pressures now
existing and the intensification of those pressures that he (Mr. Brill)
foresaw.
Mr. Brill replied that rates undoubtedly would be pushed
upward unless the System accommodated the expected credit demands.
In a sense, the present rate structure might be considered to have

10/12/65

-17

been artificially produced by the System's policy with respect to the
provision of reserves; both total and nonborrowed reserves had
declined during the summer months.
Mr. Hayes then asked whether Mr. Brill would agree that the
prime rate, which had not changed since 1960, was an example of an
artificial interest rate.

Mr. Brill commented that banks had been

shading interest charges upward even though the prime rate had not
changed.

The overall average rate on bank :oans seemed to have

remained generally level because of the increasing use of bank loans
by prime customers.
Mr. Hickman noted that the declines in total and nonborrowed
reserves in August and September and the recent increases in interest
rates had been associated with roughly stable levels of net borrowed
reserves and borrowings.

He asked whether Mr. Brill thought those

trends would continue if net borrowed reserves and borrowings were
maintained at about current levels.
Mr. Brill replied that he thought the upward trend in interest
rates was likely to continue.

The reserve relationships to which

Mr. Hickman had referred might be reversed if there was a change in
the structure of bank liabilities involving a shift from time to
demand deposits, but that seemed unlikely.

The burden of his inter

pretation, however, was that a continuation of present policy with
respect to net borrowed reserves probably would result in higher
interest rates.

-18

10/12/65

Mr. Maisel then asked what factors underlay the decline in
nonborrowed reserves during the summer when marginal reserves had
been about unchanged.
Mr. Brill said he did not have any ready explanation for that
development, but he thought the recent sharp decline in Government
deposits was a factor.

Mr. Holmes agreed.

He added that the total

and nonborrowed reserve figures were seasonally adjusted and he
strongly suspected that imperfect allowance for seasonal factors
would be part of the explanation.
Mr. Hickman concurred in the view that the change in Government
deposits was important.
of the market

He noted that the Treasury had remained out

earlier in the year when, in his judgment, it should

have been borrowing, and now was belatedly coming in.
Mr. Brill remarked that there had been some sentiment in favor
of Treasury borrowing during the summer but a decision against it had
been made because developments in Vietnam had suggested to the market
that Federal spending might be rising rapidly.

No one then was quite

clear as to what was going to happen tc miliiary spending, and there
was some feeling that a financing operation, particularly at a time
when the Treasury's balance was quite large, would mislead the market
with respect to the Treasury's expectations on that score.
Mr. Swan suggested that one factor serving to explain the
reserve developments Mr. Maisel had mentioned might have been the

10/12/65

-19-

large gains in time deposits in July and August, which permitted a
given volume of reserves to do more work.

Mr. Balderston commented

that he thought the time deposit change was an important part of the
explanation.
Mr. Hersey presented the following statement on the balance
of payments:
Straws in the wind that can tell us something about
month-to-month variations in the balance of payments look
on the whole more auspicious today than they did two weeks
or six weeks ago. To mention a few:
the August export
total looks very encouraging; the August (as well as the
July) impcrt figure is low enough, even when qualified and
corrected, to suggest that the leveling out--or slower risewhich we had expected might occur in U.S. imports in the
second half year is going to occur; new Canadian security
issues in the United States, though large in September, will
be relatively small in the weeks ahead; and, finally, the
available weekly data on reserves and liquid liabilities to
foreigners suggest a considerably smaller "regular transac
tions" deficit in September than in August.
It is quite impossible to build up a consistent picture
of the whcle and the parts of our payments position in any
one month from straws in the wind like these. Years of
experience with monthly ups and downs leave us no sensible
choice but agnosticism about the meaning of monthly figures.
For the third quarter as a whole, the still imcomplete
data on settlement items suggest a seasonally adjusted
deficit of perhaps $300 to $350 million on the "regular

transactions" basis. A quarterly deficit of this size would
be of the same order of magnitude as the deficit in the
first half of 1965--which, blown up to an annual rate, was
$1.3 billion.
On the "official settlements" basis, the deficit in
the first half was at an annual rate of $0.9 billion. This
was less than on the other basis mainly because military
export advance receipts are to be counted as reducing the
"official settlements" deficit rather than financing it.
But in the third quarter, even without assuming any more
net advance receipts on military sales, the "official
settlements" balance may turn out to have been a surplus--

10/12/65

-20-

perhaps of $100 million or more. Here, in the third quarter,
the difference between the two bases was due mainly to a
very large buildup of foreign commercial banks' balances
in the United States (including those of U.S. bank branches).
This inflow was associated in part with the more-than
seasonal easing of the Euro-dollar market in August, and
it was associated also, no doubt, with the movements out
of sterling that were still taking place on a large scale
at that time. In September, with recovery in the sterling
market and tightening in the Euro-dollar market, there seems
to have been a net withdrawal of foreign commercial bank
balances from the United States, though perhaps no more than
would be seasonally normal in September. In September,
therefore, unlike August, the "official settlements" balance
may have been once more a deficit, seasonally adjusted; and
on the whole that is the likely prospect for the coming
months too.
We might sum up the evidence for the third quarter by
saying that, apart from a slowing down in the repatriations
of liquid funds and bank credit as the voluntary programs
got a litle older, and apart from side effects of the
sterling situation, changes in the U.S. payments position
since the spring do not seem to have been particularly
significant. The abnormal surplus of the second quarterand of July and August on the "official settlements" basisis over, and deficits seem to be still the order of the day.
But I cannot avoid drawing some comfort from the July
and August export figures. To me they seem an irdication of
continuing underlying strength in our export position, simply
because I cannot find any special reasons in the demand
situations, in other countries why our exports should have
been turning up this summer. Looking ahead, too, the world
demand picture looks at least as strong as it did a few
months ago. A decline in British imports may still be in
the offing, but at least the first corner has been turned
in the return of confidence without a sharp contraction in
activity. The rapid rise in German imports will eventually
taper off, but there are increases in Japanese and French
imports still to come as offsets.
So the next couple of months' U.S. export figures will
be something to look for eagerly. We shall also have to
watch whether U.S. bank credit outflows will or will not
build up more than seasonally in the fourth quarter--as they
could without passing the target.

10/12/65

-21-

If some further moderate net improvement in the payments
position should materialize, what would be its implications
for policy? The chief implication, as I see it, would be
to restore and strengthen hopes that a lasting adjustment
of the payments position may be achievable via a combination
of current account improvement as we maintain price stability
and moderation of capital outflows as domestic demands rise,
without our having to set our feet on the slippery roads of
permanent capital controls or of an interest equalization
tax broadened beyond its present scope. For Federal Reserve
policy specifically, the implication would be to validate and
justify the weight that has been given to balance of payments
objectives in the long-run strategy of policy. But the
short-run tactics of policy, it seems to me, ought to be
completely unaffected by moderate changes in the payments
position. Whatever monetary policy can do for our external
payments equilibrium is something that can best work itself
out over an extended period of time, with the help of a
domestic economic expansion that is inflationless and
recessionless. On this reasoning, short-run decisions to
modify monetary policy should continue to be based simply on
an appraisal of the domestic situation, without much attention
to short-run variations in the payment, position.
Today, this conclusion is all
the more relevant since
the moderate improvement in the payments position of which I
have been speaking is still a gleam in the eye, not a live
fact.
Prior to this meeting the staff

had prepared and distributed a

question suggested for consideration by the Committee,
thereon.

and comments

These materials were as follows:

Money market relationships.--Assuming a continuation
of current monetary policy, what range of money market
conditions, interest rates, reserve availability, and
reserve utilization by the banking system might prove
mutually consistent in coming weeks?
Treasury bill rates have retreated somewhat from the
peaks reached at the end of September. Bill rates had
adjusted upward in the latter part of that month when the
market first reacted to the announcement of a $4 billion
Treasury tax bill auction in a period of taut money market

10/12/65

-22-

conditions, and against the background of expectations of
continuing strong credit demands and rumors of a discount
rate increase. The subsequent decline in rates represented
a response to a sharp drop in dealer bill positions occa
sioned by large-scale System and renewed corporate buying
and some easing of pressures on central money market banks.
The demand for the new tax bills in the secondary market
was somewhat better than expected.
Assuming net borrowed reserves in the neighborhood of
$100 to $150 million in the coming three weeks, the
outstanding 3-month bill, which was at 4 per cent at the
market close on Friday, may be expected to be within a
3.95-4.10 per cent range. Any slackening of public demand
for bills would likely push rates upward from current
levels partly because the System will be a net seller in
the next two weeks and partly because dealer positions
have been rebuilt, largely through purchases of the new
tax bills from banks.
Yields on U.S. Government bonds have moved downward
in sympathy with bill rates in recent days, while corporate
and municipal yields have tended to stabilize. If short-term
rates remain relatively stable and the corporate new issue
calendar remains light in October, long-term yields are not
likely to adjust upward further in the period immediately
ahead. However, in the U.S. Government securities market
investor demand still appears light and in the municipal
market the calendar seems to be building up again. In
general, both bill and bond markets still have an underlying
cautious tone and remain susceptible to unfavorable jolts
to market psychology.
The upward interest rate movements in recent months
have been associated with a reduced rate of bank credit
expansion. In September business loans increased at about
the same rate as in July and August, but acquisitions of
municipal securities were sharply reduced, and security
loans were liquidated in substantial volume. Total and
nonborrowed reserves, seasonally adjusted, declined slightly,
and banks obtained fewer funds through time certificates
of deposit in September than in the previous two months.
Rapid growth in bank credit, which resumed in the first
week of October, may be stronger over the next few weeks

10/12/65

-23-

than in September or August, as banks retain and use for a
time the additional U.S. Government deposits associated
with the recent tax and loan account financing. Business
loan demand may continue to be moderated by further
liquidation of the earlier build-up in loans to metals and
finance companies, but underlying credit demands are
expected co remain strong.
If bank credit does grow more rapidly in October money
supply expansion may also continue rapid, although consid
erably slower than the 12 per cent annual rate of increase
in September when there was a much larger than seasonal
decline in U.S. Government deposits. For the demand deposit
component, a growth rate of 4 to 5 per cent continues to
be the most likely expectation. With longer-term bill rates
pressing against CD rates, it is likely that time and savings
deposit expansion will slow somewhat frm the average rate
of over 16 per cent of the past 3 months.
Chairman Martin then called for the go-around of comments ard
views on economic conditions and monetary policy, beginning with
Mr. Hayes, who made the following statement:
The business situation has not changed since our last
meeting, and the outlook remains strong far into 1966.
Even though the reduction of steel inventories will
undoubtedly depress various business indicators for some
weeks more, other expansionary forces in the economy are
clearly s:rong enough to more than offset this particular
On the price front, nothing has
drag on the advance.
occurred in the last two weeks to increase our worries
that inflationary pressures may be building up. Such
pressures as exist continue to be moderate. As we look
further ahead, however, growing shortages of skilled labor
constitute an important threat to price stability. Although
expected additions to plant capacity may more or less keep
pace with rising industrial output, the general business
climate is certainly more conducive to price increases than
to declines; and even the 1.5 per cent rise in industrial
wholesale prices in the past year cannot be accepted with
complacence.

10/12/65

-24-

This concern over prices and costs seems to be
particularly warranted by the unsatisfactory state of
our balance of payments and the prospect that we may have
trouble keeping the U.S. trade surplus up to its present
level in view of the likelihood that imports will be
strongly stimulated by the domestic business expansion.
As I stressed two weeks ago, the basic payments problem
is highlighted by our inability to come close to equilib
rium in 1965 despite the initial success of the campaign
to place artificial barriers in the way of most types of

outward capital flows. Doubtless more could be done to
damp down direct investment, and this may help in the short
run; but the effort to reach ultimate equilibrium without
the need of artificial barriers will, in my judgment, call
for a strong concerted effort including an appreciable
contribution by monetary policy.
Since we met here two weeks ago both President Johnson
and Secretary Fowler have gone on record with ringing
assurances to the assembled Fund-Bank Governors that the
United States will move vigorously to bring its payments
into balarce. Failure to perform on this promise would
place the international standing of the dollar in very
serious jeopardy; and the central bank of the country cannot
escape an important role in that performance.
In the field of bank credit, as in that of prices and
costs, the very latest data do no: suggest any recent
deterioration in the situation. There may have been some
slowdown in September, but short-term swings in these
statistics mean very little. To me the important point
is that bank credit has advanced over the past six months
at about the 8 per cent rate which has been typical of the
1961-64 period and which the Committee has attempted
unsuccessfully to slow down on several occasions in the
last couple of years. Business loan demand in general has
been strorg and is expected to remain so throughout the
fourth quarter. Banks are responding to liquidity pressures
and heavy loan demand by stiffening loan terms and by
selective interest rate increases. Several major New York
banks feel that market conditions would amply justify an
increase in the prime rate, which has not moved since 1960;
but in the light of their belief that such an action would
meet strong political opposition, they are in effect
adopting a method of rationing that discriminates against
small borrowers. Open market interest rates of all
maturities have moved up considerably in the past month or so.

10/12/65

-25-

While exaggerated market expectations may have contributed
to the high levels reached about two weeks ago, it seems
clear to me that the main cause of the rise has been the
strength cf business and of current and prospective credit
demands. The money market continues to be in a somewhat
unsettled state because of uncertainties about interest
rate developments, compounded by confusing reports of
official pronouncements on this subject.
Looking ahead, I think we have a real basis for concern
about potential inflationary pressures, against a background
of cumulative large increases in bank credit and a serious
international payments problem that leaves us little margin
for assuming inflationary risks. For the moment, we are
perhaps estopped from any policy change until the market
has had a little more time to digest the latest Treasury
offering of tax anticipation bills; but this should not
take long. In view of recent market developments, little
room remains for action through open market operations, and
an increase in the discount rate would seem the most appropriate
method of signalling a move toward greater firmness in monetary
policy and validating the firming that has already occurred
in market rates.
The only questions in my mind involve timing and the
size of the discount rate increase--and there is some inter
relationship between timing and size. As to timing, the
Thursday after next (October 21) would seem to offer the
last suitable opportunity for quite a while, provided the
market does not experience more trouble than is evident to
date in distributing the tax anticipation bills. With the
November refunding to be announced on October 27, and with
the Treasury likely to be raising addit.onal needed cash in
late November, it may well be early or mid-December before
we shall again be free to move; and even then there may be
some natural reluctance to make a policy change so close to
the period of year-end pressures.
Another reason for prompt action is to dispel the
unfortunate but widespread notion that the System has lost
control of monetary policy. Furthermore, interest rates
on CDs are perilously close to the ceilings under Regulation Q,
so that the System may find itself, on very short notice, in
a position where raising of the ceilings is required to prevent
a problem of considerable gravity for the banks--especially
those outside of the main money centers. Under more normal
conditions it might be well to raise the ceilings promptly,
regardless of whether a discount rate change is imminent,

10/12/65

-26-

if only to dispel the notion that the two actions must
always be simultaneous. But in the present state of the
money and capital markets, an increase in Regulation Q
ceilings without a discount rate move might cause increased
uncertainty and nervousness. Finally, prompt discount rate
action would avoid possible difficulties in the event that
the U.K. authorities should later on be contemplating a
rate reduction just when we were considering an increase.
If we do act next week, there is much to be said for
making the increase 1/4 per cent. For one thing, the
period between the completion of the recent bill financing
and the November refunding will be very short indeed, and
a rise of 1/2 per cent might require rather sharp market
adjustments and could create a very shaky market atmosphere
and some sense of having been badly misled by recent official
pronouncements. There might also be considerable difficulty
in obtaining much public or political support for the larger
move, in view of the absence of very recent data pointing
to an acceleration of price increases or of credit expansion.
A 1/4 per cent increase next week, on the other hand, might
be relatively acceptable politically--or so I would hopeand would just about keep pace with recent market rate
movements--thus suggesting that money and capital markets
might well stabilize, with only modest further upward rate
adjustments.
The strongest argument against such a small near-term
move is that anything less than 1/2 per cent, which we have
thought of in the past as a minimum "normal" increase when
we are at the 4 per cent level, might seem very halfhearted
in the eyes of foreign holders of dollars who look to U.S.
monetary policy to contribute significantly to a bettering
of our international position. Indeed, I think a 1/2 per
cent increase is fully justified if we look only at interna
tional factors. But as I have already indicated, the market
situation is not now favorable for so large an increaseand we might well have much better ecoromic justification
for a 1/2 per cent rise two months from now than today, in
terms of clear-cut domestic statistics on business and
credit. Hence, in my judgment, a 1/2 per cent move must
probably be delayed till at least early December.
I am not sure which of these courses should be pursued,
nor which would be favored by my Bank's directors; and I
shall await with interest an expression of views by other
members of the Committee.

10/12/65

-27

As for open market operations, I should think we should
instruct the Manager to confirm a:out the degree of firmness
that developed in the money market in September, with the
understanding that if a discount rate increase is carried
out before our next meeting, considerable leeway for the
Manager will be desirable.
As far as the directive is concerned I would be willing
to accept alternative B, perhaps with the word "confirming"
substituted for the word "reinforcing." 1/
Mr. Ellis remarked that while a considerable variety of new
monthly data had become available for New England since the meeting of
the Committee fourteen days ago, they revealed no material deviatior
from the pattern reported in recent meetings.

Business activity in

New England continued to expand in an atmosphere of confidence.
As also reported earlier, Mr. Ellis said, New England banks
continued to reflect customers' preference for accommodation at banks
rather than in the capital market.

In order to provide for their 16

per cent year-to-year growth in total loans in the past year, District
weekly reporting member banks had expanded their negotiable certificates
of deposit by 40 per cent in a market where rates had pushed close to
the Regulation Q ceiling,

In that process, loan-deposit ratios had

advanced from a year-ago average of 70 per cent for all New England
member banks to 75 per cent today, four points above the national
average.

1/ The two alternative directives prepared by the staff are appended
to these minutes as Attachment A.

10/12/65

-28
For Boston banks, Mr. Ellis continued, the average loan-deposit

ratio had reached 77 per cent, with individual banks, of course,
pushing higher.

For the last several months, one of those high-ratio

banks had each day been a net buyer of Federal funds at a level
averaging 64 per cent of its required reserves.

Of course, that

"borrowing" by itself consistently exceeded the 100 per cent of
capital plus 50 per cent of surplus limitation, entirely aside from
the fact that that bank also had unsecured notes outstanding.
Turning to monetary policy, Mr. Ellis remarked that the
shortened interval since the Committee's previous meeting increased
the appropriateness of concentrating attention on the problem of
specifying the money market relationships that would be considered
to be consistent with a general monetary policy objective of "no
change."

Two weeks ago the Committee had directed the Account Manager

to conduct operations "with a view to maintaining about the current
conditions in the money market."
condition"

Unfortunately, the "current

prevailing at that time included a large element of

apprehension ard expectation that short-term interest rates, which
had already moved up several points in the preceding few days, were
destined to move further, perhaps propelled by a discount rate action.
The very existence of thoseexpectations and apprehensions blocked a
clear appraisal of the underlying relationships.

The central

question was, and continued to be, essentially that posed by Mr. Brill
today; namely, whether the basic strength of the economy, as translated

10/12/65

-29

into increasing credit demands, could be best maintained by accelerated
injections of reserves to forestall interest rate increases.
the Committee

Or should

seek to limit reserve creation to the rate so far

achieved in 1965--even if market demand so outpaced that rate as to
lead to interest rate increases in a market where freely fluctuating
rates were expected to play an essential economic role?
In Mr. Ellis' judgment, the Committee failed two weeks ago
to give the Manager guidance of the clarity to which he was entitled,
and in consequence it had no framework within which it could properly
praise or criticize his performance.

Nevertheless, on the assumption

that the simple arithmetic of the events in the past two weeks did
not conceal more than it revealed, he was inclined to approve the
Manager's resolution of the issues insofar as he (Mr. Ellis) understood
them.

The simple arithmetic reported by the Manager revealed that in

the last four days of the week in which the Committee last met the
Manager bought $741 million of Treasury bills on a cash basis.

He

thereby converted the average net borrowed reserve figure for the
week of October 6 from $260 million projected at the start of the week
into an expectation of approximately $65 million that finally resulted
in a published net borrowed reserve figure of $40 million.

By injecting

reserves, the Manager, of course, also supplied reassurance of no
change in policy.

Apparently many of the funds stayed in New York

banks because those banks ended the week without borrowing--for the

-30

10/12/65

first time in 19 weeks--and they sold Federal funds from strong basic
positions.

In an atmosphere of much banker and official discussion

about the prime rate, and on the eve of the auction of $4 billion tax
anticipation bills, bill rates steadied and dealers made substantial
sales.
Mr. Ellis was prepared to accept such a course of events as
having usefully taken some of the excessive speculation out of market
discussions and as an antidote to the previous two weeks of aberration
on the high side of a net borrowed

reserve target of $150 million.

At the same time, he urged on the Committee the necessity of clar
ifying for the Manager its choice between

limiting interest rate

advances or limiting the rate of reserve creation if credit demands
became so intense that such a choice was forced upon the Committee.
He referred not to the temporary pressures of market speculation, but
to the underlying pressures of credit demands too intense to be
satisfied without accelerated creation of reserves.
For his own part, Mr. Ellis said, he accepted the necessity
for temporarily abandoning reserve

targets from time to time in order

to dispel exaggerated--and sometimes poorly informed--market specula
tion.

As a basic objective, however, he urged a "no change" policy

expressed in terms of reserve targets.

By that he meant a net

borrowed reserves target centered at $150 million and borrowings
exceeding $500 million, with an expectation that Federal funds would

10/12/65

-31

hold at 4-1/8 per cent, and that short-term bill rates would hold
in the 4.00-4.10 per cent range unless market demands built so as
to move rates slowly upward.

He would not intervene to impede slow

upward rate movements reflecting underlying forces.
As for the comments on money market relationships that had
been distributed by the staff, Mr. Ellis noted that the question asked
for views on mutually consistent money market conditions "assuming a
continuation of current monetary policy."

The second paragraph of

the comments described some possibly consistent conditions if the
Committee would accept a slightly lowered and narrowed net borrowed
reserve target range of $100-$150 million, compared with recently
accepted target ranges centered at $150 million.

Successive re

definitions of "no change" of that sort could in fact move the
Committee considerably in its policy posture.
Mr. Ellis said he found neither draft directive adequate in
meeting even the minimum of directive clarity.

Alternative B called

for "reinforcing the firmer conditions in the money market that
developed in September."

That statement failed on two counts

First, those firmer conditions were excessive and speculation-based,
and should not be reestablished.

Second, they had already been

corrected and no longer existed to be reinforced.
Alternative A, Mr. Ellis continued, had the fault of assuming
that the conditions prevailing since the last meeting could be

10/12/65

-32

meaningfully averaged and that such an average could in fact serve
as a "no change" guideline to the Manager.

In the Manager's words,

the money market had been in motion; since the last meeting sharp
reserve injections had reversed the upward trend of market rates,
provided the New York banks with net free reserves, held down dealer
loan rates, and relieved dealers of high inventories of bills.

That

could hardly be characterized as "no change" in the sense that it
should be continued.
As a minimum amendment, Mr. Ellis said, and to provide a
clear and consistent choice between directive alternatives A and B,
he would suggest revisions of the concluding words of both second
paragraphs.

For alternative A he would propose calling for operations

". . . with a view to maintaining a firm tone with stable conditions
in the money market."

For alternative B he would suggest ". ..

a view to achieving a firmer tone with
market."

with

stable conditions in the money

His own preference was, of course

alternative B.

However,

he would postpone discount rate action until market rates tightened,
if in fact they did.
Mr. Irons remarked that in the Eleventh District during the
past two weeks there had been relatively little change in economic
conditions, which continued strong.

Most of the indicators had shown

strength or slight expansion, including construction contract awards,
employment, and department store sales.

Unemployment had moved down

10/12/65

-33

to about 3.2 per cent, and shortages of some types of labor probably
were developing.
In the financial area, Mr. Irons said, bank loans had risen,
particularly loans to consumers, and bank holdings of Governments
had increased.

Time and savings deposits were strong and banks had

been active in the Federal funds market, on balance buying a substan
tial volume of funds.

Borrowing from the Re.;erve Bank had been

relatively stable and quite low, but that was because banks were
getting the funds they needed from other sources.
With respect to the national situation, Mr. Irons found
himself in substantial agreement with the remarks of Mr. Noyes and
the other members of the staff.

There had been some improvement in

money market conditions during the past two weeks, with less nerv
ousness than earlier, and developments had tended to confirm the
somewhat higher rate pattern that had emerged.

The national economy

certainly was strong and on the whole continued to reflect expansionary
tendencies.

Some of the uncertainties with which the Committee recently

had been concerned remained--for example, with respect to inventories
and prices--and there undoubtedly were imbalances in the economy.
On the whole, however, there was little evidence that such problems
posed serious dangers at this time, and some might be absorbed in the
workings of the market.

10/12/65

-34
Mr. Irons said that he would prefer to maintain present

conditions in the money market at this time.

The Committee had

been exerting some pressure on the market and had some responsibility
for contributing to the recent degree of firmness.

He would not

like to see a notably firmer posture now, and he would not favor a
change in the discount rate at present.

His thinking with respect to

money market conditions ran in terms of a Federal funds rate around
4-1/8 per cent, the Treasury bill rate moving around 4 per cent, and
borrowings around $500 million.

He would attach less importance

to trying to maintain some fixed figure for net borrowed reserves.
He hoped such reserves would fluctuate around $150 million, but if
they were influenced by changes in the distribution of reserves or
by other special developments, he would not want those developments
to prevent attainment of the more basic objectives.
Mr. Irons favored alternative A of the draft directives.
Although he had not had much opportunity to consider Mr. Ellis'
proposed amendment to that directive, he thought it would be acceptable
to him.
A discussion then ensued of the possible implications for
open market cperations of the directive language Mr. Ellis had
proposed, and also of several alternative formulations that were
advanced.

In the course of this discussion Mr. Holmes responded

to a number of questions.

He indicated that he thought market

10/12/65

-35

conditions were firm and relatively stable at the moment, with a
tendency, if anything, for rates to move somewhat lower, although
that tendency might prove temporary.

He would interpret Mr. Ellis'

proposed language for alternative A (".

.

with a view to maintaining

a firm tone with stable conditions in the money market") as calling
for maintaining market rates at about their present levels, with
fluctuations, perhaps, of a few basis

point in either direction.

His interpretation of the proposed alternative B language ("

. .

with a view to achieving a firmer tone with stable conditions in
the money market") was that it would call for a gradual and orderly
movement of interest rates to a higher level.

The inclusion or

exclusion of the words "a firm tone" in alternative A might affect
his interpretation somewhat under certain possible conditions; for
example, a Federal funds rate around 4-1/8 per cent would seem to
be implied by :hose words, but such a rate might not prove consistent
with stability in other money market conditions.
Mr. Wayne said that he would much prefer the word "orderly"
to "stable" in Mr. Ellis' formulation of alternative A, in order
to provide the Manager with necessary flexibility; "stable" implied
an undesirable degree of rigidity.

Mr. Holmes observed that he

thought there was a real, if fine, distinction between the two words,
agreeing that "orderly" connoted somewhat more movement in the
market than "stable."

10/12/65

-36
Chairman Martin commented that he did not favor one suggestion

that was advanced--to call for maintaining the "existing" tone in
the money market--on the grounds that market conditions sought should
not be pin-pointed as those existing at a particular moment in time.
In his judgment the most important question arising out of the
discussion was that Mr. Wayne had raised--whether "orderly" was
preferable to 'stable."
Following this discussion the go-around resumed with remarks
by Mr. Swan.
Mr. Swan said that in view of the short interval since the
Committee's previous meeting and the fact that the economic situation
seemed to be

little changed in the Twelfth District, he would not

comment on District developments except to note that one major bank
had indicated that it expected to add rather substantially to its
bill position in the near future.
Mr. Swan agreed with the analyses of the national situation
that had been made by Messrs. Noyes and Brill, and with their
recommendations for policy.

It seemed to him there had been no

particular change in the business situation or in financial conditions
from those the Committee had expected two weeks ago.

In addition,

the Treasury financing schedule had to be considered; there still
was some distribution of the tax anticipation bills to be accomplished
and a refunding operation lay ahead.

It seemed to him that the

10/12/65

-37

Manager had performed well in dealing with the situation in the
market, achieving some stability and a leveling off of bill rates.
For whatever reason, attaining those objectives had required some
reduction in net borrowed reserves in the latest statement week.
Mr. Swan hoped that the Committee would decide to make no
change in policy today, and that, as discussed at the previous

meeting, it would agree to give primary consideration to the bill
rate, and to money market rates in general, rather than to a net
borrowed reserve target.
4.05 per cent range.

He would favor a bill

rate in the 3.95

It would be fine if that objective could be

attained with net borrowed reserves in the $50-$150 million range,
but he would not be particularly concerned if a lower level of net
borrowed reserves were to result.

He was impressed by the point

made earlier that seasonally adjusted nonborrowed reserves had
declined in August and September, whatever questions might be raised
about the seasonal adjustment factors.

Larger injections of reserves

than in the past two months might be required if, with time deposit
rates pressing against their ceilings, time deposits did not expand
much.

It seemed to him, however, that the provision of more reserves

would be quite consistent with current conditions.
Mr. Swan remarked that he was somewhat surprised by the
discussion today regarding the wording of the directive.

At the

previous meeting the Committee had been faced with a real problem of

10/12/65

-38

language, but

today the problem did not seem so serious to him. In

his judgment, the fluctuations in the money market in the last two
weeks were no greater than in many earlier inter-meeting periods
when no particular questions had been raisec.

He favored accepting

alternative A of the draft directives as originally submitted.

If

the Committee did not agree, his second choice would be to retain
the language of the September 28 directive, which called for "main
taining about the current conditions in the money market."

Although

that language involved problems of definition, it seemed better to
him than to call for a "firm tone" and "stable conditions"; such
terms would add another dimension to the instructions and would
undesirably limit the Manager's maneuverability.

The staff draft,

with its reference to conditions "since the previous meeting,"
provided a reasonable range in which the Manager could operate and,
as he had indicated, was his first choice.
Mr. Swan concluded by observing that he would not favor a
change in the discount rate at this time.
Mr. Galusha said there was nothing in recent information
about the Ninth District to suggest that the outlook had changed.
His guess continued to be that moderate economic expansion would
persist through coming months.

Moderation of the weather in the

western part of the District had improved agricultural prospects
markedly.

With regard to the credit quality, the last examination

summary continued to indicate no significant change in quality.

10/12/65

-39

Mr. Galusha remarked that if his understanding was correct
the Committee decided at its last meeting to hold money market
interest rates at then prevailing levels, or, in other words, to
resist further increases, even if that necessitated reduction in the
level of net borrowed reserves.

Implicitly, the decision was to

focus, for the time being anyway, on money market rates and condi
tions, and let net borrowed reserves find their own appropriate
level.

In his opinion the Committee should persist in that approach;

the instructions to the Account Manager should again be phrased in
terms of interest rates and money market conditions.

Mr. Holmes had

been able to follow the Committee's instructions last time, and if
the Committee gave him the same sort of instructions this time, he
should be able to do as well over the coming three weeks as he had
in the two just past.

In Mr. Galusha's opinion that was very well

indeed.
Apropos of the discussion on the directive today, Mr. Galusha
said he happened to have at hand an article by a colleague from whi-h
he would like to quote the following:
In the field of Federal Reserve policy it is possible,
of course, to give very precise directives to the Manager
of the open market account. It must be recognized that
such directives would have to be couched in terms that the
Manager can in fact execute. They would have to be written
in terms of the amount and issues of Government securities
to be bought or sold, regardless of what happens to yields,
or in terms of yields, without regard to what happens to
the portfolio. They cannot be written precisely in terms

-40

10/12/65

of both--at the present state of our knowledge. It is
an elementary error to suppose that they can be written
precisely in terms of the supply of money, however
defined, or in terms of some reserve total, be it total
reserves, excess reserves, free reserves, borrowed
reserves, or whatever, or in terms of the liquidity of
the economy--whatever that may mean. The reason is
that each of these magnitudes is influenced by factors
over which the Manager has no immediate or direct control,
and the present state of our knowledge is insufficient to
predict the behavior of these other factors with sufficient
accuracy to make appropriate allowances for changes in them.
I confess that I have on occasion couched a directiveor voted for a directive couched--in inappropriate terms.
But this always has been with the knowledge that the Manager
was present to hear all the discussion that led to the
formulation of the directive.1/
Mr. Galusha went on to say that the question at issue was
whether the Committee should continue resisting further increases in
rates and further tightening of money markets.
He favored no change in policy at this time.

He believed it should.
A sharp increase in

interest rates had already been experienced and there was nothing
in the present economic outlook to suggest tnat further increases
would be appropriate.
Nor, more particularly, did Mr. Galusha believe the discount
rate should be increased now.

Perhaps what some who advocated dis

count rate action had in mind was making an increase in the prime rate
possible--or necessary.

There was no denying that the prime rate was

out of line, and if that rate had been increased earlier the Committee

1/ The quotation is from a lecture by Mr. Bopp, entitled "Confessions
of a Central Banker," published in the volume, Essays in Monetary
Policy in Honor of Elmer Wood (University of Missouri Press, 1965).

10/12/65

-41

would be more aware than it was of how much monetary restraint it
had already effected.

If it could be guaranteed that an increase

in discount rates would produce only an increase in the prime rate
there would be less reason to oppose such action.
be unlikely.

But that would

All of the available evidence suggested that when

discount rates were increased, money markets tightened and money
market rates rose.

It was no good trying to hide behind the phrase

"technical adjustment."

For one thing, money market rates were not

anything like substantially above present discount rates.

And that

being so, increases in discount rates could not constitute other
than further monetary restraint.
In conclusion, Mr. Galusha said, he would like to say a few
words about "natural forces," which were mentioned at the previous
meeting of the Committee.

There could be no doubt that such forces

affected interest rates, but that did not absolve the Committee of
The Committee's task was to determine whether it

responsibility.

should resist or reinforce whatever natural forces were operating,
as, most emphatically, it could.
Mr. Galusha added that he favored alternative A of the direc
tive in its original form.
suggested revision.

However, he would not object to Mr. Ellis'

The Manager was cognizant of the whole context

of today's discussion and could be expected to operate in terms of
the Committee's consensus whatever specific language might be included
in the directive.

10/12/65

-42
Mr. Scanlon commented that the past two weeks had produced

further evidence of the vigorous tempo of Seventh District activity.
The machinery and equipment industry continued to report strengthening
demand for their products.

Chicago steel producers reported that new

orders had begun a surprising increase in the past 10 days.

Local

analysts had raised their estimates of output for the fourth quarter
and now expected that output in the quarter might drop only 15 per cent
below the third quarter.

Little decline in steel employment in the

District was contemplated in the near future, partly because of the
need to make up deferred repairs and maintenance on hard-pressed
equipment.

Since August virtually all announcements of price change

had been increases, with very few decreases reported.
In agriculture, Mr. Scanlon said, there had been some damage
to corn and soybean crops by heavy rains and cold weather, but no
overall assessment of the importance of that damage was possible at
this time.

It was apparent, however, that there would be a sizable

amount of soft corn and corn left in the field by harvesting machines
and that that would cause farmers to increase purchases of feeder
cattle.

Such purchases, of course, would increase demand for feeder

loans and would tend to depress cattle prices later on.
The increase in business loans of major Seventh District banks
in September was double that of a year ago and bankers expected con
tinued strong loan demand, Mr. Scanlon observed.

There was some

10/12/65

-43

evidence that demand currently was less broadly based than was the
case earlier in the year.

A large share of the September increase

was accounted for by the metals and utilities groups and might have
been chiefly to cover temporary needs of large firms with low cash
positions over the corporate tax date.

Failure of the quarterly

interest rate survey to reflect the higher rates that banks indicated
they had been charging might be attributable to the unusually heavy
volume of that type of borrowing in the survey period.

The proportion

of loans at the prime rate was slightly lower than in June.
Whether temporary or not, Mr. Scanlon remarked, loan expansion,
coupled with the runoff of CDs and outflow of demand deposits as tax
checks cleared, had been reflected in a substantial increase in both
Federal funds purchases and borrowings of major banks in both Chicago
and Detroit over the past three weeks.

Nevertheless, those banks

did not reduce holdings of Government and municipal securities and
their mortgage portfolios continued to expand.

At current levels

of borrowings they appeared to have very little room to maneuver
should loan demand increase further, and unless they were able to
increase their deposits some liquidation of longer-term assets would
appear likely.
As to policy, Mr. Scanlon said, he would favor maintaining
on average the existing firmness in the money market, recognizing
that the objectives which the Committee cited in the form of bill

10/12/65

-44

rates, reserve targets, and Federal funds rates might not be
mutually compatible.

He gathered that the Manager currently

regarded the bill rate as his prime objective, and he (Mr. Scanlon)
agreed with Mr. Irons' comments on that score.

He continued to feel

that any significant additional move toward restraint would neces
sitate a discount rate change and reconsideration of the maximum
interest rates permissible under Regulation Q.
a move today
directives.

He would avoid such

and, therefore, he favored alternative A of the draft
He would not quarrel over the suggested words in the

second paragraph, and he also could accept the paragraph in the
directive adopted at the previous meeting with no change.
Mr. Clay remarked that such additional information as had
become available concerning the national economy since the previous
meeting of the Committee did not lead to any change in his inter
pretation of the economic situation and prospects.

The situation

remained one of moderating influence from the inventory side following
the steel strike settlement, of continuing expansion in aggregate
final derand, and of orderly present and prospective economic develop
ments in terms of resource utilization and prices.
The money and capital markets had given some evidence of
relaxation from the tightness of two weeks ago, Mr. Clay noted.
Nevertheless, there was evidence of rather delicate markets, sensitive
to any stimulus toward further credit tightening.

Under those

10/12/65

-45

circumstances, any overt move toward tightening monetary policy
probably woulc. have a pronounced effect upon the money and capital
markets.
In the period ahead, Mr. Clay said, it should be the
Committee's objective to continue essentially the current monetary
policy.

That included as intermediate goals moderate rates of

growth in the reserve base, bank credit, and the money supply.

It

included as the immediate goal the maintenance of about the current
conditions in the money market.

In view of the sensitivity of the

money and capital markets, the conditions of the money market should
be the Manager's primary guide, with reserve availability adjusted
accordingly, rather than looking toward any particular net borrowed
reserve goal as the primary target.
Alternative A of the draft directive was satisfactory to
Mr. Clay.

He felt that no change shotld be made in the discount

rate.
Mr. Wayne reported that Fifth

District business continued

upward and appeared to be gaining strength from several sources.
Because of its heavy concentration of military and civil service
personnel, the District would receive a somewhat stronger stimulus
than other areas from the recent rise in the military pay scale and
the anticipated increase in civilian salaries.

The textile industry,

operating at practical capacity under heavy backlogs and spending

10/12/65

-46

record amounts for expansion and modernization, would receive an
additional boost from the new farm bill when the domestic price of
cotton dropped another three cents next summer.

Contract award

values rose sharply in late summer, bringing significant new
strength to the construction outlook.

The furniture and lumber

industries had recently displayed renewed vigor and anticipated an
unusually busy fall season.

Cigarette consumption was running

nearly 5 per cent ahead of last year's pace, but this year's
prospects for flue-cured tobacco growers had softened somewhat.
Receipts to date continued substantially above year-ago levels,
but on the basis of estimates for the rest of the season a 5 per
cent drop in total dollar sales now seemed probable.
Mr. Wayne favored no change in monetary policy at this time.
He noted that attention in recent weeks had focused on the run-up
in yields on most types of debt instruments.

In view of market

sensitivity to rumors and unexpected developments, there had been
some concern that the markets might become disorderly, requiring
substantial intervention by the System.

Evidence of a jittery

condition was the sharp run-up in bill rates in response to the
Treasury's decision in the recent auction of tax bills to raise
more new money than was generally expected and to rumors about the
possibility of increases in the discount rate, the prime rate, and
margin requirements.

While the markets seemed to have quieted down

10/12/65

-47

somewhat, it was difficult to be sure because of the unsettling
news of the President's operation.
There were reasons, however, for believing that rapid price
erosion might now be over, Mr. Wayne continued.

First, the strong

performance of sterling in the exchange market and the published
gains in British reserves had at least temporarily removed one
depressing factor.

Second, the Administration had indicated its

opposition to across-the-board increases in interest rates and had
suggested that fundamental factors did not justify the advances
which had occurred.

While he did not believe that "open mouth"

policy could determine the level of interest rates, he had observed
that on several occasions in the last few years such statements by
high Administration officials had had a stabilizing effect on the
market.

Thus, it did not appear likely that the Federal Reserve

would have to intervene with a massive rescue operation.
On the other hand, Mr. Wayne did not

believe that the markets

were in any position to withstand further tightening at this time.
While dealer inventories of Governments had been reduced dramatically
in the past two months, they were still large enough to precipitate
disorderly conditions if there should be an overt shift to tighter
policy.
In calling for no policy change, Mr. Wayne recognized that
the economy was presently strong, that prices might continue to creep

10/12/65

-48

up, and that the outlook for the next several months was for con
tinued expansion in economic activity.

New evidence of that was

found in the latest survey of purchasing agents which indicated
that new orders and production were up sharply in September, that
prices continued to rise, and that a decline in the rate of inventory
accumulation was confined largely to steel
noted a higher rate of capital investment.

stocks.

The agents also

Keeping in mind the

possibility of overheating, the Committee should also remember the
significant amount of tightening which had occurred in recent weeks
in the form of higher interest rates.

Since rates might edge up

further, even under present policy, he thought it was wise for the
present to pause to assess the effects of recent developments before
prescribing stronger medicine.
That conclusion was reinforced by still another consideration,
Mr. Wayne said.

While the view was rapidly spreading that sterling

was over the hump, he thought the situation was still too delicate
to risk additional monetary restraint at this time.

If an overt

move did become necessary, hopefully the Committee would be able
to wait until the British had had more time to consolidate and
capitalize on their recent gains.
Concerning the directive, Mr. Wayne preferred alternative A,
and he could accept the amendment suggested by Mr. Ellis; but as he
had indicated earlier he would greatly prefer the term "orderly" to

10/12/65

-49-

"stable" to give the Manager necessary flexibility.

He noted

that in the proposed amendment "maintaining" preceded "firm" and
did not connote a change in the Committee's policy posture.

The

Committee had recognized in earlier discussions that market forces
were moving in the direction of slightly firmer rates, and a policy
of "no change" would permit those pressures to work out through the
market unless disorderly conditions appeared.
should continue to be the Committee's posture.

In his opinion that
A change in the

discount rate did not appear appropriate to him at this time.
Mr. Robertson then made the following statement:
I do not agree with those who feel that the odds are
clearly in favor of a breakout of inflationary conditions
this fall. We certainly have not had any spreading of
price increases since the change in business tempo intro
duced by the steel wage settlement the first of September.
In the absence of such evidence, we need to be very careful
not to base our decisions on judgments that inflationary
conditions are bound to develop, just because they have
in past expansions. This has been a very different kind
of expansion, with both productivity advances and profit
levels maintained in a way that has effectively held off
the build-up of the kind of cost-push pressures so damaging
in some earlier cycles. I think in these circumstances
we would be well advised to wait for facts to call for
action rather than acting upon our own guesses as to what
the future might hold.
There is also another reason why I believe a policy
of "watchful waiting" is the best counsel right now. A
significant tightening of general credit conditions has
unfolded over the past two months, extending into every
major credit market according to all the indicators of
credit terms and conditions that we have in hand. This
tightening has not yet had time, however, to exercise
its full influence on the real economy. In the absence
of more overt inflation signs than I see today, I believe

-50

10/12/65

we should wait to judge the dampening influence of this
market tightening before considering the launching of a
second round of restrictive actions.
With this policy in mind, I think we should make it
crystal clear to the Manager that we do not want to see
another flurry of market tightening such as occurred in
the first days following the last meeting of this Committee.
If anything, I would want him to resolve his doubts on the
side of easing bank positions slightly, in the interests
of precluding another sinking spell in the long-term
markets fed by assumptions that the System is about to take
another overt tightening step.
To convey this policy to the Manager, I would be
satisfied with the alternative A directive distributed by
the staff, assuming that the language means what it says
and does not constitute a license to permit still further
tightening.
Mr. Shepardson said that both the staff reports and the
information generally available appeared to indicate continuing
strong economic activity and an outlook for continued strength in
the economy.

His main concern was with the rate of bank credit

expansion, which he thought was higher than could be expected to be
maintained.

If the Committee formulated its policy in terms of the

level of interest rates it would feed in automatically whatever volume
of reserves was needed to hold rates a, the target level.
the Committee

He hoped

ould not accede to all demands for credit for the

purpose of holding down interest rates.

It would be preferable, in

his opinion, to attempt to gauge the appropriate rate of bank credit
expansion and, if demands for credit were greater than that, to let
the demands be reflected in some increase in rates.

He was not sure

how the Committee could best quantify the appropriate growth rate for

10/12/65

-51

bank credit.

On the whole, however, while he thought it might not

be appropriate to retard the present rate of growth, he would prefer
to see no rise.

If the demand for credit strengthened he would

expect to see some increase in interest rat.s.

He thought that

alternative A of the draft directives, with Mr. Ellis' suggested
change, was consistent with such a conclusion.
Mr. Mitchell remarked that the basic uncertainties in the
outlook that the Committee had faced for the past several months
still remained--namely, the amount of econonic stimulus that would
be provided by the war in Vietnam and the magnitude of the inventory
adjustment and its secondary and tertiary effects.

Until those

basic uncertainties were resolved the Committee would not know how
much encouragement it should give to the upward thrust of the
For that reason he agreed with Mr. Noyes that there was

economy.

no reason to change policy at present.
Many people outside the Committee had seemed to be trying to
make monetary policy recently, Mr. Mitchell said, by resolutions,
statements, and market participation, and he did not like to think
that the Committee would yield to those forces against its better
judgment.
His own view was that the System should not be maneuvered
into a change in the discount rate but that such action should be
reserved for a real crisis or clearer evidence that the announcement

-52

10/12/65

effects of a discount rate change were needed.

In his judgment

that was not the case now.
Mr. Mitchell agreed with the view that the question today
was whether to pursue a rate or reserve objective.

His preference

was for the former; he would attempt to maintain market rates in
the range of 3.90 to 4.05 per cent unless that would require very
low levels of net borrowed reserves--say, below $50 million.

For

the directive he would favor alternative A, as originally written.
He continued to believe that M 2 (currency and total deposits), a
"proxy" variable for total bank credit, was a more useful guide and
reference variable than the official bank credit series.

The rate

of increase in both, however, reflected the growing competitiveness
of banks among depository institutions and market instruments.

For

that reason he thought it would be undesirable to attempt to formulate
policy in term, of restraining total bank credit growth.
Mr.

Daane said that the decision facing the Committee today

seemed to him to be a particularly difficult one--more difficult,
perhaps, than it appeared to some other who had spoken.

He was

impressed with Mr. Noyes' presentation--the last he would be giving,
in view of his plans to leave the System--and felt that it demonstrated
clearly how much the Committee would miss his balanced judgment and
appraisals.

He agreed with Mr. Noyes today that on the economic side

there was no conclusive evidence for a need to change policy.

Thus,

10/12/65

-53

on that score, the case for any move depended more on an intuitive
judgment that pressures were building up--if they had not already
built up--that would be detrimental to the sustainability of the
present expansion.

His own intuition told him that that was the

case, and for support he would point only to the ebullience of
expectations evident most clearly in the stock market, to what
seemed to him to be an investment boom in process, and to the
disquieting price changes of the past year.

Those price movements,

he thought, represented a significant change from the price situation
of the three preceding years.
In the bank credit and financial markets area the case for
a policy change seemed to Mr. Daane to be much stronger.

The rapid

growth in total bank credit--tempered, and perhaps disguised, only
by declines in dealer loans and in holdings of Government and other
securities--still seemed to him to point toward the need for some
further moderate restraining action.
Finally, Mr. Daane said, despite Mr. Hersey's reassuring
remarks today, he was still concerned about the balance of payments
situation.

He frankly was worried by the fact that the United States

was now in the negotiation stage on new monetary arrangements at a
time when its balance of payments position was not as strong as some
of the System's European colleagues believed.

As evidence became

public of the lack of appreciable further improvement and perhaps of

10/12/65

-54

some weakening, the System's posture would become even more
important.

Thus, while he saw nothing really new in the area of

the balance of payments to justify a policy change, such a move
would be helpful in the total picture.
Having said all of that, Mr. Daane continued, he would add
that he came out about where he had at the last meeting--with the
conclusion that the question of timing was all important.

Obviously,

any action on the Committee's part that would call for a change
in the discount rate should be taken only after the Treasury financing
was completed.

If the discount rate was to be changed he would prefer

an increase at that juncture of 1/2 per cent coupled with greater
reserve availability, similar to last November's operation.

He

would anticipate that such an action, as was also true last November,
would not offer any deterrent to healthy expansion of the economy;
he believed it would be helpful to financial markets and to the
appropriate flows of funds, and also to the country's international
posture.

But perhaps it would be wiser to wait until sometime

nearer the end of the year when the signs and portents he sensed at
present might either have become clearer or, hopefully, have
disappeared.
Mr. Daane said he might add one or two comments on the
discussion thus far.

He did not understand how Mr. Ellis could

advocate a firmer policy and yet not favor discount rate action.

10/12/65

-55

He thought Mr. Brill had made it clear that, given the anticipated
market rate pressures, a firming of policy would make the present
discount rate untenable.
Secondly, Mr. Daane felt quite strongly that the Committee
could not so readily resist basic market forces as Mr. Galusha
evidently believed.

In his judgment an effort to do so would be

at a real cost to the System in terms of its later ability to arrest
possible inflationary developments.

The Account Management should

not at all costs resist upward rate pressures if they developed.
For the directive, he could accept alternative A with Mr. Ellis'
amendment and the further modification proposed by Mr. Wayne.
Mr. Maisel remarked that it seemed to him the Committee's
appropriate policy course was clear tcday--the economy was on a
satisfactory growth path and should be helped to stay on it.

He

favored no change in policy; anything else, in his view, would
repeat past errors of reacting too fast to fears that later proved
unfounded.
rates,

He would define "no change" primarily in terms of bill

with the objective of a bill rate somewhere between 3.90 and

4.00 per cent.

Maintaining the bill rate in that range might require

supplying owned reserves at the rate of last year and the first half
of this year; the decline in owned reserves that had occurred in
the third quarter had been undesirable, he thought.

Maintaining the

bill rate might also require a decrease in borrowed and net borrowed

10/12/65

-56

reserves.

The Manager should feel free to let net borrowed reserves

decline below the $100-$150 million range, if necessary.

With that

interpretation in mind, he favored alternative A as drafted by the
staff.
Mr. Hickman said that there was little to add to the discus
sion of recent business trends that had not already been covered this
morning.

In general, the liquidation of steel inventories was going

forward at about the rate expected, consumer and business takings
continued upward as anticipated, and the amount of Federal defense
spending because of Vietnam was still unknown.

Moreover, the recent

behavior of prices--in terms of both the popular broad indexes and
various diffusion indexes--suggested continued stability, with no
evidence of a breakout either on the up side or down side.
It seemed to Mr. Hickman that additional spending for defense
would increase only moderately from now to the year end, barring
unforeseen reversals in Vietnam.

The first solid evidence of Federal

outlays for 1956 would not be known until the budget took shape in
December.

When known expansionary factors

an the Federal budget--due

to increased social security payments, tax cuts, and higher military
pay--were balanced against already legislated higher social security
taxes, it would appear that an increase of $4 to $6 billion in
additional Federal spending could be absorbed by the higher tax

10/12/65

-57

revenues expected to be generated by an expanding economy in calendar
1966.

If defense spending should go much beyond that, the situation

would call for a reduction in other types of Federal spending, higher
taxes, more restrictive monetary policy, or some combination of the
three.
Mr. Hickman still thought the Committee should be careful
about jumping to conclusions concerning the prospective course of the
economy.

Much of the recent instability in money and capital markets

had been based on expectations of economic and financial developments
that had not yet been confirmed by facts.

Whether those expectations

would prove to be correct or not, only time would tell.
Mr. Hickman believed that in an atmosphere of speculative
change, based on uncertainty, the System should act as a stabilizing
force.

Accordingly, in the absence of definite evidence of overheating

in the economy at this time, he recommended no change in policy.

As

he had frequently done in the past, he would recommend a more restric
tive policy--or even an easier one--if he thought it would promote
stable growth.
The average of net borrowed reserves of about $135 million
over the past two weeks was about what he had recommended at the last
meeting, Mr. Hickman said.

He was not pleased by the jump in net

borrowed reserves to above $200 million in the last week of September,
when interest rates were rising sharply, but be assumed it reflected

10/12/65

-58

the shortage of reserves in central money market centers.
event, in his opinion the market at that tim

In any

was too firm.

A substantial amount of tax anticipation bills would have
to be digested in the next few weeks, Mr. Hickman continued, and
that would be facilitated by stable, or perhaps slightly lower,
intermediate and short rates.

Specifically, he would like to see

the 91-day bill rate between 3.90 and 4.00 per cent; net borrowed
reserves below $150 million; and bank borrowings close to $500
million.

Alternative A of the draft directives as originally written

was acceptable to him, provided that it was not interpreted to mean
a gradual creep towards a more restrictive policy.

He did not favor

an increase in the discount rate at this time.
Mr. Hilkert remarked that it was becoming more and more dif
ficult to find pessimistic things to say about the Third District's
economy.

At the same time, it was increasingly easy to find evidence

of pressures on District banks.

Recently, output in manufacturing in

the District compared favorably with national indicators, although
steel production there had dropped faster than in the nation.

Con

struction contract awards, both residential and nonresidential, had
shown more strength in the District than nationally.
Despite the generally favorable environment, Mr. Hilkert said,
the District's performance had not been without some shortcomings.
The District had arrived at the current position by a somewhat different

10/12/65

-59

route than had the nation.

In the country as a whole, unemployment

had declined because employment had increased faster than the labor
force.

About half the metropolitan portion of the District had

followed that national pattern of expansion in 1965.

The rest--not

only the perpetual pockets of unemployment but also Philadelphiahad expanded l,ss, and in a different way.
but the labor force had not grown.

Unemployment had declined,

In other words, although unemploy

ment had dropped sharply, in about half of :he District people had not
been drawn into the labor force.

Moreover, in those same areas,

increases in employment had been primarily in manufacturing.

Growth

of the economy had not been strong enough to spill over into secondary
or supportive types of activity.

All that would seem to imply that

slack remained in some areas--notably in Philadelphia.
On the financial front, Mr. Hilkert continued, all six
Philadelphia reserve city banks had hiked rates on savings and time
deposits and had introduced new, high-yielding savings bonds.
period of one

month they had picked up $33 million.

In a

The high yield

and attractive redemption feature seemed to be producing the results
the city banks were looking for.

Contrary to some public statements,

the banks had not been motivated by an inability to compete against
other savings institutions in the area or against banks in other money
centers.

On the contrary, even before the recent rate hike the banks

10/12/65

-60

had been able to increase their share of total savings in Philadelphia
and had been holding their own in comparison with reserve city banks
throughout the nation.
Rather, Mr. Hilkert remarked, the increase in rates was related
more to cumulative reserve pressures and rising strength of loan demand.
The Philadelphia Reserve Bank's latest survey of bank lending practices
highlighted the tightening that was going on in the District, especially
in business loans.

All banks reported that loan demand was stronger

now than three months ago.

And, for the first time, there was evidence

that the banks were shifting toward price as a rationing device.

Five

out of six banks were taking a firmer attitude on interest rates on
commercial and industrial loans.

Two-thirds of the banks were seeking

new business loans less aggressively.

They reported further tightening

in their policies concerning nonlocal customers, the applicant's value
as a source of business, and compensating balances.
Other evidence of the tightening showed up in the basic reserve
deficit, Mr. Hilkert said.

The longer run drift clearly had been to

ward greater restraint--from a daily average deficit in January of
$12 million to an average of $184 million during September.

Borrowing

over that period had increased greatly, especially in the Federal
funds market.

During January, Federal funds borrowing averaged $23

million daily; in September, $154 million.
continued upward:

The loan-deposit ratio

from 71 per cent in January to 78 per cent by the

-61

10/12/65

end of September at reserve city banks.

Business loans had increased

15 per cent since the beginning of the year.

During September, they

rose 3.2 per cent, and bankers reported that the demand would stay
strong for the rest of the year.

In recent weeks reserve positions

had eased somewhat, but financial markets in the District, as in the
nation, were still unsettled and sensitive to shifts in market
psychology.
Mr. Patterson reported two cortrasting developments in the
Sixth District.

Measures of economic activity continued to show

increases and, in some sectors, acceleration.

Steel production in

September topped the August output, and heightened activity char
acterized many industrial sectors, judging from the gains in nonfarm
employment.

Tightness in the labor market in August brought a jump

in the average hours worked per week, with the gains heaviest in
Florida and Tennessee.

In banking, on the other hand, there might

have been a slowing down of loan expansion.

Business loan growth at

the weekly reporting member banks in leading cities slowed in September
and time deposits increased less than in previous months.
Mr. Patterson said that he would abbreviate the remarks he
had prepared on national economic conditions because most of his
points had already been made.

He noted that the discussion at this

meeting and the preceding one seemed to be centered on how the System
should react to the upward pressures on interest rates.

Before reaching

10/12/65

-62

a decision on that point, he would like to have better explanations
than seemed to be available at present of the forces behind the
recent firming of rates, and of what could be expected if action
of a major sort should be taken to further tighten credit.

If the

higher rates resulted from technical factors, temporary changes in
expectations, and the like, that was one thing; if they were the
result of stepped-up demands for credit, it was another.

He did

not think there were firm enough answers for a verdict that would
do justice to the problem.

At this point, the evidence did not seem

conclusive enough to him to justify the kind of major change in policy
that would be involved in raising the discount rate.

Until the evidence

was clearer, therefore, he would favor following the policy set forth
in alterrative A of the draft directive, amended to include, ".
with a view to maintaining a firm tone in the money market."
Mr. Shuford commented that like Mr. Patterson he would not
dwell on econonic and financial conditions because they had been ad
equately covered this morning.

As far as tne Eighth District was

concerned it continued to follow the national pattern of economic
strength.
As to policy, Mr. Shuford said, he seldom attempted to look
very far into the future and he hesitated to do so now, but his guess
for the longer run was that it might be necessary for the Committee
to move toward some further restraint,

He also was inclined to think

10/12/65

-63

that the next move probably should involve a change in the discount
rate, but he was not prepared to say that such action should be taken
now.

He was pleased that there had been some firming in the market

over the last few weeks.

He thought, however, that the Committee

needed more time to assess the strength of the demand for funds at
current rate levels before it decided to tighten further.
For the moment, then, Mr. Shuford favored maintaining the
somewhat firmer money market conditions of recent weeks.
would not favor any easing.

He certainly

Both monetary and fiscal policy had been

stimulative recently and the economy was operating close to capacity.
Accordingly, he was inclined to believe that any relaxation of money
market pressures would run the risk of prompting inflationary pressures.
Mr. Shuford remarked that he also hesitated to try to quantify
policy targets; as had been observed, the Manager had heard the dis
cussion at the meeting today and knew what the Committee's objectives
were.

Nevertheless, he would note that his thinking ran in terms of a

three-month bill rate between 3.95-4.10 per cent, and a Federal funds
rate around 4-1/8 per cent and probably fluctuating above that level.
Under those conditions he would expect borrowings to continue in
excess of $500 million.

He would not suggest a target for net borrowed

reserves; he agreed with those who had suggested that such reserves
should be allowed to find their own level.

He would hope that under

the conditions described growth in the money supply would slow from

10/12/65

-64

its recent rate.

As for the directive, Mr. Shuford found alternative A

as originally drafted more to his liking than the other suggested
wordings because he thought it allowed more flexibility to the Manager.
If language along the lines of Mr. Ellis' suggestion was to be adopted,
however, he agreed with Mr. Wayne that the word "orderly" should be
substituted for "stable."
Mr. Balderston said he would attempt to state the case for
reexamining present policy.

He thought his position at the moment

would be found to be close to that of Mr. Daane.
Mr. Balderston then made the following statement:
Satifactory as the System's monetary policy between the
years 1961 and 1964 may appear in retrospect, it is appropriate
to ask if the System should not now take steps to prevent
steady business expansion from being undermined by interest
rate distortions and by inflationary pressures. At stake is
the continuance of the healthy expansion and the steady but
tedious improvement of our competitive position abroad.
A number of highly publicized wage advances, including
those in the automobile, aluminum, steel, construction, and
maritime industries, have added enough to labor costs to
encourage larger and more widespread "selective" price
advances. Wage pressures combined with Government spending
for war and welfare activities both suggest to businessmen
that things will cost more later on than now. In the face
of favorable business forecasts it is inevitable that many
should increase both inventories and plant investment.
What are the symptoms of instability that can already
be seen?
(1) For some months production in excess of end use
has caused inventories to grow.
(2) Both actual plant investment and investment plans
continue strong. Rising expectations are encouraging further
marked ircreases in plant and equipment outlays, and they
are already at a high level--up 28 per cent in the two years
from the third quarter of 1963 to the third quarter of this

10/12/65

-65-

year, and up 12 per cent from the third quarter of last
year. Consumer outlays for goods, meanwhile, have risen
only about half as much--14 per cent and 6 per cent.
Production of business equipment by August was nearly 60
per cent above the 1957-59 average, while output of consumer
goods was up about 40 per cent. Further widening of this
difference would be likely to lead eventually to over
capacity and consequent sharp curtailment of equipment
outlays, even though many outlays are for modernizing rather
than expanding plant.
(3) Business loan activity is exceptionally heavy.
The annual rate of increase exceeds 20 per cent. Rising
expectations encourage borrowers to borrow and lenders to
lend--at rising interest rates. Bank credit expansion for
some time has been exceeding the rise in dollar GNP and
threatening our noninflationary economic growth.
Security-market yields higher than rates charged to bank
customers divert long-term credit demand from the open
market to the banks. This structural disequilibrium in
interest rates tends to undermine our financial stability
by further encouraging the expansion in bank credit and
money.
(4) Stock market trading volume has mounted sharply
and prices have climbed this week to historic highs.
In
September the average of 6.7 million shares was about 50
per cent above that of August and 40 per cent higher than
that for 1965 through August. Furthermore, recent trading
has featured some highly volatile stocks, thus giving
evidence of speculative participation in the market.
(5) Last, but not least, the war in Vietnam has now
expanded to the point where it has erased any lingering
bearish uncertainties, and manufacturers currently expect
it to increase Federal spending considerably at the same
time that it impinges upon the supply of useful labor.
What are the implications of these symptoms of
developing instability? They have contributed to, and
been reinforced by, the wave of heady business optimism.
Such optimism almost always overreaches itself, and gives
rise to overextended investment efforts and price mark-ups
that are greater than can be sustained by the level of
final demand. Two incentives in particular have been pushing
up investment outlays; the desire to keep labor costs from
rising, on the one hand, and the yearning for new markets,
on the other. For many businessmen, an obvious way to serve
both of these objectives has been to bild new plants close

10/12/65

-66-

to foreign markets, and the result has been a major drain
in the direct investment account in our balance of
payments.
Business outlays both at home andabroad have now
grown to the point where they are exceeding the internal
generation of funds, and businesses are turning increasingly
to banks and to the capital markets for financial assistance.
So, with less reason, are many State and local governments
whose spending proclivities have been outrunning their
ability and willingness to tax. Abetted by the abundant
availability of credit from banks eager to buy their
securities, these governments have been engaged in deficit
financing that since 1963 has exceeded the Federal
Government's total debt increase.
In this kind of financial environment, I submit that an
important degree of monetary restraint is called for, both
for domestic and balance of payments reasons. To be sure,
we have had an appreciable degree of firming in most credit
markets since the end of July. But ironically, that firming
has had the least effect upon the availability ofprime-rate
bank crecit. Yet this is the cheapest and the most open
ended source of external funds available to the large firms
who are chiefly responsible for the great bulge in both
domestic and overseas investment by American businesses.
This development, I would point out, is in contrast to
the more normal cyclical experience, in which the prime rate
increases more than other bank lending rates. This process
provides about the only effective resistance banks can mount
against the loan demands of their most powerful corporate
customers. In the current expansion, however, not only has
there not been any such positive rate deterrent to
prime-customer borrowing at banks, but the artificial
stability of the prime rate in the

face of rising corporate

bond yields has provided a powerful extra incentive for
big firms to borrow from banks, both short-term and
long-term.
We have to recognize that the consequence is to force
banks to impose just that much more restriction on the
availability of their credit to other and smaller borrowers.
Moreover, while this discriminatory influence has been at
work on theloan side of bank balance sheets, smaller banks
have also been the first to find their ability to solicit time
deposits inhibited by Regulation Q ceilings. Since smaller

10/12/65
banks generally lend to smaller borrowers, the Q ceilings
also have worked to favor most those bank customers who
least need assistance, and to hurt most those who are
most in need. However well-intentioned public policy
has been, it has served to increase the discriminatory
impact of the degree of credit restraint presently
prevailing. Given the stimulation of more prime-customer
borrowing created by business ebullience, such discrimination
is likely to increase unless remedial action is taken.
In these circumstances, it seems to me it is incumbent
on the System to act if the problem of timing can be solved.
I think our most therapeutic action would be two-fold:
an
increase in the discount rate, accompanied by a similar
increase in Regulation Q ceilings. These steps should be
beneficial in several ways. The psychological impact of
our higher discount rate, and attendant higher money-market
rates, should help to calm business exuberance at home, and
hopefully lead to reconsideration of some planning now in
progress for still further capital investment, inventory
additions, and price increases. Internationally, we should
win a new measure of confidence in the dollar, and perhaps
create interest rate incentives to investment in the U.S.
Assuredly, most banks would follow with increases in the
lending rates charged their best business customers, thereby
redressing both the present rate distortions vis-a-vis
smaller borrowers and the cost of funds in the capital
markets. Finally, the higher Q ceilings should restore a
range of flexibility for bank time-deposit rates, and the
probable higher cost of time money might induce a review
by banks of the liberality of their current lending policies.
Fitting such actions into the skein of other official
actions for Fall would require adroit timing and execution.
With one Treasury financing just completed, another due to
be announced about October 27 for payment in mid-November,
and a third tentatively listed for late November, about
the only times at which the System could take action would
be either in the week of October 18 or conceivably just
after the November refunding (November 15) and before the
A policy
third financing around the end of November.
action about October 18, however, would appear to interfere
less with market distribution of Treasury financings.
If changes in discount rates and Q ceilings were made,
they would undoubtedly generate some immediate market
reaction. The Account Manager would need to moderate any
extreme reactions without preventing orderly adjustments.
It might even prove necessary for him to produce somewhat

10/12/65

-68

smaller net borrowed reserves for a few weeks in order to
moderate bank and credit market adjustments to the higher
rate charged for borrowed reserves.
Chairman Martin commented that he believed in the
deliberative processes of the System and had never tried to use
his position as Chairman to exert one-man leadership on matters
of policy.

His position ordinarily was not crystallized until

he had heard the discussion around the table, and as the
Committee knew it was his practice to speak last.
juncture he was concerned about creeping inflation.

At this
While the

evidence was not clear, he thought there were many signs of
inflation and of inflationary psychology in the economy.

His

judgment of the Committee's record differed from that of
Mr. Maisel; in his opinion policy changes had tended to be too
late rather than too early.

One virtue of monetary policy was

that it could be flexible, changing quickly to meet changing
circumstances.

But the Committee had a tendency to feel that it

was best to "wait until all the evidence was in" before making
a policy change.

The difficulty was that when all the evidence

was in it was likely to be too late.

While he could not be

certain of his judgment he thought that might be the situation
the Committee faced now.
Nevertheless, the Chairman thought the Committee should
not make a policy change today.

As Chairman, he had the responsibility

10/12/65

-69

for maintaining System relations within the Government--for getting
the thinking of the President and members of the Administration, and
for apprising them of the thinking within the Committee--and he had
made that one of his principal concerns during the fourteen years he
had held his present office.

Last week he had given the President a

paper expressing his personal views, which he proposed to read to
the Committee shortly.

Also, since the last meeting he had talked

with the Chairman of the Council of Economic Advisers, with Treasury
officials, and with the President.

They all had expressed the view

that it would be unwise to change monetary policy now.

The President

had not taken a rigid position on the matter--he had not suggested
that the Committee should abdicate its responsibility for formulating
monetary policy--and the Council and Treasury officials were continuing
to consider their position actively.
Administration

At the moment, however, the

was strongly opposed to a change in policy.

From the

discussion today it was evident that the Committee itself was divided
in its views.

With a divided Committee and in face of strong Admin

istration opposition he did not believe it would be appropriate for
him to lend his support to those who favored a change in policy now.
At the same time, it should be borne in mind that the role of the
System was involved:

certainly he did not believe the Committee should

become subservient to the Council of Economic Advisers or to the
Treasury, nor that it should follow an unchanged policy at all times.

10/12/65

-70The Chairman went on to say that there were two facets of the

present situation that had to be considered--the economic and the
financial.

Perhaps, as Mr. Noyes had concluded, a clear case could

not be made for a policy change on economic grounds.
there was a clear case on financial grounds.

But he thought

A policy move would

help overcome the distortions that followed from the interference in
the market process last year, when some banks that had announced prime
rate increases rescinded them after the President had expressed his
disapproval of the increases.

He thought the President's action had

been a mistake--as he had told him on several occasions--because it
put the matter of interest rate determination into a political framework.
In the Chairman's judgment the role of interest rate was being
exaggerated out of all reasonable proportions.

The country's foreign

friends, while not attempting to influence decisions here, seemed to
have been united in that opinion at the recent Bank-Fund meetings.

The

head of a large domestic corporation recently had expressed to him the
view that a 1/2 per cent increase in interest rates might have some
slight effect on housing and utilities but otherwise would have little
impact on the economy and would have no implications at all for his
company's operations.
As was clear from the discussion at the last meeting, the
Chairman said, the Committee was attempting to resist a trend resulting
from market forces.

He was confident that the Manager had been doing

10/12/65

-71

everything possible to carry out the Committee's instructions,
short of destroying those forces.

Perhaps the Committee should

dampen some of the market forces, but he did not think it should
operate in terms of the level of interest rates alone.

To continue

the attempt to keep interest rates from rising would be to approach
the pegging operation conducted until 1951 and to restrict the flows
of funds.

He held no particular brief for bankers--for one thing,

he thought many had exercised poor judgment in their competition
for time deposits--but the distortions were real and one unfortunate
consequence of them was that small borrowers were being discriminated
against.
At some point, the Chairman continued, it would be desirable
to clear up that situation.

He hoped that action by the Committee

would not be delayed to the point that inflationary pressures became
so dominant that monetary policy could do little to counter them.
He also hoped that the debate about the role

of monetary policy in

dealing with the balance of payments problem could be shifted away
from the question of whether the deficit COLld be entirely overcome
by interest rate action alone.

Like almost everyone else, he did

not believe that was possible.
Chairman Martin then read the following paper which he had
presented to the President on October 6, 1965:
Memorandum for The President.

10/12/65

-72-

Too much emphasis is being put on interest rates.
The real problem is to keep funds flowing freely
and effectively to sustain healthy progress in the economy.
Whether interest rates move a bit higher--or a bit
lower--is not of cardinal importance to the economy.
What is important is whether rates are allowed to
respond to market forces so that an effective flow of funds
is assured.
The trouble confronting us is that rate ceilingsgoverned by policy determinations--are proving obstacles
to the flow of funds in accordance with natural forces.
And the most immediate obstacle is the ceiling not
on the rate that banks may charge borrowers but on the
rate they may pay depositors to attract funds that the
banks need in order to expand their loans.
Specifically, this is the way matters stand:
In vigorous competition to attract funds
to meet increasing loan demands, banks have
been offering higher and higher rates for
certificates of deposit.
But under ceilings imposed by the Federal
Reserve's Regulation Q, going back to
November in 1964, banks are forbidden to
pay more than 4-1/2 per cent to obtain
deposit funds.
Some of the leading financial-center banks
are paying the top rate already, and cannot
now go any higher to attract further funds.
Banks with lesser standing, especially
those outside the chief financial centers, are
being hard-pressed even to hold present depos
its, much less to gain added deposits, since
the ceiling puts them at a competitive dis
advantage with financial-center banks of
higher credit standing.
These impediments are being reflected in
the credit distribution process in a way that
is distinctly adverse to smaller borrowers.
This obstacle to the attraction of funds for lending
could be overcome by lifting the 4-1/2 per cent maximum rate
that banks presently may pay for deposits.
But two other things would logically be required:

10/12/65

-73-

1. A simultaneous increase in the 4 per cent
discount rate that member banks presently must pay on
their borrowings from the Federal Reserve, lest the
widened disparity impel these banks to converge on the
Federal Reserve as the cheapest possible source of funds.
2. A greater willingness to recognize that, if banks
find it more costly to obtain the funds needed to expand
their loan volume, they will either (a) charge more for
new loans, to recoup their higher costs, or (b) show less
interest in meeting new loan demand, since that would
entail increased risk for a smaller net return.
The disadvantage of the course outlined would, quite
obviously, be higher interest rates. But there would be
these outweighing advantages:
Far from restricting the flow of funds
to meet mounting loan demands, the higher
rate structure would open up a freer, more
effective flow of funds in response to the
most economically justified borrowing
demands. The position of smaller borrowers
would clearly be improved.
With this freer, more effective flow
of funds that are already available in
the economy, economic growth would be
made less dependent on a burgeoning
stream of newly created money and--in
consequence--made less vulnerable to
dangers of inflationary developments
that would end growth, and bring recession.
While these dangers can be debated--one
is always confronted by the statistics that
are not there--rising expectations, evidenced
in financial markets and real investment,
and price warnings suggest slightly higher
irterest rates would prove beneficial to
sustaining and stretching out the expansion.
And our present balance of payments picture
suggests the further advantage of needed
reinforcement of the voluntary program in
the manner outlined.
The Chairman then said that he hoped the Committee members
would continue to concentrate on the problem and on the many
imponderables in the economic situation.

Perhaps the chief question

10/12/65

-74

concerned the size of the Federal budget, which would remain uncertain
until more was known about the probable impact of the hostilities in
Vietnam.

How much stimulus Vietnam would give the economy was still

conjectural, but he was inclined to think it was likely to be larger,
rather than smaller, than the current guesses.

In any case, the

possibility of a "fiscal drag" in 1966 under discussion a short time
ago seemed to have been completely eliminated.

As had been noted,

if the Committee made no policy change now the question probably
would have to be carried over until late in the year.
Turning to the question of the directive, the Chairman
commented that Mr. Ellis' observations on the matter of clarity
were well taken.

The passage Mr. Galusha had quoted also was much

to the point; at times the Committee had to choose between interest
rate and reserve targets and could not have it both ways.

He

continued to feel that "money market conditions" could not be
defined in specific terms.
alternative A
proposed by Mr

For today's directive, he could accept

as suggested by the staff or with the amendments
Ellis and Mr. Wayne.

Subjective interpretations of

words were involved, but to him the implications of the amended
language were no different from those of the original draft.
Mr. Hayes said that he had some question about using the
term "orderly conditions" in the directive because of the Committee's
standing policy to prevent disorderly conditions.

Moreover, he

was particularly dubious about the desirability of introducing

10/12/65

-75

the term today, after the threat of disorderly conditions had
faded.

Several members concurred in Mr. Hayes' statement.
Mr. Young commented that similar points could be made

with respect to the term "stable conditions."

He proposed that

the directive simply call for "maintaining a firm tone in the
money market."
Mr. Mitchell asked whether Mr

Holmes would interpret the

language Mr. Young suggested as calling for no change in policy.
Mr. Holmes replied that he would, on the understanding that there
might still be considerable variation among the various elements
making up the complex of money market conditions.
Thereupon, upon motion duly made
and seconded, and by unanimous vote, the
Federal Reserve Bank of New York was
authorized and directed, until otherwise
directed by the Committee, to execute
transactions in the System Account in
accordance with the following current
economic policy directive:
The economic and financial developments reviewed at
this meeting indicate that over-all domestic economic
activity has expanded further in a continuing climate
of optimistic business sentiment and firmer financial
conditions, and that our international payments have been
in deficit on the "regular transactions" basis since
midyear. In this situation, it remains the Federal Open
Market Committee's current policy to strengthen the
international position of the dollar, and to avoid the
emergence of inflationary pressures, while accommodating
moderate growth in the reserve base, bank credit, and
the money supply.

10/12/65

-76-

To implement this policy, and taking into account the
Treasury financing schedule, System open market operations
until the next meeting of the Committee shall be conducted
with a view to maintaining a firm tone in the money market.
In voting favorably, Mr. Ellis said he would like to quote
a few lines from the same authority as Mr. Galusha had:
... I admit that interpretation would be easier and more
useful if every directive were straightforward and precise.
I agree that maximum effort should be devoted to achieving
this result.
Chairman Martin then said that he thought it would be
desirable to move forward with the study of the dealer market in
Government securities that the Committee had discussed in August
of this year.

If there were no objections

he would appoint five

persons from the System to the Steering Committee for the study.
He would expect them to be joined by officials of the Treasury,
including Secretary Fowler (ex officio) and Under Secretary Deming
to serve actively.

No objections being heard, Chairman Martin named Messrs.
Daane, Ellis, Hayes, and Mitchell to the Steering Committee, and
himself as Chairman.
Chairman Martin then noted that members of the staff had
been discussing possible means for improving some of the reports
prepared at the Board for the Committee's use.

He invited Mr. Brill

to comment.
Mr. Brill said that the staff had received informal comments

10/12/65

-77

from some Committee members about deficiencies in certain documents
prepared by the staff prior to each meeting, including the green
book 1/ and the questions and comments.

With respect to the latter,

for example, it had been said that the questions had fallen into a
rut, with little change from meeting to meeting in the issues raised;
and that the comments were received too late to be of much use to
the members in preparing for the meetings.

Among the criticisms of

the green book were that it often involved "number reading" rather
than analysis, and that it had inadequate scope and perspective,
focusing on details rather than on the overall picture.

Also, both

documents were said to be insufficiently forward-looking.
He might say, Mr. Brill continued, that the staff welcomed
such criticism; it liked to know whether or not it was being as
helpful as possible to the Committee.

Also, the staff not only was

inclined to agree to some extent with those criticisms but could
add a few of its own.

In defense, however, he would note that it

was extremely difficult to be profound, detailed, global, and
penetrating every three weeks, given the rates at which the economic
situation changed and at which new data became available.

Nor did

the staff feel that it was able to provide a full interpretation
of all the links in the economic process.

A System-wide investigation

of those links was now underway, and he thought the System was about

1/ The report, "Current Economic and Financial Conditions."

10/12/65

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as far along in such research as was the economics profession generally.
Academic economists who had participated in some of the staff work
agreed that the System's research into linkages was moving along at
a good pace.

However, the research was far from complete.

As to the criticism that the questions had fallen into a
rut, it seemed to Mr. Brill that as long as the Committee's policy
discussions focussed on the same issues--such as prices, inventories,
interest rates, and so on--it was appropriate for the staff to
continue to pose questions in those areas.

The question-comment

procedure had been introduced at the suggestion of Mr. Robertson
and of some staff members, and for a time it seemed to have been
employed to some extent as a framework for the Committee's delib
erations.

That had been less true recently, although some Committee

members evidertly believed the procedure still was useful.
After considering alternative means for adapting procedures
to meet such criticisms, Mr. Brill said, the staff would like to
suggest a change in procedure for the Committee's consideration.
The proposal was to combine the green book and the questions, using
the latter as the framework for much of the analysis presented in
the green book.

The green book would not be limited to comments

on the questions; other background information not directly pertinent
to the policy issues posed would still be included.

Also, comments

on the usual final question, relating to the interrelationships among

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money market variables, would continue to be distributed at the
latest possible moment because of the volatility of the elements
involved.

He was not sure the procedure would work, but perhaps

it was worth exploration.

He would like to know whether the

Committee thought such a procedure would be more helpful to it
than the present one.
Mr. Wayne said that, as one who had made some criticisms,
he would favor experimentation with the suggested new procedure.
His criticism had been directed to the fact that the questions
had tended to become routine and in the main were no longer
discussed by the Committee.

Thus, there was a loss of connection

between the staff comments and the Committee's deliberations, and
the practice of including the questions and comments in the
minutes lent mre weight to the staff's responses in the historical
record than he thought was desirable.

He was not critical of the

green book, which he considered useful.
Mr. Scanlon concurred in Mr. Wayne's remarks.

Since the

questions and comments were being used less by the Committee they
had become a needless burden on the staff.

He also would applaud

the green book, and he favored the proposed experiment.
Mr. Hayes remarked that he felt much as Messrs. Wayne and
Scanlon did.

He would stress from his viewpoint the green book was

more useful than the questions and comments, and while he saw no

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objection to the experiment he would hope that it would not involve
much curtailment of the present scope of the green book.
Mr. Mitchell said he thought the reason the questions had
become sterile was that they often were not closely related to the
issues that in fact most concerned the Committee in its discussion
at the meeting.

He was not sure whether the staff could predict

accurately the issues the Committee would focus on, but if it was
possible to dc so and to work analyses of those issues into the
green book he

would favor such a course.

In his opinion the green

book had an excessive amount of verbalization of figures that could
be obtained from tables.

But he thought it

had established itself

as an extremely useful document and he would not want to lose any
of its valuable content.

Also, he would favor an effort to make

it available earlier than at present.
Mr. Hickman said he thought the green book had been substan
tially improved over its earlier form, but there was room for further
improvement.

It was somewhat uneven; some parts contained helpful

analysis, but some were less useful.

He was a little concerned

about the proposal to incorporate the questions and comments into
it; that might result in the omission of materials on important
subjects that should be before the Committee every time, such as
developments in GNP and prices, and international conditions.

Since

he was not sure that the proposed experiment would work out well,

10/12/65

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he would favor an effort to bring the weaker parts of the green book
up to the level of the most useful parts.
Mr. Maisel said he thought the green book should be organized
around a series of standard questions, standard tables, brief com
mentaries, and analytical appendixes.

Much of the material now

presented in full paragraphs could be compressed to advantage into
single sentences.

He would hope that the analytical appendixes

covering nonrecurrent subjects would continue.
Mr. Galusha said he found the green book tremendously useful
and hoped that it would not be curtailed materially.

To the extent

that the questions were related to the subjects that the Committee
actually discussed they also had been highly useful to him and to
his staff in preparing for the meetings.

Their main value was in

pinpointing emerging issues.
Chairman Martin commented that he thought this discussion
would be of some help to the staff in working out new procedures.
Mr. Brill noted that the staff might find it desirable to
spend some time in experimenting with possible formats.
It was agreed that the next meeting of the Committee would
be held on Tuesday, November 2, 1965, at 9:30 a.m.
Mr. Hayes noted that both this meeting of the Committee and
the next meeting were scheduled for days that were holidays in some

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of the Reserve Districts.

He said that he hoped in working out

next year's schedule, the Secretariat would keep in mind the
holidays that were observed in the various Reserve Districts.
Thereupon the meeting adjourned.

Secretary

ATTACHMENT A
CONFIDENTIAL (FR)

October 11,

1965

Drafts of Current Economic Policy Directive for Consideration by the
Federal Open Market Committee at its Meeting on October 12, 1965
Alternative A (no change)
The economic and financial developments reviewed at this
meeting indicate that overall domestic economic activity has expanded
further in a continuing climate of optimistic business sentiment and
firmer financial conditions, and that our international payments have
been in deficit on the "regular transactions" basis since midyear.
In this situation, it remains the Federal Open Market Committee's
current policy to strengthen the international position of the dollar,
and to avoid the emergence of inflationary pressures, while accommodat
ing moderate growth in the reserve base, bank credit, and the money
supply.
To implement this policy, and taking into account the Treasury
financing schedule, System open market operations until the next
meeting of the Committee shall be conducted with a view to maintaining
about the same conditions in the money market as have prevailed since
the preceding meeting.

Alternative B (firming)
The economic and financial developments reviewed at this
meeting indicate that overall domestic economic activity has expanded
further in a continuing climate of optimistic business sentiment, and
that our international payments have been in deficit on the "regular
In domestic credit markets demands
transactions" basis since midyear.
have been strong and interest rates have been under some upward pressure.
Open Market Committee's current
In this situation, it is the Federal
policy tc move further to strengthen the international position of the
dollar, and to counter the emergence of inflationary pressures, by
moderating somewhat the pace of growth in the reserve base, bank
credit, and the money supply.
To implement this policy, while taking into account the Treasury
financing schedule, System open market operations until the next meeting
of the Committee shall be conducted with a view to reinforcing the
firmer conditions in the money market that developed in September.