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FIFTY SECOND

Annuaf Report
OF THE
BOARD OF GOVERNORS
OF THE FEDERAL RESERVE SYSTEM

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COVERING OPERATIONS FOR THE YEAR

1965

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DIGEST OF PRINCIPAL FEDERAL

Period

Action

RESERVE

I
POLICY ACTIONS IN 1965

Purpose

January

Reduced System holdings of U.S. Government secu
rities by about $500 million. Member bank borrow
ings averaged $300 million.

To absorb seasonal reflow of bank reserves while maintaining about
the same firmness in the money market as had prevailed in earlier
weeks.

February

Introduced a program, at the request of the President
and in cooperation with the Treasury, under which
financial institutions were asked to limit voluntarily
their expansion of foreign loans and investments.

To reduce the outflow of private capital and thus improve the U.S.
balance of payments and strengthen the international position of
the dollar.

FebruaryMarch

Limited the increase in System holdings of U.S. Gov
ernment securities to about $1.0 billion, nearly one
fifth of which were securities maturing in over 1
year. Member bank borrowings rose to an average
of nearly $500 million in late March.

To move toward firmer conditions in the money market, while off
setting a $600 million gold outflow, and to encourage more mod
erate growth in the reserve base, bank credit, and the money
supply--in an effort to reinforce the voluntary foreign credit
restraint program and avoid the emergence of inflationary
pressures.

April

Limited the increase in System holdings of U.S. Gov
ernment securities to about $2.4 billion, nearly one
third of which were securities maturing in over 1
year. Member bank borrowings averaged $500
million.

To offset a drain on bank reserves from market factors-as outflows
of $2.5 billion in currency and $700 million in gold were only
partly offset by reserves supplied from other technical factors
while attempting to maintain firm conditions in the money market
in a period of rising credit demands and shifting expectations
and at the same time accommodating no more than moderate
growth in bank reserves, bank credit, and money.

Early
December

(1) Raised the discount rate from 4 to 4
per cent
and (2) raised maximum interest rates payable by
member banks on time deposits (other than savings
deposits) from 4 to 5 2 per cent for maturities
of 30-89 days and from 4
to 5
per cent for
longer maturities.

(1) To moderate additional bank reliance on short-term borrowings
from the Federal Reserve to meet intensifying loan demand and
(2) to enable banks to attract and retain time deposits of busi
nesses and individuals and thus to assure an adequate flow of funds.

December

Increased System holdings of U.S. Government secu
rities by about $1.1 billion, one-fifth of which repre
sented securities acquired under repurchase agree
ments. Member bank borrowings averaged about
$450 million.

To moderate adjustments in money and credit markets following
the December discount rate increase and to offset part of the
seasonal drain on bank reserves.

November

L

ANNUAL REPORT OF BOARD OF GOVERNORS

Messrs. Maisel, Mitchell, and Robertson dissented from the
action taken by the Committee on two grounds. First, they
felt that the recent sharp increases in both short- and long-term
interest rates were partly the result of the fact that nonborrowed
reserves were not being supplied at the rate required by the
growing economy. They anticipated that there would be still
further increases in interest rates and tightening of credit availa
bility in longer-term financial markets if reserve growth con
tinued to be held below the economy's needs. In their judgment
evidence was lacking that inflation either existed or was just
around the corner and, accordingly, their preference was to
see no greater credit restraint develop at this time. To assure
such an outcome they favored open market operations designed
to move conditions in the central money markets back to around
their averages for the month of September. Second, the dissent
ing members felt that the language in the directive referring
to "maintaining about the current conditions in the money
market" was vague and open to misinterpretation, especially in
the light of the sharp tightening in market conditions that
actually had taken place over the past month when open market
operations were being conducted under a similar "no change"
directive. In particular, they were concerned that the wording
of the directive would permit further tightening of credit con
ditions, even though couched in terms which could be other
wise construed.

October 12, 1965
Authority to effect transactions in System Account.

Information that had become available in the 2-week period
since the previous Committee meeting lent further confirmation

FEDERAL RESERVE SYSTEM

to the view that domestic economic activity was generally strong
and was continuing to expand.
Industrial production appeared to have declined slightly in
September, principally because excess steel inventories were
beginning to be reduced. The labor market remained strong,
however, and the unemployment rate dropped to 4.4 per cent,
the lowest level in many years. Retail sales remained at a high
level.
According to weekly estimates, the industrial commodity price
index had edged up since mid-August, bringing the total rise
to 1.5 per cent since the summer of 1964, but foodstuffs con
tinued to decline from their July peak and the total wholesale
price index remained at the June-August level. The consumer
price index, after rising more than 1 per cent from March to
July, declined two-tenths of 1 per cent in August due to the
drop in average food prices.
Sales of new domestic automobiles in September remained
at the 8.9 million annual rate of the previous 3 months, and
prices for the 1966 models-most of which had now been intro
duced-appeared close to those for the 1965 models. The
growth of consumer instalment credit slowed in August, on a
seasonally adjusted basis, but early reports for September sug
gested a return of the rate of net borrowing to levels somewhat
above August.
New orders for durable goods showed somewhat less decline
in August than preliminary figures had indicated, due mainly to
an upward revision in new orders for defense production. Busi
ness inventory accumulation in August was not as large as in
July; but for the 2 months combined accumulation exceeded
the second-quarter rate and approached the high rate of the
first quarter. Construction expenditures during the third quarter
were unchanged from their second quarter level as higher out
lays for business, other private nonresidential, and public con-

ANNUAL REPORT OF BOARD OF GOVERNORS

struction offset a downdrift in residential construction activity.
In financial markets there was a slackening in the pace of
bank credit expansion in September. The annual rate of growth
in the third quarter was estimated at 5.5 per cent compared
with approximately 12.5 per cent and 10 per cent in the first
and second quarters, respectively. However, when security loans
were excluded, total loans rose at an annual rate of about 13
per cent in the third quarter, which was 1 percentage point above
the 1964 rate. The demand for business loans had been strong
recently after moderating somewhat in late August and early
September; for the month of September as a whole such loans
expanded at an annual rate of almost 13 per cent.
Following a slowdown in August, the money supply rose in
September at a seasonally adjusted annual rate of almost 12 per
cent; this reflected in part an unusually sharp reduction of U.S.
Government deposits. For the year to date the money supply
had grown at an annual rate of 3.8 per cent, a little below the
rate for 1964. Time and savings deposit growth in September
was at an annual rate of 12 per cent, considerably below the
rates of the previous 2 months. While savings deposit inflows
remained strong, run-offs of negotiable certificates of deposit
were heavy during the September tax and dividend period and
only about half had been replaced by the end of the month. Cer
tain major banks had recently pushed their offering rates on
certificates to, or close to, the ceiling of 4.5 per cent.
Money market conditions had eased slightly since the period
of considerable pressure toward the end of September, with bill
rates and other interest rates dropping back somewhat. The sup
ply situation as to Treasury bills had been eased considerably by
the System's large purchases of bills to supply needed reserves
during the late September period. This abatement of market
pressures enabled the Treasury to auction $4 billion of tax
anticipation bills at somewhat lower rates than earlier antici
pated, and the demand for these bills in the secondary market

FEDERAL RESERVE SYSTEM

proved to be better than many had expected earlier. The Treas
ury was expected to announce in late October the terms of its
November refunding; $3.3 billion of maturing securities were
held by the public. Trading activity in the stock market remained
heavy, although the volume was somewhat below the high daily
average for the month of September. Prices continued to move
in a rather narrow range at about the highs reached in the spring
of the year.
U.S. foreign trade showed some improvement in July and
August. The trade surplus exceeded a $6 1/2 billion annual rate
in those months as exports rose by about 4 per cent in July and
again in August while the growth in imports appeared to have
tapered off. Nevertheless, preliminary data for the third quarter
suggested a payments deficit on the "regular transactions" basis
at an annual rate in the order of magnitude of $1 1/4
billion, and
it appeared that in September the "official settlements" balance
may have reverted to deficit on a seasonally adjusted basis. In
foreign exchange markets the outstanding recent development
had been the further recovery of sterling, which was now trad
ing at a spot rate above par.
In the Committee's discussion of the course of monetary
policy, some members noted that any significant move toward
further firming would almost inevitably soon require considera
tion of changes in the discount rate and in the maximum rates
of interest permitted to be paid on time and savings deposits.
It was the predominant view that such changes would not be
advisable at this particular time. Accordingly, the discussion
focused on a relatively narrow range of policy objectives during
the forthcoming 3-week period. Most members of the Com
mittee believed that the best short-run alternative would be to
maintain about the existing degree of money market firmness,
recognizing that objectives expressed in terms such as bill rates,
net borrowed reserves, and Federal funds rates might not prove
to be mutually compatible. In this regard, there was some dis-

ANNUAL REPORT OF BOARD OF GOVERNORS

position to feel that the level of net borrowed reserves, one of
the indicators of market conditions, should be assigned a less
prominent role than usual in the current context. Other mem
bers of the Committee, who expressed concern about potential
inflationary pressures against a background of large cumulative
increases in bank credit and the international payments problem,
thought that any doubts in the conduct of open market opera
tions should be resolved on the side of a firmer market tone.
On the other hand, some members felt that in the absence of
clear evidence of a break-out of inflationary conditions care
should be exercised against basing actions on expectations, and
that any doubts therefore should be resolved on the side of easing
bank reserve positions slightly.
At the conclusion of the discussion, the following current eco
nomic policy directive was issued to the Federal Reserve Bank
of New York:
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.
To implement this policy, and taking into account the Treasury financ
ing 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.
Votes for this action: Messrs. Martin, Hayes,
Balderston, Daane, Ellis, Galusha, Maisel, Mitchell,
Robertson, Scanlon, Shepardson, and Irons. Votes
against this action: None.

FEDERAL RESERVE SYSTEM

November 2, 1965
Authority to effect transactions in System Account.

Gross national product advanced at an annual rate of $11
billion in the third quarter of 1965, according to preliminary
estimates, compared with an increase of $9.5 billion in the pre
ceding quarter. Although the adjustment of steel inventories
was producing a considerable drop in the rate of business inven
tory accumulation and a leveling off in industrial production
in the fourth quarter, another substantial rise in GNP appeared
likely as marked further gains were expected in outlays for busi
ness fixed investment, in Federal defense outlays, and in con
sumer incomes and spending.
Contrary to earlier indications, average prices of industrial
commodities were stable from mid-August to mid-September,
and weekly estimates showed little change through late October.
The consumer price index rose by two-tenths of 1 per cent in
September, the amount by which it had declined in August, with
seasonal increases in apparel and fuels accounting for much of
the rise.
Partial data for October suggested that industrial production
might have been maintained at about the September level, 1 per
cent below the previous month, despite a further decline in steel
output. In September, strikes in a number of industries and the
impact of "Hurricane Betsy" on crude oil output had served to
reinforce the effects of the steel contraction on total output; sub
sequently, however, settlement of the strikes and recovery of oil
production had acted to offset the further contraction.
Growth in the money supply was rapid in early October
although less so than during September-partly because U.S.
Government deposits were reduced further. Loan demand at
commercial banks continued strong and seemed likely to remain
vigorous over the final months of the year despite reduced needs
for funds by firms that had been stockpiling steel. Net borrowed