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A meeting of the Federal Open Market Committee was held in
the offices of the Board of Governors of the Federal Reserve System
in Washington, D. C., on Tuesday, October 4, 1966, at 9:30 a.m.


Martin, Chairman
Hayes, Vice Chairman

Messrs. Wayne, Scanlon, Francis, and Swan, Alternate
Members of the Federal Open Market Committee
Messrs. Ellis, Patterson, and Galusha, Presidents
of the Federal Reserve Banks of Boston, Atlanta,
and Minneapolis, respectively
Mr. Holland, Secretary
Mr. Sherman, Assistant Secretary
Mr. Kenyon, Assistant Secretary
Mr. Broida, Assistant Secretary
Mr. Hexter, Assistant General Counsel
Messrs. Eastburn, Garvy, Green, Koch, Mann,
Partee, Solomon, Tow, and Young, Associate
Mr. Holmes, Manager, System Open Market Account
Mr. Coombs, Special Manager, System Open Market
Mr. Cardon, Legislative Counsel, Board of
Mr. Fauver, Assistant to the Board of Governors
Mr. Williams, Adviser, Division of Research
and Statistics, Board of Governors

Mr. Hersey, Adviser, Division of International
Finance, Board of Governors
Mr. Axilrod, Associate Adviser, Division of
Research and Statistics, Board of Governors
Miss Eaton, General Assistant, Office of the
Secretary, Board of Governors



Messrs. Eisenmenger, Ratchford, Taylor,
Baughman, Jones, and Craven, Vice
Presidents of the Federal Reserve
Banks of Boston, Richmond, Atlanta,
Chicago, St. Louis, and San Francisco,
Mr. Geng, Manager, Securities Department,
Federal Reserve Bank of New York
Mr. Kareken, Consultant, Federal Reserve
Bank of Minneapolis
Upon motion duly made and seconded,
and by unanimous vote, the minutes of the
meetings of the Federal Open Market Com
mittee held on August 23 and September 13,
1966, were approved.
Under date of September 16, 1966, there had been distributed
to the members of the Federal Open Market Committee copies of the
report of audit of the System Open Market Account and of the report
of audit of foreign currency transactions, both made by the Board's
Division of Examinations as at the close of business May 13, 1966,
and submitted by the Chief Federal Reserve Examiner under date of
June 17, 1966.

Copies of these reports have been placed in the

files of the Committee.
Upon motion duly made and seconded,
and by unanimous vote, the audit reports
were accepted.
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 market conditions
and on Open Market Account and Treasury operations in foreign

currencies for the period September 13 through 28, 1966, and a
supplemental report for September 29 through October 3, 1966.
Copies of these reports have been placed in the files of the
In comments supplementing the written reports, Mr. Coombs
said that the Treasury gold stock would remain unchanged this

The Stabilization Fund now had about $100 million of gold

on hand, with prospective sales during the month of October of
roughly $75 million.

On the London gold market,

buying pressure

was consistently heavy during September and the original $270
million in the gold pool was further depleted by another $54 million,
to no more than $12 million.

As the Committee would recall, a

supplement of $50 million to the gold pool had been negotiated
at the September Basle meeting, and if necessary another $50 million
could probably be secured although that might well be the end of
the line.

While some slackening in the demand for gold might be

seen now that the Fund and Bank meetings were over, he continued
to think that the gold market constituted the single most dangerous
threat to the dollar.
On the exchange markets,


Coombs continued,

been a gradual improvement in confidence in

there had

sterling since the

announcement of the increase in the swap lines on September 13.
During the first 13 days of September the British were still



running a sizable deficit which, in the absence of the increase
in the swap network, would probably have reached major proportions
during the second half of the month.

The turn in the tide over

the past two weeks had enabled the Bank of England to announce
this morning a reserve increase for the month of three million
pounds, while also indicating that no net recourse to central
bank credit was made during the month.

As the Committee would

recall, the Bank of England had outstanding on August 31 $625
million of overnight money, of which $450 million was provided
by the Treasury and Federal Reserve and $175 million by certain
foreign central banks.

The position at the end of September was

somewhat improved although still vulnerable.

The overnight money

component had been reduced from $625 million to $375 million,
comprised of $200 million from foreign central banks and $175
million from the Treasury.

The remaining gap of $250 million had

been covered by a $150 million drawing on the agreement negotiated
in Basle last June providing for financing of reductions in the
sterling balances, while another drawing of $100 million of three
month money was made on the Federal Reserve.

It was to be hoped

that today's announcement that the reserve drain was stemmed
during September, which had been anticipated to some extent in
the market, would further restore market confidence.


the Bank of England took in more than $30 million and this morning



they had already taken in an additional $50 million, so the
signs were accumulating of a return of confidence.

He would

hope to see a string of reserve increases over the weeks to
The other major development in exchange markets,
Mr. Coombs observed, had been the gyrations of the French franc,
which on several days slipped below par.

The Bank of France did

not seem to be making any special effort to check the rate move
ments and, as far as he could tell, the recent selling pressure
on the franc seemed mainly attributable to such short-term
phenomena as money market pressures, an adverse tourist balance,
and similar temporary developments.

On the other hand, he

thought it possible that there might be some swing of the leads
and lags against the French franc.

The French had benefited

enormously over the years from the view that the French franc
could not possibly be devalued, so that importers did not find
it necessary to cover their dollar requirements.

That situation

might now be turning as the markets reappraised the long-term
prospects for the currency of a country which had increasingly
cut itself off from the cooperative arrangements developed among
the other major industrial countries.
Mr. Mitchell asked what Mr. Coombs thought was the effect
on the British position of the pull-back of Euro-dollar funds
through foreign branches of U.S. banks.

Mr. Coombs replied that the effect had definitely been
adverse for two or three months, although he did not know the
extent to which it had resulted in British reserve losses.


the same time, the pressures exerted on sterling by the opera
tions of American banks had simultaneously been exerted on all
major continental currencies.

He would assume that the pull

back of funds was an important factor in the third-quarter surplus
in the official settlements balance of the U.S.

It also had

important implications for the U.S. gold stock.
Mr. Mitchell then asked whether Mr. Coombs thought the
British would experience difficulties if U.S. banks continued,
for the next four or five months, to draw in funds through their
branches at the recent rate.
Mr. Coombs replied that such a development undoubtedly
would slow the pace of the British recovery.

His own impression

was that the pull had been a little too strong in some periods
recently, but if it were stopped entirely the loss to the U.S.
would be greater than the gain to the British.
Mr. Shepardson asked whether a significant share of the
funds being drawn in through U.S. bank branches was coming from
the continent.
Mr. Coombs replied that he thought the main pressure
exerted on sterling by the pull-back had occurred in July and



August, and that such pressure had lessened in September.


would be surprised if at present as much as 20 per cent of the
funds were coming from the U.K.; the main pull now appeared to
be from the continent.
In reply to another question by Mr. Shepardson,
Mr. Coombs said he did not think much of the reflow could be
attributed to the issuance of certificates of deposit in
London by American banks.

It was his understanding that the

volume of such certificates outstanding was not large.
Mr. Daane asked whether much of the money being drawn
in was likely to flow out again quickly if there was a change
in international interest rate relationships.

In other words,

how "hot" were the funds being drawn in?
Mr. Coombs responded that the funds seemed to be fairly
hot money.

In a sense, the U.S. was buying protection in the

short run, and there might have to be an accounting if cir
cumstances changed.

On balance, however, he thought it would

be inadvisable to do anything at present to change those flows

It was not possible to say where the money would go

if it was not drawn to New York, and as long as the pull-back
was not overdone the British should get by.
Mr. Brimmer remarked that he understood Mr. Solomon
planned to comment on the subject in some detail in his remarks


later in the meeting.

The pull-back of funds had domestic as

well as international implications, and the Board had been
giving the subject a good deal of consideration recently.


Committee might want to return to it after hearing Mr. Solomon's
Chairman Martin suggested that the members might offer
any comments they had on the subject in the course of the go
Thereupon, upon motion duly
made and seconded, and by unanimous
vote, the System open market trans
actions in foreign currencies during
the period September 13 through
October 3, 1966, were approved,
ratified, and confirmed.
Mr. Coombs noted that the original $450 million standby
swap arrangement with the Bank of Italy--not including the $150
million increase negotiated recently--would mature October 20,

He recommended renewal of the swap arrangement at this

time for another twelve-month period.

He would expect that in

March, when the end of the term of the $150 million increase was
reached, the two arrangements could be combined.
Renewal of the $450 million swap
arrangement with the Bank of Italy for
a term of twelve months was approved.
Mr. Coombs noted that the $100 million standby swap with
the Bank of France would mature on November 10, 1966.
ommended its renewal for another three-month period.

He rec


Renewal of the $100 million swap
arrangement with the Bank of France for
a term of three months was approved.
Mr. Coombs then noted that two three-month drawings by

the Bank of England under its swap line with the System would reach
maturity soon--a $100 million drawing maturing October 21, 1966,
and a $50 million drawing maturing October 28, 1966.

He recommended

renewal of both for further periods of three months if the Bank of
England so requested.

That would be a first renewal for the $100

million drawing, and a second renewal for the $50 million drawing.
Renewal of the two drawings by
the Bank of England was noted without
Mr. Coombs noted that four three-month drawings by the
System would be reaching maturity soon.

They were two drawings

on the Netherlands Bank, of $30 million and $25 million, maturing
October 21 and November 7, 1966, respectively; a $25 million
drawing on the Swiss National Bank maturing October 25, 1966; and
a $25 million drawing on the Bank for International Settlements,
also maturing October 25, 1966.

He recommended renewal of the

four drawings for further periods of three months, if necessary.
All would be first renewals.
Renewal of the four drawings, as
recommended by Mr. Coombs, was noted
without objection.



Before this meeting there had been distributed to the
members of the Committee a report from the Manager of the System
Open Market Account covering open market operations in U.S. Gov
ernment securities and bankers' acceptances for the period
September 13 through 28, 1966, and a supplemental report for
September 29 through October 3, 1966.

Copies of both reports

have been placed in the files of the Committee.
In supplementation of the written reports, Mr. Holmes
commented as follows:
The money and bond markets have been subjected
to wide swings in expectations since the Committee
last met. At the moment the cloud of excessive gloom
and pessimism that hung over the financial markets has
for the time being lifted and a fairly confident
atmosphere prevails--at least temporarily.
There are a number of factors that underlie this
change in sentiment.
First, there is the growing market conviction
that fiscal policy measures in addition to those
announced on September 8 will be forthcoming in the
near future to deal with the pressures on the economyparticularly the pressures stemming from the growing
cost of the Vietnamese war. Rumors and the announcement
of fiscal action had already had an impact on the bond
market at the time of the last Committee meeting, but
the additional discussion since that time has buoyed
the market significantly further.
Second, international developments have generally
tended to give the market heart. There has been a
growing feeling that prospects for negotiation in
Vietnam have improved. The lack of serious controversy
at the annual meetings of the international monetary
institutions, the feeling that the French seem to have
isolated themselves, and the apparently better outlook
for sterling have also been plus factors.
Third, despite continuing price pressures, the
market has interpreted recent economic developments



as on balance indicative of some relaxation of pressure
on the economy. And while heavy demands in the capital
markets are still anticipated, there is not the same
kind of rush to get on the financing schedule that was
present in August, and the Administration's program of
limiting the demands of Government agencies has reduced
an important source of pressure in the markets. In
this atmosphere, municipal and corporate underwriters
have become more confident in performing their under
writing functions.
Finally, the financial markets--after uncertainty
had neared a crescendo over the tax date--have become
somewhat less apprehensive about the severity of
Federal Reserve intentions with respect to monetary
policy, although there is still a great deal of
confusion about the proper interpretation of current
discount window policy. The tax date was passed with
out the dire consequences that many had predicted.
The CD runoff was large, but not as massive as had
been feared, partly because a large amount of money
became available as a result of a temporary investment
of funds arising out of the financing of a corporate
merger. As the Treasury rebuilt its tax and loan
account balances, pressure on the money center banks
relaxed somewhat and this contributed to a more
comfortable tone in the money market. The relatively
low net borrowed reserve figures published for the
week ending September 21, the lower Federal funds
rate prevailing throughout much of the period, and
the prompt action by the System in conjunction with
the FDIC and the Home Loan Bank Board on consumer CD
rates, led to a feeling that the System might be paying
more attention to the high short-term interest rates
that had emerged. And this feeling was not entirely
dispelled by the high net borrowed reserve figures
published for the week ending September 28.
How long this atmosphere will last is, as usual,
problematical. The underlying facts of the current
economic and financial situation have not changed as
much as expectations, and the markets have probably
discounted developments that have yet to appear. Unless
loan demand falls short of current expectations, there
should be, as the blue book 1/ suggests, continued
pressure on rates, particularly as the Treasury's actual

1/ The report, "Money Market and Reserve Relationships," prepared
for the Committee by the Board's staff.



moves to raise the cash it needs before the year-end
unfold. While the near-disorderly atmosphere that
prevailed in the markets in late August and the heavy
pressure on short-term rates that prevailed around the
tax date may not be duplicated, the markets remain
susceptible to new developments and to new expectations
about the future course of monetary and fiscal policy.
Short-term interest rates reached new highs early
in the period, with three- and six-month Treasury bills

reaching records of 5.59 and 6.04 per cent, respectively,
in the Treasury bill auction of September 19--a full
1/2 per cent above their end of August levels. In the
changed atmosphere noted earlier, however, a strong
demand for Treasury bills emerged with rates moving
sharply downward again as dealers' positions were
substantially reduced. By last Friday key rates were
10-20 basis points below their level at the time of
the previous meeting. In yesterday's uneventful auction
average issuing rates for the new three- and six-month
bills were set at 5.41 and 5.67 per cent, respectively.
System open market operations both were condi
tioned by market developments and the shifting atmosphere
that prevailed during the period and, to some extent,
at least, influenced these developments. The week of
September 21 was particularly complicated by a jittery
Treasury bill market, tax date churning, and market
fears of a still tougher monetary policy. In addition,
country banks exhibited a tendency to build up their
excess reserves more than normally during the first
week of their statement period, thus immobilizing
reserves that were available in the banking system.
In order to avoid adding to the market's misapprehen
siveness the System took only modest action to absorb
reserves and net borrowed reserves were permitted to
run at a low level. This approach to open market
operations involved a risk that the market might
conclude that the System had eased policy, but the
logic of the approach was fortified by the behavior
of the credit proxy, which at that time indicated that
bank credit in September might decline at an average
annual rate of about 4 per cent. In the following week,
generally comfortable conditions prevailed in the money
market as the previously built-up country bank excess
reserves came into play, and the net borrowed reserve
figure rose to its highest level during this period of



restraint. Hopefully, one result of the wide swing in
net borrowed reserve figures--from $187 million to $568
million--will be to deemphasize their importance in the
minds of market participants and analysts as a single
indicator of monetary policy intentions.
It should be noted that required reserves and the
credit proxy consistently fell below expectations
during the period since the Committee last met. The
credit proxy for September now appears to have risen
only slightly after taking account of foreign branch
balances at major U.S. banks, despite a new seasonal
adjustment that tends to make the September figures
look stronger than the old seasonal would. I believe
we should continue to be cautious about overinterpreting
short-run changes in the aggregates, particularly since
it appears probable that seasonal adjustment patterns
may be in a period of radical change. As the blue book
indicates, the Board staff is now projecting a 5-6 per
cent increase in the credit proxy over the month of
October, with the pattern involving substantially
higher growth by the end of the month compared with
the end of September. New York Reserve Bank estimates
involve a somewhat slower growth on average but about
the same level at the end of the month.
Treasury financing operations will get underway
again very shortly. An announcement of a cash offering
of $3 to $3.5 billion tax anticipation bills is expected
later this week, with the auction likely on October 13
and payment a week later. Toward the end of the month
the Treasury will announce the terms of its November
refunding, which probably will be utilized to raise
some new money, with the possibility of a combined
offering of short- and intermediate-term issues.
Mr. Wayne asked if Mr. Holmes would elaborate on his comment
about a temporary investment in CD's resulting from a corporate
Mr. Holmes said that about $1/2 billion had been invested
in CD's in mid-September in connection with the merger of an oil
and coal company.

Roughly half of that sum had been borrowed from



banks and half from insurance companies.

The CD's would mature

in mid-October, and while the eventual disposition of the funds
was uncertain presumably they would be spread around somewhere
in the banking system.
Mr. Mitchell asked what Mr. Holmes expected with regard
to October run-offs of CD's.
Mr. Holmes replied that from conversations with New York
banks the picture seemed to be mixed.

Some banks were optimistic

about replacing a large percentage of their maturing certificates,
particularly now that the level of bill rates had declined.


expected losses of as much as one-half of their maturities.
Mr. Hayes remarked that despite the concern of some banks
the general feeling seemed to be better now than it had been a
month ago, and Mr. Holmes agreed.
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 13 through
October 3, 1966, were approved, ratified,
and confirmed.
Chairman Martin then noted that legislation enacted since
the preceding meeting of the Committee gave the System authority
to engage in open market operations in securities that were direct
obligations of U.S. agencies or were guaranteed by such agencies,
and that a staff memorandum concerning such operations, dated



October 3, 1966, had been distributed.

(A copy of the memorandum

referred to has been placed in the Committee's files.)


thought some members of the Committee might be skeptical about
the desirability of undertaking outright transactions in agency
issues at this time.

The Committee certainly would want to give

careful consideration to that question, and also to the question
of authorizing repurchase agreements against agency issues.


Chairman suggested that the Committee plan on considering the
subject at its next meeting, after the members had had an opportu
nity to study the memorandum.

No objections were raised to the

Chairman's suggestion.
Chairman Martin then called for the staff economic and
financial reports, supplementing the written reports that had
been distributed prior to the meeting, copies of which have been
placed in the files of the Committee.
Mr. Partee made the following statement on economic
Every once in a while almost any economist would
give his eye teeth for just another couple of months'
figures to help clarify what is going on. For me,
this is such an occasion. Economic expansion has
proceeded at a high rate through the summer and into
the fall. Our preliminary estimates indicate a $14
billion rise in GNP for the third quarter, although
about half of this appears due to higher prices, and
the most probable outlook is for a similarly large
rise in the fourth quarter of the year. At the same
time, however, the performance of the stock market



and other attitudinal indices seems to evidence a
deterioration in business and public sentiment. This,
along with more fundamental indications of economic
imbalance, raises growing questions about the prospects
for continuing vigorous expansion, looking even a rela
tively few months further ahead.
One of the major questions in my mind concerns the
behavior of inventories. Clearly there has been a
substantial acceleration in the pace of accumulation,
with monthly additions to manufacturers' stocks increas
ing from around $600 million in the early months of the
year to more than $1 billion in both July and August.
The latter represents an 18 per cent annual growth rate
and contrasts with no gain recently in shipments, so
that stock-sales ratios have increased abruptly.
It is hard to believe that manufacturers generally
planned or desired this outcome, and in fact the expansion
in inventories this year has consistently exceeded that
indicated by Department of Commerce anticipations surveys.
In order to keep to the year-end level projected by the
latest survey, inventory accumulation would now have to
drop to a 6 per cent annual rate. This seems exceedingly
unlikely but, by the same token, a continued buildup
well above desired rates sooner or later would lead to
downward adjustments in output, with consequent implications
for income payments and consumption.
The underlying strength of consumer demand is in
its own right a question mark at present. Retail sales
have rebounded well from their spring setback, which
was mainly due to lower auto sales, but the early weeks
of September were a bit weaker, due again to the auto
market. There has not been time yet to test reception
of the 1967 models, of course, so that September may be
a poor indicator of prospects.
The latest University of Michigan survey reports
that consumer plans to buy cars and home goods are fully
as strong as a year ago. But that survey also shows a
further decline in its composite index of consumer
attitudes, reflecting mainly apprehension about rising
prices, higher interest rates, and the possibility of
a tax increase. In fact, the drop in the index this
year has been just as sharp as it was preceding the
1957-58 recession. I don't have a great deal of
confidence in the predictive value of such a measure.
But to the extent that it may be significant one would



expect a tendency towards a higher rate of personal
saving in coming months, rather than the slightly
lower one embodied in present staff projections.
The rise in business capital spending, though
it has been by far the strongest element in the
private economy, may also have passed its point of
inflection toward lower rates of gain. New orders
for machinery and equipment have remained essentially
unchanged for four months now and backlogs, though
still climbing, have risen less rapidly since mid
year. The August Commerce-SEC survey also indicated
a slowing in the rate of rise in plant and equipment
outlays, from 17 per cent in the first half to 11 per
cent in the second half of the year. And now the
probable suspension of the investment tax credit may
be having some further marginal effect on capital
spending plans, as desired. In any event, one very
recent private survey reports that business is
planning little further increase in capital outlays
for 1967 compared with 1966. Most capital budgets
for 1967 probably are still quite tentative, but if
the 3 per cent increase indicated were realized,
there would almost certainly be a downward tilt in
spending as next year progressed.
About near-term construction prospects there
can be no doubt. Housing starts have dropped by
about 500,000 units, annual rate, since early in the
year, and the pattern of building permits--plus what
we know of the mortgage market--suggests little or no
improvement for at least the next several months.
Residential construction outlays had declined by
about one-eighth by the third quarter, and a further
substantial decline is almost certain for the quarter
now commencing. Private non-residential construction
outlays also have declined significantly in recent
months, and contract awards for commercial building
have noticeably weakened. Presumably this also reflects
mainly the mortgage situation, though overbuilding in
some areas may be a factor.
Against this rather impressive list of weaknessespresent, probable and possible--must be weighed the
rising trend in Government expenditures, particularly
for defense. The figures on cash expenditures for
defense in July and August suggest a further rise in



the third quarter of well over $3 billion and perhaps
as much as $4 billion on a national income basis, but
we have no specific information on near-term prospects
other than the general indications of continued rapid
growth reported at previous Committee meetings.
There are two considerations to be kept in mind
regarding an expanding defense effort, however. The
first is that this would not necessarily insure an
expanding and ebullient economy; from mid-1951 through
the next year or so there was little real growth in
GNP and widespread evidence of weakness in the private
sectors, despite (and in part because of) the Korean
War effort. Second, spiraling defense costs would
enhance the prospect that the Administration might
seek a general tax increase, which of course could
change the fiscal implications considerably. Such a
development might well retard private sector demands
enough to call for significant modifications in monetary
Under present circumstances, whatever reasonable
dampening of aggregate demand can be accomplished is
all to the good. It is evident that there are still
significant inflationary pressures on both the demand
and supply sides of the economy, and that resource
utilization remains very near capacity levels. At the
same time, it would not seem desirable to ignore devel
opments in the private sector that might lead to
unnecessary slack and, with any easing in the defense
effort, possibly to a cumulative downward movement
later on. Given the uncertainties in the outlook, and
recognizing the substantial degree of restraint on
spending already achieved and still in process through
monetary policy, I would not like to see any further
tightening now. It may not yet be time to ease off
appreciably, but the situation requires very careful
watching and a willingness to do so whenever important
weaknesses do in fact emerge.
Mr. Axilrod made the following statement concerning financial
Credit markets during the past two months have
moved from a period of severe strain to one during



recent weeks of comparative relaxation. In this movement
expectations, demand forces, and supply conditions have
all interacted.
As Mr. Holmes has pointed out, the decline in interest
rates of recent weeks was influenced by growing market
expectations that we are likely to have either a personal
and corporate income tax increase or peace negotiations
in Vietnam. Moreover, the emerging bits of news about
economic prospects for the private sector of the economy
did not seem to indicate quite as much basic economic
strength as many had expected. And this impression was
buttressed by the relative lack of strain in short-term
markets after mid-September.
But unless expectational shifts are sustained by the
fundamentals of demand and supply they are likely to be
short-lived. Thus, the question becomes one of whether
monetary policy has become tight enough so that it is
causing cutbacks in real expenditures to noninflationary
levels. Or whether credit demands are becoming less
vigorous for other reasons, such as the investment boom's
running out of steam on its own.
Monetary policy does appear to have become quite
tight in recent months, even though we may disagree about
what variables best symbolize this tightness. While net
borrowed reserves have shown little change since June,
money supply actually dipped slightly during the summer,
interest rates rose markedly, and credit availability
was significantly restrained at depositary institutions.
And since the first of the year the money supply and total
reserves have grown by only about 2.5 per cent, as compared
with growth rates of around 5 per cent for both variables
over all of last year.
With restrained growth in such monetary aggregates,
interest rates have risen to the point where bank credit
growth, too, has been held back, even though some funds
are being obtained from abroad through the Euro-dollar
market. Major lending banks are losing CD's, net, at a
rate which we estimate at about between $1 and $1.5 billion
per month in September and October. Moreover, the extent
to which such losses can be made up by competing success
fully against other savings institutions for consumer-type time
deposits has probably been somewhat limited by the new
structure of ceiling rates on time and savings accounts.
And, perhaps more importantly, both banks and other savings



institutions remain hard pressed to compete with
interest rates available on market instruments.
While the fund flows just described represent in
large part shifts in the pattern of lending and not
necessarily limitations on the total available for
lending to final users of credit, this process of
disintermediation does have its costs in terms of
effects on the structure of interest rates. I would
expect, for instance, that disintermediation would
tend to raise long relative to short rates as banks
and other financial institutions back away from long
term markets, while former holders of CD's are likely
to purchase mainly short-term market instruments. Just
as the movement toward bank intermediation that was set
in motion by the Regulation Q changes in the early 1960's
was a tonic for long-term markets, so is the reverse
process of disintermediation likely to place a strain
on such markets, especially in the transitional period
when banks, nonbank institutions, and security markets
are moving to a new equilibrium relationship.
But disintermediation may be more an effect than
a cause in the current credit environment since, given
current Regulation Q ceilings, it is basically monetary
policy and credit demands that will determine the level
of market interest rates, and hence the degree of
disintermediation. Credit demands thus far this year
have been buttressed by heavy corporate borrowing. This
borrowing has been partly from banks, but has been
especially heavy in the bond market as one might expect
in a period when there have generally been expectations
of rising interest rates.
By borrowing heavily earlier this year, corporations
have apparently anticipated a part of their future need.
One indication is that corporate liquid assets over the
first three quarters of the year have risen by an estimated
$2 billion (seasonally adjusted and excluding some special
transactions), despite the acceleration in tax payments,
as compared with no change last year over the same period.
Thus, it appears that corporate capital market financing
could be somewhat less heavy in the period ahead without
necessarily indicating a reduction in real expenditures.
However, if the moderation of the corporate calendar in
recent weeks and the less than expected September expan
sion of bank loans to business continue for some time,



that would clearly tend to raise questions about the
trend of the investment boom.
But while there may be some lingering doubt about
the continued strength of business credit demands, it
appears certain that Federal Government demands in the
period ahead will be large--with perhaps $8-$9 billion
of gross new borrowing probably required between now
and year-end. Some abatement of business borrowing
demands would be welcome in such circumstances; however,
if business spending does continue high and they choose
to dispose of their accumulated liquid assets instead
of borrowing, renewed strains in the short-term market
could develop as both business and Government attempt
to utilize it as a source of funds.
With the supply of funds in the economy tight,
with the future strength of private credit demands a
bit uncertain, and with the duration of Federal Gov
ernment demands also uncertain (because there may be
a tax increase next year), this is probably a good
time for monetary policy to hold roughly where it is
for a while. But, in terms of day-to-day operations,
the rein on money market conditions should probably be
a fairly loose one. In this period of high uncertainty
a flexible rein will enable the feedback of information
from the nonfinancial world to have an influence on
actual money market conditions. For instance, if money
market conditions were showing a tendency to ease--as
indicated by declines in the Treasury bill or Federal
funds rates--this might suggest that credit demands
were less than would be expected if economic expansion
were continuing at its earlier pace. Accordingly, it
would seem desirable not to fully offset such an easing
tendency by exerting additional pressure on the net
borrowed reserve position of banks.
On the other hand, in the somewhat more likely
event that money market conditions tend to tighten up
over the next four weeks in the face of the expected
October increase in public and business credit demands,
then at least some of this tautness might be captured
even if it meant that net borrowed reserves moved deeper
than they were during the past three weeks on average.
But a significant movement toward deeper net borrowed
reserves and tighter money market conditions should



probably be dependent on a greater than desired expan
sion in the monetary and reserve aggregates.
The restrained growth in bank reserves and the
money supply thus far this year--and the absolute lack
of growth in bank credit during the past two monthssuggest to me that there is scope in the period ahead
for added expansion in reserves, bank credit, and money.
The blue book indicates the dimensions of a likely
further expansion in October. Such an expansion in
reserve and monetary aggregates would seem a useful
means of helping the Government and the economy get
over at least the first hurdles of the fall financing
season, while the System awaits further clarification
of basic economic and fiscal policy trends.
Mr. Solomon then presented the following statement on the
balance of payments:
What I propose to do today is to review the impact
on the U.S. balance of payments over the past year of
the acceleration in total spending on the one hand and
the tightening of credit conditions on the other--and
to indicate some of the policy questions raised by
these developments.
As best we can estimate it now, the deficit on a
liquidity basis in the third quarter was at an annual
rate of $2 billion. For the first nine months of the
year, the deficit on the liquidity basis thus comes to
an annual rate of $1.6 billion, only $200 million more
than last year, despite the substantial deterioration
in the trade balance.
On the official settlements basis, we appear to
have had a surplus of about $1 billion in the third
quarter, for rather special reasons to which I shall
return later. In the first half of this year, the
official settlement deficit was at an annual rate of
less than $900 million, compared with $1.4 billion in
1965. All in all, the balance of payments accounts
look better than might have been expected.
I turn now to a closer look at the major components
of the balance of payments.
The most conspicuous effect of accelerated aggregate
demand in the past year has been on U.S. imports, which



have increased much more rapidly than GNP. In July
August, imports were almost 25 per cent higher than a
year ago. A surge of imports is a normal response to
excess demand at home. What is encouraging is that
exports have also continued to increase at a healthy
rate. After some hesitation in the spring months,
exports picked up again this summer and in July-August
were 9 per cent larger than a year earlier.
Thus, most of the deterioration in the trade surplus
can be attributed to the extraordinary increase in imports,
which is in turn directly related to the excessive
expansion of over-all spending in the U.S. economy.
It is reasonable to think that a slowdown in the
expansion of aggregate demand will bring with it a
slackening in imports. From the viewpoint of long-run
balance of payments objectives, what is most important
is that the price level not rise too much. A temporary
bulge of imports accompanying a temporary surge of demand
is less harmful to our competitive position than a sharp
run-up in prices.
The other major factor contributing to a deterioration
in the current account surplus over the past year is the
increase in military spending abroad, which rose by $800
million (annual rate) from the first half of last year.
Most of this increase was in Asian countries.
While the current account of our balance of payments
has worsened substantially over the past year, the capital
accounts have moved the other way.
The improvement on capital account shows up in four
(1) increased borrowing abroad by U.S. corporations
to finance direct investment abroad; (2) net repayment of
U.S. bank loans by foreigners; (3) borrowing of Euro
dollars by foreign branches of U.S. banks for the use of
home offices; and (4) investment of liquid balances by
foreign official and international institutions in U.S.
assets that are classified as nonliquid.
Let me first dispose of this last item. The Committee
knows that in the second quarter there was a shift of
official dollar balances into CD's of more-than-one-year
maturity and into agency issues. It is difficult to
determine how much of this shift was a response to
"jawboning" and how much to higher interest yields on
these instruments. In any event, the liquidity deficit
would have been about $400 million higher in the second
quarter without these transactions.



Turning to other and less questionable capital flows,
we may note the increase in borrowing abroad by U.S.
corporations to finance direct investment.
U.S. corpora
tions issued nearly $500 million of securities abroad in
the first half of this year, while foreign subsidiaries
of U.S. corporations--so-called Luxembourg corporationsborrowed a similar amount. These borrowings abroad helped
to reduce the outflow of dollars to finance what appears
to be a strong determination of U.S. corporations to
continue to expand their foreign operations. It seems
reasonable to assign credit for the increased foreign
borrowing to both the Commerce Department program and
stringent credit conditions at home.
The Committee is well aware of the substantial
contribution, on the plus side of the balance of payments,
of net repayments of bank loans to foreigners. Over the
first eight months of this year, net repayments amounted
to more than $400 million, despite some renewed net
lending in the second quarter.
Finally, we come to the inflow of short-term funds
associated with the active bidding by foreign branches
of American banks for Euro-dollars for the use of their
home offices. This inflow is reflected in a large increase
in "due to foreign branches" on the books of U.S. banks.
It amounted to about $800 million in the first half of
this year and a further $1-1/2 billion since the end of
June. This massive absorption of dollars in foreign
hands--or dollars that would have gone into foreign
hands, including foreign official reserves--is the major
explanation for the large difference between the liquidity
balance and the official settlements balance thus far
this year.
No doubt part of the improvement in the balance on
official settlements this summer is a reflection of the
speculative outflow of funds from the U.K. In effect,
the dollars that the U.K. drew on the Federal Reserve
swap line and from other sources and paid out in support
of sterling were absorbed by U.S. branches abroad instead
of flowing into official reserves in Europe. From the
scanty data so far available, we know that increases in
reserves of continental countries have been rather small
this summer, and this is consistent with the recent
strength of the dollar on foreign exchange markets.



These massive short-term capital inflows are pro
viding temporary relief to the balance of payments,
which we cannot help but find refreshing. It is clear,
however, that such short-term capital inflows do not
represent a fundamental improvement in the balance of
payments, and it is important not to be carried away
by any pluses that appear in the accounts. One can
go further and say that these inflows represent hot
money that will flow out again as soon as pressure on
bank reserves is relaxed. Thus we may hate ourselves
in the morning in the sense that the relief we are
enjoying at the moment may have to be paid for in one
of two painful ways in the future: either a rapid
build-up in European official dollar holdings requiring
us to use the swaps, draw on the IMF, and sell gold,
or a severe constraint on monetary policy when ease is
called for.
We can take some consolation from the fact that
when a move toward monetary ease becomes appropriate,
excess demand will have subsided and imports will tend
to slacken. Just as the extraordinary bulge of imports
is being offset by extraordinary capital inflows, the
later outflow of capital will be offset by a slowdown
in imports.
Nevertheless, we must be prepared for the loss of
these short-term funds, and, if we don't want monetary
policy to be hamstrung in the future, we must be prepared
to finance the outflow by drawing on the IMF and losing
gold, unless we find ways to improve other components of
the balance of payments in the meantime.
Mr. Hickman observed that one of the first uses of any hot
money flowing out might well be by the British, in repaying their
drawings on the System swap line, and to the extent that was so it
would be a healthy development.

Mr. Solomon agreed with Mr. Hickman's

Chairman Martin said that preceding the go-around there
might be brief reports on some of the developments at the recent



meetings of the International Monetary Fund and International Bank
for Reconstruction and Development.

He had attended a meeting of

the Ministers and Governors of the Group of Ten on Sunday,
September 25, which was chaired by Dr. Holtrop because the Finance
Minister of the Netherlands was unable to be present.

About two

hours were spent in debating the wording of the communique that
was subsequently issued.

The communique reaffirmed the position

the Group had taken at its meeting at The Hague in July.


the French did not reassert the dissent they had made so vigorously
at the earlier meeting, and there was some inclination to feel that
that represented a slight softening of the French position.
The Chairman then invited Mr. Daane to comment on the
meeting of the Deputies of the Group of Ten.
Mr. Daane said that the Deputies of the Group of Ten met
on the afternoon of Friday, September 30.

The meeting was largely

procedural, and was concerned mainly with three questions:


arrangements and preparations for forthcoming joint meetings of the
Deputies with the IMF directors, the arrangements and preparations
for forthcoming meetings of the Deputies themselves, and the matter
of electing a chairman of the Deputies.

The first joint meeting

probably would be held in Washington in late November or early
December, although that fact was confidential at this point.
Deputies themselves would meet in Paris on November 16, 1966.




Dr. Emminger of the German Federal Bank had been persuaded to
continue to serve as Chairman until sometime after the turn of
the year.
Mr. Daane added that there was a definite spirit of
forward motion in the meeting.

The willingness evident to move

ahead in concert with the directors of the Fund struck him as
significant, particularly in light of the feelings on that
question that some of the Deputies had displayed earlier.
Chairman Martin then asked Mr. Solomon to report on the
meeting of Working Party 3 that had been held on September 23.
Mr. Solomon said that the recent Working Party 3 meeting
focused mainly on the U.S. economy and the U.S. balance of pay

But in the course of the routine multilateral surveillance

discussion--based on a presentation by Milton Gilbert of the BISsome of the European representatives suggested that the Working
Party should, before the end of the year, conduct a thorough
discussion of the recent extension of the Federal Reserve swap

Although the discussion was mainly procedural--the issue

being whether or not such a discussion should be held at a future
meeting--two points of substance were apparent:

(1) did the

extension of the swap network represent a "permanent or semi
permanent" increase in international liquidity and therefore did
it have implications for the Group of Ten work on international



liquidity; and (2) was the United States planning to use the
additional swap facilities to finance what was expected to be an
enlarged deficit.
Mr. Solomon reported that Under Secretary of the Treasury
Deming defended the swap extensions and insisted that discussion
of them properly belonged among the central bank Governors at

He (Mr. Deming) saw no reason for a discussion before the

end of the year, since the renewal dates were spread out evenly
over time.

In any event, it was impractical to envisage that

extensions would be talked about in WP-3 before they occurred.
The matter ended inconclusively with a suggestion that those who
had requested a discussion submit a note on what sort of discussion
they had in mind.
As to the U.S. economy, Mr. Solomon continued, the U.S.
delegation presented a fairly comprehensive review of monetary
policy and its effects--both internal and external--over the past

It was clear that the Working Party was strongly aware of

the degree of monetary restraint that had been achieved and was
not even hinting at additional monetary restraint.

The two

additional policy steps that were hinted at were, as might have
been expected, further fiscal action and some further restrictions
on direct investment.


Chairman Martin said he would make a further comment on

the Bank-Fund meetings themselves, as he saw them.
they were much better than he had expected.

On the whole,

The problem of the

pound had been largely removed by the System's action in enlarging
the swap network; the enlargement was viewed as postponing the
problem, which was precisely what it was intended to do.


still was some concern about whether the U.S. was too complacent
with respect to its balance of payments situation.

The dialogue

concerning new reserve assets had been advanced considerably;
there was increasing awareness of the difficulty of designing a
new asset that would supplement existing reserve assets without
replacing them.

He found that problem being discussed seriously

by proponents of new reserve assets as well as by opponents.


was a disposition to think in terms of successive steps, with a
first round involving an expansion of the existing activities of
the IMF, and a new reserve asset coming into being subsequently
rather than simultaneously.

That approach made good sense to him,

and while it was not exactly the approach now advocated by the
U.S. it was worth consideration.
The one concern that overshadowed others at the meeting,
the Chairman continued, related to the price of gold and to the
role of gold over the next few years.

It was recognized that if

France continued to buy gold automatically the gold exchange



standard would be endangered.

It was one thing for the French

to buy gold because they questioned the manner in which the U.S.
managed its affairs and accordingly were not willing to hold
dollars; but it was another thing if they were buying gold simply
for the purpose of embarrassing the gold exchange standard.


was generally recognized that in the absence of new discoveries
gold production would be inadequate to meet world needs, and that
there was a real problem with respect to speculation in gold.


was unfortunate that at the time of the meeting a British official
implied that there might be an increase in the price of gold.
Mr. Wayne asked whether the Chairman would comment on the
reactions to Secretary of the Treasury Fowler's hints that the
U.S. might take drastic action to curtail capital outflows.
Chairman Martin replied that the reaction was generally
adverse, as might have been expected.

However, the Secretary's

remarks might have served a useful purpose in impressing people
with the seriousness of the situation.
Mr. Brimmer observed that on the subject of stronger U.S.
controls of capital movements he had heard some favorable comment
by Europeans who thought that the inflow of dollars to their
countries was a source of inflation.
U.S. would take steps in that area.

They were hopeful that the


-31Mr. Galusha asked whether any pressure appeared to be

building up behind proposed legislation to subsidize U.S. gold
Chairman Martin said there was some discussion of such
legislation, but he did not think it was likely to be enacted
in the present session of Congress.
Mr. Hayes observed that there had been a vigorous denial
of the British official's remarks regarding an increase in the
price of gold by the Chancellor of the Exchequer and the Governor
of the Bank of England.

They were disturbed and puzzled by those

remarks, which were completely at variance with British policy.
He (Mr. Hayes) was as pleased as Chairman Martin had been over
the increasing realization that a new reserve asset, unless very
carefully worked out, might constitute a threat to existing reserve
assets and international liquidity.
long time.

He had held that view for a

With respect to the developments at the WP-3 meeting

reported by Mr. Solomon, it was clear from conversations he had
had with several continental central bank governors that they had
grave doubts about the wisdom of holding discussions of the swap
network in the WP-3 meetings.

They preferred to keep such discus

ions at Basle, and he also hoped that that would be the outcome.
In response to the Chairman's invitation to add his comments,
Mr. Bopp said that the surprising thing to him was that no great



surprises came out of the Fund-Bank meetings.

That perhaps was

fortunate from the point of view of the U.S.
Chairman Martin then called for the go-around of comments and
views on economic conditions and monetary policy, beginning with
Mr. Hayes, who made the following statement:
The economic expansion remains very strong, and the
outlook continues to be one of serious inflationary
pressures well into 1967. In our Bank we hold to this
opinion even though we recognize that some observers are
beginning to take a less sanguine view of next year's
business prospects. A change in Vietnam is always a
possibility, but in the meantime the current and
prospective defense build-up overshadows the moderation
of some recent business indicators. According to our
analysis, the fiscal stimulus by the Federal Government
remains very substantial during the second half of
calendar 1966 and will still be appreciable in the first
half of 1967. While the President's restraint program
has contributed a good deal to steadier financial
markets and may have helped prevent a serious breakout
of inflationary expectations generally, the actual
fiscal measures announced so far can hardly be expected
to have more than a minor direct impact on business and
Government spending, and that not until some time in
We see little hope for a letup in cost and price
pressures between now and mid-1967. In fact, cost-push
pressures are becoming more serious, while the
pressures of excess demand continue. Perhaps the
absence of an inflation psychosis to date reflects in
good measure the vigor and pervasiveness of credit
policy, together with recognition that the Vietnam War
is a major force behind the current boom and that its
future impact on the Federal budget is too uncertain to
make inflation a sure bet,
In analyzing the current inflationary threat and in
considering possible means of combatting it, I think we
should guard against the danger of placing too much of
the blame on excessive expenditures on plant and equip
ment and excessive business lending. It seems to me
that a too stimulative Federal budget is an even greater



contributory cause and that in any case the most
desirable cure is not a sharp and deliberate reduction
in private plant and equipment outlays. Because of the
long-run contribution of such spending to increased
productivity, I believe there should be at least equal
emphasis on lower Government expenditures and an in
crease in personal income taxes, i.e., the use of fiscal
policy to cut back consumption growth. Our recent
efforts to slow the pace of business lending have
seemed to me essential if an appropriate slowdown in
total bank credit growth was to be achieved, but in my
view we should avoid overemphasizing curtailment of
business loan expansion for its own sake.
As for the balance of payments, the underlying
deficit seems to be continuing at about the same rate as
in the first half of the year, although the liquidity
deficit will benefit again this quarter from special
factors--in this case, debt prepayments. We doubt
whether the August import decline is likely to persist.
In general, the unsatisfactory trade surplus--with
exports sluggish and imports at very high levelscontinues to be the major adverse factor, along with
the less measurable impact of the Vietnam situation.
The various programs to reduce capital outflows seem
to be working reasonably well, but this is perhaps
more the result of the current domestic credit situation
than the effectiveness of the programs themselves. In
recent weeks the System has quite appropriately
endeavored to learn more about the flow of funds to
major U.S. banks from their foreign branches. However,
I think we should have clearly in mind the beneficial
effects of this flow--temporary though they may beon the dollar in foreign exchange markets and in
mitigating foreign central bank demand for gold. For
these reasons, I would be very reluctant to see measures
taken which would have the effect of reversing this flow,
unless the domestic justification for such action was
very strong indeed. If concern is felt about the failure
of some of our credit series to reflect adequately these
foreign fund inflows, the statistics can readily be
adjusted to take them into account, as in fact is now
being done both at the Board and at our Bank. Likewise
the absence of reserve requirements for these liabilities
does not mean that we cannot make due allowance in our
policy determination for whatever contribution these
foreign funds may be making to a greater degree of credit



expansion than would otherwise occur. Perhaps the
best way of approaching this problem would be to
make an informal suggestion to a few of the major
banks involved not to press too hard on this source
of funds.
As usual, the interpretation of recent data on
bank credit is a perplexing task. Bank credit
indicators of the last few months are heavily
influenced by the increased amounts and changed
pattern of corporate payments to the Treasury since
April, for which statistical adjustments are
difficult to make. Nevertheless, there is a good
deal of evidence that the growth of bank credit in
September was rather slow, following a relatively
weak month of August. October may well see some
pickup in this rate of expansion. Serious un
certainties both as to the probable amount of future
CD runnoffs and as to the alternative methods by
which banks may meet these drains also add to the
difficulty of interpreting current and prospective
credit data. As Governor Mitchell has pointed out
from time to time, the change in degree of bank
intermediation will suggest greater attention to
total credit growth, but as a practical matter
statistical measurement of total credit is impossible
on a timely basis. Considerations such as these
point up the difficulty of setting forth policy
instructions in any very precise manner.
We shall soon be confronted with the need to
maintain an even keel in view of the prospective
Treasury cash borrowing in the near future. This in
itself would suggest maintenance of an unchanged
credit policy, but I believe such a policy is
warranted in any case on general economic grounds.
The securities markets have been notably unstable in
recent weeks; and while the bond market is currently
going through a phase of euphoria, this may turn out
to be another instance of an excessive swing of the
pendulum, to be followed by a swing in the other
direction. Also, I think we must reckon with the fact
that there are widely differing public interpretations
and misinterpretations of the System's policy state
ment with respect to the discount window. In these
circumstances, I think the Manager will need
substantial leeway in order to cope with market
developments, always in a context of maintaining a firm



but orderly money market. Both short-term rates and
net borrowed reserve data should therefore be
secondary considerations.
With respect to the discount rate, I feel that
while we "missed the boat" in July, developments since
that time have been such that I would not recommend
action now. I have in mind, of course, the rapid
escalation of market rates a few weeks ago, the joint
efforts of the various regulatory agencies to moderate
or even roll back deposit interest rates,
and the fact that the Administration has at long last
recognized the need for action in the area of fiscal
policy. There may of course be new dramatic develop
ments in the coming weeks pointing up the need for a
prompt increase in the discount rate, but in the
absence of such developments I would be reluctant to
see such an overt rate action.
If I may digress for a moment on the subject of
discount window administration, I should like to
express the hope that the System would hold firmly to
the line propounded in the September 1 statement in
discussing with member banks a so-called new or
revised discount program. It seems to me that the
essence of the statement was that the window would be
available as in the past to meet seasonal and unusual
needs, in accordance with Regulation A; that the
occasion of borrowing at the window would be used more
aggressively than in the past to influence member
banks in the direction of curtailing business loans in
preference to other means of adjustment; and that if
this route appeared feasible but also appeared to
require a somewhat longer period during which the
adjustment could be made, the System would be willing
to acquiesce in such a delay. It is never easy to
trace dollars in a large bank, and I am sure that there
will be many instances of borrowing where it cannot be
clearly stated whether a slowdown in business lending is
the means for liquidation of the borrowing, even though
this element may play an important part. What I feel
concerned with and what I would like to see the System
avoid is a concept on the part of the member banks that
there are two clear-cut and distinct classes of
borrowing at the discount window. The dangers of such
a sharp distinction of borrowing "tranches" were
discussed at length at the joint meeting of the



Governors and Presidents on August 23, and it was
noteworthy that the September 1 statement definitely
avoided any such definite classification of borrowings.
Doubtless an intra-System exchange of information with
respect to borrowings of a longer than usual character
may be quite useful, but I would hope that discount of
ficers would not encourage the member banks themselves
to look upon the Reserve Banks as administering two
quite separate types of discount programs. Mr. Holland
has prepared a draft letter to discount officers which
I think deals very effectively with this issue.
It seems to me that the staff's draft directive 1/
is quite appropriate.
Mr. Francis remarked that total demands for goods and services
had continued to rise at a faster rate than productive capacity in
recent months.

As a result, the economy had suffered many

inefficiencies due to the strain on its resources.

The nation's trade

balance was deteriorating, and prices were rising at an accelerated

Since May both wholesale and consumer prices had risen at over

4 per cent annual rates compared with about 3-1/2 per cent rates
earlier in the year.

The strong rise in total demand had been in

part the result of very stimulative fiscal actions and the monetary
expansion last winter and spring.
Monetary developments were more restrictive from June to
September, Mr. Francis noted.

Member bank reserves, which had been

rising at a rapid rate, declined.

The money supply of the country

also reversed its strong upward trend, and commercial bank credit rose
at a much slower rate.


Most interest rates went up much more rapidly

Appended to these minutes as Attachment A.



than in the preceding year.

He would submit a table for the

record showing this apparent shift of trend.1/
Mr. Francis commented that the fiscal influence of the
Government had continued to be very expansive, reflecting both
expenditures for Vietnam and the large outlays for welfare programs.
The high employment budget, which indicated considerable fiscal
stimulus in the year ending last June 30, was probably even more
expansive in the second half of this year.

In view of the strong

demand for goods and services and the accompanying upward pressure
on prices, the greater propensity to invest than to save, and the
stimulative stance of the Federal Government, he felt that the
increased monetary restraint from June to September had been
Whenever there was a tightening in monetary actions,
Mr. Francis continued, questions arose as to whether the monetary
restraint was too restrictive and as to the length of time restraint
should be exercised.

In the current situation, the move toward

restraint had apparently been substantial, but he believed it had
not been too great.

For one thing, current data frequently were

misleading because of later revisions, problems of seasonals, and
irregular movements.

But even if it later appeared that monetary

expansion had been halted, there were reasons to believe that there


The table referred to is appended to these minutes as Attachment B.



might have been and continued to be a decline in the demand for
money balances.

The markedly higher interest rates which were now

being experienced probably were causing some decline in the desire
to hold cash balances.

Also, with fiscal actions of the Government

operating in such an expansionary way, the appropriate monetary
growth was probably smaller than it might otherwise be.
Mr. Francis concluded that the June-September trends in
monetary developments were appropriate and should be continued for
the near future.

If demands for credit were so strong in the next

few weeks as to push interest rates up, the Committee should not
Mr. Patterson reported that, in the Sixth District, the
effects of credit tightening were shown more clearly in financial
data than in data measuring economic activity.

Although the large

city banks apparently expanded their business loans in September,
after curtailing them in August, most business loans were made at
substantially higher rates than those of three months earlier.


the large banks in Atlanta and New Orleans over 95 per cent of all
business loans were made at rates of 6 per cent or higher during the
first half of September, compared with 45 per cent in June.
Generally firmer terms on business loans were reported with no
diminution in the strength of loan demand.

At the banks outside

leading cities, however, loan expansion apparently was not large in


That the banks had been pressed for funds was suggested by

the continued selling of U.S. Government securities and slowed-up
purchases of municipals as well as a slower deposit growth,
Mr, Patterson observed.

Time and savings deposits remained un

changed at District banks in September with reserve city banks
having had practically no change in their total time deposits for
three months.

Growth of demand deposits in September recovered part

of the August decline but was less than would ordinarily have been
expected at this time of the year.

District banks had been net

purchasers of Federal funds ever since late July.
Mr. Patterson noted that any analysis of economic conditions
was complicated by the effects of the airline and construction
industry strikes on the currently available statistics.

Both total

nonfarm employment and manufacturing employment were practically
unchanged in August from the preceding month.

District lumber and

furniture industries suffered a decline, caused in part by receding
housing activity.

Announcements of new and expanded industrial plants

in the third quarter continued in a large volume and probably totaled
about $600 million, down only slightly from the $650 million total
of the third quarter of last year.

Proposed new and expanded pulp

and paper activities made up a major part of the total.

The textile

industry seemed to be catching up with the demand for nonmilitary
fabrics, although activity remained high.



On balance, the latest available financial and economic
information suggested to Mr. Patterson a less frantic pace of
expansion and a substantial bite on some sectors of the economy
in the Sixth District.

National data pointed to the same conclusion.

Mr. Patterson observed that for some time the System had
laid stress on the growing demands for credit as being primarily
responsible for tight money conditions.

There had been backing for

that statement in the continued expansion of the reserve base and
the rapid rise in bank loans and total bank credit.
was now less easy to support.

That position

Of course, the process of disinter

mediation, as Mr. Mitchell pointed out at the last meeting, might
complicate the interpretation of bank credit data.

However, it

could at least be concluded that System policy had become a much
more important factor in the recent credit tightening than it was a
few months ago.
The coming Treasury financing suggested to Mr. Patterson that
an "even keel" would be the appropriate policy to follow during the
next period.

However, aside from the even keel considerations, it

seemed to him--as it did at the last meeting of the Committee--that
policy should not be made more restrictive.

The financial markets

had behaved remarkably well recently considering the many strains they
had undergone.

The Committee should be very cautious about adding to

those strains.

He would, therefore, favor a policy of no change.

The draft directive was acceptable to him.


Mr. Bopp commented that during the past few weeks there had

been a virtual halt in expansion of total bank credit, a significant
slowdown in the rate of increase in business loans, and a marked
downturn in interest rates.

On the basis of those developments, it

might appear that the Committee was well on the way to achieving the
best of all possible worlds: a significant bite into credit flows
without a rapid escalation of interest rates.

Yet the period ahead

might well see a swift reversal in those trends.

It was quite

probable that interest rates would rise under burgeoning public and
private demands for credit and that business loans would increase
as tax, inventory, and capital spending pressures built up.
Certainly, Mr. Bopp continued, experience so far in the Third
District suggested that banks were under pressure to expand business
loans and that they would do all in their power to accommodate their
favored customers.

Indeed, one of the largest Philadelphia banks-

recently coming under deposit strains--approached the Reserve Bank
last week to discuss the conditions under which it might qualify for
the special discount program.

That bank had assumed that the principal

quid pro quo expected was a holding of the line on total loans.


the bank found it would be expected to hold down business loans, it
became more reluctant to borrow.

That bank now was advertising heavily

for 99 month consumer CD's at 5 per cent and had its loan officers on
the phone soliciting new CD's and attempting to persuade existing CD



holders to renew their deposits so that it might avoid borrowing from
the Reserve Bank.

If other banks found it equally difficult to hold

the line on business loans, it might be difficult to influence their
behavior through administration of the discount window.

It followed

that significant upward pressures on business loans might be felt and
that those pressures might be accompanied by rising interest rates as
portfolio adjustments were made to permit loan expansion.
It might be, Mr. Bopp said, that the rise in rates itself
would retard to some extent the loan increase and inhibit further
portfolio shifts.

The question remained, however, to what extent the

System should exert a further restraining influence, thus intensifying
the upward adjustments in rates and making it more difficult for the
banks to hold CD's and adjust their portfolios in order to make
business loans.
In Mr. Bopp's judgment the System's prime objective should be
to maintain conditions favorable to the recent more moderate rates of
growth in aggregate reserves and bank credit.

If necessary to

accomplish that objective, he would allow interest rates to firm,
first in response to pressures from the market, and then--if neededas a result of additional action by the System.

However, he would not

impose more restraint than needed to attain that aggregate goal in
order to help implement the selective policy toward business loans.
In view of the apparent reluctance of banks to borrow under the



special program, such a policy might lead to hyper-tightness, including
a more rapid deceleration of total bank credit than was warranted by
developong business conditions, and upward pressures on interest rates
which could complicate Treasury financing and lead again to conditions
of near-panic in financial markets.
Of course, Mr. Bopp concluded, policy over much of the next
four weeks had to be directed toward an even keel.
Treasury financing dictated that.

The imminent

In the meantime, the Committee would

have a further chance to judge the strength of loan demand and to
assess more fully bank response to the special discount program.
Mr. Hickman commented that this year there were more
uncertainties and cross-currents than usual as the annual forcasting
period was entered.

Bulls and bears could make equally strong cases

about the economic outlook, reflecting conflicting evaluations of
strategic factors in aggregate demand.

Despite the Administration's

announced intent to make more use of fiscal policy, the analyst was
faced with a step-up in defense spending, the magnitude and duration of
which were unknown and perhaps indeterminate.

Thus, any forecast of

economic activity much beyond a quarter ahead could easily be wide of
the mark and, as a consequence, could lead to inappropriate monetary
policy, fiscal policy, or both.
With regard to recent monetary policy, Mr. Hickman believed
that a great deal of pressure had been put on the banking system and


financial markets.

Both the reserve base and the bank credit proxy

declined on average in August and September, with influences to be
felt later on, even though one might be unable to identify them or to
quantify the time lags.

Since labor productivity might decline if

growth slackened, the Committee could over-play restraint and do more
harm than good in its efforts to check built-in inflation, which
would inevitably result from the failure to apply appropriate fiscal
policy a year or so ago.
While recent money market conditions had been somewhat easier
than he thought he was voting for at the last meeting, Mr. Hickman said,
in retrospect he preferred what actually occurred to a further

He recommended now that the Committee steer a course as

near the middle of the road as feasible, while attempting to achieve
money market conditions very slightly firmer than recently.

The basic

goal should continue to be to provide the reserves needed to achieve
moderate expansion in money and credit, and to promote sustainable
economic growth.

The Committee should not seek to roll back the price

level, or strain to hold it at present levels, since some inflation
was now the inevitable result of past errors and omissions.

He would

vote for the proposed staff directive, which seemed to him to be
reasonably near his position.
Mr. Hickman said he would like to devote a few minutes to
summarizing the views expressed at the regular quarterly meeting of



Fourth District Business Economists held at the Cleveland Reserve Bank
on September 20.

The tone of the discussion was less bullish and more

uncertain than in June.

The median forecast of the group showed less

than a 4 per cent increase in the production index for 1967, less than
half this year's expected increase of more than 8 per cent.

The median

GNP forecast for 1967 was a gain of 6 per cent in current dollars,
compared with about 8-1/2 per cent this year; in real terms, the group
forecasted an increase in the range of 3 per cent to 3-1/2 per cent.
The group's forecast for corporate profits was not encouraging,
Mr. Hickman continued.

No one expected after-tax profits in 1967 to be

more than 5 per cent greater than in 1966.

Nearly half predicted a

smaller gain, and the rest expected either no change or a decline in
aggregate profits.

Views on profits were based on the assumption that

corporate income taxes would not be increased in 1967, although most of
the group expected an increase.
There was widespread concern about the uncertain role of
defense spending in the business outlook, Mr. Hickman noted.


group felt that capital spending would continue strong through midyear,
with little or no short-run effects expected from the change in the tax
credit and accelerated depreciation.

Only one industry, paper and pulp,

reported that capacity coming on stream was showing signs of becoming

It was evident that the corporations represented were

feeling the bite of monetary policy in varying degrees, although they



understood the System's problem and agreed with its objectives.


group was unanimous in recommending a better balance in the mix of
monetary and fiscal policy.
Just before the meeting, Mr. Hickman observed, the Cleveland
Reserve Bank had conducted a special survey on recent financial
experience of the corporations represented.

About half the respond

ents reported that they had borrowed external funds since June.
Three-fifths of those borrowing had turned to commercial banks, one
third to the capital market, and the rest to parent companies or
foreign banks.

Only one corporation failed to obtain accommodation

from commercial banks, and that company obtained the needed money in
the capital market.

Almost all borrowers reported paying higher

interest, and individual companies reported a number of restrictive
changes in credit terms.

The results of the survey corroborated the

view expressed by the Bank's directors at the last board meeting that
the investment tax credit would have little short-run effects, but
might do serious harm in a year or so when there might be need for a
Mr. Brimmer said that he was concerned about the disposition
of some people to have Working Party 3 engage in multilateral
surveillance, as reported by Mr. Solomon.

At the previous meeting of

the Committee he had mentioned that he was disturbed by the tendency
toward reviewing national economic policies in WP-3, but had been



reminded that that reflected a long-standing intent.

Accordingly, he

was pleased to hear Mr. Hayes say that some central bank Governors
thought it was inappropriate to hold such discussions in WP-3 meetings.
With respect to the activities of U.S. banks in drawing in
funds through their branches abroad, Mr. Brimmer concurred in
Mr. Solomon's analysis, and he shared Mr. Hayes' and Mr. Coombs' views
regarding the best approach to the matter.

For the time being,

anything the System did with regard to those flows might best be done
quietly and informally.

Nevertheless, he was disturbed by the flows.

When the Board began to focus on the subject in August and asked the
staff to develop background information regarding them, he had been
convinced that the flows served to complicate monetary management.
was still of that view.


He also was concerned about the question of

While it was true that the System could offset the inflows

through use of its general monetary instruments, the handful of banks
involved would be able to obtain additional resources and thus to opt
out of monetary restraint, and the System's operations would shift the
burden to other banks.

Thus, while he agreed that no formal action

should be taken at present he hoped that at a later time the System
might consider steps to attain some control over those flows, through
the instrument of reserve requirements or otherwise.


there now were rumors in the market about possible System actions in
the matter.

It could only be hoped that they would die down.



Turning to the balance of payments, Mr. Brimmer said some
interesting developments were occurring outside the capital account.
Some recent analyses by the Administration suggested that the low
point in U.S. export performance might have been passed in the third
quarter; if there was even a slight moderation in growth of imports,
the trade balance might now begin to improve.

Over the weekend he had

participated in a bankers' forum sponsored by Georgetown University
which was attended by some of the people attending the Bank-Fund

Along with Mr. Roosa, and Mr. Shaw of the Commerce Depart

ment, he had taken part in a panel discussion on Saturday afternoon,
in the course of which Mr. Roosa expressed the view that it was now
time for the U.S. to take measures to reduce military spending abroad
outside of Vietnam.

Specifically, he urged that U.S. troop strength

in Europe be reduced.
sympathetic reception.

Surprisingly, that proposal seemed to get a
While there was a feeling on the part of some

in the audience that the international situation might require
maintaining present troop strength, there was a general disposition
to consider the question favorably.
A second point of interest, Mr. Brimmer continued, was the
view of some members of the group, expressed to him privately, that the
U.S. might have to face up to more explicit controls over direct

During the panel discussion both he and Mr. Shaw had

taken the position that, while there might be some logic to extending



the interest equalization tax to direct investments, such a step would
be risky and was perhaps undesirable at this time.

In personal

discussions a number of the bankers present took exception to that
position and indicated that the action might be desirable.
With respect to the domestic situation, Mr. Brimmer said he
would not take issue with the analyses given today by the staff and the
Committee members who had spoken thus far.

He would hope, however,

that the Committee would not again engage in "stop-and-go" operations
in its effort to influence the rate of growth of bank credit.

In one

sense the sharp reactions in the market this summer reflected the
difficulty the Committee had experienced in getting bank credit growth
under control in the spring.

If the

Committee could avoid undue

easing now it was less likely to be faced with a subsequent need to
clamp down hard in order to restrain over-rapid growth of bank credit.
He would accept the staff's draft directive with the hope that any
deviations on the part of the Manager would be in the direction of
slightly more rapid growth of bank reserves.
Mr. Maisel said it seemed evident that if it were not for a
sharp projected increase in Vietnam expenditures over the next year
the Committee would now be concerned that the level of demand might
be about to shift to too low a level.

Certainly many parts of the

private economy now indicated a downturn in spending.

At the same

time, the individual costs of restricted monetary availability



appeared to be growing.

On the assumption that the Government deficit

would be covered by a tax increase, monetary policy should not add
further to that pressure.

Given the lags behind action, the Committee

should attempt to see that reserves and credit expanded at a normal
Mr. Maisel said he supported the draft directive, but would
again make clear his belief that it should be interpreted as "no further
firming," with the proviso meaning that conditions should be consider
ably easier if required reserves continued to come in under
expectations and the credit proxy expansion fell below the 5 to 6 per
cent annual rate expected for October.
Mr. Maisel thought the Committee should also recognize the base
from which the present policy started--namely, average free reserves
of minus $370 million; a three-month bill rate averaging under 5.10
per cent; and a Federal funds rate of close to 5.50 per cent.


thought the Committee should consider the sharp run-up in rates during
the past period as unusual.

He was not concerned with the fact that

they occurred, since more randomness in movements should be welcomed
and the market should be made aware of the fact that wider movements
were to be expected.

At the same time, however, the high rates should

not be accepted as normal and as meeting the Committee's desires.


goal should be to return at least to the type of conditions prevailing
before the recent run-up.


If high demand for loans did raise rates even with a normal

increase in reserves and bank credit, Mr. Maisel observed, that
should be allowed, but there should be no attempt to either raise
rates or to hold them at present levels.

If a normal expansion of

reserves led to lower rates that should be accepted also.
Mr. Daane said that before turning to the subject of policy
he would comment on two matters that had been touched on in the pre
ceding discussion.

On the question of multilateral surveillance, he

would simply say that from the beginning that term had meant different
things to different people.
of course, not a new one.

The issue Mr. Brimmer referred to was,
From the outset the U.S. had taken the

position that it was willing to furnish its statistics to the Bank
for International Settlements--indeed, it had been more willing to do
so than some other countries--and to have such information as seemed
appropriate channeled through the BIS and the Governors meeting in
Basle to Working Party 3.

Multilateral surveillance at WP-3, as the

U.S. delegation had seen it, and as Under Secretary of the Treasury
Deming had reiterated, consisted of informal discussions of the
economic and monetary developments and policies of the various
countries concerned; questions of international credit assistance,
swap lines, and so forth, were most properly discussed at Basle.
From the outset he had shared Mr. Hayes' concern in the matter and had
tried to help in avoiding formal surveillance procedures.

But it was



necessary to recognize the desire of some of the Europeans to harden
the procedures--to move to a more active review of countries' policies
and to go beyond the stage of lecturing individual countries to some
thing approaching a formal approval of international credit
arrangements and financing policies.
That sentiment of the Europeans was perhaps most marked at the
time the package of assistance to Italy was arranged, Mr. Daane

There was considerable resentment then on the part of the

Europeans that the question of the Italian credit package had not been
submitted to Working Party 3 for review.

The U.S. view was that, if it

had been submitted to WP-3, no stabilization package would have
eventuated and Italy would not be in the position it was today.
On the question of the reflow of funds through foreign branches
of U.S. banks, Mr. Daane said, he was not convinced that such reflows
would necessarily complicate the implementation of monetary policy.


would concede that insufficient account might have been taken of them
at times, but looking to the future, it was not inevitable that they
would represent a serious constraint on monetary policy.
As to policy itself, Mr. Daane felt that at present it would be
the course of wisdom for the System to stay "steady in the boat."


the various existing uncertainties that had been mentioned and the
prospective Treasury financings augured for maintaining an even keel.
The draft directive appeared appropriate, except that it might be
desirable to add a reference to the Treasury financings.


Mr. Mitchell said that he agreed with Mr. Partee's diagnosis

of the economic situation; the private economy was showing unmistak
able signs of some slippage.

Recent inventory developments offered an

impressive sign of weakness, even after allowing for the poor quality
of the data and the uncertainty of the seasonal adjustments.


situation existing in the stock market for some time now did not augur
well for future economic activity.

The earlier general feeling of

ebullience in the economy appeared to be completely gone.


economic time series indicated that acceleration had ended, in some
cases as much as a year ago.

It was important to recognize that a

great part of the economy--namely, the private sector--had not only
lost much of its momentum but might be on the way down.
Mr. Mitchell felt that monetary policy had been playing a
significant, and appropriate, role recently.

However, he did not

believe that in the U.S. economy today monetary policy could be used
effectively to check cost-push inflation.

The most that monetary

policy could do was to slow down the rate of economic expansion.


also was impressed with the lagged effects of policy actions; some of
the consequences of the Committee's actions earlier in the year were
now appearing.

And he was impressed with

the fact that banks were

now taking the kinds of measures to counter demands for business loans,
as well as other demands, that the System had hoped for earlier--and
they were doing so without coming to the discount window at all.



Accordingly, he believed the Committee now had all the restraint that
was needed and, considering lags, perhaps more than was needed.
Mr. Mitchell said he would not want to see the System enter
a period in which there was a real threat of a downturn without
recognizing that threat.
had, in

Part of the problem was that the Committee

a way, been hypnotized by the acceleration of defense


There was no doubt that defense spending had accelerated,

but there also was no doubt in his mind that if the acceleration
continued some further fiscal action would be taken.

Thus, monetary

policy would no longer be left to deal with the situation alone.


of that suggested to him that the Committee should be concerned that
it did not go

too far in the direction of restraint rather than not

far enough.
Turning to the draft directive, Mr. Mitchell said that the
only quarrel he had with the second paragraph was that he did not
think the analysis underlying the staff's expectations for the credit
proxy was very realistic, but he could not improve on it.

He would

suggest some changes in the first paragraph, however, to make the
language more consistent with the staff views expressed orally today
and in the green book.1/

Following the phrase at the end of the first

sentence reading "despite the substantial weakening in residential

1/ The report, "Recent Economic and Financial Developments,"
prepared for the Committee by the Board's staff.



construction," he would insert a comma and add "uncertainties in
equity markets, and a sharp increase in business inventories."


the phrase of the second sentence reading "credit demands remain
strong," he would insert "still" before "remain."

Finally, he

would amend the statement of the Committee's policy in the last
sentence of the paragraph by replacing the phrase "to resist
inflationary pressures" with the phrase "to moderate the rate of
growth in credit use."
Mr. Mitchell concluded by observing that he agreed with
Mr. Hayes on the best manner at present for dealing with the pull
back of funds through foreign branches of U.S. banks.

However, he

thought there might well be some backlash in the future as a result
of those inflows.
Mr. Hayes said he was not sure he understood Mr. Mitchell's
suggested change in the last sentence of the directive's first

Was the term "credit use" meant as a synonym for credit

Mr. Mitchell replied affirmatively, but indicated that he
had had total credit, rather than bank credit, in mind.
Mr. Shepardson agreed that there were some indications of
lessening ebullience in economic activity.

However, he felt that

prospects for defense expenditures lent more strength to the economic
outlook than Mr. Mitchell had suggested.

All the evidence on defense



spending, limited as it was, pointed to significant further expansion,
and the pressures that would involve had to be recognized.

It was

true that now, hopefully, there was greater prospect of fiscal action
if those pressures developed; at the same time, such action was still
in the future.
Given the conflicts among indicators and the uncertainties in
the economic situation, Mr. Shepardson said, the staff's draft
directive, as written, seemed entirely appropriate to him.

He would

interpret the draft as calling for essentially the degree of restraint
that had existed in the recent period, with allowance for unexpected
deviations of the bank credit proxy from the projections.

At some

point it might be appropriate to take a definite easing action but at
this time, with the uncertainties existing in both directions, he
thought it was desirable to maintain firm money market conditions.
It would be unfortunate, in his judgment, if money market conditions
were permitted to ease as a result of an easing in demands; by
taking up any slack that might develop the Committee would maintain
some measure of control until such time as it was able to develop a
better assessment of the outlook.
Mr. Wayne commented that a feeling of uncertainty seemed to
be more prevalent in the Fifth District even though employment
remained strong and prices received and wages continued to inch

Rates of insured unemployment achieved, or remained near,


record lows.

Textile industry respondents to the Richmond Reserve

Bank's latest survey reported significant declines in new orders and
backlogs and an increase in finished inventories.

Reports had also

been received that some textile mills had cut back to a five-day

Major manufacturers of man-made textiles recently announced

substantial price reductions for polyester blends, reportedly to
bring quoted prices more nearly in line with the actual market and to
counter the August reduction of cotton prices.

Somewhat puzzling

were reports that the Defense Department would reduce its purchases
of military textiles this fiscal year perhaps by as much as 30 per
cent--a move that might produce downward pressures on the prices of a
number of products.

Other manufacturers also reported sluggishness

in the volume of new orders and some easing of backlogs.

The strong

demand that continued for boxing material and containers was an
indication that shipments of finished goods would continue heavy.
Without a clear indication of the reason for it, it was pertinent to
note that building permits in the District were up substantially in
August for the first time since last February--the principal weakness
was in the northern part of the District.

Thus far this season,

flue-cured tobacco prices had averaged almost 7 per cent above
year-earlier levels.
In the national economy, Mr. Wayne continued, activity
remained high and spending continued strong.

Industrial production



had moved ahead, although at a reduced rate, despite lower automobile

Substantial gains in personal income supported a high

level of retail sales.

Employment also showed moderate gains but

there were occasional reports that labor was not as scarce as it was

The continuing pressure on prices was evidenced by public

announcements of price increases in September covering over a hundred
companies and a wide range of major commodities.

Defense expenditures

seemed to be running well ahead of estimates while education and
welfare expenditures showed a steady and fairly rapid acceleration.
Despite large increases in revenue from income taxes, the deficit
in the cash budget for July and August was substantially larger than
in the same months for other recent years.
Despite those sources of strength, however, inflation had not
escalated in recent months, Mr. Wayne said.

The rates at which prices

and economic activity had been rising had not increased.
there were indications to the contrary.
course, continued to decline.
significantly in August.

In fact,

Construction activity, of

Manufacturers' new orders were down

Weakness persisted in a few prices.

Automobile sales remained low and there seemed to be some concern
about the sales prospects for the new models.

Scattered reports and

speculations indicated uneasiness about the trend of corporate profits.
Unit labor costs seemed to be inching up, interest costs were higher,
and the suspension of the investment tax credit would gradually detract



from profits,

If an increase in the income tax rate was added, the

uneasiness could be converted into pessimism.
A somewhat longer look at developments confirmed the tendency
toward slower rates of growth, Mr. Wayne observed.

In the six months

ending with August, nine major measures of economic activity,
including wholesale and consumer prices, showed an average increase
of 1.3 per cent for the period, which was substantially lower than the
increase in any of the three previous half years.

In the latest

period, two of the measures registered declines; in the three previous
periods there had been no declines.
As for policy, Mr. Wayne did not believe that the scattered
signs of slower growth were sufficient to justify any easing at this
time, although they might be adequate caution against further

The slowing had probably been accomplished to a

considerable extent by monetary restraint and if that pressure were
relaxed, growth rates might bounce back, especially in the absence
of further fiscal restraint.

It was fortunate that the middle of

September had been passed with relatively little trouble.

The sharp

drop in net borrowed reserves and the easier conditions in the money
market which followed were perhaps a cheap price to pay for results

But he would not want to see the easier conditions


If the Committee gave the market reason to believe that

policy had been eased significantly, it could lose much of what it had



worked hard to attain over recent months.

It might be that the

somewhat easier and more settled conditions in the money market
during the last half of September were due to temporary factors
and would shortly be reversed.

It might be, however, that they

were caused in part by actions of member banks to contain demand
and to ration credit.

If that should be the case, the Committee

might be able to accomplish adequate restraint without quite such
high interest rates or so much tension as there had been a month

Until it could be seen whether that was true, he would favor

keeping a firm control on the availability of reserves.
Mr. Wayne favored adoption of the draft directive.
Mr. Clay remarked that while forthcoming economic devel
opments could not be known with certainty, there appeared to be
little reason to doubt that the national economy would continue
under the pressure of over-stimulation, with resources tight and
costs and prices rising.

It might be that some sectors of economic

activity would level off or decline, but the probable additions
from the military sector suggested that aggregate demand for goods
and services would remain in excess of the capacity for orderly

Certainly, it appeared the better part of judgment

that public policy, including monetary policy, should be formulated
on that premise.


-61While proceeding on that premise led logically enough to

the need for a policy of restraint, Mr. Clay continued, it did
not indicate the particular monetary policy action to be taken
at this time.

Recent developments in both the commercial banks

and the money and capital markets caused uncertainty on that point.
Recent evidence did suggest that it would be appropriate to avoid
added restraint on the commercial banks, but such short-run devel
opments would not seem sufficient basis for a turnaround in policy.
Perhaps the best course at this time would be a general goal of
continuing the current monetary policy with a guide of "maintaining
firm but orderly conditions in the money market."

Higher interest

rates would not be a target under such a policy, but rates would
be permitted to rise if credit demands increased substantially.
The draft economic policy directive appeared satisfactory
to Mr. Clay.
Mr. Scanlon reported that current discussions of economic
prospects by Seventh District businessmen often included references
to the sharp drop in housing starts, the reduced rate of auto sales,
the continued decline in the stock market, further escalation in
Vietnam, and "tight money."

Nevertheless, no convincing evidence

could be mustered in the District to indicate that demands were
pressing less vigorously on the region's facilities and manpower.
Labor markets had tightened further, Mr. Scanlon said, and
in recent weeks new claims for unemployment compensation had been



well below the reduced level of a year earlier.

He had been

unable to uncover any evidence that construction workers had been
idled as a result of the decline in housing starts.

Such workers

apparently had been absorbed in nonresidential construction or in

Order backlogs of producers of machinery and equipment

continued to rise in August, with defense orders helping to boost
the total.

He saw no evidence that orders had been reduced signif

icantly as a result of the proposed suspension of the investment
tax credit.

A large Chicago area steel producer reported that

demand from all major customer groups--including the auto industryremained excellent, in contrast to some newspaper and trade journal
accounts of a slower order trend.
Demands for credit by businessstill appeared strong,
Mr. Scanlon observed.

Expansion in business loans, after slowing

markedly in August, continued at a moderate pace in September at
major District banks, but whatever slackening had occurred seemed
mainly a reflection of the restrictive loan policies of the banks.
Responses to the September 15 lending practice survey indicated
that most of the large District banks felt loan demand was stronger
now than three months ago, and the majority expected that demand
to show at least moderate increases in the fourth quarter.


of the respondents stressed their lack of liquidity, uncertainty
about their ability to replace CD money, and anticipated strong



loan demand as the major reasons for their firmer lending practices.
Reserve positions of the Chicago banks were showing some additional
pressure, with purchases of Federal funds up substantially and
moderately greater use of the discount window.
With large prospective demands for credit both by Government
and by private business through the fourth quarter, the pace of
credit and monetary growth seemed likely to Mr. Scanlon to accelerate
in the period ahead--again posing for policy a problem of maintaining
adequate restraint within an acceptable range of interest rates.
Recent data continued to show evidence of a general slowing in
monetary and bank credit expansion since mid-year.

It was apparent

now that at least part of the recent increase in interest rates
could be attributed to the cutback in the rate of growth in supply
of loanable funds as a result of System actions.

Given the current

and prospective price and employment conditions, it appeared appro
priate to undertake to maintain very slow rates of monetary and
credit expansion.

Therefore he favored a policy of maintaining the

recent posture but with the proviso that the Committee undertake
to offset the effects of any strengthened credit demand.
The draft directive was satisfactory to Mr. Scanlon,
although he continued to have concern about the phrase "current

It seemed to him that somewhere along the line the

System might have to define that phrase, in retrospect.




that meant reading into the record the contents of the blue book
and, if so, whether the Committee's actions were consistent with
those "current expectations" he was not certain, but it did cause
him some concern.
Mr. Galusha reported that last week witnessed the establish
ment, in the Twin Cities area, of a new pattern of share and deposit

Area savings and loan associations, taking advantage of

the recently announced Federal Home Loan Bank Board policy, introduced
six-month savings certificates which paid the ceiling rate.


the one large savings bank in the Ninth District raised its rates
on passbook and time deposits.

And last Friday the largest bank

in the District announced a 5 per cent small-denomination CD rate.
Almost certainly, all the other reserve city banks in the District
were going to follow, so it would seem that the implementation of
the new rate-ceiling legislation had had the effect of raising rates.
He need not tell the Committee, he supposed, that District bankers
outside the Twin Cities were unhappy.

Whether the savings and loan

associations were going to fare better under the new rate structure
than they did under the old was not something he as yet had any idea

Also uncertain was the real impact a reflow in their direction

might have on the depressed residential construction industry.
Mr. Galusha noted in passing that there had been very few
member banks paying more than 5 per cent on time deposits, so dealing



with the distortions induced by a roll-back would not be a quan
titatively significant problem.
Mr. Galusha said that large District banks seemed to have
gotten through September fairly well and, whether rightly or
wrongly, did not seem to be panicky about an October run-off of

Borrowing from the Reserve Bank had been moderate and very

much in the pattern of the past several months.

The banks continued

very reluctant to borrow under the new program of discount window
Turning to the issue of policy, Mr. Galusha remarked that
the GNP account projections contained in the green book seemed
entirely reasonable to him.

He certainly agreed that a highly

probable increase in Federal defense purchases "dominates the
economic outlook," but would add that, at the moment, relatively
large increases in Federal civilian and State and local purchases
also had to be expected.

For a while to come, at any rate, State

and local governments were going to be enjoying relatively high
tax flows.
Accordingly, Mr. Galusha saw no strong case for forcingor even permitting, in the face of temporarily reduced credit
demands--generally lower interest rates.

But neither could a

strong case be made, it seemed to him, for forcing generally higher
interest rates.

Almost certainly the coming few months would witness



higher income tax rates--unless, of course, they witnessed a de
escalation in Vietnam, a possibility that only the most extravagant
optimist could expect.

Even if a tax rate increase were not in

the offing, there would still be reason enough for waiting.


was not known as yet what the effect of suspending the tax credit
and accelerated depreciation was going to be.

Then, too, embar

rassing as it might be to Committee and staff members, it was not
known what effect current monetary stringency was having on the
demand for plant and equipment.

He sensed that it was appreciable;

but he could not prove or even be highly confident about that.
Like Mr. Mitchell, he, too, felt an uneasiness.

In soundings taken

with businessmen he sensed a common concern with the civilian side
of the economy.

But again, except for retail sales in the Twin

Cities and residential construction, there were no clear signs
visible to him.

That was why he was an advocate of a cautious

And since the time until the new plant and equipment

surveys would be available was short, waiting would seem to be
Mr. Galusha thus favored maintaining "firm but orderly
conditions in the money market," and aiming not, perhaps, for
last week's average of money market rates but for a slightly higher

He would expect a slight firming of money market rates

to be consistent with a rather considerable decrease in average



net borrowed reserves.

But if events were to prove that expectation

wrong, he would not back off from his rate objective.

The market

could easily be persuaded that a greater average net borrowed
reserve figure did not mean the System had changed its mind about

The directive, as drafted, seemed fine to him.
Mr. Swan said that more complete figures confirmed the

impression he had reported three weeks ago--that in the Twelfth
District in August there had been no increase in nonagricultural
employment and another small rise in the unemployment rate.


housing starts were above July but still well below the levels of
each of the first six months of 1966.

Perhaps some encouragement

for the longer-run could be found in the fact that the rental
vacancy rate was down in the second quarter from a year earlier.
However, that rate remained higher in the west than in other areas
of the country.
The most significant recent development in the banking
sector, Mr. Swan continued, seemed to be the very small growth,
both absolute

and relative to the rest of the country, in business

loans of District weekly reporting banks during the first three
weeks of September.

The increase had been only 1/3 of 1 per cent,

compared with a rise of 2-1/4 per cent at weekly reporting banks
outside the District.

While the survey of lending practices in

the District continued to show increases in the strength of business



loan demand, he wondered whether there were not some reporting
lags in that area, as there were in others.

Banks had tightened

their business loan policies somewhat, but he would hesitate to
ascribe the extraordinarily small increase in business loans solely
to that factor.
On the other side of the balance sheet, Mr. Swan remarked,
the major District banks had had their share of CD losses in the
past three weeks--both corporate CD's and, more particularly, time
deposits of States and political subdivisions.

In the three weeks

ending September 21, Twelfth District weekly reporting banks lost
5 per cent of their State and local government deposits, compared
with a corresponding decline of 1/3 of 1 per cent outside the
District; since mid-year the decline in the District had been
17-1/2 per cent, compared with 11 per cent elsewhere.
from the Reserve Bank were still quite low.


Following the recent

high reached in the week ending September 7, borrowings had declined
each week both absolutely and relative to the rest of the country.
As the Committee knew, Mr. Swan said, the new ceiling rates
on savings and loan passbook accounts were somewhat higher in
California than elsewhere.

The ceiling rates of 5-1/4 per cent on

passbook accounts and 5 per cent on bank CD's under $100,000 were
about in line with existing patterns.

However, California associa

tions could no longer offer 5-3/4 per cent on new bonus accounts,



in which there had been considerable growth during the past several

As far as banks were concerned, a few smaller banks that

had been offering 5-1/2 per cent on consumer-type certificates
might suffer losses, but the great bulk of such deposits had been
earning no more than 5 per cent.

A number of banks had argued

that the ceiling rate on CD's under $100,000 held by States and
political subdivisions should have been left at 5-1/2 per cent
rather than being reduced to 5 per cent.

That was related in part

to one kind of reaction that had occurred to the Board's earlier
action with respect to multiple-maturity deposits; to some extent
multiple-maturity deposits of governments had been replaced by a
series of fixed maturity deposits, each of which was less than
$100,000, and substantial losses of such deposits were now feared.
As to policy, Mr. Swan said, like Mr. Mitchell he shared
Mr. Partee's concern about some of the recent developments in the
private sector.

Given the probable levels of defense expenditures,

however, he saw no basis for an easing of policy, and he would
continue about as at present for the next few weeks.

While one

might hope for additional fiscal action if defense expenditures
continued to rise, such action was still in the future, and the
Committee could not make any particular assumptions as to its form
or intensity.

Accordingly, it seemed to him that the Committee



should continue to maintain the policy of caution, with exceptions
allowed for unforeseen developments under the proviso clause of
the directive.
As to the wording of the directive, Mr. Swan would support
the changes Mr. Mitchell proposed in the first two sentences.


ever, he would retain the phrase "to resist inflationary pressures"
in the last sentence of the first paragraph, particularly in view
of the statement earlier in the paragraph that inflationary pressures
were persisting.

But he was disturbed by the second part of the

last sentence, reading "and to strengthen efforts to restore rea
sonable equilibrium in the country's balance of payments."


efforts were to be strengthened was not clear; one might infer that
it was the Committee's efforts.

But that would imply additional

firming, which was not consistent with the rest of the directive.
Perhaps the word "continue" should be substituted for "strengthen."
With respect to the second paragraph, he agreed that some reference
to the Treasury financings should be included, but it should be
worded to avoid implying that the financings were the primary factor

the policy decision.
Mr. Irons reported that economic conditions in the Eleventh

District had been strong recently, with inflationary overtones, but
they were not surging.

Nonagricultural employment had risen a bit,

as it had for the past several months.

The District industrial



production index continued at a high level and showed a year-to
year gain of 9 per cent.

Construction activity varied from month

to month, but for the year to date it was up about 10 per cent
from the same period last year.

Retail sales remained strong--thus

far in 1966 they were 7 per cent above 1965--but new car registrations
were relatively unchanged this year from last year.


was enjoying highly favorable conditions; moisture was good and
the outlook was excellent.

Cash farm receipts were up appreciably

from the comparable period in 1965.
In the financial area, Mr. Irons continued, over the past
three weeks loans at District weekly reporting banks were up about
$90 million, with two-thirds of the rise occurring in commercial
and industrial loans.

Investment portfolios were reduced a bit,

with most of the reduction in holdings of Treasury securities.
Demand deposits in District banks were up substantially but time
deposits were down a little, perhaps reflecting CD experience.
Borrowings averaged $77 million as against $42 million in the preced
ing three weeks.

Only one bank had evidenced any interest in the

special program of discount administration, and apart from that
bank borrowings in the District were relatively low.

Average net

purchases of Federal funds had been running a bit higher recently
and there was a relatively wide use of the funds market, even among
smaller country banks.

There were indications, although slight as



yet, that some intermediate-size banks would shift from the Federal
funds market to the discount window for liquidity purposes if the
Reserve Bank would permit them to do so.

Some banks had indicated

that they interpreted the special program as involving a less
tight administration of the window and they almost implied that
if funds were to be made available more readily they would be
interested in getting some of them.
Mr. Irons observed that the money and capital markets had
been influenced by a variety of factors during most of September,
including rumors as well as actual events, as had already been

The result was sharp and varying movements of rates

and conditions in the market.

He had been more satisfied with the

conditions prevailing in the later part of the period than in the
earlier part, but he noted that the markets had come through the
difficult earlier time with much less of a problem than had been
On the basis of observations in his District, Mr. Irons
felt that bankers were now taking a somewhat different view than
they had three or six months ago of the System's program for
restraining bank loans.

Earlier, the situation had been one of a

scramble for funds to lend.

Now, while the banks were not nec

essarily turning down every loan application they received, they



were clearly accepting the fact that it was necessary for them to
carry out their part of the program.
As to policy for the coming period, Mr. Irons recommended
maintaining firm but orderly conditions in the market.


pressures continued strong despite the fact that monetary policy
was biting; he recognized the forces working in the other direction
but still felt that the balance was on the inflationary side.


however, the Committee should attempt at this point to achieve a
little more stability in the market than had existed at times in
the past month.

The Treasury would be in the market, and their

operations would have rate effects; and it was not possible to say
what would happen in connection with the short-term CD's that would
mature in October.
In sum, Mr. Irons favored continuing the policy of the past
few weeks while trying to bring about more stable conditions and
attitudes in the market generally.

Any effort to ease policy would

risk losing some of the recent gains, and any effort to firm would
threaten to produce other undesirable conditions in the financial

The directive as drafted was acceptable to him; in partic

ular, the second paragraph specified the proper objectives.


at this time the Account Manager had to have a great deal of flexibil
ity to meet the situations that could arise from day to day--or even



from hour to hour, as had been clear during the recent period
when he (Mr. Irons) had participated in the daily call.

He would

not favor any change in the discount rate at this time.
Mr. Ellis said that again he had to confess that the
fundamental aspects of employment, production, and income in the
First District fell into a more comprehensible pattern than did
the financial counterparts of those activities.

Measured in real

terms, seasonally adjusted employment had continued rising in the
latest available data.

Factory output, paced by year-to-year gains

of 20 per cent in machinery industries, had recorded a 13 per cent
twelve-month gain.

The Reserve Bank's fall survey of capital

investment plans of New England manufacturers was nearly completed,
and it indicated that 1966 outlays would exceed those of last year
by more than one-third.

Carry-over into next year of uncompleted

programs would account for almost twice the normal 10 per cent
recorded in previous surveys.
In the financial area, Mr. Ellis continued, like Mr. Hayes
he found the data perplexing.

In the past three weeks, business

loans in New England leveled off on a plateau 17 per cent above
last year's level.

Other loans and investments continued to grow,

however, as did both time and demand deposit totals.

On balance,

the large banks found themselves in a somewhat easier position than
contemplated earlier.

As a result, at least partially, borrowing



at the discount window in Boston declined by 35 per cent between
August and September, at a time when borrowing in the nation rose
by 4.7 per cent.
In good conscience, Mr. Ellis remarked, he had also to
report that that regional variation in borrowing might trace to
some differences in administration of the discount window.


ing the September 1st letter, he had held face-to-face conferences
with the District's eight largest banks, and he had discussed
discounting in five area conferences including officers and directors
of 41 per cent of member banks and 32 per cent of nonmember banks.
Nowhere did he find any disposition to seek extended borrowing
privileges as an assist in reserve adjustement during curtailment
of business loans.

But the Bank did receive queries reflecting

the belief that Mr. Irons had mentioned, that discount administra
tion had been eased.
Concerning the need that Mr. Hayes had noted for avoiding
the concept of two discount windows, Mr. Ellis suggested abandoning
the effort to tabulate statistics on the special discounting program.
First, the intended use of the data was not clear to him, and he
was not convinced that they would have any significant meaning.
Secondly, the requirement that discount officers report on the
program inevitably affected both the timing of their calls and



what they said when they talked with borrowing banks.

Those aspects

of the program could have undesired consequences.
Recently, Mr. Ellis said, a large life insurance company
had advised the Reserve Bank that policy loan expansions in July
and August each absorbed the equivalent of their present holdings
of cash and short-term Governments.

Their sales of stocks and

bonds to meet that drain were quite painful in present markets.
While they had a bank loan commitment of $25 million, they had not
yet had to draw on it.

They had requested an appointment with the

Reserve Bank to discuss possible sources of liquidity if their
pinch worsened.

To date, he had learned of only one savings bank

that was borrowing any significant amounts from commercial banks,
and that was to forestall sale of near-maturity Governments.
On the national scene, Mr. Ellis continued, probably the
most notable and salutary development had been the interruption of
bank credit expansion in September.

While it was tempting to

conclude that monetary policy was now--at long last--biting enough
to slow down the credit boom, he was disinclined to suggest any
change in policy based on such a short-term development.

He noted

the projections for October indicated a resumption of credit expan
sion and run-up in reserves.

The Committee should be careful to

distinguish between inflection points, which it sought, and down
turns into actual decline, which it did not seek.


-77Mr. Ellis viewed the Committee's principal problem today

as one of usefully defining to the Manager a workable concept of
"no overt change in policy."

Unfortunately, the one week in which

net borrowed reserves dropped below $200 million, in company with
declining bill rates, did suggest to some bankers that policy was
being eased.

He agreed with Mr. Hayes that now was not the time

to raise the discount rate.

Unfortunately, however, the magnitude

of the difference between the discount rate and rates on other
reserve adjustment instruments threw into question the meaning of
any given level of borrowing.

In effect, the level of borrowing

was a measure of how high and leakproof the System had built the
dikes against borrowing by its discount administration.
Mr. Ellis commented that the staff projections of October
growth rates in bank credit of 5.6 per cent, in required reserves
of 9.9 per cent, and in the money supply of 7 per cent, were all
premised on net borrowed reserves averaging $450 million, although
such a level had not been attained in any month in the present period
of tight money.

Such rates of growth were clearly adequate if not

Accordingly, he would conclude a net borrowed reserve

target of $450 million was an entirely feasible starting point in
setting policy objectives for October.
Mr. Ellis agreed with the staff comment in the blue book

that "The outlook for the coming month is consistent with a tendency



not only for short-term markets to tighten but also for long-term
rates to rise."

However, he felt some inclination to challenge

the usefulness of the subsequent and concluding paragraph, where
it was suggested that "...a failure of (money market) rates to
tend upward may mean that banks are under less loan pressure than
we currently foresee..."

Instead, he would anticipate that a

failure of money market rates to rise would more likely result from
the Committee's failure to re-establish the tightness experienced
in August.

He foresaw a danger, out of concern for Treasury

financing, of repeating the December 1965 experience.

By over

concern with the levels of rates the Committee could easily lose
its grip on required reserves, and find them flowing out even more
rapidly than the 9.9 per cent rate that the staff projected as
likely if the Committee were to be successful in achieving a net
borrowed reserve figure of $450 million.
As to the draft directive, Mr. Ellis said, the majority
view expressed around the table was that it was appropriate, which
he took to mean that it was vague enough to be acceptable.

But he

thought the Committee owed it to itself to determine what the
language meant to it.

The proviso clause began, "operations shall

be modified in the light of unusual liquidity pressures..."


understood that to mean that operations should be modified toward
ease in the event of severe liquidity pressures.

The clause also



said that operations should be modified in light "of any appar
ently significant deviations of bank credit from current expectations."
Underscoring the words "apparently" and "significant," he reflected
that while the phrase was vague he understood it to mean that
operations should be modified toward tightness if bank credit
growth exceeded expectations.

He agreed with Mr. Scanlon that the

reference to expectations posed a problem.

He thought the Committee

should attempt to define its current expectations in the course of
its deliberations; presumably the intention of the directive wording
was to refer to the projections given on pages 4 and 5 in the blue

He shared Mr. Swan's concern about the use of the word

"strengthen" in the last sentence of the first paragraph and sugges
ted use of the word "support."
Mr. Robertson then made the following statement:
Everything I have read and heard in connection
with this meeting seems to me to argue for a policy of
very watchful waiting over the weeks ahead.
On the one hand, the signs of slowdown in credit
expansion and promise of more fiscal restraint make
me disinclined to any further tightening of monetary
policy just now. On the other hand, continued cost
and price increases and the absence of any evidence of
abatement in the strong upthrust of public and private
spending make me wary of any shift toward monetary ease.
While I do not want to be premature in the matter
of easing, I most certainly do want us to be prepared
to act promptly and at the right time. With as much
cumulative restraint as we have built up within the
System, and with all the lagged effects that will result
from it in the quarters ahead, I think we have to be very
much on our guard against staying too tight too long, but



we are just beginning to attain the goal we have been
working toward and I am not yet convinced that the
time for change has arrived.
The staff expects money market conditions to
tighten a little as Treasury bill financing and
corporate borrowing for tax purposes come into the
picture in October. Consequently, a little firming
would be appropriate if bank credit and particularly
business credit run as strong as expected, or stronger.
But if they turn out to be appreciably weaker, then
I would want the Manager to begin to moderate reserve
pressures somewhat, and not to have to wait for the
next meeting to obtain a Committee authorization for
doing so. Hence, the "proviso" clause in the directive
can prove to be particularly helpful during the next
few weeks.
The actions outlined are consistent with the
substance of the directive as adopted at the last
meeting, and I would favor adopting it again with
the few language suggestions made by the staff; how
ever, I would favor Governor Mitchell's suggested
additions to the first two sentences of the directive.
Chairman Martin observed that the views on policy of
Committee members appeared to be closer together today than they
had been for some time.

He would make just one observation.


the basis of reading he had done since returning to the office
after his absence this summer, he was of the view that if it were
not for defense spending the economy might well be experiencing a
little downturn right now, and he did not think defense spending
was a very strong prop for an economy.

That led him to the view

that monetary policy had done about all it should be expected to
do at present.

The proper course for Government policy at this

juncture was clear; any substantial increase in defense expenditures



should be covered by a tax increase.

He believed that that was

recognized by the Administration, and if there was a supplemental
budget request of any size it would be accompanied by a proposal
for fiscal policy action.
The Chairman went on to say that the recent legislation
relating to deposit interest rate ceilings had been handled as
well as might have been expected.

The legislation enacted

probably was the least objectionable of the available means for
solving the problems at which it was directed.
The present was a difficult period, Chairman Martin
continued, with dislocations and disruptions in markets.


Mr. Robertson, he was inclined toward a policy of "watchful

He thought the Committee should seek to attain as much

stability as possible, particularly in view of the prospective
Treasury financings.
As to the directive, the Chairman suggested that the
Committee accept the changes in the first two sentences of the
staff's draft recommended by Mr. Mitchell, the substitution
proposed by Mr. Swan of "continue" for "strengthen" in the last
sentence of the first paragraph, and the inclusion of the ref
erence to forthcoming Treasury financings in the second paragraph
recommended by Mr. Daane.

He did not favor Mr. Mitchell's sugges

tion that the first-paragraph phrase "to resist inflationary



pressures" be replaced by other language.

Inflationary pressures

were continuing, whether they were of the demand-pull or cost
push variety.

He asked whether there were any objections to a

directive formulated in the manner he had described.
Mr. Solomon commented that citing "a sharp increase in
business inventories" among the signs of weakness, as Mr. Mitchell
had suggested, might mislead readers of the policy record if they
were not aware that a good part of the increase was involuntary.
It might be better to say "despite slower growth in final demand
than in output."
Mr. Mitchell said he would be willing to refer to an
"involuntary" increase in inventories.
Chairman Martin commented that if the phrase was likely
to be misleading it might be better to omit it.
Mr. Partee observed that of the two signs of weakness for
which Mr. Mitchell had proposed adding references, he felt the
inventory increase was more significant than the uncertainties in
equity markets.

He thought it would be understood from the context

that much of the inventory rise was considered likely to have been
involuntary and, in any case, the text of the policy record entry
prepared for today's meeting undoubtedly would make that point clear.
There was general agreement with Mr. Partee's observations.


-83Thereupon, 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 is expanding vigorously, despite the substantial
weakening in residential construction, uncertainties in
equity markets, and a sharp increase in business inventories.
Inflationary pressures are persisting and aggregate credit
demands still remain strong. The balance of payments
continues to show a sizable liquidity deficit. In this
situation, and in light of the new fiscal program announced
by the President, it is the Federal Open Market Committee's
policy to resist inflationary pressures and to continue
efforts to restore reasonable equilibrium in the country's
balance of payments.
To implement this policy, and taking account of forth
coming Treasury financings, System open market operations
until the next meeting of the Committee shall be conducted
with a view to maintaining firm but orderly conditions in
the money market; provided, however, that operations shall
be modified in the light of unusual liquidity pressures
or of any apparently significant deviations of bank credit
from current expectations.
It was agreed that the next meeting of the Committee would be
held on Tuesday, November 1, 1966, at 9:30 a.m.
Thereupon the meeting adjourned.



October 3, 1966

Draft of Current Economic Policy Directive for Consideration by the
Federal Open Market Committee at its Meeting on October 4, 1966

The economic and financial developments reviewed at this
meeting indicate that over-all domestic economic activity is expanding
vigorously, despite the substantial weakening in residential construc

Inflationary pressures are persisting and aggregate credit

demands remain strong.

The balance of payments continues to show

a sizable liquidity deficit.

In this situation, and in light of the

new fiscal program announced by the President, it is the Federal Open
Market Committee's policy to resist inflationary pressures and to
strengthen efforts to restore reasonable equilibrium in the country's
balance of payments.
To implement this policy, System open market operations until
the next meeting of the Committee shall be conducted with a view to
maintaining firm but orderly conditions in the money market; provided,
however, that operations shall be modified in the light of unusual
liquidity pressures or of any apparently significant deviations of
bank credit from current expectations.


June 1965
June 1966

June 1966
September 1966 1/

5.8 %

Money Supply
Demand Deposit Component
Currency Component
Time Deposits
Money Plus Time Deposits

1.4 %

Bank Reserves

Total Reserves
Reserves Available for Private
Demand Deposits*
Federal Reserve Holdings of
U.S. Government Securities* 2 /











- 2.1

Interest Rates
4-to 6-Month Commercial Paper
3-Month Treasury Bills
3-5 Year Governments
Long-Term Governments
Corporate Aaa Bonds
Municipal Aaa Bonds
25-Year FHA Mortgages
FHLB Average of Conventional
First Mortgage Loans Including
Fees and Charges




+ 30.6
+ 58.3
+ 13.6
+ 37.5
+ 39.2
+ 1 5 .7a



1/ September figures are estimates.
2/ Adjusted to include effects of changes in reserve requirements
on time deposits.
a June to August, partially estimated.
* Seasonally adjusted by this Bank.

Prepared by Federal Reserve Bank
of St. Louis
October 3, 1966