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MEMORANDUM OF DISCUSSION

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, September 19, 1972, at

9:30 a.m.

PRESENT:

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

Burns, Chairman
Hayes, Vice Chairman
Brimmer
Bucher
Coldwell
Daane
Eastburn
MacLaury
Mitchell
Robertson
Sheehan
Winn 1/

Messrs. Francis, Heflin, and Mayo, Alternate
Members of the Federal Open Market Committee
Messrs. Morris, Kimbrel, and Clay, Presidents
of the Federal Reserve Banks of Boston,
Atlanta, and Kansas City, respectively
Mr. Holland, Secretary
Mr. Broida, Deputy Secretary
Messrs. Altmann and Bernard, Assistant
Secretaries
Mr. Hackley, General Counsel
Mr. Partee, Senior Economist
Mr. Axilrod, Economist (Domestic Finance)
Mr. Solomon, Economist (International Finance)
Messrs. Boehne, Bryant, Gramley, Green, Hersey,
Hocter, Kareken, and Link, Associate
Economists
Mr. Holmes, Manager, System Open Market Account
Mr. Coombs, Special Manager, System Open Market
Account
1/

Left the meeting at the point indicated.

9/19/72
Mr. Coyne, Special Assistant to the Board
of Governors
Mr. Reynolds, Associate Director, Division
of International Finance, Board of
Governors
Messrs. Keir, Pierce, Wernick, and Williams,
Advisers, Division of Research and
Statistics, Board of Governors
Mr. Pizer, Adviser, Division of International
Finance, Board of Governors
Mr. Struble, Economist, Division of Research
and Statistics, Board of Governors
Mrs. Sherman, Secretary, Office of the
Secretary, Board of Governors
Mr. Merritt, First Vice President, Federal
Reserve Bank of San Francisco
Messrs. Eisenmenger, Parthemos, Taylor, Scheld,
Andersen, Tow, and Craven, Senior Vice
Presidents, Federal Reserve Banks of Boston,
Richmond, Atlanta, Chicago, St. Louis,
Kansas City, and San Francisco, respectively
Mr. Cooper, Assistant Vice President, Federal
Reserve Bank of New York

By unanimous vote, the
minutes of actions taken at
the meeting of the Federal
Open Market Committee on
July 18, 1972, were approved.
The memorandum of discussion
for the meeting of the Federal
Open Market Committee on July 18,
1972, was 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

9/19/72

period August 15 through September 13,

1972,

and a supplemental

report covering the period September 14 through 18,

1972.

Copies

the files of the Committee.

of these reports have been placed in

In comments supplementing the written reports,
observed that since the last meeting of the Committee,

Mr.

Coombs

the dollar

had strengthened further against most of the European currencies,
with reflows of short-term funds from Europe apparently offsetting
deficits elsewhere in the U.S. balance of payments.

The market

had seemed to be discounting any important or disturbing develop
ments at the forthcoming IMF meeting.

The recent sharp decline in

the London gold price, reflecting rumors of impending Russian sales,
an adverse turn in

the South African balance of payments,

and German

rejection of any gold price increase, had also helped to relieve
market anxieties.

During the past week,

the payments balance also

seemed to have benefited from some covering of short positions
against the dollar taken 3 months ago at the time of the sterling
crisis.

Finally,

the possibility of new intervention by the Federal

Reserve was very much in the minds of market traders.
Shortly after the last meeting, Mr. Coombs said, the System
sold roughly $10 million of German marks to consolidate the improve
ment of the dollar against that currency, and it had not done
anything more in marks since then.

The System also phased out its

intervention in Belgian francs, and the franc subsequently remained

9/19/72

well below its ceiling.

Since then the System had been accumulating

both Swiss francs and German marks through modest day-to-day pur
chases whenever market conditions were favorable, and it had built up
Swiss franc balances to the equivalent of $23.5 million, and mark
balances to the equivalent of $60 million.
At the last meeting, Mr. Coombs noted, he had recommended
that a tentative proposal from Mr. Leutwiler, of the Swiss National
Bank, to effect a sizable reduction in the System's Swiss franc
swap debt through joint forward operations by the Federal Reserve
and the Swiss National Bank, be referred to the Subcommittee.
Unfortunately, Mr. Leutwiler's proposal was not approved by the
President of the Swiss National Bank, Dr. Stopper, on the latter's
return from vacation.

If and when the uncovered dollar position

of the Swiss National Bank was reduced to somewhat lower levels,
the Leutwiler proposal might be revived, but for the time being
it was stalled.
Looking to the future, Mr. Coombs observed that with every
month that passed the trend of U.S. trade figures would probably
increasingly influence market psychology.

If the figures published

in the current or following month indicated a decided improvement,
the return flow of funds from Europe might suddenly jump to heavy
proportions.

On the other hand, he saw a major risk that continuing

speculation on a revaluation of the Japanese yen might tend to

-5

9/19/72

enlarge further the U.S.

trade deficit with Japan,

canceling out

possible improvement elsewhere and thereby leaving a false impres
sion of a general overvaluation of the dollar.

On the other hand,

market psychology would also be strongly influenced over coming
months by the success or failure of the Western European govern
ments in

dealing with inflationary pressures which seemed to be

gathering additional force.

At present, market opinion was inclined

to believe that the United States would do better than Europe in
controlling inflation and thereby gradually improve its competitive
position.
Finally,

Mr.

Coombs commented that the Common Market faced

a major political and technical problem in
inflicted on its

repairing the damage

monetary unification project by the sterling

crisis and the speculative problems associated with the "snake in
the tunnel."

For the time being, the threat of joint floating or

other joint defensive action against the dollar had receded,

and

the potential weakness of individual currencies was being more
closely scrutinized.

Over the next few months,

therefore,

a good

many cross-currents might appear in the market and might call for
a fairly flexible policy response.
By unanimous vote, the
System open market transactions
in foreign currencies during the
period August 15 through Septem
ber 18, 1972, were approved,
ratified, and confirmed.

9/19/72

Mr. Coombs then reported that 4 System drawings on the
National Bank of Belgium, totaling $110 million, would mature for
the fifth, sixth, or seventh time in the period from October 3 to
October 27.

The System would endeavor to repay the drawings as

they matured.

If the Belgian franc continued to weaken, it might

be possible to buy some francs in the market.

However, he would

not want to push the franc rate back to its ceiling, which would
undo much of the benefit that had resulted from the System's
intervention in the market.

In addition, it might be possible to

negotiate with the German Federal Bank and the Belgian National
Bank to use some of the System's holdings of marks in repayment
of its debt in francs, although that was a kind of operation
that he would not want to engage in very often.

If it proved

to be impossible to accumulate sufficient Belgian francs to
repay the drawings, there would be no alternative to renewing
them.
In reply to a question by Chairman Burns, Mr. Coombs said
the System could not buy francs directly from the Belgian National
Bank with dollars at this time.

The Belgians took the position

that the Smithsonian Agreement obligated them to buy dollars only
at the ceiling rate; they were likely to maintain as well that they
would buy only in the market and not directly from other central
banks.

Although they also were eager to have the swap debts repaid,

-7

9/19/72

they believed, as he did, that it was better to wait for a safer
opportunity.
Mr. Daane remarked that at the meeting of central bank
Governors in Basle over the preceding weekend, a number of governors
--and the Belgian Governor, in particular--had complimented the
System on its operations in the foreign exchange markets.
Chairman Burns remarked that he wished to express the
Committee's appreciation to the Manager for his conduct of recent
operations.
By unanimous vote, renewal for
further periods of 3 months of the 4
System drawings on the National Bank
of Belgium maturing in the period
October 3-27, 1972, was authorized.
Chairman Burns then invited Mr. Daane to report on develop
ments at the meeting in Basle on the weekend of September 9-10.
Mr. Daane remarked that to save time, he would submit a
statement for the record 1/and abstract from that statement the
two or three items most relevant to Committee policy.

First, the

Basle meeting was quiet and uneventful, and hopefully that fore
shadowed a similarly quiet and noncontroversial annual meeting of
the International Bank and International Monetary Fund, which was
to be held in Washington during the week beginning on September 24.
Second, the European governors, looking toward a meeting of their
own to be held on the day after the Basle meeting, were preoccupied
1/ Mr. Daane's statement is appended to this memorandum as
Attachment C.

9/19/72

-8

with their own problems of actual or incipient inflation and the
potential role of monetary policy in dealing with those problems.
They were worried about rapid rates of monetary expansion in their
own countries--most notably in the United Kingdom--and were search
ing for methods of controlling the money stock.

Finally, there was

considerable discussion of central bank activities in the Euro-dollar
market, in view of the German Finance Minister's proposal--incorporated
in his economic program--that central banks withdraw funds from the mar
ket.

The Standing Committee on the Euro-currency Market was charged

with the task of taking a fresh look at the question and at the related
one of the possibility of an attractive,

alternative investment outlet

in the United States--either a "money-employed account" at the
Federal Reserve Bank of New York or a new Treasury instrument.

The

latter was discussed with a view toward also utilizing any such
instrument to attract central bank funds of non-Group of Ten countries.
The Chairman then called for the staff report on the domestic
economic and financial situation, supplementing the written reports
that had been distributed prior to the meeting.

Copies of the

written reports have been placed in the files of the Committee.
Mr. Gramley made the following statement:
At the last meeting of the Committee, Mr. Partee
called attention to evidence that the pace of expansion
in real activity had slowed over the late spring and
summer months.
Since then, industrial output and employ
ment have shown signs of some strengthening.. Both manu
facturing and total nonfarm payroll employment rose
considerably in August, and the length of the factory
workweek increased. Gains in industrial output last

9/19/72

month were widespread by industry groupings; the 1/2
percentage point increase in the index was the largest
since April, and estimated production levels in June
and July were revised up a shade.
This recent pickup in the tempo of industrial
activity, however, still
leaves us well below the
gains in real output and
last
spring's
rapid
track of
employment. Manufacturing employment in August was
only a little higher than in May, and new hires in
manufacturing have not regained the rates seen earlier
this year. Industrial production from May to August
rose only about one-third as rapidly as in the previous
3 months. Rates of increase have been appreciably
slower for most major categories of industrial outputdefense equipment being the notable exception.
Some persisting effects of the June floods may
still be reflected in these figures, but that could
explain only a small part of the recent moderation in
real growth. The more fundamental factors seem to be
the leveling out of activity in residential construc
tion--though we learned late yesterday that housing
starts rose appreciably in August--and the continued
cautious policies of businesses with regard to inventory
accumulation. Nowhere have these cautious attitudes
been more evident than in the auto industry. In June
and July total business inventory accumulation was held
down by declining auto inventories at retail, and in
August stocks of domestic units fell further, to a 44-day
supply at August sales rates--the smallest supply relative
to sales in 5 years. But in other lines, too, stocks
have been permitted to decline in relation to sales; in
fact, the aggregate stock-sales ratio for manufacturing
and trade firms is now down to its lowest level since
about mid-1966.
Despite the recent lull in the rate of economic
expansion, our staff view of the outlook has not been
altered appreciably. Some moderation from the unusually
rapid pace early this year was to be expected and, indeed,
welcomed. And there is reason to anticipate a return to
rather vigorous expansion in the months ahead.
Consumer spending has continued to be very strong;
August retail sales recorded another 1-1/2 per cent
increase, following a rise of nearly 2 per cent in July.
And the mood of retailers--as conveyed, for example, by

-10-

9/19/72

1/

the red book --suggests widespread optimism about
near-term trends in consumer buying. Domestic new
car sales did fall significantly in the first 10 days
of September, but this may be explained partly by the
low level of stocks and the absence of efforts to sell
1973 models before the formal introduction date.
The outlook for business fixed capital spending
also continues favorable. Manufacturers' new capital
appropriations rose again in the second quarter, and
new orders for nondefense capital goods were unchanged
in July at a level 11 per cent above the first-quarter
monthly average. The latest Commerce survey reduced
slightly the increase in anticipated plant and equip
ment outlays for the year 1972, but the reduction was
in estimated expenditures during the second quarter.
A substantial rise is now expected in the second half
of this year, whereas little had been anticipated in
the May survey.
Turning briefly to wages and prices, recent
developments have been disappointing, even though
not unexpected. Average wage-rate increases in July
and August were more substantial, following a very
tranquil period from April through June. Since
January, however, the annual rate of increase in
average hourly earnings is still only about 4-3/4
per cent. The rapid rise in wholesale prices in
July and August and the acceleration in the rise of
the consumer price index in July were more disheart
ening. It is small comfort that the largest increases
have been mainly among commodities whose prices are
volatile. Unfortunately, with prices, what goes up
need not come down.
Looking ahead, our staff projection for the fourth
quarter of 1972 and for the year 1973 is for somewhat
larger increases in nominal GNP than the projection a
month ago. Real growth is expected to be large enough
to reduce unemployment to under 5 per cent by the fourth
quarter of next year, but the projected annual growth
rate of real output still decelerates to around 4-1/4
per cent by that time. The rate of increase in prices

1/ The report, "Current Economic Comment by District,"
prepared for the Committee by the staff.

9/19/72

-11-

is also expected to be a little higher than previously
projected, especially in the latter half of next year.
By the fourth quarter of 1973, the fixed-weight deflator
for private GNP is projected to be rising at about a
4-1/2 per cent annual rate.
Let me remind the Committee that our price projection
reflects an assumption made last June--to which we have
held--that the wage-price control program would terminate
in April. How much better we could do if some form of
controls were retained would depend very much on the nature
of the controls.
Our current GNP projection reflects, among other
things, the more expansive monetary policy assumed for
the latter half of this year. Based on figures available
a few weeks ago, we projected growth in M1 at about a
9 per cent rate in the current quarter and 7 per cent in
the fourth--in contrast to the previous assumption of
6 per cent growth in the second half of this year. This
change adds about 1 per cent to the stock of money by the
end of 1972. In 1973, we assume a 6 per cent growth rate
for M1, as we had before.
The collective staff judgment is that the marginal
effects of a 1 per cent increase in the stock of money
would be relatively small--in terms of both real activity
and prices. This seems to me reasonable. Housing and
State and local construction are usually the principal
sectors that respond to easier credit conditions. But
there is no great backlog of demands in either sector to
exploit now, so that aggregate demand would be less likely
to respond sensitively to easier monetary policy.
Having said this, I would hasten to add that current
growth rates of the monetary aggregates, and rates of
inflow of deposits to the nonbank intermediaries, seem
to me too high for comfort. There is still room for
greater resource utilization in the economy, but the
degree of slack seems likely to diminish as time goes
on, and the degree of pressure on wages and prices to
intensify. To be sure, substantial uncertainty exists
as to how actual events will unfold next year. Economic
growth may fall short of what we have projected. But I
believe the probability is just as great that demands
for goods and services may be larger than we now foresee.
If that judgment is correct, there are increasing risks
in pursuing a course of monetary policy that results in
growth of money and credit at the advanced rates that
now seem in prospect for the second half of this year.

-12-

9/19/72

Mr. MacLaury asked Mr. Gramley how much the assumption
that wage and price controls would end in April--rather than con
tinue in their present form--affected the projection of the GNP
deflator for 1973.
In reply, Mr. Gramley said that last June, in preparing
projections for 1973, the staff had made the assumption that
controls would not be extended beyond April for two reasons:
it saw no indications of Administration or Congressional pressure
for extension of the authorizing legislation, and it thought the
projections of price developments in an assumed environment
without controls would be useful to the Committee.

At that time,

Mr. Partee had expressed the judgment that termination of the
controls by April 1973 would add a few tenths of a percentage
point to the rise in prices over the balance of the year, and
he (Mr. Gramley) saw no reason to question that appraisal.

He

believed that an effective program of controls could hold the rate
of increase in prices throughout 1973 below that projected by the
staff.
Mr. Gramley added that estimation of the effects of a
continuation of controls during 1973 was very much a matter of
judgment; the econometric model gave very little help in formu
lating answers.

One had to make judgments about both the form

the controls would take and their effectiveness.

After controls

-13-

9/19/72

had been introduced in August 1971,
judgments in

the staff had made such

preparing its projections for 1972.

So far this

year, actual behavior of wages and prices had been better than
projected,

but one could not say how much of the difference

between actual and projected behavior was attributable to market
forces and how much to the controls.
Mr. Hayes commented that he, like Mr. Gramley, was
impressed with the continuing strength of the economy.

In

general,

the New York Bank's projections of economic activity were similar
to those presented by the Board's staff.

He was somewhat encouraged

by the recent behavior of wages and of consumer prices other than
those for foods.
prices.

He was discouraged, however, by the outlook for

In particular, he was concerned about the rise in

food prices

and its likely effect on wage demands in the period ahead.

More

over, after 2 years of slack in economic activity, inflation was
still a serious problem.

That raised distressing prospects for the

course of prices as rates of resource use rose in the coming year,
especially if high rates were approached rapidly.
Against that background, Mr. Hayes continued, he regarded
the Government's fiscal situation as crucial and disturbing.

He

was not optimistic about the success of the Administration's efforts
to limit Federal spending, and he foresaw the possibility of the
recurrence of a rapid expansion in such spending--comparable to

-14-

9/19/72
that in

the 1965-68 period--at a time when inflation was already

a problem.
Mr.

Hayes added that at a recent meeting of business

executives, he had been impressed by an almost unanimous expecta
tion that inflation would be worse next year.

There was general

and strong support for retention of wage and price controls next
year.
Mr.

Sheehan observed

that staff projections in

the green

1/
book 1/ suggested to him that rates of resource use would not rise
rapidly next year.

He asked Mr. Gramley to comment on the pro

jections.
Mr. Gramley noted that the unemployment rate was projected
to decline to 4.8 per cent by the fourth quarter of 1973; the
rate for men aged 25 and over would be in

a range of 2-1/4 to 2-1/2

per cent, which was about the rate prevailing in
1970.

late 1969 and early

The rate of capacity utilization in manufacturing would rise to

around 81 per cent.

In his judgment,

demand pressures on wage rates

would begin to develop under those circumstances.

The projected

figures on capacity utilization did not suggest that commodity prices
generally would be subjected to demand pressures,

but prices had

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

-15-

9/19/72

been rising and were likely to continue upward if economic
activity expanded along the lines projected.
Mr. Hayes remarked that he had read with interest a First
National City Bank analysis of the relationship between the rate
of unemployment and the behavior of prices.

Their "Phillips

curve" suggested that the equilibrium rate of unemployment was
5-1/4 per cent; a rate lower than that would accelerate the rate
of increase in prices.
Mr. MacLaury asked whether the unemployment rate for men
aged 25 and over had fallen below the range of 2-1/4 to 2-1/2 per
cent during the preceding business upswing, and what the over-all
rate of unemployment had been at that time.
Mr. Gramley replied that the rate for men aged 25 and
over passed through the 2-1/4 to 2-1/2 per cent range while the
over-all rate was 3-3/4 to 4-1/4 per cent.

If one used the rate

for that particular group as a standard, labor markets had been
tighter in earlier periods than was being projected for late 1973.
For example, the rate had been below 2 per cent in 1968 and early
1969.
Mr. Heflin observed that the tone of the red book prepared
for this meeting was generally optimistic.

In his own District,

members of the Richmond Bank's board of directors were as bullish
as he had ever known them to be.

Economic activity was expanding

-16-

9/19/72

rapidly and labor shortages were beginning to appear; industry
in the Carolinas was actively recruiting labor from outside the
District.

The directors generally were concerned about the labor

situation in prospect for the year ahead, believing that it might
prove to be like the one in 1970, and they all strongly favored
continuation of wage and price controls.
Mr. Heflin added that in view of the tone of the red book,
he was surprised that the staff had lowered the third-quarter
projection of real growth.

He sometimes wondered whether the

staff adequately took into account the materials prepared for the
red book.
Mr. Gramley replied that the staff studied the red book
carefully and found it a very useful document.

With respect to

the projections, the third quarter had been revised down very
slightly on the basis of production and employment data for
July and August; unexpectedly large increases in September would
have been required to reach the third-quarter rate of growth that
had been projected a month earlier.

However, projections of

growth in real GNP for the period from the fourth quarter of
this year through the fourth quarter of 1973 had been raised on
balance by about a half of one percentage point per quarter.
Mr. Mitchell noted that staff projections suggested a
sizable rise in inventory investment.

He asked whether inventories

9/19/72

-17

had been performing as projected earlier and what the consequences
for economic activity would be if such investment did not rise
significantly further.
In reply, Mr. Gramley said a failure of inventory invest
ment to rise further from the second-quarter rate certainly would
make a great deal of difference in the rate of economic expansion.
However, such a performance for inventories in combination with
the projected behavior of final sales would result in a steep
decline in the inventory-sales ratio.

As it was, the staff pro

jections implied a further decline in the over-all ratio from
about 1.50 recently to about 1.46 by the middle of 1973 before it
leveled out.

Such a performance was roughly the same as in the

comparable period of the business upswing that began in 1961.
Mr. Daane noted that the staff projections were based on
an assumption of growth in the monetary aggregates in 1973 consis
tent with a 6 per cent rate of growth in M 1 , and he asked what impact
higher rates of growth would have.

He also asked whether the effects

of alternative fiscal policies did not need to be considered.
In reply, Mr. Gramley said the staff had run experiments
with the econometric model to evaluate, without any judgmental
refinements, the effects of both higher and lower rates of monetary
growth next year.

A 7 per cent rate of growth in M

throughout

-18-

9/19/72

1973 resulted in additional growth by the fourth quarter of next
year of about $4 billion in nominal GNP from a base of around
$1,200 billion in the fourth quarter of this year; a step-up to
an 8 per cent rate of growth in M1 would add, roughly, another
$4 billion.

The consequences of monetary growth rates lower

than 6 per cent in 1973 would be roughly symmetrical.

However,

the full effects of the higher or lower rates of monetary growth
would not be felt within 1973 but would be spread over a longer
period.

The unrefined results of the model suggested that, during

the first year, a higher rate of monetary growth would have its
major impact on real GNP; the effect on prices was moderate.
Continuing, Mr. Gramley said the staff had not made
comparable experiments with fiscal policy.

However, fiscal policy

also was a powerful tool, and it affected economic activity with
a somewhat shorter lag than did monetary policy.
Mr. Eastburn commented that projections made at the
Philadelphia Bank suggested that with growth in M1

at a 5-1/2

per cent rate, the GNP deflator would rise at an annual rate of
3.9 per cent in the fourth quarter of 1973, whereas with growth
in M1

at 9 per cent, the deflator would rise at a rate of 4.2

per cent.

The unemployment rate in the fourth quarter of next

year would be 4.8 per cent with the slower monetary growth and
4.2 per cent with the faster monetary growth.

The differential

-19-

9/19/72

effects of the assumed rates of monetary growth on the behavior
of the deflator and the unemployment rate were not great in

1973

but would be greater later on.
Gramley observed that most econometric models based

Mr.

on data for the period since the Second World War had long lags
in the adjustment of prices to changes in the rate of monetary
growth.

The Board's model,

and many others,

suggested that

increased monetary growth eventually was reflected almost
entirely in

the rate of increase in

prices and very little

in

the rate of real growth.
Mr. Morris said he had heard recently that the House
Ways and

Means Committee was

likely to approve a ceiling

of around $250 billion on Federal expenditures for fiscal 1973.
He asked whether the staff had tried to evaluate the impact that
such a ceiling would have on economic developments in 1973.
Mr. Gramley replied that the staff had not attempted to
do so in a formal way.

However, staff projections currently

suggested that Federal outlays would reach $257 billion in
fiscal 1973, and a cutback effected over the remainder of the
fiscal year to stay within a ceiling of $250 billion could
have major effects on the course of economic activity.
Chairman Burns commented that a very serious effort was
being made in the Congress to legislate an expenditure ceiling.

-20

9/19/72
Representative Wilbur Mills,

Chairman of the House Ways and

Means Committee, was working hard for expenditure restraint;
he had a great deal of support, and prospects for passage by
the House were excellent.
were uncertain.

In the Senate, prospects for passage

Senator Roth had obtained a large number of

sponsors for his bill to establish a ceiling, but the position
of Senator Long, Chairman of the Finance Committee, was not
known.
Chairman Burns added that even if an expenditure ceiling
were legislated, it would not last indefinitely.

The merits

of a ceiling were being increasingly recognized, but it also had
a profound weakness in that the Congress virtually abdicated its
role in establishing priorities.
willing to do that for long.

The Congress would not be

If enacted, however, a ceiling

would provide an opportunity to work out other mechanisms for
imposing financial restraint.
Mr. Brimmer observed that the latest staff projections
suggested greater strength in activity than had the projec
tions of either August or June. The latest projections also
suggested a somewhat greater acceleration in prices beginning
in mid-1973 and more of a decrease in unemployment than had been
indicated earlier.

The assumed rates of growth in money and credit

-21

9/19/72
in

the third and fourth quarters of this year now were higher

than those the Committee had taken as targets, and he expected
that growth would be at about the assumed rates.

the

Therefore,

Committee was confronted with the issue of when,rather than
whether, it

would proceed to moderate the rate of monetary growth.

The staff had argued that the higher rates of monetary growth in
the third and fourth quarters of this year would make little

or

no difference to economic developments, suggesting that the Com
mittee might have a few months of leeway as to when it took action.
He asked Mr. Gramley to comment.
Mr. Gramley said econometric models suggested that it would
make little

difference to developments 2 years or so ahead whether

monetary expansion proceeded at a rate of 8 per cent in the second
half of this year and 4 per cent in the first half of 1973 or
alternatively at a rate of 6 per cent throughout the period.
However, he thought it would be safer to pursue a steadier path,
particularly when it appeared that demand pressures would intensify
as the year progressed.

There was not sufficient experience in

the postwar era to permit more than very general statements about
the effects of uneven versus steady monetary growth.
In reply to a question by Mr. Daane, Mr. Gramley added that
in

the case where monetary growth was at a rate first

of 8 per cent

and then 4--as compared with 6 throughout the period--interest rates

-22-

9/19/72
would tend to be held down in

the first

part of the period but then

to be increased sharply, creating potentially disturbing effects in
financial markets.
Chairman Burns observed that, at present, the rate of
unemployment was about 5.5 per cent and the rate of capacity utili
zation was well below its potential.

Since April industrial produc

tion had grown at an annual rate of only 4 per cent, and over the
past 6 months the physical volume of construction had been declining
gently.

Services were the only sector of the economy that had been

expanding vigorously.

Consequently, employment had been increasing

at only a moderate pace.

Clearly, the economy was not booming.

Continuing, the Chairman noted that wholesale prices had
shown some disconcertingly large increases recently.
price situation was mixed.

However, the

Prices of sensitive industrial materials

had stabilized in recent weeks, following a sharp rise.

Food prices

also had stabilized recently, according to statistics that had not
yet been released.
Concerning the outlook, Chairman Burns said no scientific
means of projecting prices had been developed, and everyone
had to form his own judgments.

In his view, the critical

factor in price developments next year would be the behavior of
wages.

The nature of the wage guideline decided upon by the Pay

Board within the next few months--and whether any reduction could
be made to stick--would be decisive.

If the Pay Board reduced

-23

9/19/72

the guideline from the prevailing 5-1/2 per cent down to 4-1/2
per cent--or preferably to 4 per cent--he would be very optimistic
about price prospects for next year.

If

the Board did not take

such action, inflationary pressures might well be renewed.
Chairman Burns observed that the Pay Board was likely to
announce its

decision early next year, well in

advance of the

scheduled expiration of the Economic Stabilization Act.
environment existing then might determine the decision,
environment depended on the behavior of prices,
and interest rates.

If

profits,

The
and that
dividends,

the Price Commission became tougher than

it had been of late, if the rise in profits moderated, if divi
dends continued on their recent course, and if

interest rates did

not rise appreciably, the environment would be favorable to a
decision to reduce the wage guideline.

If

the environment were

not so favorable and the Board nevertheless lowered the guideline,
its decision might not be allowed to prevail.
on attitudes in

That would depend

the country--particularly in the labor unions and

in the Congress.

If prices, profits, and interest rates were

rising materially at the time the Economic Stabilization Act
came up for renewal next year,

the Congress would be unlikely to

accept a wage guideline of 4 or 4-1/2 per cent.
Altogether,

the Chairman concluded, he was moderately

optimistic about price prospects for the next year.

He was reas

sured by a certain determination within the Administration to

-24

9/19/72
continue the controls program.

Some members of the Pay Board

were eager to lower the wage guideline, provided that the environ
ment proved to be favorable.
were good.

Prospects for fiscal restraint

And he felt the Federal Reserve would assure that the

average rate of monetary growth was moderate over periods of 6
months or a year, even if it permitted rapid growth for briefer
intervals.

He noted that despite concern at times that monetary

growth was too rapid, the narrowly defined money stock had risen
over the year ending in August by only 5-1/2 per cent.
Mr. Eastburn remarked that it was helpful to have
Chairman Burns' assessment of the various ingredients in an
effective program of controls.

He noted that if fairly rapid

growth in the monetary aggregates for a period of time were
followed by much slower growth in order to average out to a
reasonable rate, interest rates might rise substantially.

He

inquired whether, in the Chairman's view, substantial increases
in interest rates then would undermine the program of controls.
Chairman Burns replied that the question was very hard
to answer.

It was clear that the Pay Board would find it extremely

difficult to lower the wage guideline if consumer prices, profits,
and interest rates were rising rapidly and if the Committee on
Interest and Dividends responded to pressures to relax the dividend
guidelines.

One thing of which he was certain was that the dividend

-25

9/19/72

guidelines would not be relaxed.

Assuming, however,

that over-all

developments were of a kind that permitted the Pay Board to lower
the wage guideline, subsequent sharp increases in

interest rates

might well create problems.
The intensity of those problems would depend on how the
the whole situation unfolded,
general,

the Chairman continued.

In

the rate of increase in consumer prices would be

much more important than changes in interest rates; and changes
in the interest rates of most significance to consumersparticularly rates on mortgages and on consumer instalment loans,
which tended to be sticky--would be more important than, say,
prime rate or other lending rates to business.
sharp increases in

the

He doubted that

interest rates of the latter types would have

much of a psychological impact if

at the same time the consumer

price index were rising no faster than, say, 2 tenths of a
percentage point per month.
Mr. Hayes commented that some weight should be given to the
psychological effects of a high rate of monetary growth over an
extended period.

In the past when the public in general and

businessmen in particular viewed monetary policy as loose, attitudes
and decisions concerning prices had been affected.
Mr.

Brimmer remarked that he was concerned about the appro

priate role of monetary policy as an instrument of economic

-26-

9/19/72

stabilization over the next 9 to 12 months.

Committee members

were aware that monetary policy functioned with a lag, and they
were confronted with the need to assess the possible effects of
policy over a period of time.

In that context, he believed

that possible future actions of the Pay Board and the course of
fiscal policy should influence the Committee's decisions, but
they should not be decisive; monetary policy had an independent
role to play.
Continuing, Mr. Brimmer observed that economic activity
was gaining strength.

Output and employment in the third or

fourth quarter of 1973 would not benefit very much if the mone
tary aggregates were allowed to continue to grow at recent rates;
the impact would be greater on the rate of increase in prices.
Experience in the 1965-66 period indicated that timeliness was
as important as direction in monetary policy actions.
Mr. Daane commented that there was a tendency to exaggerate
the independent role of monetary policy.

The Committee had to

do the best it could with monetary policy while recognizing its
limitations.

The economy was subject to the influence of so many

other variables--such as interest rates, fiscal policy, and
expectations--that one could not clearly say that a difference
of a certain amount in the rate of monetary growth would have a
specific effect on the economy.

9/19/72

-27-

Mr. MacLaury said that he, like Mr. Eastburn, had found
Chairman Burns' assessment of the situation helpful.

He asked

the Chairman, in view of his references to certain signs of
slackening in the second quarter and apparently into July and
August as well, whether he concurred in the staff's forecast for
the real economy and the relatively bullish expectations for
retail sales and inventories.
Chairman Burns replied that he did.
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 domestic open market operations for
the period August 15 through September 13,

1972,

and a supplemental

report covering the period September 14 through 18,

1972.

Copies

of these reports have been placed in the files of the Committee.
In supplementation of the written reports, Mr. Holmes made
the following statement:
Over the period since the Committee last met the
monetary and credit aggregates exhibited vigorous growth,
and as the Desk attempted to keep on the RPD target,
short-term interest rates rose sharply. In the process,
financial markets became increasingly sensitive, particu
larly just before the Labor Day weekend when the banking
system badly misjudged its reserve needs and forced the
Federal funds rate up as high as 5-1/2 per cent. In
order to avoid a completely unwarranted run-up of interest
rates and the risk of disorderly market conditions, the
Desk was obliged for a time to adopt a less vigorous
pursuit of the Committee's reserve objectives. Currentlywith a measure of calm returned to the money markets--we

9/19/72

-28-

have been aiming at a reserve approach that would
envisage a 5 per cent Federal funds rate. The contin
uing sensitivity of the markets made it appear undesir
able to aim at reserve conditions that would go to the
upper end of the 4-1/2 to 5-1/4 per cent Federal funds
range specified by the Committee at the last meeting.
Treasury bill rates, which had been abnormally
low relative to other short rates, showed the most
adjustment. With dealer inventories high, the market
reacted sharply to selling by the Treasury, System,
and foreign accounts. The System, too, was running
off Treasury bills in the regular weekly auctions in
order to cut back reserves in the banking system, and
this, together with reduced foreign participation,
required the market to absorb more bills than it
wanted. Earlier, bids entered by the Desk for System
and foreign accounts had amounted to as much as two
thirds of the total amount awarded in the regular
3-month bill auctions. In the past few weeks such
bids fell to only about one-half of the total. In
yesterday's auction, average rates of 4.63 and 5.10
per cent were established for 3- and 6-month bills,
each up about 65 basis points from the auction just
preceding the last meeting of the Committee.
Other short-term rates also rose, but more
moderately, bringing about a more normal relationship
between rates on Treasury bills and on other short
term instruments. In longer-term markets, Treasury
issues again showed the most adjustment as dealers
tried to work off--at substantial losses--the inven
tories acquired in the Treasury's August refunding.
In the corporate and municipal markets--where the
calendar remained relatively light--rate adjustments
were more moderate, ranging from 10 to 15 basis points.
As mentioned earlier, a somewhat calmer atmosphere
has emerged in the markets in the past week.
Govern
ment dealers have--with the exception of an overhang
of the 6-3/8s of 1984--about completed their inventory
adjustment of Treasury coupon issues. Treasury bill
holdings are still high, however, and the market is
still sensitive to any new economic developments or
to a further firming of System policy.
The Treasury, as you know, has been experiencing
a cash problem. Their balance with the Fed has been
worked down--supplying reserves in the process--and

9/19/72

-29-

they had a small overdraft with the System a week ago.
With September tax money coming in, their position has
improved to the extent where they can shortly run the
balance up again to $2 billion or so--and help absorb
much of the reserves that will be supplied, should
the prospective changes in Regulations D and J be
has to
The Treasury still
implemented as scheduled.
raise about $10 billion in cash over the remainder of
the year, with the first bite scheduled for next month.
While no decisions have been made, the financing is
apt to take the form of an issue of tax-anticipation
bills, which should involve minimal even keel consid
erations for the System.
Open market operations over the period were
plagued by the need to absorb a large volume of
reserves at a time when the Treasury and foreign
accounts were large sellers of Treasury bills in a
market that had become increasingly sensitive as a
result of the strong economic outlook and the System's
attempt to put the brakes on reserve growth.
While
the reserve pattern indicated a need to make outright
market sales of Treasury bills over much of the period,
the sensitivity of the market was such as to require
heavy use of matched sale-purchase agreements instead.
The System did sell nearly $500 million bills in the
market and more than that amount to foreign accounts.
Another $1 billion of bills were redeemed in the
auctions. Matched sale-purchase agreements, however,
amounted to nearly $8 billion, and were used especially
heavily in the past statement week.
The aggregates and RPD's are turning in a very
strong performance, as the blue book 1/ and other
written reports to the Committee have indicated.
A
sizable part of the overshoot on RPD's--2 percentage
points--can be accounted for by the bizarre performance
of the banking system before the Labor Day weekend.
As you know, banks acted as if reserves were scarce,
bidding up the Federal funds rate to well over 5 per
cent and borrowing $1 billion over the long weekend,

1/ The report, "Monetary Aggregates and Money Market Conditions,"
prepared for the Committee by the Board's staff.

9/19/72

-30-

despite a large injection of reserves through repurchase
agreements by the System to try to dampen the feeling of
extreme tightness that had developed. By Tuesday the
banking system had, in fact, accumulated over $8 billion
in excess reserves, and it wound up the week with a daily
average of $838 million in excess reserves--four to five
times the normal amount. With that high a level of excess
reserves, there was no way to keep on the RPD path. A
missed target produced by an aberration of excess reserves
should not be a cause for great concern. But even apart
from this, RPD's have been running at or above the upper
end of the target range and only the sensitivity of the
market prevented still more vigorous action by the Desk
to absorb reserves.
Looking ahead, the blue book is forecasting exces
sively strong rates of growth of money in September and
in the fourth quarter. I should note, but without any
feeling of confidence, that the New York projections are
forecasting a 6-1/2 per cent rate of M 1 growth in September
and only 5-1/2 per cent for the fourth quarter with virtually
unchanged money market conditions. I suspect that they are
probably wrong, but it may serve as a reminder that fore
casting is not exactly a science, and that the linkages
between money market conditions and growth of the aggregates
can be highly uncertain. The projections are being put to
the test in this current week, on which we will have better
information by this Thursday. Our projectors--who I believe
are putting heavy weight on the shift in the Treasury
balance--are forecasting a level of M1 about $1.8 billion
below the Board staff's estimate.
As the blue book indicates, the Committee faces a
difficult trade-off between interest rates and the aggre
gates in the period ahead. The problem would not be so
difficult if--by any chance--the New York estimates turn
out to be more nearly right, since they imply less pressure
on interest rates to achieve a reserve or aggregate target.
With markets still sensitive, it would be helpful if members
of the Committee would indicate how relentless they would
like the Desk to be in pursuing whatever target the Committee
may choose today. We will probably need a fair amount of
flexibility in open market operations in light of the
scheduled changes in Regulations D and J, whenever they
may occur, and continued bill selling by foreign central
banks--if it occurs--could add to problems. As you know,
on occasion in the past period the System took bills from

9/19/72

-31

foreigners in order to avoid pressing the bills on an
unreceptive market, and it tried to offset the unwanted
reserve impact by other means. On occasion, too,the Desk
bought short-term bills offered by some foreign accounts
and sold longer-term bills demanded by other foreign
accounts, thus avoiding any reserve impact. We may have
to continue to operate in this manner from time to time.
Should the markets become excessively restive once
again, it might also prove desirable for the System to
buy, for example, long-term bills or other specific
issues which are a drag on the market, and offset the
reserve impact by selling short-term bills or by making
matched sale-purchase agreements. Normally the System
avoids making such market swaps and I believe that is a
proper procedure. But on occasion such operations might
help keep markets orderly while the Desk seeks to pursue
reserve growth objectives, and I would recommend that
the Committee be willing to tolerate them if they appear
to be necessary in the weeks ahead.
Mr. Coldwell asked whether any opportunities had been found
in the recent period to offset the unwanted reserve impact of bill
purchases from foreign accounts by sales of coupon issues or
longer-term agency issues in the market.
Mr. Holmes replied that no such sales had been made since
they probably would have resulted in spreading the short-term market
pressures into longer-term markets--particularly since dealers had
been trying to work off high inventories of coupon issues.

More

generally, if the System decided to engage in sales of longer-term
issues it would be desirable not to take the market by surprise,
in order to avoid an overreaction.
Chairman Burns added that in his judgment System sales of
coupon and longer-term agency issues in the recent period would

-32-

9/19/72

inevitably have been interpreted by the market as indicating a
determined Federal Reserve effort to raise the entire interest
rate structure.

The market had already formed an exaggerated

impression of the System's intentions from the operations actually
conducted, and sales of longer-term issues would have carried that
process further.
Mr. Daane noted that, according to the blue book, an
increase in the Federal funds rate of the magnitudes shown under
the specifications for alternatives B and C-

would lead to an

upward adjustment in the bill rate in a 4-3/4 to 5-1/2 per cent
range.

He personally found it hard to believe that the bill rate

could be kept within that range if the funds rate were to rise to
the 5-3/8 per cent level associated with alternative C.

He asked

for the Manager's judgment as to how vulnerable the market was at
present to increases in the Federal funds rate.
Mr. Holmes replied that the market was in a much better
technical position now than it had been a short time ago, and
accordingly it should be better able to withstand some further
firming in money market conditions without reacting unduly.

How

ever, he found it very difficult to pinpoint the particular level
of the funds rate that would precipitate an undesirable reaction.

1/ The alternative draft directives submitted by the staff for
Committee consideration are appended to this memorandum as Attach
ment A.

-33-

9/19/72

One major uncertainty was whether foreign central banks would
continue to be large sellers of bills.
Mr. Mitchell recalled that at the previous meeting
Mr. Sternlight had expressed the view that the market could
accept a Federal funds rate of about 5 per cent without much
trauma, but that to push beyond that level would pose greater
risks for the stability of longer-term interest rates.
(Mr.

Mitchell's)

In his

view, ever since the publication of figures

showing a large increase in M 1 in July, market participants had
been awaiting a signal that the System had launched on a firming
course, and he thought the sharpness of the reaction in the days
before the Labor Day weekend was attributable in part to their
belief that the System had given the anticipated signal.

Now

that August figures showing more moderate growth in M 1 had been
published the market might well be less sensitive.

He asked

what reaction the Manager would expect to Federal funds rates
consistently above 5 per cent.
In reply, Mr. Holmes said he thought the market probably
would not be greatly disturbed at present by funds rates a little
above 5 per cent and perhaps even higher.

There would, of course,

be some reaction in other market rates as the funds rate moved up,
but not necessarily a disproportionate reaction.

He added that

he would be inclined to attribute the turmoil in

the market just

-34-

9/19/72

before Labor Day primarily to the banks' misjudgments of their
reserve positions.

He did not fully understand the reasons for

that behavior, but it was consistent with a recent trend toward
increasing problems of reserve management in connection with long
holiday weekends.
Mr. Daane asked what constraint the Manager would suggest
for the funds rate if the Committee desired to keep the market
uncertain as to whether it had decided to move in a firming
direction.
Mr. Holmes replied that he was unable to specify any
particular range that would produce such a result.

In his judgment

the range could be determined only by moving toward a higher rate,
while standing ready to back away if necessary and, perhaps, trying
again later.

Such an approach would be feasible unless the

Committee was determined to achieve some particular growth rates
in the aggregates.
Mr. Daane remarked that that approach could be described
in old-fashioned terms as a "probing operation," and Mr. Holmes
agreed.
Mr. Eastburn noted that, under the experiment the Committee
had been engaged in since February, point 5 of the points for
guidance of the Manager read as follows:

"If it appears that the

Committee's various objectives and constraints are not going to

-35-

9/19/72

be met satisfactorily in any period between meetings, the Manager
is promptly to notify the Chairman, who will then promptly decide
whether the situation calls for special Committee action to give
supplementary instructions."

He asked whether consideration had

been given to the possibility of consulting with the Committee
in the period since the last meeting.
Chairman Burns responded affirmatively.

He noted that he

had talked with the Manager several times during the period, and
that in his own thinking the question of whether to consult with
the Committee had hung in the balance for a number of days.
Mr. Holmes added that there were arguments in favor of
not holding a special meeting at a time when markets were highly
sensitive and bordering on disorder; by waiting until the situation
had calmed down somewhat the Committee would be in a better position
to reassess the situation.
Mr. MacLaury said he was somewhat disturbed by the impli
cation of Mr. Daane's line of questioning that there was some level
of the Federal funds rate, determined by market psychology, that
should not be pierced.

Obviously, no one wanted markets to become

disorderly, and it would be a great advantage for the Committee
to know in advance what circumstances would create exaggerated
interest rate movements.

He would be concerned, however, if the

Committee's policy decisions were dictated by psychological consid
erations rather than reflecting more fundamental factors.

-36-

9/19/72

Mr. Mitchell commented that for many years the Committee
had in fact given the Manager guidelines in terms of market
psychology, in what could be described as a "seat-of-the-pants"
operation.
Mr. Daane said he had not meant to suggest that the
Committee should specify some rigid upper limit for the funds
rate in the coming period.

As the Manager had indicated, it was

not possible to name in advance the precise level of the funds
rate that would trigger a sharp market reaction, and he (Mr. Daane)
would want to give the Manager latitude for the exercise of
judgment.
Mr. Sheehan expressed the view that a key issue underlying
the questions raised by Messrs. Daane and Mitchell was whether
interest rates had risen in the recent period mainly because of
market forces, or whether they had been inadvertently pushed up
to undesired levels by the System's operations.
Chairman Burns noted in that connection that the bill
rate had risen about 80 basis points in the recent interval.

At

the previous meeting there had been fairly wide differences in the
members' opinions on policy, but according to his recollection no
one had said or implied that he favored an increase in the bill
rate of that magnitude.

He assumed that that was one of the

considerations Mr. Daane had had in mind in his questions today.

-37-

9/19/72

In his judgment,

the Chairman continued,

market partici

pants were concerned not so much with particular levels of money
market rates as with the apparent trend in
time.

If,

for example; it

appeared that the Desk was seeking to

move the funds rate steadily in
say, a two-week period,

System operations over

a particular direction during,

the market was likely to extrapolate

that trend into the more distant future and react in
way.

an exaggerated

Alternatively, if the Desk moved toward its goal along a

zig-zag course,

it

would create uncertainty about its

which might minimize chances of exaggerated reactions.

objectives
He asked

whether the Manager agreed.
Mr. Holmes remarked that the consequences of particular
approaches varied with circumstances.

There were times when the

Desk could put relatively steady pressure on the market without
producing sharp reactions.

At other times, however, the situation

was just as the Chairman had described it.
By unanimous vote, the open
market transactions in Government
securities, agency obligations,
and bankers' acceptances during
the period August 15 through
September 18, 1972, were approved,
ratified, and confirmed.
Mr.

Axilrod then made the following statement on prospective

financial relationships:

9/19/72

-38-

After reading the blue book material, you may feel
that the staff is engaging in the exercise of excessive
fine-tuning. It is true that financial relationships
are unlikely to develop exactly as projected or planned.
And the margins of error within which the vagaries of
human behavior and the state of the economic art permit
us to work could well mean that the alternatives pre
sented may in practice fade into one another rather
than turn out to be distinct, mutually exclusive paths.
But the alternatives are designed to bring out a
number of points deserving of Committee consideration.
The alternatives recognize, for one thing, that the
recent rise in short-term rates has already set in
motion forces that will result in some slowing in
aggregate growth rates from the third-quarter pace,
even if money market conditions firm no further.
However, the extent of such a slowing--shown in
alternative A--would still leave the aggregates growing
at rates considered excessive by the Committee in the
past. If a further slowing is to be achieved, the
alternatives suggest that the necessary constraint on
reserve growth will lead to a further tightening of
the money market.
There are many ways in which reserve and aggregate
growth slower than alternative A can be achieved. While
in our analysis they all involve tighter money market
conditions than prevailing, the degree of tightness may
develop either quickly, gradually, or after some delay.
The longer the needed tightness is delayed, the less is
the retardation likely to be achieved in aggregate
growth, or the higher are the interest rates eventually
required to attain a given aggregate growth by a partic
ular time.
The larger than usual number of alternatives pre
sented in the blue book illustrate trade-offs between
money market conditions and the speed with which growth
in the aggregates is slowed insofar as we can estimate
them. The gradual approaches of alternatives B and C
do not achieve quite as much retardation in growth of
monetary aggregates by the first quarter of next year
as does the more marked tightening of alternative D.
The more gradual approaches have the advantage, though,
of being much less likely to involve sharp, adverse,
short-run repercussions on credit market psychology.

9/19/72

-39-

And monetary growth can then be restrained further
later on--achieving M1 growth rates in the neighbor
hood of 5 to 5-1/2 per cent in the second quarterwith only a modest further tightening of the money
market likely to develop by early next year.
While the relation among reserve paths, monetary
aggregates, and interest rates is always subject to a
margin of error, in the period immediately ahead the
relationship is particularly difficult to foresee. On the
assumption that the changes in Regulations D and J take effect
this Thursday, there will be considerable uncertainties
affecting the demand for excess reserves and the multi
plier between reserves and deposits for reasons explained
in the blue book. These uncertainties affect what we
generally term the supply function for money. The more
uncertain we are about the supply function, the more
difficult it is, of course, to control money or bank
credit by controlling the reserve base.
In the period of transition--while banks (and the
System also) are adapting to the new Regulations D and
J--it
might, therefore, be desirable to give somewhat
more weight to money market conditions relative to bank
reserves in attaining aggregate objectives.
The RPD
path will still be a useful guide, but technical changes
in the path relative to aggregate objectives are some
what more likely to occur in the transition period.
The still fairly sensitive state of credit markets
is another reason to put some additional weight on money
market conditions in the period immediately ahead. While
the technical condition of credit markets has improved
in the past few weeks, investors and dealers are still
highly sensitive to changes in monetary policy indicators.
One major question in the market concerns how accommoda
tive the Federal Reserve is likely to be in this coming
period of seasonal upward pressures on short-term rates.
Clear indications that the Fed is willing to permit or
encourage tightening could lead to further anticipatory
upward adjustment of bill and other short-term rates
and to questions about the sustainability of the discount
rate.
Nevertheless, it would seem to me that the Committee
might wish to start now on an effort to slow growth in
the aggregates to rates below those shown for alternative
A. Given existing market conditions, though, the Committee
may wish to be cautious in the degree of tightening permitted

-40-

9/19/72

money markets as part of that effort. Our analysis of
the trade-offs between aggregate growth and interest
rates suggests that the cost--in terms of control of
the aggregates over an economically meaningful periodof moving quite cautiously at this point is not very
large, assuming some willingness to exert continuing
restraint as time goes on.
Mr. Brimmer referred to his earlier question to Mr. Gramley
regarding the amount of latitude available to the Committee in
moving to moderate growth in the monetary aggregates.

He asked

for Mr. Axilrod's view of the probable consequences if that move
were delayed for 2 or 3 months.
In reply, Mr. Axilrod observed that the staff's GNP
projections were based on the assumption that growth in M1 would
be brought back down to the Committee's earlier target rate of
6 per cent by the first half of 1973.

Given the likely strength

of money demands, the postponement of any firming of money market
conditions for, say, 2 months would probably result in the need
for a relatively sharp tightening in the final 6 weeks of 1972
if a 6 per cent M 1 growth rate were in fact to be achieved in
the first half of 1973.

There were, of course, alternative ways

of approximating that goal; one which the staff had explored
involved an M1 growth rate of 6-1/2 per cent in
quarter and 5 per cent in the second quarter.

the first
In that

alternative, the degree of restraint placed on the growth of
reserves in

the final weeks of 1972 probably would be sufficient

-41-

9/19/72

to push both the Federal funds rate and the bill rate up to the
area of 6-1/2 per cent by early January.
Mr. Mitchell noted that, according to weekly data shown
in the blue book, most of the growth in private demand deposits
since mid-May had occurred in two brief periods that included
holidays--the first two weeks of July and the two weeks ending
September 6.

He asked if Mr. Axilrod had any ready explanation

for that phenomenon.
Mr. Axilrod replied that he found it extremely difficult
to explain changes in the weekly money supply series, largely
because of the serious problems of making seasonal adjustments
in such data.

Those problems were magnified in weeks with

holidays that could occur on different days of the week, such
as Independence Day.

In general, one had to consider periods

longer than one week to detect significant trends in the data.
He had been surprised by the sudden sharp increase in M1 in the
first

2

weeks of July, but he had been even more surprised by

the failure of the series to decline more than it had in subse
quent weeks.
the

The fact that the money supply had remained near

early-July peak suggested that fundamental forces were making

for strength in money demands.

For all practical purposes, however,

the particular weeks in which the strength was reflected in the
data were, to a large extent, either random or a function

-42-

9/19/72

of the inadequacies of the seasonal adjustment process for
weekly data in a series subject to sizable, unpredictable
changes.
In response to a further question, Mr. Axilrod said the
Board staff's projections suggested that the money stock would
remain roughly stable in the final 2 weeks of September.

In

contrast, the New York Bank anticipated a decline.
Chairman Burns recalled that the staff had recently made
a study of the errors in projections of the monetary aggregates.
He asked what the study had revealed about the relative accuracy
of the projections made at the Board and the New York Bank.
Mr. Axilrod replied that the New York Bank's projections
had proved better than the Board's for the bank credit proxy,
and slightly better for M2 .

For M1 the Board's projections were

better on a monthly basis but there was little difference in the
relative accuracy of the quarterly projections.
Mr. Axilrod added that in preparing such projections the
staffs took into account the findings of a rather large number
of models.

Two models--plus the exercise of independent judgment-

were used regularly at the Board, and other predictive equations
prepared at the New York Bank were also consulted.

The various

models and equations that he had recently seen showed projections
of the growth rate of M1

in the first quarter of 1973 ranging

-43-

9/19/72

from 4 to 11 per cent, all based on the assumption of no change
in money market conditions.
Chairman Burns then remarked that the Committee appeared
to be ready for its discussion of monetary policy and the directive
for the coming period.

He invited Mr. Brimmer to open the discussion.

Mr. Brimmer observed that, as earlier questions of his
indicated, he was concerned about the appropriate timing of a
move to slow expansion in the monetary aggregates.

He thought it

was desirable to act now, when the move could be a moderate one,
rather than delay until a time when drastic action would be needed.
He hoped the Committee's debate would focus on the question of
how much of an increase in money market rates would be acceptable.
Personally, Mr. Brimmer said, he favored the specifications
of alternative C, although he would be willing to accept those of
alternative B.

The Desk needed more than the usual amount of

latitude in this period in view of the scheduled implementation of
the changes in Regulations D and J, but he hoped it would still be
able to achieve some moderation in the growth rates of the aggregates.
Over the last 4 weeks it had been decided to permit some slippage
from the Committee's objectives because of the sensitive state of
the money markets; and while he had accepted that judgment when
it was made, he thought the Desk should now give a little less
weight to sensitivity in the markets and more to the objective

-44-

9/19/72

of slowing the aggregates.

In response to the Manager's specific

question as to how relentlessly the Committee's targets for the
aggregates should be pursued, he would say that operations should
not be extremely vigorous, but that they should nevertheless be
designed to avoid further slippage.
Mr. Hayes remarked that a month ago Committee members
had agreed that it was important to achieve some slowing in the
growth of the monetary and credit aggregates.

Unfortunately,

that slowing had not occurred, at least not in anything like the
degree that had been hoped for.

He intended no criticism of the

Desk; concern for market sensitivity had prevented it from using
the full permissible range of the Federal funds rate constraint
even though RPD's and the aggregates were all well above path.
But the recent and prospective aggregate growth rates looked
decidedly excessive in the light of the strengthening business
situation, the disturbing budgetary outlook, and the widespread
fear of a new surge of inflation in 1973.
Of course, Mr. Hayes continued, it might be argued that
the Committee was not really willing to use an RPD target when
the price was any substantial rise in interest rates.

Yet it

seemed quite clear that that trade-off could not be ignored or
escaped.

A further increase in short-term market interest rates

was probably the price the Committee would have to pay if it was

-45-

9/19/72

going to keep any semblance of control over the aggregates in
the coming months,
in

and it

might be easier to firm now than later

the year when the Treasury would face heavy financing needs.

Also, like Mr.

Brimmer;he would prefer to start soon and move

gradually rather than delay until drastic action was needed.
Chairman Burns remarked that an economic historian
examining the record for the year would probably conclude that
the Committee had started to move some time ago.
Mr. Hayes agreed, adding that he was thinking of a start
toward achieving further moderation in

the aggregates.

Certainly,

the growth rates sought for the fourth quarter should be substan
tially lower than those that had prevailed recently.

Ideally, a

range from 5 to 6 per cent in the annual rate of growth in M1,
with commensurate ranges for M2 and the credit proxy,
appropriate.

might be

However, if the blue book relationships were anywhere

near the mark--and he thought they well might be--the interest rate
firming required to achieve such growth rates would be too high a
cost to pay,

at least in

the near future.

Also, he was impressed

by the fact that the changes in Regulations D and J--if they became
effective--would make it
measured in

unusually difficult to achieve any goal

terms of reserves.

Under those circumstances,

he

thought the most practical approach would be to set the Committee's
target for the next period in

terms of moderately firmer money

-46-

9/19/72

market conditions.

The specifications for money market conditions

associated with alternative C, with a range of 5 to 5-3/4 per cent
for the funds rate, looked about right to him.

He would hope that

such money market conditions would result in slower growth of the
aggregates in coming months than forecast in the blue book, but
if they did not the Committee would simply have to accept the
outcome.
As for the discount rate, Mr. Hayes said he thought the
time had come for action by the System.

So far he had been

inclined to temporize on that issue, but meanwhile market rates
had been moving upward.

Furthermore, he could see the need for

a visible, though moderate, signal that the System was concerned
over the course of the aggregates and the budgetary and inflationary
outlook.

When the New York Bank directors had reestablished the

present rate 2 weeks ago they had done so only with reluctance, and
they had expressed to the Board of Governors their serious concern
regarding the prospects for intensified inflationary pressures,
particularly in the light of the Federal budgetary outlook.

He would

not expect them to stand still again this week, and his present
inclination was to recommend an increase before even keel considerations
arose.
Mr. Hayes observed that the principal question remaining
in his mind concerned the most suitable amount of such an increase.
Ordinarily, in view of the inflationary risks, he would lean

-47-

9/19/72

toward a half-point rise, even though that might have some
further effect on short-term market rates.

On the other hand,

he was quite aware that the System was in a delicate position
in a period of wage and price controls, so that discretion in
the form of a quarter-point move might recommend itself.

He

would, of course, be interested to hear how others around the
table felt on that issue.
Mr. Eastburn said he would make only three points, all
of which seemed to him to argue for taking action now to moderate
the rates of growth of the monetary aggregates.

First, the blue

book projections of the aggregates might again prove to be under
estimates of the actual growth rates, as they had in the recent
past.

Second, even keel considerations would soon become impor

tant.

Third, as Mr. Axilrod's response to Mr. Brimmer's question

made clear, it would be difficult to compensate later for overly
rapid growth in the aggregates now.

He favored alternative C.

Mr. Winn noted that he had participated in the daily
conference call during the past month and that, as a relative
newcomer to the Committee, he had been impressed by the extra

ordinary variety of forces with which the Desk had to contend.
On studying the blue book, he had concluded that the Committee
would be fortunate if it could produce results anywhere within
the full range of the alternatives presented, let alone hit
the targets specified under some one of the alternatives.

-48-

9/19/72

Mr. Winn then observed that he was disturbed about the
developing inflationary psychology.

Unfortunately, the recent

high growth rates in the monetary aggregates were contributing
to that psychology, particularly since the public appeared to
be accepting the view that monetary growth rates were the key
indicator of policy.

He would be concerned about the effects

of publishing figures for September showing another month of
rapid growth, and accordingly he would like to see the Committee
move a bit further toward slowing the aggregates than it had
done thus far.

He favored the specifications of alternative C.

In a concluding observation Mr. Winn said that while
regulation of stock market credit did not fall within the
Committee's range of responsibilities, he would note that he
remained concerned about developments in that area.
Mr. Coldwell remarked that in open market operations
since the last meeting problems of market instability had taken
precedence over the attainment of the aggregate targets the
Committee had adopted.

He thought the Committee could not

accept a continuation of excessive rates of growth in the aggre
gates, like those recorded recently and projected for the future,
unless it also was prepared to accept responsibility for the
inflationary consequences of such growth rates.

The alternative

course was to move toward lower growth rates as promptly as

-49-

9/19/72

possible, even if that meant some modest increase in market
interest rates--perhaps including an advance in the discount
rate.

He did not favor higher interest rates as an end in

themselves, and he recognized that they might be unpopular in
a period of wage and price controls, but he was willing to
accept higher interest rates if needed to curtail the present
rate of growth in reserves and in the credit base.

He thought

the Committee could not afford to wait or temporize any longer,
given the expansion in money that was already in place.
Mr. Coldwell said he was dissatisfied with all of the
staff's alternatives for the operational paragraph of the direc
tive.

He would prefer a paragraph reading as follows:

"To

implement this policy, while taking account of developments in
credit markets, international developments, and the effects of
bank regulatory changes, the Committee seeks to achieve an
orderly tightening in bank reserve and money market conditions
which will foster slower growth in monetary aggregates over the
months ahead."

That, in his judgment, was a direct statement of

the appropriate objective.

In implementing such a directive, he

would favor a progressive increase in the Federal funds rate,
although he hoped the funds rate would not have to rise above
5-1/2 per cent.

Also, he thought that use should be made of

every possible opportunity to reduce reserve availability,

-50-

9/19/72

and--if market circumstances permitted--that securities sold by
the Desk should include longer-term issues.
In a concluding observation, Mr. Coldwell said he probably
would soon recommend a quarter-point increase in the discount
rate to the directors of the Dallas Reserve Bank.
Mr. Mayo remarked that, like a number of others, he favored
alternative C.

For the Federal funds rate, he believed a range of

tolerance of 4-3/4 to 5-3/4 per cent around the 5-3/8 per cent figure
shown under C would be appropriate, although he hoped the funds rate
would not have to rise anywhere near 5-3/4 per cent.
Mr. Mayo went on to say that he thought the Manager should
be given more than the usual amount of latitude during the period
in which the financial system was digesting the effects of the
changes in Regulations D and J, since it was impossible to foretell
the specific form those effects would take.

Moreover, he would

want to instruct the Desk to place much more than the usual amount
of emphasis on money market conditions in the coming period.

He

was not suggesting that the Committee abandon its current experi
ment, and he thought it would be appropriate for it to continue
to specify goals in terms of RPD's.

However, in view of the

uncertainties created by the System's own action in adopting the
D and J changes, it would be desirable to engage temporarily in
what might be described as an "even keel" operation.

9/19/72

-51-

For similar reasons, Mr. Mayo continued, he would prefer
to delay an increase in the discount rate for a few weeks,

even

though he believed an increase this week or next probably could
be justified on strictly economic grounds.

The delay would give

the System an opportunity to observe the effects of the regulatory
actions.

Also, now that the System had indicated its willingness

to make the discount window available to both member and nonmember
banks to facilitate their adjustments to the actions,

it

would

seem desirable to keep the rate unchanged for a few weeks.
Mr. Morris remarked that before turning to current policy
he might first call the Committee's attention to a development
on which he had been pondering recently.

Despite the fact that

the Federal Reserve had been following an expansionary policy
for 2 years or more, most measures of liquidity indicated that
the position of New England banks,
He believed that in

at least, was quite illiquid.

recent years banks had greatly intensified

their efforts at aggressive portfolio management.

That was

reflected, for example, in the fact that New England country banks
as a group had been net buyers of Federal funds for the past
several months; at the moment, their net purchase position was as
high as at any time in 1969.

He was not sure whether greater

aggressiveness was a New England phenomenon or a national one,
and he thought it

would be desirable for the staff to undertake

-52-

9/19/72

research on that question.

If the phenomenon was national, it

would suggest that the banking system was likely to respond more
quickly to a firming of monetary policy than it had during the
recoveries from past recessions, when banks had started from
more liquid positions.

It might also help explain the sharpness

of the recent rise in short-term interest rates.
As to current policy, Mr. Morris said he would support
alternative C.

Even if growth in the aggregates slowed to the

extent projected under that alternative, for 1972 as a whole M1
and M 2 would rise at rates of 8.1 and 9.8 per cent, respectively.
Since he thought the Committee would not want growth for the
year to exceed such rates, it would seem desirable to continue
to move toward higher money market rates.

The 5-3/8 per cent

central value shown for the funds rate under alternative C
appeared to him to be appropriate.

If the Committee adopted

alternative C he would expect the Desk to operate a little more
aggressively in the next 4 weeks than it had in the recent
period.
Turning to the discount rate, Mr. Morris said it was his
view, and also that of the directors of the Boston Bank, that
once the discount rate got substantially out of line with market
rates it was very difficult to bring it back into line.

It

seemed to him that the System had to decide now whether it

9/19/72

-53-

intended to keep the discount rate in
with the market in

the future.

If

fairly close alignment

the answer was yes,

the rate would seem appropriate now.

increase in

then an

All of the

evidence suggested that the uptrend in money market rates was
not just a temporary development,
held at its

and if

the discount rate were

present 4-1/2 per cent level much longer it

was

likely soon to be a full percentage point below the Federal funds
rate.
than if

The System would then be faced with a much greater problem
it

had kept the margin narrow by taking successive small

bites.
Mr.

Francis said he would associate himself with those

who had expressed a desire to move towards slowing the rate of
expansion in the monetary aggregates as soon as possible.

In

that connection, he noted that the staff's GNP projections--which,
on the whole, appeared reasonable to him--suggested that the rate
of increase in

average prices would rise progressively throughout

the four quarters of 1973.

An assumption underlying those pro

jections, according to the green book, was that M1, would expand
at annual rates of 9 and 7 per cent, respectively, in the third
and fourth quarters of 1972, and at a 6 per cent rate in 1973.
Such growth rates were almost exactly the rates called for under
alternative D, the most restrictive of the 4 policy alternatives
described in

the blue book;

the only exception was that the growth

-54-

9/19/72

rate

for the third quarter of 1972 shown under D--as well as

under the other alternatives--was at the somewhat higher level
of 10-1/2 per cent.

Such a comparison suggested that the

Committee might want to consider alternatives even more restric
tive than D.

On balance, however, he thought growth rates in

the vicinity of those shown under D would not be far wrong.
Mr. Heflin said he was as concerned as anyone at the
table about the problem of inflation, but he was also aware of
other considerations that the Committee had to take into account
in deciding on policy.

As the Chairman had indicated, the economy

was not yet in a boom situation.

In particular, the fact that

there was still some distance to go before full employment, on any
reasonable definition, was reached constrained the Committee's
freedom of action.

He did not think Committee members would

want to ignore their objectives in the area of employment--which,
indeed, were objectives of over-all Government policy--or would
want to take any monetary action that could result in pinching off
the recovery before the employment objectives had been attained.
It would be better, he thought, to let the nation's pool of unused
resources take care of the demand aspects of the inflation problem,
and to let the wage-price program take care of the cost-push aspects.
And he did not think the members could ignore the implications of
interest rate movements for the problems facing the Committee on

-55

9/19/72

Interest and Dividends and for the Government's control program
as a whole.
That was not to say, Mr. Heflin continued, that he would
not want to move toward a more restrictive monetary policy at this
time.

The question was how far to move.

It seemed to him that

an increase in the Federal funds rate over the next 4 weeks to,
say, 5-3/4 per cent would give the market a signal that should
not be given at this time.

It was not at all clear to him that

that much of an increase was necessary to avoid the kind of
drastic action later which Mr. Axilrod had described in response
to Mr. Brimmer's question about the consequences of delaying
action altogether.
On balance, Mr. Heflin observed, he favored specifications
closer to those of alternative B than C.

He would set a 5-1/4 per

cent upper limit on the Federal funds rate, and he hoped it would
not move much above 5 per cent during the coming period.

If the

Committee was going to set a target for growth in RPD's he would
favor a range for the September-October period of 11 to 15 per
cent, although he was impressed with the difficulties of making
any RPD projections at this time in view of the scheduled imple
mentation of the changes in Regulations D and J.

In that connec

tion, he thought the directive language should reflect the present
uncertainty as to whether those regulatory changes would actually
be put into effect.

Finally, the Manager would have to have

-56-

9/19/72

maximum leeway during the coming period and might, for a time
at least, have to rely on the funds rate for his principal guide.
Mr. Daane said his response to the Manager's question was
that the Desk should not be at all relentless in pursuing specific
targets for the aggregates during the period immediately ahead.
Like others, he would prefer to see somewhat more moderate growth
However, he thought the Manager would need

in the aggregates.

maximum latitude in the coming period in light of the prevailing
uncertainties as to the degree of the vulnerability of the market
and the reserve impact of the changes in Regulations D and J,
assuming they were implemented.

It was particularly important at

this time that open market operations should not tend to confirm
the market's view that the System planned to rush up the hill
with interest rates.
Mr. Daane noted that market participants watched the funds
rate closely for clues to the System's policy intentions.

The

Manager had suggested that the market probably could tolerate a
funds rate a little above 5 per cent without undue reactions.

If

the rate were to rise as high as 5-3/4 per cent in the next few
weeks, however, he (Mr. Daane) would expect interest rates to be
off to the races.

The difficulties would be enhanced by the

Treasury's cash financing next month, and that would be so
even if the financing took the least unsettling form of an issue
of tax-anticipation bills.

-57-

9/19/72

In his judgment, Mr. Daane continued, the Desk should be
concerned with the "tone and feel" of the market.

On the basis

of long and close contact with open market operations during his
34 years with the Federal Reserve System, he was still persuaded
that there was real meaning in that concept.

He would like to

see the Desk probe upward with the Federal funds rate, backing
and filling and feeling its way, in an effort to achieve somewhat
slower growth in the aggregates without giving the market the
sense of certainty about System intentions that would precipitate
an upward ratcheting of interest rates generally.
Mr. Daane remarked that he would prefer a directive cast
in terms of money market conditions.

As to specifications, those

shown under alternative B were probably most nearly consistent
with the prescription of cautious probing that he favored.

As

was often the case, however, he found it difficult to assess the
significance of the alternatives shown for growth rates in the
aggregates.

For the fourth quarter, for example, the annual rates

of growth shown under alternatives B and C differed by only one
quarter of a percentage point for M1 and by only one-half of a
point for M

and the bank credit proxy.

His confidence in the

accuracy of the staff's projections was not great enough for him
to advocate one pattern of growth rates over the others when the
differences were that small.

-58-

9/19/72

Mr. Daane then said he might add some comments regarding
the discount rate, without prejudging how as a member of the Board
he would vote on any actions that might be proposed by the Reserve
Banks.

At the moment he was concerned that a discount rate increase

would be interpreted as leading the market toward higher interest
rates, and that it would have the same kind of undesirable effects
as a large rise in the Federal funds rate.

More generally, he

disagreed with Mr. Morris regarding the desirability of tying the
discount rate closely to market rates.

In his judgment there

were times--and this was one of them--when there was positive
merit in a discount rate that was out of line with market rates,
because it could then serve as a drag on market rates and reduce
the risk of sharp upward surges.
Mr. Mitchell observed that the discussion so far revealed
considerable sentiment for "gradualism."

That term had been

highly popular when the present Administration took office 4 years
ago with the stated objective of applying economic stabilization
measures in a gradual rather than abrupt fashion.

One problem

with a gradualist approach was that it took so long to become
effective that everyone became unhappy over the lack of progress.
Another was that it exposed policy-makers to such criticisms as
"Why have you begun to restrain economic activity when unemploy
ment is as high as it is today?"

While such criticisms could be

-59-

9/19/72

answered with explanations about the lags in the system, the
explanations often would be convincing only after the fact;
earlier, the policy-maker was forced to admit that no one could
say how long the lag would prove to be in a particular case.
Thus, it was much easier to defend a move toward restraint after
concrete evidence of the need for it was in hand.
Mr. Mitchell noted that Chairman Burns had suggested today
that the Committee had already embarked on a course of gradual
restraint.

Perhaps the Chairman was right, but he (Mr. Mitchell)

would not have placed that interpretation on recent policy.

It

was his view that the Committee had moved into an accommodative
stance and was still in such a stance.

And he thought that was

the better place to be at the moment.
Mr. Mitchell observed that several speakers today had
referred to the staff's GNP projections and econometric model in
support of the policy course they favored.
model had a number of defects.

He might note that the

For one thing, it did not take

into account the nature of future actions by the Pay Board and the
Price Commission.

For another, it incorporated highly uncertain

assumptions about fiscal policy.

And for a third, it did not

take account of the effects of the scheduled changes in
D and J,

Regulations

because no one could be sure at this point what those

effects would be.

-60-

9/19/72

Perhaps the model took account of market expectations in
some manner, Mr.

In any case, that was a

Mitchell continued.

subject with which the Committee had to be concerned, since the
market's assessment of the System's intent could have important
consequences.

In the area of open market operations--unlike that

of discount rate actions--the System had a choice as to whether
to offer a signal of policy intent.

At this point he would not

want to signal a Federal Reserve judgment that tightening should
occur.

He would not object strongly if market forces themselves

were creating tighter conditions,
not be leading the trend.

but he thought the System should

In his judgment the difficulties

experienced around the Labor Day weekend had arisen because the
market interpreted System operations as signaling a move toward
firmer conditions in reaction to high growth rates in the aggre
gates.

At present, the Committee did not--and could not--know

what would happen to the aggregates in

the months ahead, partly

because of uncertainty about the consequences of the changes in
Regulations D and J.
In view of that uncertainty,

Mr. Mitchell remarked, he

agreed with those who thought the directive should be formulated
in

terms of money market conditions.

The language Mr. Coldwell

had proposed might be acceptable, perhaps with some minor modifi
cation.

Like some others, he had difficulty in

choosing among

-61-

9/19/72

the alternative sets of specifications, but if he had to make a
choice it would fall between those given under alternatives B
and C.
As to the discount rate, Mr. Mitchell said he would
prefer not to make a change at this time if one could be avoided,
because that also would transmit a kind of signal.

He thought,

however, that the point at which a change was needed might already
have been reached--or soon would be--if the System followed the
course of keeping the discount rate reasonably in line with
market rates.

He agreed with Mr. Morris that the discount rate

should not be permitted to get far out of line with the market,
and he thought there were circumstances in which a quarter-point
increase would be a neutral action in the sense that it would be
interpreted as catching up with rather than leading the market.
On that basis a near-term increase of a quarter-point might be
relatively harmless, and he probably would not find himself
strenuously opposing such an action should it be proposed.

As

he had indicated, however, he would prefer on balance to avoid
a rise at this time if possible.
Mr. Sheehan noted that during the first quarter of 1972
the Federal Reserve had not reduced the discount rate from its
4-1/2 per cent level despite a decline in short-term market rates
well below that level.

He asked whether Mr. Mitchell thought the

-62-

9/19/72

System's failure to lower the discount rate then had created any
difficulties.
Mr. Mitchell replied that in his judgment the System was
almost always better off when it kept the discount rate in line
with the market.

If the recent practice of some commercial banks

in tying their prime rates to market rates proved to be successful,
he thought it might offer a splendid example for the System to
follow.

He agreed with Mr. Daane that there were times when it

might be desirable to deviate from such a course, but he disagreed
that this was such a time.
Mr. Sheehan asked whether Mr. Mitchell thought the System's
inaction last spring had kept market rates from falling as far
as they otherwise would have, and similarly, whether inaction now
would tend to moderate upward pressure on market rates.
Mr. Mitchell replied that he doubted that there had been
much rate effect in the spring; the major consequence of holding
to a 4-1/2 per cent discount rate then had probably been that of
leading people to wonder why a reduction had not been made.

The

consequences of inaction at present would depend on the interpre
tations the market placed on the objectives of open market
operations.

He thought observers were puzzled about those

objectives at the moment.

They probably would remain puzzled if

the discount rate was kept unchanged and the Federal funds rate
was held within a range of, say, 4-7/8 to 5-1/4 per cent.

-63-

9/19/72

Mr. Hayes observed that it was the almost unanimous view
of people in the New York financial district that short-term rates
were in a rising trend.
Mr. Mitchell remarked that it was precisely that attitude
which he thought the System should try to modify.

The System had

weakened in that effort around the Labor Day weekend; if it had
not, such expectations would not have fed on themselves.
Mr. Hayes remarked that the view he mentioned was not
attributable to developments during the past few weeks but had
developed earlier.
Mr. Kimbrel expressed the opinion that a move toward some
moderate slowing of the monetary aggregates was overdue.

It seemed

to him, however, that just as there were times when circumstances
called for policy to be aimed primarily at aggregate objectives,
there were other times when primary emphasis should be placed on
money market conditions.

At present, in view of the many

uncertainties and technical unknowns, it could be argued that
the Committee's main concern should be to provide member banks
with adequate reserves to make the necessary adjustments and to
avoid sharp changes in short-term rates.

Thus, it might be appro

priate to place primary emphasis on money market conditions in the
period until the next meeting of the Committee.

Personally, he

favored seeking somewhat firmer money market conditions in this

-64-

9/19/72

period, but he thought the conditions associated with alternative
C represented about as much firming as the Committee could expect
to accomplish.

He would grant the Manager the latitude to cope

with possible market problems, but hoped there would be a minimum
of slippage in money market conditions.
Mr. Kimbrel noted that there had been a spirited discussion
of the discount rate at the last meeting of the executive committee
of the Atlanta Bank's board.

The conclusion was that an increase

in the discount rate would not be desirable at the moment in view
of the impending changes in Regulations D and J.

Also, the direc

tors would prefer to follow the market rather than lead it, and
they were not sure that an increase now would be clearly a follow
ing action; and they certainly would not want to signal an overt
change in the System's stance at this time.
Mr. Robertson said he was concerned about inflation and
about the need to purge the economy of inflationary expectations.
That, in his judgment, was the most important problem facing the
System now.

At its last meeting the Committee had set guidelines

for the Manager's operations, but as soon as the Manager had begun
to tighten up on the provision of reserves and the growth rates of
the aggregates he had been compelled to beat a hasty retreat by
developments in credit markets.

The Manager had found himself in

a very difficult situation, and his actions were justified under

-65-

9/19/72

point 3 of the points for his guidance, which indicated that the
Federal funds rate was to move in an orderly way and was not to
bounce around unchecked within the specified range.

Nevertheless,

the recent experience was an unfortunate one.
Mr. Robertson expressed the hope that the Committee would
learn from that experience, rally its forces, and try again.

To

sluice in all of the reserves necessary to hold interest rates
down would be to foster growth in the monetary aggregates at
a pace that would finance a new round of inflation.

The Committee

should not attempt to hold down interest rates but should utilize
its powers to moderate inflation.

In his judgment, that required

moving now; he would not wait.
Specifically, Mr. Robertson continued, he would direct the
Manager to pull back on the rate of growth in RPD's and the mone
tary aggregates to the fullest extent possible without permitting
the funds rate to rise above, say, 5-1/2 per cent, and the bill
rate perhaps not above 5-1/4 per cent, in the period before the
next meeting.

As he read the alternatives for the directive, he

thought C would fit such a course more closely than the others.
In a concluding observation Mr. Robertson said he thought
the Committee should not be too sensitive to interest rates.
Rather, it should let market forces play their full part
should limit itself to moderating sharp movements.

and

-66-

9/19/72

Mr. MacLaury said he would begin by indicating why he
thought the Committee should move now to restrain growth in the
monetary aggregates rather than delaying further.

First,

September was the third successive month of monetary growth in
excess of earlier expectations.

Also, an arithmetic calculation

like that cited by Mr. Morris revealed that growth in M1 over
the year 1972 would exceed 8 per cent even if the Committee today
adopted alternative D--the most restrictive of the 4 alternatives
presented in the blue book and one for which he held no particular
brief.

And it was worth noting that the staff's projections for

the first quarter of 1973 were now stronger than 4 weeks ago;
thus, a 6 per cent growth rate was anticipated in the first
quarter under alternative D, in contrast to the 4-1/2 per cent
pace projected in the previous blue book on the basis of a
roughly similar assumption for the Federal funds rate.

It was

quite likely that such upward revisions would be found necessary
for successive quarters of 1973--at least if the current assess
ment of the strength of the economy proved correct, as he thought
it would.
Despite such considerations, Mr. MacLaury remarked, it
was obvious that the Committee did not have to act in any partic
ular month or in any particular quarter.

But it was equally

obvious that the Committee should not rely on that fact to postpone

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action at meeting after meeting.

Moreover, the present meeting

offered a better opportunity for action than later ones would,
in view of the prospects for Treasury financing operations over
the period through early 1973.

And action now would, of course,

not commit the Committee to continuous firming; if it turned out
that the blue book projections of the aggregates were too high
and those of the New York Bank were nearer the mark, policy could
be modified at subsequent meetings.
As to the nature of the action to be taken, Mr. MacLaury
said that this was a time--if there ever was one--for temporarily
setting aside RPD targets, in view of the uncertainties associated
with the scheduled changes in Regulations D and J.

He favored

focusing on money market conditions in the coming period, and he
found the directive language proposed by Mr. Coldwell to be
particularly attractive.

He would formulate the Desk's instructions

in terms of a point target for the Federal funds rate; while the
Desk could not be expected to hit such a target precisely, it
could be expected to come reasonably close--certainly closer than
to a target growth rate for a monetary aggregate.

He agreed with

Mr. Daane that it would be a grave mistake to have the funds rate
rise to the area of 5-3/4 per cent at present, but he thought a
target rate of 5-3/8 per cent, to be attained on average in the
coming period, would be appropriate.

Unlike Mr. Daane, however,

-68-

9/19/72

he thought the Desk should be a little more relentless than it
had been in the recent period in pursuing the targets set for it.
Mr. MacLaury said he concurred in the Manager's view
that it might be desirable in the coming period for the System
to buy longer-term bills or other specific issues which were a
drag on the market, and offset the reserve impact by selling
short-term bills.

Such operations could be helpful in easing

pressures at particular points of the maturity structure and,
more generally, in attaining the Committee's objectives without
exacerbating problems in the market.
As to the discount rate, Mr. MacLaury observed that he
had been advising the directors of the Minneapolis Reserve Bank
that an increase was neither necessary nor desirable at this time.
He thought they agreed that the balance of considerations argued
against an increase, even though--like Mr. Mitchell and othersthey would be happier if it were possible to keep the discount
rate in line with market rates.
Mr. MacLaury then said he might comment on certain earlier
observations by Mr. Mitchell and Chairman Burns.

In his remarks

on gradualism, Mr. Mitchell had suggested that it would be difficult
for the System to justify beginning to firm gradually now, consider
ing the level of the unemployment rate.

He (Mr. MacLaury) would

make the opposite point that, considering the change in circumstances

-69-

9/19/72

over the past 2 months, it was difficult for the System to justify
its failure to produce any net firming of money market conditions
in that interval.

He noted in that connection that the average

Federal funds rate was 4.61 per cent during the statement week
ending July 5 and nearly the same--4.69 per cent--in the latest
statement week, ending September 13.

Although Treasury bill rates

had risen considerably over the same interval, he would attribute
their rise primarily to the fact that they had been depressed
earlier as a result of special factors.
Continuing, Mr. MacLaury said the Chairman's remarks on
which he wished to comment were those relating to the implications
of changes in interest rates--along with changes in prices, profits,
and dividends--for the nature of the decisions to be taken by the
Pay Board.

He agreed that those implications posed a potentially

serious problem which should be taken into account in formulating
monetary policy.

As the Chairman had noted, however, the interest

rates that mattered most in that connection were those on mortgages
and on consumer loans.

While efforts might be made to see that

such rates did not rise abruptly, he thought short-term market
rates would still be free to rise.

In particular, he would not

expect an increase during the coming 4 weeks of the magnitude he
was proposing--about 3/8 of a point in the Federal funds rate--to
have significant adverse effects of the kind under discussion.

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9/19/72

Chairman Burns said he had not planned to comment further
until the remaining members had expressed their views on policy.
In light of Mr. MacLaury's concluding remarks, however, he might
say a word at this point about the Committee on Interest and
Dividends, which as the members knew was a Government-wide
Committee including only one representative from the Federal
Reserve Board.

A rather strong body of sentiment was developing

within that Committee in favor of a public statement admonishing
lenders in all categories to act prudently in setting interest
rates, and suggesting gently--but still suggesting--that if they
failed to do so the Committee would establish guidelines for
interest rates.

The proposal for such a statement was facing

some opposition, but it might be approved.

If guidelines were

established the result would be a confrontation between the
Federal Reserve and the Executive establishment--a prospect
that was extremely disturbing.
The Chairman went on to say that the policy views of each
of those who had spoken thus far seemed reasonable, in the sense
that they were justified in terms of the speaker's own view of
the future.

The difficulty was that visions of the future were

so clouded.

His own position was complicated not only by the

role he played on the Committee on Interest and Dividends but
also by the fact that he had had a certain influence in moving

9/19/72

-71-

the Ways and Means Committee of the House of Representatives
towards a ceiling on Federal expenditures.

One of his arguments

had been that in the absence of an expenditure ceiling interest
rates would rise significantly, and that the Federal Reserve
would be unable to check the rise even if it wanted to do so.
He might add that he had just been asked to testify tomorrow
morning in an executive session of the Ways and Means Committee.
As Mr. Heflin had suggested, the Chairman observed, the
problem was an all-Government one.

The Federal Reserve had to

discharge its own responsibility, but in doing so it had to take
account of what was being done and planned and thought elsewhere
within the Government.
Mr. Winn left the meeting at this point.
Mr. Sheehan referred to Mr. Mitchell's comments on
gradualism and noted that when he had joined the Committee in
January his thinking on policy had tended to run in terms of a
gradualist approach.

At that time the Federal funds rate had been

about 3-1/2 per cent; since then it had risen by about a half of
a percentage point per quarter.

With respect to the comments of

Messrs. Daane and Robertson today, it was interesting to note that
despite the difference in their policy views they both seemed to
be approaching the same thought with respect to the market.

Thus,

-72-

9/19/72

Mr. Daane had urged that the Committee not confirm the market's
view that the System was rushing up the hill with respect to
interest rates; and Mr. Robertson had urged that market forces
be permitted to play their full part.
Mr. Sheehan then observed that he had been surprised by
the magnitude of the movement in interest rates following the
preceding meeting.

In particular, he had been startled by the

level the funds rate had been permitted to reach before the
Labor Day weekend without further consultation with the Committee.
Apparently, his understanding of the Committee's expectations and
instructions at the preceding meeting had differed from that of
others.
Continuing, Mr. Sheehan remarked that he did not perceive
the exuberance in the economy that others did; indeed, he was a
little surprised by the Chairman's views on the strength of the
economy.

On the basis of discussions with a number of industrial

ists and bankers in Boston last night, he would now question
whether any significant stimulus could be expected from inventory
investment.

For example, the head of one large corporation had

indicated that his company did not plan to increase inventory
investment; that it had developed the tightest and best inventory
controls it had ever had, and was now able to fill 95 per cent of
its orders without difficulty.

The same kind of development

-73-

9/19/72

appeared to be occurring elsewhere.

Earlier in the year he

(Mr. Sheehan) had thought that businesses were simply moving
slowly in adapting their inventory policies to the upturn in
activity, but he no longer believed that was the case.
More generally, Mr. Sheehan said, against the background
of the staff's projections of GNP and industrial production, and
with the unemployment rate at 5-1/2 per cent, he did not see a
need for sharp increases in short-term interest rates.

Rather

than lead market rates up, he would prefer to maintain a sense
of uncertainty about the course of System policy.

He favored

alternative B, and during the next 4 weeks he would like to keep
the Federal funds rate in the range Mr. Mitchell had mentioned4-7/8 to 5-1/4 per cent.
Mr. Bucher said that like other Committee members he was
getting a little worried about the growth rates of the monetary
aggregates and was inclined toward Mr. Brimmer's views on that
subject.

At the same time, from his experience before joining

the Committee he was well aware of the relationship between
market psychology and interest rates, and he understood the
need for sometimes moving cautiously to avoid creating undesired
market reactions.

He might also note that he had learned in his

few months on the Committee that the projections made by the
staff--both at the Board and the New York Bank--were not as

-74-

9/19/72

infallible as he might have thought earlier when he was an
outsider.
Evidently, Mr. Bucher continued, the Committee had posed
a problem for the Manager at the previous meeting by giving him
specifications for the aggregates and for money market rates
that proved to be inconsistent.

Today, if everything else were

equal, he would prefer the interest rate specifications of
alternative A and the aggregate growth rates of D; but, of course,
other things were not likely to be equal.

On balance, he would

opt for the growth rates of alternative C, and he would be willing
to accept a Federal funds rate as high as 5-1/2 per cent in the
coming period.

If the specifications for the funds rate were to

be set in terms of a range--as might be desirable in light of
the risk of undue market reactions--he would favor the range of
4-3/4 to 5-1/2 per cent.

Like Mr. MacLaury, however, he saw

advantages in a point target; certainly, if he were the Manager
he would prefer working with a specific target rather than a
spread.

If a point target were to be used he could accept

5-3/8 per cent but would prefer a lower figure.
Mr. Clay observed that the monetary policy problem today
was an intensification of the similar problem the Committee had
faced at the last meeting.

In his judgment monetary policy was

excessively stimulating and needed to be restrained.

It was not

-75-

9/19/72

reasonable to expect that the Committee could reduce the growth
rates of the monetary aggregates to an appropriate degree without
having interest rates move upward.

Allowing excessive growth

rates in the aggregates to avoid upward movements in interest
rates only aggravated the problem.

To be sure, it was important

in his opinion that whatever adjustment in interest rates did
take place should be gradual rather than abrupt.
All factors considered, Mr. Clay said, alternative C of
the draft directives appeared to be the best choice today, although
if growth paths for the monetary aggregates were considered alone
those of alternative D would be more desirable.

He would favor

giving the Manager a good deal of leeway to avoid unduly abrupt
changes in interest rates.
Mr. Clay added that in his judgment a quarter-point increase
in the discount rate was justified at this time on both economic
and market grounds.

Such an action, in his view, would not consti

tute leading the market, and it would have the advantage of keeping
the discount race within striking distance of market rates.

He

remembered a previous episode in which the discount rate was far
below market rates for an extended period.

System officials were

in agreement that the discount rate was much too low, but in view
of the size of the increase that would have been required to bring
it into line with the market, they considered it necessary to delay

-76-

9/19/72

an increase until market rates had declined enough to narrow the
gap.

It was with that recollection in mind that he favored an

increase now.
Mr. Merritt noted that at other recent meetings he had
favored a move toward slowing the expansion in the aggregates.
He was of the same view today, but in light of the uncertainties
about the effects of the amendments to Regulations D and J--assuming
they were implemented--he would now want to move with less speed
than he would have urged earlier.

For the same reason, he would

prefer to cast the Desk's instructions in terms of money market
conditions.
Specifically, Mr. Merritt said, he thought the Committee
should formulate its primary target in terms of a range for the
Federal funds rate, and instruct the Manager to probe within that
range while granting him a great deal of latitude.

Earlier, he

would have considered 5-1/2 per cent acceptable as an upper limit
for the funds rate, but given present circumstances he would not
like to see the rate rise above 5-3/8 per cent during the next
few weeks.

For the lower limit he would suggest 4-7/8 per cent.

With respect to the discount rate, Mr. Merritt observed
that while he generally favored keeping that rate as closely in
line with the market as feasible, he thought the period immediately
ahead might not be a good time for an increase.

The volume of

-77-

9/19/72

member bank borrowings would influence his attitude to some extent.
Borrowings on the order of $500 million probably could be tolerated
without a rate change.

However, if an increase in the funds rate

to 5-1/4 or 5-3/8 per cent was associated with a rise in borrowings
into the $600 to $800 million area, an increase in the discount

rate might very well be justified.
Chairman Burns said he might make a few observations before
attempting to derive the Committee's consensus.

He had been keeping

a close watch on the aggregates, and had been highly disappointed
by what he had observed.

He had been watching interest rates, and had

been very much disappointed by developments in that area also.
question was how to balance one against the other.

The

He wondered,

however, whether there was a full appreciation of the extent to
which interest rates had risen thus far in 1972.

According to the

blue book table labeled "Selected Interest Rates," the increases in
average rates from the month of January to the latest statement
week, in terms of basis points, were as follows:

Federal funds,

119; 90-day Treasury bills, 134; 1-year bills, 157; 90-119 day
commercial paper, 97; AAA corporate new issues, 25; municipal
bonds, 26; and 10-year Governments, 60.

The only rate series in

the table that had been essentially stable was the FNMA auction
yield.

There had been some movement in other mortgage interest

rate series, but not very much.

If there was merit in the staff's

-78

9/19/72

belief that changes in interest rates had a lagged effect on
growth rates in the monetary aggregates, forces had already been
released that should be serving to moderate those growth rates.
The magnitude of that effect was highly uncertain, however, and
that produced a dilemma for the Committee.
As to the views of members on policy, the Chairman
continued, it appeared from the discussion that a majority favored
alternative C and that a substantial minority favored B.

Postponing

the question of specifications for the moment, he would suggest that
for the operational paragraph the Committee consider the language
of alternative C with one small but significant modification.

The

modification he had in mind was the addition of the word "special"
before "account" in the second clause,making the beginning of the
paragraph read "To implement this policy, while taking special
account of developments in credit markets, international develop
ments, and the effects of bank regulatory changes ..

.. "

The

purpose of the change was to emphasize that, partly because of the
sensitive state of credit markets and partly because of the uncer
tainties regarding the reserve effects of the impending bank
regulatory changes, money market conditions were to be given
special

importance and the Desk was to have more than the usual

degree of flexibility.

He asked whether alternative C, so modified,

was considered satisfactory by the Committee for the operational
paragraph.

-79-

9/19/72

After discussion, it was agreed that the proposed modification
was satisfactory.
Mr. Mitchell suggested that the reference to bank regula
tory changes be placed ahead of the reference to credit market
and international developments, so that the ordering would be in
accordance with the probable relative importance of the three
types of factors.
Mr. Robertson observed that it might also be desirable to
qualify the reference to bank regulatory changes to take account
of the uncertainty as to whether they would in fact become
effective in the coming period.

As the Committee knew, Federal

court hearings on Regulation J were under way today in both
Washington and Los Angeles.
Mr. Holland said he had just received word that the U.S.
District Court for the District of Columbia had issued a temporary
restraining order preventing the Board from implementing the amend
ments to Regulation J

for the time being.

After further discussion, it was agreed that the operational
paragraph of the directive should read as follows:

"To implement

this policy, while taking special account of the effects of possible
bank regulatory changes, developments in credit markets, and

-80-

9/19/72

international developments, the Committee seeks to achieve bank
reserve and money market conditions that will support more moderate
growth in monetary aggregates over the months ahead."
The Chairman then said he would propose a particular
interpretation of that language, including a set of specifications,
which appeared to him to be a reasonable compromise of the members'
views.

For RPD's, for which the average annual rate of growth in

September and October shown under alternative C was 13.4 per cent,
he would suggest specifying a range for that period of 11-1/2 to
15-1/2 per cent.

For the Federal funds rate the range would be

4-3/4 to 5-3/8 per cent.

For the monetary aggregates, the

specified rates would be those of alternative C--for M 1 , 11-1/2
per cent in September and 7 per cent in the fourth quarter; the
same for M2; and for the adjusted credit proxy, 9 per cent in
September and 11 per cent in the fourth quarter.

Those growth

rates would not be considered as targets, but as what might be
called "guiding" figures, in the following sense:

if the Manager

assessed incoming data as confirming the high rates projected,
he would have the authority to move the Federal funds rate
towards the upper end of the indicated range.

On the other hand,

if the aggregates appeared to be considerably weaker, he would
be expected to hold the funds rate unchanged or perhaps edge it
down in the range.

9/19/72

-81-

Finally, the Chairman said, it would be understood that
in light of the special circumstances now prevailing the Manager
would pay more attention to money market conditions than customarily,
and he would have greater latitude than in any other period so far
this year.

And if firming actions were required, they would be

carried out with discretion, and not so evenly as to convey an
obvious policy signal.
In response to a question, Mr. Holmes said the Desk had
been aiming at a funds rate of 5 per cent in recent days, and the
rate had been about at that level yesterday.

This morning it had

been tending up toward 5-1/4 per cent and the Desk had been
resisting the movement.
Mr. Holmes then noted that the Chairman had used the blue
book projections in formulating the proposed specifications.

He

presumed from the discussion that Committee members would be
pleased if M1 actually grew in September at the 6-1/2 per cent
rate projected by the New York Bank staff on the assumption of no
change in money market conditions.
Chairman Burns remarked that he personally would be even
more pleased if the September growth rate were 4 per cent.
Mr. Holmes said he assumed the Committee would not want
him to reduce the funds rate from existing levels if M 1 did in
fact appear to be growing at a 4 per cent rate.

-82-

9/19/72

Chairman Burns said that would be his interpretation also.
However, if M1 were still weaker--say, not growing at all or perhaps
at a 1 per cent rate--he thought the Manager would want to consider
moving toward the lower end of the range, depending on how the
markets were behaving.
Mr. Mitchell asked whether the policy course under consid
eration had direct implications for the discount rate. While views
on the matter differed, he would be somewhat troubled if rising
market rates opened a large gap above an unchanged discount rate,
since he thought there were limits to the extent to which the
latter could be permitted to lag.

As had already been mentioned,

the discount rate had been held above market rates for a consid
erable period earlier this year, but that had not posed any great
problem because market rates had been expected to move back up.
Now, however, a large gap was likely to create greater problems
because there would be widespread expectations of a continuing
rise in market rates.
Chairman Burns observed that he, for one, was not prepared
to express an opinion on the discount rate today, other than that
he was not eager for an increase.
Mr. Brimmer said there was some question in his mind as
to whether the lower limit for the funds rate should be set at
4-3/4 per cent, as the Chairman had suggested, or at 4-7/8 per

9/19/72

-83-

cent, which was closer to the prevailing level.

What concerned

him particularly was the risk of further slippage in working
toward the objective of moderating growth in the aggregates.
Mr. Daane expressed the view that the slightly wider range
suggested by the Chairman was consistent with the proposal that
the Manager should be given increased latitude in light of prevail
ing uncertainties.

So long as the Committee's objectives for the

aggregates were clear to the Manager, it would seem undesirable to
narrow the range for the funds rate and thus reduce the Manager's
flexibility to back and fill as he worked toward those objectives.
Mr. MacLaury said it might be helpful to distinguish
sharply between the two different kinds of uncertainty involved
in the discussion today.

One was the uncertainty associated

with the scheduled changes in Regulations D and J. In his judg
ment, by having the Manager focus on money market conditions for
this period, the problems arising from that source could be dealt
with effectively, and accordingly they could be set aside.

The

second kind of uncertainty related to the possibility of undesirable
market reactions to any firming operations by the System.

That

could be dealt with by instructing the Manager to use a probing
approach in any firming operations, standing ready to back off if
the market reaction indicated that he was moving too fast.

As he

(Mr. MacLaury) had indicated earlier, he would favor instructing

-84-

9/19/72

the Manager to probe toward a funds rate of 5-3/8 per cent--not
as a ceiling but as an average level during the coming period.
Under such an instruction, no lower limit for the funds rate
would have to be specified.
Chairman Burns said he wanted to make it clear that he
would much prefer not to see the funds rate rise to 5-3/8 per
cent in the coming period.

He would be willing to tolerate a

5-3/8 per cent rate if required by circumstances, and he had
proposed specifications under which the Manager would have the
But he definitely did not want

authority to move to that level.

to press eagerly toward higher funds rates regardless of other
circumstances.
Mr. Robertson said he also would not favor pushing up the
funds rate aggressively without regard to the performance of the
aggregates or other circumstances.

But he did want to slow the

growth in RPD's and the aggregates--to the extent that could be
done without causing undesired reactions in the market--and he
believed that a higher funds rate was required for the purpose.
Accordingly, he thought the Desk should be instructed to move
the funds rate up in an orderly way toward 5-3/8 per cent.

He

saw no need to specify a floor for the funds rate.
Mr. Hayes asked whether it would be contemplated under
the specifications the Chairman had proposed that the Desk would
raise the funds rate to 5-3/8 per cent over the period until the

-85-

9/19/72

next meeting if the aggregates appeared to be growing at the rates
now anticipated, and if firming operations were found to produce
no particular problems in the market.
Chairman Burns replied affirmatively.

He then proposed

that the Committee vote on a directive consisting of the general
paragraphs as drafted by the staff and the operational paragraph
agreed upon earlier, with that directive to be interpreted in the
manner he had outlined.
Messrs. MacLaury and Robertson indicated that they planned
to cast dissenting votes.
Mr. Coldwell asked whether a favorable vote would imply an
intent to validate growth in RPD's at a rate in the middle of the
range the Chairman had mentioned, or, alternatively, whether the
intent was to seek slower growth in RPD's--assuming no problems
were encountered in the course of moving the funds rate up within
the range specified for it.
The Chairman replied that the latter approach was the one
he had intended.
Mr. Coldwell then said he planned to cast an affirmative vote.
Mr. Holland noted that Mr. Mayo would be called upon to vote
as alternate for Mr. Winn, who had left the meeting earlier.
With Messrs. MacLaury and
Robertson dissenting, the Federal
Reserve Bank of New York was autho
rized and directed, until otherwise
directed by the Committee, to execute
transactions for the System Account
in accordance with the following
current economic policy directive:

9/19/72

-86-

The information reviewed at this meeting suggests
a substantial increase in real output of goods and
services in the current quarter, although well below
the unusually large rise recorded in the second
quarter. In July and August, wages and prices
advanced somewhat more rapidly on balance than in
the immediately preceding months, while the unemploy
ment rate remained substantial. Foreign exchange
market conditions have remained quiet in recent weeks
and the central bank reserves of most industrial
countries have continued to change little. In July,
the large excess of U.S. merchandise imports over
exports persisted.
In August on average, growth slowed in the
narrowly and broadly defined money stock and in
the bank credit proxy, but in recent weeks the
money stock has been expanding more strongly.
Since mid-August, interest rates on Treasury bills
have increased sharply, while yields on most other
market securities have advanced more moderately.
In light of the foregoing developments, it is
the policy of the Federal Open Market Committee to
foster financial conditions conducive to sustainable
real economic growth and increased employment, abate
ment of inflationary pressures, and attainment of
reasonable equilibrium in the country's balance of
payments.
To implement this policy, while taking special
account of the effects of possible bank regulatory
changes, developments in credit markets, and
international developments, the Committee seeks to
achieve bank reserve and money market conditions
that will support more moderate growth in monetary
aggregates over the months ahead.
Mr. Holland noted that the specifications for RPD's shown
in the blue book, including those for alternative C--on which the
guiding range for RPD's approved by the Committee was based--reflected
adjustments designed to take account of the effects of the scheduled

-87-

9/19/72
changes in Regulations D and J.

He assumed the Committee would

want the staff to make appropriate adjustments in that guiding
range if, in fact, the regulatory actions did not become effective.
It was agreed that such adjustments should be made.

Secretary's
agreed upon
distributed
appended to
ment B.

Note: The specifications
by the Committee, in the form
following the meeting, are
this memorandum as Attach

Secretary's Note: Following the meeting
Messrs. MacLaury and Robertson each sub
mitted summary statements of their reasons
for dissenting from the directive, which
they asked be incorporated in the record.
Mr. MacLaury indicated that he had
dissented because he had become increas
ingly disturbed by the rapid rates of
growth in the aggregates, given the
prospective strength of the economy, and
he felt that the Committee's current
operating procedures did not assure that
money market conditions would be permitted
to tighten sufficiently to slow this
excessive monetary growth in the near
future. Mr. Robertson dissented because
of his belief that with the existing
potentiality for increased inflationary
pressures, the Committee was not doing
enough to curb the rate at which reserves
were being fed into the banking system by
the Federal Reserve and to slow down the
rate of growth in the monetary aggregates.
In his view, the failure to do so might
result in a new groundswell of inflation
later on.
Chairman Burns then noted that a memorandum from the
Secretariat dated September 12, 1972,1/ set forth a tentative
1/ A copy of this memorandum has been placed in the Committee's
files.

-88-

9/19/72

Committee meeting schedule for 1973 which--like this year's
schedule--called for twelve meetings at monthly intervals.

After discussion, it was agreed that the tentative
schedule proposed was satisfactory.
It was agreed that the next meeting of the Federal Open
Market Committee would be held on Tuesday, October 17, 1972, at
9:30 a.m.
Thereupon the meeting adjourned.

Secretary

ATTACHMENT A
September 18, 1972

CONFIDENTIAL (FR)

Drafts of Current Economic Policy Directive for Consideration by the
Federal Open Market Committee at its Meeting on September 19, 1972
GENERAL PARAGRAPHS
The information reviewed at this meeting suggests a substantial
increase in real output of goods and services in the current quarter,
although well below the unusually large rise recorded in the second
quarter. In July and August, wages and prices advanced somewhat
more rapidly on balance than in the immediately preceding months,
while the unemployment rate remained substantial. Foreign exchange
market conditions have remained quiet in recent weeks and the central
bank reserves of most industrial countries have continued to change
little. In July, the large excess of U.S. merchandise imports over
exports persisted.
In August on average, growth slowed in the narrowly and
broadly defined money stock and in the bank credit proxy, but in
recent weeks the money stock has been expanding more strongly.
Since mid-August, interest rates on Treasury bills have increased
sharply, while yields on most other market securities have advanced
more moderately.
In light of the foregoing developments, it is the policy of
the Federal Open Market Committee to foster financial conditions
conducive to sustainable real economic growth and increased employ
ment, abatement of inflationary pressures, and attainment of
reasonably equilibrium in the country's balance of payments.
OPERATIONAL PARAGRAPHS
Alternative A
To implement this policy, while taking account of develop
ments in credit markets, international developments, and the effects
of bank regulatory changes, the Committee seeks to achieve bank
reserve and money market conditions that will support some moderation
of growth in monetary aggregates over the months ahead.

Alternative B
To implement this policy, while taking account of develop
ments in credit markets, international developments, and the effects
of bank regulatory changes, the Committee seeks to achieve bank
reserve and money market conditions that will support somewhat
more moderate growth in monetary aggregates over the months ahead.
Alternative C
To implement this policy, while taking account of develop
ments in credit markets, international developments, and the effects
of bank regulatory changes, the Committee seeks to achieve bank
reserve and money market conditions that will support more moderate
growth in monetary aggregates over the months ahead.
Alternative D
To implement this policy, while taking account of develop
ments in credit markets, international developments, and the effects
of bank regulatory changes, the Committee seeks to achieve bank
reserve and money market conditions that will support moderate
growth in monetary aggregates over the months ahead.

ATTACHMENT B

STRICTLY CONFIDENTIAL (FR)

September 22,

Points for FOMC Guidance to Manager
In Implementation of Directive

1972

SPECIFICATIONS
(As agreed, 9/19/72)

1.

Guiding rate of growth in aggregate
reserves expressed as a range rather
than a point target.

9-1/2 to 13-1/2% seas.
adj. annual rate in
RPD's in Sept.-Oct.1/

2.

Range of toleration for fluctuations
in Federal funds rate--enough to allow
significant changes in reserve supply,
but not so much as to disturb markets.

4-3/4 to 5-3/8%

3.

Federal funds rate to be moved in an
orderly way within the range of tolerance
(rather than to be allowed to bounce
around unchecked between the upper and
lower limit of the range).

4.

Guiding expectations for monetary
aggregates (M1, M2, and bank credit),
to be given some allowance by the
M1:
Manager as he supplies reserves
M2:
between meetings.
Proxy:

5.

3rd Q.
(SAAR)

4th Q.

11

10-1/2

11

10

7-1/2
7-1/2
11

Sept.

9

10-1/2

If it appears the Committee's various
objectives and constraints are not
going to be met satisfactorily in any
period between meetings, the Manager
is promptly to notify the Chairman,
who will then promptly decide whether
the situation calls for special Com
mittee action to give supplementary
instructions.

1/ Modified from range of 11-1/2 to 15-1/2 per cent initially
approved at 9/19/72 meeting, in order to allow for nonimplementation
of changes in Regulations D and J.

ATTACHMENT C

Mr. Daane's Statement on September
Basle Meeting

The Basle meeting of central bank governors on the weekend
of September 9-10 was quiet and uneventful, which hopefully augurs
for a similarly quiet and noncontroversial Fund and Bank meeting
this next week. Actually, I think the governors in Basle were
largely preoccupied with their next day meeting in Rome dealing
with such questions as the establishment and scope of a European
monetary fund.
The Sunday afternoon discussion was concerned largely with
the question of central bank placements in the Euro-dollar market.
This stemmed from German Finance Minister Schmidt's inclusion in
his economic program of the matter of central bank placements in,
Much of the
or more accurately withdrawals from, the Euro-market.
investment
an
attractive
of
discussion centered on the possibility
outlet in the United States (either a "money employed account" at
the Federal Reserve of New York or a new Treasury instrument) with
a view toward also utilizing any such instrument to attract central
bank funds of non-G-10 countries. After lengthy discussion, the
governors charged the Standing Committee on the Euro-currency
Market with taking a fresh look at the question of central bank
placements, not only in terms of limiting further additions but
also making withdrawals.
In the "tour d'horizon", principal interest focused on a
renewed concern with inflation in a number of the countries repre
sented and on the possible role of monetary policy in dealing with
the problem. Governor O'Brien of the Bank of England indicated
that the money supply growth for the first half of the year had
been as high as 30 per cent and that inflation prospects were
"not comforting". The German Bundesbank president had also talked
about the need to reduce the rate of money expansion including the
possible need for new instruments. The only other comment at the
Sunday afternoon session which I might mention was that of the
Japanese Deputy Governor, Mr. Inoue, who noted that their central
bank had been supporting the dollar almost every day since the
Smithsonian Agreement, and in the last two months had taken in
around $1-1/2 billion.
At the Sunday night session of governors, President Zijlstra
had returned to the question of achieving better control of the money
supply, with a large number of the governors present expressing great

sympathy with both the objective and the need, if necessary, to
The consensus
develop new instruments to achieve adequate control.
was that money supply growth was proceeding too fast, that monetary
authorities should be able to find a way to control money supply
growth, and that, if necessary, new instruments could or should be
devised.
(1) It was
Two other housekeeping items deserve mention:
bank
of
central
meeting
usual
be
the
there
would
that
noted
economists at the BIS November 9-11, with the topic being "The
Effect of Exchange Rate Changes on Balance-of-Payments Developments(2) It was noted that the
Experience in Recent Years (1967-72)".
BIS staff would continue to follow developments related to establish
ing a telecommunications system for effecting international payments
(see attached "Note for the Governors").

Attachment

9th September 1972

Note for the Governors
Establishment of Telecommunications Systems
for Effecting International Payments

You will recall that, at your meeting in September 1971, it
was decided that the computer experts of the central banks of the
Group of Ten countries and Switzerland should study the possibility
of using a communications system for effecting international payments
similar to the one which was being studied at that time by the central
banks of the EEC.
In particular, it was suggested that they should
contact commercial banks or banking associations considering estab
lishing alternative networks with the aim of discouraging the
development of a series of possibly incompatible telecommunications
facilities.
As you were advised by a note dated 12th December 1971,
contacts were established with the sole remaining major group effort
in this area, the MSP (Message Switching Project).
This is a body
which initially involved 44 European and 25 American banks (now
vastly more); it has completed a feasibility study on the technical,
legal and administrative aspects of the matter and is committed to
the establishment, possibly within the month, of an international
organization to be named SWIFT (Society for Worldwide Interbank
Financial Telecommunications), with headquarters in Brussels and
incorporated in conformity with Belgian law.
The MSP Steering Committee declined the suggestion that the
BIS represent the central banks of the Group of Ten countries and
Switzerland in that Committee and invited the central banks and the
BIS to join the proposed network merely as users on the same basis
as the commercial banks in their respective countries.
This matter was reviewed at a meeting held at the BIS on
4th September 1972 and the majority of the Group decided to submit
the following recommendations:
1.
While the details of costs and possible membership rules
remain unclear, on the basis of such information as is available,
the majority of the Group recommends that the Governors agree in
principle that central-bank participation in SWIFT is consistent
with the general interest of such banks to improve the mechanism
for effecting international payments in a timely and orderly manner.
To this end it is proposed:

-2-

(a) that the central banks should join SWIFT and participate
in their national groups (*) in order to follow and influence
the development of SWIFT as a message switching mechanism,
and
(b) that the Group continue to meet at the BIS to exchange
information acquired at the national level and to formulate
specific objectives to meet the interest of central banks,
in particular to be able to develop as far as possible a
common policy for the central banks as regards future
developments in this field.
2.
In addition to the participation of individual central banks
in their national groups, it remains the unanimous wish of the Group,
if appropriate terms can be arranged, that the BIS should represent
the central banks or maintain a relationship with whatever inter
national governing body might develop in SWIFT with a view to keeping
the central banks informed as to the continuing development of that
network.
Should the Governors agree to points 1 and 2 above as regards
the central banks' participation in the SWIFT project, it is the belief
of the majority of the members that it would be preferable to partici
pate in the project from its inception.
3.
The National Bank of Belgium, while agreeing with the usefulness
of maintaining informal contacts in connection with SWIFT, believes
that the central banks will not have the possibility of influencing
it in becoming
(a) a general system open to all banks and financial institutions,
(b) a system which would enable central banks to benefit from its
advanced technology by providing monetary authorities in the
various countries with direct and primary data on inter
national payments traffic,
(c) a system which takes into consideration the specific
requirements of the EEC countries as a future monetary
union.

(*) All central banks of the Group of Ten countries and Switzerland,
with the exception, for different reasons, of the National Bank
of Belgium, the Swiss National Bank, the Federal Reserve System
and the Bank of Japan, have now paid the $3,200 for obtaining
the documents from the MSP without taking any decision as regards
future participation.