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MINUTES OF T H E M E E T I N G OF T H E F E D E R A L ADVISORY COUNCIL M a y 16, 1960 The second statutory meeting of the Federal Advisory C ouncil for 1960 was convened in Room 932 of the Mayflower Hotel, Washington, D. C., on M a y 16, 1960, at 9:30 A .M . Present: D istrict No. 1 D istrict N o. 2 D istrict No. 3 D istrict No. 4 D istrict No. 5 D istrict N o. 6 D istrict N o. 7 D istrict No. 8 D istrict No. 9 D istrict No. 10 D istrict No. 11 D istrict No. 12 Secretary Assistant Secretary Ostrom Enders John J. M cCloy Casimir A. Sienkiewicz Reuben B. Hays John S. Alfriend General John C. Persons Homer J. Livingston Norfleet Turner Gordon M urray R. Otis M cClintock I. F. Betts Charles F. Frankland Herbert V. Prochnow "William J. Korsvik On motion duly made and seconded, the mimeographed notes of the meeting held on February 15-16, 1960, copies of which had been sent to the members of the C ouncil, were approved. A complete list of the items on the agenda for the meeting, and the conclusions of the Council are to be found in the Confidential M emorandum to the Board of Governors from the Federal Advisory Council, which follows on pages 17 and 18. The meeting adjourned at 12:35 P .M . HERBERT V. PROCHNOW Secretary WILLIAM J. KORSVIK Assistant Secretary 14 M I N U T E S OF T H E M E E T I N G OF T H E F E D E R A L ADVISORY COUNCIL M ay 16, 1960 A t 2:30 P .M ., the Federal Advisory Council convened in the Board Room of the Federal Reserve Building, Washington, D. C. Present: M r. Homer J. Livingston, President; Messrs. Ostrom Enders, John J. M cC loy, Casim ir A. Sienkiewicz, Reuben B. Hays, John S. Alfriend; General John C. Persons; Messrs. Norfleet Turner. Gordon M urray, R. Otis McClintock, I. F. Betts, Charles F. Frankland, Herbert V. Prochnow, Secretary, and W illiam J. Korsvik. Assistant Secretary. D r. W oodlief Thomas, Adviser to the Board, discussed the subject, “Scope of M onetary Policy and Availability of C redit” . Copies of his remarks were distributed to each member of the Council. HERBERT V. PROCHNOW Secretary WILLIAM J. KORSVIK Assistant Secretary 15 MINUTES OF T H E M E E T I N G OF T H E F E D E R A L ADVISORY COUNCIL M ay 16, 1960 At 8:00 P.M., the Federal Advisory Council reconvened in Room 932 of the M a y flower Hotel, Washington, D. C. Present: Mr. Homer J. Livingston, President; Messrs. Ostrom Enders, John J. McCloy, Casimir A. Sienkiewicz, Reubeti B. Hays, John S. Alfriend; General John C. Persons; Messrs. Norfleet Turner, Gordon Murray, R. Otis M cClintock, I. F. Betts, Charles F. Frankland, Herbert V. Prochnow, Secretary, and W illiam J. Korsvik, Assistant Secretary. The Council reviewed its conclusions regarding the items on the agenda, and sent to the office of the Secretary of the Board of Governors the Confidential Memorandum which follows on pages 17 and 18, listing the agenda items with the conclusions reached by the Council. The Memorandum was delivered to the Federal Reserve Building at 10:30 P.M . on M ay 16, 1960. The meeting adjourned at 9:15 P.M . HERBERT V. PROCHNOW Secretary WILLIAM J. KORSVIK Assistant Secretary 16 CONFIDENTIAL M EM ORANDUM TO T H E B O A R D OF G O V ERN O RS FROM THE F E D E R A L A D V IS O R Y C O U N C IL R E L A T IV E T O T H E A G E N D A F O R T H E J O IN T M E E T IN G O N M A Y 17, 1960 ) 1. W h a t arc the views of the Council regarding the current business situation and prospects of business activity during the remainder of the current calendar year? The C o u n c il’s judgm ent as to the current expectations of the business co m m u n ity and the general public and the impact of those expectations on capital expenditures, business inventories, and consumer expenditures would be appreciated. The members of the C ouncil report that business is at a relatively high level. While there was some hesitation in the economy in the latter part of the first quarter, employ m ent, retail sales and business activ ity in general improved in April. However, the output of steel, the production of durable goods and construction, including housing, are not enjoying the high level of activ ity that characterizes the economy generally. The C ouncil believes th a t the expectations of the business community and the general p ublic indicate th a t capital expenditures and consumer purchases will be at a high level for the rem ainder of the year. Despite the favorable outlook, the rate of business b uy ing for inventories will probably lessen, as total inventories are at record levels, reflecting the rapid b u ild u p in the first quarter. W hile the ratio of inventories to sales is below historical averages, there are some indications that it is less favorable than it was earlier this year. A ltho ug h business m ay not be as buoyant as the optimistic forecasts early this year, the C ouncil believes th a t business will continue good during the remainder of the current calendar year. 2. H ow does the current dem and for credit compare with demands at this season of other recent years? W h at is the prospective demand lor bank loans and other credit during the remainder of this year? W ill the anticipated substantial increase in plant and equipm ent expenditures be financed by internal funds, term loans, or resort to capital markets? M o st members of the Council report that the current demand for credit exceeds that at this season in other recent years. The C ouncil believes that the dem and for bank loans and other credit will be strong during the remainder of the year. The anticipated substantial increase in plant and 17 equipment expenditures will be financed largely by internal funds with some resort to the capital markets. In those instances where internal funds prove to be inadequate, principally in medium and smaller businesses, term loan financing by banks may be required. 3. Has there been a reduction in liquidity of banks so great as to hamper them in meeting the more essential needs for credit? Are there differences in this respect among groups of banks, such as money market banks, banks engaged principally in industrial and commercial lending, and banks in agricultural areas? While there have been increases in certain types of longer-term credit, indicating some lessening in the liquidity of banks, the reduction has not been so great as to hamper the banks in meeting the more essential needs for credit. The Council uses the phrase, “essential needs for credit,” in the sense of customary, short-term or seasonal credit requirements. In the opinion of the Council there are no significant differences in these developments among groups of banks. However, banks which are reluctant to liquidate portions of their bond portfolios at a loss may be hampered in meeting all of the essential needs for credit in their communities. 4. W hat have been recent developments in the volume of the various forms of savings? Is public interest in United States Government securities as widespread as it was last fall? Total savings appear to be increasing with a larger share of the increase going to those institutions, such as the savings and loan associations which are paying higher rates. While the public interest in United States Government securities now is greater than it was a year ago, it is not as great as it was at the time of the issuance of the “magic 5’s.” 5. The Board would be glad to have the views of the Council regarding the appro priateness of monetary and credit policy in recent months. The members of the Council believe the Board’s monetary and credit policy in recent months has been appropriate and well executed. The degree of restraint appears to have been suitable under prevailing conditions. 18 M I N U T E S O F JOINT C O N F E R E N C E O F T H E F E D E R A L A D V I S O R Y C O U N C I L A N D T H E B O A R D OF G O V E R N O R S OF T H E F E D ERAL RESERVE S Y S T E M M ay 17, 19(50 At 10:30 A .M ., a joint conference of the Federal Advisory Council and the Board of Governors of the Federal Reserve System was held in the Board Room of the Federal Reserve Building, Washington, D. C. Present: Members of the Board of Governors of the Federal Reserve System: Chairm an W m . M cC . M artin, Jr.; Vice Chairman C. Canby Balderston; Governors M . S. Szymczak, J. L. Robertson, Chas. N. Shepardson and G. H. King, Jr.; also M r. M erritt Sherman, Secretary, and M r. Kenneth A. Kenyon, Assistant Secretary of the Board of Governors. Present: Members of the Federal Advisory C ouncil: M r. Homer J. Livingston, President; Messrs. Ostrom Enders, John J. M cCloy, Casimir A. Sienkiewicz, John S. Alfriend, Norfleet Turner, Gordon Murray, R. Otis M cClintock, I. F. Betts, Charles F. Frankland, Herbert V. Prochnow, Secretary, and W illiam J. Korsvik, Assistant Secretary. Absent: M r. Reuben B. Hays and General John C. Persons. The President read the first item on the agenda and the conclusions of the Council as given in the Confidential M emorandum to the Board of Governors from the Federal Advisory Council, as printed on pages 17 and 18. There followed an informal exchange of views on the business outlook, including some discussion of current international developments and the effect they might have on United States economy. In discussing the decline in the level of farm land prices, the view was expressed th a t the fear of inflation was tending to diminish. In response to an inquiry on foreign competition from Chairm an M artin, President Livingston said that he was concerned that more and more people seemed to be thinking in terms of protection. President Livingston read the second item on the agenda, and the conclusions reached by the Council, as expressed in the Confidential Memorandum. In response to a question by Governor Balderston, President Livingston said that term lending was on the increase but not to a significant extent. The third and fourth items on the agenda and the conclusions of the Council were then read by President Livingston. The President of the Council then read the fifth item on the Agenda and the conclu sions of the Council as expressed in the Confidential Memorandum to the Board. An extended discussion followed. In response to the question on monetary and credit policy in the months ahead. President Livingston noted that he felt the Council would favor making money somewhat easier rather than tighter. It was suggested by M r. M cCloy that the Board might wish to consider accomplishing this objective by acting on the reserve requirements of the 19 central reserve city banks as outlined by the recent statute enacted by the Congress. President Livingston added that he shared Mr. M cC loy’s view but did not want to suggest action on reserve requirements of the central reserve city banks if that would be in conflict with the Board’s general credit policy. Chairm an M artin replied that the various questions involved in implementing reserve requirement legislation were under continuous study by the Board. Various other matters were then discussed by the members of the Board and the Council. President Livingston noted that many members of the Council were concerned about the declining liquidity of the commercial banking system and its ability to provide the legitimate short-term credit requirements of the community. In response to a question by Governor Shepardson as to how banks would meet the problem if loan ratios were to go higher, President Livingston, replied that most bankers recognized an obligation to care for the needs of short-term commercial borrowers. If necessary, he continued, the bank would turn down term loans and reduce consumer credit so as to be in a position to take care of the essential needs of short-term commercial borrowers. Chairman M artin expressed agreement with an observation by President Livingston that inflation psychology seemed to have died down and recalled having publicly stated that in his opinion inflationary psychology had been partially liquidated. There then followed a discussion of Regulation Q. President Livingston reported that he believed banks generally would be opposed to an increase in the 3 per cent ceiling. He also observed that there might be a question whether the law prohibiting the payments on demand deposits should not be changed. It m ight be argued, he continued, that the markets should determine the rates payable on deposits in a free enterprise system. While acknowledging this, M r. Sienkiewicz observed that the soundness of the entire banking system was a prime consideration. The meeting adjourned at 12:15 P.M . HERBERT V. PROCHNOW Secretary WILLIAM J. KORSVIK Assistant Secretary 20 NOTE: This transcript of the Secretary's notes is not to be regarded as complete or necessarily entirely accurate. The transcript is for the sole use of the members of the Federal Advisory Council. The concise official minutes for the entire year are printed and distributed later. HoV.P. W.J.K. The Secretary* s notes of the meeting of the Federal Advisory Council on May 16, I960, at 9 0 0 A.M., in Room 932 of the Mayflower Hotel, Washington, D. C. All members of the Council were present. The Council approved the Secretary's notes for the meeting of February 15-16, i9 6 0 . Livingston noted that the Council’ s next regularly scheduled meeting on the third Monday and Tuesday in September will conflict with the annual meeting of the American Bankers Association. After some discussion, it was finally decided to suggest to the Board of Governors that the next meeting of the Council be scheduled for September 14-15, i960. ITEM I WHAT ARE THE VIEWS OF THE COUNCIL REGARDING THE CURRENT BUSINESS SITUATION AND PROSPECTS OF BUSINESS ACTIVITY DURING THE REMAINDER OF THE CURRENT CALENDAR YEAR? THE COUNCIL1S JUDGMENT AS TO THE CURRENT EXPECTATIONS OF THE BUSINESS COMMUNITY AND THE GENERAL PUBLIC AND THE IMPACT OF THOSE EXPECTATIONS ON CAPITAL EXPENDITURES, BUSINESS INVENTORIES, AND CONSUMER EXPENDITURES WOULD BE APPRECIATED. Livingston read Item I and asked the members of the Council to comment on this item as it pertained to their districts. There was general agreement among the members of the Council that business is at a relatively high level. Many reported an improvement in April in employment and sales. The output of steel, production of durable goods, and construction, however, were not at as high a level as the economy in general. The Council observed that the expectations of the business community and the general public indicate that capital expenditures and consumer purchases will be at very satisfactory levels. The members of the Council tended to confirm the recent surveys of business capital investment plans and consumer buying intentions. It was agreed that inventories are high as the result of a rapid build-up in the first quarter and that as a consequence business buying for inventories probably will lessen in the period ahead. The -ouncil concluded, however, that business will continue good during the remainder of the year. ITEM II HOW DOES THE CURRENT DEMAND FOR CREDIT COMPARE WITH DEMANDS AT THIS SEASON OF OTHER RECENT YEARS? WHAT IS THE PROSPECTIVE DEMAND FOR BANK LOANS AND OTHER CREDIT DURING THE REMAINDER OF THIS YEAR? WILL THE ANTICIPATED SUBSTANTIAL INCREASE IN PLANT AND EQUIPMENT EXPENDITURES BE FINANCED BY INTERNAL FUNDS, TERM LOANS. OR RESORT TO CAPITAL MARKETS?__________ _______________________ Livingston read Item II. A brief discussion followed in which the members of a strong current demand for credit that exceeded that prevail Digitizedthe for FRASER Council reported "this season in recent years* It was agreed that the demand for bank loans 3nd other credit will be strong during the remainder of the year. The Council anticipates that plant and equipment expenditures will be financed largely by internal funds with some resort to the capital markets. However, a number of members reported that the internal funds of medium and smaller businesses may prove inadequate and that some term-loan financing by banks may be required. ing ITEM III HAS THERE BEEN A REDUCTION IN LIQUIDITY OF BANKS SO GREAT AS TO HAMPER THEM IN MEETING THE MORE ESSENTIAL NEEDS FOR CREDIT? ARE THERE DIFFERENCES IN THIS RESPECT AMONG GROUPS OF BANKS, SUCH AS MONEY MARKET BANKS, BANKS ENGAGED PRINCIPALLY IN INDUSTRIAL AND COMMERCIAL LENDING, AND BANKS IN AGRICULTURAL AREAS?____________________________ ______________ _________________________ Livingston read Item III and referred briefly to Governor Mills1 recent speech on the increasing proportion of bank assets being invested in real estate, consumer and term loans. An extended discussion followed on the liquidity of banks. While it was agreed that some reduction in the liquidity of banks had occurred, the members of the Council did not believe it had hampered the banks in meeting the more essential needs for credit in their communities. The Council was of the opinion that there was no significant difference in these developments among groups of banks. It observed, however, that banks which are reluctant to liquidate por tions of their bond portfolios because of the decline in bond prices may be hampered in supplying the credit demanded by borrowers in their communities. A brief discussion followed on the reduction of reserve requirements of the central reserve city banks in accordance with the law enacted by the Congress at the last session. There also were comments on the possibility of lowering reserves on savings deposits. Enders suggested that the members ticularly those relating to changes in that consideration be given to putting September. The members of the Council of the Council review these proposals, par reserve requirements on time deposits, and the matter on the agenda for the meeting in concurred with the suggestion. ITEM IV WHAT HAVE BEEN RECENT DEVELOPMENTS IN THE VOLUME OF THE VARIOUS FORMS OF SAVINGS? I S PUBLIC INTEREST IN UNITED STATES GOVERNMENT SECURITIES AS WIDE SPREAD AS IT WAS LAST FALL? L iv in g s t o n re a d Ite m I V . I n t h e d is c u s s io n w hich f o llo w e d , t h e members o f th e Council r e p o r te d t h a t t o t a l s a v in g s a p p e a r t o be in c r e a s in g b u t t h a t a s i n th e p a s t the la r g e r s h a re o f t h e in c r e a s e i s g o in g t o th e s a v in g s and lo a n a s s o c ia t io n s w hich are paying h ig h e r r a t e s . There was some d is c u s s io n on th e 3 p e r c e n t c e i l i n g on in te re s t w hich can be p a id t o s a v in g s d e p o s it o r s . M ost o f th e members o f th e Council believe t h a t p u b l i c i n t e r e s t i n U n ite d S t a t e s governm ent s e c u r it ie s i s g r e a t e r now + -han i t was a y e a r ago b u t n o t as g r e a t as i t was l a s t f a l l a t th e tim e o f th e issuance o f th e "m agic 5 , s *" 3. ITEM V THE BOARD WOULD BE GLAD TO HAVE THE VIEWS OF THE COUNCIL REGARDING THE APPROPRIATENESS OF MONETARY AND CREDIT POLICY IN RECENT MONTHS. T.i v in g s t o n re a d I t e m V and o b se rv e d t h a t t h i s ite m in v o lv e d a review o f the oast ra th e r t h a n comments on t h e f u t u r e . There was g e n e ra l agreement t h a t th e fe d e ra l Reserve B oard h a d done a good jo b and t h a t m onetary c r e d it p o lic y had been appropriate and w e l l e x e c u te d . The m e e tin g a d jo u r n e d a t 1 2 :3 5 P .M . 4. THE COUNCIL CONVENED IN THE BOARD ROOM OF THE FEDERAL RESERVE BUILDING, WASHINGTON, D . C., AT 2 :3 0 P .M . ON MAY 16, I9 6 0 . ALL MEMBERS OF THE COUNCIL WERE PRESENT. Dr. Woodlief Thomas, A d v is e r t o t h e Board of Governors of the Federal Reserve discussed the subject, "Scope of Monetary Policy and Availability of Credit." A copy of Dr. Thomas' remarks is attached. System, * * * * * THE COUNCIL CONVENED AT 8;00 P.M. ON MAY 16, I960, IN ROOM 932 OF THE MAYFLCWER HOTEL. ALL MEMBERS OF THE COUNCIL WERE PRESENT. The Council prepared and approved the attached Confidential Memorandum to be sent to the Board of Governors relative to the Agenda for the joint meeting of the Council and the Board on May 17. The Memorandum was delivered to the Federal Reserve Building at 10:30 P.M. on May 16. It was agreed that the President of the Council would make some comment at the joint meeting with the Board on the reduction of reserve requirements of the central reserve city banks. It was also agreed that the Council would inquire of the Board if it would be helpful if the Council took some action on the Patman Bill relating to membership in the Federal Reserve System. Livingston invited members of the Council as an "intellectual exercise" to consider the idea of paying interest on demand deposits. He stated that a number of corporate treasurers had indicated to him that they would keep funds on deposit in their demand accounts rather than buy Treasury bills or commercial paper if they received 2 per cent on such demand deposits. A brief discussion followed in which a number of members of the Council indicated that the earnings of many banks would not permit the payment of interest on demand deposits. The meeting adjourned at 9:15 P»M. SCOPE OF MONETARY POLICY AND AVAIIABIUTY OF CREDIT* Credit developments in the past year have furnished clearer — though not necessarily new — in sig h ts in to the role and functioning of monetary policy. Newly developed s t a t is t ic a l tools of analysis have con tributed to this c la r ific a tio n * One o f the common fa u lts in appraising monetary policy is fa ilu r e to recognize the lim ited area or scope of it s operations, while at the same time b e lit t l in g the broad area of it s in d i rect consequences. Some of the recent events and some of the appraisals of monetary policy th a t have appeared in the past year illu s tr a te th is fault, Scope of Monetary Policy Opera tio n s . - Monetary policy opera tions, i t is always important to keep in mind, are d ire c tly concerned ffith the provision of money, defined narrowly to cover only cash balances that the public holds in currency or on demand deposit with banks. Mone tary policy operations exert th e ir influence by supplying reserves to the banking system to be used as a b asis for expansion of th e ir loans and in vestments and creation o f money. In deciding what course monetary p o lic ie s should pursue, the basic question is how much money should the banking system be permitted to create at the tim e. What are the considerations involved in find ing an answer to th is question? Monetary p o lic y operations should be viewed as a part of the saving-investment process that provides for balanced economic growth. Changes in the money supply are in effect the portion of savings that the p u b lic chooses to hold in the form o f cash balances. 3he volume of bank credit extended necessarily corresponds to th is amount (with due allowance fo r other elements in bankst balance sheets). This in effect is the q u a n tita tiv e lim it on the scope of monetary policy opera tions, But determination ol’ what i s tte appropriate quantity is not so r simple. In q u an tita tiv e terms, changes in the money supply are but a fraction of aggregate current savings, and correspondingly changes in bank credit are o rd in a rily only a sm all part o f t o t a l c a p ita l and credit made available in any period. On the average the t o t a l of commercial bank credit outstanding and annual changes in th a t t o t a l amount to less than one-fourth of the corresponding aggregates fo r a l l types of c re d it. I f time and savings deposits at banks are excluded from bank cre dit, giving a figure corresponding to the money supply narrowly defined, the propor tion is reduced to a smaller fig u re * The amount o f Federal Reserve credit reeded to meet the currency demand and supply the reserves held against the deposits created is in tu r n a sm all fra c tio n of any addition to the soney supply. Remarks by Woodlief Thomas, Adviser to the Board of Governors of the Federal Reserve System, to the Federal Advisory Council, May IS, I960. -2- These q u a n tita tiv e comparisons are s ig n if ic a n t because they indicate why monetary p o lic y o p e ra tio n s, or even commercial bank cre d it ^-tension, should not be expected to provide d ir e c t ly any amount of c re d it that way be wanted to meet s p e c if ic demands0 Ihe r e la tio n s h ip between amount of cre d it th a t may be desired at any time and the volume of cash balances th a t the p u b lic i s w i l l i n g to ho ld is not fix e d or autom atic. Ihe bulk of cre d it needs must be met out o f saving , not by the cre atio n of additional money. This does not mean, however, th a t monetary p o lic ie s do not in fluence the broader aspects o f economic a c t i v i t y . Ihe influe nce can be tremendous, though not c o n tr o lla b le through monetary p o lic y measures, faa multiple expansion of bank c r e d it created on the b asis of a given amount of reserves exerts a correspondingly greater d ire c t impact on the economy than does the p a r t ic u la r op eration of the c e n tral bank in supplying the reserves. This expansion r a t i o a t present is about six to one fo r de mand deposits at member banks, Use o f the deposits by t h e ir holders provides a fu rth e r m u ltip le exoansion, and th is ra te o f use has v aried w idely during the past fo rty years, with s ig n ific a n t v a r ia tio n s i n the course o f a business cycle. Ihe transactions v e lo c ity ra te i s somewhat more than 25 to one — i t was larger in the 1920 fs and h a lf as much a t the end o f World War I I . The income velocity rate (computed from GNP) has varied between li to one and 2 to one. I t is new about 3 1/2 to one. To what extent the total volume of monetary transactions is affected by monetary policies and to what extent determined by other factors may vary considerably from time to time. If the public should want to hold more cash than is provided, spending will be curtailed as attempt is made to build up cash balances. Under such circumstances policies may well be directed toward encouraging monetary expansion, if economic resources are not being fully utilized. If, however, more money is provided than the public wants to hold in cash balances, spending is stimulated j the total volume of spending might increase even more rapidly than the supply of money. At times of strong credit demands accompanied by restraint on monetary expansion, the bidding up of interest rates might induce the more active use of existing cash. Under these conditions the creation of additional money ought to be restricted. Conversely, slack credit demands that result in falling interest rates may encourage the holding of large idle balances. At such times an increase in the volume of money, relative to the volume of transactions, might appropriately be provided or encouraged. In the final analysis, the willingness and ability of the pub to spend are influenced by many other factors than the supply of money outstanding, narrowly defined to include only cash balances, or than changes in that supply. As previously pointed out, the velocity of money has varied considerably over time. One important influence is the public fs li c -3holdings of liquid assets other than cash and the ability to convert such assets into cash. Monetary policy formulation must take into con sideration any actual or potential changes in the publics holdings of liquid assets, including money substitutes, as well as money proper, and also changes in the rate of use of money. Policies adopted should be directed toward adjusting the supply of money accordingly. Monetary policies through their ordinary procedures can exer cise but little direct control over the types of loans and investments that banks acquireB Nor can they control the extent or type of uses that the public makes of the money that is being created — not to mention usage of the large stock of money already in existence. Since the magni tudes of these uses are so much greater than the actual quantitites of monetary policy operations, it should be evident that monetary policy should not be expected to control or determine all aspects of economic activity. For the same reason monetary policies should not be expected to determine the structure of interest rates, although they do have some limited effect on the level. In the long run, both the level and structure of interest are determined by the relationship between credit demands and the volume of saving available for lending,, These amounts in turn are influenced by interest rates, and monetary policy must be careful to avoid endeavoring to maintain an inappropriate level of rates* Credit Expansion w ithout Monetary Expansion* - This rather simplified'description of~TTie scope and impact of monetary policy opera tions is well illustrated by events of 1959 and early I960, The facts are cogently revealed in the complex interrelationships of the Federal Reserve flow-of-funds tabulations, which are now published quarterly in the Federal Reserve Bulletin. An extensive analysis of factors affect ing saving and interest rates and the role of monetary poliqy, based in part on flow-of-funds data, is given in the 1959 Annual Report of the Board of Governors of the Federal Reserve System* In brief, the striking feature of the past year is that the increase in the total volume of all types of credit outstanding was larger in 1959 than in any previous peacetime year, while bank-created money shewed practically no growth* The total credit growth was ^ 0 bil lion, against !$1*5 billion in 1958 and also in 1955 — previous record years. This credit growth included record-breaking increases in mortgage loans, other consumer credit, and U*S* Government borrowing (excluding war years), with business borrowing relatively moderate. Total loans and investments of commercial banks and the Federal Reserve Banks (excluding interbank transactions) increased by less than U.5 billion. Most of this expansion was counterbalanced by increases in time deposits, U.S* Government deposits, and bank capital, rather than by an increase in the public*s holdings of demand deposits and currency, which amounted to little over $1 billion. -ll- The next striking and somewhat paradoxical development is that commercial bank l o a n s increased in 1959 more than in a n y previous year. In addition to the moderate growth in time deposits and in bank capital, the principal source of funds to meet these loan demands was the sale by banks of U0S0 Government securities to nonbank holders. In other words, banks supplied record amounts of credit to businesses and consumers to finance expanding economic activity, but the funds to meet these credit demands were largely obtained from the savings of the public — past and current — and only to a negligible extent through creation of new money by the banking system. In addition to absorbing about $8 billion of Government securities from banks, nonbank investors also took on some &10 billion of additional securities issued by the Government and by Government agencies. Further more, they supplied some of the funds for a record expansion in mortgage credit and other consumer credit and they increased their holdings of cor porate and State and local government securities by moderate, though not record-breaking amounts, Some of these funds represented genuine long-term savings of individuals invested directly or through savings institutions, A sig nificant development in 1959 was the large increase in direct investment and the decrease in amounts channeled through financial institutions. A substantial portion of the funds reflected an increase in holdings of liquid assets and a shift in the form of such holdings from cash balances or other claims on financial institutions to direct investment in liquid, interest-bearing assets, Hie outstanding example of this type of develop ment was the accumulation of short-term Government securities by nonfinancial corporations. Another of lesser magnitude was the shift of foreign banking funds — and probably some domestic balances — from time deposits at banks to Treasury securities. Another example is the popularity of the 5 per cent Treasury notes (the magic fives) and to some extent of Treasury bills among relatively small investors in the latter part of the year and in early I960, Holdings of marketable Gov ernment securities by individuals showed a remarkable increase — estimated by the S.E.C, at &10 billion. Rise in Interest Rates, - Interest rates played a significant role in these developments. Although there was an increase in gross savings — by businesses and individuals — available for lending and investment, borrowing demands were even larger. With a monetary policy that restrained the creation of addi tional bank credit, the pressure of the enormous credit demands upon the supply of savings available for lending caused interest rates to rise. Ihere were also other factors responsible for rising interest rates. One ^as the prevalent expectation of continuing inflation with a diminution in the value of savings, A corollary of this attitude was the popularity 0f equities and other forms of income-producing property, such as farm l3ndse Federal Reserve policy became more restrictive in supplying re serves , Reserves were reduced by the gold outflow, which was only partly offset by Federal Reserve purchases of securities. Member banks had to increase their borrowings at the Reserve Banks in order to main tain their reserve positions. This exerted a restraining influence that induced banks to sell Government securities in order to meet loan demands, te re st It is reasonable to draw the conclusion that the higher in rates that resulted had a number of effects: (1) They no doubt stimulated some increase in the total volume of saving --at least as compared with what might have happened under the circumstances if attempt had been made to keep interest rates down. (2) They caused savings, including liquid balances, to be shifted from lodgment in institutions with limited or no interest return to direct investment in marketable securities. (3) To an increasing extent, higher interest rates, to gether with increases in stock prices without commensurate in crease in earnings and dividends, offset the advantage of equities as an inflation hedge and diminished their popularity, while increasing the popularity of fixe d-int ere st securities. Loan Expansion, Monetary Contraction, and Declining Interest Rates. - Events in the first 'four months oi‘i960 introduced a somewEaT different turn of events that give a further insight into the role of interest rates. In the first quarter of this year, abstracting from the usual seasonal decline in bank credit and the money supply, bank loan demand continued heavy and banks continued to meet these demands by reducing their holdings of Government securities. The securities sold by banks were absorbed by nonbank investors. In this process the money supply actually decreased by somewhat more than the usual seasonal amount. This decrease in the money supply was not forced by any tightening of monetary restraints. To some degree, the reduction in required reserves resulting from the decline was permitted to ease the situation. Member bank borrowings (and net borrowed reserves) tended to decline, but in the early weeks of the year they continued large enough to keep the banks under some restraint and to induce them to sell Government securities to meet loan demands. In March and April, Federal Reserve operations eased seasonal pressures and member bank borrowings declined considerably. The striking new feature that apreared in I960 was a marked decline in interest rates. Most rates — both short and long — declined to th e lowest levels s in c e the spring of 1959. To some extent this decline i n rates may be attributable to seasonal influences, similar to those t h a t have developed following sharp rises characteristic of q u a rte rly t a x and other settlement periods during the past year or more. To a significant degree, however, it seems to reflect a change in b a s ic forces and in expectations0 March was the first quarterly tax payment month since 1958 when interest rates d id not rise* Many factors accounted for this decline in interest rates, along with a strong loan demand and net liquidation of total bank c red it a Certainly one of the most important was the substantial de clin e in over-all credit demands due to the termination of the large Government deficits that characterized 1958 and 1959» Another in fluence has been the lessened allure of common stocks and the shift from stocks to fixed interest securities. A most significant factor seems to be the desire of the public to hold liquid assets in other forms than cash — a tendency initiated by the higher interest rates in 1959 but which developed so far as to bring down the level of rates in I960. To what extent the decline in interest rates may represent an increase in the volume of saving relative to over-all credit demands wi 11 be revealed only as more information becomes available. Accompanying the decline in the money supply in the early weeks of I960 was a marked increase in the rate of turnover of money. In the early part of last year, an increase in turnover accompanied a slackening in the rate of growth in the money supply. After the middle of that year, when economic activity was limited by the steel strike, the volume of money declined slightly and the turnover rate showed little change. Despite some lull in economic activity due largely to weather conditions in February and March I960, the rate of deposit turn over rose sharply in February and remained high in March and April — about 7 per cent higher than last year. Money supply was less than 1 percent lower. On balance, it is evident that expansion in the total volume of monetary transactions and of economic activity generally was not prevented by the decline in the money supply that has occurred since last summer. Conclusions as to Past Year, - Restraint on monetary expansion in the face oi1 vigorous credit demands in 1959 caused rising interest rates, which in turn attracted into investment savings adequate to finance a substantial economic expansion and a large Government deficit with little monetary creation. In early I960 the continued flow of saving into in vestment, together with termination of the Government deficit, resulted in both a contraction of total bank credit and a decline in interest rates, along with a continued high level of economic activity. These develop ments may be viewwd as an indication of the effectiveness of a restric tive monetary policy in permitting economic expansion without unsustain able credit developments. Freely functioning money and capital markets with flexiblt interest rates served to bring saving and investment into balance and to allocate financial resources among various claimants. -7- More recently there have been signg of another shift in the money market* Interest rates have turned up, and in some cases have regained about half of the decline of the first quarter. Stock prices also rose from the lows of early March but then declined again. These shifts in securities markets accompanied growing indications of a pick up in economic activity 0 The rise in interest rates has occurred not withstanding an eaEier reserve position at banks, with a decline in member bank borrowing to the lowest level in over a year. Interest rates — particularly on Treasury bills — have tended to fluctuate widely at below previous highs* Some decline in in te r e s t rates from the high levels reached in late 1959 and early i 960 might have been expected in view of the decrease in Government borrowing — in f a c t a net reduction in the public debt* Private credit demands have not increased sufficiently to offset that influence 0 Yet, with so much l i q u i d i t y held in Treasury bills rather than in bank deposits and with b i l l rates below the discount rate, wide fluctuations in bill rates are to be expected in response to temporary variations in cash needs. Bank credit developments show evidences of some shift in trend. Bank liquidation of Government securities seems to have lessened. Banks acquired substantial amounts of the new Treasury issues in April and have been slower in liquidating them than in some other recent financings. Loans on securities have also increased — particularly to dealers in Government securities which built up their position. Bank loans to con sumers and to finance companies also increased. Business loans, ex cluding those to finance companies, have shown only moderate changes in recent weeks. The money supply decline seems to have halted. Some increase — seasonally adjusted — has occurred in the past two months, U.S. Govern ment deposits have remained at a higher than expected level. Time deposits have shown some moderate expansion, with an increase in interbank time deposits. Federal Reserve operations played an important role in facili tating the flotation of the Treasury issues and perhaps in bringing about a shift in bank credit. Substantial purchases of bills in the market and liberal repurchase accommodation to dealers have provided additions to the reserve supply. In contrast to recent trends, required reserves increased much more in April than had been projected on the basis of the estimated increase in Treasury deposits at banks and the usual trends in other de p o s its , In addition, Easter currency demands absorbed more reserves than had been expected, but much of this has returned. Member banks were able to meet the substantial increase in required reserves and at the same time reduced somewhat further their borrowings at the Reserve Banks, With respect to current Federal Reserve operations, it can hardly be said that the System is following a particularly restrictive policy. Although the discount rate remains at k per cent, reserves have been made available and member bank borrowings have declined to a moderate -8level with a lessening in the number of borrowing banks. Rates on Treas ury bills — except for the new one-year issue — have remained below the discount rate. Question may be raised as to how much credit restraint is likely to be needed in the near future. Although economic activity is at a relatively high level and will probably continue its expanding trend, the expansion is likely to be moderate and the threat of a boom in this country does not seem to have much basis, although boom conditions exist in some other countries. There are many structural elements in the current economic situation of this country that may serve to prevent or limit any revival of speculative tendencies, without the need for credit restraint. The elimination of the Federal Government deficit has removed one c f th e most important factors working tovrard inflationary tendencies, but there can be speculative o r otherwise unsustainable developments with out a deficit. Evidences of excess capacity and of some elements of slack in the economy, however, may help to d&mpen any such tendencies. Growth in the la b o r force has not kept pace with the population of working age, yet re p o rte d unemployment continues larger than at some previous times of high activity* Ihe margin is not large, but there are growing signs of successful efforts to economize on the use of labor. Hie high level of wages and other labor costs encourages such attempts. This tendency is lik e ly to continue. There is also an increased margin of unused productive capacity in industrial plant and equipment. Capital expenditures are expected to increase moderately in the year ahead and will add to that capacity equip ment that will help to lower costs and further reduce the need for labor. Building activity generally has been reduced from the high levels reached in 1959, and there may be some doubt whether a building boom of great proportions could be regenerated even with an increase in the avail ability of financing and lower long-term interest rates. Ihe post-strike inventory expansion quickly revealed that stocks of goods were larger than necessary under the circumstances. Although the adjustment to a more normal rate of inventory accumulation may have ended or be approaching an end, only moderate stimulation should be expected from this source in the near future. Requisites for further maximum and sustainable growth in the economy rest primarily in the selling and pricing policies of business. Demands for the increased supply of goods and services that industry is capable of producing will need to be stimulated by attractive pricing and by offering goods that the public wants. It is to be hoped that growing competition at home and abroad will foster the adoption of such practices. The necessary adjustments, however, will not be easy to make in view of past rising price trends. Failure to make them and any tendency toward price increases will be more of a damper on the economy than a basis for expansion. -9 - In the meantime, u n t i l demands are s tim u la te d , business p r o f it s are not lik e ly to in c re a s e much. C ontin ue d in cre ase i n wages and other lab or costs may o f fs e t th e e f f e c t s o f in cre ase d p r o d u c tiv ity and exert a squeeze on p r o f i t s . For t h i s reaso n th e re should be l i t t l e cause to fear the resumption o f s p e c u la tiv e te n d e n c ie s i n the stock market. In te re s t r a te s i n the p a s t year reached a le v e l th a t has en couraged saving and a t t r a c t e d sa v in g s in t o fix e d - in te r e s t investm ent. The current ra te o f s a v in g i s p ro b a b ly adequate to meet the c re d it and investm ent demand t h a t w i l l develop t h i s y e a r. Not only does the current le v e l c f in te r e s t r a te s r e l a t i v e t o re tu rn s on e q u itie s out a damper on stock prices, but i t may a ls o r e s t r a in spending fo r consumption and en courage ce rtain types of in v e s tm e n t, At present there seems to be no reason to force in t e r e s t r a te s any h ig h e r „ Slackening i n the r a te o f growth i n the money supply was neces sary during the past year i n view o f the r a p id expansion o f the preceding year and the large volume o f l i q u i d i t y b e in g su p p lie d by the issuance of short-term Government s e c u r itie s to finance the d e f i c i t . Although these liquid assets are s t i l l o u ts ta n d in g , t h e ir growth has ceased, and some expansion in money might s a fe ly be resumed. One lim it a t io n on c re d it and monetary expansion, other than the availability of reserves, r e s ts i n the reduced l i q u id i t y po sitio n s of banks. Although no s a tis f a c to r y standards are a v a ila b le to measure the possible impact o f t h is f a c t o r , there has c le a r ly been a s ig n ific a n t change. This enumeration of existing structural limitations on exuberance is not intended to convey the impression that adequate growth will not occur. Nor should it be interpreted as suggesting that monetary and f i s c a l policies should be redirected toward increasing buying power or stimulating credit expansion. It is designed merely to indicate that official restraints on the use of credit may be less necessary in the immediate future than they have been at other times of high activity in the postwar period. The situation may change quickly and may even now be in the process of changing. Presently available information and analysis, however, supports the view that the current somewhat more relaxed monetary policy is not inappropriate. CONFIDENTIAL MEMORANDUM 'IKE EOAFD OF GOVERNORS FROM THE FEDERAL ADVISORY COUNCIL RELATIVE TO THE AGENDA FOR THE JOINT MEETING ON MAY 17, I960 1, TO What are the views of the Council regarding the current business situation and prospects of business activity during the remainder of the current calendar year? The Council’ s judgment as to the current expectations of the business community and the general public and the impact of those expectations 0:1 capital expenditures, business inventories, and consumer expenditures would be appreciated. The members of the Council report that business is at a relatively high level. While there was some hesitation in the economy in the latter part of the first quarter, employment, retail sales and business activity in general improved in April. However, the output of steel, the production of durable goods and construction, including housing, are not enjoying the high level of activity that characterizes the economy generally. The Council believes that the expectations of the business community and the general public indicate that capital expenditures and consumer purchases will be at a high level for the remainder of the year. Despite the favorable outlook, the rate of business buying for invento ries will probably lessen, as total inventories are at record levels, reflecting the rapid buildup in the first quarter. While the ratio of inventories to sales is below historical averages, there are some indica tions that it is less favorable than it was earlier this year. Although business may not be as buoyant as the optimistic fore casts early this year, the Council believes that business will continue good during the remainder of the current calendar year, 2. How does the current demand for credit compare with demands at this season of other recent years? What is the prospective demand for bank loans and other credit during the remainder of this year? Will the anticipated substantial increase in plant and equip ment expenditures be financed by internal funds, term loans, or resort to capital markets? Host members of the Council report that the current demand for credit exceeds that at this season in other recent years. The Council believes that the demand for bank loans and other credit will be strong during the remainder of the year# The anticipated substantial increase in plant and equipment expenditures will be financed largely by internal funas with sane resort to the capital markets. In those instances where internal funds prove to be inadequate, principally in medium and smaller businesses, term loan financing by banks may be required, 3, Has there been a reduction in liquidity of banks so great as to hamper them in meeting the more essential needs for credit? Are there' differences in this respect among groups of banks, such as money market banks, banks engaged principally in industrial and commercial lending, and banks in agricultural areas? While there have been increases in certain types of longer-term credit, indicating some lessening in the liquidity of banks, the reduc tion has not been so great as to hamper the banks in meeting the more essential needs for credit. The Council uses the phrase, "essential needs for credit, n in the sense of customary, short-term or seasonal credit requirements. In the opinion of the Council there are no significant dif ferences in these developments among groups of banks. However, banks which are reluctant to liquidate portions of their bond portfolios at a loss may be hampered in meeting all of the essential needs for credit in their communities, What have been recent developments in the volume of the various forms of savings? Is public interest in United States Government securities as widespread as it was last fall? Total savings appear to be increasing with a larger share of the increase going to those institutions, such as the pavings and loan associations which are paying higher rates* While the public interest in United States Government securities now is greater than it was a year ago, it is not as gTeat as it was at the time of the issuance of the "magic $ fs*M 5, The Board would be glad to have the views of the Council regarding the appropriateness of monetary and credit policy in recent months. The members of the Council believe the Board’ s monetary and credit policy in recent months has been appropriate and well executed. Ihe degree of restraint appears to have been suitable under prevailing conditions. ON MAT 1?, I960, AT 10:30 A.M., THE FEDERAL ADVISORY COUNCIL HELD A JOINT MEETING WITH THE BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM IN THE FEDERAL RESERVE BUILDING, WASHINGTON, D.C. WITH THE EXCEPTION OF MR. HAYS AND GENERAL PERSONS, ALL MEMBERS OF THE COUNCIL WERE PRESENT. MR. HAYS AND GENERAL PERSONS WERE OBLIGED TO BE ABSENT BECAUSE OF PREVIOUS COMMITMENTS. THE FOLLOWING MEMBERS OF THE BOARD OF GOVERNORS WERE PRESENT: CHAIRMAN MARTIN, VICE CHAIRMAN BALDERSTON, GOVERNORS SZYMCZAK, ROBERTSON, SHEPARDSON AND KING. MR. SHERMAN, SECRETARY, AND MR. KENYON, ASSISTANT SECRETARY OF THE BOARD OF GOVERNORS, ALSO WERE PRESENT. The minutes of the joint meeting are being prepared in the office of the of the Board of Governors of the Federal Reserve System. Their content will be compared with the notes of the Secretary of the Council. Assuming they are in substantial agreement, they will be distributed to the members of the Council. Secretary The meeting adjourned at 12:15 P.M. * * * * * * The next meeting of the Council will be held September 1^-15, I960.
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