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o The FOMC in 1980: A Year of Reserve Targeting R. ALTON GILBERT and MICHAEL E. TREBING O n October 6, 1979, the Federal Reserve an nounced the beginning of a new approach to the implementation of monetary policy: it would attempt to achieve better control of the growth of the monetary aggregates by “placing greater emphasis in day-to-day operations on the supply of bank reserves and less emphasis on confining short-term fluctuations in the federal funds rate.”1 A reason for adopting such a strategy was to “assure better control over the expan sion of money and bank credit.”1’ The 1980 calendar year was the first full year of monetary policy under the new procedure of reserve targeting. The year was a turbulent one for the economy and for the conduct of monetary policy. Interest rates fluctuated more than during past years, an outcome that was anticipated when the reserve targeting strat egy was adopted. The growth rates of the monetary aggregates, however, were also highly variable during 1980, even though the new procedure for implement ing monetary policy was intended to promote better monetary control. A brief period of credit controls contributed to turbulence in the economy and the conduct of monetary policy, bv reducing demand for credit by more than anticipated by the Federal Re serve when the controls were imposed. The conduct of monetary policy was also affected bv unusual developments during the year. The Deposi tor}’ Institutions Deregulation and Monetary Control Act of 1980 altered the institutional environment in which monetary policy is implemented. In addition, Note: Citations referred to as “Record” are to the “Record of Policy Actions of the Federal Open Market Committee” found in various issues of the F e d e r a l R eserv e Bulletin. 1“Announcements: Monetary Policy Actions,” F e d e r a l R eserv e B ulletin (October 1 9 7 9 ), p. 830. -Ibid. 2 the Federal Open Market Committee (Committee) specified its objectives in terms of new measures of the monetary aggregates, which were released in February 1980. This article discusses the monetary policy decisions of the Committee during 1980. The Committee speci fies its objectives for each calendar year in terms of ranges of growth rates for several monetary aggre gates. Policies to be implemented between meetings are stated in terms of growth rates for the monetary aggregates and ranges for the federal funds rate. Growth rates of the monetary aggregates over 1980 are compared with the announced target ranges for the year to determine how successfully the Federal Reserve controlled money growth on an annual basis. Next, the pattern of money growth during the year is compared with the short-term objectives of the Committee. Finally, the current procedure for imple menting monetary policy is described and policy actions analyzed to determine the factors that ac counted for the pattern of money growth over the vear. NEW MEASURES OF MONETARY AGGREGATES In response to significant financial innovations in recent years, the Board of Governors announced new definitions of the monetary aggregates in February.3 The Committee specified its 1980 objectives for money growth in terms of these new monetary aggregates: MIA, M1B, M2, M3 and commercial bank credit. :iFor a description of the new aggregates, see Thomas D. Simp son, “The Redefined Monetary Aggregates,” F e d e r a l R eserv e B ulletin (February 1 9 8 0 ), pp. 97-114; and R. W . Hafer, “The New Monetary Aggregates,” this R ev iew (February 1 9 8 0 ), pp. 25-32. F E D E R A L R E S E R V E B A N K O F S T . L O U IS A U G U S T /S E P T E M B E R 1981 Organization of the Committee in 1980 The Federal Open Market Committee (Committee) consists of twelve members: the seven members of the Federal Reserve Board of Governors and five of the twelve Federal Reserve Bank presidents. The Chair man of the Board of Governors is, by tradition, also chairman of the Committee. The president of the New York Federal Reserve Bank is, also by tradition, its vice chairman. All Federal Reserve Bank presidents attend Committee meetings and present their views, but only those presidents who are members of the Committee may cast votes. Four memberships rotate among the Bank presidents and are held for one-year terms begin ning March 1 of each year. The president of the New York Federal Reserve Bank is a permanent voting member of the Committee. The Account Manager has the major responsibility for formulating plans regarding the timing, types, and amount of daily buying and selling of securities in ful filling the Committee’s directive. Each morning the Manager and his staff plan the open market operations for that day. This plan is developed on the basis of the Committee’s directive and the latest developments af fecting money and credit market conditions, monetary aggregate growth, and bank reserve conditions. The Manager, in a conference call, then informs staff members of the Board of Governors and one voting president about present market conditions and open market operations that he proposes to execute that day. Other members of the Committee are informed of the daily plan by wire. Members of the Board of Governors at the beginning of 1980 included Chairman Paul A. Volcker, Philip E. Coldwell, J. Charles Partee, Emmett J. Rice, Frederick H. Schultz, Nancy H. Teeters, and Henry C. Wallich. Governor Phillip E. Col dwell’s term expired in 1980 and was replaced by Lyle E. Gramley. The following presidents served on the Committee during January and February 1980; John J. Balles (San Francisco), Robert P. Black (Richmond), Monroe Kimbrel (At lanta) and Robert P. Mayo (Chicago). The Com mittee was reorganized in March, and the four rotat ing positions were filled by: Roger Guffey (Kansas City), Frank E. Morris (Boston), Lawrence K. Roos (St. Louis), and Willis J. Winn (Cleveland). In April, Anthony M. Solomon was appointed as president of the Federal Reserve Bank of New York. Thomas M. Timlen had served on the Committee in his role as al ternate to the president of the New York Bank since August 1979 when Chairman Volcker, then president of the New York Federal Reserve Bank, was appointed as Chairman of the Board of Governors. The directives issued by the Committee and a sum mary of the reasons for Committee actions are pub lished in the “Record of Policy Actions of the Federal Open Market Committee.” The “Record” for each meeting is released a few days after the following Com mittee meeting. Soon after its release, the “Record” appears in the Federal Reserve Bulletin. In ad dition, “Records” for the entire year are published in the Annual Report of the Board of Governors. The “Record” for each meeting during 1980 included: The Committee met eleven times during 1980 to discuss, among other things, economic trends and to decide upon the future course of open market opera tions.1 As in previous years, however, telephone or telegram consultations were held occasionally between scheduled meetings. During each regularly scheduled meeting, a directive was issued to the Federal Reserve Bank of New York. Each directive contained a short review of economic developments, the general eco nomic goals sought by the Committee, and instructions to the Manager of the System Open Market Account at the New York Bank for the conduct of open market operations. These instructions were stated in terms of short-term rates of growth of MIA, M1B and M2 that were considered to be consistent with desired longer-run growth rates of the monetary aggregates. The Committee also specified ranges for acceptable movements in the federal funds rate for the inter meeting period. xNo formal meeting was held in June 1980. 1) A staff summary of recent economic develop ments — such as changes in prices, employment, industrial production, and components of the national income accounts — and projections of general price, output, and employment develop ments for the year ahead; 2) A summary of recent international financial de velopments and the U.S. foreign trade balance; 3) A summary of recent credit market conditions and recent interest rate movements; 4) A summary of open market operations, growth of monetary aggregates and bank reserves, and money market conditions since the previous meeting; 5) A summary of the Committee’s discussion of cur rent and prospective economic and financial con ditions and of current policy considerations, in cluding money market conditions and the movement of monetary aggregates; 6) Conclusions of the Committee; 7) A policy directive issued by the Committee to the Federal Reserve Bank of New York; 8) A list of the members’ voting positions and any dissenting comments; 9) A description of any actions and consultations that may have occurred between the regularly scheduled meetings. 3 F E D E R A L R E S E R V E B A N K O F S T . L O U IS A U G U S T /S E P T E M B E R 1981 One objective of the revisions was to include in a narrow monetary aggregate the increasing number of transact ion-type accounts available at commercial and mutual savings banks, savings and loan associations and credit unions. The MIA definition of the money stock is the same as old M l except that it excludes demand deposits held by foreign commercial banks and official institutions. The M IB definition includes MIA plus other checkable deposits, which include automatic transfer service ( A TS) accounts, negotiable order of withdrawal (NOW ) accounts, credit union share drafts, and demand deposits at thrift institutions. The Committee has chosen to establish these ranges from the fourth quarter of the previous year to the fourth quarter of the current year.5 These ranges must be reviewed before Congress in Julv of each year, although the Committee may reconsider the annual ranges at any time.6 The period to which the annual ranges apply, however, may not be changed. Thus the base period (the fourth quarter of the prior year) remains the same even if the Committee should change the desired growth rates of the aggregates for the Jvear. Financial innovations that caused difficulty in inter preting the growth of a narrow monetary aggregate in recent years included the permission for all commercial banks to offer ATS accounts, and for all depositor)' institutions in the state of New York to offer NOW accounts. Both changes occurred in the fall of 1978. The difference between the growth rates of MIA and M IB indicates the problems the Com mittee faced in evaluating the growth of old M l in 1979 relative to previous years. From IV/1978 to IV/1979, MIA increased 5 percent — the same as old M l — compared with a 7.4 percent increase in the previous year.4 In contrast, the growth of M IB slowed less in 1979, increasing 7.7 percent from IW 1978 to IV/1979, compared with an 8.2 percent increase from IY/1977 to IV/1978. Thus, a small reduction in the rate of money growth, measured as M IB, would ap pear to be a very sharp slowing in money growth if checkable deposits other than demand deposits at commercial banks are excluded from the measure of the money supply. These ranges reflect the Committee’s objective of slowing money growth in 1980: Another objective of these revisions was to capture in a broader aggregate the effects of other financial innovations. For example, shares in money market mutual funds and overnight repurchase agreements at commercial banks, which are close substitutes for assets in the narrower aggregates, are included in the new M2 measure. ANNUAL TARGETS FOR 1980 The Full Employment and Balanced Growth Act of 1978 (also called the Humphrey-Hawkins Act) re quires the Committee to announce before Congress in February of each year growth ranges for monetary and credit aggregates over the current calendar vear. 4Growth of old M l was also about the same as growth of MIA in 1978 — 7.2 percent from IV /1977 to IV /1978. Growth rates of monetary aggregates referred to in this article reflect data revised as of January 1981. 4 Table 1 indicates the annual growth targets the Committee adopted for the new aggregates at its meeting in February 19S0.7 The targets established for 1980 represented reductions in the growth rates of the aggregates from 1979. The midpoint of the range for MIA in 1980 was 4.75 percent, compared with an actual 5 percent increase in 1979. The deceleration would be especially marked for M IB; the midpoint of the M IB range for 1980 was 5.25 percent, compared with growth of 7.7 percent in 1979. In the Committee’s discussion of the ranges for the coming year, the members agreed that monetary growth should slow further in 1980, following some deceleration over 1979, in line with the continuing objective of curbing inflation and providing the basis for restoration of economic stability and sustainable growth in output of goods and services.8 The “Record” of the Committee’s February meet ing, however, indicates that there were some differ ences of view regarding the appropriate aggregates to be specified as targets, because of uncertainty about the impact of shifts between savings accounts and interest-earning ATS and NOW accounts: 5Prior to 1979, the Committee adopted one-year growth rates each quarter, and the base period for the annual targets an nounced each quarter was brought forward to the most recent quarter. This method resulted in a problem referred to as “base drift.” Growth in an aggregate above (below ) an annual growth range in a quarter would raise (low er) the base level for calculation of the next annual growth path. Specification of annual objectives in terms of calendar year growth rates, which eliminates the base drift problem within a calendar year, does not solve this problem from one calendar year to the next, since new ranges are established from the end of each calendar year. KAt its mid-year review of the annual ranges, the Committee also establishes tentative ranges for the monetary aggregates for the next year — measured from the fourth quarter of the current year to the fourth quarter of the following year. 7“Record” (April 1 9 8 0 ), p. 329; and “Monetary Policy Report to Congress,” Federal Reserve Bulletin (M arch 1 9 8 0 ), p. 178. 8“Record” (April 1 9 8 0 ), p. 329. F E D E R A L R E S E R V E B A N K O F S T . L O U IS Table 1 Planned Growth of Monetary Aggregates for 1980 (percent changes, fourth quarter to fourth quarter) Aggregate1 Proposed range Actual growth rate in 19792 M1A 3.5-6.0% 5.0% M1B 4.0-6.5 7.7 M2 6.0-9.0 9.0 M3 6.5-9.5 9.8 1\11A is defined as currency plus private demand deposits at commercial banks excluding deposits due to foreign com mercial banks and official institutions. M1B is defined as MIA plus other checkable deposits ( negotiable-order-of-withdrawal accounts, automatic trans fer service accounts, credit union share drafts, and demand deposits at mutual savings banks). M2 is M1B plus savings and small-denomination time deposits at all depository institutions, shares in money market mutual funds, overnight repurchase agreements issued by commercial banks, and overnight Eurodollar deposits held by U.S. residents at Caribbean branches of U.S. banks. M3 is M2 plus large time deposits at all depository in stitutions and term repurchase agreements issued by com mercial banks and savings and loan associations. -D ata as revised by Board of Governors in January 1981. With respect to MIA, its growth would be dampened in the event of enactment of nationwide NOW ac count legislation and, as would be expected, a large transfer of funds from demand deposits to NOW ac counts. In support of retaining MIA on the list, how ever, it was noted that enactment of the legislation would tend to distort growth of M1B also — in the opposite direction as a result of transfers of funds from savings deposits to NOW accounts — and no doubt would lead the Committee to reconsider what ever ranges it adopted at this meeting.9 As depositors shifted funds from non-interest-earn ing checking deposits to ATS and NOW accounts, MIA would be expected to decline and M1B to in crease. An analysis by the Board staff of recent ex perience with ATS and NOW accounts, especially in the Northeast, indicated that the flow of funds from demand and savings deposits would account for most of the growth of interest-earning checkable accounts. Surveys indicated that roughly two-thirds of the funds flowing into ATS and NOW accounts would come from demand deposits and roughly one-third from savings deposits. In early 1980, however, the Com»lbid. A U G U S T /S E P T E M B E R 1981 mittee assumed that the public’s adjustment process was about complete and that the growth rates of the two aggregates would differ only by about one-half percentage point for the year.10 For this reason, the annual ranges for MIA and M1B announced in Febru ary differed by only one-half percentage point. ACTUAL MONEY GROWTH AND THE ANNUAL RANGES From the fourth quarter of 1979 to the fourth quar ter of 1980, MIA and M1B increased 5 percent and 7.3 percent, respectively. Thus, the growth of MIA was within its preannounced annual range, but the growth rate of M1B exceeded the top of its range by 0.8 percentage points. Though the Committee’s target ranges for the growth of the monetary' aggregates in 1980, which were first established at the February meeting, allowed for a difference of only 50 basis points in growth rates of MIA and M1B, the difference turned out to be about 230 basis points. In interpreting the influence of the growth in ATS/NOW accounts on the growth of monetary aggregates in 1980, the Federal Reserve Board estimated that MIA growth was about 125 basis points higher and M1B growth was about 50 basis points lower than the actual recorded data.11 Effects of the unanticipated growth of ATS/NOW accounts on the growth of MIA and M1B relative to annual ranges are illustrated in chart 1. In those charts the levels of those aggregates are not adjusted for the growth of ATS/NOW accounts, but the dashed lines are the annual ranges adjusted for the growth of ATS/ NOW accounts: the annual growth rates for MIA are reduced by 125 basis points, while those for M1B are increased by 50 basis points. With the annual ranges adjusted in this manner, the growth rates of MIA and M1B each exceeded the top of their adjusted annual ranges by about 25 basis points. The significance of money growth during 1980 for the rate of inflation depends on how rapid money growth was relative to the trend growth rate of recent years, since the rate of inflation tends to be related to the trend of money growth over several years.12 In the three years ending IV/1979, M1B increased at an 8 10“Monetary Report to Congress,” Federal Reserve Bulletin (M arch 1 9 8 0 ) ,p. 178. 11Monetary Policy Objectives for 1981 (Board of Governors of the Federal Reserve System, 1 9 8 1 ), p. 5. 12Albert E . Burger, “W hat Happened to the Economy in the First Half of 1980?” this Review (August/September, 19 8 0 ), pp. 9-15; Keith M. Carlson, “The Lag from Money to Prices,” this Review (O ctober 1 9 8 0 ), pp. 3-10. 5 F E D E R A L R E S E R V E B A N K O F S T . L O U IS A U G U S T /S E P T E M B E R 1981 C h a rt 1 R a n g e s f o r M I A a n d M 1B f o r P e rio d IV /1 9 7 9 to I V /1 9 8 0 Bil li ns of dollars APR. M AY _________ ^ JUNE JULY AUG. SEPT. OCT. NOV. DEC. JAN. FEB. MAR. 1979 percent annual rate. The 7.3 percent increase in M1B in 1980 represents a small reduction in the rate of money growth relative to the trend in the previous three years, but not as great a reduction as indicated by the Committee at the beginning of the year. In the February 1981 Monetary Policy R eport to Congress, 6 APR. M AY JUNE JULY 1980 AUG. SEPT. OCT. NOV. DEC. JAN. FEB. MAR. 1981 M1B is adjusted for the effects of shifts of savings deposits into ATS/NOW accounts by reducing the growth rate for 1980 by 50 basis points. Even with that adjustment, the growth of M1B in 1980 exceeded the midpoint of the annual range by about 150 basis points. AUGUST F E D E R A L R E S E R V E B A N K O F S T . L O U IS SEPTEM BER 1981 C h a ri 2 R a n g e s fo r M 2 , M 3 a n d B a n k C re d it fo r P e rio d IV /1 9 7 9 to IV /1 9 8 0 The expansion of the broader monetary aggregates, M2 and M3 (chart 2), also exceeded targets for the year, increasing 9.8 percent and 10 percent, respec tively (IV/1979 to IV/1980). The growth of bank credit was 8 percent for the year, consistent with the adopted range of 6 to 9 percent. 7 F E D E R A L R E S E R V E B A N K O F S T . L O U IS THE NATURE OF THE SHORT TERM DIRECTIVE The annual target ranges announced bv the Com mittee set broad guidelines for Federal Reserve actions during the year. Decisions of the Committee that in fluence the day-to-day implementation of monetary policy are specified in the short-term policv directives, which are issued by the Committee at each meeting to the Manager of the Open Market Account at the Federal Reserve Bank of New York. At each meeting in 19S0, the Committee specified short-term growth rates for MIA, M IB and M2.13 These short-term ob jectives for money growth are chosen by the Com mittee to guide open market operations over inter meeting periods. The Committee also specifies ranges for acceptable movements in the federal funds rate for intermeeting periods. The short-run directives adopted at Committee meetings since October 6, 1979, contrast sharply with directives issued prior to that time.14 The differences reflect increased emphasis on monetary control and reduced emphasis on confining movements of the federal funds rate. For example, the directive adopted at the April 22, 1980, meeting stated: In the short run, the C om m ittee seeks expansion of reserve aggregates consistent with grow th over the first half of 1 9 8 0 at an annual rate of 4 .5 p ercen t for M IA and 5 p ercen t for M IB , or som ew hat less, provided that in the period before the next regular m eetin g the weekly average federal funds rate re mains within a range of 13 to 19 p ercen t. T h e C om m ittee believes th at, to be consistent with this short-run policy, M 2 should grow a t an annual rate of about 6 .7 5 p ercen t over the first half and that bank cred it should grow in the m onths ahead at a p ace com patible w ith grow th over the y ear as a whole within the ran ge agreed upon. If it appears during the period before the n ext m eet ing that the con strain t on the federal funds rate is inconsistent with the objective for the expansion of reserves, the M an ager for D om estic Operations is prom ptly to notify the C hairm an w ho will then d e cide w hether the situation calls for supplem entary instructions from the C o m m ittee.15 13At meetings prior to July 1980, growth rates adopted for M2 were cited as those deemed to be consistent with objectives adopted for MIA and M IB. Beginning with the July meeting, the Committee has stated short-term objectives for growth of M2 along with objectives for growth of MIA and M IB. 14For an historical perspective on the Committee’s short-run operating procedures, see Henry C. Wallich and Peter M. Keir, “The Role of Operating Guides in U.S. Monetary Policy: A Historical Review,” Federal Reserve Bulletin (September 1 9 7 9 ), pp. 679-91. 15“Record” (June 1 9 8 0 ), p. 488. 8 A U G U S T /S E P T E M B E R 1981 At each meeting prior to adopting the new ap proach to implementing monetary policy, the Com mittee specified its short-run objective for the growth of each monetary aggregate as a range of growth rates over a two-month period (the month of the meeting and the month after the meeting). The range for the growth rates of each monetary aggregate was usually several percentage points wide. The Committee set an intermeeting range for the federal funds rate, which was generally no more than one percentage point wide, and specified an initial level of the fed eral funds rate that was thought to be consistent with the short-run ranges set for M l and M2. Growth rates of M l and M2 relative to the two-month ranges were intended to serve as indicators of when the federal funds rate should be allowed to change within its range. For example, the directive of the Committee from the meeting on September 18, 1979, read: E a rly in th e period before the next reg u lar m eeting, System open m arket operations are to be d irected at attaining a weekly average federal funds rate slightly above the cu rren t level. Subsequently, operations shall be d irected at m aintaining th e w eekly average federal funds rate within the range of 1 1 .2 5 to 1 1 .7 5 p ercen t. In deciding on the specific objective for the federal funds rate, th e M an ager for D om estic O p era tions shall be guided m ainly by the relationship b e tween the latest estim ates of annual rates of grow th in the S eptem ber-O ctob er period of M l and M 2 and the follow ing ranges of tolerance: 3 to 8 p ercen t for M l and 6 .5 to 1 0 .5 p ercen t fo r M 2. If rates of grow th of M l and M 2, given ap proxim ately equal w eight, ap p ear to be close to or beyond the u pp er or low er limits of th e in dicated ranges, the objective for the funds rate is to be raised or low ered in an orderly fashion within its ra n g e .16 The significance of these changes in the directive is that, under the old procedure, open market operations were directed toward maintaining the federal funds rate within a narrow range as long as growth rates of monetary aggregates stayed within specified ranges, whereas, under the new procedure, open market oper ations are directed toward hitting targeted growth rates for monetary aggregates, as long as the federal funds rate remains in a relatively wide range. As a result of the changes instituted since October 6, 1979, the Manager of the System Open Market Account, who is responsible for implementing the Committee’s directives, has had to change the focus of domestic open market operations from maintaining a weekly average federal funds rate within a specified range to maintaining the growth of “reserve aggre16“Record” (November 1 9 7 9 ), pp. 912-13. F E D E R A L R E S E R V E B A N K O F S T . L O U IS AU G U S T, SEPTEM BER 1981 C h a rt 3 FO M C R a n g e s fo r th e F e d e ra l Funds Rate JA N . FEB. MAR. APR. M AY JUNE JULY AUG. SEP. O C T. NOV. DEC. 1979 JA N . FEB. M AR. APR. MAY JUNE JULY AUG. SEP. OCT. NOV. DEC. 1 980 N O T E : R ates a r e c a lc u la te d a s w e e k ly a v e r a g e s o f e ffe c tiv e d a ily ra te s . A t e a c h m e e tin g th e C o m m itte e s p e c ifie d a ra n g e f o r th e f e d e r a l fu n d s ra te . These ra n g e s a re in d ic a t e d f o r t h e f i r s t f u ll w e e k d u r in g w h ic h th e y w e r e in e ffe c t. gates” consistent with specified growth rates of MIA, M1B and M2. Growth rates of reserve aggregates are not specified in either the directive or the Record of Policy Actions. T he C om m ittee votes on growth rates o f the monetary aggregates, not the reserve aggre gates. Consequently, it is left to the staffs of the Board of Governors and the Open Market Desk of the Federal Reserve Bank of New York to establish guidelines for the growth of these reserve aggregates consistent with the Committee’s objectives. The Committee has assigned a less critical role to the federal funds rate in guiding open market opera tions under the new operating procedure. The Federal Reserve made the following statement about the role of the constraint on the federal funds rate in its report to Congress on monetary policy in 1980: T h e [C om m ittee] lias con tinu ed to set b road ranges of toleran ce fo r m oney m arket in terest rates — gen er ally specified in term s of th e federal funds rate. T hese ranges, how ever, should not be view ed as rigid co n straints on th e O pen M ark et Desk in its pursuit of reserve paths set to achieve targ eted rates of m onetary grow th. T h ey h ave not, in p ractice, served as true constraints in the period since O cto b er 1 9 7 9 , as the C om m ittee typically has altered the ranges w hen they have becom e binding. But, in a w orld of u ncertain ty ab ou t econom ic and financial relationships, the ranges for interest rates h ave served as a useful triggering m echanism for discussion of the im plications of c u r rent developm ents for p o licy .17 SHORT-TERM ORJECTIVES OF THE COMMITTEE IN 1980 The growth rates of the monetary aggregates and the ranges for the federal funds rate specified by the Committee at meetings in 1930 are presented in table 2. Chart 3 displays the weekly average federal funds rate and ranges for the federal funds rate voted by the Committee during 1979 and 1980. During 1980, the width of the range for the federal funds rate was between 4 and 8.50 percentage points. On several 17“Monetarv Policy Report to Congress,” Federal Reserve Bulle tin (M arch 1 9 8 1 ), p. 204. 9 Table 2 F O M C Operating Ranges — 1980 Short-Run Operating Ranges Date of meeting Federal funds rate range Periods to which monetary growth paths ap plyi January 8-9, 1980 11.50-15.50% December-March (G row th rate of 4-5% applies to M1 and 7% to M2 series in use prior to revisions in February 1980.) February 4-5* (n o change) December-March February 22 March 7 11.50-16.50 11.50-18 Actual growth rates-’ Growth paths specified M1A M1B M2 between 4-5% about 4.5 about 5% about 6.5 December-June 4.5 or somewhat less 5 or somewhat less about 7.75 A pril 22“ 13-19 December-June 4.5 or somewhat less 5 or somewhat less about 6.75 10.50-19 A pril-June3 June-Septem ber August 12 8-14 June-Septem ber September 16f 8-14 August-Decem ber O ctober 21® 9-15 Septem ber-Decem ber November 18h 13-17 3.2% 4.5% 7.4% 0.6 2.3 8.1 (sam e) (interm eeting conference) 8.50-14 8.50-14 July 9 M2 (interm eeting conference) 13-20 May 6d M1B (interm eeting conference) March 18b May 20" M1A on the order of 7% Septem ber-Decem ber November 26' December 51 13-18 13- * (interm eeting conference) (interm eeting conference) December 12k Decem ber 18-191 13- 5 15-20 (interm eeting conference) Decem ber-M arch8 7-7.5 7.5-8 8 6.9 7.8 14.4 about 7 about 8 13.4 17.1 14.3 about 12 (sam e) about 8.5 about 7.25 or somewhat less about 7.75 or somewhat less 4.2 6.9 7.5 1.5 3.8 7.1 about 2.5 or somewhat less about 8 about 9 about 6.5 about 5 or somewhat less about 5 or somewhat less 1.5 3.8 7.1 growth centered on 4.25 growth centered on 4.75 growth centered on 7 2.3 11.7 about 6.5 about 4 about 2.5 or somewhat less Long-Run Ranges Date of meeting February 4-5, 1980 Target period IV /7 9 -IV /8 0 July 9m July 29" M1A M1B M2 M3 Bank Credit 3.5-6% 4-6.5% 6-9% 6.5-9.5% 6-9% 5.5-8.5 — — (reconfirm ed above ranges) IV /80-IV /81 3-5.5 3.5-6 G row th objectives specified by the Committee over quarterly periods are interpreted in terms of monthly data. For example, the February 4-5 directive called for expansion of reserve aggregates consistent with growth of M IA “over the first quarter” at an annual rate of about 4.5 percent. This period is interpreted as being from December to March. 2Money data revised as of January 1981. 8Growth paths were specified in “Record” but not in directive issued to the Federal Reserve Bank of New York. Directive states, . . the Committee seeks expansion of reserve aggregates consistent with growth of MIA, M1B, and M2 at rates high enough to promote achievement of the Committee’s objectives for monetary growth over the year . . [“Record” (July 1 9 8 0 ), p. 569]. 4At this meeting the directive was modified to give the Open Market Desk “leeway for pursuit of the Committee’s short-run objectives for the behavior of reserve aggregates without operations being precisely constrained in the current statement week by the 18 percent upper limit of the intermeeting range for the federal funds rate . . [“Record” (January 1 9 8 1 ), p. 33]. 5The suspension of the upper bound on the federal funds rate constraint was extended until the next Committee meeting. •’Growth paths for M IA and M1B are adjusted for shifts of demand and savings deposits into A TS/N O W accounts. The actual growth rate for M1B is computed using data adjusted for these shifts. Table 2 (continued) Footnotes — Dissents to F O M C Actions “Messrs. Coldwell and Wallich dissented from this action because they favored a more restrictive policy for the period imme diately ahead. Believing that inflationary expectations had worsened in recent weeks while prospects for economic activity had strengthened, they thought that money and credit were too readily available and current levels of interest rates were not ex erting sufficient restraint. bMr. Wallich dissented from this action because he favored pursuit of a more restrictive policy for the period immediately ahead to assure maintenance of firm general credit restraint, especially as a means of buttressing the new anti-inflation program. 'M r. Wallich dissented from this action because he believed that it represented a premature and excessive relaxation of restraint. He favored a policy for the period until the next meeting directed toward lower rates of monetary growth over the first half of the year, accompanied by an intermeeting range for the federal funds rate that would allow for considerably less decline. ^Messrs. Guffey and Solomon voted against this action because they preferred smaller reductions in the lower limit of the fed eral funds rate and Mr. Wallich voted against it because he preferred to maintain the lower limit at 13 percent. 'Mr. Partee dissented from this action because he believed that it involved a risk of extending the shortfall in monetary growth relative to the Committee’s growth ranges for the year. In an effort to guard against the continuation of such a shortfall, which could worsen recessionary prospects, he preferred to direct operations toward achieving somewhat higher rates of monetary growth in the May-June period. He also preferred an intermeeting range for the federal funds rate with a lower limit below 8.5 percent, because such a range would be less likely to interfere with reserve-supplying operations consistent with the objectives for the aggregates. Mr. Roos dissented because in his view the annual growth rate objective of 3.5 to 6 percent for M IA established by the Committee in February 1980 was consistent with reduction of inflation without aggravating recessionary pressures. He be lieved that the 8.5 to 14 percent constraint on the federal funds rate was incompatible with that agreed-upon objective and would cause money growth to remain below it. Such slow growth would unnecessarily exacerbate the current economic slowdown. Historically, deep recessions had inevitably brought about countermeasures that intensified inflation. 'Messrs. Guffey, Roos, Wallich and Winn dissented because they believed that, given the excessive monetary expansion in re cent months and the outlook for inflation, the directive adopted at this meeting incurred too much of a risk that the Com mittee’s objectives for monetary growth in 1980 would be exceeded. To enhance the prospects for restraining monetary growth to rates consistent with the longer-run ranges, they favored specifying lower rates of growth for M IA, M1B, and M2 over the August-to-December period than those that were adopted. “Messrs. Morris, Roos, Wallich and Winn dissented from this action because, given the excessive monetary expansion in recent months, they favored specification of lower monetary growth rates for the period from September to December than those adopted at this meeting. In their view, such a policy stance was appropriate in order to enhance the prospects for restraining growth of the monetary aggregates within the Committee’s ranges for the period from the fourth quarter of 1979 to the fourth quarter of 1980 and thereby contribute to restraining inflation. hMrs. Teeters dissented from this action because she believed that it would result in additional increases in interest rates, which would intensify downward pressures on demands for housing, automobiles, and business fixed capital and thus risk a major contraction in economic activity with a substantial rise in unemployment. In her view, open market operations over the weeks immediately ahead should be directed toward maintaining the federal funds rate within a range of 11 to 15 percent. Mr. Winn dissented from this action because he favored specification of lower rates of expansion in the monetary aggre gates for the period from September to December than those adopted at this meeting. In his view, more vigorous action was appropriate in order to enhance the prospects for restraining the expansion of the monetary aggregates and establishing growth paths consistent with the monetary growth objectives for 1981 contemplated by the Committee in July 1980. 'Mrs. Teeters dissented from this action for essentially the same reasons that she had dissented from the action to adopt the domestic policy directive at the Committee’s meeting on November 18, 1980. JMrs. Teeters dissented from this action for essentially the same reasons that she had dissented from the action to adopt the domestic policy directive at the Committee’s meeting on November 18, 1980. Mr. Wallich dissented from this action because he preferred to raise the upper limit of the federal funds rate range for the remainder of the intermeeting period, which in his view would be consistent with the action on the preceding day to raise Federal Reserve discount rates. kMrs. Teeters dissented from this action for essentially the same reasons that she had dissented from the action to adopt the domestic policy directive at the Committee’s meeting on November 18, 1980. ‘Mrs. Teeters dissented from this action because she believed that the objectives for monetary growth were unduly restrictive in terms of their eventual effects on output and employment without improving prospects for significantly tempering the rate of inflation. Pending completion of the Committee’s review of its ranges for growth in 1981, she preferred specification of moderately higher rates for monetary growth over the first quarter. Mr. Wallich dissented from this action because, given the excessive monetary expansion in recent months, he favored specification of lower monetary growth rates for first quarter of 1981 than those adopted at this meeting along with a higher intermeeting range for the federal funds rate. In his view, such a policy stance was appropriate both to restrain monetary growth if economic activity remained strong and to moderate the probable decline in interest rates if economic ac tivity weakened. "‘Mr. Wallich dissented from this action because he believed that the ranges for growth of M IA and M1B over the year ending in the fourth quarter of 1980 should be reduced by 0.5 percentage point. In his opinion, efforts to bring these aggre gates up to the ranges adopted in February implied excessively rapid monetary growth over the months ahead. “Mrs. Teeters dissented from this action because she believed that it was undesirable to specify precise numerical ranges for monetary growth in 1981 so far in advance while economic activity was still contracting. In her opinion, monetary goals for 1981 specified at this time could prove to be inconsistent with other, as yet undetermined, economic policies and with the objective of reducing inflation while encouraging a sustainable recovery in economic activity. She was especially concerned about a possible inconsistency in view of the unusually great uncertainties generated by the introduction of NOW accounts nationally and by shifts in the relationship among money, interest rates and nominal GNP. F E D E R A L R E S E R V E B A N K O F S T . L O U IS AU G U ST, SEPTEM BER 1981 C h a rt 4 G r o w th O b je c tiv e s fo r M1B B i l l i o n s of d o l l a r s Billions of d olla rs 198 0 N O TE: The d a s h e d lin e s re p re s e n t g ro w th o f M1B fro m th e a v e r a g e le v e l o f IV /1 9 7 9 a t a n n u a l rates o f 4 a n d 6 .5 p e rc e n t. The c o n tin u o u s lin e is the w e e k ly a v e ra g e le v e ls o f M1B, re v is e d as o f J a n u a ry 1981. The s h o rt lin e s re p re s e n t th e levels o f M1B im p lie d b y th e s h o rt-te rm o b je c tiv e s o f th e Com m ittee. In s p e c ify in g s h o rt-te rm o b je c tiv e s fo r g ro w th o f th e m o n e ta ry a g g r e g a te s a t e a c h m e e tin g , th e C o m m itte e s p e c ifie s a n in it ia l p e rio d , a te rm in a l p e rio d , a n d d e s ire d g r o w th ra te s fo r e a ch a g g re g a te . The s h o rt lin e s in d ic a te le v e ls o f M1B d e r iv e d b y e x tr a p o la tin g g ro w th fro m th e in itia l p e rio d s a t th e ra te s d e s ire d b y th e C om m ittee. Levels o f M1B d e riv e d b y such e x tra p o la tio n a re p lo tte d fo r o n ly th o s e w e e k s b e tw e e n C o m m ittee m ee tin g s to w h ic h th e y a p p ly . Levels o f M1B in the in itia l p e rio d s fro m w h ic h M1B is e x tra p o la te d are as o f th e J a n u a ry 1981 re v is io n . occasions, however, the federal funds rate moved near or outside the ranges specified by the Committee. Consequently, the ranges specified by the Committee in 1980 do not appear to have constrained Federal Reserve actions in the same manner as under the prior operating procedure. During much of the year, M1B was outside the annual target range, plotted in chart 4 as the cone representing growth from IV/1979 at annual rates between 4 and 6.5 percent. From April through July, M1B was below the annual target range and, from September through part of December, above the an nual target range. This fluctuation of M1B about the annual target range indicates either that the Com mittee specified short-term objectives for the growth of M1B that were outside the annual target range, or that M1B deviated substantially from the Committee’s short-term objectives during much of the year. Chart 4 presents the relation of the short-term ob jectives of the Committee to the annual target range, 12 and deviations of M1B from the short-term objectives. Until late in the fall of 1980, the short-term objectives for M1B were either within the annual target range or on growth paths consistent with returning to the annual range. At the meeting in February, the Com mittee voted for growth of M1B at about a 5 percent rate from IV/1979, and at meetings in March and April, for growth from IV/1979 at a rate of 5 percent or somewhat less. At meetings in May, July and Au gust, the Committee voted for growth rates faster than the annual objectives, to gradually bring M1B from levels below the annual range to within the an nual range. The short-term objective for M1B voted at the September meeting implied growth near the top of the annual range. Until the meeting in October, therefore, movement of M1B outside the annual tar get range reflected deviations o f m oney growth from the short-term objectives. After the meeting in September, M1B increased rapidly, rising several billions of dollars above the F E D E R A L R E S E R V E B A N K O F S T . L O U IS annual target range. At meetings in October and November, the Committee specified growth rates of the aggregates from the average level of September; consequently, the short-term objectives for M1B voted at those meetings implied levels above the annual target range. The discussion at the Committee meet ings in October and November, summarized in the appendix, indicates that Committee members were concerned about the effects of increases in interest rates that might have resulted from a policy of bring ing monev growth down to within the annual range. THE USE OF THE NEW PROCEDURE TO CONTROL MONEY GROWTH The wide fluctuations of M1B about the annual target range over most of 19S0 reflected deviations of M1B from the short-term objectives of the Committee. In analyzing monetary policy actions in 1980, there fore, it is important whether the deviations of M1B from the short-term objectives reflect problems with the control of money growth that are basic to the procedure, or reflect constraints placed on the use of the procedure that are not explicitly stated in the directives of the Committee. The procedure for implementing monetary policy adopted on October 6, 1979, involves using open mar ket operations to meet specific objectives for the levels of nonborrowed reserves (N BR ). Prior to October 6, 1979, in contrast, the objective of open market opera tions was to keep the federal funds rate within the range specified by the Committee at the last meet ing. Because the objective of open market operations under the current operating procedure is to control NBR, the federal funds rate changes in the direction of changes in the demand for reserves. The major pol icy actions under the current operating procedure are changes in the objective for NBR and changes in the discount rate. Determining Objectives for Nonborrowed Reserves Decisions of the Committee implicitly determine the objectives for NBR. After each Committee meeting, the staff of the Board of Governors estimates the aver age level of total reserves ( T R ) that is consistent with the short-run objectives of the Committee for the growth of monetary aggregates. These average levels of TR (called TR paths) are specified for periods of three to five weeks between Committee meetings. When periods between Committee meetings are longer A U G U S T /S E P T E M B E R 1981 than five weeks, they are divided into two subperiods, and a TR path is calculated for each subperiod.18 The Committee decides on an initial level of bor rowed reserves that is used in determining the NBR path. Although this “borrowings assumption” is not a part of the official record of each Committee meeting, the staffs of the Board of Governors and the Federal Reserve Bank of New York consider it a decision of the Committee when planning open market operations between meetings.19 The NBR path is obtained simply by subtracting the borrowings assumption from the TR path estimated by the staff of the Board of Gov ernors. The objective of the Open Market Desk is to use open market operations to make the average level of NBR over the weeks between meetings of the Com mittee equal to the NBR path. To help the Open Mar ket Desk gauge the effects of each day's open market operations on NBR, the NBR path is converted into weekly objectives for NBR. 18The measure of total reserves used in the reserve targeting procedure was changed after the reserve requirement pro visions of the Monetary Control Act of 1980 were imple mented in November 1980. Prior to that date, total reserves were measured as total reserves of member banks, which in cludes their vault cash, plus reserve balances at Federal Reserve Banks. Federal reserve requirements were extended to all depository institutions in November 1980. Under the gradual phase-in of reserve requirements, most nonmember depository institutions hold vault cash that currently exceeds their required reserves. The measure of total reserves used since November 1980 excludes this surplus vault cash (vault cash less required reserves of institutions with vault cash in excess of their required reserves). Total reserves are now measured as total reserve balances at Reserve Banks, plus total vault cash at all depository institutions subject to reserve requirements, less the excess of vault cash over re quired reserves at institutions with vault cash in excess of their required reserves. The staff of the Board of Governors uses the following procedure to estimate the TR path for an intermeeting period. The staff calculates the average levels of the monetary aggre gates on a seasonally adjusted basis over the weeks until the next intermeeting period that are implied by the vote of the Committee for growth rates of the aggregates. Average levels of the aggregates on a seasonally adjusted basis are converted to average levels on a nonseasonally adjusted basis. Growth of currency on a nonseasonally adjusted basis is estimated for the intermeeting period and subtracted from the non seasonally adjusted levels of the monetary aggregates associ ated with the vote of the Committee. The rest of the estima tion procedure involves estimating the average level of TR that would tend to yield the average levels of the monetary aggregates voted by the Committee, less estimated currency. That estimate of TR includes: ( 1 ) an estimate of required reserves on liabilities of de pository institutions not included in the monetary aggregates (such as large certificates of deposit), ( 2 ) required reserves on the level of transaction deposits implicitly voted by the Committee, ( 3 ) an assumption about the average level of excess reserves. 19Free I J. Levin and Paul Meek, “Implementing the New Operating Procedures: The View from the Trading Desk,” New Monetary Control Procedures, vol. 1, Federal Reserve Staff Study ( Board of Governors of the Federal Reserve Sys tem, February 19 8 1 ), p. 7. 13 F E D E R A L R E S E R V E B A N K O F S T . L O U IS The initial specifications of the path levels for TR and NBR are generally made on Friday after a Com mittee meeting. The Federal Reserve staff also makes a projection of what TR will be over the intermeeting period. Projections and path levels for TR are respeci fied approximately once each week. Projections of TR are respecified on the basis of additional information about the demand for reserves, and changes in the TR path are based on additional information about the relation between the monetary aggregates and TR. These so-called multiplier adjustments change the NBR path by the same amount as the TR path, and the weekly objectives for NBR are respecified such that the average of NBR over the period will equal the new path level. If the revised projection of TR is substantially dif ferent from the new specification of TR, the NBR path might be changed to keep TR closer to path, reducing (increasing) the NBR path if TR are pro jected to be above (below) the TR path. On several occasions the NBR path was changed in this manner between Committee meetings by the senior Board staff and the management of the Open Market Desk, in consultation with the Chairman of the Federal Reserve Board. Controlling Money Growth by Targeting on Nonborrowed Reserves Projections of average levels of TR over intermeet ing periods provide a guide to policy actions. A de viation of a projection of TR from the path level indicates that changes in the supply of NBR or the discount rate are appropriate to avoid a deviation of money growth from the short-term objectives of the Committee. If TR are projected to exceed the TR path, appropriate actions would be to reduce the path level for NBR, raise the discount rate, or both. Reduc ing the NBR path with the TR path unchanged in volves increasing the implied level of borrowings. Re ductions in the NBR path and increases in the dis count rate tend to increase the federal funds rate and reduce the amount of reserves demanded by the bank ing system. If, in contrast, TR are projected to be below path, the actions that would be appropriate to speed the return of the money stock to the targeted level are to increase the NBR path, reduce the dis count rate, or both. There are various reasons why money growth might have deviated from the short-term objectives of the Committee under this operating procedure. One rea son could have been that the path levels for TR were 14 A U G U S T /S E P T E M B E R 1981 inconsistent with the short-term objectives for money growth, even after adjustments during intermeeting periods. With errors in specifying TR paths, the Fed eral Reserve could have taken actions to keep TR near path levels and yet miss the objectives for money growth. Another possibility is that, even if the TR paths were specified accurately, errors in projecting TR could have caused the Federal Reserve to take actions that turned out to be inappropriate for keeping TR near the path level. A final possibility is that projec tions of T R relative to path levels indicated the ac tions that would have been appropriate to meet the short-term objectives for money growth, but for some reason, those actions were not taken. EXPERIENCE WITH MONETARY CONTROL UNDER THE RESERVE TARGETING PROCEDURE In most intermeeting periods, the path levels and projections of TR were reasonably accurate. Thus, the differences between the projections and path levels of TR generally indicated the nature of policy actions that would have been appropriate to keep money growth from deviating substantially from short-term objectives. A notable exception to this general conclusion ap plies to the intermeeting period that began shortly after the imposition of credit controls. The Federal Reserve did not accurately project the effects of credit controls on the demand for reserves during that pe riod; consequently, the differences between projec tions and path levels of TR did not indicate the actions that would have been necessary to prevent the decline of the money supply below target during that period. With the exception of this period, begin ning shortly after the imposition of credit controls, money growth deviated most from the short-term ob jectives of the Committee in those periods in which the Federal Reserve did not take the actions that the procedure indicated as appropriate for hitting money targets. The large deviations of money growth from short term objectives occurred when interest rates were changing rapidly. In contrast, money growth was closest to short-term objectives in the summer, when short-term interest rates were below the discount rate and were relatively stable. A reluctance to take actions indicated by the procedure as appropriate for hitting money targets when short-term interest rates were F E D E R A L R E S E R V E B A N K O F S T . L O U IS A U G U S T /S E P T E M B E R 1981 Table 3 The Credit Restraint Program of 1980 Date Action March 141 The Federal Reserve Board announced a series of monetary and credit actions as a part of a general govern ment program to curb inflation. The actions included: 1. A voluntary Special C redit Restraint Program applied to dom estic com m ercial banks, bank holding com panies and business cred it extended to U.S. residents by the U.S. agencies and branches of foreign banks. Banks were expected to restrain the ir growth in total loans to a range of 6 to 9 percent while m aintaining a reasonable availability of funds for small business, farmers, housing, sm aller agriculturally oriented com mercial bank correspondents and th rift institutions. 2. A program of restraint on certain types of consum er credit. A special deposit requirem ent of 15 percent was imposed on increases in certain types of consum er cred it by many lenders. Consumer credit covered by the program included loans extended via cred it cards, checking account overdraft plans, other forms of revolving credit, open-end credit, unsecured closed-end credit, or secured cred it not extended to pur chase the collateral. Excluded credit was autom obile credit, cred it used to purchase household appliances or furniture, mortgages and home im provem ent loans. 3. An increase in reserve requirements (from 8 to 10 percent) on managed liabilities at member banks and U.S. branches and agencies of foreign banks, and a change in the base upon which the reserve require ment was to be calculated. 4. A special deposit requirem ent for nonmember banks of 10 percent on increases in their managed liabilities. 5. A special deposit requirem ent of 15 percent on increases in the total asset of money market mutual funds above the level of March 14. 6. A surcharge of 3 percent on discount w indow borrowings by banks w ith deposits of $500 m illion or more that borrow frequently. May 7- Surcharge elim inated for large member banks that borrow frequently at the discount window. May 233 1. Marginal reserve requirements and special deposit requirements on managed liabilities of large banks re duced from 10 percent to 5 percent. 2. Special deposit requirem ents on managed lia bilities of nonmember institutions also reduced from 10 per cent to 5 percent. 3. July 34 Special deposit requirem ent on increases in covered cred it reduced from 15 percent to 7.5 percent, and the special deposit requirem ent on assets of money market mutual funds reduced. Announcem ent of plans to com plete phaseout of special measures of cred it restraint. The Board also elim i nated the 2 percent supplem entary reserve requirem ent on large tim e deposits of member banks (in itiated in November 1978). ' “Announcements: 2“Announcements: 3“Announcements: 4“Announcements: Monetary and Credit Actions,” F e d e r a l R eserv e B ulletin (April 1 9 8 0 ), pp. 315-18. Removal of Surcharge on Discount Rate,” F e d e r a l R eserv e B ulletin (M ay 1 9 8 0 ), p. 393. Credit Restraint Program: Changes,” F e d e r a l R eserv e B ulletin (Ju n e 1 9 8 0 ), p. 479. Phaseout of Credit Restraint Measures,” F e d e r a l R eserv e B ulletin (Ju ly 1 9 8 0 ), p. 559. changing rapidly would have been consistent with the sentiment expressed at Committee meetings. At the meeting on April 22, the Committee expressed con cern that the objectives of Federal Reserve policy might be misinterpreted if interest rates were falling rapidly. (See the appendix for summaries of discus sion at Committee meetings.) At meetings in Septem ber, October and November, several members of the Committee expressed the view that, while favoring reductions in growth of the monetary aggregates, they were concerned about the effects on interest rates if the Federal Reserve pursued an aggressive policy of slowing money growth. The summary of a Federal Reserve staff study of the new operating procedures recognizes the need for more prompt adjustments of the NBR path relative to the TR path or the discount rate than those imple mented in 1980 to promote closer control of money in the short run. E vid en ce of the past y ear suggests th at during an in term eetin g period relatively p rom pt dow nw ard (o r u p w ard ) adjustm ents in the original nonborrow ed reserve path m ay be needed in an effort to offset, over tim e, in creased (o r d ecreased ) dem an d for b or row ing when m oney is strengthening (o r w eaken in g ) relative to targ et. As an altern ative, m ore prom pt upw ard (o r dow n w ard ) adjustm ents in the discount rate w ould ten d to discourage (o r en co u rag e) b or row ing over time. . . . T h ese adjustm ents run the risk of increasing the volatility of short-run interest rate m ovem ents in view of th e transitory fluctuations often experienced in short-run m oney dem and. 15 F E D E R A L R E S E R V E B A N K O F S T . L O U IS H ow ever, they could also dam pen the am plitude of longer-term swings of interest rates by m ore prom ptly leading to adjustm ents by banks th at bring m oney grow th back tow ard p ath .20 In the February 1981 Monetary Policy R eport to Con gress, the Federal Reserve also stated the need for more prompt adjustments of NRR paths or the dis count rate when T R are projected to deviate from path, in order to achieve better monetary control.21 CONCLUSIONS Over the year 1980, the Federal Reserve achieved a small reduction in the trend rate of money growth relative to recent years. Growth rates of M IR and M2, however, exceeded their annual target ranges. Thus, the Federal Reserve did not achieve the degree of deceleration in money growth that it announced as its objective for the year. Money growth was highly variable during the year, falling below the annual target range during April through July, and rising above the annual range in September through part of December. Until the fall of 1980, the short-term objectives of the Committee were either within the annual target range, or consist ent with returning money growth to the annual target 20Stephen H. Axilrod, “Overview of Findings and Evaluation,” New Monetary Control Procedures, vol. I, pp. A23-24. 21Monetary Policy Report to Congress (Board of Governors of the Federal Reserve System, February 25, 1 9 8 1 ), pp. 32-33. 16 A U G U S T /S E P T E M B E R 1981 range. In the fall, however, the Committee voted for the growth of M IR to exceed the top of the annual range, in recognition of a larger than anticipated shift of savings deposits into ATS accounts and con cern for the effects of a more restrictive policy on short-term interest rates. Thus, the fact that money growth for the year exceeded the top of the annual target range reflects decisions of the Committee in weighing objectives for monetary control, adjustments to annual money targets for growth of ATS/NOW accounts, and concern about volatility in interest rates. The record of policy actions under the reserve tar geting procedure reflects additional dimensions of monetary policy decisions in 1980. The largest devia tions of money growth from the Committee’s short term objectives occurred when the Federal Reserve failed to take the type of actions that the reserve targeting procedure indicated as appropriate to keep money growth near the short-term objectives. Expe rience with the reserve targeting procedure does not support the view that fluctuations of the money sup ply in 1980 reflect problems with monetary control that are basic to the operating procedure. The Fed eral Reserve has indicated that better short-term con trol of money growth, using the current procedure, requires more prompt adjustment of the NRR path relative to the TR path, or more prompt adjustment of the discount rate. Thus, short-term monetary con trol may be improved under the reserve targeting pro cedure in 1981 and in future years. A U G U S T /S E P T E M B E R F E D E R A L R E S E R V E B A N K O F S T . L O U IS 1981 Appendix: Summary of Discussion at Committee Meetings January 8-9 Meeting1 Staff projections suggested that a contraction in real GNP would develop in the first quarter of 1980. Price increases were projected to accelerate in the early part of the year, due mainly to substantial in creases in energy prices. Since the previous meeting, interest rates had fluctuated over a wide range, but rates were, nevertheless, less volatile than during the period just after October 6, 1979, when the Federal Reserve announced changes in its monetary policy operating procedures.2 On balance, interest rates had declined slightly since the Committee’s last meeting. The Committee specified growth for the first quar ter of 1980 at an annual rate of between 4 and 5 percent for M l and 7 percent for M2. The federal funds constraint of 11.50 percent to 15.50 percent originally adopted at the October 6, 1979, meeting was kept intact. February 4-5 M eeting Staff projections continued to suggest that real growth would contract moderately in the period ahead, and that inflation would continue to be rapid due to increases in energy costs. International tensions (in particular, the Russian invasion of Afghanistan) were adding a major degree of uncertainty in pro jecting output and prices. Most members thought that a moderate contraction in real output was likely in 1980. Over the intermeeting period, long-term in terest rates had risen about one percentage point. At this meeting, both short-term and long-term ranges for the aggregates were specified in terms Note: Citations to “Record of Policy Actions of the Federal Open Market Committee” of meetings in 1980 are referred to as “Record,” in various issues of the Federal Reserve Bulletin. Money growth rates referred to in this appendix are taken from the published minutes of the Committee’s meetings for 1980 and, therefore, may not correspond to more recent benchmark revisions. The data reflect information available to the Com mittee at the time of the meetings. ' “Record” (M arch 1 9 8 0 ), pp. 231-36. of the newly defined aggregates. Consequently, the staff of the Open Market Desk now had to formulate intermeeting paths of total and nonborrowed reserves consistent with the Committee’s short-run objectives for the new aggregates. The Committee adopted short-term objectives of 4.5 percent and 5 percent for MIA and M1B, respec tively. Several members dissented from these actions because they felt interest rates were not exerting enough restraint and that credit was readily available (see table 2 in text). During the period between the February 4-5 meet ing and the next scheduled meeting in mid-March, two conference calls among Committee members were held to discuss the federal funds rate constraint of 11.50 to 15.50 percent that had been in place since October 6, 1979. The federal funds rate had risen to almost 15 percent after mid-February, and member bank borrowings had increased as the spread between the federal funds rate and the discount rate widened. Incoming data also suggested that MIA and M1B were growing at rapid rates in February. The Com mittee voted on February 22 to temporarily raise the upper end of the federal funds rate range to 16.50 percent until the situation could be reassessed. The range was further widened to 11.50-18 percent in a telephone conference of March 7. The “Record” of that meeting states: On March 6 the federal funds generally traded around 17 percent, despite sizable reserve-supplying opera tions by the System, and the Manager advised that in his opinion additional leeway above the existing upper limit of 16.50 percent was needed for operational flexibility in meeting reserve objectives.4 March 18 Meeting5 On March 14, President Carter announced a series of monetary and credit control actions in accordance with the legal authority granted to the President under the Credit Control Act of 1969. The Board of Governors imposed reserve requirements and special deposit requirements on certain types of consumer credit and managed liabilities of commercial banks, -F o r a discussion of the period of October 6, 1979, to the end of 1980 and the announcement of the new operating pro cedures, see Richard W . Lang, “The FOMC in 1979: Intro ducing Reserve Targeting,” this Review (M arch 1 9 7 9 ), pp. 2-24. <Ibid., p. 332. 3“Record” (April 1 9 8 0 ), pp. 325-32. 5“Record” (M ay 1 9 8 0 ), pp. 399-406. 17 F E D E R A L R E S E R V E B A N K O F S T . L O U IS A U G U S T /S E P T E M B E R 1981 a surcharge of 3 percent on frequent borrowers from the discount window, a special deposit requirement on money market funds, and a voluntary restraint program for the growth of total loans of commercial banks ( see table 3 in text for a chronological summary of these actions). This program was later viewed by the Committee as having played a greater role than had been anticipated by affecting the demand for credit and the flow of funds between financial institutions.8 several quarters. Price indices were rising at about a 12 percent annual rate in the first quarter. Interest rates had declined considerably during the intermeet ing period, after reaching new highs in late March and early April. The prime rate reached 20 percent, but had fallen slightly from that level by the time of the meeting. In March MIA and M1B declined at annual rates of 3.5 percent and 2 percent, respec tively, after expanding at rates of 12 percent in February. Information available at this meeting indicated that real output was continuing to grow in the first quarter. In light of the credit control package an nounced just a few days before the meeting, how ever, Committee members continued to stress the unusual degree of uncertainty which affected fore casts of the economy. In its discussion of the near term, the Committee noted that the growth of MIA and M1B over the first two months of the year had ex ceeded growth rates that were considered consistent with objectives established for the December to March period. Most members favored extending by one quarter the short-term growth rates adopted for the first quarter. There was some sentiment for seek ing even slower rates of money growth over the first half of the year to underscore support for the new anti-inflation program. Most members of the Committee favored retaining the short-run objectives for money growth adopted at the prior meeting. Some members, however, were concerned that further declines in interest rates might be misinterpreted by market participants as an “easing” of monetary policy. Members differed in their views regarding the range for the federal funds rate to be adopted for the short-run directive. Since the conference calls during the previous intermeeting period had resulted in changes of the upper limit, the range had been widened from 4 to 6.50 percentage points (from 11.5015.50 percent to 11.50-18 percent). Some members sought to retain the widened range, while others wanted to restore a 4 percentage-point band. The Committee adopted a range of 13-20 percent, noting that procedures had been established for changing ranges between meetings when such changes seemed appropriate to the Committee. April 22 Meeting7 Although it was known that real gross national product had grown in the first quarter at about a 1 percent annual rate, information available at this meeting suggested that economic activity had begun to decline near the end of that period and that economic activity would continue to decline for It was observed th at a significant decline in interest rates, if th at w ere to o ccu r in com in g w eeks, should be regard ed as a consequence of the C om m ittee’s continuing emphasis on its announced objectives for achieving lim ited m onetary grow th and not as a shift tow ard a stim ulative policy. T h e C om m ittee’s m one tary objectives should be p erceived as fully consistent w ith a m oderation of inflationary forces over tim e as well as w ith resistance to recessionary tendencies in the short ru n .8 In light of the outlook for a lower federal funds rate in the weeks immediately ahead, the Committee lowered the u pper limit of the federal funds rate range from 20 percent to 19 percent, but did not change the lower bound of 13 percent. During a tele phone conference call on May 6, the Committee re duced the lower limit of the range for the federal funds rate to 10.50 percent. May 20 Meeting9 Evidence accumulated since the last meeting in dicated that economic output in the second quarter would decline markedly. In foreign exchange mar kets, the dollar had declined over most of the pre vious four weeks; the trade-weighted value of the dollar had fallen about 3.5 percent since the Com mittee’s last meeting. All of the major monetary aggregates had declined in April, with MIA and M1B declining at annual rates of 18.5 percent and 14.5 percent, respectively, while M2 fell at a 3 percent annual rate. These ag gregates fell to levels well below the paths established G“Monetary Policy Report to Congress,” F e d er a l R eserv e B u lle tin (M arch 1 9 8 1 ), pp. 198-99. sibid., p. 487. 7“Record” (Ju n e 1 9 8 0 ), pp. 484-89. n“Record” (July 1 9 8 0 ), pp. 565-70. 18 F E D E R A L R E S E R V E B A N K O F S T . L O U IS earlier by the Committee. These declines were also accompanied by major declines in both short-term and long-term interest rates. The Committee adopted an approach of gradual return to the monetary growth paths consistent with the vear’s annual targets. The Committee directed operations to achieve growth of MIA, M1B, and M2 over May and June at annual rates of 7 to 7.5 per cent, 7.5 to 8 percent, and about 8 percent, respec tively. There were differing views, however, on how aggressively these objectives for the growth of the monetary aggregates should be pursued if the fed eral funds rate declined sharply. C oncern was expressed th at a m ore aggressive ap proach would lead to such sharp declines in the fed eral funds rate and oth er short-term interest rates in the period im m ediately ah ead th at th ere could be a perverse im p act on long-term interest rates by ex acerb atin g inflationary expectations, and there could also be strong adverse effects on the value of the dollar in foreign exchan ge m arkets. M oreover, a g gressive efforts to prom ote m onetary grow th might have to be reversed before long, perhaps leading to significant increases in interest rates in a period of substantial weakness in the econom y. T h e possibility was also suggested th at the dem and for m oney had shifted dow nw ard once again, so th at vigorous efforts in the short run to bring m onetary growth into line with the C om m ittee’s longer-run objectives could result in excessive creation of m oney.10 July 9 Meeting and Mid-Year Review11 The Committee noted that the growth of MIA and M1B had accelerated in June to annual rates of 13.8 percent and 16.8 percent, respectively, following little change in May and sharp contraction in April. The growth of M2 also accelerated to a 17.3 percent annual rate in June, up from a rate of 8.8 percent in May and a small decline in April. Although market interest rates declined considerably in late May and the first half of June, market rates were again beginning to rise. Staff projections of the economy indicated that the decline in GNP for the second quarter was larger than previously anticipated. Declines in real growth were expected to continue throughout the end of the year, and a recovery was forecast to begin at the beginning of 1981. The Committee agreed that open market opera tions for the third quarter should be geared to A U G U S T /S E P T E M B E R 1981 achieving growth rates of MIA, M1B, and M2 at annual rates of about 7 percent, 8 percent and 8 percent, respectively. However, in light of the short fall in money growth over the first half of the year, the Committee would accept faster growth. It was noted at this time that growth of the narrow aggre gates might fall near the lower bounds of their respective annual ranges. In July of each year, the Committee must review for Congress its monetary growth ranges for the year, and provide a preliminary indication of its ranges for the next year. At its July 9 meeting, the Committee reviewed the annual ranges adopted at its February meeting, and analyzed the growth of the monetary aggregates over the first half of the year. The expansion of MIA and M1B over the first two quarters had fallen substantially below the long-run growth paths established by the Committee in Feb ruary. The growth of M2, on the other hand, was stronger and by mid-year was near the midpoint of its range. The Committee examined annual targets for the growth of the monetary aggregates in terms of the relative growth rates of MIA and M lB (as affected by the shift into NOW and ATS accounts), and concluded that “in view of recent evidence of a preference for interest-bearing transactions accounts over demand deposits that was greater than antici pated, it appeared likely that M lB would grow some what faster relative to MIA than had been projected earlier in the year.”3- There was general agreement, however, that the growth of these accounts was not “large enough to justify ‘fine-tuning’ the growth ranges at the expense of causing public confusion about the meaning of the adjustments.”13 The Committee voted to retain the targets for 19S0 as adopted at its Feb ruary meeting. In reaffirming these ranges, it was recognized that the growth rates of MIA and M lB might fall below the midpoints of their ranges for the year. In its discussion of growth ranges for 1981, the Committee agreed that further reduction in money growth from the ranges established for 1980 would be appropriate. Committee members disagreed, how ever, about specific objectives for the growth of the aggregates in 1981, because they expected institutional changes resulting from the Monetary Control Act of 1980 (MCA) to blur the meaning of the narrow aggregates in 1981: Mlbid., pp. 567-68. n “Record” (Septem ber 1 9 8 0 ), pp. 747-54 and “Monetary Policy Report to Congress,” F e d er a l R eserv e B ulletin (July 1 9 8 0 ), pp. 531-42. 12“Reeord” (Septem ber 19S 0), p. 750. 13Ibid. 19 F E D E R A L . R E S E R V E B A N K O F S T . L O U IS In p articu lar, relationships am ong the aggregates will be affected by introduction of N O W accoun ts on a nationw ide basis as of D ecem b er 3 1 , 1 9 8 0 , as au thor ized by th at act. D uring 1 9 8 1 , shifts of funds from dem and deposits to N O W accoun ts are likely to be substantial, and will retard th e grow th of M IA . At the sam e time, transfers from savings deposits and other interest-bearing assets to N O W accounts will en han ce th e grow th of M IB . T o the exten t th at funds are shifted into N O W accoun ts from other deposit com ponents of M 2 and M 3, grow th of these ag g re gates will be u naffected.14 The Committee decided not to announce precise target ranges for 1981 due to the uncertainty sur rounding the possible impact of the MCA on the relationship among the aggregates. After monetary oversight hearings before the Senate and House bank ing committees, however, the Committee later that month announced more specific objectives: ranges for the growth of MIA, M IB and M2 for 1981 would be reduced “on the order of 1/2 percentage point from the ranges adopted for 1980, abstracting from institutional influences affecting the behavior o f the aggregates.”15 (Italics added.) August 12 Meeting16 Early in the intermeeting period, the monetary aggregates grew slightly faster than the rates specified by the Committee for the period from June to Sep tember. At its July meeting, the Committee had agreed that moderately faster growth than the shortrun targets would be acceptable. Later in the inter meeting period, both MIA and M IB appeared to be growing considerably faster than their specified rates. The growth rates of MIA and M IB from the fourth quarter of 1979 through July, however, were still be low rates consistent with the Committee’s ranges for the year. Market interest rates had risen during the intermeeting period; short-term interest rates increased about 50 basis points and long-term rates about 75 basis points. The staff projected that real GNP would continue to decline through the end of the year, but not as rapidly as the preliminary estimate of a re duction in real GNP at a 9.1 percent annual rate for the second quarter. In its deliberations on the short-run aggregate di rective, the Committee took note of a staff analysis which suggested that, if third quarter growth con tinued for M IB, that aggregate would be near the A U G U S T /S E P T E M B E R midpoint of its annual range by the fourth quarter; the growth of M2 would be at the upper end of its range. In July MIA and M IB grew at annual rates of about 7.5 percent and 10.8 percent, respectively, and M2 grew at a 17 percent rate. Some members expressed concern that a short-run target for MIA appreciably below the 7 percent rate voted at the prior meeting would cause further in creases in interest rates at a time when the longerrun targets did not clearly suggest the need for re duced growth in the monetary aggregates.17 The Com mittee voted for a slightly reduced rate of growth for MIA (6.5 percent) over the third quarter and higher rates for M IB and M2 (9 percent and 12 percent, respectively). A federal funds rate range of 8 to 14 percent was adopted. September 16 Meeting18 Staff projections reviewed at this meeting sug gested that the economy would recover by the end of the year. Declines in real GNP for the third quarter were expected to be less pronounced than had been thought just a month earlier. The Committee, for the most part, shared the outlook that the economy was somewhat stronger than had been anticipated pre viously, and some members believed the economy was stronger than the staff was projecting. There was broad agreement, though, on the staff estimate of only modest gains in the economy in 1981. The growth of MIA and M IB accelerated in August to annual rates of about 19.5 percent and 22 percent, respectively, and M2 grew at a 14.3 percent rate. It was then evident that policy over the period ahead should be directed toward a deceleration in money growth in order to achieve the Committee’s objectives for the year. For the period from the fourth quarter of 1979 through August, the growth of MIA was in the lower half of the Committee’s longrun range, but M IB was in the upper half of its range, and M2 was somewhat above the upper limit of its range. Market interest rates exhibited wide fluctuations in the intermeeting period, but on balance had risen since the last meeting. Although there was broad agreement that tary expansion should be reduced in the ahead, views differed concerning the specific run growth objectives to be adopted. One 14Ibid. 15Ibid., p. 753. 17Ibid., p. 838. 1•'“Record” (October 1 9 8 0 ), pp. 835-39. 18“Record” (November 1 9 8 0 ), pp. 883-87. 20 1981 mone period shortgroup A U G U S T /S E P T E M B E R F E D E R A L R E S E R V E B A N K O F S T . L O U IS favored growth rates on the lower side of the ranges discussed at the meeting, emphasizing “the need for a policy posture that would minimize any risk of exacerbating inflationary forces in the economy or worsening inflationary expectations.”11’ Another group favored more rapid rates of money growth (but less rapid than the July-September period) and appeared to be concerned about a recent rise in interest rates, since “these increases might well begin to reduce money and credit demands over the months ahead, that economic recovery was in its very early stages, and that some sectors such as housing were especially sensitive to emerging credit conditions.”20 A middle course was adopted by the Committee — one calling for the growth of MIA, M IB and M2 over the August-December period at annual rates of about 4 percent, 6.5 percent and 8.5 percent, respectively. October 21 Meeting21 Preliminary data available at this meeting indicated that real GNP had expanded in the third quarter at an annual rate of 1 percent. Staff projections sug gested that the third quarter marked the beginning of a recovery. Prices continued to rise at about a 10.5 percent annual rate. Early in the intermeeting period, data indicated that the monetary aggregates were continuing to grow at rates faster than those consistent with the Com mittee’s objectives for the August-December period. Short-term interest rates also rose over the intermeet ing period; long-term rates, however, changed little on balance. In the days just prior to the October 21 meeting, the federal funds rate was trading in the area of 12.50 to 13 percent, compared with 10.50 to 11 percent just before the last Committee meeting on September 16. In its discussion of policy for the near term, all of the voting members favored the pursuit of a sharp reduction in monetary expansion over the final months of 1980 in order to reach their long-run money growth objectives for the year. Nevertheless, as in the pre vious meeting, members differed in their views about the exact short-run policy directive to be adopted. One group favored growth objectives for the final months of the year consistent with the growth rates adopted at the Committee’s meeting in September; 1981 that is, thev would adjust for the overshoot in Sep tember in order to achieve the long-run objective of the Committee for the year. Another group placed less significance on specifying short-run targets precisely consistent with the AugustDecember objectives and cited the volatility of shortrun money growth data. O th er m em bers, while also seeking sharply red u ced grow th rates of the aggregates in the months ahead, attach ed less significance to targets precisely con sistent with the A u gust-to-D ecem b er objectives ad op ted a m onth earlier, in light of th e inherent volatility of the d ata in the short run. C om m ittee a c tions affected the m oney supply only w ith som e lag, and given actions already in p lace and the u n certain ties of the econom ic outlook, the possibility could not be excluded th at very ambitious short-run objectives with resp ect to restrain t could gen erate undesirable instability in both interest rates and the m oney supply over a som ew hat longer period and thus be cou n ter to the C om m ittee’s m ore fundam ental goals.22 The Committee adopted a short-run directive that attempted to reconcile the competing views expressed by various groups. The Committee agreed to target paths for MIA, M IB and M2 over the SeptemberDecember period at annual rates of about 2.5 per cent, 5 percent and 7.25 percent, respectively. It was noted that M IB could exceed the upper bound of its long-run range if increases over the months ahead equaled or exceeded the adopted numerical speci fications. November 18 Meeting23 Data available to the Committee at this meeting suggested that economic activity was continuing to expand in the fourth quarter. Short-term interest rates rose 1.75 to 3 percentage points over the intermeeting period, while long-term rates increased about 75 basis points. Staff projections suggested that growth of real output in the fourth quarter would be slightly greater than the 1 percent growth rate in real GNP for the third quarter. The staff’s projections continued to predict little growth over the next few quarters. MIA and M IB grew at about 9 and 11 percent annual rates, respectively, in October and were sub stantially above the short-run objectives voted at the last Committee meeting. The growth of M2 acceler ated slightly to a 9 percent rate. Through October, MIA was in the upper part of the Committee’s annual 19Ibid., p. 886. -°Ibid. 22Ibid., pp. 971-72. 21“Record” (D ecem ber 1 9 8 0 ), pp. 968-73. 23“Record” (January 1 9 8 1 ), pp. 27-33. 21 F E D E R A L R E S E R V E B A N K O F S T . L O U IS range; M1B and M2, however, were above thenannual ranges. Most members favored reaffirming the short-run objectives for the monetary aggregates over September-December that were voted at the last meeting, which would require sharp declines in the aggregates during the remainder of the year. Members had differ ing views, however, on how aggressively to pursue these objectives. W hile favoring sharply red u ced grow th of the m one tary aggregates in the p eriod im m ediately ahead, a num ber of m em bers expressed con cern about in adver tently con trib utin g to the volatility of interest rates, because of the im plications of such volatility for econ om ic activity, for inflationary psychology, and for the functioning of financial m arkets. Specifically, a substantial reduction in the provision of nonbor row ed reserves or oth er m easures in a highly a g gressive pursuit of the short-run m onetary grow th rates being con tem p lated m ight lead prom ptly to fu rth er increases in interest rates, w hich w ere p rob ably already constraining the business recov ery and slow ing m onetary grow th. Subsequent declines in rates m ight be unduly large, and if m onetary grow th accelerated again in lagged response, inflationary exp ectation s could well be h eig h ten ed .-' Shortly after the November meeting, data indicated that the monetary aggregates were growing con siderably faster than the rates consistent with the Committee’s short-run objectives. In addition, the federal funds rate was just above 17 percent, the upper end of the range specified at the November meeting. During a telephone conference on Novem ber 26, the Committee raised the upper limit of the federal funds range to 18 percent. The federal funds rate continued to rise, however, and by the morning of December 5 was above 18 percent. On December 5 the Committee temporarily suspended the upper bound of the range, and on December 12 suspended the range until the next scheduled meeting. December 18-19 Meeting"5 Information analyzed at this meeting suggested that real economic growth would expand more than in the previous quarter. Prices continued to rise at about a 10.5 percent annual rate. The trade-weighted value of the dollar against major foreign currencies had risen about 2.5 percent since the Committee’s mid-November meeting. Staff projections suggested that real output growth, after some accelerated A U G U S T /S E P T E M B E R growth in the current quarter, would decline in the first half of 1981. Slow economic growth during the remaining portion of 1981 was also projected. The rise in prices over this period was projected to re main rapid, but not as rapid as in 1980. Growth of MIA and M1B moderated in November but was still above the Committee’s objectives for the period from September to December. The expansion of M2 and M3 in November continued to accelerate. In early December, however, MIA and M1B were actu al!}' falling. As measured from the fourth quarter of 1979 through November, growth of MIA was in the upper part of its long-run range; M1B and M2, how ever, exceeded their respective long-run ranges. The Committee, in its consideration of a short-term policy directive, reviewed the tentative long-run ranges for 1981 adopted in July. It was agreed that money growth over the first quarter of 1981 should be consistent with the tentative ranges adopted in July for 1981: targeted growth rates for the aggre gates were intended to represent a 0.5 percentage point reduction in the ranges adopted for 1980, ab stracting from effects of deposit shifts connected with the introduction of NOW accounts on a nationwide basis in January 1981. In the short-run the C om m ittee seeks behavior of reserve aggregates associated with grow th of M IA , M 1B , and M 2 over the first q u arter along a path consistent w ith the ranges for grow th in 1981 co n tem p lated earlier, which will be review ed in F e b ru ary 1 9 8 1 . Those ranges, ab stractin g from the effects of deposit shifts co n n ected with the introduction of N O W accoun ts on a nationw ide basis, im ply grow th in these aggregates cen tered on 4 .2 5 p ercen t, 4 .7 5 p ercen t, and 7 p ercen t respectively. It is recognized th at the introduction of N O W and A TS accoun ts nationw ide at the beginning of 1981 is likely to widen the d iscrep ancy betw een grow th in M IA and M 1B to an exten t th at cann ot now be accu rately estim ated, and operational reserve paths will be d e veloped in light of evaluation of those differences as th ey em erge.28 In other words, the Committee’s task of monitoring and selecting money growth rates over the short-run would have to rely on staff estimates of how these institutional changes were affecting growth of the aggregates. In turn, the Manager of the Open Market Desk would have to translate these short-term paths adopted by “abstracting from the effects of deposit shifts” into reserve paths consistent with these growth rates. 24Ibid„ p. 30. - 5“Record” (February 1 9 8 1 ), pp. 149-54. 22 1981 sq b id ., p. 154. Grain Export Agreements — No Gains, No Losses CLIFTON B. LUTTRELL T h e b e has been a tremendous amount o f public ity about the U.S. grain export agreements with the U .S.S.R. in 1975 and China in 1980. The threat of not renewing the agreement with Russia, which would have terminated October 1 this year, was considered by some to be a heavy penalty — both to the United States and the Soviets. Virtually no econom ic anal ysis has been done, however, that looks behind the publicity to determine the actual econom ic conse quences of the treaties. This article assesses the major econom ic consequences of these agreements. The A greem ents The first bilateral grain sale agreement was made with the Soviets in 1975 for a five-year period begin ning October 1, 1976; the second was made with China in 1980 for a four-year period beginning January 1, 1981. Both agreements call for sales to be made in cash at prevailing market prices. They set minimum and maximum quantities of grain to be purchased from the United States, and prohibit the re-export o f the grain to other nations. The Soviet agreem ent stipulated that beginning October 1, 1976, the U.S.S.R. would buy six million metric tons of wheat and corn in about equal pro portions from U.S. private commercial sources in each 12-month period. This quantity could be in creased up to 2 million metric tons in any 12 months without consultation. If the U .S.S.R. wished to pur chase additional amounts in any year, it w'as required to immediately notify the U.S. government. The agreement with China calls for U.S. grain exports to China of 6 to 8 million m etric tons each calendar year beginning January 1, 1981, of which 15 to 20 percent will be corn and the remainder, wheat. China may purchase an additional 1 million tons without prior notification.1 O bjectives o f the A greem ents The purpose of the agreements, according to U.S. government officials in press releases and hearings, is to provide greater stability in Soviet and Chinese purchases of grain from the United States. The agreements allegedly will require the Soviets and C hinese to purchase grain on a regular basis; hence, there should be fewer “surprises” to the U.S. grain markets. The importing nations are assured that during the term of the agreements the United States shall not exercise any discretionary authority to control exports purchased according to the agree ment. Charles W. Robinson, a participant in the Soviet agreement, stated, “ instead o f uncertainty each year as to whether Soviet purchases would be 15 or 20 million tons or zero, grain producers and the markets now have an additional elem ent that can be taken into accou n t. . .” He further contended that farmers, consumers and our maritime industry 'T h e Bureau of National Affairs, Inc., D aily R ep o rt f o r E x ecu tiv es, O ctober 22, 1980, pp. L 4-5; United States D epartm ent of Agriculture, R ep o rt o f th e S ecreta ry o f A g ricu ltu re, 1975, p. 11; A g ricu ltu ral O u tloo k (D ecem ber 1980), pp. 18-19; And M onthly E co n o m ic L e tte r (First National City Bank of New York, D e cem ber 1975), pp. 12-13. 23 F ED ER A L RESERVE B A N K OF ST. LO UIS “would all benefit from the expanding opportunities for employment generated by this long-term agree ment.”2 Form er Agriculture Secretary Bob Bel giand, in announcing the agreement with China, said it was necessary to “reduce the elem ent o f surprise.”3 The alleged gains to the maritime industry are mentioned because the agreement contains a clause requiring that U.S. vessels carry not less than one-third of all of the grain purchased pursuant to the agreement. W hile no official press releases have claimed that the agreements will increase overall grain exports, a number of statements to this effect have been made. For example, in connection with a summary o f the U.S. farm export outlook, the United States Departm ent of Agriculture reported that “the fouryear grain agreement betw een the United States and China will boost future U.S. exports of grain to China well above the 4 million tons exported to China in 1979 as well as the previous record of 4.3 m illion in 1973.”4 The Secretary of Agriculture re ported that “grain sales under the C hinese agree ment w ill probably be worth about $1 billion per year.”5 Furthermore, news coverage of the treaties generally viewed the agreements as vehicles for enhancing export sales. The St. L ou is G lo b eD em ocrat, referring to the Chinese agreement, reported “the agreem ent is expected to help ap pease grain farmers angered by a U.S. grain embargo. . . . The agreement is designed to help trade ex pansion. . . .”6 The favorable early impact of the Soviet agree ment on the farm sector was emphasized by The E co n o m ist: “The day the farmers have been waiting for more and more impatiently came on Monday, October 20th when the grain agreement with the Russians was finally signed.”7 Such announcements led both the farming sector and much of the public at 2Statem ent of Charles W. Robinson, U ndersecretary for Econom ic Affairs, D epartm ent o f State, U nited S ta tes -S o v ie t G rain A g r ee m ent, S .2492 a n d O th er M atters, Hearings Before the Subcom mittee on International Finan ce of the Com m ittee on Banking, Housing and Urban Affairs, United States Senate, Ninety-Fourth Congress, S.2492, D ecem ber 9 & 10, 1975, pp. 66, 67 and 72. 3Statem ent by Secretary of Agriculture Bob Bergland in D aily R ep o rt f o r E x ecu tiv es, O ctober 22, 1980, pp. L4-5. *A nricu ltu ral O u tloo k (D ecem ber 1980), p. 18. AUG ./S EPT. 1981 Table 1 U.S. Real Farm Exports (millions of 1967 dollars) Calendar year Total farm exports Percent of farm com m odity sales 19701 6,599 14.4% 1971 1 6,808 14.6 1972 7,521 15.4 1973 9,877 20.3 1974 11,458 23.8 1975 11,829 24.8 1976 12,364 24.1 1977 12,916 24.2 1978 13,992 25.4 1979 14,417 26.4 1980 16,772 29.5 ’ Total exports to Soviets were insignificant. P rior to 1972, the Soviets were generally net exporters of grain. SOURCE: A gricultura l O utlook, U.S. Foreign A gricultura l Trade Statistical Report, A gricultura l Statistics, Econom ic Report o f the President. large to view the agreements as vehicles for increas ing overall U.S. grain exports and stabilizing year-toyear levels of exports. ASSESSING TH E IMPACT O F TH E RUSSIAN GRAIN AGREEM ENT Although it is too early to assess em pirically the consequences of the grain agreement with China, the Russian agreement provides an opportunity for analysis. From 1917 to 1972, the U .S.S.R. was gen erally a net exporter o f grain. Beginning with the marketing year 1971/72, however, it becam e a net importer of grain and has remained so each year since then, importing much ol its additional require ments from the United States.8 Hence, the United States exported grain to the Soviets for five years prior to the effective date o f the treaty and for five years since the treaty was signed. Although the em bargo placed on grain shipments to the Soviets in mid-1979/80 (early January 1980) limited exports to the amounts stipulated in the agreement, it is pos sible at least partially to assess the treaty’s effective ness in achieving the objectives that have variously been associated with it. sD aili/ R ep o rt f o r E x ecu tiv es, O ctober 22, 1980, p. L5. 6“Grain D eal,” St. L o u is G lo b e-D em o c ra t, O ctober 23, 1980. ''The E co n o m ist (O ctober 25, 1975), p. 70. 24 8The marketing year begins Ju n e 1 for wheat, barley, and oats, and O ctober 1 for com and sorghum grain. AUG ./SEPT. 1981 FED ER A L RESERVE B A N K OF ST. LO U IS Table 2 U.S. Exports of W heat and Feed Grain (millions of metric tons) Feed grain Wheat Combined Marketing year1 Total 1970/71 20.2 — 19.0 — 39.1 1971/72 16.6 — 24.6 2.9 41.1 2.9 1972/73 30.9 9.5 39.3 4.2 70.2 13.7 1973/74 33.1 2.7 41.1 5.2 74.2 7.9 1974/75 27.7 1.0 35.9 1.3 63.6 2.3 1975/76 31.9 4.0 50.0 9.9 82.0 13.9 1976/77 25.9 2.9 50.6 4.5 76.5 7.4 1977/78 30.6 3.3 56.3 9.2 86.9 12.5 To USSR Total To USSR Total To USSR — 1978/79 32.5 2.9 60.2 8.3 92.7 11.2 1979/80 37.4 3.9 71.4 11.3 108.8 15.2 1980/81 41.5 3.0 73.1 5.0 114.6 8.0 'Y ear beginning June 1 fo r wheat, barley, oats and rye; O ctober 1 fo r corn and sorghum. SOURCE: U.S. Department of A griculture, Foreign A griculture Circular. Im pact on Volum e o f Grain Exports If the agreement has resulted in larger overall grain exports without offsetting declines in the ex ports o f other farm products, total U.S. farm exports would be expected to show a one-time upward shift following the agreement, other things equal. How ever, this has not occurred. Real U.S. farm exports, which are shown in table 1, had been increasing at an 11 percent rate from 1970 to 1976 when the grain agreement becam e effective. This trend largely re flected the freer foreign trade policies that the United States and other nations established in the 1950s and 1960s.9 Following the treaty (1976-80), farm exports grew at a slower 7.9 percent rate. Hence, if other fac tors that affect exports remained unchanged, there is no evidence that the growth of total real farm exports has increased in response to the Soviet treaty. grain exports slowed from 21.4 percent over the 1971/72-1975/76 period to 7.9 percent for the 1975/76-1979/80 period following the treaty. An nual growth in total exports o f wheat plus feed grain decelerated from 16.0 percent prior to the treaty to 6.9 percent following the treaty. U.S. wheat and feed grain (largely corn) exports are shown in table 2. Again, there is no evidence that the growth of either wheat or feed grain exports has accelerated following the treaty. U.S. wheat exports rose at an average annual rate o f 9.6 percent from 1970/71 to 1975/76 (the last pre-treaty market ing year) and at a 5.4 percent rate from 1975/76 to 1979/80. The annual rate o f increase in total feed The record of U.S.S.R. grain imports and utiliza tion before and after the treaty is shown in table 3. There was no major break in overall grain imports by the Soviets at the effective treaty date (October 1976). The Russians, however, apparently shifted some grain purchases from other nations to the United States following the treaty until the embargo in early 1980. For the five years prior to the treaty, U .S.S.R. purchases average 8.1 million metric tons o f grain per year from the United States (72 percent of Soviet net grain imports) and 3.2 m illion metric tons per year from non-U.S. sources. During the three years following the treaty and prior to the early 1980 grain embargo, Soviet purchases from the United States rose to 10.6 million m etric tons per year (84 percent o f total Soviet imports), while imports from non-U.S. sources declined to 2.0 m illion metric tons peryear. Hence, the gains in U.S. sales to the Soviets tended to be offset by reduced Soviet grain pur chases elsewhere. 9See Clifton B. Luttrell, “ Rising Farm Exports and International Trade P olicies,” this R ev ieio (July 1979), pp. 3-10. This, however, does not indicate that American farmers gained significantly from this response, 25 F ED ER A L RESERVE B A N K OF ST. LO UIS AU G ./S EPT. 1981 Table 3 U.S.S.R.: Grain Supply and Utilization (millions of metric tons) Net grain im p orts1 Marketing year June-July Production 1970/71 187 1971/72 181 2.9 1972/73 168 1973/74 223 1974/75 Utilization Total grain im ports2 of non-Soviet nations From rest of w orld Total Food - 7 .0 -7 .0 45 187 - 7 109.7 1.6 1.3 45 180 + 2 108.4 13.7 7.3 21.0 45 187 + 2 113.3 7.9 -2 .7 5.2 45 214 + 14 137.2 196 2.3 -1 .9 0.4 45 206 -1 0 135.4 1975/76 140 13.9 11.5 25.4 45 180 -1 4 126.8 1976/77 224 7.4 0.3 7.7 45 221 + 11 148.3 From U.S. — Total Change in stocks 1977/78 196 12.5 4.1 16.6 45 228 -1 6 149.9 1978/79 237 11.2 1.6 12.8 46 231 + 19 161.1 1979/803 179 15.2 15.0 30.2 46 225 -1 6 168.3 1980/814 189 25.0 34.0 47 225 - 177.0 8.0= 2 'T o ta l im ports less exports. P rior to 1972 the Soviets were generally net exporters of grain. 2W orld trade less Soviet im ports P re lim in a ry 4Forecast E s tim a te d SOURCE: U.S. Department of A griculture: Foreign A gricultura l C ircular: G rains; USSR A gricultura l Situation: Review of 1976 and O utlook fo r 1977. since they sell grain in the world market. Shifting Soviet purchases from one nation to another does not alter world demand for grain or the average grain price. Shifts in Soviet grain purchases from other grain-exporting nations to U.S. fanners are offset by reduced U.S. exports to non-Soviet nations. No overall change necessarily occurs in total world grain trade. Stability o f USSR Grain Im ports Soviet grain purchases from the United States were somewhat more stable following the signing of the treaty than before. For example, as shown in table 4, the standard deviation (a measure of the variation around the arithmetic mean) o f such exports declined (although the decline was not sta tistically significant) from 6.0 million metric tons during the six pre-treaty years (1970/71-1975/76) to •3.2 million in the fixe years following the treaty.10 However, as shown in table 3, the Soviets realized an unusually small harvest in 1975/76 which tended to 10The coefficient of variation (the standard deviation divided by the arithm etic mean) declined from .887 to .297. 26 distort the results toward less stability in the pre treaty years. Stability o f W orld G rain M arkets Just because Soviet grain purchases from the United States may have been more stable following the treaty, however, does not mean that world grain markets were stabilized by the treaty. In fact, the in creased stability of purchases from the United States may have led to less stable purchases from other na tions. Although the difference is not statistically sig nificant, the standard deviation of net Soviet pur chases from other nations rose from 7.0 million metric tons in the pre-treaty years to 10.6 million metric tons following the treaty. As a result, total imports by the Soviets show little evidence o f increased sta bility since the treaty. The standard deviation of total Soviet imports declined only from 12.7 million metric tons prior to the treaty to 11.0 m illion metric tons following the treaty. Any apparent increase in stability o f Soviet grain imports following the treaty can in part be explained by smaller fluctuations in year-to-year Soviet grain production in the post-treaty years. Grain production in the Soviet Union has always varied widely from FED ER A L RESERVE B A N K OF ST. LO UIS AUG ./SEPT. 1981 Table 4 M e a su re s of Annual Variation in U.S.S.R. Grain Production, Im ports and Utilization, Before and After Treaty (millions of metric tons) Before treaty (1970/71-1975/76) A rithm etic mean Standard deviation 182.5 27.8 U.S. 6.8 O ther nations 0.9 7.7 Production Coefficient of variation After treaty (1976/77-1980/81) Arithm etic mean Standard deviation .152 205.0 24.5 6.0 .887 10.9 3.2 .297 7.0 7.458 9.2 10.6 1.148 12.7 11.0 .550 Coefficient of variation .119 Im ports from : 1.646 20.1 Total utilization Total im ports 192.3 14.31 .074 226.0 Non-U.S.S.R. im ports 121.8 13.0 .106 160.9 3.71 12.2 .016 .075 'S tandard deviations which were significantly different at the 5 percent level. SOURCE: Table 3. year to year, reflecting a larger variability in weather conditions compared with many other nations, but the variation was somewhat less following the treaty.11 Furthermore, total international grain imports by all non-Soviet nations were apparently more stable following the agreement. The standard deviation ol such imports declined (although the decline was not statistically significant) from 13.0 million tons prior to the treaty to 12.2 million following the treaty, and the coefficients of variation declined from .106 to .075, respectively. Stability o f G rain Price To the extent that Soviet grain purchases from the United States following the agreement were stabilized at the expense of greater instability in their purchases elsew here, the agreements were not a factor in stabilizing either U.S. or world grain prices. The U.S. price is determined by world supply and demand conditions, and Soviet pur chases from an\' other nation typically have about the same impact on U.S. grain prices as if the pur chases were made directly from the United States. Although prices of feed grain and wheat appar ently stabilized somewhat from the pre-treaty years 1970-76 to the post-treaty years 1977-80, this appar“ During the six pre-treaty years the standard deviation of Soviet grain production declined from 27.8 million m etric tons with a coefficient o f variation of .152, to 24.5 million metric tons with a coefficient of variation o f .119 following the treaty. ent stability is not statistically confirmed.12 More over, the average price of all U.S. crops shows greater reduction in variation than feed grain and wheat prices. H ence, apparent price variability de clined more in crops n ot involved in the treaty than in feed grain and wheat. Once again, there is no evi dence that the treaty provided a price-stabilizing impact on the traded grains. Grain Storage Increased storage o f grain by the Soviets following the treaty could have resulted in less variable Soviet grain imports and, hence, had some effect on world grain prices.13 Greater buildup o f grain reserves 12During the pre-treaty years the coefficient of variation of the price of feed grain was .387 and for all crops .321, while in the post-treaty years the coefficient o f variation of the price of feed grain was .139 and for all crops .101. In other words, the co efficient of variation for all crops was 83 percent as large as the coefficient for feed grain in the pre-treaty period but was only 73 percent as large in the post-treaty years. T he coefficient of variation for all crops likewise declined relative to wheat, drop ping from 68 percent of the wheat coefficient in the pre-treaty years to 44 percent in the post-treaty years. 13A factor that tended to increase the variability o f Soviet im ports following the treaty was the increased stability of Soviet grain usage. Total year-to-year grain utilization by the Soviets was definitely stabilized about 1976/77, the year in which the treaty was made. During the five pre-treaty years total grain utilization fluctuated quite sharply from year to year having a standard deviation of 15.7 million metric tons. Follow ing the treaty the standard deviation of total grain utilization was only 4.3 million metric tons. The coefficients of variation of grain usage prior to and following the treaty were .08 and .02, respectively. 27 F E D E R A L RESERVE B A N K OF ST. LOUIS during good crop years would permit the Soviets to utilize such reserves and to import less than other wise following poor crop years. Charles Robinson contended that a Soviet buildup of grain reserves is inherent in the agreement because they are com mitted to purchase a minimum quantity o f grain each year.14 O f course, it could always be argued that the Soviets have less incentive to store large quantities of grain with an assured supply available at market prices. Nevertheless, with greater grain stocks, the Soviets could have supplemented grain usage with less imports following relatively small grain harvests. The data, however, indicate that no buildup in Soviet grain stocks occurred following the treaty. Total Soviet grain stocks declined 13.0 million metric tons during the six pre-treaty calendar years 1970/ 71-1975/76 and declined another 5.0 million during the five post-treaty years 1976/77-1980/81 (table 3). Furthermore, as indicated earlier, Soviet grain pro duction was larger and somewhat less v a ria b le in the post-treaty years than during the pre-treaty years. H ence, if the Soviets had plans for increasing their stock of stored grain, the post-treaty years would have been a relatively favorable period in which to do so. Evidence, however, indicates that instead of increasing stocks, the Soviets increased re liance on world markets to smooth out the impact of variation in annual production on short-run supply so as to maintain relatively stable consumption. Exports Follow ing Treaty Consistent With A W orld Grain Market Grain is sold by those nations in which the cost of producing it is low relative to the world price; it is purchased by those nations in which the cost of pro ducing (more) grain is high relative to the world price. Unless the Soviet or Chinese grain agreements have an impact on overall grain demand or upon world grain production (supply), they will have no impact on overall grain shipments or on total U.S. grain exports.15 •“Statem ent by Charles W. Robinson, p. 69. 15Like the recent grain embargo to the Soviets, the grain export agreem ent is not consistent with a com mercial world grain market. Such a market continues to function despite the nu merous trading agreem ents betw een governments that often ignore market price, and w hile a world market exists, govern ment actions such as bilateral trade agreem ents and grain embargos can do little to increase or impede world trade or to reduce price variability caused by crop failures or above average crops in individual nations. Grain continues to move from areas w here grain prices are relatively low to areas where grain prices are relatively high. For a further discussion of 28 AUG ./SEPT. 1981 Table 5 Soviet Grain Utilization, Livestock Inventory and M eat Production, Before and After Treaty (annual rates of ch an ge )1 1972-75 1977-80 0.6 % Grain u tiliza tio n 2 4.9 % Cattle 2.1 1.4 Hogs 0.4 5.3 Sheep 1.3 0.9 Poultry 3.2 7.9 Meat production 3.2 1.5 11976, the year of the agreement, was excluded because of extrem ely low Soviet grain production. 2Marketing year as in table 3. SOURCE: U.S. Departm ent of A griculture, Foreign A gri culture, and table 2. Livestock numbers as of January 1; meat production fo r calendar year. For example, if the Soviets purchase more grain from the United States and less elsew here (i.e., there is no change in total Soviet imports) at market prices, other grain exporting nations will, in turn, export less to the Soviets and more to the other im porting nations such as Japan and W estern Europe. The world price would still allocate world grain production (supply) to world consumers (demand) as though the treaty did not exist, and total U.S. exports would remain unchanged. If the agreement, for example, required the Soviets to purchase more grain from the United States in any one marketing year than they wanted to purchase, they could re duce their purchases from other nations or sell some of their domestically produced grain on the world market to offset the unwanted purchases. Hence, the minimum purchase requirem ents of the agreement likewise have little net impact on world grain trade or world grain price. Despite the greater stability in grain utilization in the Soviet Union in recent years, there is no evi dence that the volume o f grain utilization, livestock numbers or meat production have accelerated since the agreement. Total Soviet grain use rose 4.9 per cent per year during the four years prior to the agreement and 0.6 percent per year from 1977 to 1980 after the agreem ent (table 5). this topic see Clifton B. Luttrell, “T he Russian Grain E m bargo,” this R ev iew (August/September 1980), pp. 2-8. FED ER A L RESERVE B A N K OF ST. LOUIS The rates of increase in Soviet cattle and sheep numbers have declined, the former from 2.1 to 1.4 percent per year and the latter from 1.3 to 0.9 per cent per year. W hile the rate of increase in hogs ac celerated, almost all the gain was the result of a catch-up process to replenish hog numbers that were reduced sharply following the very sharp decline in the 1975/76 grain crop. Hog numbers dropped 20 percent from January 1975 to January 1976, and in January 1977 were still about 12 percent less than in 1975. Hog numbers rose only about 0.3 percent per year during the entire period 1972-80. O f the food animals, only poultry has accelerated since the agreem ent from a 3.2 percent annual rate in the four years prior to the treaty to a 7.9 percent rate during the post-treaty years. Overall, Soviet meat production, while main taining greater year-to-year stability since the agree ment, has shown less growth. During the four pre treaty years meat output rose at a 3.2 percent rate; in the post-treaty years it has risen at a 1.5 percent rate. Consequently, the trend toward rising depend ence on imports of grain by the Soviets occurred largely prior to the grain agreement. There is no evidence that the treaty has increased the trend oi led to additional overall imports. SUMMARY The Soviet grain agreem ent may have had some AUG ./SEPT. 1981 desirable side effects. I f information on crop condi tions is obtained through the treaty, it serves as a tool to help price the grain stocks on hand, and hasten the expansion or contraction of production in the rest o f the world in response to the latest Soviet crop conditions. There is little evidence, however, that the agreem ent has contributed to rising U.S. grain exports, greater stability o f U.S. grain exports, or greater grain price stability. Soviet grain purchases from U.S. sources have becom e somewhat more stable, but their purchases from other grain-exporting nations have apparently becom e more variable, offsetting the price-stabiliz ing effects o f their less erratic U.S. purchases. U.S. grain prices have stabilized somewhat since 1976. However, relative to the price behavior o f all crops, both feed grain and wheat prices have been less stable since the agreement. These results are consistent with a world grain market where grains move relativ ely fr e e ly b e tween areas. In such a world market, agreements can do little to affect the overall grain trade of a nation. Increased sales to one nation are offset by reduced sales to other nations. The world price allocates production to consumers and a decision by one nation to make all o f its sales to or purchases from another nation will not have a significant im pact on total world grain trade or on the world grain price. 29
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