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June 1966 F E D E R A L R E A e N v K O F ie S T . L O U I S w , CO N TEN TS Page Total Demand, Prices, and Real Growth . . . . 1 Federal Reserve Open Market Operations in 1965: Objectives, Ac tions, and Accomplish ments ............................ Total Demand Prices, and Real Growth 1 R IC E S C O N T IN U E D T O R IS E in April and early May, while growth of real product apparently slowed. Total demand for goods and services continued to be stimulated by Government expenditures relative to the tax rate structure and by monetary expansion. Prices Most price movements have been upward in recent months. From M arch to April the consumer price index rose at a 5.5 per cent annual rate, the same as for the past three months. This index rose at a 3.8 per cent rate from O ctober to April, after rising at a 1.7 per cent rate from m id-1964 to late 1965 and at a 1.2 per cent rate from 1958 to 1964. Th e wholesale industrial price index increased at a 3.5 per cent annual rate from M arch to April and has risen at a 2.9 per cent rate since last O ctober. This compares with a 1.4 per cent rate from June 1964 to O ctober 1965 and a 0.3 per cent rate for the period 1958-64. Volume 48 • Number 6 FEDERAL RESERVE BANK OF ST. LOUIS P.O.Box 442, St. Louis, Mo. 63166 The overall wholesale price index rose at a 4.7 per cent annual rate from O ctober to April and according to preliminary data remained high in May. This index increased at a 2.3 per cent rate from m id-1964 to O ctober 1965 and was virtually un changed from 1958 to 1964. Th e rate of increase in the overall index has slowed since February, as declines in prices of farm products and processed foods have partially offset rising indus trial prices. 19 57 -5 9=1 00 Prices 195 7-5 9=1 00 growing less rapidly despite an acceleration in the demand for goods and services. Real product in creased at a 6.0 per cent rate from the fourth to the first quarter compared with 6.8 per cent in the four preceding quarters. Sp e nd in g and Production Billions of Doll ars 800 Quarterly Totals at Annual Rates Billions of Dollars 800 7 50 7 00 650 6 00 Latest data plotted: April preliminary Source: U.S. Department of Labor The gross national product deflator, the broadest of the price indexes, rose at a 3.6 per cent rate from the fourth quarter of 1965 to the first quarter of this year. This price measure rose 1.9 per cent during 1965 and at a 1.4 per cent rate from 1958 to 1964. The average price of farm land in the United States rose 8 per cent from March 1965 to March 1966, ac cording to the Department of Agriculture. In com parison, farm land prices increased at an average an nual rate of 5.6 per cent during the past decade. Real Product Output of goods and services has been rising rapidly, but recent data indicate that the pace of the rise may be slowing, perhaps in response to capacity limitations. Industrial production rose at a 3 per cent annual rate from March to April and, according to initial reports, changed little from April to May. This moderate growth compares with an extremely rapid 14 per cent rate from last September to March and 8.9 per cent over the past year. Payroll employment has risen only moderately since March, after rising rapidly earlier this year. Estimates of total civilian employment indicate a decline during the January May period. These figures may give some evidence of a lack of employable manpower. These recent data, indicating reduced rates of in creases in real product and employment, cover a very short period and are highly tentative. Current data are frequently revised, but even in final form most economic time series are very irregular over a short time span. Also, various sectors of the economy may be expected to perform differently in any short period of strong demand. Nevertheless, the recent data may indicate that use of productive resources is becom ing so complete that the rapid expansion of total de mand is resulting less in increases in real product and more in price rises. Gross national product estimates for the first quar ter of 1966 also provide evidence of real product Page 2 550 500 45 0 1959 1960 1961 1962 1963 1964 1965 1966 Source: U.S. Department of Commerce Latest data plotted: 1st quarter 1966 LI G N P in current dollars. [2 G N P in 1958 dollars. Total Demand The rise in prices and some continued expansion of real product have occurred in response to strong de mands for goods and services. Although the latest figures indicate a decline in spending, the trend has been strongly upward. Retail sales, according to pre liminary figures, totaled $25.2 billion in April, down from $25.6 billion in March. Retail sales figures are subject to large revisions. For example, the January re tail sales figure, originally reported at $24.8 billion, was later revised to $25.0 billion. A larger revision was made for February when the original $24.6 billion estimate was revised to $25.3 billion. In the first quarter of the year retail sales were up at a 10 per cent annual rate from the third quarter of last year. Taking a broader view of the economy, the strengthening of demand has been quite clear. Total spending for goods and services rose at a 9.9 per cent annual rate from the fourth quarter of last year to the first quarter of this year. In the preceding year these outlays increased at an 8.8 per cent rate. From 1960 to 1964 the average growth in aggregate de mand was at a 5.7 per cent rate. Consumer purchasing power has been growing at a rapid rate in recent months. Personal income has risen at an 8.9 per cent annual rate since late last summer compared with a 6.5 per cent gain in the previous 12 months and a 5.4 per cent average rate of increase from 1960 to 1964. Fiscal Actions Total demand has continued to be stimulated by Government actions. The economic impact of the Federal Government’s taxing and spending actions, as indicated by the high-employment budget, are currently the most expansionary in many years. The level of this budget declined from a $7.2 billion sur plus at an annual rate in the first half of 1965 to a $0.3 billion surplus in the second half of 1965 and is estimated to be at about the same level in the first half of 1966. Barring unanticipated departures from the January budget plan for expenditures and taxes, this budget is expected to remain at about the first-half level in the last half of this year. However, there seems to be considerable likelihood that defense spending in the second half will exceed the forecasts in the January budget plan. H ig h -E m p lo y m e n t B u d g e t So urces: C o u n c il o f Econom ic Advise rs, B o ard of G o v e rn o r s of the F e d e ra l Reserve The above discussion assumes a neutral or un changing monetary policy. When monetary policy is considered flexible, there is accordingly a range of appropriate fiscal actions. It then becomes possible for the high-employment surplus to be at a low level during a period of excessive demand, provided the fiscal stimulus is accompanied by sufficient mone tary restraint. Such a policy mix results in higher interest rates than would a mix of policies including greater fiscal restraint. Monetary Developments The money supply, seasonally adjusted, declined from April to May. It has declined or increased relatively little in the middle month of each quarter for the past two years. This situation should be con sidered when evaluating data regarding money supply over a period of less than three months. In view of this problem the money supply should probably not be considered to have increased so rapidly as the in dicated 14 per cent annual rate from March to April nor to have declined as indicated in May. The money stock has increased about 6 per cent in the past year. The general upward trend of money seems to be continuing when full account is taken of seasonal adjustment difficulties. Growth has not been so rapid for any other 12-month period since World War II. The next highest rate was 5.6 per cent during the Korean War. The money supply increased at a 2.6 per cent rate from 1960 to 1964 and at a 1.4 per cent rate from 1953 to 1960. System , a n d F ede ral Reserve B a n k of St. Louis L atest d a t a plotted: 1st quarter 1966 preliminary. 2nd quarter and last half 1966 estimated by Federal Reserve Bank of St. Louis. The smaller the surplus (or larger the deficit) in the high-employment budget, the less is the amount that the Government withdraws from the income stream at high employment relative to what it spends and the greater is the stimulus of fiscal actions. A common opinion holds that the level of the high-em ployment surplus should be low when aggregate de mand is inadequate to maintain high employment. A shift from surplus to deficit in this budget is ap propriate if planned private saving tends to ex ceed planned investment. A deficit in the high-em ployment budget stimulates total demand and thus propels the economy toward greater production as long as there are unused resources. If private demand gains sufficient momentum, the high-employment bud get should assume a less stimulative position by means of a reduction of government expenditures or an increase of tax rates. If demand becomes ex cessive, the high-employment budget should run whatever surplus is necessary to hold total demand within appropriate limits. Rapid increase in the money supply might be justi fied if the velocity of money were declining, that is, if spending were declining and the demand for money to hold, increasing. However, the increase in money has been accompanied by a continuing rise in the turnover of money. Income velocity of money, which is the ratio of gross national product to the money supply, rose to 4.24 in the first quarter of 1966 from 4.18 in the third quarter of 1965 or at about a 3 per cent annual rate. Velocity has risen at a 3 per cent average rate since the last peak in business activity in the spring of 1960. The ratio of GNP to the money supply plus bank time deposits was 2.25 in the first quarter of 1966, the same as in the third quarter of 1965. Time Deposits Time and savings deposits at commercial banks in creased at about a 14 per cent annual rate from March to May. However, since November the growth of these funds at commercial banks has generally been more moderate than previously. During the past six Page 3 months these deposits have grown at about a 10 per cent annual rate compared with 16 per cent in the previous year. Time deposits rose at a 15 per cent rate from 1960 to 1964 and at a 7 per cent rate from 1953 to 1960. The decline in the rate of growth of time deposits at commercial banks has been one aspect of a gener al decline of the rate of net flow of funds into and through almost all financial intermediaries. The decline of the role of financial intermediaries has been accompanied by more direct investment in the capital and money markets and by a greater use by corpora tions of their own liquid funds. Time deposits at the weekly reporting banks have risen at about a 13 per cent rate since November compared with the 10 per cent rate at all commer cial banks. Weekly reporting banks, which are pri marily large banks, provide condition statements more frequently and in greater detail than other banks. They hold about 55 per cent of total commercial bank time and savings deposits. Large negotiable and smaller certificates of de posit have both risen rapidly at these banks, while saving deposits have declined. Large negotiable cer tificates of deposits have increased at a 15 per cent annual rate since November compared with a 30 per cent jump in the year ended in November. Savings deposits have declined at a 7.6 per cent rate since November, with the drop particularly sharp since Feb ruary. These deposits grew 12 per cent in the year ending in November. Other time deposits have risen at a 67 per cent rate since November compared with 27 per cent in the previous year. This category in cludes small denomination certificates of deposit. Growth in Time Deposits A n n u a l Rates o f C ha n g e W e e k ly R e p o rtin g Bank s Time Deposits Ra t, .i o c I S c a le M illio n s W e e k ly R e p o r tin g M e m b e r B a n k s 7 o f D o lla r s K a M illio n s n .. R a t io c I S c a le o f D o lla r s A ll C om m e rcial Banks Feb. N ov. N ov. N ov. 1 9 6 6 -M a y 1 96 5 -M a y 196 4 -N ov. 1961 -N o v . 1966 1966 1965 1964 Large CD's S avings O th e r Tim e Total Total 30.1 15.1 29.5 N .A . — 16.2 — 7.6 11.8 11.7 85.0 6 6.7 2 7.0 4 0 .5 1 16.0 12.6 18.1 19.7 11.5 10.4 16.3 17.4 1 Includes some large C D ’s. N .A .— N ot available. While the growth of total time and savings deposits at commercial banks in the past six months has been at a slower rate than in the preceding five years, it has nonetheless remained rapid. The rise of time de posits over the past several years has resulted in large part from aggressive bidding for funds by banks as demands for bank credit have risen. The higher in terest rates which banks have paid have enabled them to compete effectively for funds which have in turn been channeled primarily into bank loans. Because of the higher rate of return on capital investment and great competition for lendable funds, savers are receiving higher interest rates. This en couragement to savers is highly desirable at a time when total demands for goods and services are tend ing to exceed our capacity to produce and demands for investment funds are exceeding saving. Despite the keen competition for funds, other financial insti tutions also have continued to grow. Preliminary data show that in the first four months of this year shares in savings and loan associations rose at a 4 per cent annual rate and deposits in mutual savings banks increased at a 3.5 per cent rate. Bank Credit L a te s t d a ta p lo tte d : Page 4 M ay The total of bank loans and investments grew from January to May at an 8.1 per cent rate, slightly less than the 10 per cent rate of the previous 12 months. Total bank credit expanded at an 8.0 per cent rate from 1960 to 1964 and at a 4.3 per cent rate from 1953 to 1960. Total bank credit has risen in response to huge credit demands, rapid growth in the reserve base, and bank acquisition of funds in competition with other financial intermediaries and other money market participants. Bank loans have risen even faster than total bank credit. Individual banks have accommo dated strong loan demands by attracting funds, by reducing their holdings of Federal securities, and by adding to their holdings of municipal securities at a lesser rate. Total loans at commercial banks have increased at a 14 per cent annual rate since last fall, about the same rate as in the preceding 12 months, while total investments have risen slightly since fall. Bank holdings of Government securities have declined at a 9.7 per cent rate since December, while holdings of municipal securities have increased at about an 11 per cent rate, after rising 15 per cent in the previous 12 months. In May U. S. Government security hold ings amounted to only 18.2 per cent of total credit at all commercial banks. Since Government securities are used as collateral for certain deposits, sale of these securities as a source of loan funds is limited. Business loans at all commercial banks increased in the four months ending with May at an 18 per cent annual rate, about the same rate as during the past year. These rates of increase of commercial bank business loans compare with about a 6 per cent rate of increase of real product in the nation since early 1965 and an 8.4 per cent average rate of increase in business loans from 1953 to 1965. Interest Rates Despite the rapid monetary expansion over the past year, strong demand for loan funds pushed interest rates up. Key rates rose substantially after last July. The increase was especially rapid in December in spite of exceptionally rapid increases of total bank credit and the money supply. Some interest rates have hov ered at or slightly below their peaks in recent months, while others have continued to rise. In May and early June many interest rates were rising. Reflecting a recent decline in stock prices, yields on common stocks were higher in May than in Feb ruary. Higher long-term interest rates used in cap italizing expected corporate earnings may have been a factor in the lower stock prices. From a longer view, yields on stocks have fluctuated in a relatively narrow range since 1958. Even though they have risen substantially over the past year, interest rates in the United States on both short- and long-term securities are still below those in most other industrialized countries. For example, yields on U.S. Treasury bills increased from 3.89 per cent last May to 4.63 per cent this May, while yields on three-month Euro-dollar deposits in London rose from 4.99 per cent to 5.75 per cent. Bank borrowing from the Federal Reserve has in creased since February as money market interest rates have been high relative to the discount rate. At times in recent weeks, the interest rate on Federal funds, which are, in effect, overnight loans from one com mercial bank to another, touched 5V4 per cent or three-quarters of a percentage point more than the basic Federal Reserve rate. Conclusion Prices continue to rise rapidly in response to a high and increasing total demand for goods and ser vices. At the same time there are some indications that increasing employment of previously unused re sources is resulting in a reduction of the rate of in crease of real product. Government fiscal actions and monetary expansion continue to facilitate rapid ex pansion of total demand and have stimulated large credit demands. These credit demands have been so vigorous that relatively high interest rates have devel oped despite the record monetary expansion. If the present level of total demand is too high, several alternatives are available for dampening it. The Government might reduce its expenditures or increase its taxes. These actions would reduce the demand for goods and services directly and take some of the pressure off credit markets, making control of monetary growth less difficult and limiting interest rate increases. Decisions on Government expenditures and tax rates, however, take into consideration factors other than economic stabilization. Total demand might also be restrained by reduction of the rate of expansion of bank reserves, bank credit, and the money supply. Such restraint might initially cause a further rise in interest rates. However, after a period, lower rather than higher rates might result from less rapid monetary expansion. The rise in inter est rates in the past year has resulted from increases in credit demands flowing from greater spending, optimistic expectations, and inflation fears. If total demand for goods and services were to be moderated by monetary restraint or other means, demand for credit might recede, causing lower interest rates des pite more moderate growth in bank credit and money.1 1F o r f u r t h e r d i s c u s s i o n b e a r i n g o n t h i s p o in t , s e e “ I n t e r e s t R a te s , 1 9 1 4 -1 9 6 5 ,” b y N o r m a n N . B o w s h e r in th e O c t o b e r 1 9 6 5 i s s u e o f t h is Review. Page 5 F ed eral R eserv e O p en M arket O perations in 1965: , , Objectives Actions and Accomplishments T h e FED ER A L RESERV E SYSTEM buys and sells U. S. Government securities as its major tool of monetary management. These actions, commonly re ferred to as open market operations, are conducted with a view to changing member banks reserves so as to alter the rates of expansion of bank deposits, bank credit, and the money stock. The ultimate goals of Federal Reserve monetary management are high employment, relatively stable prices, and a viable in ternational balance of payments. This article reviews Federal Reserve System open market transactions in 1965 within the framework of the Federal Open Market Committee’s stated goals. These goals are expressed in the Committee’s eco nomic policy directives issued in 1965 which appear in the recently released Fifty-Second Annual R eport o f the B oard o f Governors o f the F ed eral R eserve System, C overing O perations for the Year 1965. Threat of inflation and a continuing balance-of-pay ments deficit were problems continually challenging monetary authorities in 1965, the fifth consecutive year of the current economic expansion. In response to these problems, the Federal Open Market Com mittee (FOMC) resolved upon mildly restrictive policy during the year. A change in policy was first reflected in the February 1965 economic policy directive call ing for slightly firmer money market conditions with a view to accommodating more moderate rates of ex pansion of member bank reserves, bank credit, and the money supply. The final policy steps of the year were early December increases in the discount rate and in the maximum interest rates payable by member banks on time deposits other than savings deposits (Regulation Q). Economists discuss stabilization policy in terms of an optimum mix of fiscal, debt management, and monetary actions.1 Present institutional arrangements, however, provide for the separate formulation of 1 F is c a l a c t io n s in v o lv e th e p la n n e d r e la t io n s h ip b e t w e e n G o v e r n m e n t e x p e n d itu r e s a n d ta x s tru c tu re s. D e b t m a n a g e m e n t a c tio n s in v o lv e th e te r m a n d m a t u r it y s tr u c t u r e o f th e p u b lic d e b t. M o n e t a r y a c t io n s in v o lv e th e ra te s o f e x p a n s io n o f to t a l re se rv e s, b a n k c re d it, a n d th e m o n e y s u p p ly a n d m o v e m e n t s in in te r e s t ra te s. Page 6 these policies, and different time horizons are in volved. Fiscal policy is embodied in the President’s budget message presented in January and subsequent ly amended by Congress. Fiscal actions relate to a one-year period (July to June) which, at the time of the President’s message, is not to begin until six months in the future. Budgets are usually not sub ject to major revisions within the budget period, and when such revisions do occur, they generally require considerable time to become effective. Treasury debt management policy, involving the maturity schedule of the national debt, is not readily adaptable to shortrun changes. Monetary policy, on the other hand, has considerable flexibility in the short run. Policy for mulation during 1965 worked within the context of a fiscal policy moving toward a more stimulative stance and a relatively fixed maturity schedule of the Fed eral debt.2 Tools of monetary policy are reserve requirements of member banks, the discount rate, and open market transactions. These factors determine the cost and volume of reserves available to member banks. Re serve requirements on demand deposits have remain ed unchanged since 1960; requirements on time de posits have been unchanged since 1962. The dis count rate was raised to 4 per cent in November 1964 and to 4Y2 per cent in. December 1965, the highest level since 1930. Open market operations, which are the chief means of providing monetary policy with a high degree of short-run flexibility, were carried out almost daily during the year. Directives for Open Market Operations in 1965 At each of its 16 regular meetings in 1965 the FOMC issued a current economic policy directive to the New York Federal Reserve Bank, whose staff carries out open market transactions for the System. The direc tives generally cited the major economic conditions the Committee considered important for policy and 2 “ B u d g e t P o l i c y in a H i g h - E m p l o y m e n t E c o n o m y , ” i n t h e A p r i l 1 9 6 6 i s s u e o f t h is Review, p r e s e n t s a c o m p r e h e n s i v e d i s c u s s i o n o f r e c e n t f is c a l p o l i c y . stated the System’s ultimate goals regarding output, prices, and the balance of payments. Goals for inter mediate objectives, such as the rates of growth of bank reserves, bank credit, and money were indi cated; these goals were specified in qualitative terms, such as “more moderate.” As a means of achieving both sets of goals, operating instructions, in terms of a set of money market conditions, were given to the New York Federal Reserve Bank.3 Specified money market conditions, noted by such qualitative state ments as “slightly firmer” or “about the same,” were intended to be consistent with or contribute to at tainment of the FOM C’s intermediate and ultimate objectives. The following directive, issued on December 15, 1964, was in force at the beginning of 1965 (brackets and numbers have been inserted by the authors). Ex cerpts from this directive and the sixteen directives issued in 1965 are recorded in Exhibit I. The brac keted phrases in the following directive are numbered to correspond to the columns in Exhibit I. [1 . I n th e lig h t o f th e e c o n o m ic a n d f in a n c ia l d e v e lo p m e n t s r e v ie w e d a t t h is m e e t in g ,] it r e m a in s th e F e d e r a l O p e n M a r k e t C o m m i t t e e ’s c u r r e n t p o l i c y [ 2 . t o fa c ilit a t e c o n t in u e d e x p a n s io n o f th e e c o n o m y ] [3 . b y a c c o m m o d a t in g m o d e r a te g r o w t h in th e re se rv e b a se , b a n k c re d it, a n d th e m o n e y s u p p ly , ] w h ile s e e k in g [2 . to a v o id th e e m e r g e n c e o f in fla t io n a r y p r e ss u r e s a n d to s t r e n g t h e n th e in t e r n a t io n a l p o s it io n o f th e d o lla r .] T o im p le m e n t t h is p o lic y , a n d r e c o g n iz in g t h a t [5 . in t e r n a t io n a l u n c e r t a in t ie s a n d y e a r - e n d s e a s o n a l p r e s s u r e s c o n t in u e to r e q u ir e a la r g e r t h a n u s u a l d e g r e e o f f l e x i b i l i t y i n o p e r a t io n s , ] S y s t e m o p e n m a r k e t o p e r a tio n s s h a ll b e c o n d u c t e d w it h a v ie w to [4 . m a in t a in i n g a b o u t th e s a m e c o n d it io n s in th e m o n e y m a r k e t a s c u r r e n t ly p r e v a il.] E c o n o m ic C o n s id e ra tio n s a n d U lt im a t e O b je c tiv e s The FOM C’s general view of changes in the pace of domestic expansion and movements in the balance of payments as observed at the time of each meeting during 1965 are presented in Exhibit I, Column 1. From January to early May note was given to a gen erally strong further expansion of the domestic econ omy and a continuing adverse balance of payments. From early May to the end of August recognition was made of a slower pace of domestic expansion and some improvement in the balance of payments. During the last four months of the year the Com mittee cited a pickup in economic activity, a rise in prices, and a deficit in the balance of payments. 3 I n so m e o th e r re c e n t y e a rs su c h in d iv id u a l m e a su re s o f m o n e y m a r k e t c o n d it io n s a s n e t b o r r o w e d re s e rv e s w e r e s t ip u la t e d a s g u id e s f o r o p e n m a r k e t o p e r a t io n s r a t h e r t h a n g e n e r a l m o n e y m a r k e t c o n d it io n s . For purposes of further analysis, the three periods of economic expansion during 1965 noted in the di rectives correspond approximately to the first quarter of the year, the second and third quarters, and the fourth quarter. Total demand (GNP in current dollars) rose at an 11 per cent annual rate during the first quarter compared with a 4 per cent rate of growth in the last quarter of 1964, when there were major work stoppages. During the second and third quar ters of 1965, the rate of growth in total demand moderated to 7 per cent; then the rate accelerated to 10 per cent in the last quarter. In response to changes in economic developments there were changes in the FOM C’s ultimate objec tives regarding the domestic economy (Exhibit I, Column 2). Whereas in late 1964 there was emphasis both on facilitating continued expansion in the econ omy and on avoiding the emergence of inflationary pressures, in early 1965 major emphasis shifted to the latter objective and continued unchanged throughout the year. Strengthening the international position of the dollar remained an ultimate objective throughout the year. In t e r m e d ia te O b je c tiv e s a n d O p e ra tin g In s tru c tio n s The FOM C’s strategy for achieving its ultimate goals shifted during 1965 as the goals changed. Its strategy involved changing money market conditions and altering rates of change in the reserve base, bank credit, and the money supply. At the beginning of the year the goal, “. . . to facil itate continued expansion of the economy,” was car ried over from late 1964. This goal was to be achieved .. by accommodating moderate growth in the re serve base, bank credit, and the money supply” (Ex hibit I, Column 3). In February and March, when greater emphasis was placed on the domestic goal of avoiding the emergence of inflation, the strategy with regard to the intermediate objectives was changed to “. . . accommodate growth . . . but at a more moderate pace than in recent months.” Then in late March the ultimate goals were to be achieved, “. . . while accommodating moderate growth in the reserve base, bank credit, and the money supply.” This instruction with respect to intermediate objec tives remained unchanged through the rest of the year. As a part of the strategy for achieving the Com mittee’s ultimate and intermediate objectives, ap propriate operating instructions in terms of money market conditions were given to the New York Federal Page 7 Exl EXCERPTS FRO M FEDERAL O PEN M ARKET CO M Date o f FOMC M e e tin g (1) (2) Econom ic C o n sid e ra tio n s U ltim a te O b je c tiv e s 1964 in lig h t o f the econ o m ic a nd fin a n c ia l d e v e lo p m e n ts re v ie w e d a t th is m e e tin g to fa c ilita te c o n tin u e d e x p a n s io n o f the e con o m y . . . to a v o id the e m erg e n ce o f in fla tio n a ry pressures a nd to s tre n g th e n the in te rn a tio n a l p o s itio n o f the d o lla r Jan. 12 same as a b o ve to fa c ilita te co n tin u e d e xp a n s io n o f the e con o m y . . . to a v o id the e m erg e n ce o f in fla tio n a ry pressures a nd to s tre n g th e n the in te rn a tio n a l p o s itio n o f the d o lla r, p a rtic u la rly in v ie w o f th e c u rre n t u n s e ttle m e n t in fin a n c ia l m arkets a b ro a d Feb. 2 the g e n e ra lly strong a nd c o n tin u in g e x p a n s io n o f the d om e stic e conom y a n d c o n tin u in g adverse p o s itio n o f o u r in te rn a tio n a l b ala n ce o f p aym ents M a r. 2 same as a b o ve to s u p p o rt fu lly the n a tio n a l p ro g ra m to stre n g th en the in te rn a tio n a l p o s itio n o f the d o lla r, a n d to a v o id the em erg e n ce o f in fla tio n a ry pressures M a r. 23 a g e n e ra lly strong fu rth e r e x p a n s io n o f the d om e stic econ o m y a n d the c o n tin u in g need to im p ro v e o u r in te rn a tio n a l b a la n ce o f p a ym e n ts, as h ig h lig h te d by h e a v y g o ld o u tflo w s in re cen t m onths to re in fo rc e the v o lu n ta ry re s tra in t p ro g ra m to s tre n g th e n the in te rn a tio n a l p o s itio n o f the d o lla r, and to a v o id the e m erg e n ce o f in fla tio n a ry pressures A p r. 13 same as a b o ve same as abo ve M a y 11 a g e n e ra lly stro n g fu rth e r e xp a n sio n o f the dom e stic e con o m y a n d some im p ro v e m ent in o ur in te rn a tio n a l b ala n ce o f p a ym e n ts, b u t w ith g o ld o u tflo w s c o n tin u in g same as abo ve M a y 25 a g e n e ra lly stro n g fu rth e r e x p a n s io n o f the dom e stic e conom y, a lth o u g h a t a som e w h a t slo w e r pace, a n d some im p ro v e m e n t in o u r in te rn a tio n a l b ala n ce o f p a ym e n ts, but w ith g o ld o u tflo w s c o n tin u in g same as abo ve June 15 c o n tin u in g e xp a n sio n o f th e d om e stic econ o m y, a lth o u g h a t a so m ew h a t slow er pace th a n in the firs t q u a rte r, a n d m a in te n a nce o f e a r lie r im p ro v e m e n t in o u r in te rn a tio n a l b ala n ce o f p a ym e n ts, b u t w ith g o ld o u tflo w s c o n tin u in g same as a b o ve J u ly 13 c o n tin u in g e x p a n s io n o f the d o m e stic e conom y, a lth o u g h a t a s low e r pace th a n in the firs t q u a rte r. R eflecting the la rg e in itia l im p a c t o f the a d m in is tra tio n ’s b a la n c e o f p aym ents p ro g ra m , th e re w as a surplus in o u r in te rn a tio n a l p a ym e n ts in the second q u a rte r . . . w ith g o ld o u tflo w s c o n tin u in g same as a b o v e A u g . 10 the d om e stic e con o m y has e x p a n d e d fu rth e r, b u t a t a s low e r pace th a n e a rly in the y e a r, a n d . . . the im p ro v e m e n t in o u r in te rn a tio n a l p a ym e n ts th a t occurre d in the second q u a rte r has been m a in ta in e d fo r the tim e b e in g , a lth o u g h g o ld o u tflo w s have co n tin u e d a n d in te rn a tio n a l d e ve lo p m e n ts a re cre a tin g u n c e rta in tie s in s e curitie s a nd fo re ig n e xch a n g e m arkets to s tre n g th e n the in te rn a tio n a l p o s itio n o f the d o lla r, a n d to a v o id the e m e rg e n ce o f in fla tio n a ry pressures A u g . 31 th e d om e stic econ o m y has e x p a n d e d fu rth e r, b u t w ith m arkets c h a ra c te riz e d b y u n c e rta in tie s as to p ossib le d e v e lo p m e n ts in steel, s te rlin g , a n d V ie t N am . O u r in te r n a tio n a l paym e n ts have re v e rte d to d e fic it in A u g u s t, a nd g o ld o u tflo w s have con tin u e d , a lth o u g h a t a m ore m o d e ra te ra te same as abo ve Sept. 28 the d o m e stic e con o m y has e x p a n d e d fu rth e r in a c lim a te o f o p tim is tic business se n ti m e nt a nd firm e r fin a n c ia l c o n d itio n s , a n d . . . o u r in te rn a tio n a l p a ym e n ts have been in d e fic it since m id y e a r. Some o f the u n c e rta in tie s p re v io u s ly a ffe c tin g fo re ig n e x ch ange m a rkets have d im in is h e d same as a b o v e O ct. 12 o v e r-a ll d om e stic e conom ic a c tiv ity has e x p a n d e d fu rth e r in a c o n tin u in g c lim a te o f o p tim is tic business se n tim e n t a n d firm e r fin a n c ia l c o n d itio n s , a n d . . . o u r in te r n a tio n a l p a ym e n ts have been in d e fic it on th e " r e g u la r tra n s a c tio n s ” basis since m id year same as a b o v e N ov. 2 o v e r-a ll d om e stic econ o m ic a c tiv ity has e x p a n d e d fu rth e r in a c o n tin u in g c lim a te o f o p tim is tic business se n tim e n t a n d firm e r fin a n c ia l c o n d itio n s , a n d . . . o u r in te rn a tio n a l p aym e n ts have re m a in e d in d e fic it same as a b o v e N o v . 23 o v e r-a ll d om e stic econ o m ic a c tiv ity is c o n tin u in g a ra te o f e x p a n s io n c o m p a ra b le to th a t o f the th ird q u a rte r d e s p ite th e c o n tra c tiv e e ffe c t o f a re d u c tio n in steel in v e n to rie s. Business se n tim e n t contin u e s o p tim is tic a nd fin a n c ia l c o n d itio n s a re firm e r. M e a n w h ile , o u r in te rn a tio n a l p aym e n ts have re m a in e d in d e fic it same as a b o v e Dec. 15 1965 the to a v o id the e m erg e n ce o f in fla tio n a ry pressures a nd to s u p p o rt o th e r m easures th a t m ay be ta ke n to s tre n g th e n the in te rn a tio n a l p o s itio n o f the d o lla r D e c e m b e r 6 ^ D i s c o u n t r a t e r a is e d f r o m Dec. 14 d om e stic econ o m ic e xp a n sio n is g a in in g in stre n g th in a c lim a te o f o p tim is tic b u s i ness se n tim e n t, w ith c o n tin u in g a ctive d em a n d s fo r c re d it a n d some fu rth e r u p w a rd cre e p in p rice s. A lth o u g h th e re a p p e a rs to have been some re cen t im p ro v e m e n t in o u r in te rn a tio n a l p a ym e n ts, the nee d fo r fu rth e r p rogress re m ain s. 4% to 4 V i% to c o m p le m e n t o th e r re cen t m easures ta k e n to resist the e m erg e n ce o f in fla tio n a r y pressures a nd to h e lp restore re a s o n a b le e q u ilib r iu m in the co u n try 's b a l ance o f paym e n ts Source: Fifty-Second A nn u a l R eport of the B oard of G overnors o f the F ed era l Reserve System , C overing O perations fo r the Y e a r 1 9 6 5 . a n d R e g u la t io n Q libit I IMITTEE CURRENT ECONOMIC POLICY DIRECTIVES Instructions fo the Federal Reserve Bank of New York (3) In te rm e d ia te O b je c tiv e s O p e ra tin g b y a c c o m m o d a tin g m o d e ra te g ro w th in the serve base, b a n k c re d it, a nd the m o ne y s u p p ly re (4) Instructions (5) S p e cia l C o n s id e ra tio n s the in te rn a tio n a l u n c e rta in tie s a nd y e a r-e n d seasonal pressures c o n tin u e to re q u ire a la rg e r than usual d e g re e o f fle x ib ility in o p e ra tio n s m a in ta in in g a b o u t the same c o n d itio n s in the m oney m a rk e t as have p re v a ile d in recent weeks ta k in g th e c u rre n t T re a sury r e fu n d in g in to account . . . in te rn a tio n a l u n c e rta in tie s a n d s h iftin g season al pressures re q u ire a la rg e r th a n usual d e g re e o f fle x ib ility in o p e ra tio n s m o vin g to w a rd s lig h tly firm e r co n d itio n s in the m oney m a rk e t than have p re v a ile d in recent w eeks ta k in g in to a ccou n t Treasury fin a n c in g same as a b o ve m a in ta in in g the s lig h tly firm e r c o n d itio n s in the m oney m a rk e t th a t have p re v a ile d in recent weeks none w h ile a cco m m o d a tin g m o d e ra te g ro w th in the re serve base, b a n k c re d it, a n d the m oney s u p p ly a tta in in g m a rket none same as a b o ve m a in ta in in g the firm e r co nd itio ns in m a rk e t th a t have re c e n tly p re v a ile d same as a b o ve m a in ta in in g a b o u t the same co n d itio n s in the m o ne y m a rk e t as have p re v a ile d in recent weeks ta k in g in to a ccou n t the c u rre n t Treasury fin a n c in g same as abo ve same as a bo ve none same as a b o ve same as a b o ve none same as abo ve same as a b o v e ta k in g in to account the fo rth c o m in g Treasury fin a n c in g same as a b o ve same as a b o ve ta k in g in to account the Treasury fin a n c in g a b o u t to be c o m p le te d a nd the u nse ttled c o n d itio n s in se curitie s a n d fo re ig n e xcha n g e m arkets sam e as abo ve same as a b o ve ta k in g in to a ccou n t u nse ttled c o n d itio n s cu ritie s a nd fo re ig n e xcha n g e m arkets same as abo ve m a in ta in in g a b o u t the m o ne y m a rk e t same as a b o ve j to accom m o d a te g ro w th in the reserve base, ban k c re d it, a n d the m oney s u p p ly b u t a t a m ore m o d e rate pace than in re cen t m onths ♦ same , sam e as a b o ve same as abo ve 4y2% same as abo ve to 5 y 2 % o n t im e in s lig h tly firm e r co n d itio n s in the m oney m a in ta in in g as a bo ve c o il i n g r a is e d f r o m m a in ta in in g a b o u t the same c o n d itio n s m oney m a rk e t as c u rre n tly p re v a il a firm the current co n d itio n s tone in the m oney m oney ta k in g in to account the fo rth c o m in g Treasury fin a ncin g se in the ta k in g in to accou n t the cu rren t Treasury fin a n c in g m arket ta k in g in to accou n t the Treasury fin a n c in g schedule m a in ta in in g a b o u t the same c o n d itio n s in the m o ne y m a rk e t th a t have p re v a ile d since the last m e e tin g o f the C om m ittee same as a b o v e sam e as a b o ve none ( o t h e r th a n s a v in g s ) in d e p o s its m o d e ra tin g a n y fu rth e r adjustm ents in m oney a nd c re d it m a rkets th a t m ay d e v e lo p ta k in g in fo a ccou n t the fo rth c o m in g T reasury fin a n c in g a c tiv ity a n d w id e ly flu c tu a tin g seasonal pressures a t th is tim e o f y e a r in a d d itio n to the re cen t increase in Reserve Bank d is c o u n t rates Reserve Bank (Exhibit I, Column 4). These instruc tions were specifically changed three times in 1965. In early February and late March instructions were given for moving toward or attaining slightly firmer money market conditions. Starting in April and con tinuing to November the maintenance of current mar ket conditions was generally called for. After the Federal Reserve discount rate and the Regulation Q ceiling on time deposits other than savings accounts were increased in early December, operating in structions were given for . . moderating any further adjustments in money and credit markets that may develop.” In summary, the FOM C’s policy during 1965 may be divided, on the basis of the content of the direc tives, into the following periods: December 1964 and January 1965—maintaining current market conditions while giving consideration to special market uncer tainties of late 1964; February and March—moving toward firmer money market conditions; April through November—maintaining the firmer market conditions; and December and January 1966—moderating the market’s adjustment to changes in the discount rate and Regulation Q.4 From time to time during 1965 considerations in addition to those already discussed appeared in the directives. For example, in more than one-half of the policy periods the FOMC directed that open market transactions should give explicit recognition to Trea sury financing activities (Exhibit I, Column 5). The Federal Reserve traditionally tries to maintain an “even keel” in the money market (prevent undue movements in interest rates and other market condi tions) when the Treasury is conducting a significant financing operation. Open Market Operations in 1 9 6 5 The preceding sections have briefly described the FOM C’s goals and strategy for 1965; the following sections examine actual open market operations, money market conditions, and the resulting rates of monetary expansion. Selected periods for analyzing 1965 are pre sented, means of measuring policy are discussed, and the course of these measurements during each of the selected periods of analysis is presented. 4 I t m ig h t b e a p p r o p r ia t e to d iv id e th e A p r il- N o v e m b e r p e r io d in t o t w o s u b p e r io d s , A p r il t h r o u g h A u g u s t a n d S e p t e m b e r t h r o u g h N o v e m b e r . T h e r e w a s a d is c u s s io n w it h in th e C o m m itte e a t th e S e p t e m b e r 2 8 m e e t in g o v e r th e q u e s t io n o f w h e t h e r in s t r u c t io n s c a llin g f o r “ m a in t a in in g a b o u t th e c u r r e n t c o n d it io n s in th e m o n e y m a r k e t ” a m o u n t e d to a n a c t u a l f ir m i n g i n p o l i c y , s in c e it a p p e a r e d t h a t a d d e d f ir m n e s s h a d d e v e lo p e d in th e m a r k e t d u r in g S e p te m b e r . S e e th e d is s e n t o f G o v e r n o r s M a is e l, M it c h e ll, a n d R o b e rtso n . Page 10 P e r i o d s o f A n a l y s is For purposes of analyzing open market operations in 1965, the four periods discussed previously were expanded to five by dividing the April through No vember period into two subperiods.5 Since System actions and changes in economic conditions both may affect money market conditions and changes in the intermediate guides, the periods were selected so as to give due consideration to each of these factors. December 1964 and January 1965. Directives called for facilitating money market adjustments to year-end uncertainties and accommodating moderate growth in reserves, bank credit, and money. Total demand, due primarily to work stoppages from major strikes, rose at a slower rate from the third to fourth quarters of 1964 than over the preceding quarter; but by the year’s end economic activity was rising rapidly. February 1965 and March 1965. Directives calling for slightly more restriction were adopted within the context of a marked increase in total demand for goods and services. April 1965 through August 1965. Directives called for maintenance of the more restrictive position achieved in the previous period. The rate of increase in total demand remained high but was slightly less rapid than in early 1965. September 1965 through November 1965. Directives called for maintaining the degree of restraint achieved in the previous period. The economic environment had changed as evidenced by an acceleration in the rate of expansion in total demand. December 1965 and January 1966. Policy called for moderating market adjustments to changes in the discount rate and in Regulation Q within the context of rapidly rising total demand. In addition to these five periods, two other periods are used for purposes of comparison. August 1964 through November 1964 was the FOMC policy period immediately prior to 1965; this period is used as a starting point for analyzing 1965. The period 1959 through 1964 is used for purposes of comparing devel opments in 1965 with a longer run trend. This period extends from the last full year of expansion in eco nomic activity (1959) before the most recent recession to the end of 1964, when the economy was again at a high level of resource utilization. Rates of growth over this period might approximate trends and pro vide a benchmark from which to judge movements 5 T h e p e r i o d s s e l e c t e d c o r r e s p o n d a p p r o x i m a t e l y t o t h o s e li s t e d b y t h e A c c o u n t M a n a g e r . Fifty-Second Annual Report of the Board of Governors of the Federal Reserve System, Covering Operations for the Year 1965, p p . 1 5 7 - 1 9 6 . during 1965, when the economy was moving yet closer to capacity output. E x h ib it II IN D ICATO RS OF M O N E Y M ARKET PRESSURE D ire c tio n o f C ha n g e M e a su re s o f O p e n M a rk e t O p e ra tio n s In arriving at directives in terms of money market conditions and in assessing such conditions, the FOMC and the Federal Reserve Bank of New York observe various money market quantities and interest rates. As is the case for any market-determined magnitude, ex post data reflect both supply and demand con siderations. Federal Reserve action, such as changing its holdings of Government securities, usually is con sidered to affect the supply of funds to the money market. The demand for funds is strongly influenced by the economic environment, particularly growth in economic activity and changes in expectations. In order to gauge the extent that movements in the ob served data reflect demand considerations as well as changes in overall market pressure, the System Ac count Manager at the New York Bank and his staff frequently interview various money market partici pants, such as Government security dealers.0 Federal Reserve open market purchases and sales of Government securities were the major methods em ployed in 1965 to effect changes in money market conditions, the rate of monetary expansion, and the rate of economic growth; the discount rate and ceil ing rates on certain time deposits were changed late in the year. These open market transactions are sum marized in this article by rates of change in the Fed eral Reserve’s holdings of Government securities (Table I). The quantities commonly observed during 1965 as indicators of money market conditions were mem ber bank borrowings from Reserve Banks, net reserve positions of all member banks (excess reserves less borrowed reserves), basic reserve positions of major money market banks (net reserve positions less pur chases of Federal funds), and the volume of Govern ment security dealer borrowings. Frequently observed interest rates were the Treasury bill rates, the Federal funds rate, the Federal Reserve discount rate, rates on negotiable certificates of deposit, and Government security dealer financing costs. The direction of change in each of these measures implying firmer market conditions is presented in Exhibit II.7 The 6 M a n y f in a n c ia l a n a ly s t s h a v e m is t a k e n ly in f e r r e d c h a n g e s in S y s t e m p o lic y f r o m e x p o s t c h a n g e s in n e t b o r r o w e d re s e rv e s a n d s h o r t -t e r m in te r e s t ra te s. F r e q u e n t ly c h a n g e s in th e d e m a n d f o r f u n d s , n o t S y s t e m a c t io n s , a c c o u n t f o r t h e o b s e r v e d m o v e m e n t s in th e se v a r ia b le s . 7 F o r a m o r e e x te n d e d d is c u s s io n o f th e p r o c e s s o f im p le m e n t in g o p e n m a r k e t p o lic y a n d th e u se o f m o n e y m a r k e t g u id e s , s e e L e o n a l l C . A n d e r s e n a n d J u le s M . L e v i n e , “ I m p l e m e n t a t i o n o f F e d e r a l R e s e r v e O p e n M a r k e t P o l i c y i n 1 9 6 4 , ” t h is Review, J u n e 1 9 6 5 . Im p ly in g In d ic a to r G re a te r Pressure M e m be r bank b o rro w in g s fro m h ig h e r Federal Reserve Banks N e t reserve p o s itio n lo w e r (or more n e g a tiv e ) Basic reserve p o s itio n low e r (or more n e g a tiv e ) D ealer b o rro w in g s h ig h e r Treasury b ill rales h ig h e r Federal fu n d s rate h ig h e r Federal Reserve d is c o u n t rate h ig h e r N e g o tia b le ce rtificate s o f d e p o s it rates h ig h e r G o ve rn m e n t security d e a le r fin a n c in g costs h ig h e r accompanying charts show movements in these money market measures during last year. Since levels of these variables are commonly used in analyzing money market conditions, average levels of these variables for each period are summarized in Table I. The intermediate guides to policy stipulated through out 1965 were the reserve base, bank credit, and the money stock. While long-term interest rates were not specifically cited as an intermediate guide, it may be assumed that they were included as a part of money market conditions. The rates of expansion in these intermediate variables were to be more moderate during 1965 than previously; rates of change in mem ber bank reserves, bank credit, and money for each of the selected periods of analysis are presented in the accompanying table. Long-term interest rates are also summarized in the table. Shorter run move ments in these intermediate guides are presented in charts. In interpreting movements in these intermediate guides, both money market conditions and the demand for credit must be considered. If a set of money market conditions is achieved by the System and if actions are taken to maintain these conditions within a certain range, then the demand for funds strongly affects movements in reserves, bank credit, and money. A u g u s t t h r o u g h N o v e m b e r 1964 This period serves as a helpful background for analyzing 1965. The directive at the beginning of the period called for slightly firmer money market condi tions and moderate expansion in the reserve base, bank credit, and money.8 3I b i d . f o r a d i s c u s s i o n o f m o n e t a r y d e v e l o p m e n t s d u r i n g t h e la s t f iv e m o n t h s o f 1 9 6 4 . Page 11 Table I M EASU RES OF FEDERAL RESERVE OPEN M ARKET A C T IO N S, INTERMEDIATE OBJECTIVES, A N D M O N EY M ARKET C O N D IT IO N S A p r il 1965 th ro u g h N o v e m b e r 1965 P o lic y in d ic a t e d P a c e o f e c o n o m ic a c t i v it y F e d e ra l m a rk e t R e s e rv e a c tio n s A u g u s t 1964 th ro u g h N o v e m b e r 1964 D ecem ber 1964 a nd J a n u a ry 1965 F e b rua ry 1965 an d M arch 1965 m o vin g to w a rd s lig h tly firm e r m o ne y m a rke t c o n d itio n s fa c ilita tin g m oney m a rket adju stm e n ts to ye a r-e n d u n ce rtain ties m o ving to w a rd s lig h tly m ore re s tric tio n slow e r g ro w th ra p id g ro w th at ye ar's end m arked increase in g ro w th open Federal Reserve h o ld in g s o f U.S. G o ve rn m e n t securities A p r il 1965 th ro u g h A u g u s t 1965 S e p te m b e r 1965 th ro u g h N o v e m b e r 1965 m a in ta in in g th e m ore re s tric tiv e p o s itio n a c h ie v e d in F e b ru a ry a nd M arch slow e r e xp a n s io n D ecem ber 1965 a nd J a n u a ry 1966 1959 to 1964 m o d e ra tin g m a r ke t adju stm e n ts to changes in th e d is c o u n t ra te a n d R eg u latio n Q n ot a p p lic a b le ra p id g ro w th h ig h -e m p lo y m e n t tre n d 8 .5 % 11.6% 5 .7 % ra p id g ro w th A n n u a l Rates o f C h a n g e , S e a son a lly A d ju s te d 1 10.8% In t e r m e d ia t e o b je c t iv e s Tota l reserves o f m em ber banks 16.8% 10.1% 1 4 .2 % 5.4 4.1 9.8 3.5 0.2 13.2 2.7 Bank c re d it, a ll co m m ercia l banks 9.6 12.2 12.7 9 .0 9.3 11.5 6.8 M o n e y s u p p ly 4 .9 3.4 1.1 3.6 7 .6 10.2 1.8 M o n e y s u p p ly plus tim e d ep o sits 9.2 10.1 7 .7 8.8 11.6 10.5 5.6 M o n th ly A ve rag e s o f D a ily Figures, N o t S e a son a lly A d ju s te d 1 3- to 5-Y ear U.S. G o v e rn m e n t s e cu rity y ie ld 4 .0 4 % Long-term U.S. G o v e rn m e n t s e cu rity y ie ld C o rp o ra te A a a b o n d y ie ld State a n d lo ca l A a a b o n d y ie ld 4 .0 6 % 4 .1 2 % 4 .1 9 % 4 .4 6 % 4 .8 9 % 4.12 4 .1 4 4 .1 5 4.19 4 .3 4 4.43 4 .43 4.43 4 .42 4.49 4 .6 0 4 .7 4 3.08 2.97 3 .09 3 .16 3 .34 3 .4 0 P eriod A verages o f D a ily Figures, N o t S e a son a lly A d ju s te d 3 M o n e y m a r k e t c o n d it io n s M e m b e r b a n k b o rro w in g s fro m Federal Reserve banks M illio n s o f D ollars $ 351 Basic reserve p o s itio n 8 N e w York C ity banks 38 O th e r banks D ea le r b o rro w in g s $ 271 $ 411 $ 518 $ 4 90 $ 428 61 137 — 20 — 155 — 124 — 23 — 2 80 — 462 — 4 65 — 501 — 585 — 295 — — 196 5 70 — — 232 848 — — 653 708 3,801 3,8 7 7 3,3 3 8 N e t reserve p o s itio n 2,882 3 ,9 1 9 2,992 Per C ent 3 -M o n th T reasury b ill ra te 3 .5 6 % 3 .8 3 % 3 .9 3 % 3 .8 6 % 4.01 % 4 .4 8 % Fe d e ra l fu n d s ra te 3.46 3.88 4.01 4 .09 4 .0 6 4 .3 7 Federal Reserve d is c o u n t ra te 4 3 .5 0 4 .0 0 4 .0 0 4 .0 0 4 .0 0 4 .5 0 ( 1 2 / 6 /6 5 ) S e co n d a ry m a rk e t ra te on n e g o tia b le c e rti ficates o f d e p o s it 3 .8 9 4 .1 4 4 .2 4 4 .3 0 4 .42 4 .8 7 G o v e rn m e n t se cu rity d e a le r fin a n c in g costs (in N e w Y ork) 3 .8 4 4.28 4 .4 5 4 .4 0 4 .42 4 .7 7 iC h an g e from end of preceding period to end of period considered. 2MonthIy averages of daily figures for last m onth in period, except state and lo cal A a a bond yields, w hich are m onthly averages of Thursday figures for last m onth in period. SExcept secondary m arket rates on negotiable certificates of deposit, which a re period averages of F rid ay closing rates. 4D ates of discount rate increases at the F ed eral R eserve Bank of New York are shown in parentheses. Page 12 Federal Reserve holdings of Government securities expanded at an 11 per cent annual rate, nearly double the average annual rate of expansion from 1959 to 1964 (Table I ).9 Total demand and output, as mea sured by the increase in GNP from the third to fourth quarter, grew slowly during this period, primarily as a result of a major work stoppage. As a result of open market operations and the economic environ ment, money market conditions firmed slightly (Table I). From August to November moderate rates of mone tary expansion were specified in the directives. How ever, the rates of expansion of reserves, bank credit, and money were greater from August to November than they were earlier in 1964 (Table I). These rates of increase were considerably greater than their average annual rates of growth from 1959 to 1964 (Table I). Rates of M o n e t a r y Expansion Annual Rates of Change T h re e -M o n th M o v in g A v e r a g e s D e c e m b e r 1964 a n d J a n u a r y 1965 In the course of facilitating money market adjust ments to increases in the discount rate and ceiling rates on time and savings deposits, the Federal Re serve’s holdings of Governments rose at a 17 per cent annual rate from November to January compared with the already high 11 per cent rate of increase in the previous policy period. Despite these develop ments, most measures of money market conditions indicated firming. It appears that huge demands for credit accompanying the post-strike spurt in business activity in late 1964-early 1965 more than offset the expansive open market transactions, resulting in some money market firming. Changes in the intermediate guides were in diverse directions, but all grew more rapidly than their 195964 trends. Bank credit and money plus time deposits expanded more rapidly during this period than from August to November, while bank reserves and money moved upward at slower rates. All of these inter mediate guides grew at about twice their rates of expansion from 1959 to 1964. Long-term interest rates were little changed. Interest Rates on Selected Intermediateand Long-Term Securities Per C ent Per C ent H o n e y Sup ply Plu s Time Deposits \ 5 .6 % ... : i. .................. i 1964 i i i i i i i i 1965 i i i i i 1966 [2 M o n t h ly a v e r a g e s o f T h u r s d a y fig u r e s. D a s h e d l in e s a r e a v e r a g e a n n u a l r a t e s o f c h a n g e c o m p u t e d fr o m a v e r a g e d a t o f o r 1 9 5 9 a n d 196 4 . 9 P a r t o f t h e 1 9 5 9 - 6 4 i n c r e a s e i n t h e S y s t e m ’s p u r p o s e s o f o ffs e t t in g a m a r k e d r e d u c t io n in s t o c k . A s a r e s u lt , i n p e r i o d s o f le s s r a p i d g o l d a c q u i s i t i o n s o f s e c u r i t ie s b y t h e S y s t e m m i g h t s lo w e r . Fe b ru a ry a n d M a rch p o r tfo lio w a s fo r t h e n a t i o n ’s g o l d lo s s e s t h e r a t e o f a p p r o p r ia t e ly b e In February and March the FOMC adopted di rectives calling for slightly firmer money market conditions and more moderate growth in the reserve base, bank credit, and money. The System’s holdings Page 13 B a s ic R e s e r v e P o s it io n a M o n e y M a rk e t Banks M illio n s and the rate of increase in money iiars plus time deposits was slightly high er. The question remains as to 0 whether the rates of increase in these variables could be considered 2oo moderate. They were all consider ably higher than their rates of ex400 pansion from 1959 to 1964. Long term interest rates rose somewhat -600 over this period. 800 S e p t e m ber th ro u g h Novem ber (Jirectives jn this period called for maintaining about the same moni 1. . . 1 NOV. DEC. JAN. FEB. MAR -'200 ey market conditions as m the pre 1966 ceding period and for m o d era te growth in the reserve base, bank credit, and money.10 The rate of expansion in the System’s portfolio de clined slightly from that of the April-August period. Money market guides moved in diverse directions. Changes in the basic reserve positions of money mar ket banks, the three-month Treasury bill rate, CD rates, and dealer borrowing costs indicate slightly firmer market conditions, while changes in member bank borrowings from Reserve banks, net reserve posi tions of member banks, the Federal funds rate, and dealer borrowings indicate slightly easier conditions. 1000 JULY AUG. SEPT. OCT. NOV. DEC. JAN. FEB. MAR. APR. MAY JUNE JULY AUG. SEPT. OCT. 1964 1965 LLBasic reserve position is the net reserve position minus net purchases of Federal funds. of Governments expanded at a 14 per cent rate com pared with a 17 per cent rate in the preceding period. This slightly slower pace of open market purchases, in conjunction with an expansion in the demand for loan funds stemming from a rapid rise in total de mand for goods and services, resulted in firmer mar ket conditions. Bank reserves grew rapidly and bank credit ex pansion showed a further acceleration. Money plus time deposits continued to expand at a rapid rate, but money expanded only slightly. Long-term in terest rates remained about unchanged. The intermediate guides also showed diverse move ments. The level of member bank reserves was little A p ril th ro u g h A u g u s t From April through August the FOMC directives called for unchanged money market conditions and moderate rates of increase in the in M i l l i o n s o f D o l l a r s termediate guides. The System in 6 0 0 creased its holdings of securities at a 10 per cent annual rate compared with a 14 per cent rate during the move to firmer market conditions. T h e in flu e n ce o f less exp an siv e open m a rk e t o p e ra tio n s and a more moderate rise in total demand resulted in diverse movements in measures of money market condi tions. Bank borrowing from Reserve Banks and the net reserve position in dicated some firming, while money market rates indicated little change. The rates of increase in bank re serves and bank credit were below those of the previous period, while money grew at a much faster rate Page 14 10S e e f o o t n o t e 4 f o r r e f e r e n c e t o a d i s c u s s i o n o f w h e t h e r o r n o t t h e s e d i r e c t i v e s a c t u a l l y c a l l e d f o r f ir m e r m o n e y m a r k e t c o n d i t io n s . R e s e r v e P o s i t i o n 11 A ll M e m b e r B a n k s **-n i r> n M illio n s or D o lla r s 600 JULY AUG SEPT. OCT. NOV. DEC JAN. FEB. MAR. APR. MAY JUNE JUIY AUG. SEPT OCT. NOV. DEC. JAN FEB M> 1964 1965 1966 LLThe net reserve position is excess reserves less borrowings from Reserve Banks. It is called free reserves when positive and net borrowed reserves when negative. changed; bank credit expanded at about the same rate as in the preceding period; and both money and money plus time deposits grew at accelerated rates. By comparison with 1959-64, money rose about four times as fast, money plus time deposits increased twice as rapidly, and bank credit grew at about half again as great a rate. On the other hand, long term interest rates increased significantly from August to November. U .S . G o v e r n m e n t S e c u r it y D e a l e r F i n a n c in g D e c e m b e r 1965 a n d J a n u a r y 1966 In early December the Federal Re serve discount rate was increased from 4 per cent to 4Vz per cent. The ceiling rate on time deposits other than savings was lifted from 4x/2 per cent to 5 V2 per cent. Operating instructions were given for . . mod erating any further adjustments in money and credit markets that may develop.” Accommodating moderate growth in the intermediate guides was still called for. Despite a marked increase in the System’s holdings of Government securities, rapidly rising credit de mands produced firmer money market conditions. This is particularly apparent judged by market interest rates as indicators of firmness. K e y M o n e y M a rk e t R a te s 1964 |_1 Closing rates on Fridays. (2 Weekly averages of doily figures. 1965 Although money market conditions appeared firmer, growth in bank reserves, bank credit, and money accelerated from the high rates of expansion prevail ing during the September-November period. How ever, long-term interest rates continued to rise. Summary and Conclusions In order to resist domestic inflation and to strength en the dollar internationally, the FOMC adopted pol icy directives during; 1965 calling for Per C e n t J , ,, 5.5 some restraint. Over the year the Com mittee’s stated intermediate objectives called for accommodating m o d e ra te growth of reserves, bank credit, and the money supply, presumably at a more moderate rate than in 1964. To achieve these objectives, the Committee instruct ed the New York Federal Reserve Bank early in the year to achieve firmer money market conditions. Subsequently, instructions were issued to conduct open market operations in such a manner as to maintain these market conditions. These instructions were in force up to 3.0 early December, when the discount rate and certain Regulation Q ceiling rates were raised. 1966 A review of monetary developments during the year indicates that money 0 market conditions did become somewhat firmer. Despite this firming, the rate of monetary expansion was rapid during 1965. During the year as a whole, rePage 15 serves, bank credit, and money rose at rates con siderably in excess of their longer run average rates. After the fact, it appears that the demand for loan funds was so strong that money market conditions tightened by virtue of the large demand for funds, but did not become tight enough to be an effective restraint on the volume of borrowing. bank credit and for substantial growth in the money supply.. . .”u “Under the pressures of the demands for credit and with the shift in the composition of bank deposits that occurred, this increase in the re serve base [$1 billion] supported a record expansion of bank credit and deposits.”12 By permitting only a slight firming in money mar ket conditions, the System accommodated a sizable portion of this strong loan demand by “. . . providing the reserve base for rapid expansion in commercial 11 Annual Report, p . 1 5 5 . 12Annual Report, p . 1 5 7 . 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