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FEDERAL RESERVE BANK
OF ST. LOUIS
MARCH 1979
* -
The FOMC in 1978:
Clarifying the Role of the Aggregates
RICHARD W. LANG
I N its policy deliberations in 1978, the Federal Open
Market Committee (F O M C ) clarified the roles that
the monetary aggregates play in p olicy considerations
in tw o respects. The interpretation and emphasis to
b e placed on the F O M C ’s two-month growth ranges
o f the monetary aggregates were clarified b y changes
in the w ording o f the dom estic policy directive. The
Committee also clarified the role o f the growth ranges
o f the narrowly-defined m oney stock ( M l ) , relative
to the growth ranges o f the more broadly-defined
monetary aggregates during the transition to the new
automatic transfer service (A T S ) between checking
and savings accounts.
This article discusses these clarifications, and re
views the decisions o f the F O M C in 1978. Table I
summarizes the F O M C ’s dom estic p olicy directives
in 1978. A Supplement at the end o f the article pre
sents excerpts from the monthly “ R ecord o f Policy
Actions o f the F O M C ” that provide a more detailed
m eeting-by-meeting summary o f F O M C discussions.
FOMC OPERATING OBJECTIVES
IN 1978
The Federal Reserve Reform Act of 1977 required
the Board o f Governors o f the Federal Reserve System
to consult with committees o f the Congress on a quar
terly basis in 1978 about the System’s objectives and
plans for the ranges o f growth o f monetary and
Note: Unless specified otherwise, citations throughout this ar
ticle are from either the “ Record of Policy Actions of the
Federal Open Market Committee” or “ Statements to Con
gress,” Federal Reserve Bulletin (February 1978 through Feb
ruary 1979).
Page 2
credit aggregates over the next twelve months. Such
consultations began in 1975 at the request o f C on
gress as expressed in H ouse Concurrent Resolution
133.
Chairman G. W illiam Miller met with Congressional
committees on M arch 9, April 25, July 28, and N o
vem ber 16, 1978 to present the one-year growth
ranges of the monetary aggregates ( M l , M2, and
M 3 ) adopted at the previous F O M C meeting. These
annual ranges are based on the quarterly average for
the most recent quarter to the quarterly average one
year later (see Charts I and II, and Table I ) . The
F O M C has emphasized repeatedly that these one-year
ranges are “ subject to reconsideration at any time as
conditions warrant”1 and that “short-run factors might
cause growth rates from month to month to fall out
side the ranges contem plated for the year ahead.”2
An allowance for “short-run factors” that might af
fect M l and M 2 is reflected in the shorter-run growth
ranges set b y the F O M C each month. T h e two-m onth
ranges for both M l and M 2 were, with one exception,
consistently w ider than the longer-run ranges in 1978.
These short-run ranges are believed to be consistent
with the longer-run growth ranges, and are specified
over m oving two-m onth periods. For example, the
F O M C at its January meeting specified short-run
ranges for M l and M 2 over the January-February
period.3 At the February m eeting the F O M C set new
1“ Record” (April 1978), p. 302.
2Ibid., p. 299.
3Since the FOM C usually met in mid-month in 1978, these
two-month ranges are typically set when a quarter of the twomonth period is over.
F E D E R A L R E S E R V E BAN K O F ST. L OUI S
MARCH
1979
Organization of the Committee in 1978
The Federal Open Market Committee (FOM C)
consists of the seven members of the Federal Reserve
Board of Governors and five of the twelve Federal
Reserve Bank Presidents. The Chairman of the Board
of Governors is also, by tradition, Chairman of the
Committee. The President of the New York Federal
Reserve Bank is a permanent member of the Committee
and, also by tradition, its Vice Chairman. All Federal
Reserve Bank Presidents attend the meetings and pre
sent their views, but only those Presidents who are
members of the Committee may cast votes. Four mem
berships rotate among the Bank Presidents and are
held for one-year terms beginning March 1.
Members of the Board of Governors at the beginning
of 1978 included Chairman Arthur F. Bums, Vice
Chairman Stephen S. Gardner, Phillip E. Coldwell,
Phillip C. Jackson, Jr., David M. Lilly, J. Charles
Partee, and Henry C. Wallich. In addition to Paul A.
Volcker, President of the Federal Reserve Bank of
New York, the following Presidents served on the
Committee during January and February 1978: Roger
Guffey (Kansas City), Robert P. Mayo (Chicago),
Frank E. Morris (Boston), and Lawrence K. Roos
(St. Louis). In March, G. William Miller succeeded
Mr. Burns as Chairman. The Committee was reorgan
ized in March and the four rotating positions were
filled by: Ernest T. Baughman (Dallas), David P. Eastbum (Philadelphia), Mark H. Willes (Minneapolis),
and Willis J. Winn (Cleveland). Chairman Miller
succeeded Mr. Lilly, whose term had expired, as a
member of the Board. After the resignation of Mr.
Burns from the Board at the end of March, Mrs. Nancy
H. Teeters succeeded him as a member of the Board
in September. During November two vacancies oc
curred on the Board as a result of the death of Vice
Chairman Gardner and the resignation of Mr. Jackson.
These positions remained open for the remainder of
1978.
The Committee met monthly during 1978 to discuss,
among other things, economic trends and to decide
upon the future course of open market operations.
However, as in previous years, occasional telephone
or telegram consultations were held between scheduled
meetings.1 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 economic goals
sought by the Committee, and instructions to the Man
ager of die System Open Market Account at the New
York Bank for the conduct of open market operations.
These instructions were stated in terms of money mar
ket conditions and short-term rates of growth of M l
and M2 which were considered to be consistent with
1Consultations were held on March 10, May 5, June 16,
September 8, October 31, December 8, and December 29,
1978 to consider modifying inter-meeting ranges for the
Federal funds rate.
desired longer-run growth rates of the monetary aggre
gates. Special factors, such as conditions in domestic
financial markets and foreign exchange markets, were
also taken into account.
The Manager makes all decisions regarding the ex
act timing and amount of daily buying and selling
of securities in fulfilling the Committee’s directive.
Each morning the Manager and his staff plan the
open market operations for that day. This plan is de
veloped on the basis of the Committee’s objectives for
money and credit market conditions, monetary aggre
gate growth, and other factors which may be of con
cern to the Committee. The Account Manager, in a
conference call, then informs one voting President and
staff members of the Board of Governors about pres
ent 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.
A summary of the Committee’s actions is presented
to the public in the “Record of Policy Actions of the
Federal Open Market Committee.” The “Record” is
released a few days after the following FOMC meet
ing. Soon after its release, the “Record” appears in the
Federal Reserve Bulletin and, in addition, “Records”
for the entire year are published in the Annual Report
of the Board of Governors. The “Record” for each
meeting during 1978 generally included:
1) A staff summary of recent economic develop
ments, such as prices, employment, industrial
production, and components of the national in
come accounts; and projections of real output
growth 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, the
growth of monetary aggregates, and bank re
serve 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,
including money market conditions and the move
ment of monetary aggregates;
6 ) Conclusions of the FOMC;
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.
Page 3
F E D E R A L R E S E R V E BANK O F ST. L OUI S
MARCH
1979
Table I
F O M C O perating Ranges
1978
Short-Run Tolerance Ranges1
Date of
Meeting
Federal Funds
Rate Ranges
Initial
Federal Funds
Rate Target
Period to which
M l & M 2 ap ply
Ranges Specified
Ml
Jan u a ry 17
6 Vi - 7 %
6 % %
Jan.-Feb.
February 28
6 'A -7
6%
Feb.-Mar.
1-6
M arch 10 2
Ml
5 -9 %
M2
6 .6 %
7 .4 %
2.3
4 % -8%
4.9
6»/4
March 21
6%
April 1 8
6 % -7%
7
M ar.-Apr.
4-8
5 % -9
A p r.-M a y
4-8 %
5 % -9 %
M a y-June
6%
7
M ay 52 *
M a y 1 6"
2% -7% %
Actual Growth Rates3
M2
3-8
9.6
8.0
13.1
10.3
7.9
8.9
7 ’/4
7 % -7 %
7%
June 162
4-9
7%
June 20°
7 % -8
7V4
June-July
5 -1 0
6 -1 0
6.5
8.6
July 18d
7 % -8
7%
July-Aug.
4-8
6 -1 0
7.7
10.2
A ugu st 1 5 '
7 % -8 %
7 % - 8 Vi
8
12.4
September 82
Aug.-Sept.
4-8
6 -1 0
11.2
Sept.-Oct.
5-9
6 Vi -1 0 V2
5 % -9 %
7.7
9.8
-0 .2
5.6
6 -9 %
-0 .2
3.7
5 -9
-1 .7
0.8
September 19 f
8y4 - 8 %
8%
8%
October 17 8
8 % -9 > / 4
9
Oct.-Nov.
-6 % 4
Novem ber l 2
9 % - 9 y4
9 % -10
9%
Nov.-Dee.
-5 4
Novem ber 21
December 82
December 1 9 h
9%
1 0 f or slightly 1
10 I
above
J
9 % -10%
December 2 9 2
Dec.-Jan.
2-6
Longer-Run Ranges5
Date of
M eeting
Target
Period
Ml
M2
M3
February 28
1 V / 77-IV / 78
4 - 6 '/ , %
6 % -9 %
7 % -1 0 %
A pril 1 8
1/78-1/79
4 -6 %
6 % -9
7 Vi -1 0
July 1 8 1
11/78-11/79
October 17 J
111/78-111/79
Bank
Credit
7 -1 0 %
7 % -1 0 %
4 -6 %
6 % -9
7 % -1 0
8 % -1 1 %
{2 -6 )6
6 % -9
7 % -1 0
8 % -11 %
1Short-run ranges were adopted at each o f the FOM C’s regularly scheduled m eetings. The ranges fo r the m onetary aggregates w ere specified
in term s o f tw o-m onth sim ple annual rates o f change from the month p rio r to the m eetings at which the ranges w ere established to the
m onth follow in g the m eeting. The ranges fo r the Federal funds rate were specified to cover the period fro m the m eeting at which the ranges
w ere adopted to the follow in g regularly scheduled m eeting. Short-run ranges were m ade available in the “ R ecord o f P olicy A ction s o f the
Federal Open M arket C om m ittee” shortly a fter the follow in g FOM C m eeting.
2T elephone or telegram consultations w ere held between scheduled m eetings to consider m od ify in g inter-m eeting ranges fo r the Federal funds
rate.
3Data used are revised data as o f February 8, 1979, which include revisions o f seasonal factors.
4A t this m eeting only an u p p er lim it fo r the range o f M l grow th was specified.
^Chairman o f the Federal Reserve Board G. W illiam Miller announced intended grow th rates o f m onetary aggregates over the indicated one-year
periods in statements presented b efore Congressional com m ittees each quarter.
6This M l grow th range was n ot given the same weight as the M2 and M3 grow th ranges because o f uncertainties associated w ith the intro
d uction o f A T S on N ovem ber 1, 1978.
ranges for the February-M arch period. The twom onth and one-year ranges adopted during 1978 are
shown in Table I.
Short-Run Ranges: Clarifying the Directive
At each monthly meeting, the FO M C sets an inter
m eeting range for the Federal funds rate along with
the two-month ranges for M l and M2 growth. Within
that range, the Committee’s objective for the Federal
funds rate is stated in terms o f a specific level that is
thought to be consistent with the short-run ranges set
for M l and M2. If the two-month growth rates of M l
and M 2 appear to be deviating in specified ways from
Page 4
their respective ranges, the dom estic policy directive
provides that the Federal funds rate objective can
be changed within its range, or the range itself can
be reconsidered b y the Committee.
Prior to the June 20, 1978 meeting, the w ording of
the domestic policy directives follow ed the same two
general formats as in 1977 in terms o f specifying the
relationship betw een the two-m onth growth ranges
of M l and M 2 and the Federal funds rate objective.
One format, called an “aggregates directive,” indi
cated that over the inter-meeting period greater
weight was to be given to M l and M 2 growth than to
money market conditions. The other format, called a
MARCH
F E D E R A L R E S E R V E B A N K O F ST. L O U I S
1979
Table i (continued)
Supplementary Footnotes
■Messrs. Black and W illes dissented from this action because they p referred to make use o f the full range specified fo r the Federal funds rate
at the A pril 18 m eeting. They believed that a further upw ard adjustm ent in the Federal funds rate would help m oderate pressures fo r M l
and M2 grow th to increase furth er in the second quarter as nom inal G N P expanded, and would be regarded as a positive step in resisting
inflationary pressures.
bMr. W illes dissented at this m eeting because he favored m ore vigorous measures to reduce the rate o f m onetary grow th, given the accelera
tion o f inflation and its adverse effect on consum er and business confidence and spen din g plans. Specifically, he preferred a range o f 2Vi to
6Vi percent fo r the annual rate o f grow th in M l over the M ay-June period and an inter-m eeting range o f IVx to 8 p ercent fo r the Federal
funds rate.
cMessrs. W illes and W in n dissented at this m eeting because they favored m ore vigorous measures to curb the rate o f grow th in the m onetary
aggregates. Both preferred low er ranges o f tolerance fo r the 2-month grow th rates in M l and M2 than those approved b y the m ajority. In
addition, Mr. W illes favored an u p p er lim it fo r the Federal funds rate range o f 814 percent. Mr. W illes felt that a further rise in short-term
interest rates would not significantly dam age econom ic prospects and that, to the extent that such a rise tended to m oderate inflationary ex
pectations, it would have a positive im pact on the econom y. Mr. W inn felt that if the Comm ittee did n ot a ct now to assure a reduction in the
rates o f grow th o f the aggregates, an excessively restrictive policy w ould be required later on if the C om m ittee’s longer-range objectives were
to be achieved.
dMessrs. Baughm an, W illes, and W in n dissented at this m eeting because they favored m ore vigorous measures to curb the rates o f grow th in
the m onetary aggregates. All three p referred directin g operations initially tow ard an increase in the Federal funds rate to 8 percent, and
preferred providing fo r a further increase to a level o f 8V4 percent i f grow th in the m onetary aggregates appeared to be strong relative to
the specified ranges. In addition, Mr. W illes favored sp ecify in g a 2-m onth range fo r M l o f 3 to 7 percent.
eMessrs. Partee and W illes dissented at this m eeting. Mr. Partee dissented because he favored a 2-month tolerance range fo r M l grow th that
was somewhat higher than the range advocated by the m ajority. H e did not believe that a further m ove toward firm er m oney m arket condi
tions was warranted unless m onetary expansion proved to be distinctly on the high side, especially in view o f the m arked slow ing in real
econom ic grow th that now appeared to be in progress.
Mr. W illes dissented because he favored a m ore vigorous effort to curb the expansion o f the m onetary aggregates in light o f current and
expected inflationary pressures in the dom estic econom y and the weakness o f the dollar in foreign exchange m arkets. H e p referred to specify
a low er 2-month tolerance range fo r M l grow th than was agreed up on b y the m ajority.
f Messrs. W allich and W illes dissented at this m eeting because they favored m ore vigorous m easures to curb the rates o f grow th o f the m one
tary aggregates. They believed that such measures were essential to deal with the problem o f inflation and that they could be undertaken with
out a significant risk o f p recip itatin g a recession. In their view , cu rren t levels o f interest rates adjusted fo r expected rates o f inflation were
not high.
*Mrs. Teeters and Mr. W illes dissented at this m eeting. Mrs. Teeters dissented because she believed that f o r the tim e being operations should
be directed toward m ain taining the m oney m arket conditions currently prevailing. In her view , the Comm ittee should w ait to evaluate the
effects o f the substantial increases in interest rates over recent m onths b efore contem plating additional firm ing in m oney m arket conditions.
Mr. W illes dissented because he believed that the directive allowed fo r unacceptably rapid m onetary grow th. H e preferred an up p er limit o f
5 percent fo r M l grow th over the October-N ovem ber period, favored raising the Federal fun ds rate objective to 9Va percent during the
inter-m eeting period, b arrin g unforeseen weakness in m onetary grow th, and favored p rovid in g fo r an increase in the Federal funds rate to
9Vi p ercent i f the m onetary aggregates appeared to be g row in g m ore rapidly than expected.
hMrs. Teeters and Mr. W allich dissented at this m eeting. Mrs. Teeters dissented because she believed that fo r the tim e being open m arket o p
erations should be directed tow ard m ain taining the m oney m arket conditions currently prevailing. In her view , the Committee should w ait to
evaluate the effects o f the substantial firm ing in m oney m arket con ditions o f the past tw o m onths b efore con tem plating any additional firm ing.
Mr. W allich dissented because he favored a somewhat m ore restrictive policy posture than that adopted by the Committee. In his opinion,
the underlying econom ic situation was still strong and the strength o f demands was adding to inflationary pressures and expectations while
interest rates were not high in real term s and w ere not exertin g strong restraint.
‘ Messrs. Jackson and Partee dissented. See footnote 35 o f text.
JMessrs. W allich, W illes, and W in n dissented. See footnote 42 o f text.
“m oney market directive,” indicated that greater
weight was to be given to m oney market conditions
than to growth rates o f M l and M2. In particular, an
“aggregates directive” specified that the Federal funds
rate objective w ould be m odified within its range if
M l and M 2 growth rates appeared to be deviating
significantly from the midpoints of their two-month
ranges. A “money market directive,” on the other hand,
specified that the Federal funds rate objective w ould
be m odified within its range if M l and M 2 growth
rates appeared to be approaching or exceeding the
limits of their two-m onth ranges.
For example, the m oney market directive o f the
January 17, 1978 meeting stated:
If, giving approximately equal weight to M l and M2,
it appears that growth rates over the two-month pe
riod are approaching or moving beyond the limits of
the indicated ranges, the operational objective for the
weekly-average Federal funds rate shall be modified
in an orderly fashion within a range of 6 V to 7 per
2
cent.4 [Italics added.]
4“ Record” (M arch 1978), p. 207.
In contrast, the aggregates directive o f the April
18, 1978 meeting stated:
If, giving approximately equal weight to M l and M2,
it appears that growth rates over the two-month pe
riod will deviate significantly from the midpoints of
the indicated ranges, the operational objective for the
Federal funds rate shall be modified in an orderly
fashion within a range of 6% to 7% percent.5 [Italics
added.]
The w ording o f the domestic p olicy directive began
to change with the M ay meeting. In previous direc
tives, the Committee indicated that M l and M 2 growth
rates within the short-run ranges were exp ected to
occur. For example, the April directive stated:
The Committee seeks to encourage near-term rates
of growth in M l and M2 on a path believed to be
reasonably consistent with the longer-run ranges for
monetary aggregates cited in the preceding para
graph. Specifically, at present, it expects the annual
growth rates over the April-May period to be within
“ “Record” (June 1978), p. 476.
Page 5
F E D E R A L R E S E R V E BAN K O F ST. L OUI S
MARCH
1979
ranges of 4 to 8 % percent for M l and 5% to 9% per
cent for M2.6 [Italics added.]
the brevity of the period to which the operational
paragraphs of any single directive applied.10
In the M ay directive the F O M C deleted the w ord
“ expects” with regard to the two-m onth ranges o f M l
and M 2 growth, changing the w ording as follow s:
A ccording to the Committee, adjustments in the F ed
eral funds rate are intended to increase the likelihood
that the growth rates o f M l and M 2 will fall within
their one-year ranges.
The Committee seeks to encourage near-term rates
of growth in M l and M2 on a path believed to be
reasonably consistent with the longer-run ranges for
monetary aggregates cited in the preceding para
graph. Specifically, at present, the ranges of tolerance
for the annual growth rates over the May-June period
will be 3 to 8 percent for M l and 4 to 9 percent for
M2.7 [Italics added.]
The reasons for this change in wording, along with
additional changes in the June directive, were re
ported in the “R ecord o f Policy Actions” o f the June
20, 1978 meeting. The Committee felt that their in
tentions with regard to the short-run ranges had been
misinterpreted at times, partly because of the w ord
ing o f the directive. Consequently, at the M ay meet
ing the F O M C “ deleted one potentially misleading
phrase from the language previously em ployed, to
the effect that the Committee ‘expects’ the twomonth growth rates to be within the indicated
ranges.”8 The F O M C made this change to make
clear that the two-m onth ranges o f M l and M 2 growth
rates were not necessarily the growth rates they ex
p ected to occur.
The Committee at the June meeting “ agreed upon
a more thorough revision o f the customary language
[of the directive], in an effort to reduce the chances
of misinterpretation.”9 The main objective of the
changes in the directive’s w ording was to avoid the
possible misinterpretation that the two-m onth growth
ranges were the Committee’s short-run target ranges;
that the Committee w ould attempt to achieve M l and
M 2 growth rates within these two-month ranges by
changing the Federal funds rate. The Committee
noted that the two-m onth ranges could not be con
sidered targets.
In fact, however, the Manager [of the System
Open Market Account] could not be expected regu
larly to achieve two-month growth rates in M l and
M2 within the specified ranges for various reasons —
including the lag between changes in the Federal
funds rate and changes in these growth rates, and
6Ibid.
It was noted in the discussion that the Committee’s
objectives for the monetary aggregates were em
bodied in the one-year ranges established at quarterly
intervals, and that the adjustments made from time
to time in the Federal funds rate were intended to
increase the likelihood that the longer-run growth
rates would fall within these ranges.11
W hat, then, is the purpose o f setting two-month
ranges of growth for the monetary aggregates? “The
purpose of the two-month ranges was to provide the
Manager [of the System Open Market Account] with
an indicator for determining w hen changes in the
[Federal] funds rate were appropriate. . . ”12 [Italics
added.]
Revisions in the w ording o f the directive resulted
in the follow ing “ aggregates” and “m oney market” di
rectives. The “aggregates” directive o f the June 20,
1978 m eeting stated:
In the short run, the Committee seeks to achieve
bank reserve and money market conditions that are
broadly consistent with the longer-run ranges for
monetary aggregates cited above, while giving due
regard to developing conditions in financial markets
more generally. During the period until the next reg
ular meeting, System open market operations shall be
directed initially at attaining a weekly-average Fed
eral funds rate slightly above the current level. Sub
sequently, operations shall be directed at maintaining
the weekly Federal funds rate within the range of 7%
to 8 percent. In deciding on his specific objective for
the Federal funds rate the Manager shall be guided
mainly by the relationship between the latest esti
mates of annual rates of growth in the June-Julv pe
riod of M l and M2 and the following ranges of tol
erance: 5 to 10 percent for M l and 6 to 10 percent
for M2. If, giving approximately equal weight to M l
and M2, their rates of growth appear to be signifi
cantly above or below the midpoints of the indicated
ranges, the objective for the funds rate shall be raised
or lowered in an orderly fashion within its range.13
The “money market” directive o f the July 18, 1978
meeting stated:
In the short run, the Committee seeks to achieve
bank reserve and money market conditions that are
10Ibid.
7“ Record” (July 1978), pp. 564-65.
11Ibid.
8“ Record” (August 1978), p. 663.
12Ibid.
9Ibid.
13Ibid., pp. 664-65.
Page 6
MARCH
F E D E R A L R E S E R V E BANK O F ST. LOUIS
1979
C h a rt I
T w e lv e -M o n th M ] R a n g e s A n n o u n ce d D u rin g 1978
1977
1978
1979
Note: M| data used are seasonally adjusted and incorporate the benchmark adjustments and revised seasonal (actors released by the Board of Governors on February 8, 1979.
Page 7
F E D E R A L R E S E R V E BAN K O F ST. L OUI S
broadly consistent with the longer-run ranges for
monetary aggregates cited above, while giving due
regard to developing conditions in financial markets
more generally. During the period until the next reg
ular meeting, System open market operations shall be
directed at maintaining the weekly-average Federal
funds rate within the range of 7% to 8 percent. In
deciding on the specific objective for the Federal
funds rate the Manager shall be guided mainly by
the relationship between the latest estimates of an
nual rates of growth in the July-August period of M l
and M2 and the following ranges of tolerance: 4 to 8
percent for M l and 6 to 10 percent for M2. If, giving
approximately equal weight to M l and M2, their
rates of growth appear to be close to or beyond the
upper or lower limits of the indicated ranges, the ob
jective for the funds rate shall be raised or lowered
in an orderly fashion within its range.14
The only major difference between these tw o di
rectives is whether the Federal funds rate objective is
to be changed as a result o f 1 ) deviations o f m one
tary aggregate growth from the midpoints o f their
two-m onth ranges (an “aggregates directive” ), or 2 )
aggregate growth rates close to or beyond the limits
o f their two-m onth ranges (a “ money market direc
tive” ). These new formats clarify the role that m one
tary aggregate growth has played in the F O M C ’s
directives, particularly in terms o f the weight given
to monetary growth relative to money market condi
tions. The near-term operating objective is the F ed
eral funds rate in either form o f the directive, as it
had been under the earlier formats.
Short-Run Ranges: Allowing for ATS
At the O ctober 17, 1978 meeting, the F O M C con
sidered the impact o f the introduction o f the auto
matic transfer service (A T S ) between checking and
savings accounts on their short-run ranges. The C om
mittee noted that the two-month growth rate o f M l
might be reduced significantly as a result of the intro
duction of ATS, while the two-month growth rate of
M 2 might be slightly higher than it otherwise w ould
have been.15 A number of proposals w ere considered
to allow for the effects o f ATS on the short-run m one
tary growth ranges, including one to eliminate M l as
an operating guide entirely. The Committee eventu
ally decided to emphasize the growth o f M 2 as a
14“ Record” (September 1978), p. 754.
15“ Record” (D ecem ber 1978), pp. 953-54. For a discussion of
the effect of ATS on growth of the monetary aggregates, see
Scott Winningham, “ Automatic Transfers and Monetary Pol
icy,” Federal Reserve Bank of Kansas City Economic Review
(November 1978), pp. 18-27; or John A. Tatom and Richard
W . Lang, “ Automatic Transfers and the Money Supply Pro
cess,” this Review (February 1979), pp. 2-10.
Page 8
MARCH
1979
short-run operating guide. Only an upper limit for
the two-month growth o f M l was specified, “reflect
ing a judgment that rapid growth in M l w ould have
significance for p olicy while slow growth might rep
resent chiefly transfers from demand to savings ac
counts because o f the introduction o f A TS.”16 In the
past, M l and M2 had received roughly equal weight
in the Committee’s short-run operating instructions.
In light o f the uncertainties introduced by ATS, the
Committee in O ctober favored giving greater weight
than usual to m oney market conditions. This was also
the case at the N ovem ber 21, 1978 meeting, “although
some sentiment was expressed for a return to basing
decisions for open market operations primarily on the
behavior o f the monetary aggregates.”17 The Com m it
tee in N ovem ber again placed primary emphasis on
M 2 growth in specifying its short-run operating
ranges, setting only an upper limit on the two-month
growth o f M l.
The Committee at the D ecem ber 19, 1978 meeting
again specified a low er limit for the two-m onth range
o f M l growth, and M l again was given equal
weight with M 2 in assessing the behavior o f the ag
gregates. These changes from the O ctober and N o
vem ber directives were taken “because recent experi
ence had suggested that the impact o f ATS on the
annual rate of growth o f M l cou ld be estimated
within fairly narrow limits.”18
W hile the O ctober and N ovem ber directives speci
fied only upper limits for M l growth because rapid
M l growth was considered m ore significant than
slow M l growth, the D ecem ber directive indicated
that rapid growth o f both M l and M 2 w ere consid
ered more significant than slower growth of M l and
M2. The D ecem ber directive instructed the Manager
o f the System Open Market A ccount to respond more
quickly to high rates of M l and M 2 growth than to
low rates o f growth.
Specifically, the objective for the funds rate was to be
raised in an orderly fashion within its range if the
two-month growth rates of M l and M2 appeared to
be significantly above the midpoints of the indicated
ranges. On the other hand, the objective was to be
lowered in an orderly fashion only if the two-month
growth rates appeared to be approaching the lower
limits of the indicated ranges.19
16“ Record” (D ecem ber 1978), p. 954.
17“ Record” (January 1979), p. 56.
18“ Record” (February 1979), p. 150.
19Ibid., pp. 150-51.
MARCH
R E S E R V E B A N K O F ST. L O U I S
1979
Chart II
T w e lv e -M o n th M
2 Ranges
A n n o u n ce d D urin g 1978
Range for 111/78 lo 111/79
Billi
_________________________________________ M e e t i n g
940
of
O c t o b e r 1 7___________________________________________
920
900
880
860
840
820
800
Ra ti
Billi
940
920
900
880
860
840
820
800
R ati
Bil li
of
Dollars
940
920
900
880
860
840
820
800
Range for IV / 7 7 to IV /7 8
Rati
B il li
Meeting
of
February
28
940
920
900
880
860
840
820
800
OCT.
NOV.
DEC.
JAN.
FEB.
MAR.
APR.
MAY
JUNE
JULY
AUG.
SEPT.
OCT.
NOV.
DEC.
JAN.
FEB.
MAR.
APR.
M AY
JUNE
JULY
AUG.
SEPT.
M 2 data used are seasonally adjusted and incorporate the benchmark adjustments and revised seasonal factors released by the Board of Gi
Page 9
FEDERAL . R E S E R V E B AN K O F ST. L OUI S
MARCH
The w ording o f the D ecem ber direc
tive indicates that the Committee was
no longer as uncertain about the impact
o f ATS on M l growth and that, conse
quently, short-run M l growth again
could play its role as a guide to changes
in the Federal funds rate objective.
Thus, the introduction o f ATS affected
only temporarily the role o f M l in im
plementing the F O M C ’s policy direc
tives in 1978.
1979
Ch art III
F O M C S h o r t - R u n R a n g e s fo r M o n e t a r y A g g r e g a t e s
1978
Short-Run Ranges: Implementation
Percent
The Open Market Desk’s implementa
tion o f the F O M C ’s dom estic policy di
rectives in 1978 resulted in rates o f M l
growth that often exceeded the longerrun ranges set by the F O M C (Chart I ) ,
and which, at times, exceeded the
shorter-run ranges as w ell (Chart I I I ).
Rates o f M2 growth, on the other hand,
were generally within both the longerrun and shorter-run ranges (Charts II
and I I I ) .20
Page 10
P .t .i.l
the meeting at w hich the ra n g e s were a d o p te d to the month fo llow in g the meeting.
Q. Actual grow th rates are re vise d d ata a s of Fe b ru ary 8, 1979, w hich in clud e re vision s of se a so n a l factors.
12 The sh a d e d are as represent two-month ra n g e s a d o p te d b y the Committee a t each re gu la rly sc h e d u le d meeting. The ran ge s
ore show n for the p eriod ove r which they w ere specified to apply.
[3 A t both the O c to b e r a n d N o ve m b er m eetings the F O M C set o n ly u p p e r b o u n d a rie s for M ).
The weekly-average Federal funds rate was almost
always within its ranges during 1978 (Chart I V ). This
is not surprising since the short-run implementation
of policy, whether under a “m oney market” or an
“aggregates” directive, remained keyed to control of
the Federal funds rate. Since the two-month ranges
for the monetary aggregates were generally w ider than
the one-year ranges, and since for most o f 1978 the
Onen Market Desk was instructed to give equal weight
to M l and M2, there could be substantial fluctuations
in either M l or M 2 from the midpoints of their
specified ranges under a “m oney market” directive,
without leading the Desk to change its operating tar
get level for the Federal funds rate. Under an “aggre
gates” directive, there could be substantial fluctua
tions from the m idpoint of the range o f one of the
aggregates without leading the Desk to change its
Federal funds rate objective, provided that the other
monetary aggregate was growing at a rate close to the
m idpoint o f its range.
20Data used in the tables and charts
of February 8, 1979, which include
factors. Previously-reported data show
data used here, although growth rates
M 2 lo le r a n c e R a " 9 es
are revised data as
revisions of seasonal
similar patterns to the
differ somewhat.
Longer-Run Ranges
The FO M C began 1978 with longer-run growth
ranges o f 4 to 6 V percent for M l, 6 V to 9 percent
2
2
for M2, and 8 to IOV2 percent for M3. These ranges,
which were adopted in O ctober 1977, applied to
monetary growth from third quarter 1977 (111/77)
to third quarter 1978 (111/78). The FO M C reviewed
these one-year ranges at its February 1978 meeting
and decided to reduce both the upper and low er limit
o f the M3 range b y one-half percentage point while
leaving the M l and M 2 ranges unchanged (T a ble I ) .
W hen newly-appointed Chairman Miller announced
the new M 3 range on March 9, 1978, he noted that
this reduction was made “in light of the higher level
of market interest rates now prevailing and the ap
parent effect o f these rates in retarding growth in
time and savings deposits at thrift institutions.”21
The Committee’s decision to retain the 4 to 6 %
percent range for M l took into account a number of
factors.
First, it was observed that any increase in the 6 V
2
percent upper limit of the range could strengthen
2^‘Statements” (M arch 1978), pp. 188-89.
F E D E R A L R E S E R V E B AN K O F ST. L OUI S
Chart IV
F O M C R a n g e s ( or F e d e r a l F u n d s R a t e
P erc e nt
P e rc e n t
1978
LL W e e k ly a ve ra ge s of effective d a ily rates.
12. At each meeting d urin g 1978 the F O M C e sta b lish ed a ra n ge for the Federal fun d s rate. These ra n g e s are
full week d urin g which they were in effect.
inflationary expectations, which already appeared to
be intensifying, and could accentuate the current
weakness of the dollar in foreign exchange markets.
Second, because the rate of growth of M l in 1977 —
about 7% percent — had significandy exceeded the
upper limit of the Committee’s earlier ranges, it was
suggested that a decision now to reduce the range
might lack credibility. Third, it was noted that if the
actual rate of growth in M l during 1978 were to fall
within a 4 to 6% percent range, that would represent
a significant slowing from the 1977 rate. Indeed, one
Committee member observed that if — as seemed
likely — some slackening were under way in the pro
cesses of financial innovation that recently had been
facilitating economies in transactions balances, an un
changed rate of growth in M l could be interpreted as
involving an increase in monetary restraint. Finally,
it was suggested that current uncertainties regarding
the economic outlook militated against an adjustment
in the M l range. While Committee members found
these considerations persuasive, it was observed in the
discussion that further gradual reductions in monetary
growth ranges would be needed over time if growth
rates consistent with general price stability were to be
achieved.22
In addition, Chairman Miller noted in his testimony
before Congress that the F O M C anticipated that the
growth of the monetary aggregates w ould decelerate
MARCH
1979
during 1978 from their rates in 1977.
He also emphasized, however, that the
Federal Reserve w ould continue to put
“the long-run performance o f the econ
om y above the pursuit o f any fixed
monetary growth rates.”23
By the April meeting, when the
longer-run ranges again were reviewed,
the Committee agreed that in the do
mestic policy directive “more weight
should be given to the objective o f re
sisting inflationary pressures. . . ,”24 The
Committee also remained concerned, as
it was during m uch of 1978, about the
declining value o f the dollar in for
eign exchange markets. On the basis
o f data available at the April meet
ing, M l growth averaged 5.1 percent
over the first quarter o f 1978, declining
from the 7.4 percent rate recorded in
the fourth quarter o f 1977.25 Growth of
1979
M 2 and M3 also decelerated in the first
indicated for the first
quarter o f 1978, com pared to the fourth
quarter o f 1977. Growth rates o f all
three measures over the first quarter
w ere below the midpoints o f their ranges (o n the
basis o f data available in April 1978).
The Committee decided not to change the one-year
ranges for M l, M2, and M3 growth at the April meet
ing. In announcing these ranges on April 25, 1978,
Chairman Miller noted:
Although the FOMC at this time has not made a
further reduction in its monetary growth ranges, it
remains firmly committed to a gradual reduction in
monetary growth over time to rates more nearly con
sistent with reasonable price stability. The ranges just
adopted in fact contemplate that actual monetary
growth in 1978 and into early 1979 will be slower
than last year.26
Several Committee members noted at the April meet
ing that, since M l growth had exceeded the 6 % per
cent upper limit o f its longer-run range in all but
one quarter since the fourth quarter o f 1976, holding
monetary growth within the existing ranges was more
important than reducing the ranges further.27
^ “ Statements” (M arch 1978), p. 189.
-• “ Record” (June 1978), p. 473.
•
25M1 growth for first quarter 1978 was revised up to 6.8 per
cent in February 1979, while M l growth for fourth quarter
1977 was revised up to 7.6 percent.
26“ Statements” (M ay 1978), p. 376.
22“ Record” (April 1978), pp. 297-98.
27“ Record” (June 1978), p. 471.
Page 11
F E D E R A L R E S E R V E B AN K O F ST. L OUI S
The point was stressed that retention of the exist
ing ranges for the year ahead should be interpreted as
constituting a tighter monetary posture than had been
contemplated when the ranges were adopted in Feb
ruary 1978. It was observed that since then the pro
spective rate of inflation had increased — which im
plied, other things being equal, that nominal GNP
and the associated transactions demand for money
would expand more rapidly than had been antici
pated at that time. It was recognized that such an
implication could form the basis of an argument for
raising the twelve-month range for M l, or at least its
upper limit. It was suggested, however, that the
ultimate conclusion of such an argument was a mone
tary policy that always accommodated the existing
rate of inflation and that could be expected to lead to
still higher rates of inflation and still more rapid
monetary growth.28
It was suggested that the M 2 and M3 ranges might
be reduced since growth o f savings and time deposits
at banks and thrift institutions could be expected to
slow further as market interest rates rose relative to
Regulation Q ceilings. This suggestion received little
support, however, and the existing M 2 and M 3 ranges
w ere retained.29
Growth o f M l and M 2 accelerated during the sec
ond quarter. On the basis o f data available at the
July meeting, M l increased at an 8.5 percent rate,
w ell above the upper limit of its longer-run range,
and M 2 increased at an 8.5 percent rate, still within its
longer-run range. M3, on the other hand, increased at
close to the same rate in the second quarter ( 8.2 per
cent) as in the first quarter ( 8.0 p ercent), near the
bottom o f its range.30
The longer-run ranges again were review ed at the
July meeting. Most members o f the Committee agreed
to retain the existing ranges for M 2 and M3, but
few er agreed about the range for M l. Although a
majority of the Committee favored retaining the exist
ing M l range, a few o f the members preferred to in
crease its upper limit.31 The argument to increase the
upper limit o f the M l range was based on the expec
tation that M l growth over the next four quarters
w ou ld have to exceed the 6 V percent upper limit in
2
order to avoid the risk of a downturn in econom ic
activity.
That expectation was based on the probable rates of
inflation and on the recent behavior of the income
MARCH
1979
velocity of money. In this connection it was empha
sized that the high rate of inflation in prospect for
the quarters immediately ahead was attributable in
part to governmental actions and to some strong
forces in the private sector — including the effects of
the depreciation of the dollar — that were not likely
to be moderated appreciably by the stance of mone
tary policy. In these circumstances, it was argued, the
Committee ought to raise the upper limit of the range
for M l to allow for a growth rate that— given up
ward cost pressures on prices — was more nearly con
sistent with the generally anticipated rate of growth
in real and nominal GNP for the year ahead and that,
consequently, was more likely to be achieved.32
Several arguments were m ade in favor of retain
ing the 4 to 6 V percent range. First, M l growth
2
in the second quarter o f 1978 had substantially ex
ceeded the 6 V percent upper limit. Retaining the
2
same range for M l over the period 11/78 to 11/79,
and using this higher second quarter level o f M l as a
base, allow ed M l growth to be higher than 6 % per
cent over the five-quarter period beginning in 1/78.
Second, M l growth on average had exceeded the C om
mittee’s longer-run ranges for more than one year, so
that reducing M l growth to a rate within the existing
range w ould be a m ove toward moderating inflation.
Third, an increase in the M l growth range could be
misinterpreted as a de-emphasis o f the F O M C ’s p ol
icy o f fighting inflation.
Since that was not the case, it would be consistent to
retain the existing range, although the rate of growth
over the period might be around the upper limit of
the range.33
A final argument against changing the M l growth
range involved the im pact o f ATS on the growth of
M l after N ovem ber 1, 1978. Members o f the C om
mittee noted that ATS w ould tend to “reduce the
demand for M l and increase its incom e velocity,” so
there could be slower M l growth over the period 11/78
to 11/79 without necessarily reducing growth o f real
output.34
Although a majority o f the Committee voted in July
to retain the existing ranges for M l, M2, and M3, there
were tw o dissenting votes.35 In addition, one member
of the Committee proposed that increased emphasis
32Ibid., p. 750.
ssibid.
28Ibid., p. 472.
- 9Ibid., pp. 471-72.
30Data revisions resulted in the following second-quarter growth
rates as of February 8, 1979: 9.6 percent for M l, 8.7 per
cent for M2, and 8.7 percent for M3.
31“ Record” (September 1978), p. 749.
Page 12
34Ibid., pp. 750-51.
35“ Messrs. Jackson and Partee dissented from this action be
cause they preferred to raise the upper limit of the range for
M l to a level more nearly consistent with the anticipated
growth in GNP — Mr. Jackson, to 7% percent; Mr. Partee, to
8 percent,” Ibid., p. 751.
F E D E R A L R E S E R V E B AN K O F ST. LO UI S
be given to M 2 growth in the future, and reduced em
phasis be given to M l growth. Although this proposal
received no support from other Committee members
at the time it was temporarily adopted for both the
short- and long-run ranges at the O ctober 17, 1978
m eeting as a result o f the discussion o f the possible
impact o f the introduction of ATS.
Chairman Miller outlined the impact o f ATS on the
growth of M l and the broader monetary aggregates
on July 28, 1978, when he announced the longer-run
ranges set at the July 18 meeting. H e noted that dur
ing the transition period in which bank customers ad
just to ATS, M l growth w ould be low ered while M 2
and M 3 growth w ould be little affected. M 2 and M3
growth were expected to grow within their ranges,
although there “ are always great uncertainties sur
rounding monetary projections.”38
In announcing the longer-run ranges in July, Chair
man Miller also reported that the F O M C saw little
chance that inflation w ould diminish over the next
four quarters, particularly because o f certain inflation
ary biases that exist in the U.S.
These biases — regulatory, legislated, and expectational — prevented the Committee from taking a
further step at this time toward the lowering of the
monetary growth ranges — a process that must be
continued over time if the Nation is to achieve rea
sonable price stability. . . .
These observations underscore the limitations of mon
etary policy as the main bulwark against inflation and
the need to mount a broad attack on the economic
problems we face.37
During the third quarter, all o f the monetary aggre
gates increased at rates near or above the upper
limits of their long-run ranges. At the time of the
O ctober 17 meeting when the longer-run ranges again
were reviewed, Committee members continued to an
ticipate m oderate growth of real output over the year
ahead, although some members felt that the possi
bility of a downturn in econom ic activity in 1979 had
increased.38 The Committee noted that it was faced
with tw o unusual causes o f uncertainty in setting the
longer-run monetary growth ranges. One was the e f
fect of the ATS program and the other was the form
and effect of the President’s forthcom ing wage and
price program.
MARCH
1979
The point was made in the Com mittee’s discussion
that the w age-price program w ould have its greatest
impact were it not considered a substitute for fiscal
and monetary restraint. The effect o f the ATS program
on growth o f the aggregates received further discus
sion b y the Committee, and weighed heavily in their
choice o f a range for M l growth. A staff analysis indi
cated that ATS w ould low er M l growth b y a signifi
cant, but uncertain, amount while M2 growth could be
raised slightly. M 3 growth was not likely to be notice
ably affected, according to the staff report.39
A number o f proposals to deal with the uncertain
ties raised by the introduction o f ATS were discussed.
One proposal was to eliminate M l from the list of
monetary aggregates and adopt ranges only for M2
and M3. Another proposal was to adopt M l, M2, and
M3 ranges as at previous meetings, in the expecta
tion that the introduction o f ATS w ould have little
effect on monetary growth in the few months before
the longer-run ranges again were reviewed. Other
proposals suggested m odifying the M l range by
changing either the lower limit or both limits to take
into account the effect o f ATS on M l growth over the
next four quarters. One o f these proposals also sug
gested the consideration o f a growth range for an addi
tional monetary aggregate, M 1 + (defined as M l plus
savings accounts at com m ercial banks, negotiable
orders o f withdrawal [N OW ] accounts, demand d e
posits at mutual savings banks, and credit union share
drafts).40
A majority o f the Committee voted to retain the
existing ranges for M 2 and M3 (T a ble I ) for the
period 111/78 to 111/79. The Committee also indi
cated that it expected growth of M l to be within a
range o f 2 to 6 percent over that period, “ depending
in part on the speed and extent o f transfers from de
mand to savings deposits resulting from the introduc
tion o f A TS.”41 This expected range of M l growth
was both low er and w ider than the one adopted in
July. In addition, the Committee noted that a range
o f 5 to IV2, percent for the new monetary aggregate,
M 1 + , w ould b e generally consistent with the ranges
o f growth for the other monetary aggregates. D e
spite the lowering of the M l range in light o f the
expected impact o f ATS, three o f the Committee’s
members dissented because they felt that an upper
limit o f 6 percent was too high.42
39Ibid., p. 951.
36“ Statements” (August 1978), p. 646.
40Ibid., p. 952.
37Ibid.
•tilbid, p. 953.
38“ Record” (Decem ber 1978), p. 950.
42“ Messrs. Wallich, Willes, and Winn dissented from this action
because, with the Committee’s longstanding objective of slow-
Page 13
F E D E R A L R E S E R V E BAN K O F ST. LOUIS
The w ording o f the O ctober “R ecord o f Policy
Actions” indicated that the Committee placed less
emphasis on M l relative to M 2 and M3, because of
the uncertainties associated with the introduction of
ATS. Whereas the Committee “ adopted” ranges of
growth for M2 and M3 over the period 111/78 to
111/79, the Committee only “expected” M l to grow
within a range o f 2 to 6 percent.43 At previous meet
ings in 1977 and 1978, the Committee had always
“ adopted” ranges of growth for all three monetary
aggregates.44 That the M 2 and M 3 growth ranges
w ere given more weight than M l b y the Committee
in O ctober is also evident in Chairman Miller’s state
ment to Congress that “the continuity in the F O M C ’s
objectives with respect to the monetary aggregates
for the one-year period from the third quarter of 1978
to the third quarter o f 1979 is more clearly indicated
b y the broader aggregates, M 2 and M3.”4
B
In addition, the F O M C at both the O ctober and
N ovem ber meetings placed primary emphasis on M2
growth in specifying its short-run operating ob je c
tives, setting only an upper limit on the two-month
growth rate o f M l. This change in the dom estic policy
directive, the change in w ording o f the longer-run
growth ranges, and the widening of the longer-run
range o f M l growth all indicate that the FO M C
placed less weight on the behavior o f M l during the
latter part o f 1978 as a result o f the introduction of
ATS. However, at the D ecem ber m eeting the C om
mittee returned to specifying a lower limit for the
two-m onth range of M l growth, and gave equal
weight to M l and M 2 growth. W hen the longer-run
ranges were review ed at the February 6 , 1979 meet
ing, the Committee again “adopted” growth ranges
for all three monetary aggregates.48 Thus, the intro
duction o f ATS reduced only temporarily the roles of
the M l growth ranges as guides or objectives of
policy.
mg the rate of inflation in mind, they preferred to specify
an upper limit of less than 6 percent for the rate of growth
of M l, adjusted for the estimated effects of ATS. In their
view, the upper limit of 6 percent, adjusted for ATS, rep
resented an unwarranted increase from the 6% percent
upper limit of the existing (pre-A TS) range.” Ibid., pp.
952-53.
43Ibid., p. 953. This distinction was pointed out in comments
by the Board staff on an earlier draft of this paper.
44See the “ Records” (M arch 1977), p. 257; (June 1977), p.
571; (September 1977), pp. 832-33; (D ecem ber 1977), p.
1071; (April 1978), p. 299; (June 1978), p. 473; and (Sep
tember 1978), p. 751.
45“ Statements” (November 1978), p. 846.
46“ Record of Policy Actions of the FOM C,” Federal Reserve
Press Release (M arch 23, 1979), p. 10; forthcoming in the
Federal Reserve Bulletin (M arch 1979).
Page 14
MARCH
1979
Nevertheless, Chairman Miller indicated when an
nouncing the monetary aggregate ranges on N ovem
ber 16, 1978 that institutional changes such as ATS
raise general questions about the use o f monetary
aggregates in assessing monetary policy.
While monetary aggregates are useful indicators of
financial conditions, the continuing change in the in
stitutional environment and in public preferences for
different deposits indicates that any single monetary
measure, or even a set of several measures, can by no
means be the sole focus of policy. Thus, a broad
range of financial indicators — including nominal and
real interest rates, credit flows, and liquidity condi
tions — necessarily must be considered in assessing
the stance of monetary policy.
. . . it is clear that in the present environment we
cannot rely solely on monetary management to con
tain inflationary pressures.47
He also noted that institutional changes such as ATS
can result in existing measures o f the monetary ag
gregates becom ing outdated.48 Subsequently, the
Board of Governors announced a proposal in Febru
ary o f this year to redefine the monetary aggregates,
largely in order to take into account recent institu
tional changes that have increased the variety o f d e
posits available to the public.49
SUMMARY AND CONCLUSIONS
The views expressed b y Committee members about
both the short- and longer-run ranges o f growth of
the monetary aggregates and the changes in the d o
mestic policy directive served to clarify and, for a
time, to alter the roles o f the monetary aggregates in
F O M C policy considerations during 1978. The role
o f the two-m onth growth ranges for M l and M 2 in
adjusting the Federal funds rate objective was clari
fied at the M ay and June meetings with changes in
the w ording of the domestic policy directive. The
Committee made it clear that the one-year growth
ranges o f the monetary aggregates, not the twomonth ranges, em bodied the Committee’s objectives
for growth o f the monetary aggregates.
The introduction o f ATS in N ovem ber o f last year
temporarily shifted the Committee’s emphasis away
from the narrowly-defined money stock, M l, toward
the more broadly-defined aggregates, M 2 and M3.
The Committee, at the D ecem ber 1978 meeting, re47“ Statements” (November 1978), p. 847.
48Ibid.
49“ A Proposal for Redefining the Monetary Aggregates,” Fed
eral Reserve Bulletin (January 1979), pp. 13-42.
F E D E R A L R E S E R V E BAN K O F ST. LOUIS
MARCH
turned to giving M l and M 2 equal emphasis in p ro
viding guides for determining when to change the
Federal funds rate objective, and, at the February
1979 meeting, returned to giving equal weight to M l,
M2, and M 3 in the specification of the one-year
growth ranges. An additional monetary aggregate,
M 1 + , was introduced, but was given less emphasis
than M 2 or M3.
Although the Committee in some ways clarified the
roles o f the various monetary aggregates during 1978,
Chairman Miller s com ment in N ovem ber that current
1979
measures o f the aggregates “ are becom ing out
dated,”50 and the Board’s recent proposal to redefine
the monetary aggregates, suggest that the roles of the
monetary aggregates in monetary policym aking will
be the subject o f further debate in 1979. W hether or
not additional changes in the roles of the monetary
aggregates occur, will depend in large part on the
observed effects o f ATS on the aggregates during
the com ing year.
50“ Statements” (November 1978), p. 847.
SUPPLEMENT
FOMC Discussions in 1978
This supplement consists o f selected excerpts from
the “ R ecord o f Policy Actions” for each of the F O M C
meetings in 1978. Each “ R ecord” includes analyses of
current and projected econom ic developments, discus
sions o f current p olicy actions, and long- and shortrun operating instructions issued by the F O M C to the
Trading Desk. The full text of each “ R ecord o f Policy
Actions” appears in issues o f the Federal Reserve
Bulletin.
Meeting Held on January 17, 1978
At its December meeting the Committee had decided
that operations in the period immediately ahead should
be directed toward maintaining about the prevailing
money market conditions, provided that the monetary
aggregates appeared to be growing at approximately the
rates then expected.
The Committee also had included in its directive to
the Federal Reserve Bank of New York the following
sentence: “In the conduct of day-to-day operations, ac
count shall be taken of emerging financial market condi
tions, including the unsetded conditions in foreign ex
change markets.” This instruction had been added to
provide the Manager with somewhat greater flexibility,
in part because of the Committee’s view that pressures
on the dollar in foreign exchange markets might appro
priately influence the nature and timing of domestic open
market operations from day to day.
On January 4, 1978, it was announced that the Ex
change Stabilization Fund of the U.S. Treasury would
henceforth be utilized actively, together with the swap
network operated by the Federal Reserve System, to
check speculation and to help re-establish order in the
foreign exchange markets. On January 6 the Board of
Governors announced approval of an increase in Federal
Reserve discount rates from 6 to 6 V percent, and in an
2
accompanying press release noted that the recent dis
order in foreign exchange markets constituted a threat
to orderly expansion of the domestic and international
economy. The Board expressed the hope that the need
for this increase would prove temporary. It also noted
that the condition of the domestic economy was sound
and that credit supplies to sustain the economic expan
sion would remain ample.
With the monetary aggregates apparently expanding
at rates well within the Committee’s specified ranges, the
Manager of the System Account continued to aim for a
Page 15
F E D E R A L R E S E R V E B AN K O F ST. L OUI S
Federal funds rate of around 6% percent in the last weeks
of December and the first statement week of January.
Due to technical factors, however — including the usual
money market churning around year-end — Federal funds
actually traded at rates somewhat above this level. The
Manager in early January also shaded his Federal funds
rate objective slightly upward because of downward
pressures on the dollar in foreign exchange markets. On
January 9, following the January 6 increase in Federal
Reserve discount rates to 6% percent, the Federal Open
Market Committee concurred in the Chairman’s recom
mendation to raise the inter-meeting range for the Fed
eral funds rate to 6% to 7 percent and to instruct the
Manager to aim for a rate of around 6% percent over the
next few days. In the days remaining until this meeting,
the funds rate averaged 6.75 percent.
According to the latest projections, growth in real gross
national product (GNP) would be sustained at a good
pace throughout 1978. It was also expected that the rise
in prices would remain relatively rapid and that the un
employment rate would decline moderately further over
the year ahead.
In the Committee’s discussion of the economic situa
tion, most members agreed that the staff’s projection of
the growth rate in real GNP over the full year 1978 was
reasonable. However, there was some difference of opinion
regarding the probable profile of the expansion during
the course of the year. Specifically, a number of members
thought that growth might be faster in the first half of
1978 and slower in the second half than had been
projected.
Serious concern continued to be expressed about the
dollar’s weakness in foreign exchange markets. . . . As
at the December meeting, the observation was made that
the position of the dollar would be strengthened by adop
tion in this country of an effective energy program, of a
tax policy conducive to business investment here, and of
a more effective attack on inflation, as well as by pursuit
abroad of faster rates of economic growth.
In the Committee’s discussion of policy for the period
immediately ahead, a number of members suggested that
any significant easing of money market conditions would
be undesirable at this time because of the weakness of
the dollar in foreign exchange markets and — in the view
of some — because of the cumulative growth rates in the
monetary aggregates over recent months. Each of the
three members who had dissented from the decision of
January 9 to seek a higher Federal funds rate indicated
that he would not now advocate a rollback since that
decision had been implemented and absorbed by the fi
nancial markets. At the same time, there was little senti
ment for further firming actions in the coming inter-meet
ing period unless the monetary aggregates appeared to
be growing at rapid rates.
Consistent with these views, most members expressed
a preference for continuing to give greater weight than
usual to money market conditions in conducting opera
tions in the period until the next meeting of the Com
mittee. However, a few favored basing operating decisions
primarily on the behavior of the monetary aggregates,
Page 16
MARCH
1979
particularly if growth rates appeared to be higher than
desired.
At the conclusion of the discussion the Committee de
cided that operations in the period immediately ahead
should be directed toward maintaining prevailing money
market conditions, as represented by the current 6% per
cent level of the Federal funds rate. . . . It was under
stood that very strong evidence of weakness in the mone
tary aggregates would be required before operations were
directed toward reducing the Federal funds rate from its
current level.
Meeting Held on February 28, 1978
Data that became available during the inter-meeting
period suggested that growth in the monetary aggregates
over the January-February period would be well within
the specified ranges. The Manager of the System Open
Market Account, therefore, continued to aim for a Fed
eral funds rate of around 6% percent.
Other short-term interest rates also changed little on
balance over the inter-meeting period, even though short
term credit demands remained relatively strong.
The latest projections suggested that growth in output
would be less rapid in the first quarter of 1978 than had
been expected earlier, in large part because of the adverse
weather, but that the weather-related losses would be
about made up later.
In the Committee’s discussion of the economic situation
and prospects, the members agreed that the expansion in
activity was likely to continue throughout 1978. Most
members thought that the staff’s GNP projection was
reasonable, but two or three members believed that
growth in real GNP would fall somewhat short of the
projected rate. Several members emphasized that the
degree of uncertainty with regard to economic prospects
and projections had been increasing.
It was observed that at the current stage of this busi
ness expansion some deceleration in growth toward a
rate that could be sustained for the longer term would
be a desirable development. The comment was also made
that some deceleration would be acceptable in light of
the inflationary pressures in the economy and of recent
developments in the foreign exchange markets.
Considerable concern was expressed that the rate of
inflation might accelerate significantly as the year pro
gressed. The comment was made that prospects for in
flation had been inhibiting business decisions to invest in
fixed capital, and it was suggested that an acceleration
would adversely affect confidence and would dampen
expansion in spending of other kinds. Such price behavior,
it was noted, would pose difficult questions concerning
the appropriate role of monetary policy.
In the Committee’s discussion of policy for the period
immediately ahead, it was suggested that recent develop
ments in the foreign exchange markets militated against
any marked easing of money market conditions at this
time, and that the uncertainties in the economic situa
tion militated against any market firming. All of the mem
MARCH
FEDERAL. R E S E R V E BAN K O F ST. LO UI S
bers favored directing initial open market operations
during the coming inter-meeting period toward the ob
jective of maintaining the Federal funds rate at about
the prevailing level of 6% percent, and a majority pre
ferred to continue giving greater weight than usual to
money market conditions in the conduct of operations
until the next meeting.
Meeting Held on March 21, 1978
1979
strike, and uncertainty about the strength of the prospec
tive rebound in economic activity. However, a number of
members favored some firming of money market conditions
during the inter-meeting period with a view to keeping
under control the anticipated pickup in monetary growth,
unless data for the first 2 weeks of the period suggested
that monetary growth over the March-April period was
likely to be significantly weaker than expected. There
was also some sentiment for a slight easing if the incom
ing data suggested unexpected weakness in monetary
growth.
As the inter-meeting period progressed, it became evi
dent that in February M l had contracted somewhat and
M2 had increased relatively little. Staff projections for the
February-March period suggested that M l would grow
at a rate below the lower limit of the range specified by
the Committee and that M2 would grow at a rate close
to its lower limit. It also appeared, however, that the
weakness in the aggregates might reflect the prolongation
of the coal strike and the severe winter weather and in
view of recent developments in foreign exchange markets,
the Committee voted on March 10 to instruct the Man
ager to continue aiming at a Federal funds rate of 6%
percent for the time being. For the full inter-meeting
period, the funds rate averaged 6% percent.
These differences of emphasis notwithstanding, mem
bers of the Committee did not differ greatly in their
preferences for operating specifications for the period
immediately ahead, and all favored a return to basing
decisions for open market operations between meeting
dates primarily on the behavior of the monetary aggregates.
The information reviewed at this meeting suggested
that growth in real output of goods and services in the
first quarter of 1978 had been adversely affected by un
usually severe weather and by the lengthy strike in coal
mining but that the underlying economic situation had
changed litde. . . . Staff projections suggested, however,
that the shortfall in growth from the rate expected at
the time of the February meeting would be about made
up over the next quarter or two and that on the average
over the four quarters of 1978 output would grow at a
good pace.
Projections made on the basis of data that had become
available in the days immediately following the March
meeting suggested that over the March-April period both
M l and M2 would grow at rates that were high within
their specified ranges. The figures were regarded as espe
cially tentative, however, since the strength was concen
trated in the part of the period for which growth rates
were projected. Consequendy, the Manager of the System
Open Market Account continued to seek a Federal funds
rate of about 6% percent.
The Committee members agreed that, the rate of price
advance was likely to remain relatively rapid in 1978, and
they expressed a great deal of concern about this prospect.
The comment was made that the pace of increase in prices
appeared to be accelerating in this country while deceler
ating in European countries. Several members observed
that inflation led to recession, and it was suggested that
the greater the inflation, the worse the ensuing recession.
For that reason, it was suggested, special emphasis should
be given to the Committee’s long-standing objective of
helping to resist inflationary pressures while simultaneously
encouraging continued economic expansion. It was noted
that an effective program to reduce the rate of inflation
had to extend beyond monetary policy.
In the Committee’s discussion of policy for the period
immediately ahead, it was suggested that an easing of
money market conditions would be inappropriate in light
of the outlook for prices, the recent behavior of the dollar
in foreign exchange markets, and the likelihood that the
demand for money would strengthen substantially again
as growth of nominal GNP picked up. It was also sug
gested that a firming of money market conditions in the
absence of actual evidence of excessive growth of the
monetary aggregates would be premature, given the weak
ness of recent economic statistics, the still unsettled coal
All of the members favored directing open market oper
ations during the coming inter-meeting period initially
toward the objective of maintaining the Federal funds
rate at about the prevailing level of 6% percent.
Meeting Held on April 18, 1978
Market interest rates in general were subjected to up
ward pressure during much of the inter-meeting period,
apparently because of investor concerns about the deterior
ation in the balance of U.S. foreign trade, the acceleration
of the rise in prices, and the possibility of a surge in
monetary growth in April.
The rate of expansion in total credit at U.S. commercial
banks during March was close to that in February. Growth
in loans, particularly business loans and real estate loans,
accelerated. At the same time banks reduced their hold
ings of Treasury securities — resuming the pattern of net
liquidation of investments that had been interrupted by
substantial acquisitions of Treasury securities in February.
Over the first quarter, total bank credit grew at an annual
rate of about IOV2 percent, compared with 8% percent
in the second half of 1977. Business loans (net of bankers
acceptances) increased in March at an annual rate of 23
percent, approaching the rapid pace recorded in the first
half of 1974.
In the Committee’s discussion of the economic situation,
most members indicated little or no disagreement with
the staff projection of moderate growth in real GNP over
the year ahead, following the current rebound from the
slow pace estimated for the first quarter. However, several
members expressed the view that growth would be stronger
in the current quarter than had been projected.
Page 17
F E D E R A L R E S E R V E BAN K O F ST. LO UI S
Committee members in general were deeply concerned
about price prospects. Views were expressed to the effect
that people in both the public and private sectors ap
peared as yet not to be making the sorts of difficult de
cisions required to reduce the pace of the rise in prices;
that expectations of a high rate of inflation seemed to be
growing and, as a result, actions of businessmen and con
sumers might tend to make their expectations self-fulfilling; that the rate of increase in wage rates might well
accelerate if prices rose at the projected rate or if the
labor contract recendy negotiated in the coal industry
were viewed as a pattem-setter; and that individual
efforts to profit from inflation could lead to some specula
tive activity. The comment was also made that in the
past several weeks the public’s attention increasingly had
been focused on the problem of inflation.
It was noted that the current rise in prices was more
rapid than the rate that had been projected early in 1977.
Questions were raised as to whether the recent accelera
tion of the rise was attributable primarily to special fac
tors affecting foods and to the depreciation of the dollar
in foreign exchange markets or whether it reflected more
general influences, such as the pressures that frequently
emerge in the latter phase of a business upswing or the
effect of the rate of monetary growth during 1977. As at
other recent meetings, the observation was made that
monetary policy could be no more than one element in
an effective program to fight inflation.
In considering the language of the domestic policy di
rective to be adopted at this meeting, Committee members
agreed that in the statement of the Committee’s general
policy stance in the fourth paragraph more weight should
be given to the objective of resisting inflationary pressures
by citing that objective first.
In the discussion of policy for the period immediately
ahead, members of the Committee took account of the
likelihood that the demand for money would expand significantly in association with the current rebound in eco
nomic activity and of the early indications that M l was
growing rapidly in April. All of the members agreed that
operations designed to achieve firmer market conditions
needed to be undertaken promptly if M l growth were to
be held to a path reasonably consistent with the Com
mittee’s longer-run range. At the same time the members
felt that, pending additional evidence on the pace of
monetary expansion, the degree of firming sought should
be modest.
All of the members favored directing open market op
erations during the coming inter-meeting period initially
toward a Federal funds rate slightly above the current
level of 6% percent.
Subsequent to the meeting, on May 5, a telephone
conference meeting was held . . . pursuant to the decision
at the April meeting that an increase in the Federal funds
rate above IV* percent . . . would not be sought until
the Committee had had an opportunity for further
consideration.
The acceleration of growth of nominal GNP in the cur
rent quarter from the reduced pace in the first quarter
Page 18
MARCH
1979
appeared to be the main factor explaining the sharp ac
celeration of monetary growth in April. Other transitory
forces — specifically, mobilization of cash by the public to
make unusually large payments of Federal income taxes
not withheld, somewhat slower processing of tax returns,
and the upsurge in the volume of trading on the stock
exchanges — might also have contributed to the April
rate of monetary growth.
In its discussion the Committee agreed that, while the
firming in money market conditions that had been accom
plished since the meeting of April 18 had clearly been
appropriate, there was some question as to whether fur
ther firming at this point would be desirable.
At the conclusion of the discussion the Committee di
rected the Manager, until further instructed, to seek to
maintain the weekly-average Federal funds rate at about
IVt percent, with any deviations tending to be in the
direction of higher rather than lower funds rates.
Meeting Held on May 16, 1978
The narrowly defined money supply ( M l ) , which had
grown at an annual rate of 5 percent in the first quarter
on a quarterly-average basis, expanded at a rate of 19
percent in April. . . . The latest weekly data suggested
that growth of M l would slow substantially in May.
The rate of expansion in total bank credit accelerated
sharply in April, reflecting an unusually large increase in
security loans and sizable additions to bank holdings of
both U.S. Government and other securities.
The rise in the Federal funds rate was accompanied by
upward pressures on interest rates in general.
In the Committee’s discussion of the economic situation
and outlook, the members generally agreed that real out
put of goods and services was growing rapidly in the
current quarter, but they differed on the likely course
of activity in succeeding quarters.
Committee members were deeply concerned about the
recent acceleration of inflation and about prospects for
prices. Several expressed the view that the rise was likely
to be more rapid than projected by the staff. Thus, it was
suggested that the supply-related increase in prices of
foods over the remainder of 1978 would exceed the staff
projection and that the effect on the over-all price level
this year would influence the outcome of labor contract
negotiations in 1979. It was also suggested that pressures
had begun to develop on labor resources, particularly
skilled labor, and on some types of capacity. A few mem
bers observed that in these circumstances it would be
desirable for growth in real output to diminish in the
second half of this year toward a rate that could be sus
tained for the longer term.
Committee members differed somewhat in their judg
ments concerning the course of policy for the period im
mediately ahead, in part because of varying views about
the current and prospective economic situation and in
F E D E R A L R E S E R V E B AN K O F ST. L OUI S
part because of differing judgments about the appropriate
response to the surge of M l in April. The differences
essentially concerned the degree of any further firming of
money market conditions that might be pursued during
the next few weeks. No member advocated an easing of
money market conditions.
Several reasons were advanced for pursuing a very
cautious approach to any further firming at this time, in
cluding the fact that transitory influences had contributed
to the April surge in M l. It was observed that, despite
the surge, the annual rate of growth of M l, and also of
M2, over the 3, 6, and 12 months ending in April had
been lower than growth over the four quarters of 1977.
It was also noted that a significant degree of firming of
money market conditions had been achieved since the
April meeting of the Committee. Moreover, it was pointed
out, the administration’s new tax proposals — which had
just been announced — were considerably less stimulative
than the earlier ones, particularly as they affected the
fourth quarter of 1978. It was suggested that further
significant monetary firming at this time might risk pro
voking dislocations in financial markets that would con
tribute eventually to the onset of a downturn in economic
activity. Finally, it was argued, a very cautious approach
would give the Committee time to evaluate incoming
evidence concerning both the underlying strength of eco
nomic activity and the consequences of the firming that
had already been achieved.
In support of a somewhat more restrictive posture, it
was suggested that the relatively low rate of growth of
M l in the first quarter of 1978 represented an aberration
related to the temporary weakening in the pace of eco
nomic activity and that, abstracting from that aberration,
the trend of monetary expansion had accelerated. Views
were expressed to the effect that further significant firm
ing of money market conditions in the coming period in
order to moderate growth of the monetary aggregates
would have a beneficial effect on public confidence; that
partiy for that reason, such firming would reduce the
chances for a further build-up of inflationary forces, and
that it would increase the chances of achieving a rate of
growth in real output that could be sustained for the
longer term. In this connection, it was suggested that at
times in the past when high levels of resource use had
been approached, lags in the application of monetary
restraint had contributed to bringing on a downturn in
economic activity and to increasing the depth and duration
of the downturn. The comment was made that if further
significant action were not taken in the present circum
stances, current monetary policy might be found in rerospect to have been procyclical.
With respect to operating specifications for the period
ahead, most members preferred ranges of tolerance for
the annual rate of growth in M l over the May-June pe
riod that more or less encompassed the Committee’s
longer-run range of 4 to 6 V percent; the preferences
2
centered on 3 to 8 percent.
All of the members favored directing operations during
the coming inter-meeting period initially toward a Fed
eral funds rate slightly above the current rate, which was
in the area of 7Vi to 7% percent.
MARCH
1979
Meeting Held on June 20, 1978
Data that became available a few days before this meet
ing suggested that M l would grow in the May-June
period at an annual rate of about 7% percent, close to
the upper limit of its range. M2 also was projected to
grow in the 2-month period at a IVz percent rate, in the
upper half of the range specified for that aggregate. These
data suggested the need for Committee consultation, and
on June 16, in view of the proximity of the meeting sched
uled for June 20, the Committee voted to direct the Man
ager to continue for the time being to aim for a Federal
funds rate of IV2 percent.
Other market interest rates had risen further in recent
weeks. Reflecting not only the rise in the funds rate but
also substantial business credit demands, market rates on
short-term securities had increased from 30 to 60 basis
points since mid-May, and commercial banks had raised
the rate on loans to prime business borrowers in two steps
from 8 % to 8% percent. Yields on long-term securities
rose 5 to 20 basis points over the same period, apparently
in response to the rise in short-term rates and investor
concerns about the prospects for inflation.
The rate of expansion in total bank credit, which had
accelerated sharply in April, slackened somewhat in May
but remained above the average for other recent months.
Bank holdings of securities changed little, but total loans,
led by a surge in business loans, grew at an exceptional
pace.
The information reviewed at this meeting suggested that
output of goods and services had expanded rapidly on the
average in the second quarter, reflecting the economy’s
rebound in late winter and early spring from the effects
of the unusually severe winter weather and the lengthy
coal strike. More recently, however, the rate of expansion
appeared to have slowed. The rise in average prices —
as measured by the fixed-weighted price index for gross
domestic business product — accelerated markedly in the
second quarter, due in large measure to substantial in
creases in food prices.
The renewed downward pressure on the dollar appeared
to reflect market concern about the high rate of inflation
in the United States relative to rates in other industrial
countries and about the continuation of large deficits in
U.S. foreign trade and surpluses in the trade of Germany
and Japan.
In the Committee’s discussion of the economic situation
and outlook, the members generally agreed that the growth
in real output of goods and services over the coming three
quarters would be substantially slower on the average than
it had been in the unusually strong quarter just ending.
However, they still expected real GNP to grow at a mod
erate, average rate during the year ending with the second
quarter of 1979. . . . A majority feared that the rise in
prices would be greater than the staff anticipated. Most
members thought that the unemployment rate at the end
of the period would be little changed from the rates
recendy prevailing.
At this meeting, in discussing policy for the period im
mediately ahead, Committee members expressed consid
Page 19
F E D E R A L R E S E R V E BAN K O F ST. LO UIS
erable concern about recent rates of growth in the mone
tary aggregates, particularly in light of the continuing
strength of inflationary pressures and expectations. The
members agreed that open market operations in the inter
meeting period should be directed initially toward achiev
ing slightly firmer money market conditions, and that later
in the period the objectives of operations should depend
on incoming data for M l and M2.
There was greater diversity of views with respect to
the ranges of tolerance to be specified for the annual rates
of growth in M l and M2 in the June-July period. . . .
It was noted during the discussion that if the monetary
aggregates accelerated in June, as suggested by early data,
growth over the June-July period at rates near the mid
points of some of the lower ranges proposed could be
achieved only if there were to be a sharp slowing in
July. Some members, who were inclined to stress the
risks to the economy of rapid firming of money market
conditions, saw this circumstance as an argument for spec
ifying relatively high 2-month ranges for M l and M2.
Other members, who placed more stress on the importance
at this time of limiting growth in the aggregates for the
sake of moderating inflationary pressures and expectations,
thought such finning would be called for if the growth in
the aggregates did not in fact slow sharply.
Meeting Held on July 18, 1978
Incoming data throughout the inter-meeting period sug
gested that growth in the monetary aggregates would be
well within the ranges that had been specified by the
Committee, and the Manager continued to seek reserve
conditions consistent with a Federal funds rate averaging
about 7% percent. In the final days of the period the
funds rate fluctuated around a level somewhat above 7%
percent.
The expansion in total credit at U.S. commerical banks
slowed substantially in June from the unusually rapid
rates in the preceding 2 months, as growth of business
loans decelerated sharply after a surge in May. Growth
of other types of loans moderated as well, but bank
holdings of Treasury securities increased.
Despite the consensus that continuing moderate growth
in real GNP was still the most likely development, some
members suggested that for a number of reasons — in
cluding the high rate of inflation and developing financial
stringencies — the probabilities of such an outcome were
lower than they had seemed to be earlier. A few members
observed that the chances of a decline in output during
the period had increased.
All members of the Committee expected a continuation
of a rapid rate of inflation over the period to the second
quarter of 1979 — in the view of several members, even
more rapid than the pace projected by the staff.
Most members of the Committee thought that the un
employment rate a year ahead, in the second quarter of
1979, would be little changed from the average rate in
recent months, which was well below the level that had
been expected earlier. It was suggested that the rate of
Page 2 0
MARCH
1979
participation in the labor force would continue to rise, in
part because of the pressure of inflation on family budgets.
Several members proposed that for the time being
operations be directed toward maintaining the money mar
ket conditions currently prevailing. It was argued that, in
light of increased uncertainties in the economic oudook,
such a “pause” would afford the Committee an opportun
ity to evaluate additional evidence on the current situa
tion and outlook. It was suggested that, coming on top
of the considerable finning in money market conditions
over the past year or so, further significant firming would
risk bringing on a recession. It was also observed that the
restraining effects of the rise in interest rates over the
past month had not yet been fully felt and that any addi
tional firming that might be appropriate could be achieved
at a later time.
On the other hand, a number of members favored a
prompt further firming of money market conditions. Such
a course was needed, it was suggested, to bring growth in
M l within the Committee’s longer-run range. Given the
rate of inflation, it was argued, current levels of interest
rates were relatively low and were much less restrictive
in real terms than their nominal levels might suggest.
And the point was made that failure to pursue additional
firming at this time might well create a need for a greater
degree of firming later.
With respect to the Federal funds rate, most members
favored ranges centered either on 7% percent, the mid
point of the IVz to 8 percent range specified at the June
meeting, or on the somewhat higher level that had devel
oped in the most recent days; . . . A majority of the
members favored giving greater weight than usual to
money market conditions in the conduct of open market
operations until the next meeting.
Meeting Held on August 15, 1978
In the Committee’s discussion of the economic situation,
there was general agreement that the outlook for eco
nomic activity had changed litde since the July meeting,
and that in the year ending with the second quarter of
1979 output of goods and services was most likely to
grow at about the moderate pace projected by the staff.
This judgment was qualified by the recognition that the
weakness of the dollar in foreign exchange markets might
have unfavorable repercussions on the domestic economy.
Committee members who differed with the staff eco
nomic projection all expected average growth to be a little
less than the staff figure.
One negative element in this pattern, which seriously
concerned all members of the Committee, was the unex
pectedly high recent rate of inflation in prices and wages
and the related possibility that an appreciable slowing of
inflation would prove more difficult to achieve than pre
viously had been anticipated. It was observed in this con
nection that the declining value of the dollar in foreign
exchange markets was contributing significantly to inflation
in the United States. Nearly all the Committee members
expected price increases for the year ahead to be more
rapid than the staff was projecting.
F E D E R A L R E S E R V E BAN K O F ST. LO UI S
Other members of the Committee suggested that an
important change in the outlook since the July meeting
was an apparent stiffening in the resolve of labor leaders
to hold out in forthcoming contract negotiations for siz
able wage setdements. One member also cited apparent
efforts by some businessmen to accelerate increases in
wages and prices because of their concern that controls
might be imposed.
In the discussion of policy for the period immediately
ahead, most members expressed a preference for some
slight firming of money market conditions. Several mem
bers emphasized the need to restrain the expansion of
the monetary aggregates, especially in light of current and
prospective inflationary pressures. It was suggested that
an indication at this time of the System’s continued deter
mination to resist inflation would have a favorable impact
on confidence, both in the domestic economy and in for
eign exchange markets. With regard to the latter, the
members were seriously concerned about the weakness of
the dollar. They recognized that interrelated governmental
actions would be needed to make progress in this area.
No sentiment was expressed at this meeting for an eas
ing of money market conditions. On the other hand, it
was suggested that a sharp move toward restraint under
present circumstances might incur an undue risk of pre
cipitating a recession.
There were only small differences among most Com
mittee members in their preferences for operating speci
fications for the period immediately ahead. They were
nearly unanimous in favoring a return to basing decisions
for open market operations between meetings primarily
on the behavior of the monetary aggregates.
The Committee decided to include in its directive a
reference to developments in foreign exchange markets
as well as the usual reference to conditions.in the domes
tic financial markets. The purpose of the added instruc
tion was to provide the Manager with some flexibility to
adjust the nature and timing of his operations in light of
possible pressures on the dollar in foreign exchange
markets.
Meeting Held on September 19, 1978
Immediately following the August 15 meeting the Man
ager of the System Open Market Account began to seek
bank reserve conditions consistent with an increase in the
weekly-average Federal funds rate to around 8 percent.
Later in August, incoming data suggested that growth
in M l would be at the upper limit of the range specified
by the Committee and that growth in M2 would be close
to the upper limit of its range. Accordingly, the Manager
sought reserve conditions consistent with a further increase
in the Federal funds rate to 8 Vi percent, the upper limit of
the 7% to 8V4 percent range specified for the inter-meet
ing period.
In early September, available data suggested that both
M l and M2 would grow at rates significantly above the
upper limits of their respective ranges. With the Federal
funds rate already at its upper limit, the Committee de
cided on September 8, at a telephone conference meeting,
MARCH
1979
to raise the upper limit of the range for the Federal funds
rate to 8 V percent and to instruct the Manager to aim
2
promptly for a weekly-average Federal funds rate of
about 8% percent.
The rise in the Federal funds rate during the inter
meeting period was accompanied by appreciable increases
in rates on other short-term market instruments. Yields on
long-term securities, however, generally edged down.
After a surge in July, total credit at U.S. commercial
banks expanded at a substantially slower rate in August,
mainly because of large declines in bank holdings of U.S.
Treasury securities and in security loans. Growth in busi
ness loans accelerated further but remained well below
the average rate in the first half of 1978.
In the Committee’s discussion of the economic situation
and outlook, the members generally concurred with the
staff’s view that real output of goods and services would
grow at a moderate pace over the period from the second
quarter of 1978 to the second quarter of 1979. At the
same time, a number of members anticipated a little less
growth than the staff projected and one anticipated a
little more. The observation was made that even a slight
shortfall in growth of output from the rate projected by
the staff implied an upward drift in the unemployment
rate.
All members of the Committee expected a continuation
of a rapid rate of inflation over the period to the second
quarter of 1979 — in the view of several members, even
more rapid than the pace projected by the staff.
In the discussion of policy for the period immediately
ahead, considerable concern was expressed about recent
rates of monetary growth. It was observed that for an
extended period of time M l had been growing at rates
in excess of the longer-run range adopted by the Com
mittee and that a slowing of growth was necessary in
pursuit of the Committee’s objective of resisting inflation
ary pressures while encouraging continued moderate eco
nomic expansion. Most members believed that some addi
tional firming in money market conditions during the
next few weeks was needed to help assure a slowing in
growth of money over the months ahead, although they
differed with respect to the degree of firming that they
thought the Committee ought to contemplate.
In this connection, the comment was made that current
levels of interest rates were not exerting as much restraint
on credit flows as might be supposed. Thus, it was ob
served, interest rates adjusted for expected rates of infla
tion were not high and might even be negative. Moreover,
the degree of nonprice rationing of credit, particularly
credit for housing, had been reduced by such structural
changes in the financial system as the introduction of the
6-month money market certificates.
Two members, stressing the magnitude of the increases
in interest rates that had already occurred, proposed that
for the time being operations be directed toward maintain
ing the money market conditions currently prevailing. It
was argued that, in light of the recent slowing of the
expansion in economic activity and of uncertainties in the
economic outlook, such a “pause” would afford the Com
Page 21
F E D E R A L R E S E R V E BAN K O F ST. L OUI S
mittee an opportunity to evaluate additional evidence on
the current situation, including the effects of the recent
increases in interest rates. It was observed that, histori
cally, growth in output had never been held at about its
trend rate for very long and that further increases in in
terest rates at this time might slow growth to a rate below
trend or might even provoke an actual downturn.
Most of the members favored directing open market
operations toward an increase in the Federal funds rate
to about 8 % percent shortly after this meeting.
Meeting Held on October 17, 1978
Following the September 19 meeting the Manager of
the System Open Market Account began to seek bank re
serve conditions consistent with an increase in the weeklyaverage Federal funds rate to around 8¥2 percent. As
September progressed, incoming data suggested that
growth in M l would be around the upper limit of the
range specified by the Committee and that growth in M2
would be in the upper portion of its range. Accordingly,
the Manager sought reserve conditions consistent with
further increases in the Federal funds rate, and by late
September the rate was around 8% percent, the upper
limit of the inter-meeting range specified by the Com
mittee. During the first half of October the objective for
the funds rate remained 8% percent, although on many
days the rate was above or below that level for techni
cal reasons.
A considerable rise in interest rates on most short-term
market instruments was associated with the increase in
the Federal funds rate during the inter-meeting period.
The expansion in total credit at U.S. commercial banks,
which had slowed in August, accelerated in September
nearly to the pace experienced on the average in earlier
months of the year.
The Board of Governors announced an increase in Fed
eral Reserve Bank discount rates from 7% to 8 percent on
September 22 and a further increase to 8V percent on
2
October 13. Both actions were taken primarily to bring
the discount rate into closer alignment with other short
term interest rates, but also in recognition of conditions
affecting the dollar in foreign exchange markets. The
Board indicated in addition that the increase of Vz per
centage point in mid-October was approved in light of
the continued high rate of inflation and the recent rapid
expansion of the monetary aggregates.
In the Committee’s discussion of the economic situation
and outlook, the members generally agreed that real out
put of goods and services was likely to grow moderately
over the year ending in the third quarter of 1979, at a
rate about or a little below that projected by the staff.
. . . All members expected that average prices of goods
and services would continue to rise rapidly.
Despite the general agreement that real output was
likely to grow moderately over the next four quarters,
some members cited elements in the current situation that
could contribute to a downturn in activity before the end
of the period.
Page 22
MARCH
1979
In the discussion of policy for the period immediately
ahead, members of the Committee noted that the uncer
tainties associated with introduction of ATS would affect
growth of the monetary aggregates in the OctoberNovember period — the 2-month period for which growth
ranges were being considered — in much the same way
as they would growth over the year ahead. Specifically,
growth of M l over the 2-month period might well be less
than otherwise by a significant but undetermined amount,
and growth of M2 might be marginally greater.
As in the case of the longer-run ranges, various pro
posals were advanced for taking account of the unusual
uncertainties. In general, these proposals involved plac
ing less emphasis on the behavior of M l as a guide to
operations in the inter-meeting period and more on the
behavior of M2, rather than the approximately equal
weight that typically had been given to the two aggre
gates. . . . At the same time, most members of the Com
mittee favored giving greater weight than usual to money
market conditions in the conduct of operations in the
period until the next meeting of the Committee.
In the discussion, concern was expressed about recent
rates of monetary growth, and most members believed
that some additional firming in money market conditions
in the period immediately ahead was needed to help
assure a slowing in growth over the months ahead.
Other members believed that for the time being opera
tions should be directed toward maintaining the money
market conditions currently prevailing, as represented by
a Federal funds rate of about 8 % percent, because they
felt that such a pause was needed to evaluate the lagged
impact of the substantial increases in interest rates over
recent months.
Subsequent to the meeting, on October 31, the Com
mittee voted to approve a delegation of authority to
Chairm an M iller to take certain actions in im plem entation
of a broad Government program to strengthen the dollar
in foreign exchange markets and thereby to counter con
tinuing domestic inflationary pressures, if he determined
that the arrangements with the U.S. Treasury and with
certain foreign monetary authorities were substantially as
contemplated in a consultation among the members of the
Committee on the preceding day.
Early on the morning of November 1 the Treasury and
the Federal Reserve announced measures being taken to
implement such a program. Specifically, the Board of
Governors approved (1 ) an increase of 1 percentage
point, from 8 % to 9% percent, in the discount rate at
the Federal Reserve Bank of New York, effective immedi
ately, and ( 2 ) establishment of a supplementary reserve
requirement, in addition to the existing reserve require
ments on deposits at member banks, equal to 2 percent
of time deposits in denominations of $100,000 or more.
At the same time the System announced increases in its
reciprocal currency (swap) arrangements with the central
banks of Germany, Japan, and Switzerland by a total of
$7.6 billion, to $15 billion, and activation of the swap
arrangement with the Bank of Japan. It further stated that
the foreign currencies available under the expanded ar
rangements would be used along with foreign currencies
available to the Treasury in a program of forceful inter
F E D E R A L R E S E R V E BAN K O F ST. LO UI S
vention in the exchange markets in coordination with for
eign central banks to correct recent excessive movements
in exchange rates.
As part of this program, on October 31 the Federal
Open Market Committee voted to approve a delegation
of authority to Chairman Miller to modify the domestic
policy directive by raising the range for the Federal funds
rate to 9% to 9% percent and by instructing the Manager,
in deciding on the specific objective for the rate within
that range, to be guided by developing conditions in do
mestic and international financial markets. The Chairman
approved the modification of the directive on November
1, effective on that date.
Meeting Held on November 21, 1978
The rise in the Federal funds rate during the inter
meeting period was accompanied by substantial increases
in yields on most short-term market instruments. Advances
in rates on Treasury bills were moderated, however, by
large investments by foreign central banks of dollars ob
tained in currency support operations. Commercial banks
increased the rate on loans to prime business borrowers
from 10 percent to 11 percent during the period. Yields
in bond markets advanced considerably during the second
half of October, but a large portion of the increase was
offset by sizable declines in early November.
In the Committee’s discussion of the economic situation
and outlook, most members indicated that over the past
month they had scaled down their expected rates of
growth in real output of goods and services for the year
ending in the third quarter of 1979. One or two members
still anticipated moderate expansion over the period, but
many projected slow growth, and some thought that a
downturn in activity was likely or that the risks of an
actual recession or a growth recession had increased. It
was emphasized, however, that the uncertainties associ
ated with any forecast of real output had increased
significantly.
Most members expected that, over the year ending in
the third quarter of 1979, the unemployment rate either
would change little or would increase from the average
level in the third quarter of 1978. All members contin
ued to anticipate a rapid rise in average prices of goods
and services.
Some skepticism was expressed, as it had been at the
October meeting, that growth in output could be tapered
down to a relatively slow rate without bringing on a re
cession, especially in view of the rapid inflation. It was
stressed, on the other hand, that economic conditions in
this period differed from those in other business expan
sions in ways that made it reasonable to expect a reduction
in the rate of growth and a concomitant decrease in the
rate of inflation without a slide into recession.
In the discussion of policy for the period immediately
ahead, the members of the Committee agreed that, in
seeking to achieve bank reserve and money market condi
tions broadly consistent with the longer-run ranges for
monetary growth cited above, due regard should be given
to the program for supporting the foreign exchange value
of the dollar as well as to developing conditions in do
MARCH
1979
mestic financial markets and to uncertainties associated
with the November 1 introduction of ATS. Against that
background, the members differed somewhat in their
views as to whether, and to what degree, additional firm
ing in money market conditions should be sought during
the next few weeks; no sentiment was expressed for eas
ing money market conditions. As they had at the October
meeting, moreover, most members favored giving greater
weight than usual to money market conditions in the con
duct of operations in the period before the next meeting,
although some sentiment was expressed for a return to
basing decisions for open market operations primarily on
the behavior of the monetary aggregates.
With respect to the monetary aggregates, almost all
members proposed that the Committee take account of
the unusual uncertainties associated with the introduction
of ATS in the same way that it had at the October meet
ing — namely, by giving primary emphasis to growth of
M2 and by specifying only an upper limit, rather than a
range, for growth of M l.
Meeting Held on December 19, 1978
The narrowly defined money supply ( M l) declined at
an annual rate of about 4¥2 percent in November. The
contraction reflected, among other things, the shifts of
funds from demand deposits to savings deposits associ
ated with the introduction of the automatic transfer serv
ice (ATS) and effects of the substantial rise in short
term market interest rates since April. Meanwhile, growth
of M2 and M3 slackened further.
In subsequent weeks, newly available data led to pro
gressively lower estimates of growth, and by the end of
the first week in December the projections might, under
normal circumstances, have called for a reduction in the
objective for the Federal funds rate to 9% percent. On
December 8 , however, the Committee approved a recom
mendation by the Chairman to instruct the Manager to
continue aiming for a Federal funds rate of 9% percent
during the period before the next regular meeting of the
Committee, unless growth of the aggregates should appear
to weaken significantly further.
The information reviewed at this meeting suggested
greater strength in economic activity than had been evi
dent at the time of the Committee’s meeting a month
earlier. . . .
The growth of total credit at U.S. commercial banks was
appreciably slower in November than in September and
October. However, bank loans other than security loans
continued to expand rapidly. To finance this expansion
banks liquidated a sizable amount of security holdings
and issued a substantial volume of large-denomination
time deposits.
Most market interest rates rose further during the inter
meeting period, as financial markets seemed to react to
indications of continued strength in business conditions,
added evidence of intense inflationary pressures, and the
OPEC announcement of a large increase in oil prices.
In the Committee’s discussion of the economic situa
tion and oudook, most members expressed litde or no
Page 23
F E D E R A L R E S E R V E BAN K O F ST. L OUI S
disagreement with the staff projection of a gradual slowing
of the expansion during 1979 and of a slight rise in the
unemployment rate. At the same time, however, the ob
servation was made that the latest information provided
contradictory indications of underlying trends in economic
activity and some members commented on the prospects
for alternative courses of activity. The members continued
to anticipate that average prices of goods and services
would rise rapidly, and it was observed that the outlook
for inflation had been worsened by the recent OPEC
announcement of a substantial rise in oil prices during
1979.
Concerning the over-all situation, it was suggested on
the one hand that the current and prospective pace of
growth in activity was too rapid, that output was be
ginning to press against the limits of capacity, and that
inflationary pressures — which for a long time had been
greater than generally projected — were still increasing.
An alternative appraisal of the latest data was that the
strength in the current quarter, especially in consumer
spending, most likely was an aberration — similar to others
during the past few years — and that economic activity
was remarkably well balanced for the present stage of
the expansion. It was also suggested, however, that the
strength in demands and activity, although possibly per
sisting for a quarter or two, might culminate in a recession
for the second half of 1979.
In the discussion of policy for the period immediately
ahead, most members of the Committee advocated some
additional firming in money market conditions. A few
members preferred to direct operations toward maintain
ing the money market conditions currently prevailing. No
member recommended an easing in money market condi
tions per se, but one suggested that whether money mar
ket conditions were firmed or eased be determined alto
gether on the basis of the incoming evidence on the
behavior of the monetary aggregates.
Several reasons were advanced for some additional
firming in money market conditions. Available economic
data suggested that growth of output had not yet been
slowed and that inflationary pressures remained intense.
The strength of demands for bank loans and other credit
seemed to provide a more reliable indication of underly
ing economic conditions than did the recent weakness of
growth in the monetary aggregates. In any case, it was
observed, weakness in monetary expansion following a
long period of strong growth could be accepted for a
time. Some additional firming in money market conditions,
Page 24
MARCH
1979
moreover, would help to maintain public confidence in the
program to moderate inflation and to support the foreign
exchange value of the dollar.
In support of the preference for maintaining prevailing
money market conditions, rather than firming, it was ob
served that over the preceding 2 months the Committee
had increased monetary restraint substantially. Because
the evidence on current and prospective economic devel
opments was conflicting, the Committee ought to pause
and evaluate the effects of its recent actions before con
templating additional firming; if the unexpected shortfall
in monetary expansion persisted, it might contribute to a
recession. The uncertainties in the current situation also
provided the grounds for the proposal to base the Com
mittee’s objective for money market conditions altogether
on the incoming evidence on the behavior of the monetary
aggregates: It was suggested that whether fundamental
economic conditions were strong or weak would inevitably
become evident in renewal of rapid monetary expansion
or in continuation of sluggish expansion, leading in either
case to appropriate objectives for money market
conditions.
At the conclusion of the discussion the Committee
agreed to instruct the Manager to direct open market op
erations toward raising the Federal funds rate to 10 per
cent or slightly higher. . . .
Subsequent to the meeting, on December 29, 1978, pro
jections of growth in the monetary aggregates suggested
that for the December-January period M2 would grow at
an annual rate well below the lower limit of the 5 to 9
percent range specified by the Committee and that M l
would grow at a rate in the lower portion of its range of
2 to 6 percent. Since the meeting of the Committee on
December 19 the Manager had been aiming for a Federal
funds rate of about 10 percent or slighdy above, although
Federal funds had been trading at higher levels in re
sponse to exceptional demands for excess bank reserves
near the end of the year. The behavior of the aggregates
would have called for a reduction in the objective for the
funds rate toward the 9% percent lower limit of its speci
fied range. However, in view of uncertainties about the
interpretation of the behavior of the aggregates at this
time, and against the background of domestic and inter
national economic and market conditions, Chairman Miller
recommended that the Manager be instructed to continue
to aim for a Federal funds rate of 10 percent or slighdy
above, pending a review of the situation in the telephone
conference, tentatively planned for January 12.
Benefits of Borrowing from the Federal
Reserve when the Discount Rate is Below
Market Interest Rates
R. ALTON GILBERT
O n e o f the privileges o f membership in the F ed
eral Reserve System is borrow ing at the discount
window. Bankers generally rate access to the discount
w in dow as one o f the most, if not the most, important
benefits o f Federal Reserve m em bership.1 This paper
analyzes the distribution o f the benefits o f borrow
ing from the Federal Reserve w hen the discount rate
is b elow market interest rates, using data from Eighth
District member banks. Specifically, the issues consid
ered are whether the distribution o f such benefits is
concentrated or dispersed among member banks, and
whether these benefits accrue primarily to the larger
or smaller member banks.
THE DISCOUNT FUNCTION:
PURPOSES AND ADMINISTRATION
Lending to member banks is called the discount
function o f Federal Reserve Banks.2 In the early years
o f its operation, the Federal Reserve changed the
amount o f reserves in the banking system primarily
by discounting commercial paper. From 1917 through
1929, discounts and advances to member banks repre
sented substantial portions of member bank reserves,
and in some years were even larger than these re
serves. As initially developed, however, the purpose of
Federal Reserve discount policy was not only to pro1Peter S. Rose, “Banker Attitudes Toward the Federal Reserve
System: Survey Results,” Journal of Bank Research (Summer
1977), pp. 77-84.
2The term “discount function” originated from the mechanism
through which Federal Reserve Banks extended credit to
member banks in the early years of Federal Reserve System
operation. Member banks would sell short-term loans that had
been made to their commercial customers, endorsing the notes
to their Federal Reserve Banks and receiving a fraction of the
face amounts of the notes, the fraction reflecting the discount
rate. This operation is called discounting a note. Most Fed
eral Reserve loans to member banks are now called advances;
Federal Reserve Banks lend the amounts requested by mem
ber banks, with various types of assets submitted to the
Federal Reserve as collateral.
vide reserves to the banking system. The policy also
attempted to reduce speculation by refusing credit to
banks which used funds for such purposes, and to
increase the liquidity o f the banking system b y p ro
viding a means for banks to discount their com mercial
paper.3
Th e objectives o f the discount function are now
m ore limited. In most circumstances the Fed attempts
to restrict borrowings from the discount w indow to a
small percentage o f total member bank reserves by
keeping the discount rate close to other short-term
interest rates, and by requiring banks to reduce their
borrowings if they have exceeded certain general
guidelines. Since 1955, when objectives o f the dis
count function were redefined, discounts and ad
vances have averaged only 2.4 percent o f member
bank reserves, and have accounted for 3 percent or
more in only eight years.
The discount function is now view ed as a “safety
valve” for the banking system, allowing banks to
meet reserve requirements by borrow ing to adjust
their reserve positions to unusual shocks, such as
unanticipated deposit withdrawals or loan demands.
Credit through the discount w indow , generally avail
able only to m em ber banks, also is view ed as a service
which enhances the attractiveness of membership. O f
course, the Fed still has the important responsibility
o f lender of last resort in the event o f a financial
crisis.4
The Federal Reserve makes credit available to
m em ber banks for various purposes and maturities.
3Howard H. Hackley, L ending Functions of the F ederal Re
serve Banks: A History (Washington, D.C.: Board of Gov
ernors of the Federal Reserve System, 1973).
4For comments on how the Federal Reserve System views the
discount function, see R eappraisal of the F ederal Reserve Dis
count Mechanism, Volumes 1-3 (Washington, D.C.: Board of
Governors of the Federal Reserve System, 1971).
Page 25
F E D E R A L R E S E R V E BAN K O F ST. L OUI S
MARCH
Table I
Discount Rates on Advances to Mem ber Banks
Type of Credit
Current
Discount Rate
Adjustment and Seasonal Credit
Type of Collateral
Debt obligations of the U.S. Treasury and
Federal intermediate credit banks,
commercial, agricultural and industrial
paper eligible for discount at Federal
Reserve B anks,* and m ortgages on
one- to four-fam ily properties
A n y other collateral which a Federal
Reserve Bank considers to be satisfactory
Emergency Credit
9 .5 0 %
10.00
10.50
♦Section 13 o f the Federal R eserve A ct specifies paper eligible for
discount as follow s: “ notes, drafts, and bills o f exchange arising
out o f actual com m ercial tra n sa ction s; that is, notes, drafts, and
bills o f exchange issued or draw n fo r agricultural, industrial, or
com m ercial purpose, or the proceeds o f which have been used, or
are to be used, fo r such purp oses."
The differences in purpose and maturity are ex
pressed form ally in a three-way classification: adjust
ment credit, seasonal credit, and emergency credit.
Guidelines have been developed for extending each
category o f credit to ensure that member banks b or
row only for “ appropriate” purposes.
Adjustm ent credit is available to meet unexpected
temporary credit demands caused b y sudden deposit
withdrawals or unanticipated increases in loan de
mand. Regulations specify that member banks are not
to borrow in order to profit from differences between
the discount rate and market interest rates. In par
ticular, banks are not to he n et sellers o f Federal funds
w hile receiving adjustment credit.5
Maturities o f adjustment credit loans range from
one to thirty days, but can be renew ed.6 Reserve
Banks generally grant adjustment credit immediately
upon request.7 However, the longer a reserve adjust
ment loan is outstanding, the more thoroughly the
Reserve Bank lending personnel inquire about the pur5An exception to this policy applies to member banks that hold
deposits of the U.S. Treasury on which they pay interest.
Those banks may lend in the Federal funds market amounts
equal to the Treasury deposits and still be eligible to receive
adjustment credit from the discount window.
6E verything You Always W anted to Know A bout Borrowing at
the D iscount W indow (B ut D id N ot Ask) (Federal Reserve
Bank of Kansas City, January 1978), pamphlet, pp. 2-3.
7Although adjustment credit is granted upon request, prior
arrangements between member banks and their Reserve Banks
are necessary. A certificate authorizing certain officers of a
member bank to initiate borrowing requests must be on file
with the Reserve Bank. Loans to member banks must be fully
Page 26
1979
poses for borrow ing and the reasons why a member
bank has not arranged for other sources o f finance.
The discount rate on adjustment credit depends
upon the type o f securities m em ber banks use for col
lateral. Table I specifies the types o f assets which
Reserve Banks accept as collateral and the current
discount rates which apply to loans with different
types of collateral.
Seasonal credit is available to m em ber banks with
total deposits o f less than $500 million which have
seasonal patterns in their deposits and loans. (Larger
banks generally have a greater ability to cop e with
seasonal influences.) Seasonal borrow ing must be for
four weeks or longer, and most banks arrange for
seasonal credit in advance. M em ber banks m ay be
net sellers o f Federal funds while borrow ing seasonal
credit, as long as they d o not increase their sales of
Federal funds b y unusual amounts while borrow ing.8
The interest rate on seasonal credit is the same as
that on adjustment credit. If the discount rate changes
while a bank has an outstanding loan, the interest
rate on this loan is adjusted from the effective date of
the change. Such changes o f the discount rate apply
to both seasonal and adjustment credit.
E m ergency credit may b e m ade available to mem
ber or nonmember banks with severe financial diffi
culties. Banks that receive em ergency credit presum
ably are unable to borrow from sources other than
the Federal Reserve, and therefore, are likely to
borrow from the Fed for extended periods of time.
The discount rate on loans classified as emergency
credit is higher than that on adjustment and seasonal
credit.9 Reserve Banks have some discretion in deter
mining the conditions under which the higher dis
count rate should be applied. A general guideline
Reserve Banks use to classify a loan as em ergency
collateralized. Member banks which borrow frequently es
tablish continuing lending agreements with their Reserve
Banks. Under these agreements, the banks use certain bonds,
which they hold in safekeeping with their Reserve Banks, as
collateral for adjustment credit loans. Officers of member
banks which have established the authority to borrow and
have set up continuing lending agreements can receive adjust
ment credit by telephoning their Reserve Bank. If an officer
calls before a specified time of the day, the amount of the
loan is credited to the member bank’s reserve account that
same day.
8Everything You Always W anted to Know, pp. 3-4. There is
no official formula for determining the permissible amount that
a seasonal borrower may lend in the Federal funds market.
Reserve Bank lending personnel make that judgment for each
seasonal borrower.
9In a national emergency, member banks may be exempt from
paying the higher discount rate on emergency credit.
F E D E R A L R E S E R V E BAN K O F ST. LO UIS
MARCH
credit is continuous borrow ing o f m ore
than a bank’s required reserves for more
,
r
. n
t an our wee s.
1979
.
**
u
d
i n
M e m b e r B a n k B o rro w in gs
Qn(j S h o r t -T e r m Interest R a t e D iffe r e n tia l
MEASURING
THE BENEFITS
OF BORROWING FROM
THE FEDERAL RESERVE
Total benefits of access to the discount
w in dow are difficult to measure, since
these benefits are somewhat subjective.
Access to credit in em ergency situations
is important to many member banks
which either seldom borrow or do not
plan to borrow from the Fed except in
em ergency situations. The value of ac
cess to credit from the lender o f last
resort depends upon the bankers’ views
on the probability o f em ergency situa
tions developing and the benefits of
avoiding such risks.
L a t e s t d a t a p lo tte d : F e b r u a r y
One benefit which can be easily quan
tified, however, is the interest expense
saved b y banks which borrow when
the discount rate is below interest rates on alternative
sources o f funds. As Chart I indicates, borrowings
are typically small when the discount rate is above
the Federal funds rate. During such periods, mem
ber banks rely primarily on other sources of funds
in adjusting their reserves to seasonal influences, un
anticipated deposit withdrawals, and unexpected loan
demands. In contrast, when the Federal funds rate
rises above the discount rate, borrowings increase
sharply.
In the follow ing analysis, benefits are measured as
interest expense saved b y borrow ing at the discount
rate instead o f borrow ing the same amount at the
Federal funds rate. These savings in interest expense
relative to reserve balances held at the Federal R e
serve are used to analyze variations in the benefits
BORROWING BY EIGHTH DISTRICT
MEMBER BANKS: 1974 TO 1977
Since most mem ber banks never borrow — even in
periods when the discount rate is substantially below
market interest rates — benefits from borrow ing at the
Fed are concentrated in a small percentage of mem
ber banks.10 For example, only about one-fourth of
Eighth District member banks borrow ed in 1974
(T a ble II), a year in which the discount rate was
below the Federal funds rate by an unusually wide
margin. In addition, only about 7 percent o f member
banks borrow ed during 1976, when the discount rate
was above the Federal funds rate for 344 days.
In each year the percentage o f member banks that
borrow ed was higher for large banks than for small
banks. For instance, com pare the percentages o f banks
o f various sizes w hich borrow ed in 1974 and 1976. In
among banks of different size. In addition, the re
sponsiveness o f member banks to borrow ing when the
discount rate is below the Federal funds rate is ana
lyzed, using the interest expense saved per dollar
borrow ed, which is highest for banks which borrow
when
the
differential
greatest.
betw een
the
tw o
rates
is
10The pattern of borrowing at the discount window by Eighth
District member banks in the years 1974-77 is similar to
that in other periods and other Districts. See Andrew F.
Brimmer, “ Member Bank Borrowing, Portfolio Strategy, and
the Management of Federal Reserve Discount Policy,” W est
ern Economic Journal (September 1972), pp. 243-97; and
A. A. Dill, “ Member Bank Borrowing: Process and Expe
rience,” Federal Reserve Bank of Atlanta Review (April
1973), pp. 50-54.
Page 27
F E D E R A L R E S E R V E BANK O F ST. LOUIS
MARCH
1979
Table II
Analysis O f Borrowing By Eighth District Member Banks From The Federal Reserve
(1 )
Size G roup
(Total assets in
millions of dollars)
Total
Num ber of
Member
Banks
(2 )
Percent
of Banks
that
Borrowed
(3 )
(4 )
(5)
(6)
(7 )
Total Dollar
Benefit from
Borrowing
Percentage
Allocation
Percentage
of Total Dollar
Allocation
Am ount of
of Total Assets
Borrowing
Am ong All
Am ong
Mem ber B anks1 Size G roups
Percentage
Distribution
of Benefit
Average
Benefit
Per Dollar
Borrowed
(1 9 7 4 )
Less than $ 1 0
97
1 0 .3 %
.4 %
2 .9 %
$
7 ,7 5 5 .5 0
.5 %
$ 0 .0 3 4 4
$ 1 0 - $24 .9
174
20.1
13.4
2.3
4 2 ,0 2 7 .0 3
2.7
0 .0 3 3 5
$ 2 5 - $4 9 .9
88
33.0
13.4
4.4
73 ,5 7 9 .6 0
4.8
0 .0 3 0 5
$ 5 0 - $ 9 9 .9
41
46.3
12.8
7.0
1 1 7 ,3 5 6 .6 9
7.6
0 .0 3 0 5
16.9
3 0 9 ,4 8 0 .6 8
20.1
0 .0 3 3 2
69.0
9 9 2 ,4 9 0 .0 5
64.3
0 .0 2 6 2
$ 1 0 0 - $ 3 9 9 .9
19
63.2
14.4
$ 4 0 0 an d over
10
100.0
43.1
A ll Sizes
429
2 6 .8 %
1 0 0 .0 %
10 0 . 0 %
$ 1 ,5 4 2 ,6 8 9 .5 5
1 0 0 .0 %
(1 9 7 5 )
Less than $ 1 0
-1 2 .6 %
168
4.8
12.3
3.1
-4 4 6 .6 7
-1 5 .1
-0 .0 0 2 7
87
5.8 %
2 .5 %
$ -0 .0 0 4 0
-3 7 4 .6 3
$ 1 0 - $2 4 .9
1 .8 %
$
$ 2 5 - $4 9 .9
102
15.7
15.1
15.1
-3 ,3 4 5 .8 7
-1 1 3 .1
-0 .0 0 4 2
$ 5 0 - $9 9 .9
40
12.5
12.3
9.3
7 3 9 .2 4
25.0
0 .0 0 1 5
$ 1 0 0 - $ 3 9 9 .9
22
18.2
16.0
10.3
1,725.88
58.4
0.0031
$ 4 0 0 and over
10
50.0
41.9
60.4
4,65 9 .5 8
158.2
0 .0 0 1 4
1 0 0 .0 %
1 0 0 .0 %
2,957.53
1 0 0 .0 %
A ll Sizes
429
1 0 .0 %
$
(1 9 7 6 )
Less than $ 1 0
77
$ 1 0 - $24 .9
150
6 .5 %
3.3
-2 4 6 .7 7
4 .3 %
10.3
2 .1 %
5.3
2 .6 %
-3 2 1 .5 6
5.6
$
$ -0 .0 0 4 6
-0 .0 0 2 9
$ 2 5 - $49 .9
126
7.1
17.8
29.6
-1 ,8 9 4 .8 0
33.3
-0 .0 0 3 1
$ 5 0 - $9 9 .9
40
5.0
11.8
7.5
-3 3 9 .8 0
6.0
-0 . 0 0 2 2
$ 1 0 0 - $ 3 9 9 .9
27
18.5
18.5
21.6
-1 ,5 9 5 . 9 2
28.0
-0 .0 0 3 6
$ 4 0 0 and over
10
60.0
39.5
33.4
-1 ,2 8 9 .4 8
22.7
-0 .0 0 1 9
1 0 0 .0 %
$
-5 ,6 8 8 . 3 3
1 0 0 .0 %
$
-6 7 .0 3
-.1 %
All Sizes
430
7.4 %
1 0 0 .0 %
Less than $ 1 0
62
8 .1 %
1 .6 %
(1 9 7 7 )
.2 %
$ -0 .0 0 1 3
$ 1 0 - $24 .9
143
7.0
9.1
1.4
1,202.27
1.0
0 .0 0 3 7
$ 2 5 - $4 9 .9
123
13.0
16.3
3.4
4 ,0 7 0 .0 7
3.3
0.0051
$ 5 0 - $99 .9
52
19.2
13.7
3.1
3,826.05
3.1
0 .0 0 5 3
$ 1 0 0 - $ 3 9 9 .9
31
38.7
19.7
30.8
4 0 ,7 8 9 .0 3
32.8
0 .0 0 5 6
10
100.0
59.9
0.0051
$ 4 0 0 and over
A ll Sizes
421
1 5 .0 %
39.6
61.2
74,571.81
1 0 0 .0 %
1 0 0 .0 %
12 4 ,3 9 2 .2 0
P e rc e n ta g e distribution based upon total assets as o f June 30 each year.
Page 28
$
1 0 0 .0 %
F E D E R A L R E S E R V E BANK O F ST. LOUIS
MARCH
1979
1974, a year when the average differential between the
Federal funds rate and the discount rate was relatively
wide, only 10 percent o f member banks with total
assets less than $10 million borrow ed from the Fed,
whereas 100 percent of banks with total assets over
$400 million borrowed. In 1976, 6.5 percent of banks
in the smallest category borrow ed, com pared to 60
percent o f banks in the largest category.11
greater than during any o f the past ten years. H ow
ever, this differential was almost as w ide during peri
ods in 1969-70 and 1973. Thus, the response o f mem
ber banks to the availability o f substantial benefits
from borrow ing during 1974 does not represent unique
bank behavior, but is assumed to be typical o f mem
ber banks’ response to the relatively large benefits
which are occasionally available.
The percentage distribution o f the dollar amount of
borrowings among banks o f various sizes depends
upon whether the discount rate is above or below the
Federal funds rate. M em ber banks with total assets of
$400 million or m ore accounted for about 43 percent
o f the assets (T a b le II, column 3 ), and for about 69
percent o f total borrowings (colum n 4 ) o f all Eighth
District member banks in 1974. For member banks in
the smaller categories, shares o f total borrowings were
smaller than shares o f total assets in 1974. In contrast,
the larger banks accounted for a smaller share
o f total borrowings (33.4 percent) than total assets
(39.5 percent) in 1976, when the discount rate was
generally above the Federal funds rate. Thus, a
greater share o f Reserve Bank lending goes to the
relatively large banks in periods w hen the discount
rate is below the Federal funds rate.
In 1977, the other year analyzed, the discount rate
was above the Federal funds rate for the first four
months. However, the Federal funds rate exceeded
the discount rate for the rest of the year, with the
differential rising to about 75 basis points for a few
weeks during the summer and fall. An analysis of the
borrow ing patterns o f individual member banks dur
ing 1977 demonstrates their response to a change in
the differential betw een the Federal funds rate and
the discount rate from negative to positive.
DISTRIBUTION OF BENEFITS FROM
BORROWING AT A RELATIVELY LOW
DISCOUNT RATE
Distribution of the benefits to member banks is
analyzed for tw o years.12 The first year is 1974, in
which these benefits were substantial. The differential
betw een the Federal funds rate and the discount rate
rose to over 5 percentage points around mid-1974, and
averaged about 2.7 percentage points that year —
u The restriction that banks not lend in the Federal funds mar
ket while receiving adjustment credit may be one important
reason why proportionately fewer of the small member banks
borrow. Most o f the small banks are generally net lenders in
the Federal funds market. However, as noted above, member
banks which have pronounced seasonal patterns in their de
posits and loans may obtain seasonal credit while continuing
their usual amounts of lending in the Federal funds market.
12Benefits to a member bank from borrowing are calculated for
each day by dividing the difference between the Federal
funds rate and discount rate by 365 (since those interest
rates are stated as percent per annum) and multiplying by
the amount borrowed. Benefits are calculated for each year
by summing daily benefits. The discount rate used in cal
culating benefits from borrowing at the discount window is
the lowest discount rate available to member banks in the
Eighth District on each date, which are loans under sections
13 and 13a of the Federal Reserve Act. During the years
covered by this study, 1974-77, no Eighth District member
bank was classified as receiving emergency credit.
Distribution of Benefits in 1974
During 1974, 115 Eighth District member banks
received benefits of about $1.5 million from borrow
ing at the discount w in dow (T a ble II, colum n 5 ).
These benefits were concentrated am ong the larg
est banks (colum n 6 ). The ten banks with total assets
over $400 million had a saving of interest expense
equal to almost $1 million, about 64 percent of total
benefits from borrowing. In contrast, member banks
with total assets less than $100 million — which com
prised 93 percent o f all member banks in the Eighth
District and w hich held 43 percent o f total assets —
received only about 16 percent o f the benefits.
That the relatively large banks received such a
large proportion o f the benefits reflects, to some ex
tent, the fact that most of the large banks bor
row ed in 1974, whereas fe w o f the smaller banks
borrow ed. A m ethod of analyzing the distribution of
benefits am ong individual m ember banks is to ex
amine the size o f their benefits relative to some
measure o f bank assets or liabilities. This approach
shows whether the small member banks which bor
row ed in 1974 received benefits, relative to their size,
com parable to those received by larger banks. The
measure used to adjust for bank size is average reserve
balances held at the Fed. Thus, benefits which ac
crue to member banks from borrow ing are calculated
as im plicit rates of return on average reserve balances
held at the Fed.
Benefits from borrow ing in 1974 as percentages of
reserve balances fo r various-sized banks are presented
Page 29
F E D E R A L R E S E R V E B A N K O F ST . L O U I S
MARCH
1979
Table III
Additional Analysis O f Borrowing By Eighth District Member Banks From The Federal Reserve In 1974
(1 )
Size G roup
(Total assets
in millions
of dollars)
Num ber of
Banks that
Borrowed
(2)
Num ber of
Banks that
Borrowed
M ore than
30 Days
(3)
(4 )
(5 )
Benefit from Borrow ing as a Percent
of A verage Reserves at the Fed:
(6 )
(7 )
(8)
Num ber of Banks that
Borrowed, with Benefit
from Borrowing as a
Percent of Average
Reserves at the Fed:
A ll Banks
that
Borrowed
A ll Banks
Borrowing
M ore than
30 Days
Range
Below
0 .1 0 %
0 .3 6 %
0 .6 7 %
0 .0 2 0 % - 2 .1 4 0 %
3
3
2
Above
0 .5 0 %
Above
0 .7 5 %
Less than $ 1 0
10
6
$ 1 0 - $2 4 .9
35
15
0.18
0.35
0 .0 0 3 % - 0 .7 5 4 %
21
3
2
$ 2 5 - $49 .9
29
13
0.19
0.35
0 .0 0 1 % - 1 .2 9 2 %
17
4
2
$ 5 0 - $99 .9
19
13
0.13
0.15
0 .0 0 3 % - 0 .5 9 4 %
7
2
0
$ 1 0 0 - $ 3 9 9 .9
12
11
0 .3 4
0.36
0 .0 0 8 % - 0 .648%
1
4
0
$ 4 0 0 and over
10
10
0.25
0.25
0 .1 9 4 % -0 .3 0 8 %
0
0
0
in Table III, column 3. The average
on reserve balances were largest for
total assets up to $10 million (0.36
almost as high for banks with total
$100 and $400 million (0.34 percent).
rates o f return
the banks with
p ercent), and
assets between
One factor which limits the usefulness of this rate
o f return in making comparisons among different
sized banks is that banks borrow for varying lengths
o f time (T a b le III, columns 1 and 2 ). T o adjust for
this influence, benefits as percentages of reserve bal
ances are recalculated, eliminating those banks which
borrow ed thirty days or less (colum n 4 ). This adjust
ment has a substantial effect on the average implicit
return on reserve balances for banks with total assets
less than $10 million, raising the return from 0.36
percent to 0.67 percent.
Another way to examine the distribution o f benefits
am ong individual member banks which borrow ed in
1974 is to examine the dispersion o f these benefits
am ong banks of similar size. Benefits from borrow
ing as percentages o f average reserve balances at
the Fed are rather narrowly dispersed for the ten
largest banks, essentially betw een 0.2 percent and 0.3
percent, with a 0.25 percent return for the group as a
whole. This narrow dispersion of benefits reflects the
fact that all ten banks borrow ed substantial amounts
in 1974, and that administrative actions b y Federal
Reserve Bank lending personnel kept borrowings
within the limits which apply to the amounts and
duration o f borrow ing of each member bank. The
smaller member banks w hich borrow ed most heavily
in 1974 received benefits which, as percentages of
their average reserve balances at the Fed, were sub
stantially higher than those for any o f the ten largest
banks.
Digitized forPage 30
FRASER
One way to determine the importance of these
benefits is to com pare them to other benefits banks
receive from Fed membership. The value of “free”
Fed services, other than access to the discount w in
dow , average about one-half percent o f reserve bal
ances at the Fed fo r m em ber banks with total assets
less than $50 m illion.13 Thus, when com pared to the
implicit rates o f return from use o f other F ed services,
the benefits some banks obtained b y borrow ing from
the F ed in 1974 appear to be substantial. For instance,
the six banks with total assets less than $10 million
that borrow ed m ore than thirty days received benefits
that probably exceeded the value of other Fed serv
ices they used that year. Thus, several smaller banks
obtained major increases in their benefits from Fed
membership in 1974 b y borrow ing from the Fed when
the discount rate was substantially below the Federal
funds rate.
Distribution of Benefits in 1977
The year, 1977, is a good period for examining the
relationship betw een timing o f borrow ing b y member
banks and changes in the differential betw een the
Federal funds rate and the discount rate. The dis
count rate was a bove the Federal funds rate during
the first four months of 1977, the differential averag
ing 54 basis points. From M ay through July, the dis
count rate was slightly below the Federal funds rate,
with an average differential o f 14 basis points. The
differential rose to over 70 basis points for about four
weeks in late summer and fall o f that year. From
13R. Alton Gilbert, “ Utilization o f Federal Reserve Bank Serv
ices By Member Banks: Implications for the Costs and Bene
fits of Membership,” this Review (August 1977), pp. 2-15.
MARCH
F E D E R A L R E S E R V E BANK O F ST. LOUIS
August through D ecem ber, the discount rate was b e
low the Federal funds rate b y an average o f 56 basis
points.
Fifteen percent of all Eighth District member
banks borrow ed in 1977 (T a ble II, column 2 ). The
percentage o f member banks w hich borrow ed is
positively related to bank size. The total dollar
amount borrow ed was concentrated among the larg
est banks; those with total assets over $100 million
accounted for about 59 percent o f total assets o f all
Eighth District m em ber banks, but 92 percent of
total borrowing. The total dollar benefit to Eighth
District m em ber banks from borrow ing in 1977 was
about 8 percent of the total for 1974. The total benefit
was also concentrated among the largest banks; m em
ber banks with total assets over $100 million received
92.6 percent of the benefit.
The average benefit per dollar borrow ed, shown in
the last column o f Table II, is used to analyze
borrow ing patterns in 1977.14 Banks which borrow ed
primarily when the differential between the Federal
funds rate and the discount rate was both positive
and relatively large had the highest average benefits
per dollar borrowed.
Banks in each size group with total assets o f $25
million or more have approximately the same average
benefits per dollar borrow ed, averaging about 0.5
cents per dollar borrowed. In contrast, banks with
total assets between $10 and $25 million had average
benefits per dollar borrow ed o f 0.37 cents, and banks
with assets up to $10 million had negative average
benefits o f 0.13 cents per dollar borrowed. Thus,
m em ber banks with total assets less than $25 million
appear to be less responsive in timing their borrow
ing from the Fed to the size of the differential b e
tween the Federal funds rate and the discount rate.
1979
Table IV
Average Benefit Per D ollar Borrowed
By Eighth District Mem ber Banks In 1977
_
Size G roup
(Total assets
in millions
of dollars)
.,
,
Num ber
of Banks
that
Borrowed
. . . .
Num ber of
_
.
Frequent
Borrowers
in 1 9 7 5
or 1 9 7 6 1
A verage Benefit Per
_
„
,
Dollar Borrowed
AH
Borrowers
Frequent
Borrowers
Deleted
$ 0 .0 0 4 8
5
2
$ -0 ,0 0 1 3
$ 1 0 - $2 4 .9
10
3
0 .0 0 3 7
0 .0 0 4 7
$ 2 5 - $4 9 .9
16
4
0.0051
0 .0 0 5 3
$ 5 0 - $9 9 .9
10
12
10
3
0 .0 0 5 3
0 .0 0 5 5
2
0 .0 0 5 6
0 .0 0 5 6
3
0.0051
0.0061
Less than $ 1 0
$ 1 0 0 - $ 3 9 9 .9
$ 4 0 0 and over
*Bank which borrow ed in 1977 and also borrow ed on three o r m ore
occasions in either 1975 or 1976.
from the discount w in dow regularly in making short
term reserve adjustments to unanticipated events, such
as deposit withdrawals or loan demands, and d o not
change that m ethod o f reserve management when the
discount rate rises slightly above short-term market
interest rates.
In a year such as 1977, banks w hich borrow fre
quently as part of their regular approach to reserve
management are likely to have low er average benefits
per dollar borrow ed than banks which borrow only
when the discount rate is b elow the Federal funds
rate b y a relatively w ide margin. Frequent borrowers
are m ore likely to have borrow ed during the first
part of the year when the discount rate was above
the Federal funds rate, or when the benefits from b or
row ing were relatively low, since borrow ing during
those periods may have been dictated by their reserve
management policies.
This conclusion may be misleading because influ
ences on borrow ing patterns other than bank size
have not been held constant. An additional influence is
the use o f the discount w in dow for reserve adjustment
on a routine basis. Some member banks borrow infre
quently, primarily when the discount rate is below
the Federal funds rate, whereas other banks borrow
at the discount w indow several times each year, even
during periods when the discount rate is a slight
penalty rate. Frequent borrowers apparently borrow
T o determine whether such a pattern exists, banks
which borrow ed in 1977 are divided into tw o groups:
those that borrow ed frequently in previous years,
and those that borrow ed infrequently. Frequent bor
rowers are those that borrow ed on three or more
separate occasions in either 1975 or 1976, when the
discount rate was generally above the Federal funds
rate.15 Average benefits per dollar borrow ed in 1977
are recalculated for each group o f banks, eliminating
the frequent borrowers. As indicated in Table IV,
this adjustment increases the average benefit per
dollar borrow ed for banks in all but one size group:
banks with total assets between $100 and $400 mil
14This measure is calculated for a bank by dividing the dollar
amount o f its benefit by average daily borrowings from the
Fed, which equals the sum o f amounts borrowed on each
day divided by 365.
15Specification of banks as frequent borrowers is not in terms
of borrowing for three or more days, but borrowing for three
or more distinct periods of one or more days each, with inter
vening periods o f no borrowing.
Page 31
lion have the same average benefit after eliminating
the frequent borrowers. The differences between the
average benefit per dollar borrow ed for banks with
total assets less than $25 m illion and those for most of
the larger banks are narrowed b y rem oving the fre
quent borrowers. Thus, the relatively small member
banks w hich borrow infrequently appear to be about
as sensitive as most of the larger banks to borrow ing
when the differential between the Federal funds rate
and the discount rate is relatively w id e.16
CONCLUSIONS
One benefit o f Federal Reserve membership is the
savings in interest expense which accrues to member
16The purpose of distinguishing between frequent and infre
quent borrowers in this paper is to examine the responsive
ness of relatively small banks which borrow infrequently to
borrowing when the discount rate is below the Federal funds
rate. However, in making the distinction between frequent
and infrequent borrowers, additional issues are raised. W hy
do some member banks borrow frequently? What is the
value of the discount window to frequent borrowers? If fre
quent borrowers became nonmember banks, what sources of
short-term credit would they use as substitutes for adjust
ment credit from the discount window? These issues are
beyond the scope of this paper.
banks that borrow from the Federal Reserve when
the discount rate is b elow short-term market interest
rates. The dollar amounts o f such benefits are con
centrated am ong the largest banks since most o f the
smaller banks never borrow.
M em ber bank borrowings during 1974 were ex
amined in detail, since that was a year in which the
differential betw een the Federal funds rate and the
discount rate was relatively w ide. W ith the savings
in interest expense from borrow ing at the discount
w indow com puted as a percentage of average reserve
balances at the Federal Reserve, the relatively small
member banks which borrow ed heavily during 1974
benefited as m uch or m ore than the large banks.
Borrowing patterns in 1977 provide evidence on
h ow member banks respond when the differential
betw een the Federal funds rate and the discount rate
changes from negative to positive. Except fo r mem
ber banks w hich borrow frequently as part o f their
reserve management strategies, the relatively small
member banks which borrow at the discount w indow
appear to be about as sensitive as larger banks to
borrow ing during periods when the discount rate is
below the Federal funds rate.
@FedFRASER