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FEDERAL RESERVE BANK OF ST. L O U IS may 1971 o l. 5 3 , N o . Digitized for V FRASER 5 The Economy: A Moderate Recovery I OTAL SPENDING on goods and services rose at a 7.3 per cent annual rate from the third quarter of 1970 to the first quarter of 1971, compared with a 4.6 per cent increase in the preceding year. A consider able first quarter spurt in the pace of overall economic activity can be attributed largely to a reversal of those forces accompanying work stoppages in the automobile industry late last year. First quarter gains in the auto sector accounted for about two-thirds of the $30.8 billion increase in GNP. Monetary growth, as measured by the narrowly defined money supply, accelerated sharply in early 1971. Most interest rates are currently higher than their February or March lows, though still well below the 1969-70 peaks. Federal Government expenditures, which have a short-run stimulative effect on total spending, rose more rapidly in early 1971 than in the previous two quarters. Some progress in combating inflation has become apparent this year, while unemployment has remained at about 6 per cent of the labor force. Cutbacks in Demand and Production R a tio S c a le Q uarterly Totals at Annual Rates R a tio S ea l# T rillio n s o f D o lla rs ___________________Seasonally Adjusted__________________ T rillio n s o f D o lla rs Total Spending n Real Product £ 1963 1964 1965 1966 1967 1 968 12GNP in current dollors. [2 GNP in 1958 dollars. Percentages are a nnual rates of c h a n g e lo r perio d s indicated. Latest d a ta plotted: 1st quarter Page 2 1969 1970 1971 Source: U.S. Department of Commerce defense spending have led to significant unemploy ment in defense-related industries. Continuation of rapid monetary expansion, however, probably would be reflected in considerable gains in total spending, but would entail the risk of re-enforcing still formida ble inflationary pressures. Stabilization Actions The recent monetary ease evidenced in the growth of the money stock is an extension of the expansive policies undertaken last year. The Federal budget, on a national income accounts basis, has been in sub stantial deficit since early 1970, compared with a large surplus in 1969. On a high-employment basis, which provides a better measure of fiscal stimulus, the budget has been in surplus and has changed little in recent quarters. Monetary Actions The monetary base, the prime determinant of growth in the money supply,1 increased at a 10.5 per cent rate from November to April, compared with a 6.2 per cent rate from February 1970 to November and a 2.9 per cent rate in the preceding eleven months. The growth pattern of Federal Reserve credit, the principal source component of the monetary base, has been similar to that of the base. Federal Reserve credit rose at a 13.6 per cent rate from November to April, compared with a 6.5 per cent rate from Febru ary 1970 to November and a 3 per cent rate in the preceding eleven months. Money increased at a 12.5 per cent annual rate in the three months from January to April, after rising 4.7 per cent in the year ending in January. The growth of the money supply over the past three months was greater than any other consecutive three-month period since January 1950. The growth of the monetary base and Federal Reserve credit 'See “Elements of Money Stock Determination,” this Review (October 1969), pp. 10-19, for an explanation of the linkages between the monetary base and the money supply. F E D E R A L R E S E R V E B A N K OF ST. LO U IS MAY 1971 M o n e y Stock a n d M o n e t a r y B a se Sea onolly Adj sted 250 +3.0% Mon y Stock 200 +2.5% + 55% , ^ 2 2 1 .2 + 6.37 ■3.8%_____ - 0 5% 150 ?0 c Jt 58 s 1 < t i 100 5 c £ 11 t 90 Monetary Base* 80 100 +6 £ % , ^ 8 6 .0 +2.2% 90 80 6 J% ^^ +1.2% 70 + 5 .1% 3 3 ■R t 1963 1964 1965 1966 R 5 a 5 2 2 « - i— t t 1967 1968 1969 1970 50 ( 1971 •Uses of the monetary base are member bank reserves and currency held by the public and nonmember banks. Adjustments are made for reserve requirement changes and shifts in deposits among classes of banks. Data are computed by this bank. Percentages are annual rates of change for periods indicated. Latest data plotted: April the first quarter, compared with an average surplus of $7 billion in calendar year 1970 and $9.7 billion in calendar year 1969. The high-employment budget averaged a $7.2 billion rate of deficit from 1966 to 1968. According to research at this Bank, fiscal actions alone, regardless of the method of measurement, have little long-run influence on total spending for goods and services, but these actions affect the transfer of goods from one sector of the economy to another.2 For example, expenditures associated with the award of a large Government defense contract require the trans fer of funds from some individuals or businesses to others, when the funds are provided through taxes or bond purchases. If the Federal Reserve, rather than the public, finances the award, the end result may be an expansion of the money stock and further inflation. If the Government does not wish to enlarge its overall control of resources, the defense award could be paid for through the elimination of some other Government project. Composition of Federal O u tlays* Per Cent ranked in the 98th and 71st percentiles, respectively, for the same three-month period. Such rapid growth rates of the monetary aggregates, if continued much longer, suggest future increases in total spending at rates far in excess of the growth rate of potential real output. Per Cent 60 60 50 50 Defense — 40 40 Human Resoiirces 30 30 Fiscal Actions Federal Government expenditures rose at an 8.4 per cent annual rate from the fourth quarter of 1970 to the first quarter of 1971, a slightly faster rate than the 5.9 per cent annual rate of increase over the preceding two years. On a national income accounts basis, the Federal budget was in deficit at a $13.3 billion annual rate in the first quarter of 1971, com pared with an $11.5 billion average rate of deficit in calendar year 1970. The large current deficit re flects more a shortfall in tax receipts, caused by the slowing in overall economic activity, than accelerating growth of Government expenditures. The rate of in crease of Government expenditures has slowed since mid-1968. Expenditures rose at a 14.5 per cent rate from mid-1965 to mid-1968 and have risen at a 6.4 per cent rate since mid-1968. The hypothetical high-employment budget, which reflects presumed income and expenditure patterns of the Government at a 4 per cent rate of unemploy ment, was in surplus at a $6.6 billion annual rate in 20 20 Physical Resources 10 10 ----Inte est Payments 1 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 Sources: O ffic e o f M a n a g e m en! a n d B u d g e t a n d F e d e ra l Reserve Bank of Si. Louis ‘ U n ified B udget basis; outlays include net lending. Latest d a ta plotted: 1971 a n d 19 72 from 1 9 7 2 F e d e ra l b u d g e t The Government allocated a greater share of its spending to human resources than to defense expendi tures in the first quarter of this year. Prior to 1971, defense spending exceeded expenditures on human resources. Both defense expenditures and total Fed eral outlays as a per cent of total spending peaked in mid-1968. Since then the Government has allocated a declining share of its expenditures to defense. Some effects of this shift in national priorities are evidenced by the large number of defense workers currently 2See “The ‘Crowding Out’ of Private Expenditures by Fiscal Policy Actions,” this Review (October 1970), pp. 12-24. Page 3 F E D E R A L R E S E R V E BA N K OF ST. LO U IS MAY 1971 Federal Outlays a as a Per Cent of Total Spending Real Product* A d j u s t e d a n d U n a d ju st e d for 1970 A uto m o b ile W o r k S t o p p a g e s Billions of D o lla r s I tal Oull ays B illion s of D o lla r s \ \ 1 1 Adjusted Monde! nse / Unadjusted Real Produc --- 1 1969 ' / V -L O1— tlense \ 1970 1971 S ources: U.S. D e p a rtm e n t o f C o m m e rce a n d E conom ic R e p o rt o f the P re sid e n t, 1971 ’ G ro ss n a tio n a l p ro d u c t in 1958 d o lla rs . U Real p ro d u c t w a s a d ju s te d fo r the e ffe c ts o f a u to m o b ile in d u s try strikes in the fo llo w in g e le m e n ta ry w a y; N o m in a l G N P w a s in c re a s e d b y $ 2 b illio n fo r 111/1970, b a s e d on d a ta fro m the U.S. C o m m e rce D e p a rtm e n t N e w s R elease o f O c to b e r 2 2 ,1 9 7 0 , a n d $14 b illio n fo r 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 Sources: O ffic e o f M a n a g e m e n t a n d B u d g e t a n d F ed e ral Reserve Bank of St. Louis [^ U n ifie d Budget basis; outlays in clu d e n e t le n din g. £ Total Spending is Gross N a tio n a l P roduct in current dollars. IV /1 9 7 0 , b a s e d on the E con o m ic R e p o rt o f the P re side n t, 1971, a n d d iv id e d b y the G N P p ric e d e fla to r in b o th q u a rte rs. Latest d a ta p lo tte d : 1st q u a r te r 1971 Latest d a ta plotted: 1971 a n d 1 9 72 o u tlays from 1 9 72 F e d e ra l b u d g e t; 1971 a n d 1972 to tal s p e n d in g es tim ate d by F ed e ral Reserve Bonk of St. Louis. among the unemployed. Defense Department-gener ated employment declined at an estimated 7.9 per cent annual rate from 1968 to 1971, after rising at a 12.2 per cent rate from 1965 to 1968.3 Output, Prices and Employment Recent output, employment and price trends have been obscured somewhat by the automobile work stoppages last year and preparations for a possible steel strike this summer. Allowance for these irregular fluctuations in activity, particularly the automobile strike, suggests that real output has risen slightly since the middle of last year. Rates of price increase have slowed somewhat, and the level of employment has remained about unchanged since last summer. None of these developments is necessarily inconsis tent with those of the early recovery stages following other postwar recessions. The addition (to adjust for auto strike influences) of about $2 billion to nominal GNP in the third quar ter of last year and $14 billion in the fourth quarter indicates that a slow recovery from a mild recession probably began in the third quarter of 1970. The ac companying chart presents an approximation of the changes in real output with and without adjustment for auto strike influences over the past year and a half. The adjusted data indicate that three quarters 3Economic Report of the President, 1971, p. 44. Page 4 of negative or negligible growth from IV/1969 to 11/1970 were followed by three quarters of moderate gains in real output from III/1970 to 1/1971. The transitory influence of the auto strike on em ployment, industrial output and prices does not seri ously hamper the comparison of these economic variables with past recession-recovery periods. The following chart indicates the relative mildness of the current recession-recovery in terms of payroll em ployment and industrial production, and the relative severity of the current inflation. Industrial production did not decline as steeply in the current recessionrecovery period as in previous comparable periods, but it also has not rebounded as sharply. In fact, industrial production in the first quarter of 1971 (six quarters after the peak) was still below the third quarter 1969 peak; industrial production on average for the three comparable earlier periods had risen above the earlier peak after six quarters. Recent data indicate that industrial production increased at a 3.7 per cent annual rate from March to April 1971, but it continued at a rate below the 1969 peak. Prices An inspection of the consumer and wholesale price indexes suggests that some progress has been made in slowing price rises. Consumer prices rose at a 4 per cent rate from July 1970 to March 1971, compared with a 5.9 per cent increase the previous year. Whole sale prices of industrial commodities rose at a 4 per cent rate in the July-to-April period, about the same as F E D E R A L R E S E R V E B A N K OF ST. LO U IS MAY 1971 C o m p arison of Three Economic Indicators Re ce ssion — Re co ve ry P e rio d s P e a k s - 100 115 P e a k s - 100 115 Industrial Production 3 R D Q T R .5 3 3R D Q T R ’5 7 2 N D QTR. 6 0 3 R D G TR.69 110 110 105 105 J 1968-71 100 100 95 95 A v e r a g e o f 1 9 5 2 -5 4 , ' a n d 1959-61 90 85 9 5 6 - 5 8 ,V i i i I 90 ---- 1---------i-------------------1---------1---- i Payroll Employment 105 85 105 1968-71 / 100 t A v e r a g e o f 1 9 5 2 - 5 4 ,1 9 5 6 - 5 8 , _________ a n d 1959-61 95 90 GNP Price Deflator 110 110 — i— i A v e r a g e o f 1 9 5 2 - 5 4 ,1 9 5 6 - 5 8 , a n d 1959-61 100 ^ - 105 100 8-71 95 90 95 _L_ 90 105 100 " .............' ---- i---------1--------- i--------- i---------i-------- --------- L--------1---------1---------1--------- 1--------4 - 3 - 2 - 1 0 1 2 3 QUARTERS T O A N D FRO M PEAK 95 90 S o u rc e s : U.S. D e p a rtm e n t o f L a b o r , B o a rd o f G o v e rn o rs o f th e F e d e ra l R e serve S y s te m , a n d U .S . D e p a rtm e n t o f C o m m e rc e 1969-71 period as in the average of the three earlier periods. Six quarters after the peak, however, payroll employment was at about the level of the peaks in both the recent and the earlier periods. The fact that payroll employment did not decline or rebound as much as the average of the earlier comparable periods suggests the mildness of the latest economic slow down and recovery. The current employment situation is similar to the 1961 recession-recovery period in terms of the gap between real and potential output, as estimated by the Council of Economic Advisers. A fairly reliable relation between real output, potential output and the unemployment rate has been established.4 The greater the gap between actual and potential output, the higher the unemployment rate. The gap between real and potential output at the end of 1961 (three quarters after the trough of the recession) was about 6.3 per cent of potential output, not substantially dif ferent from the 5.9 per cent in early 1971. Elimination of the gap between real and potential output, which did not occur until four years after late 1961, was accompanied by a fall in unemployment to 4 per cent of the labor force or less. The composition of the unemployed has changed since past recession-recovery periods. The trough years, 1954, 1958, and 1961, were marked by substan tial unemployment among full-time, blue-collar, mar ried male workers. The trough year 1970 was charact erized by marked unemployment among part-time workers (all workers other than full-time workers), teenagers, and women. This changed nature of un employment carried over into early 1971. L a te s t d a t a p lo tte d : 1st q u a r t e r 1971 T a b le I the increase in the preceding year. Wholesale prices of farm products and processed foods and feeds, a more volatile price index than most others, was about unchanged from July to April after rising 3.3 per cent the previous year. The accompanying chart indicates that price in creases began to slow a few quarters after the peak in the three comparable earlier periods, but have con tinued to rise rapidly since the most recent peak. The upward momentum of prices generated over the decade of the 1960’s has been difficult to halt. Employment Both payroll and total civilian employment have been about unchanged since late last summer. Pay roll employment was not cut back as much in the Ratio of the Unemployment Rate of Selected Workers to the Overall Unemployment Rate A ll W o rk e rs F u ll tim e Blue C o lla r M a rrie d M en Teen agers (1 6 -1 9 ) W om en ( 2 0 and ov e r) 100% 1954 100% 73% 229% 100 95% 1 06 131% 1 95 8 150 75 234 90 1961 100 1 00 137 69 251 94 1970 1 00 92 127 53 312 98 The number of employed as a proportion of the population of labor force age (16-64) was higher in 1970 than in earlier trough years, reflecting a stronger job market and higher labor force participation rates. This ratio was 64.2 per cent in 1970, compared with 61.8 per cent in 1961, 61.4 per cent in 1958 and 60.5 per cent in 1954. 'See “A Monetarist Model for Economic Stabilization,” this Review (April 1970), pp. 7-25. Page 5 F E D E R A L R E S E R V E B A N K OF ST. LO U IS Secular increases in the labor force participation rate of women are one probable cause for their higher unemployment, and the 1947-55 baby boom has been a strong force increasing the number of young-adult entrants into the labor force. A changing attitude toward the role of women in society, growing numbers of young workers, and an increasing supply of mili tary veterans (whose unemployment rate is consid erably higher than their civilian counterparts) will tend to assure continued rapid growth of the labor force in the near future. Spending in Major Sectors Among those economic sectors usually considered cyclically sensitive, residential construction activity is one of the few which has displayed strong signs of recovery in recent months. Consumer spending on durable goods has shown little strength apart from first quarter automobile sales. Spending (on inventory and on plant and equipment) has also remained sluggish. G N P S p e n d in g C om p onents C yc lic a lly S e n sitiv e Sectors B i ll i o n s of D o l l a r s B ill io n s of D o l l a r s MAY 1971 Housing and Consumer Expenditures Residential construction continued at a brisk pace in the first quarter. From the second quarter of last year to the first quarter of 1971, nominal spending on residential structures rose at a 36.2 per cent rate, com pared with a 16.2 per cent decline in the preceding year. Falling mortgage interest rates, increased avail ability of funds from savings institutions, and continu ing Federal housing subsidies have stimulated build ing activity in recent months. New housing starts and new building permits, both of which lead actual home construction, were at a higher level in the first quarter of this year than at any quarter in more than a decade. The outlook for business structures, however, is not so favorable for the near future. Commercial and industrial construc tion contracts, which normally lead business construc tion, were at a six-year low in the first quarter. Consumer spending, which constitutes more than 60 per cent of total spending, increased at a 7 per cent annual rate from the second quarter of last year to the first quarter of 1971, after rising 7.2 per cent in the previous year. Consumer spending on durable goods, which is more cyclically oriented than spend ing on services or nondurable goods, has not re bounded strongly from a 1969-70 slump. Such spend ing increased at an 8.2 per cent rate from the second quarter of last year to the first quarter of 1971, com pared with a 9.6 per cent annual rate of increase from 1961 to 1968. Much of the drop in fourth quarter automobile sales was offset by first quarter post-strike purchases. A rapidly expanding money stock, a March-April surge in all retail sales (an estimated 7 per cent higher than a year earlier), improved credit conditions, and high stock market prices suggest possible future consumer spending strength. Unfavorable price and unemploy ment developments, however, would tend to counter a strongly optimistic consumer spending outlook. Business Spending S o u rc e : U.S. D e p a rtm e n t o f C o m m e rc e Latest d a ta p lo tte d : 1st q u a r t e r 1971 Page 6 Spending on producers’ durable equipment and structures slowed to a 3 per cent annual rate of in crease from the second quarter of 1970 to the first quarter of 1971, down from a 5.4 per cent rise the previous year. Possibly contributing to the slowing in investment has been a fall in manufacturing capacity utilization from 79.8 per cent in the first quarter of 1970 to 73.1 per cent in the first quarter of 1971. After-tax corporate profits, which often lead invest F E D E R A L R E S E R V E BA N K OF ST. LO U IS ment activity, increased at an 11.1 per cent rate from 11/1970 to 1/1971, after falling 11.7 per cent the pre vious year. Continued profit recovery, lower interest rates, and a sustained surge in consumer spending would, if realized, spur investment spending later this year. Lengthy work stoppages and continued excess capacity would tend to restrain such spending. Inventory spending was not strong in any quarter of 1970 nor in the first quarter of 1971. The increase of business inventories was $3.5 billion in 1970 and $1.4 billion (annual rate) in the first quarter of 1971, compared with an average $9.7 billion increase from 1965 to 1969. The inventory-to-sales ratio did not in crease so much in early 1970 as in past recessionary periods. Consequently, inventory liquidation need not be so great as in past recovery periods. Steel inven tories (as well as steel production) are expected to rise rapidly before the possible mid-summer steel strike. Steel inventories would be worked off later this year with a strike (as in 1959) or without one" (as in 1968). Summary Total spending rose rapidly in the first quarter of this year, with much of the increase attributable to a post-strike automobile rebound. Residential construc tion spending has expanded rapidly in the current recovery period, but consumer, business and Federal Government spending have declined or expanded only moderately through the first quarter of this year. Partial elimination of work stoppage influences sug gests that a mild recovery from a mild recession has been underway since last summer. The declines in payroll employment and industrial production were MAY 1971 not as steep as the average of three comparable earlier periods, nor has the recovery been as sharp. Monetary actions have been very stimulative in re cent months. The money supply grew at a 12.5 per cent rate from January to April, a rate greater than any other consecutive three-month period since Jan uary 1950. The monetary base and Federal Reserve credit have also risen at extremely high rates in early 1971. Some slight signs of progress in slowing the rate of inflation emerged in the first part of 1971. Inflationary pressures, as evidenced by continuing high wage set tlements, are far from being erased. Prices, preceded by monetary expansion, rose virtually unabated through the second half of the decade of the 1960’s, in contrast to the 1950’s when they were slowed by policy actions on several occasions. The momentum of price increases has been much stronger recently than in the 1950’s. Policies of moderate restraint and moderate expan sion were undertaken in 1969 and 1970, respectively, to slow price increases gradually. These policies of gradualism may be in jeopardy of being abandoned prematurely at the first signs of progress in arresting inflation. A repeat of the excessively stimulative poli cies of 1967-68 risks reversal of the modest progress achieved thus far in curbing inflation. The moderate economic slowdown of 1969-70 will have served no useful purpose if the battle against inflation is termi nated short of success. In addition, the costs of slow ing prices in terms of lost employment and production will be far higher in subsequent years if the current inflation and inflationary expectations are permitted to continue. Page 7 Social Priorities and The Market Allocation of Credit Speech by DARRYL R. FRANCIS, President, Federal Reserve Rank of St. Louis, to the College of Rusiness and Industry, Mississippi State University, February 23, 1971 I n RECEN T YEARS there has been much discus sion concerning financial responsibility for the alloca tion of resources for social goals. Some contend that there is a widening gap between the performance of our financial institutions and the desires of society. They assert that society is concerned primarily with the relative shares of total expenditure in individual sectors of the economy, and that this is inconsistent with the concern of national monetary policymakers for aggregate activity and the profit motive governing the private financial community. For several decades many economic sectors have allegedly fared unfavorably from the market alloca tion of resources, especially the allocation of credit. Such sectors include housing, state and local govern ments, small business, low income groups, -and agricul ture. A natural consequence of this alleged inefficient allocation of credit has been a number of proposals designed to improve the system of credit allocation. In a world of scarce resources the allocation of credit is an important function. It is a major deter minant of the type and quantity of goods and services available to consumers. This function can be per formed either through competitive markets or on the basis of social priorities administered by the govern ment. Allocations through the marketplace are the result of individual decision-making in the daily pur chasing of goods and services. Such purchases indi°The issues discussed in this speech have been presented to other groups recently by President Darryl R. Francis. Page 8 cate to producers the type and quantity of goods and services desired by consumers. Producers in turn pur chase resources such as labor and capital to provide a level of production necessary to meet consumer de mands at market prices. In contrast, social priorities are actually restrictions imposed on the community by delegated authority. In making the choice between these systems of resource allocation, we are faced with issues concerning both economic welfare and freedom. In this discussion I shall contend that the main tenance of maximum welfare in individual sectors is consistent with both a monetary policy concerned primarily with aggregates and the profit motive of private financial firms. Most shortcomings in financial market performance in recent years were the result of impediments to the operation of free markets. Credit controls designed to alleviate alleged hardships often do not alter resource flows in the socially desired di rection. If aid to low income groups is the social ob jective, cash payments are a more efficient means of providing assistance than credit reallocations. I believe that the market system of credit alloca tion is superior to any other system. It provides greater economic welfare and more individual free dom of choice. Rather than attempting to improve welfare in specific sectors, the monetary authorities can make a greater contribution to overall welfare by concentrating on the maintenance of national eco nomic stability. Given the appropriate actions for overall stability, market forces will assure that indi vidual sectors are treated equitably in a competitive MAY 1971 F E D E R A L R E S E R V E B A N K OF ST. LO U IS enterprise economy free from excessive restrictions. Consumer preferences as reflected by demands for goods and services will provide the incentive for pro ducers in each sector to acquire necessary resources, including credit, for a level of output consistent with maximum satisfaction. Case for Social Priorities Overstated Most of the impetus for setting social priorities on credit flows or on goods and services produced has occurred during periods of great depressions or of high nominal interest rates (notably agriculture in the 1930’s and housing more recently). When market rates exceed limits established by usury laws, Regula tion Q and other restrictions on savings yields, credit flows are diverted from normal patterns. These market barriers have tended to starve some sectors, while other sectors not subject to the regulations have paid the market rates and obtained more funds than would have been available under free market conditions. Such restrictions, however, probably have little effect on the total volume of credit or savings. In order to correct the assumed defects of capital and credit markets, proposals have been made to es tablish priorities on credit flows through various finan cial agencies, including the Federal Reserve System.1 Variable reserve requirements against bank assets, selective open market purchases, the discount mech anism, moral suasion, quotas, margin requirements, and direct controls have been suggested as means for altering credit flows to specific sectors. If reserves were required against assets rather than liabilities, and it was desired, for example, to increase invest ment in housing relative to other investments, re quired reserves could be increased on other invest ments and reduced on residential mortgages. This would provide incentive for banks to make more residential mortgage loans. It has also been suggested that Federal Reserve Open Market purchases include FNMA securities, thereby increasing the volume of funds available for home mortgages. Credit Priorities Included in Federal Reserve Act A number of credit priorities were included in the discount provisions of the original Federal Reserve 1See Tom Connors, “Variable Reserve Requirement Imposi tion Opposed by Burns,” New York Journal of Commerce, April 1, 1971, and “Bunting Opposes Fed on Credit Alloca tion,” American Banker, April 19, 1971, for discussions of this subject. Act. Agricultural paper, for example, was given the special consideration that maturities of such paper not exceeding six months (later extended to nine months) were eligible for discount. Short-term paper, or real bills, arising from commercial transactions was like wise given preference over most other instruments in the credit market. Maturity requirements were more stringent for other paper. With the decline of the discount mechanism as a major monetary policy instrument in the 1930’s, this means of channeling credit to areas with high priori ties declined. Other restrictions on credit, however, tended to offset this move toward free market alloca tion. Margin requirements placed on stock market credit may have channeled a small amount of funds to other areas. At the beginning of World War II, the buildup of defense industries was given high priority and received aid through the V loan program admin istered by the Federal Reserve. Consumer credit con trols were instituted about this time, and both con sumer and real estate credit controls were used dur ing the Korean conflict to reduce credit and demand for resources in these sectors.2 Following World War II and the Korean buildup, the central bank reverted to its pre-war position with respect to credit allocation. As market interest rates increased in recent years, Regulation Q and other restrictions reduced credit flows through normal bank channels. These restric tions probably resulted in a loss of funds to the hous ing industry and a gain to other sectors which could pay market rates for the diverted funds. Since credit flows are an important determinant of production, the problem of credit allocation is similar to that of allocating other resources. The solution de pends upon whether the individual should be given freedom of choice in the marketplace to decide what goods and services will be available for consumption, or whether this decision should be imposed on the individual through social action. It is my belief that such rights to choose goods and services for consump tion should be left to the individual. Public Action Appropriate for Some Activities I recognize that a number of functions can be per formed more efficiently in the public sector. Main tenance of social order, air pollution control, common 2Federal Reserve Bulletin, September 1941, p. 825-836; Oc tober 1950, p. 1314-1321; and December 1950, p. 1577-1581. Page 9 F E D E R A L R E S E R V E B A N K OF ST. L O U IS defense, and monetary controls provide general bene fits which cannot be completely captured by an indi vidual. For example, air pollution control, which may require considerable expenditure by some sectors, pro vides substantial benefits to the entire community. Some producers and consumers in minimizing costs fail to control harmful waste products. Such polluting activities which violate the rights of others to clean air and water must be regulated by government action. A lighthouse is a classic example of a service that should be in the public sector. It provides equal benefits to both owners and nonowners of ships in its vicinity, and its use by one ship does not reduce its services for other vessels. We justify expenses for public education on the basis that all citizens receive some benefits from the educated individuals. In order for the public to gain the benefits of such public goods and services, collective expenditures are necessary. These expenditures may not provide benefits to tax payers in proportion to the taxes collected from each individual, but the alternative may result in the elimi nation of services with a consequent reduction in welfare to the entire community. Private Action More Efficient for Most Activities In contrast to activities which are performed more efficiently in the public sector, most economic benefits readily accrue to the individual without specific com munity action. Given the premise that individuals spend their funds so as to maximize satisfaction, in dividual expenditures for goods and services provide a more efficient guide to producers than do priorities established by legislative action. The establishment of legal priorities is simply a method of substituting col lective for individual decision-making. The establishment of priorities involves a tradeoff of one type of activity or good for another. Total volume of goods and services produced is not in creased. The diversion of resources to enhance output in one sector, such as residential housing, with a re duction of resources in other areas, however, is not neutral with respect to economic welfare. If marginal expenditures by each person result in optimum satis faction prior to the diversion, the goods and services foregone are of greater value to consumers than the gains from the additional houses. In other words, given the pattern of income distribution, the additional houses provide less welfare than would have been provided by the goods and services foregone, as indi Page 10 MAY 1971 cated by free market purchases prior to the arbitrary diversion. Thus, such socially established priorities force individuals into a pattern of expenditures which provides less-than-optimum want satisfaction. There is also a possible tradeoff between housing and other forms of wealth, with no resultant decline in current consumption. For example, given full use of resources, more houses could be built at the expense of investment elsewhere without reducing other types of current consumption. The long-run impact of such action would reduce national wealth and goods and services available for consumption in future periods. One prime example of the inefficiency of producing under arbitrarily determined priorities in the United States is our agricultural programs of the past several decades. In the 1930’s and again in the 1950’s, farm incomes were thought to be too low relative to in comes in nonfarm occupations. We first moved to remedy the alleged problem by setting a floor under farm commodity prices with the aid of a government price support program. Price supports were generally established above free market levels, thus providing incentive for production of a surplus of farm products. Our stocks of farm products, which were purchased by the government in its price support operations, soon rose to enormous levels. Numerous measures have been taken to reduce these stocks, including subsidized exports, subsidized school lunches, food stamps to low income groups, a land rental program to remove millions of acres of cropland from produc tion, and crop allotments which arbitrarily limit the acreage planted to many crops. The alleged problem and inefficient programs continue. Fundamental economics tells us that the long-run market price is the only price providing just enough incentive for farmers to produce the quantity of farm products that will clear the market. It is the only price which will avoid an accumulation of excesses or short ages. The market price is also the only price that will provide sufficient incentive for labor and other re sources to adjust between agriculture and other sec tors of the economy so as to maximize overall eco nomic output. Other resource combinations will tend to reduce output and thus the volume of goods and services available to consumers. Agriculture, like other sectors of a competitive econ omy, is self-adjusting, provided that market forces are permitted to operate freely. If incomes to farm resources are too low relative to returns in other areas, more farmers and farm youth will obtain em F E D E R A L R E S E R V E B A N K OF ST. LO U IS ployment in the nonfarm sector. Similarly, if incomes rise higher in agriculture relative to other sectors, we will have an expansion of farm workers until returns to workers of equal ability are equal in all sectors of the economy after allowance for nonmoney factors. Our public housing is another example of the waste ful use of resources based on public ordering of pro duction. Despite the sizable subsidies provided oc cupants, a large proportion of public housing units are often vacant, and the operations are in a constant state of insolvency. Such waste of resources resulting from public deci sions is not limited to our nation or our time. Modem hotels built by governments of some underdeveloped countries where few potential customers reside are now largely vacant. The numerous edifices of the Middle Ages and the very expensive royal mauso leums of ancient times are examples of resource di versions which were detrimental to most of the people. Social priorities which increase flows of some types of goods and services, in addition to their inefficien cies, are extremely biased against those individuals who already possess adequate amounts of these goods and in favor of those who are in the process of pur chasing such goods. For example, those persons who already have adequate homes are penalized when resources are diverted from other areas through social action to home building. With fewer resources allo cated to other areas, all consumers must pay a higher price for nonhousing goods and services. In contrast, only the prospective home purchaser gains from the subsidy on home construction or home financing. It is true that the private sector makes errors in re source use. Here, however, the decision-maker suffers a financial loss when resources are used inefficiently, giving him great incentive to avoid waste. Obviously, all individuals and firms do not have equal access to credit markets, as access is determined in part by the assets of the borrower. Nevertheless, lending is deter mined in part by the anticipated productivity of capital. Furthermore, the market system minimizes waste of scarce credit resources and thereby provides more funds to all productive uses. In contrast, other methods of allocation offer no assurance that efficient use of credit will be achieved. MAY 1971 to lower income groups. The well-being of the lower income groups would be enhanced more by money income than by the same amount of income diverted to them in the form of housing subsidies. The subsidy forces a pattern of consumption on these groups which conforms to the authorities’ tastes, not the individual’s. The value of this forced spending pattern to the in dividual is not as high as the value of an equal amount of funds. It is, therefore, my conclusion that efforts to improve the welfare of lower income groups should be limited to direct transfers of funds rather than providing particular goods and services. The supposedly wasteful consumption patterns on the part of some households are not a sufficient reason for a government or central bank to alter these patterns. Our own spending patterns may appear similarly un wise to others; any government edict altering our consumption patterns detracts from our personal well being. Controlling Financial Flows Difficult In addition to the inefficiencies created by arbitrary credit allocation, attempts to alter financial flows in the past have been less than satisfactory. The recent period, in which Federal Reserve Regulation Q and other interest rate restrictions limited the yield on sav ings accounts, shows the complex nature of credit allocation.3 While an objective of the restrictions was to maintain low interest rates to home purchasers, the reverse was closer to the actual result. Supply and demand forces in financial markets were not given sufficient consideration. The flow of savings through financial intermediaries was retarded, as many savers invested their savings at higher rates in other assets not subject to the restrictions. This tended to reduce the supply of funds to savings institutions — the major suppliers of home mortgage credit. Mortgage loan de mand, however, rose as a result of rising total demand caused by excessive money creation, and the rates charged on new mortgages rose sharply. The restric tions actually diverted funds away from home mort gages and caused higher rates to home purchasers than would have been charged had banks and savings and loan associations been free to compete for de posits through interest rate adjustments. Cash Payments Most Efficient for Welfare The proposed variable reserve requirements on bank assets may likewise yield unexpected results. As in the case of Regulation Q, if these restrictions lead to inefficiencies in banking, savings will bypass the The allocation of goods and services through social priorities is an inefficient means of providing welfare 3Charlotte E. Ruebling, “The Administration of Regulation Q,” this Review (February 1970), pp. 29-40. Page 11 F E D E R A L R E S E R V E B A N K OF ST. LO U IS commercial banking system. The nation’s larger busi ness firms have direct access to money markets if banking efficiency in meeting their demands is im paired. Other credit agencies can offset bank credit diverted from low priority consumer uses. Commercial banks are only one of several agencies which channel funds from savers to investors. Esti mates published by Bankers Trust Company, New York, indicate that commercial banks supplied less than 20 per cent of all investment funds raised in 1969 and only about 25 per cent of all short-term funds raised.4 Of the total investment funds supplied, both the contractual-type and the deposit-type sav ings institutions exceeded the quantity raised by com mercial banks. The contractual institutions, which in clude life insurance companies and private and gov ernment pension funds, raised an estimated $23 billion —more than double the amount of such funds raised by commercial banks. Commercial banks likewise supplied a relatively small portion of the short-term funds raised — only $9.5 billion of the $38.6 billion total. All other savings institutions supplied $6.4 billion. Almost two-thirds of the total raised, $24.4 billion, was supplied by other business corporations. Other investor groups such as brokers, consumer lenders, and foreign investors were net users of $1.7 billion of short-term funds. These nonbank sources of investment funds may completely offset efforts by the monetary authorities to enhance credit flows to specific sectors. Federal Reserve Should Concentrate On Economic Stabilization Finally, and probably more important, is the fact that attempts by the central bank to stimulate or re tard activity in specific sectors may not be consistent with the maintenance of appropriate monetary poli cies for economic stabilization. The Federal Reserve System is eminently qualified to stabilize overall eco nomic activity, provided it is not hampered by exces sive duties and restrictions which have little in com mon with this overall objective. Once the System be comes excessively concerned with activity in individ ual sectors rather than with the economy as a whole, its usefulness will be greatly impaired.® 4Bankers Trust Company, The Investment Outlook for 1971, New York, 1971, pp. 10-11. 5For further discussion of this point, see a statement by Arthur F. Burns, Chairman, Board of Governors of the Federal Reserve System, before the Subcommittee on Financial In stitutions of the Committee on Banking, Housing and Urban Affairs, United States Senate, March 31, 1971. Page 12 MAY 1971 It is doubtful that the Federal Reserve can detect the forces contributing to change in economic activity in specific areas better than other market participants. Some lines of activity decline because of changes in basic supply or demand factors not associated with financial impediments. Such factors are automatically detected and acted upon in the marketplace, where the appropriate resources are adjusted to meet the changed conditions. Waste of resources is minimized during the adjustment process. It has been my experi ence that the application of specific government pro grams to ease the burden of such adjustments has not only been inefficient but has also prolonged the ad justment period unnecessarily. Our programs for agri culture are examples of such inefficiency. The Federal Reserve is not likely to improve on this poor record of other government agencies by attempting to alter economic activity in specific sectors through credit allocation. The loss by some sectors of rights to equal access to credit markets, like other restrictions on economic activity, is a further unnecessary encroachment on individual freedom. As indicated earlier, any social action which channels funds to one sector of economic activity reduces the volume of funds available for other sectors. This loss of funds to sectors having lower priority is an impingement on individual rights to purchase savings at market prices. Conclusion In conclusion, the case for establishing high social priorities for output in specific sectors of our competi tive private economy has been greatly overstated. The use of legislative action to increase output in specific sectors is a means of determining through collective rather than individual decision-making what goods and services will be produced. We can justify some collective decision-making during national emergen cies on the basis that it is necessary for survival, but the competitive market is a more efficient allocator of resources most of the time. Many suggestions for setting priorities on credit flows have occurred during periods of high interest rates or major depressions resulting from ill-advised public policies. The maintenance of a fairly stable rate of growth in the stock of money and removal of useless regulations will permit the free-market system to work effectively and alleviate most of the observed problems. This country’s record of performance in establishing social priorities in the private sector has been less than F E D E R A L R E S E R V E B A N K OF ST. LO U IS MAY 1971 successful. Our farm programs designed to correct the alleged illness of income allocation are examples of such failures. Earlier price support programs which ignored basic supply and demand forces were fol lowed by more expanded programs to correct newly observed problems. Like the proverbial punching bag that expanded elsewhere when punched from the front, each new regulation created another problem that required new legislation. We still have not been able to get the government out of agriculture, and the expanded programs continue at great social cost. Such regulations have been a factor in retarding our farm export markets. They have reduced output in both the farm and nonfarm sectors of the economy and have been relatively ineffective in increasing re turns to individuals. Their proponents fail to recognize that resources, including labor, adjust to income in centives in all sectors. Finally, the Federal Reserve is not an appropriate agency to be in charge of social priorities. The use of such mechanisms as variable reserve rates on different bank assets to alter credit flows increases the problem of maintaining control over monetary aggregates. Con trol over these aggregates is essential for economic stabilization. More important is the fact that attempts to maintain economic health in specific sectors of the economy will detract from the central bank’s overrid ing responsibility for appropriate stabilization policies for the total economy. To the extent that the authorities are successful in altering credit flows and production patterns in the private sector, they reduce national welfare. Produc tion based on collective decisions imposes a spending pattern on the individual that is not compatible with maximum want satisfaction. If an increase in the wel fare of the low income groups is the objective of such If a stable rate of growth is achieved in total eco nomic activity, the freely functioning credit and cap ital markets will provide the most efficient allocation of funds to specific sectors. It is through this route of providing sufficient flows for an appropriate level of total activity that the central bank can make its maxi mum contribution to national welfare. actions, welfare can be purchased at a lower cost through cash grants than through credit subsidies for specific goods and services. With cash grants, each person can obtain maximum want satisfaction for each dollar spent. In contrast, subsidies of goods and serv ices impose the spending pattern of a group on the individual. REVIEW IN D EX — 1971 Month of Issue Title of Article Jan. Current Stabilization Policy The Revised Money Stock: Explanation and Illustrations Expectations, Money, and the Stock Market Feb. Stabilization Policies and Employment Operations o f the Federal Reserve Bank o f St. Louis — 1970 Population, The Labor Force, and Potential Output: Implications for the St. Louis M odel Mar. Month of Issue Title of Article Apr. Monetary Aggregates and Recent Economic Trends Controlling Money in an Open Economy: The German Case Summary o f U.S. Balance o f Payments, 1970 May The Economy: A Moderate Recovery Social Priorities and the Market Allocation o f Credit The Year 1970: A Modest” Beginning for Monetary Aggregates Capital Markets and Interest Rates in 1970 T he 1971 National Economic Plan The Implementation Problem o f Monetary Policy Page 13 The Year 1970 —A “Modest” Beginning For Monetary Aggregates by JERRY L. JORDAN and N EIL A. STEVENS T J AST YEAR marked a transition for the economy, for the direction of monetary policies, and for the im plementation of these policies. At the beginning of 1970, the nation was suffering from the continuation of inflation caused by the excesses of 1965 through 1968, as well as weakness in production resulting from the corrective steps taken in 1969. Monetary policy makers were faced with the question of whether a growth rate of total spending could be achieved which would be conducive both to reduction of infla tion and to renewed growth in production. In the first two meetings of 1970 the Federal Open Market Committee,1 the primary monetary policy making group, decided to change the direction of its policy by moving cautiously toward a less restrictive policy. As the year 1970 progressed, real GNP de clined slightly, unemployment rose considerably, and price increases tended to slow.2 Because of this slug gish performance of the economy, the Committee pursued a more expansionary policy through the year. The method of implementing the Committee’s pol icy decisions also was modified in 1970, compared to the approach taken in the previous two decades. At the January meeting, the Committee stated its desire to have increased emphasis placed on achieving spe cific growth rates of certain monetary aggregates. The amount of emphasis given to achieving growth targets of the aggregates, however, varied considerably dur ing the year. which is released to the public about 90 days after each meeting.3 The records include the directive to the New York Federal Reserve Bank, a summary of information reviewed by the Committee members, discussion of prevailing and prospective economic conditions, and a summary of the discussion on policy matters by the members. PO LICY O BJECTIV ES AND T H EIR IM PLEM ENTATION IN 1970 The Committee’s basic concern in the long run is the performance of the economy in terms of produc tion, employment, prices, and the balance of pay ments. The variable over which the Committee has direct control, the buying and selling of Government securities, does not affect these ultimate objectives direcdy. Open market operations, however, affect var ious monetary and financial variables, including the money stock, bank credit, and market interest rates. These variables, in turn, affect the spending decisions of consumers and businesses, and ultimately influence production, employment, prices, and the balance of payments. Interest Rates and Monetary Aggregates In general, there are at least two broad views con cerning the manner in which Federal Reserve policy actions are transmitted to the economy. Each view has associated with it an indicator which measures the thrust of monetary actions on the ultimate policy goals.4 The first view emphasizes interest rates, and the second emphasizes the money supply. This article examines and summarizes the monetary policy decisions of the Committee in 1970. The main source of information is the “Record of Policy Actions of the Federal Open Market Committee,” The interest rate approach uses market interest rates as the indicator of the effect of policy actions on 1The Federal Open Market Committee (FOMC) henceforth will be referred to as the“Committee” in this article. 2See Norman N. Bowsher, “1970 —Economy in Transition,” this Review (December 1970), pp. 2-13 for a review of eco nomic developments in 1970. 3A11 quotes in this paper are from these records unless speci fied otherwise. 4See Albert E. Burger, “The Implementation Problem of Monetary Policy,” this Review (March 1971), pp. 20-30, for a detailed discussion of the indicator problem. Page 14 F E D E R A L R E S E R V E B A N K OF ST. LO U IS ultimate objectives. In general, followers of this ap proach believe that Federal Reserve actions dominate movements in interest rates, and that policy actions are transmitted through interest rates to investment and consumption expenditures, and thus the ultimate policy objectives. The Federal Reserve does not control interest rates rigidly. Day-to-day open market operations are deter mined by looking at money market conditions, which include such measures as free reserves, member bank borrowings, the Federal funds rate, Treasury bill rates, and the attitudes of major market participants. Using these measures as “gauges,” the Federal Reserve can affect the amount of “pressure” or “ease” in the mar ket, thereby influencing interest rates in the desired direction. MAY 1971 An alternative approach to economic stabilization uses the money supply as the main indicator of the thrust of policy actions on economic activity. Accord ing to this view, changes in the nation’s money stock have a substantial influence on the growth of total spending in the economy over a year or more. It is contended that policy actions should be directed towards maintaining relatively stable growth of the money stock in order to achieve a long-run growth of total spending which is consistent with full employ ment and stable prices. Supporters of this view believe that changes in the public’s demand for credit dominate movements in market interest rates, and that the present demand for credit is outside the direct control of the Federal Reserve. It is held that current actions of the Federal Federal Open Market Committee in 1970 The Federal Open Market Committee consists of the seven members of the Federal Reserve Board of Gover nors, and five of the twelve Federal Reserve District Bank Presidents. The Chairman of the Board of Gover nors is also, by tradition, Chairman of the Committee. The President of the New York Federal Reserve Bank is a permanent voting member of the Committee and is its Vice-Chairman. All other Federal Reserve Bank Presi dents attend the meetings and present their views, but votes may be cast by only four of these Presidents, who serve as voting members for one-year terms on a rotation basis. At the first two meetings of 1970, the Committee in cluded the Governors and five Presidents: Mr. Hayes (New York), Mr. Bopp (Philadelphia), Mr. Scanlon (Chicago), Mr. Clay (Kansas City), Mr. Coldwell (Dal las). At the February meeting, Arthur F. Burns was elected the new Chairman of -the Committee. Mr. Burns had been appointed by President Nixon to the Board of Governors to succeed Mr. Martin, effective February 1, 1970. At the March meeting, the four rotating positions of the Committee were filled by new members who were to serve one-year terms. The new members were the late Mr. Hickman (Cleveland), Mr. Heflin (Richmond), Mr. Francis (St. Louis), and Mr. Swan (San Francisco). The Committee meets about every four weeks to dis cuss economic trends and to decide on open market opera tions. At these meetings they may discuss other possible policy actions for subsequent weeks and months. During 1970, the Committee met thirteen times. At each of these meetings, a directive was issued which stated the ultimate goals of the Committee and provided general guidelines "The Manager of the System Open Market Account may be referred to as the “Account Manager” or “the Desk,” mean ing the Trading Desk of the New York Federal Reserve Bank. as to how the Manager of the System Open Market Ac count” at the New York Federal Reserve Bank should conduct open market operations to achieve these goals (see Exhibit I). The first paragraph of each directive gave a short review of economic data considered, and the general economic goals sought by the Committee. The second paragraph gave operating instructions to the Ac count Manager. These instructions were stated in terms of money and short-term credit market conditions, growth rates of monetary aggregates, and any special factors to be taken into account, such as Treasury financing operations. In previous years, the directive was stated in general terms which provided an outline by which the Desk should operate. In 1970, the Committee tended to specify more precisely what the directive meant in quantitative terms of variables such as monetary aggregates and money market conditions. That is, the directive with accompanying interpretations became more specific as to the short-term guidelines the Account Manager was to follow and targets he was to achieve. The decisions on the timing and amount of daily buy ing and selling operations of securities in fulfilling the Committee’s directive are the responsibility of the Account Manager. Each morning, he and his staff decide on a program for open market operations to be undertaken that day. In developing this program, money and credit market conditions and aggregate targets desired by the Committee are considered as well as other factors which may be of concern at that time. Each morning, the Ac count Manager places a conference call to staff members of the Board of Governors and one voting President, to give information about the present market conditions and the market operations which he proposes to execute that day. Other members of the Committee are informed of the daily program by wire summary. Page 15 Page 16 EXHIBIT I FEDERAL OPEN MARKET COMMITTEE E C O N O M IC POLICY DIRECTIVES D ate o f FO M C M e e tin g Policy Consensus Operating Instructions Proviso Clause of Directive J a n u a ry 15 In lig h t o f th e fo re g o in g d e ve lo p m e n ts, it is th e p o lic y o f th e F e d e ra l O p e n M a rk e t C om m itte e to fo s te r fin a n c ia l c o n d itio n s conducive to th e o rd e rly re d u c tio n o f in fla tio n a ry pres sures, w ith a v ie w to e n c o u ra g in g s u s ta in a b le econ o m ic g ro w th and a tta in in g re a so n a b le e q u ilib riu m in th e c o u n try 's b a la n ce of p a ym e n ts. D issents: N on e To im p le m e n t th is p o lic y , w h ile ta k in g accou n t o f th e fo rth c o m in g T re a sury re fu n d in g , p o s s ib le b a n k re g u la to ry changes a n d th e C o m m itte e ’s d e sire to see a m odest g ro w th in m o ne y a n d b a n k c re d it, System o pen m a rket o p e ra tio n s u n til th e n e x t m e e tin g o f th e C om m ittee s h all be c o n d u cte d w ith a v ie w to m a in ta in in g firm co n d itio n s in th e m one y m a rk e t; p ro v id e d , h o w e v e r, th a t o p e ra tio n s s h a ll be m o d ifie d i f m o ne y a n d b a n k c re d it a p p e a r to be d e v ia tin g s ig n ific a n tly fro m c u rre n t p ro je c tio n s . F e b ru a ry 10 N o C ha n g e D issents: M r. H ayes M r. B rim m er M r. C o ld w e ll . . . w h ile ta k in g accou n t o f th e c u rre n t T re a sury re fu n d in g . p ossible b a n k re g u la to ry ch an g e s a n d th e C o m m itte e ’s desire to see m o d e ra te g ro w th in m o ne y a n d b a n k c re d it o v e r th e m onths a h e a d . System o p e n m a rk e t o p e ra tio n s u n til th e n e x t m e e tin g o f th e C o m m ittee sh a ll be c o n ducted w ith a v ie w to m o vin g g r a d u a lly to w a rd s o m ew h a t less firm c o n d itio n s in th e m one y m a rk e t; p ro v id e d , h o w e v e r, th a t o p e ra tio n s s h a ll be m o d ifie d p ro m p tly to re sist a n y te n d e n c y fo r m o ne y a n d b a n k c re d it to d e v ia te s ig n ific a n tly fro m a m o d e ra te g ro w th p a tte rn . M a rc h In lig h t o f th e fo re g o in g d e ve lo p m e n ts, it is th e p o lic y o f th e F e d e ra l O p e n M a rk e t C om m itte e to fo s te r fin a n c ia l c o n d itio n s co nd u cive to o rd e rly re d u c tio n in th e ra te o f in fla tio n , w h ile e n c o u ra g in g th e re s u m p tio n o f s u s ta in a b le eco n om ic g ro w th a n d th e a tta in m e n t o f re aso n a ble e q u ilib riu m in th e c o u n try 's b a la n ce of p a ym e n ts. D issents: N one . . . th e C om m ittee desires to see m o d e ra te g ro w th in m oney a n d b a n k c re d it o v e r th e m onths a h e a d . System open m a rk e t o p e ra tio n s u n til th e n e x t m e e tin g o f th e C om m ittee s h a ll be co nd u cte d w ith a v ie w to m a in ta in in g m oney m a rk e t c o n d itio n s c o n s is te n t w ith th a t o b je c tiv e . no p ro v is o clause A p r il 7 N o C ha n g e D issents: N one . . . th e C om m ittee desires to see m o d e ra te g ro w th in m oney a n d b a n k c re d it o v e r th e m onths a h e a d . System open m a rk e t o p e ra tio n s u n til th e n e x t m e e tin g o f th e C om m ittee s h a ll be co nd u cte d w ith a v ie w to m a in ta in in g m oney m a rk e t c o n d itio n s c o n siste n t w ith th a t o b je c tiv e , ta k in g accou n t o f th e fo rth c o m in g T re a sury fin a n c in g . no p ro v is o clause M ay 5 N o C hange D issents: M r. Francis . . . th e C o m m ittee desires to see m o d e ra te g ro w th in m oney a n d b a n k c re d it o v e r th e m onths a h e a d . System o pen m a rk e t o p e ra tio n s u n til th e n e x t m e e tin g o f th e C om m ittee s h a ll be c o n d u cte d w ith a v ie w to m a in ta in in g b a n k reserves a n d m o ne y m a rk e t c o n d itio n s co nsiste n t w ith th a t o b je c tiv e , ta k in g accou n t o f th e c u rre n t Tre a sury fin a n c in g ; p ro v id e d , h o w e v e r, th a t o p e ra tio n s s h a ll be m o d ifie d as nee d e d to m o d e ra te excessive pressures in fin a n c ia l m a rk e ts , s h o u ld th e y d e v e lo p . M ay N o C hange D issents: N on e . . . in v ie w o f c u rre n t m a rk e t u n c e rta in tie s a n d liq u id ity s tra in s , o p e n m a rk e t o p e ra tio n s u n til th e n e x t m e e tin g o f th e C om m ittee s h a ll be co nd u cte d w ith a v ie w to m o d e ra t in g pressures on fin a n c ia l m a rk e ts , w h ile , to th e e x te n t co m p a tib le th e re w ith , m a in ta in in g b a n k reserves a n d m oney m a rk e t c o n d itio n s co n s is te n t w ith th e C om m ittee 's lo n g e r-ru n o b je c tiv e s o f m o d e ra te g ro w th in m one y a n d ban k c re d it. no p ro v is o clause 10 26 June 23 Page 17 N o C hange D issents: N one . . . in v ie w o f p e rs is tin g m a rk e t u n c e rta in tie s a n d liq u id ity s tra in s , o pe n m a rk e t o p e ra tio n s u n til th e n e x t m e etin g o f th e C om m ittee s h a ll c o n tin u e to be co nd u cte d w ith a v ie w to m o d e ra tin g pressures o n fin a n c ia l m a rkets. To th e e x te n t c o m p a tib le th e re w ith , th e b a n k reserves a n d m o ne y m a rk e t c o n d itio n s m a in ta in e d s h a ll be c o nsiste n t w ith th e C o m m itte e ’s lo n g e r-ru n o b je c tiv e o f m o d e ra te g ro w th in m o ne y a n d b a n k c re d it, ta k in g a ccou n t o f th e B o a rd 's re g u la to ry a c tio n e ffe c tiv e Ju ne 24 a n d some p ossib le co n s e q u e n t s h iftin g o f c re d it flo w s fro m m a rk e t to b a n k in g ch an n e ls. no p ro v is o clause J u ly 21 N o C hange D issents: N one . . . w h ile ta k in g a cco u n t o f p e rs is tin g m a rk e t u n c e rta in tie s , liq u id ity s tra in s , a n d th e fo rth c o m in g T re a s u ry fin a n c in g , th e C o m m ittee seeks to p ro m o te m o d e ra te g ro w th in m one y a n d b a n k c re d it o v e r th e m onths a h e a d , a llo w in g fo r a p o s s ib le c o n tin u e d s h ift o f c re d it flo w s fro m m a rk e t to b a n k in g ch an n e ls. System o pen m a rk e t o p e ra tio n s u n til th e n e x t m e e tin g o f th e C om m ittee s h a ll be co nducted w ith a v ie w to m a in ta in in g b a n k reserves a n d m o ne y m a rk e t c o n d itio n s c o n siste n t w ith th a t o b je c tiv e ; p ro v id e d , h o w e v e r, th a t o p e ra tio n s sh a ll be m o difie d as n e e d e d to c o u n te r excessive pressures in fin a n c ia l m a rkets sh o u ld th e y d e v e lo p . August 1 8 N o C hange D issents: M r. H ayes M r. Brim m er M r. Francis . . . th e C om m ittee seeks to p ro m o te some e a s in g o f c o n d itio n s in c re d it m arkets a n d s o m e w h a t g re a te r g ro w th in m o ne y o v e r th e m onths a h e a d th a n occurred in th e second q u a rte r, w h ile ta k in g account o f p o s s ib le liq u id ity p ro b le m s a n d a llo w in g b a n k c re d it g ro w th to re flect a n y c o n tin u e d s h ift o f c re d it flo w s fro m m a rk e t to b a n k in g c h a n n e ls . System o pe n m a rk e t o p e ra tio n s u n til th e n e xt m e e tin g o f th e C om m ittee s h a ll be c o n d u cte d w ith a v ie w to m a in ta in in g b a n k reserves a n d m o ne y m a rk e t c o n d itio n s c o n s is te n t w ith th a t o b je c tiv e , ta k in g accou n t o f th e effects o f o th e r m o n e ta ry p o lic y action s. no p ro v is o clause S e p te m b e r 15 N o Change D issents: M r. H ayes . . . th e C o m m ittee seeks to p rom o te some e asin g o f c o n d itio n s in c re d it m arkets a n d m o d e ra te g ro w th in m one y a n d a tte n d a n t b a n k c re d it e x p a n s io n o v e r th e m onths a h e a d . System o pe n m a rk e t o p e ra tio n s u n til th e n e xt m e e tin g o f th e C o m m itte e s h a ll be c o n d u cte d w ith a v ie w to m a in ta in in g b a n k reserves a n d m o ne y m a rk e t co n d itio n s c o nsiste n t w ith th a t o b je c tiv e . no p ro v is o clause O c to b e r 2 0 N o C hange D issents: M r. H ayes . . . th e C om m ittee seeks to p ro m o te some e a s in g o f c o n d itio n s in c re d it m arkets a n d m o d e ra te g ro w th in m o ne y a n d a tte n d a n t b a n k c re d it e x p a n s io n o v e r th e m onths a h e a d . System o pe n m a rk e t o p e ra tio n s u n til th e n e x t m e e tin g o f th e C o m m ittee s h a ll be co nducted w ith a v ie w to m a in ta in in g b a n k reserves a n d m one y m a rk e t c o n d itio n s c o nsiste n t w ith those o b je c tiv e s , ta k in g accou n t o f th e fo rth c o m in g T re a sury fin a n c in g s . no p ro v is o clause N o v e m b e r 17 N o C hange D issents: M r. M a is e l . . . th e C om m ittee seeks to p ro m o te some e a s in g o f c o n d itio n s in c re d it m arkets a n d m o d e ra te g ro w th in m o n e y a n d a tte n d a n t b a n k c re d it e x p a n s io n o v e r th e m onths a h e a d , w ith a llo w a n c e fo r te m p o ra ry s h ifts in m o ne y a n d c re d it d e m a n d s re la te d to th e a u to s trik e . System o pe n m a rk e t o p e ra tio n s u n til th e n e x t m e etin g o f th e C o m m ittee s h a ll b e co nd u cte d w ith a v ie w to m a in ta in in g b a n k reserves a n d m one y m a rk e t c o n d itio n s c o n s is te n t w ith th o se o b je c tiv e s . no p ro v is o clause N o C hange D isse n ts: M r. Francis . . . System o pe n m a rk e t o p e ra tio n s s h a ll be co nd u cte d w ith a v ie w to m a in ta in in g th e re c e n tly a tta in e d m o n e y m a rk e t c o n d itio n s u n til th e n e x t m e e tin g o f th e C o m m itte e , p ro v id e d th a t th e e xp e c te d rates o f g ro w th in m oney a n d b a n k c re d it w ill a t le a s t be a chieved. SOURCE: “ Record o f Policy Actions o f the Federal Open Market C o m m itte eC u rr e n t Economic Policy Directive MAY 1971 F E D E R A L R E S E R V E B A N K OF ST. LO U IS Reserve influence the public’s future demand for credit through its delayed influence on total spend ing. Such lagged effects of previous policy actions result in current interest rates giving misleading infor mation about the effects of monetary actions on total spending. For instance, when an economic recovery is occur ring, rising interest rates reflect a growing demand for credit, as business firms seek to expand productive capacity and build inventories. If policymakers view the rising interest rates as being restrictive, they may attempt to direct open market operations to resist the tightening of credit conditions, in order to stabilize or slow the rise in interest rates. To accomplish this, re serves would have to be supplied at rapid rates, re sulting in an accelerating growth rate of the money stock. After some time lag, the rapid growth in money would induce further acceleration in growth of total spending, resulting in inflation and even higher inter est rates as an inflation premium becomes built into market interest rates. Before 1970, the Committee followed more closely the money market conditions approach of implement ing its policy decisions. In 1970, more emphasis was placed on monetary aggregates. However, according to an article in the February 1971 Federal Reserve Bulletin, the increased emphasis on aggregates since early 1970 “is consistent with a variety of economic theories, and does not necessarily imply any particular judgment as to the importance for the economy of monetary flows relative to interest rates and credit conditions or relative to other influences such as fiscal policy and technological innovation.”5 In 1970, a hybrid approach was employed of con trolling money market conditions on a day-to-day basis with a view to controlling monetary aggregates over the longer term. According to this approach, the growth of the demand deposit component of the money stock can be influenced by appropriate adjust ment of money market pressures. The central idea is that the demand for money is influenced by interest rates as well as so-called transactions needs of the public, and that money market pressures can be con trolled in such a way to achieve a desired growth of deposits. At the January 1970 meeting, the Committee ex plicitly stated its desire to have more importance placed on achieving growth rates of monetary aggre gates when conducting open market operations. A B“Monetary Aggregates and Money Market Conditions in Open Market Policy,” Federal Reserve Bulletin (February 1971), p. 86. Page 18 principal change in the implementation of policy, which accompanied the greater attention on mone tary aggregates, was that the Committee adopted a somewhat longer horizon in specifying the desired changes in policy variables. Specifically, quarterly goals for money6 were set at the meeting preceding each quarter and reviewed as the quarter progressed. This longer time horizon allowed greater flexibility in attaining the money and bank credit targets, while avoiding excessive short-run fluctuations in interest rates. Modifying Objectives Although the Committee put more emphasis on achieving desired growth rates of monetary aggre gates, other short-run objectives were specified in most directives, as was done in the past. In addition to policy goals regarding production, prices, employ ment and the balance of payments, the Federal Re serve has generally assumed responsibility for main taining orderly and smoothly functioning money markets. This responsibility is assumed, partly be cause orderly market conditions are considered desir able by some in order to successfully achieve the objectives of the Committee. According to the Fed eral Reserve Bulletin, “the nation’s central bank has a unique responsibility for maintenance of orderly conditions”7 in the money market. One interpretation of this objective is that disorderly markets might develop in absence of the Federal Reserve’s efforts. In accord with this self-imposed objective, empha sis on aggregates received secondary importance when conflicts arose. For instance, at the late May meeting and the June meeting, the Committee was largely concerned with excessive pressures in credit markets, and directed that open market operations be con ducted so as to moderate such conditions. Many followers of the money supply approach, however, believe that the Federal Reserve System can make its greatest contribution toward avoiding disorderly mar ket conditions by keeping the growth of money in a moderate range. Most directives in 1970 also called for other items to be taken into account as open market operations were carried out. Five directives called for specific consideration of either regulatory changes (Regula tions D and Q) or the shifts in funds from market to banking channels caused by changing relationships be tween Regulation Q ceilings and market interest rates. 6Targets for bank credit were also given at some meetings, but, in general, money was the dominant aggregate target. 7“Monetary Aggregates and Money Market Conditions in Open Market Policy,” p. 94. F E D E R A L R E S E R V E BA N K OF ST. LO U IS During 1970, six directives called for the Account Manager to consider “forthcoming” or “current” Treas ury financings. Historically, the Federal Reserve has assumed some responsibility in keeping market con ditions conducive to the success of Treasury financings, often referred to as “even-keel” operations. The objec tive of “even-keel” operations is to stabilize money market conditions during the period between the Treasury’s announcement of a security offering and their sale, and thus to maintain an orderly and recep tive market for these securities. In effect, the Federal Reserve may buy securities in the market while the Treasury is selling. Particular emphasis was placed on even-keel operations in late April and in May of 1970, “when it appeared that the Treasury’s cash financing might be in jeopardy.” MAY 1971 M o n ey Stock R atio Scale B illio n s o f D o lla rs 2 40 2 30 8Ibid., p. 94, for a rationale for continuing the use of money market conditions. Also see Paul Meek and Rudolf Thunberg, “Monetary Aggregates and Federal Reserve Open Market Operations,” Monthly Review, Federal Reserve Bank of New York (April 1971), pp. 80-89. nFor a detailed explanation of the revision, see Albert E. Burger and Jerry L. Jordan, “The Revised Money Stock: Explanation and Illustrations,” this Review (January 1971), pp. 6-15. 10Because of the revision, three money series are used in this paper: old, revised, and roughly adjusted. Unless otherwise specified, references to money will be the old series. +12.)%/l f i 221.2 220 +55% / 210 210 +3.0%^ 6.0 Revised SeriesM 200 200 Old Series +7 190 oj 190 >/ / S' 180 Achieving Targets for Monetary Aggregates Uncertainties surrounding a revision of the money stock series caused difficulties for policymakers in 1970. In the latter half of 1970, it became known that a measurement error arising from certain international transactions was contained in the money series.9 The revised series was available to the Committee in com pleted form at the November meeting, but at the preceding two or three meetings, the Committee had only a rough idea of the magnitude of the underesti mation of money growth indicated by the old money series.10 230 220 170 In carrying out day-to-day open market operations in 1970, the Desk relied mainly on money market con ditions.8 On a daily basis, the Desk concentrated principally on the Federal funds rate, which was thought to be consistent with the desired target growth rates for the monetary aggregates. Ry main taining the Federal funds rate in a prespecified range, an attempt was made to obtain the desired growth of aggregates. This approach implies that the quantity of securities purchased by the Desk is not as important in influencing the near-term growth of money as the effect of these actions on money market conditions. R atio Scale B illion s o f D o lla rs 240 M o n th ly A v e ra g e s o f D a ily F ig u res 160 180 -o <> -0.5% Q. < t 1966 170 S. 0 c 0 0 1 .* 1967 1968 S fs R k ♦ 1969 160 1970 1971 jjjS e rie s p u b lis h e d p rio r to N o v e m b e r 19 70 . b jT h e re vis ed series re flects a n n u a l revisions o f s e a s o n a l (ac to rs a n d b e n c h m ark ad ju s tm en ts, as w e ll as m a jo r ad ju s tm en ts fo r a n u n d e re s tim a tio n o f th e o ld series a ris in g fro m in te rn a tio n a l tran s ac tio n s . P e rc e n ta g e s a r e a n n u a l rates of c h a n g e fo r p e rio d s in d ic a te d . L atest d a t o p lo tte d : A p ril Initially, it appeared that in the first three quarters of 1970, money growth had been in the range desired by the Committee, but the revised series indicated that money had grown more rapidly than desired. For instance, the old money series grew at a 4.4 per cent annual rate dining the first three quarters of 1970, compared with a 6.1 per cent rate for the revised series. At the September meeting, some members ex pressed the view that “it would be desirable to place less emphasis on a specific growth rate for the money stock.” The experience in 1970 suggests that some improve ment in technique may be needed in controlling ag gregates. The following bar chart shows actual growth rates of money as measured by the old and revised series, compared to that desired by the Committee in the four quarters of 1970. Better control over mone tary aggregates might have been achieved by a more direct method, such as by concentration on bank re serves or the monetary base, rather than the state of money market conditions. F E D ER A L OPEN MARKET CO M M ITTEE DECISIONS IN 1970 This section presents a summary of the 1970 policy decisions of the Committee. The discussion outlines the economic data and forecasts available to the Com mittee at the time of each meeting and the policy de cisions at each meeting. The policy directives of the Page 19 F E D E R A L R E S E R V E B A N K OF ST. LO U IS MAY 1971 F O M C ’s M oney Stock Targets and Actual Rates Achieved Per C e n t 1 0 1----------- P er C e n t A n n u a l R ates o f C h a n g e * --------- 10 [ g g g j TARGET 9 9 j l H O L D M O N E Y SERIES (4th q tr. N .A .) ^ R E V I S E D M O N E Y SERIES 8 8 7 7 05 6 6 D < (C) 9- 5 Z O 4 ■ 5 4 3 3 < 2 1 ----------- IV .V .V 1st q u a r te r —- TTdTq u a r te r q u a r te r m q u a r te r 2 1 1970 N .A . — N o t a v a ila b le . * Rates o f ch a n g e a re c a lc u la te d u sing th e le v e l in th e la s t m o n th o f a q u a rte r co m p a re d to th a t in th e la s t m o n th o f th e p re ce d in g q u a rte r. N o te : The “ Record o f P o lic y A c tio n s o f th e F e de ra l O p e n M a rk e t C o m m itte e ” fo r th e J a n u a ry m e e tin g d id n o t s p e c ify a m o n ey ta r g e t. (A ) The e x a c t m o n ey ta rg e t w a s n o t s p e c ific a lly sta te d in th e “ R e c o r d ." H o w e v e r, p ro je c tio n s p re se n te d a t th is m e e tin g in d ic a te d a g ro w th ra te o f 3 to 4 p e r ce nt “ i f p re v a ilin g m o n ey m a rk e t c o n d itio n s w e re m a in ta in e d ” a n d 4 to 5 p e r cent “ i f m o n ey m a r ke t c o n d itio n s w e re eased s o m e w h a t.” Since th e F e b ru a ry d ir e c tiv e a sked f o r e a s in g , p re s u m a b ly a b o u t a 4 p e r cent ta r g e t w as d e s ire d b y th e C o m m itte e . (B ) A t th is m e e tin g , p ro je c tio n s in d ic a te d (C ) The C o m m itte e (D ) The C o m m itte e w as w illin g sta te d th a t it to o n ly a 2 p e r ce n t g ro w th ra te o f m oney in th e fir s t q u a rte r. p re fe rre d a ccep t 4 d e v ia tio n s fro m th is p e r cent b ecause o f ta r g e t to Committee for 1970 can be divided into four periods. January through April entailed the important decisions to move toward more emphasis on monetary aggre gates in implementing monetary policy and to pursue a more expansionary monetary policy than was sought during 1969. May through July was characterized by pressures in financial markets and subsequent subor dination of monetary aggregates in an effort to main tain money market conditions conducive to some eas ing of strained market conditions. From August through November, the Committee reinstated target growth ranges of monetary aggregates and, in addi tion, specifically called for some easing in money and credit markets. In December, the Committee moved Page 20 be on th e u p s id e . w e a k c re d it d e m a n d s a t th e tim e , a ttrib u te d to th e a u to s trik e . towards less emphasis on monetary aggregates and more emphasis on money market conditions. January through April: Emphasis on Monetary Aggregates The Committee gradually moved toward a more ex pansionary policy in this period. Many members were concerned about a possible renewal of inflationary expectations if easing came too fast or was too pro nounced. In addition to changing the direction of monetary policy action, the Committee also stated its desire to have more emphasis placed on monetary aggregates in the formulation and implementation of policy. F E D E R A L R E S E R V E B A N K OF ST. LO U IS MAY 1971 Economic Outlook and Policy Decisions of the Committee January 15 M eeting —Available data showed that real GNP had not grown in the fourth quarter of 1969, industrial production had fallen for five consecutive months, and prices were still rising rapidly. Board of Governors staff projections noted that prospects were for “little change in real economic activity in early 1970.” The staff also projected that prices would con tinue to rise rapidly, with perhaps some moderation as the year progressed. Some expansionary elements were noted, including plans by businesses to increase expenditures on new plant and equipment in 1970, reduction of the income tax surcharge from 10 to 5 per cent on January 1 and its elimination on July 1, and the 15 per cent increase in social security benefits as of January 1. Although the Committee was aware of the reduced level of economic activity, it was “agreed that any marked relaxation of monetary restraint would be pre mature at present in light of the persistence of infla tionary pressures and expectations.” The main con cerns of Committee members continued to be inflation, and the need to show the public a willing ness to persist in its restrictive policies until there was evidence that real progress against inflation was being attained. Staff projections suggested that there would be little change in money and some decline in bank credit if prevailing money market conditions and Regulation Q ceilings were maintained. Members expressed con siderable concern over these prospects and disagreed D e m a n d a n d Pro duction R a tio S cale T rillio n s o f D o lla rs Quarterly Total* at Annual Rotes Seasonally Adjusted R a tio S e a l* T rillio n s o f D o lla rs 1.1 1.0 .9 .8 .7 over the course of action that should be taken. Some members wanted money market conditions to remain “sufficiently firm to be consistent with a posture of monetary restraint,” but “likely to be conducive to modest growth in bank credit and the money stock over the first quarter.” Other members wanted the main emphasis put on a relaxation of Regulation Q, and some favored “maintaining the prevailing condi tions in the money market.” The final decision of the Committee was to place increased emphasis on “the objective of achieving modest growth in monetary aggregates” giving “about equal weight” to bank credit and the money stock. The Committee continued in a way similar to the past, by directing that open market operations should be conducted “with a view to maintaining firm condi tions in the money market.”11 The Committee also added a proviso clause in the January directive, stat ing “that operations shall be modified if money and bank credit appear to be deviating significantly from current projections.” In view of the Committee’s de sire to pay more attention to aggregates, presumably the proviso clause was to be invoked sooner and more vigorously than in the past. It was noted that the Board of Governors planned to consider raising Regulation Q interest rate ceilings IX G N P in current dollars. (2 GNP in 1958 dollars. Percentages are annual rotes of change for periods indicated. Latest d a ta plotted: I st q u arter Source: U.S Department of Commerce 11Presumably, firm conditions did not mean prevailing con ditions, but some slight easing, since the staff had projected no growth in money and a decline in bank credit if prevail ing money market conditions were maintained. But most members were apparently unwilling to specify an actual easing of market conditions in the directive at this time because of the continued rapid rise in prices. Page 21 FEDERAL Page 22 RESERVE EXHIBIT II M A JO R FEDERAL RESERVE ACTIO NS OTHER THAN OPEN MARKET OPERATIONS IN 1970 BANK OF Nature of Action Effect of Action J a n u a ry 2 0 The B o a rd o f G o ve rn o rs ra is e d m axim um in te re s t ra te s p a y a b le on This a c tio n a llo w e d s a v in g fu n d s to re -e n te r b a n k in g c h a n n e ls , thus (E ffe c tiv e J a n u a ry 21 ) tim e a n d savings d ep o sits e n c o u ra g in g Date of Announcement ST. g ro w th o f m ore b ro a d ly d e fin e d a g g re g a te s such as L O U IS (R e g u la tio n Q ) . b a n k c re d it a n d m o ne y stock plus tim e d e p o sits. J u n e 23 The B o a rd o f G o ve rn o rs suspended R e g u la tio n Q c e ilin g s on la rg e (E ffe c tiv e J u n e 2 4 ) ce rtific a te s o f d e p o s it a n d o th e r s in g le -m a tu rity tim e d e p o s its o f 3 0 - This a c tio n w as ta k e n b y th e B oard in a n e ffo rt to a llo w b an ks to be in a p o s itio n to accom m o d a te business custom ers u n a b le to o b ta in to 8 9 - d a y m a tu ritie s . fu n d s in th e co m m ercia l p a p e r m a rk e t, w hich a t th e tim e w as und e r stress. The e ffe c t w as to e n c o u ra g e g ro w th o f la rg e CD ’s. A u g u s t 17 The B o a rd o f G o ve rn ors p la ce d reserve re q u ire m e n ts (R e g u la tio n D) By these a c tio n s , la rg e c e rtific a te s o f d e p o s it a n d fu n d s o b ta in e d (E ffe c tiv e in th e reserve c o m p u ta on fu n d s o b ta in e d b y m em ber b an ks th ro u g h th e issuance o f co m b y b a n k s th ro u g h issuance o f co m m ercia l p a p e r b y th e ir a ffilia te s tio n m e rcia l p a p e r b y th e ir a ffilia te s . w ere p la c e d o n e q u a l term s. S u b s e q u e n tly , b a n k -re la te d com m ercial p e rio d b e g in n in g O c to b e r 1) The B oa rd a ls o re du ce d reserve re q u ire m e n ts fro m 6 to 5 p e r cent on tim e d e p o s tis in excess o f $ 5 p a p e r d e c lin e d r a p id ly . m illio n . N o v e m b e r 10 The B o a rd o f G o ve rn o rs a p p ro v e d a re d u c tio n in th e d is c o u n t ra te This (E ffe c tiv e a t a ll Reserve Banks b y b y Reserve Banks fro m 6 to 5 % per cent. m a rk e t rates w h ic h h a d fa lle n s u b s ta n tia lly . N ovem ber 30 The B o a rd o f G o ve rn o rs a p p ro v e d a n o th e r re d u c tio n in th e d is c o u n t This (E ffe c tiv e a t a ll Reserve Banks b y ra te b y Reserve Banks fro m 5 % to 5 % r a p id ly fa llin g s h o rt-te rm in te re s t rates. The B o a rd reserve re q u ire m e n ts fro m a c tio n b ro u g h t th e d is c o u n t ra te in to c lose r a lig n m e n t w ith N ovem ber 16) p e r cent. a c tio n a ls o b r o u g h t th e d is c o u n t ra te m ore in lin e w ith the D ecem ber 1 1) N ovem ber 30 (E ffe c tiv e in th e 4 -w e e k reserve c o m p u ta tio n p e rio d e n d in g D ecem ce n t to 20 o f G o ve rn o rs ra ise d per cent “ re s e rv e -fre e ” base. on E u ro d o lla r b o rro w in g s th a t 10 per exceed the The a c tio n w as in te n d e d to h e lp th e b a la n c e o f p a y m e n ts b y d is c o u ra g in g b an ks fro m re d u c in g th e ir E u ro d o lla r b o rro w in g s b e lo w th e ir re s e rv e -fre e base. ber 2 3) MAY 1971 F E D E R A L R E S E R V E B A N K OF ST. LO U IS MAY 1971 soon. Effective January 21, 1970, the Board raised ceilings on time and savings deposits. The effect of this change was to encourage growth in bank credit and other broadly defined aggregates (see Exhibit I I). In 1969, disintermediation of time deposits from banks as well as other financial intermediaries had occurred as market interest rates rose above Regula tion Q ceilings. Most of these funds were simply channeled to other market instruments, such as com mercial paper, and to that extent did not affect total credit in the economy. The increase in Regulation Q ceiling rates encouraged a rechanneling of funds back into banks. This outflow and inflow of time deposits during 1969 and 1970, however, distorted the growth rates of broadly defined aggregates such as money stock plus net time deposits, making interpretation of these series less meaningful as indicators of monetary influences. February 10 M eeting — Evidence of further weak ening in the economy was presented, although it was expected that some real growth would occur in the second half of the year. Weakness in the labor market was becoming evident, as unemployment rose from 3.5 per cent in December 1969 to 3.9 per cent in January 1970. The Committee agreed that “it was appropriate to move gradually toward somewhat less restraint at this time.” The directive issued to the Desk called for both “moderate growth in money and bank credit over the months ahead” and “somewhat less firm conditions in the money market.” The word “moderate” meant a faster rate of growth for aggregates than the “modest” growth called for at the January meeting. Three members of the Committee, Mr. Hayes, Mr. Brimmer, and Mr. Coldwell, dissented from the Feb ruary directive. They believed that “any overt move toward less firm money market conditions was pre mature at this time and could strengthen market ex pectations of substantial easing.” They stressed the continuing inflationary pressures, business plans for large volume capital spending, and the prospectively large balance-of-payments deficit. Although they agreed that some growth in money and credit was de sirable, they preferred a directive similar to Janu ary’s which called for “firm” money market conditions along with some growth in aggregates. M arch 10 and April 7 M eetings — At these meet ings, important changes in the wording of the direc tive were made, clarifying the meaning of the new attention to aggregates. Although the earlier directives of 1970 gave increased importance to the money stock and bank credit, they continued to be stated in terms of money market conditions, with an appended proviso clause regarding the aggregates. In the March and April meetings, an objective with respect to money market conditions was not specified in the directives. Rather, the wording of these directives in dicated a willingness on the part of the Committee to E m p lo y m e n t a n d U n e m p lo y m e n t Latest doto plotted: A pril Sources: U.S. Deportment of Labor and U.S. Department of Commerce, Bureau of the Census Page 23 F E D E R A L R E S E R V E B A N K OF ST. LO U IS MAY 1971 Selected Short-Term Interest Rates P er C e n t Per C e n t S o u rc e : B o a rd o f G o v e r n o r s o f th e F e d e ra l R es e rv e S y s te m [ ^ W e e k ly a v e ra g e s o f d a ily fig u re s . L a te s t d a t a p lo tt e d : M a y 14 allow money market conditions to fluctuate if neces sary, in order to attain desired money and bank credit growth targets. The March directive stated: . . . the Committee desires to see moderate growth in money and bank credit over the months ahead. System open market operations until the next meet ing of the Committee shall be conducted with a view to maintaining money market conditions consistent with that objective. Page 24 The growth targets for the money stock at the March meeting called for a 2 per cent annual growth rate in the first quarter (December 1969 to March), and a 3 per cent rate in the second quarter ( March to June). At the April meeting, a 3 per cent growth tar get for the money stock was reaffirmed as the appro priate rate for the second quarter. FEDERAL. R E S E R V E B A N K OF ST. LO U IS MAY 1971 Yields on Selected Securities P er C e n t Per C en t S o u rce : B o a rd o f G o v e rn o rs o f th e F e d e ra l R eserve S ystem a n d M o o d y 's In v e s to rs S e rv ic e t l W e e k l y a v e ra g e s o f d a ily fig u re s . [2 T h u r s d a y fig u re s . L a te st d a ta p lo tte d : S ta te a n d L o c a l - M a y 7 ; O th e r s - M a y 14 Although as a whole the Committee showed in creased willingness to let money market conditions fluctuate in achieving aggregate targets, some mem bers at the April meeting expressed concern about the possibility of wide fluctuations in money market con ditions. It was noted that “precise achievement” of targets for growth of monetary aggregates “could not be expected, in part because of the desirability of avoiding excessive fluctuations in money market con ditions and in part because of uncertainties regarding future relationships among financial variables.” This view is in keeping with the February 1971 Bulletin article: Money market conditions, measured by movements in short-term interest rates, eased on balance from January through April, as some growth in monetary aggregates was sought. The monetary base, the main determinant of the growth trend of the money stock, grew at a 6.7 per cent annual rate from December 1969 to April . . . whatever longer-run path for the aggregates may be included as guidance for open market operations, 12“Monetary Aggregates and Money Market Conditions in Open Market Policy,” p. 80. short-run, self-correcting variations in money and credit demands need to be accommodated in order to avoid inducing unnecessary, and possibly desta bilizing, fluctuations in money market conditions.12 Money Market Developments and Monetary Aggregates Page 25 F E D E R A L R E S E R V E BA N K OF ST. LO U IS 1970. The money stock grew slowly in the first part of this period, but grew very rapidly in late March and in April. On balance in the period, money grew at a 5.7 per cent annual rate from December 1969 to April 1970. Analysis given at the March meeting indicated that further easing actions would be necessary to achieve even a 2 per cent rate of growth of money in the first quarter and a desired 3 per cent rate in the second quarter. Money market conditions eased further af ter the March meeting, and staff projections showed that growth rates of aggregates were falling short of the Committee’s desired rates. Later in the month, estimates of money growth were revised upwards, and the Committee no longer sought easing of money market conditions to promote growth of money. The money stock jumped sharply upward in the last week of March, due to technical factors involving a four-day Easter holiday abroad. With this bulge, money grew at a 3.9 per cent rate in the first quarter (December to March), almost double the expected 2 per cent rate at the time of the March meeting and higher than the 3 per cent rate desired by the Committee for the second quarter. The Committee thus showed considerable concern for the achievement of the growth targets for mone tary aggregates in early 1970, especially the money stock. This commitment was principally characteristic of the March and April meetings, when directives stated that money market conditions were to be con sistent with the growth targets for aggregates. Whether individual members of the Committee pre ferred a given money target because they agreed with the underlying money market condition associ ated with the target, or vice versa, is difficult to assess. The Committee was willing, however, to accept firmer conditions in late March and April in order to hold down the growth of money when projections indicated money was growing rapidly. As noted earlier, how ever, the Committee evidently was not willing to pursue a given quarterly target independent of the money market conditions that might be implied by the actions required to achieve the aggregate target. May through July: Emphasis on Moderating Pressure in Money and Credit Markets During this period, there was considerable concern by members of the Committee about pressures in the money markets and a possible liquidity crisis. Follow ing the late May and June meetings, open market Page 26 MAY 1971 operations were aimed primarily at dealing with the unsettled atmosphere in the money and credit mar kets, and less emphasis was placed on achieving targets for monetary aggregates. Economic Outlook and Policy Decisions May 5 M eeting — Preliminary Commerce Depart ment estimates indicated a decline in real GNP for the first quarter. Projections suggested little real economic growth in the second quarter, but some renewed growth in the second half of 1970. It was noted at this meeting that prices continued to rise, although there were some moderating tendencies. The unemployment rate continued upward, reaching 4.8 per cent in April. The unsettled condition of financial markets was also noted at this meeting. Most interest rates had risen from the April to May 5 meeting, counter to the general expectation of many market participants. Also, common stock market prices fell sharply in April and continued to fall in May. Apparentiy, many factors contributed to the interest rate increases. Factors cited at the May 5 meeting included concern by market participants about the prospects for success of the Government’s anti-infla tionary program, the Cambodian military operations, and the unusually heavy demand for funds in the capital market. Rising interest rates appeared to be particularly unsettling due to the general expectation that continued declines in interest rates would ac company the slowdown in economic activity. In light of these various developments, and in view of the fact that money was growing more rapidly than previously projected and that attempts to main tain the 3 per cent growth target for money might have undesired consequences, the Committee in creased its second quarter growth target for money to 4 per cent. The staff analysis indicated that this rate could be achieved “with money market conditions similar to or slightly firmer than those currently pre vailing.” The Committee felt that the “demand for money” was greater than was thought earlier.13 Ac cording to a recent Federal Reserve report, “while anxieties in financial circles that a general liquidity squeeze was emerging proved to be clearly exagger ated, it is true nonetheless that their net effect was to cause a sharp increase in over-all demand for liquidity.”14 i:iIn this context, demand for credit is implied, rather than demand for money. The ambiguity is widely discussed in economic literature. l4Federal Reserve Board of Governors, The U.S. Economy in Transition — A Prelude to the Annual Report for 1970, p. 18. F E D E R A L R E S E R V E B A N K OF ST. LO U IS The operating clause of the early May directive was quite similar to that of the previous month, ex cept a proviso clause was added which stated: . . . that operations shall be modified as needed to moderate excessive pressures in financial markets, should they develop. Mr. Francis dissented from the decision to accept the faster target rate of growth in money. He argued that a 4 per cent annual rate in the second quarter would imply a 6 per cent rate from February to June, and he considered such a rate excessive. May 26 M eeting — It was observed that revised Commerce Department figures for real GNP showed a decline at a 3 per cent annual rate in the first quar ter of 1970. Real GNP was still expected to rise in the second half of 1970, although not as much as previ ously expected, with projections indicating no growth in the second quarter. Uncertainties and strains surrounding the “liquidity crisis” continued to be primary concerns of the Com mittee at the late May meeting. The Committee stated a desire to see moderate growth in money and bank credit, but priority was to be given to the objec tive of moderating pressures in financial markets. The Committee acknowledged that this might bring a higher growth rate of money than the 4 per cent con sidered appropriate as the long-run objective. Projec tions indicated a 7 per cent rate of growth of money was likely in the second quarter, compared with an earlier target of 3 per cent, and indicated firmer money market conditions would develop if an effort were made to hit the 4 per cent target of the Committee. June 23 M eeting — Financial markets were reported to have “calmed considerably” immediately following the May 26 meeting, and interest rates on many short-term instruments were tending to move down ward. Long-term rates, however, continued to move upward, many reaching their 1970 peaks in June. New uncertainties were introduced into financial mar kets by the insolvency of the Penn Central Railroad, which caused the commercial paper market to be particularly sensitive. Yields on commercial paper tended to rise, as investors became more selective and aware of the risks involved in such paper. In view of the uncertainties and strains in financial markets, the Committee again directed that open mar ket operations be carried out with the objective of moderating these pressures. Analysis indicated growth MAY 1971 of money at about a 5 per cent annual rate from June to September, assuming prevailing money market con ditions were maintained. The Committee directed that to the extent possible this growth rate should be achieved while at the same time moderating market pressures. Thus, the target growth rate of money was increased from the 3 and 4 per cent rates targeted earlier in the year. In addition to the actions taken by the Committee, two other actions were taken by the Federal Reserve. On the same day as the June Committee meeting, the Board of Governors suspended Regulation Q ceilings on 30- to 89-day maturity CD’s and other single-maturity time deposits of $100,000 or more. Also, in late June the administration of the discount window was temporarily relaxed, in order to accommodate banks which were lending to firms having difficulty in ob taining financing in the commercial paper market. July 21 M eeting — Preliminary Commerce Depart ment figures indicated that real GNP had increased only slightly in the second quarter, but projections continued to suggest that real GNP would pick up in the second half of 1970. Data for June showed that industrial production had declined further, but retail sales and housing starts had risen. The unemploy ment rate had declined to 4.7 per cent in June, from 5 per cent in May. In view of the declining market interest rates, the Committee decided to place less emphasis on mod erating market pressures and more emphasis on achieving the targets for monetary aggregates. The Committee agreed that a 5 per cent rate of growth in money remained the appropriate target for the third quarter (from June to September), but stated that if deviations from this target rate developed, they should be on the upside. The wording of the operating clause of the July directive was similar to the May 5 direc tive, calling for open market operations to be carried out to achieve growth targets for aggregates, but added a proviso clause that open market operations should be modified if financial pressures developed. Money Market Conditions and Monetary Aggregates From April through July, the money stock (old series) increased at a 2 per cent annual rate, while the adjusted bank credit proxy increased at an 8 per cent rate. The latter series was heavily influenced by the reintermediation of time deposits into banks. The monetary base grew at a 5.6 per cent rate in this Page 27 F E D E R A L R E S E R V E B A N K OF ST. LO U IS M onetary B ase a n d Federal Reserve Credit MAY 1971 In general, the directives in this period called for a dual policy objective of both “some easing of condi tions in credit markets” and “moderate growth in money and attendant bank credit expansion.” Easing in credit markets was sought during this pe riod because members of the Committee were con cerned about the lack of decline in long-term interest rates. These members felt that it was desirable to have long-term rates decline in order to encourage recovery of residential construction and state and lo cal government spending. In general, the instructions in the directives were as follows: . . . the Committee seeks to promote some easing of conditions in credit markets and moderate growth in money and attendant bank credit expansion over the months ahead. System open market operations until the next meeting of the Committee shall be con ducted with a view to maintaining bank reserves and market conditions consistent with those objectives. . . Q.Uses o f the m o n etary b as e a r e m e m b e r b an k reserves an d currency h eld b y th e p u b lic a n d n onm em ber banks. A djustm ents a r e m a d e fo r reserve requirem ent changes a n d shifts in d ep o s its a m o n g classes of banks. D a ta a r e com p u ted b y this bank. [2 Total Federal R eserve c red it o u ts tan d in g includes holdings o f securities, loans, flo a t, a n d " o th e r" assets. Adjustm ents a re m a d e fo r reserve re q u ire m e n t ch an g es a n d shifts in deposits am ong classes o f b an k s. D a ta a re com puted b y this bank. P e rc e n ta g e s a r e a n n u a l ra te s o f c h a n g e fo r p e rio d s in d ic a te d . L ates t d a t a p lo tte d : A p ril period. The substantially slower growth of money than the base is attributable largely to the rapid growth of time deposits. This rapid reintermediation of time deposit funds into banks absorbed reserves which otherwise could have supported an expansion in demand deposits. In general, short-term rates rose in April and May and tended to fall in June and July. Open market operations were aimed primarily at moderating pressures in financial markets following the May 26 and June 23 meetings. Although at the time of the May 26 meeting a 7 per cent rate of growth in money was expected in the second quarter, the old series grew at a 4.2 per cent rate, close to the 4 per cent target desired (the revised data released in late November indicated the growth of money in this period was at about a 6 per cent annual rate). August through November: Easing in Money and Credit Markets In the four meetings from August 18 through No vember 17, the emphasis on moderating money mar ket pressures was reduced, and longer-run objectives in terms of growth in aggregates were re-established. Page 28 At times, these dual policy objectives could be in conflict with one another, but, in practice, they were not generally in conflict over this period. The de mands for credit in the private economy continued to ease as the pace of economic activity continued to slow, at least partly in response to restrictive actions of late 1969. Economic Outlook and Policy Decisions August 18 M eeting —Projections for real GNP re mained much the same in August as in July; that is, for some increase in real GNP in the second half of 1970, although below potential. It was noted that prices were still rising rapidly, but not as fast as earlier. The money stock was expected to grow at an an nual rate of about 4 per cent over the third quarter, if prevailing money market conditions were main tained, and more easing in money markets was be lieved needed to achieve a 5 per cent rate of growth in money. In the discussion by members of the Committee, an abatement of expectations of continu ing inflation was noted, and it was agreed that policy should be directed at stimulating real growth of the economy, while at the same time being careful not to revive inflationary expectations. To stimulate real growth, the Committee directed open market opera tions to promote some easing in credit markets and to seek growth in the money stock at about a 5 per cent annual rate. As in the July directive, the Committee stated that it preferred deviations from this target to be on the upside. F E D E R A L R E S E R V E B A N K OF ST. LO U IS Three members, Mr. Hayes, Mr. Brimmer, and Mr. Francis, dissented from this directive. They dis sented primarily because “they were opposed to the promotion of ‘some easing of conditions in credit markets’ as a specific objective of Committee policy at this time.” They considered this easing unnecessary to expand economic activity and involving “risk of rekindling inflationary expectations.” S eptem ber 15 M eeting —At this meeting the Com mittee was informed that the money stock series con tained a definite bias. Board of Governors staff analysis indicated that further easing of money mar ket conditions would be necessary in order for the money stock (roughly adjusted for bias) to grow at an annual rate of 5 per cent in the fourth quarter. The Committee decided that a 5 per cent growth in money and some easing in credit markets remained appropriate objectives for monetary policy in the fourth quarter. Some members felt money should grow somewhat faster than 5 per cent, while others felt that the money series should be de-emphasized at this time, in part due to the uncertainties relating to the forthcoming revision of the money stock series. Some members preferred that bank credit be given more weight, be lieving that reintermediation was about over. How ever, it was decided that for the present, “prepon derant weight” should be given to the money stock “in assaying the implications of the behavior of finan cial aggregates for System operating decisions.” Mr. Hayes dissented from the directive, and ex pressed concern about again aiming toward “an easing of conditions in credit markets.” He noted that inter est rates had already fallen and “was not convinced that further easing would be required to achieve the objective . . . of moderate growth in money and bank credit.” He also expressed concern over “the possible inflationary effects of a policy calling for progressive easing of credit conditions.” O ctober 20 M eeting — A rise in real GNP at a 1.4 per cent annual rate for the third quarter was indi cated by preliminary Commerce Department figures. Also in September, there had been a fall in industrial production which was attributed primarily to the au tomobile strike. Unemployment had advanced in September to 5.5 per cent from 5.1 per cent in Au gust. Real GNP was projected to move up slightly in the fourth quarter, but the auto strike clouded most statistics at the time. MAY 1971 Analysis presented indicated that if money market conditions similar to those recently prevailing were maintained, the money series (roughly adjusted) would grow at about a 5 per cent annual rate over the fourth quarter (from September to December). The Committee agreed that this remained an appro priate target, accompanied by some easing in credit market conditions. As at the previous meeting, some members expressed a desire for a faster growth rate of money, while others wanted less emphasis given to achieving money growth targets. Mr. Hayes again dissented for essentially the same reasons as the previous meeting. He did not disagree with a 5 per cent growth rate in money, but “he was concerned about the directive language reading ‘the Committee seeks to promote some easing of condi tions in credit markets,’ because it implied to him that a persistent push toward lower interest rates was intended, irrespective of market forces. Such a course, in his view, would involve undue risks of rekindling inflationary expectations and of weakening the inter national position of the dollar.” Substantial declines in short-term market interest rates had occurred so far in 1970, reflecting the weak ness in demand for credit relative to supply. In re sponse to similar supply and demand forces, the prime rate, the interest rate charged by banks on loans to their best business customers, had been re duced from 8 per cent to 7% per cent on September 21. On November 11 and succeeding days, the Fed eral Reserve Banks reduced their discount rate from 6 per cent to 5% per cent. On November 12, the prime bank loan rate was reduced to 7% per cent, and only two weeks later was reduced to 7 per cent. N ovem ber 17 M eeting — Board of Governors staff projections reviewed by the Committee indicated that real GNP would not grow in the fourth quarter, and data for October showed a decline in retail sales and industrial production, while the unemployment rose further. The weaknesses in economic activity were at least partially caused by the automobile industry strike. Projections suggested a rebound in economic activity in the first quarter of 1971, assuming an end to the strike in the near future. The money stock rose only slightly (revised series) in October, and analysis given at the November meet ing indicated that further easing of money markets conditions would be necessary if even a 4 per cent rate of growth in money was sought in the fourth Page 29 F E D E R A L R E S E R V E BA N K OF ST. LO U IS quarter.15 This shortfall below the 5 per cent target growth of money desired by the Committee was at tributed to weakness in the demand for money and credit, mostly associated with the auto strike. Again, the view prevailed that the dem and for money, or the “transactions needs” of the nonbank public, determines the growth of the money stock. This view appears to attribute relatively little significance to growth of bank reserves or the monetary base in the determina tion of the growth of money, even over a period of three or four months. The Committee agreed that some further easing of credit and moderate growth in money remained appropriate targets, but felt that the actions that might be necessary in order to achieve a 5 per cent growth in money in both the fourth quarter of 1970 and the first quarter of 1971 could result in unde sirable fluctuations in money and credit market condi tions. The consensus of the Committee members was that a “4 per cent growth rate in the fourth quarter would be acceptable if the results of operating experi ence over coming weeks bore out the indication of the staff analysis that attainment of a 5 per cent rate would require a sharp easing of money market condi tions.” This decision was made with the expectation that money would grow faster in the first quarter of 1971. Mr. Maisel dissented from this directive because he favored growth of money in the fourth quarter “at least as high as the rate that had prevailed on the average in the first three quarters of the year.” Thus, he favored growth in money at about a 6 per cent annual rate, whereas the Committee was willing to ac cept a 4 per cent rate of growth in the fourth quarter. Money Market Conditions and Monetary Aggregates The money stock (revised series) grew at a 4.6 per cent annual rate from July to November, and the monetary base increased at a 4.2 per cent annual rate. Both short-term and long-term interest rates de clined considerably during these months. For exam ple, three-month Treasury bills fell from about 6.45 per cent in July to about 5.3 per cent in November, and yields on corporate Aaa bonds declined from 8.44 per cent to 8.05 per cent. Following the August and September meetings, open market operations were aimed at easing credit mar kets and achieving moderate growth in money. Short term interest rates fell somewhat during this period, 15Revision of the money series had been completed and was available to members at the November meeting. Page 30 MAY 1971 but yields on corporate and municipal bonds declined only slightly. At the mid-September meeting, a 4.5 per cent growth rate of money (old series) was ex pected for the third quarter (June to September),16 but a 5.2 per cent rate was obtained, close to the 5 per cent target desired. The revised money series grew at a 6.2 per cent rate in the third quarter. Growth of the money stock fell short of expecta tions in October and November. Projections had indi cated an increase at a 4.5 per cent rate in October (roughly adjusted series), while the actual rate was about 1 per cent ( revised series). The shortfall was attributed to the weakness in credit demand associ ated with the automobile strike and slow business activity. The Federal funds rate dropped sharply in this period; however, by observing the monetary base it is evident that the slow growth in money is attribu table to the small increase in the monetary base in October and November. The base grew at only a 2 per cent annual rate in these two months. Following the November meeting, easier money market conditions were sought in order to promote easing in credit markets and growth of money. Part of open market purchases were made in intermediateand long-term securities, which tend to lower longerterm interest rates. Both short-term and long-term interest rates fell substantially between the November and December meetings. 16About 1 percentage point less was expected for the roughly adjusted series, that is, 3.5 per cent. F E D E R A L R E S E R V E B A N K OF ST. LO U IS December: Less Emphasis on Aggregates Less emphasis on aggregates prevailed during the December 15 meeting. The summary of discussion said, “the outlook for the monetary aggregates was particularly uncertain at this time, both because of the difficulties of assessing the precise impact on fi nancial markets of the surge in activity expected in the aftermath of the automobile strike and because of the churning in those markets that is typical of the period around the year-end.” In view of these uncer tainties, a number of Committee members suggested that less weight be given to aggregates and more to money market conditions. The status of monetary aggregates as indicators of monetary policy actions was somewhat unclear at this juncture. Some members favored less emphasis only on a temporary basis, while others were for less em phasis on “more general grounds.” Some members brought attention to more broadly defined monetary MAY 1971 the first quarter of 1971. Money was expected to grow faster than 5 per cent in the first quarter of 1971, and members concluded that movements in this series in the immediate future should appear consistent with the faster anticipated average rate. The Committee agreed that “money market conditions should be eased if it appeared that shortfalls from those growth paths were developing, but that otherwise operations should be directed at maintaining the conditions most re cently attained.” The operating clause of the Decem ber directive read: System open market operations shall be conducted with a view to maintaining the recently attained money market conditions until the next meeting of the Committee, provided that the expected rates of growth in money and bank credit will at least be achieved. Mr. Francis dissented from this directive, because he favored both maintaining a target 5 per cent an nual rate of monetary growth and increasing the em phasis on money rather than reducing it. He expressed concern that a rate of growth in money at a rate faster than 5 per cent could possibly prolong inflation and even intensify it, while holding the growth in money to a 5 per cent rate “was likely to assure steady prog ress toward moderating price increases, along with a gradually increasing pace of expansion in real output.” At the December meeting, it was still expected that a 5 per cent growth of money would occur in the fourth quarter, even though the growth of money in October and November had been substantially below this target. However, growth of money was substan tially less than expected in late December; for the fourth quarter, money grew at a 3.4 per cent rate. Immediately after the December meeting, open mar ket operations were aimed at maintaining the pre vailing money conditions. Since the demands for credit were continuing to ease substantially, market conditions remained easy. Nevertheless, Desk opera tions did not result in enough additional reserves to achieve the desired growth in money. CONCLUSION aggregates. For instance, money plus net time de posits grew at a rapid 10 per cent rate from February to December, partly reflecting the rapid reintermedia tion of time deposits into banks.17 There was some disagreement as to the appropriate targets for money in the fourth quarter of 1970 and 17Net time deposits are defined as total time deposits at com mercial banks less large negotiable certificates of deposit. The year 1970 marked a “modest” beginning for the use of monetary aggregates in the formulation and implementation of monetary policy decisions. The emphasis on aggregates, however, varied during the year. After the initial statement by the Committee at the January meeting, its position on monetary aggregates evolved; at the March and April meetings the objec tive of the directive was stated totally in terms of Page 31 MAY 1971 F E D E R A L R E S E R V E B A N K OF ST. LO U IS monetary aggregates. Beginning in May and continuing through the July meeting, the emphasis on aggregates was greatly reduced, and replaced by other short-term objectives such as moderating pressures in financial markets. However, targets for aggregates still were to be sought to the extent that they were consistent with these other objectives. The Committee raised the targets for money in several stages from a 3 per cent rate for the second quarter (March meeting) to a 5 per cent target for the third quarter at the July meeting.18 The emphasis on aggregates was some what reinstated at the August meeting and continued through the November meeting. However, the objec tive of achieving “some easing of conditions in credit markets” also was stated explicitly. The December meeting left the future status of monetary aggregates somewhat in doubt. The direc tive was again stated in terms of money market con ditions; some Committee members expressed reserva tions about the use of monetary aggregates, and some desired more use of money market conditions. Part of the return to primary emphasis on money market con ditions at the end of the year may have been due to the data problems involving the revision of money stock series. As was noted earlier, according to the old series money growth had been fairly close to that 18The Committee desired to have deviations from the 5 per cent target on the upside. sought by the Committee, but with the revision, money had grown faster in the first three quarters of the year than desired. Although growth of the money stock (old series) was quite close to the quarterly targets desired by the Committee, by looking more closely one could argue that this was partly an accident. For example, at the May 26 meeting a 7 per cent growth rate of money was expected for the second quarter. An un expected shortfall in money occurred in June, and a 4.2 per cent rate was achieved in the second quarter, quite close to the earlier 4 per cent target. Growth of aggregates for the fourth quarter of 1970 was consid erably under-achieved. Growth of money in October and November fell short of expectations, even though money market conditions eased as was called for in the directive. Despite these shortfalls, at the De cember 15 meeting, a 5 per cent rate of money growth was expected for the period September to December, but only a 3.4 per cent rate (revised series) was achieved. These developments give the impression that con trol methods for money have yet to be perfected. Part of the problem may lie with the “money market conditions” approach. A more direct approach such as controlling bank reserves or the monetary base may be a more reliable method for controlling the money stock. This article is available as Reprint No. 68.
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