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T I G H T M O N E Y A n A d d r e s s by H u g h D. Galu s h a , Jr. President F e d e r a l R e s e r v e B a n k of M i n n e a p o l i s at the 13th A n n u a l I n s t i t u t e U n i v e r s i t y of M i n n e s o t a School of B u s i n e s s A d m i n i s t r a t i o n Alumni Association St. Paul H i l t o n Hotel O c t o b e r 27, 1966 T I G H T M O N E Y In a w o r l d that lives i n c r e a s i n g l y f r o m m o m e n t to mo m e n t , w i t h s e l d o m m o r e t h a n t w e n t y - f o u r h o u r s in full view, there is an u n d e r s t a n d a b l e t e n d e n c y to look u p o n t o d a y ’s p r o b l e m s as h a v i n g a p p e a r e d s o m e t i m e s h o r t l y be f o r e we w o k e u p this morn i n g . Of course, this is not the case. Whe r e we are tod a y is a l w a y s the result of a j o u r n e y that star t e d a long time ago. nection, In this c o n it is a u s e f u l e x e r c i s e to look b a c k o v e r the past at the s ignals we f o l l o w e d and s h o u l d n ' t have, as wel l as those we d i d n ’t f o l l o w and should have. F a i l u r e to chart the r i ght co u r s e m a y ha v e b e e n b e c a u s e some of the signals w e r e only partly visible, some w e r e not clear, and a f ew m a y e v e n ha v e been t o t a l l y o b s c u r e d , a n d v i s i b l e o n l y in r etrospect. Hope f u l l y , such an e x e r c i s e im p r o v e s the speed and a c c u r a c y of the i d e n t i f i c a t i o n of fut u r e signals; but at the least, it a f f o r d s an o p p o r t u n i t y to a n t i c i p a t e o u r c r i t i c s and the m a j o r o f f e n s e s f or w h i c h they wi l l seek to c o n s i g n us to the limbo of d i s c r e d i t e d pr o p h e t s . T h a t there is s e l d o m u n a n i m i t y a m o n g the c r i t i c s as to the p r e c i s e n a t u r e of the m i s s e d si g n a l s is scant comfort. Yet, it seems to me, there are e n o u g h of the s i g n a l s n o w c l e a r l y v i s i b l e to ju s t i f y the p o l i c y d e c i s i o n s m a d e by the Fed o v e r the last tw e l v e months. ci s i o n s , B e fore d i s c u s s i n g these p o l i c y d e it m i g h t be h e l p f u l if we look at some of the signals l eading up to them. C o m m e n c i n g in m i d - 1964, the m o n e y su p p l y star t e d to incr e a s e rapidly. T h i s rate of in c r e a s e l e v e l l e d off a little at the end of 1964, a n d e v e n t o o k a d o w n t u r n in M a y of 1965. But it then took off a g a i n at an a c c e l e r a t e d rate. T hrough October, the annual rate wa s 4.4%, but t h i s i n c l u d e d an a n nual rate for O c t o b e r alo n e of 9.5%. A f t e r a b rief pause, it s tarted its rapid a s c e n t again, and in M a r c h r e a c h e d a h i g h p oint of n e a r l y $172 billion. ing a bit for a bout six week s , After falter it m a d e one m o r e sharp spurt b e f o r e s t a r t i n g to s h r i n k to its p r e s e n t level, w h i c h is a b o u t $170 billion. D u r i n g this same period, total loans and i n v e s t m e n t s of c o m m e r c i a l b a n k s s h o w e d a c o n t i n u e d increase. This rate of increase, w h i c h had been f a i r l y c onstant, has o n l y r e c e n t l y b e g u n to falter. Even more disturbing d u r i n g this period, h o w e v e r , w as the v e r y sharp r u n - u p of c o m m e r c i a l loans at the m a j o r banks. In the fall of 1964, the rate of i n c r e a s e of c o m m e r c i a l loans s t a r t e d to a c c e l e r a t e , a n d e v e n t h o u g h o t h e r types of loans s h owed a v e r y m o d e s t g rowth, the rate of g r o w t h of this i m p o r t a n t c o m p o n e n t w as e n o u g h to p r o d u c e an o v e r - a l l sharp rate of i n c r e a s e f o r total loans. F o r exam p l e , b a n k credi t rose at a n annual rate of 1 1 . 3 % in Octo b e r , a n d at an a n n u a l rate of 9 . 7 % d u r i n g the f i r s t ten m o n t h s of 1965. d u r i n g all of 1964. Thi s we m u s t c o n t r a s t w i t h a g r o w t h rate of 8 . 4 % B u s i n e s s loans s h owed a d e c l i n e in Octob e r , but the rate of g r o w t h d u r i n g the f i r s t ten m o n t h s of 1965 w as 19%, w h i c h w a s c o n s i d e r a b l y m o r e t h a n the 1 1.9% of 1964. A d i f f e r e n t p i c t u r e is shown by d e m a n d d e p osits. late 1964 to date, the a v e r a g e level of d e m a n d d e p o s i t s h as f l u c t u a t e d about a f a i r l y c o n s t a n t tre n d line. A l t h o u g h time a nd s avings d e p o s i t s g r e w f a i r l y r a p i d l y d u r i n g the fir s t part of 1965, they, d r e w to a close. D u r i n g the p e r i o d of too, st a r t e d to level off as 1965 Real c o n c e r n star t e d to d e v e l o p d u r i n g the fall of 1965 a b o u t the a b i l i t y of ba n k s to c o m p e t e w i t h o t h e r f i n a n c i a l i n t e r m e d i a r i e s . An attempt to i n c r e a s e the p r i m e rate had failed, a n d the banks w e r e s tuck at a 5% level. T h r o u g h m o s t of 1964, a n d by the end of 1965, ban k rates w e r e l a g g i n g m a r k e t 2. ra t e s g e n e r a l l y . Thi s w a s i n c r e a s i n g the p r e s s u r e on b a n k s to m a k e b u s i n e s s loans, b e c a u s e it w a s o b v i o u s l y to the a d v a n t a g e of the st r o n g c o r p o r a t e c r e d i t to go to the banks i n s t e a d of to the market. T he s urveys of b u s i n e s s s p e n d i n g st a r t e d c o m i n g in at h i g h e r and h i g h e r rates. T he f irst s u r v e y r e p o r t e d in O c t o b e r of 1965 i n d i c a t e d a p r o b a b l e 8% i n c r e a s e in 1966 o v e r 1965. W h at w e r e some of the o t h e r signs? rate of labor u t i l i z a t i o n . Well, one of the s e w a s the v e r y h i g h At the b e g i n n i n g of 1964, the rate of u n e m p l o y m e n t d r o p p e d b e l o w 5% f o r the f i r s t time since e a r l y 1960. c o n t i n u e d , d r a f t c alls a d d e d d o w n w a r d pressure. As the d o w n w a r d trend In S e p t e m b e r of 1965, the rate of u n e m p l o y m e n t r e a c h e d 4 . 4 % , a nd a n x i o u s v o i c e s b e g a n to be h e a r d as the sc r a m b l e f or the t r a i n e d h e l p i n c r e a s e d in intensity. hours worked per week increased dramatically. of course, move. In the fall of 1965, the W i t h the i n c r e a s e in overti m e , came a n i n c r e a s e in c o n s u m e r spending, and c o n s u m e r pri c e s b e g a n to T h i s m o v e m e n t , w h i c h st a r t e d in a b o u t M a y of 1965, w a s at first d i s c o u n t e d b e c a u s e of the su p p l y f a c t o r in the o t h e r c o m p o n e n t s - namely, food. T h i s c o m f o r t did not last long, f or the index, a l t h o u g h m o v i n g at a lesser rate, c o n t i n u e d to increase. October, The c o n s u m e r price i n d e x stood at 1 0 8 . 5 % in 1964; 1 0 9 . 3 % on M a y 1, 1965; 1 1 0 . 1 % on J u l y 1, 1965; and 1 1 0 . 4 % on N o v e m b e r 1, 1965. E v e n that old r e l i a b l e index, that of w h o l e s a l e prices, b r o k e a w a y f r o m its long p e r i o d of s t a b i l i t y and b e g a n to c l i m b in e a r l y 1965. Between October, 1964 and O c t o b e r , 1965, it ha d i n c r e a s e d f r o m 10 0 . 8 % to 103.1%. A n d then t here w a s the b a l a n c e of payments. A l t h o u g h the v o l u n t a r y c r e d i t r e s t r a i n t p r o g r a m w a s r e g a r d e d as at least a q u a l i f i e d success, a t t e m p t to im p r o v e o u r b a l a n c e on goods a n d serv i c e s w as not. 3. the The i m p r o v e m e n t in the s e c o n d q u a r t e r f o l l o w i n g the s e t t l e m e n t of the m a r i t i m e strike did not c onti n u e . It b e c a m e o b v i o u s that the p r e s s u r e of c o n s u m e r d e m a n d w a s r e d u c i n g the e x p o r t p o t e n t i a l at the same time it w a s i n c r e a s i n g the imports. Of course, t here w a s Vi e t N am and the level of g o v e r n m e n t spending. I recall that it w as in A u g u s t of 1965 that the O p e n M a r k e t C o m m i t t e e of the F e d e r a l R e s e r v e S y s t e m f irst b e g a n d i s c u s s i n g Viet N am in terms of a war. the fall w o r e on, the rate of s p e n d i n g for Viet N am increased. As T he rate of s p e n d i n g w a s then as d i f f i c u l t to d e t e r m i n e as it is now, but it w as o b v i o u s it w a s at a v a s t l y i n c r e a s e d rate f r o m the e a r l i e r p r o j e c t i o n s . This, then, w a s t he scene. But in a d d i t i o n to these tr a c k s left by the e c o n o m y in its s t e a d y a c c e l e r a t i o n , response. there w a s a d e e p e n i n g tone of e m o t i o n a l I n t u i t i v e r e s p o n s e s are at least as i m p o r t a n t to m o n e y m a n a g e r s as they are to a i r p l a n e pilots. T h e r e w e r e str o n g f e e l i n g s that the A d m i n i s t r a t i o n w o u l d not be r e p o r t i n g a b u d g e t that w o u l d i n d i c a t e a lower rate of spending, e s p e c i a l l y w i t h the a c c e l e r a t i o n then u n d e r w a y in Vi e t Nam. There were those w h o felt that we should w a i t in a n y case u n t i l mor e n u m b e r s w e r e in, i n c l u d i n g the budg e t. But the d e l a y w o u l d have f o r c e d a p o s t p o n e m e n t s u b s t a n t i a l l y a f t e r the f i r s t of the year, b e c a u s e of the T r e a s u r y f i n a n c i n g plans. ing that m o s t of the c r i t i c i s m , h o wever, w a s ba s e d on timing, It is i n t e r e s t r a t h e r than g e n e r a l r e c o g n i t i o n of the e m e r g e n c e of i n f l a t i o n a r y p r e s s u r e s . This wa s the b a c k g r o u n d as the e nd of N o v e m b e r approa c h e d . Wh a t w e r e the p o l i c y d e c i s i o n s m a d e by the Fed w h i c h hav e c o n t r i b u t e d to the s u b j e c t of m y tal k t o day? ncontributedM . The m o r e c o m p l i c a t e d the w o r l d becomes, the g r e a t e r b e c o m e s o u r d e s i r e to find single causes, You w i l l note the q u a l i f i c a t i o n in the w o r d to sepa r a t e the w o r l d into good guys and 4. bad g uys -- into simple shades of b l a c k a n d white. F e w t imes in o u r h i s t o r y has one of o u r m a j o r i n s t i t u t i o n s shif t e d so r a p i d l y ba c k a n d f o r t h f r o m the p o s i t i o n of a good gu y to that of a bad guy, a n d v i c e versa, as the Fe d e r a l Reserve S y stem has in the past tw e l v e m onths. I a m a f r a i d o u r e c o n o m y is m u c h too c o m p l i c a t e d to pe r m i t such a s i m p l i s t i c view. We tend to thi n k of the e c o n o m y as a large b a s i n in w h i c h the m a j o r i n g r e d i e n t s are c o n t a i n e d in a f l u i d state. Ideally, these i n g r e d i e n t s f l o w e a s i l y to m a i n t a i n a level of e q u i l i b r i u m a n d c o n s t a n t l y ev e n t h r o u g h o u t the basin. By si m p l y i n c r e a s i n g or d e c r e a s i n g the f l o w of the p a r t i c u l a r i n g r e d i e n t t h r o u g h the v a r i o u s f a u c e t s f e e d i n g the basin, not o n l y can the m i x be varied, but the v o l u m e of the e c o n o m y as well. Unfortunately, ment, e m p l o y m e n t , ingredients, the f l o w of m o n e y a nd credit, s k i l l e d h e l p a v a i l a b i l i t y , a n d the m a n y o t h e r e c o n o m i c is not q u i c k l y and e v e n l y r e d i s t r i b u t e d a r o u n d the economy, no r is the s upp l y a l w a y s in p r o p o r t i o n to a n ideal mix. the o t h e r c o m p o n e n t s in the e c o n o m y changes, credit. like i n d u s t r i a l d e v e l o p As the r e l a t i o n s h i p of so m u s t the s u p p l y of m o n e y and The c ontrol of the Federal R e s e r v e Sy s t e m o v e r the supply of m o n e y an d c r e d i t is n e i t h e r as p r e c i s e n o r as e x c l u s i v e as its c r i t i c s w o u l d m a i n t a i n . A f t e r all, there are o n l y f o u r tools at the d i s p o s a l of the S y s t e m -- O p e n Market operations, the d i s c o u n t rate, the c ontrol of time d e p o s i t rates t h r o u g h R e g u l a t i o n Q, and r e s e r v e r e q u i r e m e n t s . Of these, f r e q u e n t l y used. the O p e n M a r k e t o p e r a t i o n s are the least v i s i b l e and the m o s t By b u y i n g or se l l i n g g o v e r n m e n t s e c u r i t i e s for the S y st e m a c c o u n t in the ope n m a r k e t , the s u pply of ban k r e s e r v e s is e i t h e r i n c r e a s e d o r d e c r e a s e d , a n d the l o a n a b l e fu n d s of the b a n k i n g s y s t e m a r e c h a n g e d in d i r e c t ratio. T h e s e d e c i s i o n s are m a d e d a i l y in a c c o r d a n c e w i t h the state of the m o n e y market, the level of b a n k rese rves, a n d all the rest of the e c o n o m i c i n d i c a t o r s 5. that m a k e up the b e w i l d e r i n g m a t r i x of the m o n e y market. is m a d e daily, A l t h o u g h the d e c i s i o n it is in a c c o r d a n c e w i t h the spirit of a d i r e c t i v e a d o p t e d a b o u t e v e r y t h ree w e e k s by the O p e n M a r k e t Committee. b e a r i n g on the c o n d i t i o n of the m o n e y mark e t , As onl y one of the f a c t o r s the a c t i o n of the O p e n M a r k e t D e s k o f t e n m u s t be r e a c t i v e r a t h e r than positive. Often, on p a r t i c u l a r days, the D e s k is not free to m o v e w i t h i n even the v e r y br o a d limits of the d i r e c t i v e b e c a u s e of fea r s that its effor t s , w h e n c o m b i n e d w i t h fo r c e s p r e s e n t in the m a r k e t that day, m i g h t p r o d u c e e x a c t l y the o p p o s i t e e f f e c t d e s i r e d by the d i r e c t i v e. G e n e r a l l y , O p e n M a r k e t o p e r a t i o n s have be e n of a t i g h t e n i n g o r d e r since e a r l y in the s u m m e r of 1965. Th a t they did not p r o d u c e the d e s i r e d r e s u l t s quickly, a nd in fact a p p e a r e d e x p a n s i o n a r y un t i l m i d - s u m m e r of 1966, is less a resu l t of d e l i b e r a t e a c t i o n than the c l i m a t e in w h i c h O p e n M a r k e t o p e r a t i o n s had to be co n d u c t e d . W i t h such a v i g o r o u s e x p a n s i o n u n d e r way, the m o n e y s u p p l y p r e t t y m u c h h ad to i n c r e a s e rapidly; o t h e r w i s e u n p r e c e d e n t e d levels of i n t e r e s t rates w o u l d have resulted. C r i t i c i s m of this p e r i o d is n o w m o u n t i n g , b a s e d p r e t t y m u c h on the p e r f o r m a n c e of the m o n e y s u p p l y d u r i n g this period. However, I hope that h i s t o r i a n s of a n o t h e r d e c a d e wi l l support the s t a t e m e n t that, for the mos t part, O p e n M a r k e t o p e r a t i o n s d u r i n g this p e r i o d w e r e c o n s i s t e n t w i t h the s t a n c e of m o n e t a r y policy. It s i m p l y w a s not p o s s i b l e for the Fed, as o n l y one of the i n f l u e n c e s in the m o n e y ma r k e t , to c urtail the e x p a n s i o n p r o c e s s as d r a m a t i c a l l y as its c r i t i c s are n o w say i n g should have b e e n done. tainly, Cer it is q u e s t i o n a b l e w h e t h e r the t i g h t e n i n g w h i c h di d take place, p a r t l y b e c a u s e of the F ed's a c t i o n a n d p a r t l y b e c a u s e of the c o n t i n u e d g r o w t h in loan demand, c o u l d have b e e n a c c e l e r a t e d m u c h m o r e w i t h o u t the c o m p l e t e l y i n t o l e r abl e r u n -up of rates r e f e r r e d to earlier. 6. As it is, the cry w as h e a r d w i t h i n c r e a s i n g f r e q u e n c y as the s p ring w o r e on, that all we w e r e s e e i n g wa s h i g h cost m o n ey, not tight money. But b a c k to tool n u m b e r two, the d i s c o u n t rate. f r e q u e n t l y r e f e r r e d to as a signal rate. The d i s c o u n t rate is A l t h o u g h its a v o w e d p u r p o s e is to e s t a b l i s h the i n t e r e s t rate to be paid by m e m b e r banks on t heir b o r r o w i n g s f r o m the F e d e r a l R e s e r v e B a n k of t h e i r d i s t r i c t , d i r e c t i o n of m o n e t a r y policy. it does i n d i c a t e shifts in It w a s o b v i o u s to all, as 1965 d r e w to a close, that the A m e r i c a n b a n k i n g s y s t e m had w o r k e d itself into a b l i n d alley. t h i n g ha d to be don e to free b o t h the loan a nd the d e p o s i t rates. Some This wa s d o n e D e c e m b e r .5, 1965, w h e n the d i s c o u n t rate w a s i n c r e a s e d f r o m 4 to 4%%, t h e r e b y f r e e i n g c o m m e r c i a l b a nks to i n c r e a s e t h e i r loan rate. May I emphasize that the rate a d j u s t m e n t s of the c o m m e r c i a l banks to t h e i r c u s t o m e r s was e n t i r e l y a v o l u n t a r y act on the part of the banks. tion to the i m p o r t a n c e of r e s t r a i n i n g credit, By g i v i n g o f f i c i a l r e c o g n i the m o n e t a r y a u t h o r i t i e s at one s t r o k e e s t a b l i s h e d an o p e r a t i n g c l i m a t e in w h i c h the banks b e c a m e free to act. At the same time, R e g u l a t i o n Q - o u r third tool - w a s amended. This r e g u l a t i o n sets the m a x i m u m rate w h i c h a m e m b e r b a n k can p ay on time deposits. T h i s m o v e w a s v e r y i m portant. C o m m e n c i n g in 1961, ban k s had p l a c e d i n c r e a s i n g r e l i a n c e on c e r t i f i c a t e s of d e p o s i t to p r o v i d e them w i t h fu n d s w h e n they n e e d e d t h e m to loan. T he C.D. served as the banks' r e s p o n s e to the c o m p e t i tion f o r f u n d s that d e v e l o p e d w i t h the i n c r e a s i n g s o p h i s t i c a t i o n of c o r p o r a t e t r e a s u r e r s and the m a n a g e r s of o t h e r large d e m a n d d e p o sits. w a s m a d e in D e c e m b e r of 1965, though, b a n k s had bee n at a d i s a d v a n t a g e , as m a r k e t i n t e r e s t rates c o n t i n u e d to m o v e up d u r i n g 1965. R e g u l a t i o n Q a full 1%, f r o m 4 ^ % to 5^%, Until the c h a n g e 7. By i n c r e a s i n g it w a s h o p e d s u f f i c i e n t h e a d r o o m w o u l d be p r o v i d e d to r e s t o r e ban k s to a c o m p e t i t i v e position. to c o m p e t e fo r f u nds w i t h a v e n g e a n c e . s a v i n g s an d loans, w e r e the p r i n c i p a l A nd they b e g a n Other financial intermediaries, mainly sufferers. T he su p p l y of funds a v a i l a b l e f o r m o r t g a g e lending, p a r t i c u l a r l y r e s i d e n t i a l c o n s t r u c t i o n , b e g a n to slow up. W h i l e not the e n t i r e reason, this did c o n t r i b u t e to the d e c l i n e of r e s i d e n t i a l c o n s t r u c t i o n that has c o n t i n u e d to this year. Unfortunately, the e c o n o m y c o n t i n u e d on its d i z z y pace. w a s some fiscal r e s p o n s e -- namely, A l t h o u g h there the t a x bill signed on M a r c h 15, w h i c h s u s p e n d e d the d e c r e a s e in e x c i s e taxes, a nd a c c e l e r a t e d c o r p o r a t e tax p a y m e n t s -- it wa s not enough. T he Fed m o v e d a g a i n w i t h its f o u r t h tool, the re s e r v e requirement. of m i d - J u l y , As the r e s e r v e r e q u i r e d a g a i n s t time d e p o s i t s in e x c e s s of $5 m i l l i o n w as i n c r e a s e d f r o m 4 % to 5%. T h i s w a s a i m e d at the larger b a nks - in fact, it a f f e c t e d s o m e t h i n g less t h a n 1,000 of the m o r e than 14 , 0 0 0 c o m m e r c i a l b ank s in the U n i t e d States. commercial But it w a s these la r g e r banks that ha d been swel l i n g the loan s t a t i s t i c s b e c a u s e it was, of course, at these banks the l a r g e s t p r o p o r t i o n of U. S. d e p o s i t s is held. The e f f e c t of this move as a real d e t e r r e n t is at least a r g u able; a l t h o u g h it d id d e c r e a s e m o d e s t l y the i n t e r e s t m a r g i n b e t w e e n b u s i n e s s b o r r o w i n g and b u s i n e s s lending. Its p r i n c i p a l e f f e c t w a s p r o b a b l y that of a signal of w o r s e to come if the b asic credit s i t u a t i o n did not change. A n d it did not. Therefore, the r e s erve r e q u i r e m e n t w a s i n c r e a s e d a g a i n on A u g u s t 17 on the same type of time d e p o s i t and the same c a t e g o r y of banks. Meanwhile, " back at the r a n c h ” - w h i c h saying has a v e r y special a p p l i c a t i o n in this c o n t e x t - r e a l i g n m e n t s w e r e t a k i n g p l ace a m o n g the various financial intermediaries. put it m i ldly. To say that the S & Ls w e r e h u r t i n g is to T h e i r a n g u i s h b e c a m e not o n l y vo c a l but loud. A l t h o u g h the Fed m o v e d in June to roll b a c k the m a x i m u m rate that could be paid on s o - c a l l e d m u l t i p l e m a t u r i t y time d e p o s i t s in an e f f o r t to cur b the i s s u a n c e of c o n s u m e r type C-Ds by banks, it w a s not enough. E v e n the fact that the rate of in c r e a s e of time m o n e y in ba n k s had s l owed u p a p p r e c i a b l y , i n d i c a t i n g they w e r e not w h o l l y to b l a m e fo r the p l i g h t of m u t u a l s avings ban k s and s a v ings and loans, w a s no d e t e r r e n t to C o n g ress. In S e p t e m b e r a u t h o r i t y w as g r a n t e d to the Fed to set i n t e r e s t rate m a x i m u m s f o r d i f f e r e n t sizes and k i n d s of d e p osits. H o p e f u l l y , by a l l o w i n g r e c i p r o c a l a c t i o n by the F D I C a p p l i c a b l e to b a n k s that are not m e m b e r s of the R e s e r v e System but are in s u r e d by the FDIC, and the Fe d e r a l Home L o a n B a n k B o a r d to do the same f o r savi n g s a nd loans, rate ch a n g e s w i l l be c o o r d i n a t e d a m o n g the ag e n c i e s , and the c o m p e t i t i v e ba l a n c e a m o n g the v a r i o u s f i n a n c i a l i n s t i t u t i o n s can be p r e s e r v e d on a n o r d e r l y basis. W h e t h e r in fact this h as b e e n a c c o m p l i s h e d n a t i o n a l l y is still q u e s t i o n a b l e , but c e r t a i n l y it had one v e r y p r o n o u n c e d local effect, a n d that is to e n r i c h the v a r i o u s a d v e r t i s i n g media. W h i l e not i n v o l v i n g an of f i c i a l c h a n g e in one of the f o u r m o n e t a r y t o o l s m e n t i o n e d earl i e r , the f a mous l e t t e r of S e p t e m b e r 1, 1966, f r o m the d i s t r i c t b anks w r i t t e n at the r e q u e s t of the B oard of G o v e r n o r s , mentioned. Rightly or wrongly, should be this l e t t e r i mplies that the rate of b u s i n e s s s p e n d i n g is the pr i m e t a r g e t of cu r r e n t m o n e t a r y policy. R e m e mber, though, that the Fed can o p e r a t e o n l y w i t h the f o u r tools, a n d o n l y one of these, the open market operations, is of g e n eral m o n e y m a r k e t a p p l i c a t i o n . The o t h e r three -- the d i s c o u n t rate, R e g u l a t i o n Q, a nd r eserve r e q u i r e m e n t s -- are limited to m e m b e r b a n k s in the c o m m e r c i a l b a n k i n g system. T h i s l e t t e r r e f e r r e d to the u s e of the d i s c o u n t w i n d o w and its a v a i l a b i l i t y d u r i n g the t h r e a t e n e d r u n-off of c o m m e r c i a l b a n k time d eposits. At the b e g i n n i n g of this fall, we w e r e look i n g at C.D. m a t u r i t i e s in S e p t e m b e r of $5.3 billion, out of total in O c t o b e r of $3.5 billion, a nd in N o v e m b e r of $2.2 billion, levels of a bout $1 8 . 2 billion. to go u p in Au g u s t , these C.Ds. As the m o n e y m a r k e t rates c o n t i n u e d t here w a s real c o n c e r n that b a n k s w o u l d be u n a b l e to h o l d The p r o b l e m has not e m e r g e d in the d i m e n s i o n s feared, but n e i t h e r are we out of the w o o d s yet. Th i s letter w as w r i t t e n to a s s u r e ban k s that the d i s c o u n t w i n d o w w o u l d be o p e n to them, to a s s i s t t h e m t h r o u g h this p e r i o d of p o t e n t i a l d e c l i n i n g d e p o s i t s , w i t h i n the spirit of the a d m i n i s t r a t i o n of the d i s c o u n t w i n d o w e s t a b l i s h e d in 1955 in R e g u l a t i o n A. Briefly, the c o n d i t i o n s that mus t be satisfied, a c c o r d i n g to R e g u l a t i o n A, c e n t e r a r o u n d u n e x p e c t e d s e a sonal d e m a n d or u n e x p e c t e d d e c l i n e s in deposits. w a s i n d i cated, though, It in this l e tter that u se of the w i n d o w by a b a n k c o n f r o n t e d w i t h severe a t t r i t i o n in its time d e p o s i t s w o u l d be c o n d i t i o n e d u p o n a s h o w i n g of a r e d u c t i o n in b u s i n e s s loans. To the d e g r e e that a case can be m a d e that this wa s an a t t e m p t to s e l e c t i v e l y control o u r a d m i n i s t r a t i o n of ba n k c redit, it is a d e p a r t u r e f r o m the spirit of R e g u l a t i o n A as it has b e e n commonly understood. for y e a r s to come, A d e b a t e is r a g i n g curren t l y , a nd w i l l c o n t i n u e to do so I suspect, as to the p r o p r i e t y of this action. It m u s t be a d m i t t e d that banks d id not ru s h to the w i n d o w to get 4 % % m o n e y w i t h this c o n d i t i o n a t t a c h e d to it. Howe v e r , I t hink a case m a y be m a d e by a future h i s t o r i a n that it c o n t r i b u t e d to the s l a c k e n i n g in the rate of b u s i n e s s l e n d ing t his fall, if for the o p p o s i t e r e a s o n i n t e n d e d by the System. The d i s t a s t e of b a nks to s ubject t h e m s e l v e s to the ty p e of s c r u t i n y h i n t e d at in the l e t t e r m a y h ave had m u c h to do w i t h the r e a r r a n g e m e n t s of t h e i r loan p o r t f o l i o s n o w go i n g on. 10. W hat has b e e n the r e sult of t h ese a c t i o n s ? c e d e d that the pace of i n f l a t i o n has bee n slowed. C e r t a i n l y it m u s t be c o n T he sharp u p t u r n in the c o n s u m e r p r i c e i n d e x and the w h o l e s a l e p r i c e index has b e e n halted. f o r loans has s hown signs of easing. e s c a l a t i o n of m o n e y m a r k e t rates. m e n t s in c o r p o r a t e spending. i n d u s t r y h as been slowed. The d e m a n d T h e r e has bee n some m o d e r a t i o n in the M o s t i m p o r t a n t l y , there hav e b e e n p o s t p o n e T h e r e are signs that the e x p a n s i o n of A m e r i c a n It took time to a c c o m p l i s h this. rates w a s c e r t a i n l y not e n o u g h by itself. T he i n c r e a s e in Tho s e of us w h o hav e d e a l t w i t h A m e r i c a n b u s i n e s s are w e l l a w a r e that i n t e r e s t rates and taxes as sp e c i f i c b u s i n e s s d e t e r m i n a n t s are m u c h m o r e i m p o r t a n t on the su p p l y side than on the d e m a n d side. A l t h o u g h it is true that the i n v e s t o r w i t h fun d s to pla c e c o n siders b o t h e l e m e n t s in m a k i n g c h o i c e s a m o n g i n v e s t m e n t a l t e r n a t i v e s , the b u s i n e s s m a n look i n g fo r f u n d s is m o r e c o n c e r n e d w i t h the a v a i l a b i l i t y of m o n e y and the c o m p a r a b i l i t y of tax rates w i t h his peers. a h e a d w i t h his business. A f t e r all, he m u s t m o v e His a l t e r n a t i v e s are m u c h s i m p l e r a nd f e w e r than th o s e a v a i l a b l e to the b r o a d s p e c t r u m investor. H o wever, c h a n g e s in rates - - o f b o t h m o n e y and taxes -- and offic i a l c o n c e r n of the Fede r a l g o v e r n m e n t and its v a r i o u s a g e n c i e s , do go into the m a t r i x of the e m o t i o n a l c l i mate, a nd do h e l p shape the o v e r - a l l c u m u l a t i v e s p i r i t of o p t i m i s m or p e s s i m i s m w h i c h a f f e c t s b u s i n e s s judg m e n t f a r m o r e t h a n t e c h n i c i a n s care to a c k n o w l e d g e . W h e t h e r these f e w i n d i c a t i o n s of the s l o w - u p in the i n f l a t i o n a r y surge of o u r e c o n o m y that s t a r t e d its cu r r e n t ph a s e e i g h t e e n m o n t h s ago are s h o r t - t e r m p h e n o m e n a , o r w h e t h e r w e m a y be l ooking at a p e r i o d of c o m p a r a t i v e s t a bili t y , do n ' t k n o w a n d I ’ m not g o i n g to guess, but I c e r t a i n l y ho p e it to be so. 11. I I d o u b t that m o n e t a r y p o l i c y can do m u c h more. m a d e fo r fiscal action. A case can still be It w o u l d be f o r t u n a t e indeed if Federal, state and local g o v e r n m e n t s w o u l d take s e r i o u s l y the e x h o r t a t i o n s that have b e e n d i r e c t e d to the b u s i n e s s c o m m u n i t y to p o s t p o n e b u i l d i n g p lans until there has been some r e s o l u t i o n of Viet Nam. A tax incr e a s e to h e l p c a r r y the cost could still be appropriate. F o r w h a t m o n e t a r y p o l i c y needs is a r e s t o r a t i o n of e l b o w room. I s u s p e c t that the r e l i a n c e p l a c e d on this single i n s t r u m e n t has s u s p e n d e d t e m p o r a r i l y its f u t u r e e f f e c t i v e n e s s . m o n e t a r y policy. We h a v e p l a c e d too m u c h r e l i a n c e on We are i n j u r i n g the i n d u s t r i a l a n d social c a p a c i t y of 1968, 1969, a n d beyond; and w e h a v e put a d i s p r o p o r t i o n a t e part of the e c o n o m i c c ost of V iet N am on a few indust r i e s . T h i s is w h y I b e l i e v e g r e a t e r reli a n c e u p o n f iscal p o l i c y w as e s s e n t i a l , a nd b a r r i n g a sharp d o w n t u r n in b u s i n e s s levels, w i l l c o n t i n u e to b e . f i s c a l policy, I w o u l d d o u b t that e v e n if there is a m o d e s t shift in the cost of m o n e y wil l fall v e r y far. p o s t p o n e d in this country. P r o j e c t s are be i n g B u i l d i n g p l a n s have been p o s t p o n e d , an d o u t s i d e the b o r d e r s of our c o u n t r y e x i s t s an i n s a t i a b l e d e m a n d f o r funds, a part of w h i c h o r i g i n a t e s in the p r i v a t e sector, w i t h the u s u a l e c o n o m i c impera t i v e s , but a m u c h g r e a t e r part in the p u b l i c s e c t o r w i t h p o l i t i c a l overtones. Balance of p a y m e n t s c o n s i d e r a t i o n s a l o n e will r e q u i r e rates that r e f l e c t w o r l d cr e d i t conditions. It is d o w n the road a f ew y e a r s that o ur real c h a l l e n g e m a y lie, The d e s i r e to a l l e v i a t e h u m a n m i s e r y and s t i m u l a t e e c o n o m i c growth, both l a u d a b l e an d r e l ated o b j e c t i v e s , m u s t be g e a r e d to the c a p a c i t y of o u r p e o p l e a n d our e c o n o m y to p r o d u c e g o ods and services, profits, wa g e s , and taxes, at a rate that w i l l not d e s t r o y us in the process. c o n f u s e the role of m o n e y an d credit. It is an easy m i s t a k e to A f t e r all, we have all of m a n ' s 12. p o s t - b a r t e r h i s t o r y to p rove h o w e a s i l y p e o p l e and t h e i r g o v e r n m e n t s can slide into f a i l u r e by an u n w i l l i n g n e s s to r e c o g n i z e that n a t i o n a l interest, h i g h m o t i v e s , a nd e c o n o m i c c a p a c i t y are not n e c e s s a r i l y in c o n s t a n t propor t i o n . Th e t e m p t a t i o n to o p e n the spigot m a r k e d " m o n e y and c r e d i t " as a single cure-all -- or to clo s e it for the same r e a s o n -- has a l w a y s had a m e c h a n i s t i c ap p e a l to those w h o v i e w the e c o n o m y as p r e c i s e l y a nd si m p l y c o n t r o llable . A n d if the spigot is b e i n g m a n i p u l a t e d f o r m o t i v e s that are beyond q uesti o n , the c h a l l e n g e r of the p r o c e s s s o m e h o w is la b e l l e d an o p p o n e n t of the moti v e , w h i c h in an i d e a l i s t i c n a t i o n is suicide, indeed. b a t t l e g r o u n d of m o n e t a r y p o l i c y in the future. 13. This, then, will be the
@FedFRASER