memoranda · October 14, 1974
Memorandum of Discussion
MEMORANDUM OF DISCUSSION
A meeting of the Federal Open Market Committee was held
in
the offices of the Board of Governors of the Federal Reserve
System in Washington,
1974,
D. C.,
on Monday and Tuesday, October 14-15,
beginning at 5:30 p.m. on Monday.
PRESENT:
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Burns, Chairman
Hayes, Vice Chairman
Black
Bucher
Clay
Holland
Kimbrel
Mitchell
Sheehan
Wallich
Winn
Messrs. Coldwell, MacLaury, Mayo, and Morris,
Alternate Members of the Federal Open
Market Committee
Mr. Eastburn, President of the Federal Reserve
Bank of Philadelphia
Mr. Broida, Secretary
Mr. O'Connell, General Counsel
Messrs. Leonard and Williams, First Vice
Presidents of the Federal Reserve Banks
of St. Louis and San Francisco,
respectively
10/14/74
Chairman Burns noted that this was the last meeting
of the Committee Mr. Coldwell would attend in his capacity
as President of the Federal Reserve Bank of Dallas.
As
the members knew, Mr. Coldwell had been nominated by
President Ford to fill a vacancy on the Board of Governors,
and the nomination had been approved by the Senate last week.
Accordingly, he would be attending future meetings of the
Committee in a different capacity.
The Chairman then observed that he had called for
this executive session for the purpose of discussing a num
ber of matters, including that of staff attendance during
the Committee policy deliberations.
Board members and
Reserve Bank Presidents had discussed that and related sub
jects in a meeting on September 11, and while he had had to
leave before the conclusion of that meeting, he had before
him Mr. Holland's memorandum
1/
had emerged.
summarizing a consensus that
He concurred in some but not all of the points
listed in the memorandum.
1/ A copy of this memorandum, entitled "Meeting of Board
Members and Federal Reserve Bank Presidents September 11, 1974,"
has been placed in the Committee's files.
10/14-15/74
-3-
After some further comments, the Chairman remarked
that it would be inefficient for the Committee as a whole
to spend the time needed to deliberate on certain of these
procedural matters.
Accordingly, he would appoint a Sub
committee for the purpose, consisting of Messrs. Hayes,
Black, Coldwell, and Mitchell, with Mr. Mitchell as chair
man.
Mr. Partee would serve as staff adviser to the subcom
mittee.
Chairman Burns then said that in the time remaining
today he would summarize developments at the meeting of
Foreign Ministers and Finance Ministers of five leading
industrial countries that had been held in Washington
during the weekend preceding the Bank-Fund meetings for
the purpose of discussing the oil problem.
The Committee
might then consider some aspects of the economic program
the President had announced on October 8.
Following discussion of these matters, the meeting
recessed until 9:30 a.m. the following morning, Tuesday,
October 15, 1974.
In addition to those present on Monday
afternoon, the following staff members were present:
10/15/74
Mr. Altmann, Deputy Secretary
Mr. Partee, Senior Economist
Mr. Axilrod, Economist (Domestic Finance)
Mr. R. Solomon, Economist (International Finance)
Messrs. Brandt, Bryant, Doll, Hocter, Pierce,
and Reynolds, Associate Economists
Mr. Holmes, Manager, System Open Market Account
Mr. Coombs, Special Manager, System Open Market
Account
Mr. Coyne, Assistant to the Board of Governors
Mr. Wonnacott, Associate Director, Division of
International Finance, Board of Governors
Mr. Keir, Adviser, Division of Research and
Statistics, Board of Governors
Miss Pruitt, Economist, Open Market Secretariat,
Board of Governors
Mrs. Ferrell, Open Market Secretariat Assistant,
Board of Governors
Messrs. Eisenmenger, Boehne, and Scheld, Senior
Vice Presidents, Federal Reserve Banks of
Boston, Philadelphia, and Chicago, respec
tively
Mr. Garvy, Vice President and Senior Adviser,
Federal Reserve Bank of New York
Messrs.Snellings, Jordan, and Green, Vice
Presidents, Federal Reserve Banks of
Richmond, St. Louis, and Dallas, respec
tively
Mr. Kareken, Economic Adviser, Federal Reserve
Bank of Minneapolis
Mr. Keran, Director of Research, Federal Reserve
Bank of San Francisco
Mr. Sandberg, Assistant Vice President, Federal
Reserve Bank of New York
10/15/74
By unanimous vote, the Committee
ratified the action of members on
September 25, 1974, authorizing and
directing the Federal Reserve Bank
of New York, under the provisions of
270.4(e) of the Regulation relating
to Open Market Operations of Federal
Reserve Banks, to engage in such open
market transactions in foreign curren
cies, including transactions for the
System Open Market Account, as may be
necessary to carry out the arrangements
that have been made by the Federal
Reserve Bank of New York, with the con
currence of the Board of Governors of
the Federal Reserve System, for the
disposition of assets and liabilities
of the Franklin National Bank.
Mr. Sheehan observed that in his opinion the New York Bank's
handling of the Franklin National Bank problem had been splendid.
Chairman Burns remarked that the Franklin National Bank
matter was one of the most difficult that the Federal Reserve
had ever had to deal with and that the System as a.whole was
greatly indebted to Messrs. Hayes and Debs and their colleagues
at the New York Bank.
Also, Frank Wille, Chairman of the Federal
Deposit Insurance Corporation, had dealt with his part of the
problem with great skill and fine spirit throughout the difficult
period of the Franklin National Bank problem.
Mr. Hayes commented that he and his colleagues at the
New York Bank appreciated the team work that they had enjoyed
with the Board of Governors and its staff.
10/15/74
Mr. Holland remarked that Mr. Coombs also deserved the
compliments of the Committee for the manner in which he had
untangled the difficult technical problems involved in Franklin's
foreign exchange book.
By unanimous vote, the minutes
of actions taken at the meetings of
the Federal Open Market Committee
held on August 20 and September 10,
1974, were approved.
The memoranda of discussion for
the meetings of the Federal Open
Market Committee held on August 20
and September 10, 1974, were accepted.
Before this meeting there had been distributed to the
members of the Committee a report from the Special Manager of
the System Open Market Account on foreign exchange market con
ditions and on Open Market Account and Treasury operations in
foreign currencies for the period September 10 through October 9,
1974, and a supplemental report covering the period October 10
and 11, 1974.
Copies of these reports have been placed in the
files of the Committee.
In supplementation of the written reports, Mr. Coombs
made the following statement:
10/15/74
At the time of the last Committee meeting the
dollar was showing considerable strength against the
mark and other European currencies. In the absence
of sizable sales of dollars and other foreign exchange
by the German Federal Bank, the dollar would probably
have risen appreciably above its central rate against
the mark. The dollar remained buoyant until late
September, when confidence suddenly began to weaken.
The weakening seemed to reflect market fears that
recessionary tendencies in the United States were
gathering momentum and might compel a major easing
of credit policy that would tend to divert inter
national flows of funds from the dollar markets to
European centers where interest rates would come
down more slowly. The IMF meeting in Washington
provided a great deal of grist for the rumor mills.
Even more disquieting, we began to get reports early
in October of renewed diversification moves by the
oil-producing countries, involving shifts out of
both sterling and dollars into marks and other
European currencies.
As the dollar slipped back against the mark,
we began on October 2 to resist the decline, and by
October 4 had sold $36 million of marks from balances.
Then on October 9--last Wednesday--an adverse market
reaction to President Ford's economic message plus
further diversification of petrodollars pushed the
dollar down sharply in European trading before the
New York opening. As selling pressure on the dollar
continued after the New York opening, the German
Federal Bank urged us to intervene forcefully and
promised to reinforce our operations in Frankfurt
the next day. Accordingly, we sold the remaining
$26 million of our balances and a further $78 mil
lion worth of marks financed by new drawings on the
swap line, for a total intervention last Wednesday
of $104 million worth of marks. Then on the following
day, Thursday, the German Federal Bank intervened even
more forcefully to buy $186 million, and we followed
up in New York with another $15 million. On last
Friday and yesterday the market turned somewhat more
10/15/74
quiet, but today new pressures on the dollar have led
the German Federal Bank to spend another $30 million
in support operations.
And again there are reports
of oil money moving out of both sterling and dollars
into marks and other Continental currencies. At the
present moment we have an offer of marks out in New
York, 15 million marks, in order to try to provide some
resistance to a further rate decline.
As for the Franklin foreign exchange book, we
took over contracts totalling $724 million and so far
have settled $86 million, leaving $638 million to go.
All of the contracts have been confirmed, and we shall
be able to bridge all of the maturity gaps in the book
by short-term swaps with foreign central banks. Our
major remaining problem is with two Italian institutions
belonging to the Sindoha group which are now in receiver
ship. The Bank of Italy has assured us that our contracts
with these institutions will be honored, but we are pre
sently trying to resolve the question of whether they
will settle in the foreign currencies specified or, in
stead, will pay us the net amount due in dollars. When
this issue is settled, the rest of the operation should
proceed in a fairly routine way. We continue to anti
cipate that there will be no losses to the Federal Reserve.
Chairman Burns asked Mr. Coombs to explain how swaps with
foreign central banks were used to bridge maturity gaps in Franklin's
foreign exchange book, and he asked how long a period would be
required to complete the operation.
In response, Mr. Coombs said the Franklin book might,
for example, indicate that a payment of $10 million worth of
French francs was to be made on January 10 while balancing
receipts of francs were not due until 20 days later.
The francs
10/15/74
required for the payment on January 10 would be obtained by
drawing on the swap line with the Bank of France, and 20 days
later the incoming receipts of francs would be used to reverse
the swap.
The swap drawing itself was on a flat basis, involving
no cost to the System, and the only interest involved was the
amount that the Bank of France earned for the 20 days during
which it held the dollar counterpart of the swap.
With respect
to the time period, the operation would not be completed until
August, but the bulk of the contracts would be fulfilled by
the end of March.
The Chairman then asked whether recent disturbances
in the foreign exchange markets had been caused by shifts of
OPEC funds, whether information was available on the amount
of such shifts, and what might be the best means of dealing
with them.
So far, apparently,shifts had been small, but
potential movements were quite large.
Mr. Coombs replied that shifts of OPEC funds were one
of the causes of the recent disturbances.
The information
available on the amounts involved was limited, because foreign
exchange dealers, understandably, were very reluctant to reveal
10/15/74
-10-
customers' names.
However, frequent reports were being obtained
from London, and it was apparent that OPEC funds were being
moved out of sterling as well as out of the dollar.
Managers
of petrodollars might have been led to move funds by a $700 mil
lion equivalent issue of notes by the German Finance Ministry.
Through some misunderstanding, the German commercial banks had
sold a large amount of the notes to foreigners, including Arab
countries.
After the German Federal Bank involved itself in
the situation, the sale of notes was suspended, but some
managers of OPEC funds nevertheless gained the impression that
Germany might welcome inflows of such funds.
Concerning the problems caused by the flows, Mr. Coombs
remarked that for some time he, like the Chairman, had regarded
the situation as essentially unmanageable.
Over time, such
shifts in funds from one currency to another would create
increasing difficulties.
However, it was necessary to inter
vene in the markets in an effort to maintain orderly conditions
and to resist a sudden decline in a currency's value.
Mr. Eastburn asked whether it was realistic to assume
that the kind of speculation in foreign exchange that had led
to the problems of the Franklin National Bank and to those of
the Herstatt Bank and the Banque du Bruxelles was no longer
being engaged in.
10/15/74
-11-
Mr. Coombs replied that it was not unlikely that such
speculation was continuing.
It was true that the losses suf
fered by those banks had had a chastening effect on some
traders, but the losses had counterparts in the profits
that accrued to other institutions, and the profits might well
provide a temptation to continue speculating.
Mr. Holland said Mr. Coombs' remarks seemed to imply
that it was desirable to continue intervening in the market
for the purpose of resisting unduly sharp movements in rates
against the dollar but that it was also desirable to avoid
cumulating substantial swap drawings in trying to deal with
the existing fundamental disequilibrium.
He asked whether
Mr. Coombs agreed.
Mr. Coombs replied that the amount of funds that could
be shifted from one currency to another was so large that it
probably would not be possible to resist sharp movements in
rates against the dollar without substantial drawings on the
swap lines.
In the circumstances, $100 to $150 million of
market intervention might be required.
Chairman Burns remarked that such a market environment
raised the question of whether intervention should be held to
a small scale and movements in rates allowed to occur.
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10/15/74
In response, Mr. Coombs said the consequences of
reducing the scale of intervention and allowing the rates to
move down sharply would be very painful.
At the same time,
however, it was important to avoid supporting the dollar at
an unduly high level.
In his view, more attention should be
paid to the exchange rates at which the System intervened in
the market--and to the rates at which swap drawings were made
and repaid--than to the over-all volume of intervention.
In
the recent period of intervention to support the dollar against
the German mark, for example, the System's balances of marks
had been sold at rates that resulted in profits of nearly $1.2
million.
Moreover, recent swap drawings, on the average, had
been made at a rate about 4 per cent below the dollar-mark
central rate.
As time went on, the oil-exporting countries
would find it difficult to place much of their funds outside
the United States.
Consequently, the long-term trend was
favorable to the United States, and it would be a pity to
allow current shifts of $100 million or so out of dollarsas oil-producing countries achieved some diversification--to
depress the exchange rate for the dollar.
Chairman Burns, noting Mr. Coombs' judgment that the
longer-term trend was favorable to the United States, asked
10/15/74
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why it was necessary to intervene to any considerable extent
and whether minor fluctuations in the exchange rate were of
much importance.
Mr. Coombs observed that at times, as in the early
part of this year, the rate for the dollar had declined
sharply; that it could do so again; and that such declines
might have a major inflationary impact on the price level.
In his judgment, it was a good strategy to allow the rate
to drop about 4 or 5 per cent--at which point swap drawings
could be made at reasonably favorable rates--and then to
attempt to resist further declines.
Mr. Holland commented that he was troubled by the
prospect that the System would incur a large cumulative debt
on the German swap line by drawing large amounts of marks
periodically to defend the dollar and by not repaying the
drawings during the intervening periods between attacks be
cause the dollar had not recovered enough or because repay
ment would entail some further decline in
to him that it
the rate.
It seemed
would be unwise to use the swap lines to sup
port the dollar over the time span that might be required for
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10/15/74
everyone to come to the understanding that petrodollars would
be placed in this country and that the dollar, consequently,
would be strengthened against other currencies in general.
In response, Mr.
Coombs said he agreed that swap
drawings should not be allowed to cumulate, and over the past
year, the System had moved quickly--sometimes over protests
from the Treasury--to buy the marks needed to repay drawings.
With respect to the underlying strength of the dollar, he
thought it was already apparent.
Occasionally, however, the
market was disturbed by some development, such as the recent
German issue of notes available for purchase by foreigners,
the effort of oil-producing countries to achieve some diver
sification, and possibly some misinterpretation of the degree
of easing in monetary policy in this country.
developments were more or less manageable.
Such short-term
He was more con
cerned about developments over the next 1 to 3 years, when the
cumulation of oil funds could lead to some shifts having a certain
sinister quality.
Mr. Holland remarked that he applauded the manner in
which each drawing so far this year had been repaid in a short
period of time.
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10/15/74
In reply to a question by Mr. Black, Mr. Coombs observed
that while he anticipated that the System would not incur any
losses in fulfilling the foreign exchange contracts taken
over from the Franklin National Bank, there would be the
interest cost of the swap drawings made to bridge maturity
gaps.
Chairman Burns commented that the Federal Reserve might
incur some losses in connection with the Franklin matter, but
the System's action in taking over Franklin's foreign exchange
contracts was an extraordinary example of the purposeful dis
charge of a central bank's responsibility for the stability of
the financial system.
It
was an example that might well be
followed by central banks elsewhere.
in
In this country,
reactions
the financial community had been highly favorable to the
action.
By unanimous vote, the System open
market transactions in foreign currencies
during the period September 10 through
October 14, 1974, were approved, ratified,
and confirmed.
Chairman Burns noted that a memorandum from Messrs.
Hayes, Mitchell, and Wallich, dated October 11, 1974, and enti
tled "Considerations underlying a Subcommittee decision regarding
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-16-
repayment of Belgian franc swap debt," had been distributed to
the Committee.1 /
He asked Mr. Mitchell to comment.
Mr. Mitchell noted that, as indicated in the Subcommit
tee's memorandum, the members agreed that the swap debt ought to be
settled as expeditiously as possible, that proposing to the U.S.
Treasury at this time that SDR's be used if necessary might
cause protracted discussions with Treasury officials and thus
delay rather than expedite settlement of the debt, and that,
at least for the time being, the proposal should not be made.
However, the members differed as to whether Treasury partici
pation could be avoided:
Mr, Hayes thought it could not be,
Mr. Wallich thought it could be, and he (Mr. Mitchell) was
undecided.
He then asked Mr.
Coombs whether there had been
any further developments.
Mr. Coombs replied that to his knowledge the Belgian
Minister of Finance had not yet replied to the Treasury's com
munication of September 25, inquiring whether Belgium was pre
pared to accept an equal sharing of profits and losses on the
swap debt.
Chairman Burns asked whether Mr. Coombs had any advice
to give to the Committee with respect to the Belgian debt.
1/ A copy of the memorandum referred to has been placed in
the Committee's files.
10/15/74
-17-
Mr.
Coombs observed that repayment of the debt would
be stalled until the Belgians replied to the proposal for
equal sharing of profits and losses.
proposal,
Should they reject the
the System would have a case for purchasing the
francs in the market, accepting additional losses of 3 or 4
per cent.
However, the Belgians probably would object to any
sizable amount of market purchases, and they would have the
support of their partners in the European Community snake;
the Belgian franc was close to the ceiling of the snake band,
and if System purchases were to push the franc to the ceiling,
one or more of the other countries would lose reserves in con
ducting support operations.
It was for that reason that he
had contemplated a request for Treasury assistance, in accord
ance with the terms of a 1968 letter from Treasury Secretary
Fowler to Chairman Martin.
such assistance.
The use of SDR's was one means of
The Treasury might prefer, alternatively, to
sell to the Belgians a bond denominated in Belgian francs for
the purpose of acquiring the currency with which to repay the
swap debt.
Such instruments had been used on a number of
occasions in the 1960's.
Mr. Mitchell commented that, while he would wait for
the Belgians' response to the Treasury communication, he
10/15/74
-18-
believed that the debt ought to be cleaned up.
If acquisition
of francs through market purchases could only be accomplished
over a relatively long period, he would be inclined to seek
Treasury assistance in some form.
Chairman Burns remarked that he agreed with Mr. Mitchell.
Mr. Holland observed that--taking account of much of
Mr. Coombs' views--he would propose a program
that he believed
would terminate the debt in a responsible way.
First, Mr. Coombs
should communicate with the National Bank of Belgium immediately
and then again at frequent intervals in
order to press them for
a reply to the question of profit and loss sharing.
Because
it was a difficult question for them, the Belgians might be
inclined to delay action,
Chairman Burns commented that Mr. Coombs might raise
the issue with the Belgians at 3-week intervals.
Mr. Coombs said he would contact the Belgians on the
following day.
Continuing, Mr. Holland remarked that should the Belgians
respond with anything less than an unequivocal agreement to the
loss-sharing arrangement, the System should make known to the
U.S. Treasury its willingness to assume all losses in cleaning
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10/15/74
up past debt while leaving open for future consideration the
sharing of profits and losses on future drawings.
In that
connection, the System might advise the Treasury that while
the loss was not large, it was larger than it would have been
had the System repaid the debt a year ago, as it had wished
to do, instead of delaying in accordance with the Treasury's
wishes.
Third, the System should inform the Belgians of its
desire to make progress in repaying the debt and should nego
tiate with them about the acceptable amount of periodic System
purchases of francs in the market.
Even purchases of no more
than $100,000 worth of francs a week would permit progress in
reducing the debt, and making some progress was important.
Finally, even while buying Belgian francs in the market, the
System should press the Treasury to consider funding the debt
with a bond denominated in Belgian francs or using SDR's to
repay it.
It was important to clean up that debt.
And the
System should endeavor to heighten the Treasury's awareness
that central bank debt ought to be treated differently than
government-to-government debt.
Mr. Wallich remarked that Mr. Holland's program was a
plausible way of proceeding to clean up the debt, and it would
10/15/74
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be better to incur a loss in acquiring the necessary francs
than to allow the debt to continue indefinitely.
However, he
would not wish to seek Treasury assistance with respect to any
future debts, because the Treasury, if asked to bear the ultimate
responsibility associated with intervention in the foreign
exchange market, might take the position that it ought to con
trol those operations.
Also, he would not favor the use of
SDR's; he preferred the use of a bond denominated in Belgian
francs.
Mr. Coombs commented that from the inception of the
swap network it had been understood that drawings were short
term and that the Treasury would assist, if necessary, in
repaying them.
by selling gold.
On many occasions
the Treasury had done so
Treasury involvement in repayment of the
Belgian debt, through use of a bond or SDR's, would permit
acquisition of the required francs at current market rates,
but it would not shift any of the loss from the System to the
Treasury.
In reply to a question by Mr. Mayo, Mr. Coombs said the
major part of the loss, amounting to something over $50 million
of the total, would be incurred in the process of writing up the
debt to take account of the two devaluations of the dollar. The
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10/15/74
remainder of the loss would depend on market rates of exchange
at the time of acquisition of the francs; it would amount to
3 to 4 per cent on the written-up total of $320 million.
Chairman Burns observed that the essence of the matter,
as he saw it, was that the System ought not to maintain an open
speculative position for an extended period; swap drawings should
be short-term debts.
It was likely that other countries soon
would be drawing on the swap lines, and the System should be
in a position to enforce repayment within a short period--if
not within 3 months, certainly within a year.
The System's
ability to do that would be undermined if it dragged its own
repayments out over a period of years.
Mr.
Wallich remarked that he agreed with what the
Chairman had just said--which was the main reason for taking
steps now to repay the Belgian debt--except that he was con
cerned about the reference to a speculative position.
all, Germany held some $30 billion in
reserves,
After
and perhaps
one could characterize that as a speculative position.
However,
it was a fact of life that a reserve position--positive or nega
tive--in a period of floating exchange rates entailed a risk of
loss.
Both Germany and Japan had experienced enormous losses on
10/15/74
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their holdings of foreign exchange when they had allowed their
currencies to appreciate against the dollar.
He feared that
if a great deal of emphasis were given to avoiding losses, the
United States would be deprived of a useful instrument in the
international system.
If the United States could not hold
balances or incur debt in foreign currencies for purposes of
intervention in the foreign exchange market, it would once
again become a passive factor and the exchange rate for the
dollar would be determined by the market intervention of other
countries.
Chairman Burns remarked that he had not intended to
suggest that the risks of loss should not be incurred for
the purposes indicated by Mr. Wallich.
remarks,
In making his earlier
he had been concerned primarily with prospective
drawings by other countries and with the System's ability to
hold foreign central banks to repayment within a year.
Mr. Hayes commented that he recognized the importance
of Mr. Wallich's concern that dependence on Treasury assistance
in repaying swap debts might strengthen Treasury's wish to
share in the making of decisions at earlier stages, but some
degree of Treasury participation or acquiesence had always
10/15/74
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been recognized in connection with swap drawings.
It was
significant, also, that over the years most swap drawings
had been repaid without Treasury participation, and one could
expect that most drawings in the future would be self-liqui
dating.
Chairman Burns observed that it was evident from the
discussion that the Committee was eager to repay the Belgian
debt as expeditiously as possible.
Mr. Coombs then noted that a swap drawing of $180 mil
lion by the Bank of Mexico would mature soon.
As the members
might recall, the Bank had given firm assurances when making
the drawing last August that it would repay by the first
maturity, and recently the Governor of the Bank had reaffirmed
the intention to do so.
Mr. Coombs noted, in addition, that a number of swap
drawings dating back to 1971 would mature for the thirteenth
time soon.
They included the 6 drawings on the National Bank
of Belgium, totaling $230 million, which matured in the period
from November 4 through November 14, and two Swiss franc drawings
--one of $600 million on the Bank for International Settlements
and one of $371.2 million on the Swiss National Bank--which
matured on November 14 and 15, respectively.
While there was a
10/15/74
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possibility of repaying some or all of those drawings before
maturity, that was not assured and he would recommend that
the Committee authorize their renewal if necessary.
Since
the swap lines in question had been in continuous use for
more than one year, express authorization was required for
renewal under the provisions of paragraph 1(D) of the Autho
rization for Foreign Currency Operations.
In response to a question by Chairman Burns, Mr. Coombs
observed that the easiest and best way to repay the outstanding
drawings in Swiss francs would involve acquisition of the nec
essary francs through issuance by the U.S. Treasury of a bond
denominated in Swiss francs,
The Treasury already had $1.6
billion of such bonds outstanding.
Another method involved the
use of SDR's, which the Swiss probably could accept.
However,
the Treasury was more likely to agree to the issuance of a bond.
Alternatively, the debt could be reduced in small increments
through market purchases of francs.
In that connection, one
disadvantage of the 50-50 loss sharing agreement was that it
gave the other party an opportunity to object to purchases in
the market more vigorously than if it had to bear no share of
the loss.
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10/15/74
By unanimous vote, renewal for
further periods of 3 months of System
drawings on the National Bank of Belgium,
the Swiss National Bank, and the Bank
for International Settlements, maturing
in the period November 4 through 15,
1974, was authorized.
Chairman Burns then called for the staff report on the
domestic economic and financial situation, supplementing the
written reports that had been distributed prior to the meeting.
Copies of the written reports have been placed in the files
of the Committee.
Mr. Partee made the following statement:
Evidence of current and prospective weakness in
the economy has accumulated over the past month or
two, and there now appears to be a rather widespread
expectation among businessmen, investors, and con
sumers that the recession will deepen. It is not
that there have been no optimistic notes; industrial
production rose a little in September, the substan
tially smaller increase in wholesale prices last
month was heartening, and the very recent rally in
stock market prices has been a relief, to say the
least. But gloom about the economy is the prevailing
mood; unemployment, underlined by the sharp September
increase, is generally expected to rise substantially
further, while labor costs and prices are expected to
continue climbing at a fast pace.
Partly reflecting this pessimistic sentiment,
consumer buying has tended to weaken further in
recent weeks. There was a spurt in new car sales
during the summer, reflecting the buying of 1974
models in anticipation of higher prices and less
desirable features for the 1975 model year, but
recently sales have faded again as the supply of
the 1974's is being exhausted. Sales of furniture
and major appliances have weakened dramatically over
10/15/74
-26-
the last 2 months, and purchases of color TV sets
also have dropped sharply. The latest consumer
surveys, moreover, show substantial softness in
buying plans for the period ahead. With prices
continuing to rise at a relatively fast pace, we
would not expect to see much strength in consumer
buying until at least next summer.
The sluggishness of demand at the consumer
level, in turn, appears to be contributing to a
marked change in business inventory attitudes.
Inventories at retail are said by many to be
excessive, not only in durable goods but also in
some nondurable lines, such as textiles and apparel.
Manufacturers' attitudes toward inventory positions
appear to be changing too, as the list of industrial
materials in short supply narrows and there is more
uncertainty about future price trends. Our index
of sensitive materials prices has now dropped 18
per cent from its April high, while the factory
utilization rate for major industrial materials
is estimated to have dropped further, to 87 per
cent in September. Our staff projection still
assumes positive inventory investment through 1975,
but at a very moderate, and declining, pace.
There has also been more questioning than be
fore about the strength of the outlook for business
capital spending. We continue to project substan
tial further growth over the next year in dollar
terms, and a small further rise in real outlays,
because order backlogs remain so large and needs
for additional capacity in many strategic industries
are so pressing. But there is no denying that the
tendency is toward cutbacks and stretchouts. The
list we have been keeping since spring now shows a
net reduction of nearly $15 billion in previously
announced capital spending plans, mostly by the
utilities and mainly applicable to 1975 and later
years. And the confidential Lionel Edie survey of
capital spending plans for 1975 shows a rather dis
appointing increase of only 10 per cent in dollar
outlays, with considerable strength in manufacturing
offset in part by weakness in spending on commercial
facilities.
10/15/74
-27-
Of all of the major sectors of the economy, the
outlook is most bleak--at least for the near-termin housing. Starts dropped to 1.1 million units in
August, as you know, with permits even lower, at an
annual rate of only 900,000.
But the real problem,
I fear, is the financial condition of the builders.
Completed property has not sold at all well. The
inventory of unsold houses offered by merchant builders
at the end of August amounted to an 11-month supply,
and the overhang of condominium apartments and office
space also is reported to be very heavy. The carrying
cost of this inventory, plus the raw land that had
been purchased earlier for future development, is
exceedingly high. Many builders say that the problem
is no longer production, which they have long since
given up, but orderly retrenchment and survival.
Under the circumstances, the flow of credit to this
industry--which must include construction financing
as well as permanent mortgages--may be very slow to
revive.
In sum, we have seen nothing in the current
evidence that would lead us to strengthen our economic
projection. Indeed, we have cut back the projection
of the near-term outlook as compared with 5 weeks
ago, reflecting mainly weaker housing starts and,
in the third quarter, lower inventory accumulation
and net exports than had been expected earlier.
Real GNP is now projected to decline 2 per cent from
mid-1974 to mid-1975, before commencing a very modest
recovery. The unemployment rate is expected to rise
to 7 per cent by the second quarter of next year, and
then to increase somewhat further during the second
half as the projected economic recovery is insufficient
to lift employment in line with the growing labor force.
Let me emphasize that this projection does not allow
for any over-all inventory liquidation or for significant
weakening in real capital spending, both of which con
ceivably could develop.
Despite this exceedingly bleak outlook, we do not
see the basis for expecting any quick reduction in the
rate of inflation. We anticipate that the over-all rate
of price increase will fall back by early next year to
the one-digit level, but that it will then hold at a
10/15/74
-28-
relatively high--though declining--pace throughout
the year. The problem is that the increase in wage
rates is likely to remain in the 9 to 10 per cent
range, in view of the insistent demands of both
organized and unorganized workers for cost of living
compensation, and that weakness in over-all output
is unlikely to be accompanied by sizable productivity
gains.
Even with lower materials prices, and some
narrowing in profit margins, the cost-push effect
on prices will be strong. I would note also that
our price projection depends on reasonably moderate
increases in food prices which, with the recent
further deterioration in food production prospects,
may be an overly optimistic assumption.
The problem of policy, therefore, remains as
it has been before. The outlook for real economic
activity is weak--too weak to be sustained for long
without serious economic dislocations and unaccept
able material and social costs. But the outlook for
inflation also remains distressingly poor; the rate
of price increase, though probably declining, is
It
likely to remain too high to tolerate for long.
does seem clear, however, that the additional weak
ness that appears now to be developing in the economy
is counter-productive. It will create strong demands
for remedial action but will serve little purpose in
further dampening inflationary forces. Some moderate
easing up in restraint would probably improve the
performance of the real economy in 1975, and it might
help to avert the worst of the financial problems for
the housing industry and for other sectors that have
been most seriously affected by the high cost and
limited supply of credit this year.
Mr. MacLaury commented that his view of the economic
outlook was similar to Mr. Partee's.
According to press
reports, the Wharton School had incorporated the features of
the President's program into its projections and had found them
to have a slightly negative impact on over-all activity.
His
10/15/74
-29-
own staff's assessment was the the program would have no
significant effect on over-all economic activity.
He asked
whether the Board staff had appraised the program.
Mr. Partee replied that, as the listing in the supple
ment to the green book 1/ indicated, many of the stimulative
features of the President's program had already been reflected
in staff projections.
Specifically, the staff had assumed
total Federal budget outlays of just under $300 billion in
fiscal year 1975; an expanded public employment program that
was somewhat larger than that recommended by the President;
extended unemployment benefits; and additional funds for
housing credit.
The tax proposals in the program had not
been reflected in the projections, and on balance, they would
increase Government revenues.
Taking account of the tax pro
posals,therefore, would weaken the projections of economic
activity.
Mr. Mitchell remarked that projections made by econ
ometric models had the advantage of being internally consistent,
but the models had no historical precedent for the present
situation.
He asked Mr. Partee for his personal view of the
economic outlook for 1975.
In response, Mr. Partee observed that, in making its
projections, the staff was not bound by the econometric model.
1/ The report, "Current Economic and Financial Conditions,"
prepared for the Committee by the Board's staff.
10/15/74
-30-
The staff presented a judgmental projection, which of necessity
followed a middle course, taking into account the behavior of
the model, other kinds of evidence, and the judgments of vari
ous senior staff members.
The recent record of staff pro
jections of real GNP, but not of projections of prices and
nominal GNP, had been better than that of most other forecasts.
For quite a few months, the staff had been projecting the
current weakness in activity.
With respect to his personal view, Mr. Partee con
tinued, he believed that the economy was a good deal weaker
than indicated by the latest staff projections.
ability
was
The prob
seemed fairly high that a liquidation of inventories
developing.
If it developed, it would depress output in
the period immediately ahead even more than indicated by the
projections, although the subsequent upturn might also be some
what stronger.
Business capital investment plans also were
likely to weaken considerably through the autumn and winter,
as corporate managements reevaluated their weakening market
prospects and took account of higher capital costs.
And,
finally, financial problems probably would be more severe
than any encountered since the second world war.
the economic outlook was rather grim.
Altogether,
10/15/74
-31-
Mr. Morris commented that he, like Mr. Partee, fore
saw more weakness in economic activity than suggested by the
staff projections.
Assuming that the Committee's objective
for monetary policy was to contribute toward a course of
economic activity that would gradually reduce the rate of
inflation over the next few years, he questioned whether more
slack in the economy would be generated in 1975--even in the
staff projections--than the American people would be willing
to accept for any length of time in the interest of dampening
inflation.
In response, Mr. Partee noted that staff projections
suggested that next year the unemployment rate would rise in
each quarter and would average 7 per cent; that housing starts
would total only 1.25 million; and that automobile sales,
including imports, would be only about 9 million units.
That
performance implied more slack than was necessary to put the
economy on a less inflationary path.
In his view, moreover,
it was not sustainable; before the year was over, Government
action would be taken to reduce unemployment and restimulate
the economy.
Mr. Partee added that the recovery, when it came, should
not be so vigorous that economic activity rose from well below
the desired path in 1975 to above it as 1976 progressed--as,
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10/15/74
it might be argued, activity did in the 1972 recovery.
There
fore, while some stimulus to the economy was needed, a sharp
change in policy should be avoided.
Such a change would run
the risk of regenerating inflationary expectations and specu
lative buying, thereby stimulating too rapid an advance in
activity in late 1975.
Policy actions taken to influence the
course of economic activity in 1975 had to be viewed, also,
in terms of their effects on developments in 1976.
In response to a question by Mr. Mayo, Mr. Partee
said he would assume that a change in the withholding schedule
for personal income taxes would be part of the Administration's
recommendations to the Congress.
The surcharge on corporate
income taxes would affect quarterly declarations.
Mr. Mayo remarked that his view of the economic outlook
now, in contrast with 5 weeks earlier, was as pessimistic as
Mr. Partee's.
In his District, there was evidence that shortages
were being eliminated more rapidly than had been expected, and
delivery delays were fewer.
Especially discouraging was the out
look for food prices; his staff had estimated that, because of
the poor crops this year, food prices might rise as much as
14 per cent by early 1975, contributing 3 to 4 percentage points
to the rise in the total consumer price index.
Mr. Partee commented that the staff projections of prices
had not taken into account the further deterioration in crop
-33-
10/15/74
conditions recently reported by the Department of Agriculture.
Higher prices for corn and soybeans affected prospects for
supplies and prices of pork, poultry, eggs, milk, and vegetable
oils in 1975.
Chairman Burns remarked that the price outlook for the
affected foods was clouded by present uncertainties concerning
export policies for foodstuffs.
Mr. Eastburn, noting that staff projections of economic
activity for the second half of 1974 and the first half of 1975 had
undergone successive downward adjustments, asked how confident the
staff was of an upturn in the economy during the second half of 1975.
Mr. Partee replied that he thought an upturn in the second
half was likely.
That expectation was based on two major elements.
Residential construction activity was expected to turn up in
response to the declines in interest rates and improved avail
ability of credit associated with the lower projected levels
of over-all economic activity, and he believed that the chances
for a turnaround in housing were good.
Second, it was assumed
that real consumer incomes would be increasing by then, as the
rise in wage rates exceeded that in consumer prices.
It seemed
reasonable that in the environment of the period ahead, prices
of some industrial materials would be declining and profit margins
would be squeezed.
It was possible, of course, that the gains in
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10/15/74
real income for those remaining employed would be offset in the
total by declines in the number of persons employed.
Finally,
if inventory liquidation occurred in the first half, its depressing
effect on total real GNP might be over by midyear and a second
half upturn would be even more likely.
Mr. Leonard commented that the September increase in the
unemployment rate from 5.4 to 5.8 per cent was discouraging.
Al
though the major part of the increase was among female and teenage
workers, unemployment had also risen for household heads and mar
ried men.
However, it seemed to him that it was important to look
beyond the unemployment figures.
Total civilian employment rose
at an annual rate of 5 per cent in September; from April to
September, the rise was at a 2 per cent annual rate, or about
double the long-term rate of increase in the population.
The
statistics suggested that the increase in the rate of participation
in the labor force was among women and teenagers.
That was not
hard to understand; it reflected the desire to maintain family
income in the face of rapid inflation.
The statistics also sug
gested that participation rates for married men and heads of house
holds had fallen, and
he thought
that to some extent the rise in
the rate of unemployment of those key labor force groups might reflect
decreases in their participation rates and in the number employed
rather than a rise
in the actual number of unemployed.
-35
10/15/74
In response, Mr. Partee said the substantial increase
in
total civilian employment in
September followed a decline
in August; over the 2 months, employment expanded at the rela
tively modest annual rate of 1.2 million persons.
ment in
nonfarm establishments,
Total employ
which the staff had long viewed
as a more reliable indicator of short-run movements, changed
little over the 4 months from May to September.
Perhaps of
even greater significance, the number of production workers on
manufacturing payrolls declined in each month from June to
September; in the past such a decline often had been followed
by a more general contraction in employment and economic activity.
It
was noteworthy, also,
that initial
claims for unemployment
insurance had risen sharply from early September--when the last
household survey of employment was made--to early October, and
initial
claims were more than 50 per cent above the level of a
year earlier.
Mr. Sheehan .remarked that in recent months the St. Louis
Bank had been more optimistic about the economic situation and
outlook than he had been.
ments in
The latest red book 1 / review of develop
the Eighth District called attention to a generally high
level of employment and to other indications of strength.
Recently,
however, General Electric had laid off a sizable number of workers
1/ The report, "Current Economic Comment by District," prepared
for the Committee by the staff.
-36-
10/15/74
at its Louisville plant, and he asked if other such pockets of
weakness might be developing in the District.
In response, Mr. Leonard commented that the layoffs
at General Electric--which might not have been reported in
time to be included in the red book--were caused mainly by a
fall in demands for electric ranges, which in turn was associ
ated with the weakness in the housing market.
In his opinion,
the low level of residential construction activity reflected a
lack of demand.
Mr. Hayes observed that the income tax surcharges proposed
by the President applied only to calendar year 1975 while the
investment tax credit would last indefinitely, providing some
stimulus, on balance, to the economy.
He asked whether the stim
ulus might not be felt when economic activity was already in
recovery, perhaps contributing to the sort of excessively rapid
rebound that Mr. Partee had referred to.
In reply, Mr. Partee observed that a small permanent loss
of revenue would result from adoption of the income tax recommen
dations endorsed by the President for individuals in the lower
income brackets.
With respect to the increase in the investment
tax credit--to 10 per cent from the present rates of 4 per cent
for public utilities and 7 per cent for other industries--the
stimulative effects would be offset in part by a change in the
-37-
10/15/74
treatment of depreciation for tax purposes.
At present, depre
ciation was taken on the full cost of the purchased equipment,
but under the new proposals, it could be taken only on the net
cost after deduction of the tax credit.
Except for public util
ities--and for companies that purchased mainly short-lived equip
ment, which would now receive the full investment tax credit--the
net stimulative effect might not be very great.
It was possible
that on further consideration the depreciation provision of the
proposal would be changed.
In reply to a question by Mr. Hayes, Mr. Partee commented
that the combination of growth in M1 at the assumed rate of 5-3/4
per cent over the projection period and growth in nominal GNP at
the projected rates implied some decline in short-term interest
rates in the near term but then a rise in the second half of next
year.
He would not expect long-term rates to decline much if at
all; even during the next few quarters, strong demands for funds
in the long-term markets, as in 1970, would tend to hold up such
rates.
Mr. Hayes observed that, while he was somewhat less
optimistic about the outlook than he had been 5 weeks earlier,
he still was somewhat more optimistic than the Board's staff,
in large part because of the expected strength in business capital
investment.
Concerning Mr. Morris' question about the degree of
-38-
10/15/74
slack being generated in the economy, he felt that much, perhaps
most, of the developing slack was generated, not by monetary
policy, but by the excesses of the past few years.
example was housing:
A notable
while credit policy was a major deterrent
to residential construction activity, of equal importance in
contributing to the slack was the extraordinary increase in the
price of housing and the over-building in many areas as a conse
quence of 3 or 4 years of high rates of construction activity.
In the automobile industry, the prospective slack resulted from
the large increases in prices on the new models and from the
energy situation.
Chairman Burns commented that the major weakness in
demand was in the consumer markets, including the market for
housing, and that the weakness was directly attributable to the
erosion in workers' real income caused by inflation.
In his
view, the recessionary tendencies now at work in the economy
resulted mainly from the forces that had been released by the
inflationary boom,
Mr. Mitchell said he agreed that the inflation-induced
decline in real income was an important factor in the weakness
in consumer demand, but it was also true that consumers were
finding it impossible to finance turn-overs of houses because
of the stance of monetary policy.
Presumably, monetary policy
10/15/74
-39-
had been tight because there had been a need to restrain
expansion in activity.
The Chairman said he agreed that high mortgage interest
rates and reduced availability of mortgage credit had had a major
impact on residential construction.
However, he would emphasize
that sharply rising costs of land and construction, over-building
in 1971, 1972, and part of 1973, and erosion in real purchasing
power of consumers had been important in bringing on the decline
in home-building activity.
Mr. MacLaury commented that in his view the main question
was whether additional slack in the economy would be counter-pro
ductive.
The issue, therefore, was whether the Committee should
attempt to lessen the slack in prospect.
Mr. Kimbrel asked whether the CPI might not be overstating
the actual rise in prices in view of more widespread discounting
from list prices, special sales, and consumers' efforts to seek out
bargains.
In response Mr. Partee noted that the CPI was based, not
on list prices, but on actual prices collected by shopping in the
market.
However, special sales would be reflected in the index
only if they occurred during the few days of the month in which
price data were collected.
With respect to automobiles, it might
be difficult to determine dealers' transactions prices without
actually making purchases.
-40-
10/15/74
Mr. Wallich remarked that he was puzzled by the impli
cation of the projection that increased slack in the economy
did not moderate the rise in prices, even though he recognized
that exogenous forces, like poor crops, exerted
upward pressures.
One reason for the unusual price behavior might be the employment
situation.
An unemployment rate of 7 per cent, as projected to
be reached in the second quarter of next year, was 3 percentage
points above the rate that used to be associated with full employ
ment.
However, if one took the unpopular position that a 5 per
cent rate now was a more appropriate full employment base, then
the unemployment rate exceeded it by only 0.8 of a percentage
point in September and would exceed it in the second quarter of
next year by 2 percentage points.
Moreover, the unemployment
rate for married men--which was the most important group from
the point of view of wage determination--had increased relatively
little, to 2.8 per cent in September.
The rate for married men
excluding those unemployed for less than 5 weeks was only 1.5
to 2 per cent, and that was a more realistic measure of the
labor force slack existing at the present time.
Mr. Partee remarked that the present structure of the labor
force was such that a moderate decline in business activity prob
ably would have little effect on wage demands.
In addition, the
large rise in the cost of living that had occurred over the past
2 years provided both organized and unorganized labor with a strong
-41-
10/15/74
argument for substantial increases in wages, and employers were
likely to agree that their employees should be compensated for
at least a major share of the increase in the cost of living.
Mr. Wallich then asked if, given the prevalence of
escalator clauses in wage agreements, the slackening in the rate
of inflation projected for the latter part of 1975 might not
result in a slowing of the advance in wage rates which would,
in turn, further reduce pressure on prices.
Also, he asked
whether, following the very poor performance in recent quarters,
significant gains in productivity might lie ahead as adjustments
were made to the energy situation and as shortages of materials
became less important.
Mr. Partee repliedthat the projected slowing in the annual
rate of increase in the GNP deflator to 7 per cent by the fourth
quarter of 1975 was expected to moderate the rate of increase in
wages as the year progressed.
Concerning productivity, the pro
jections did incorporate an increase in the period ahead, although
at a quite modest pace.
One could argue for a higher rate of in
crease, but it would represent a significant departure from histor
ical experience.
Mr. Winn asked how changes in wealth affected the staff
projections.
-42-
10/15/74
Mr. Partee remarked that in the Board's model the changes
in wealth had their main impact on consumption, although they
also had some effect on capital spending.
One of the ways in
which monetary policy affected consumption was through its impact
on the value of financial assets.
Mr. Pierce observed that for the period ahead a rise in
prices of common stocks had been assumed, which had a significant
influence on the behavior of consumption.
Mr. Winn commented that, surprisingly, sales of furs,
jewelry, and other luxury goods appeared to be quite strong.
Mr. Black remarked that sales of high-priced lines of
furniture seemed to be holding up better than sales of the
lower-priced lines.
Mr. Kimbrel said luxury-type automobiles were selling
well in his District.
Mr. Partee observed that reports from retailers indicated
that, in general, consumers were shifting their purchases down in
terms of quality and price.
However, he had no evidence concerning
luxury goods.
Mr. Coldwell noted that, as had been said earlier, mone
tary restraint--as well as inflation--had had a dampening effect
on demands, particularly for consumer goods and in the construction
industry.
Presumably, that had been an objective of policy.
The
-43-
10/15/74
curtailment in demands was swelling inventories and slowing
economic activity, and the problem in the period ahead was to
halt the decline in activity before it became too deep.
Mr. Coldwell then asked about the revision in the staff's
expectations for net exports, which seemed to be a major feature
of the change in the staff's projections since the last meeting.
Mr. Bryant replied that the reduction in the projection
of net exports reflected an upward adjustment in projected imports,
which was attributable chiefly to higher prices.
Mr. Coldwell noted that a footnote in the green book
called attention to revisions from previous green books in the
procedure for estimating the fixed-weighted price index, and he
asked what effect the revision had had on the estimates.
Mr. Partee replied that the projection procedures had been
revised to incorporate additional components of the over-all GNP
deflator.
This change had raised the price index for the third
quarter of this year, and for subsequent quarters, by about 1 per
centage point.
In response to a further question by Mr. Coldwell,
Mr. Partee said there was as yet no basis to judge how Christmas
business might develop this year, but he expected that sales
-44-
10/15/74
would be weak.
Judging by Eastman Kodak's sales to retailers,
the retailers were optimistic about selling cameras.
However,
retailers of furniture, appliances, and television sets,
judging both from recent factory orders and consumer sales,
were rather gloomy.
Mr. Eastburn said he had been assuming that, with
a decline in interest rates and improvement in the avail
ability of money next year, financial strains would ease and,
in particular, the financial condition of banks would improve.
He asked Mr. Partee, in view of his earlier statement about
the financial difficulties that lay ahead, whether he expected
that banks as well as others would experience difficulties.
Mr. Partee replied that bank liquidity positions
probably would be easing, on the average, and the banking
system as a whole would be under less pressure.
The possibil
ity that concerned him was that some particular banks might
be known to have a large volume of loans to customers who
were experiencing severe financial difficulty or even facing
bankruptcy; those banks could well experience liquidity pro
blems as deposits were withdrawn and loans failed to be paid
off on schedule.
-45-
10/15/74
Before this meeting there had been distributed to the
members of the Committee a report from the Manager of System
Open Market Account covering domestic open market operations
for the period September 10 through October 9, 1974, and.a
supplemental report covering the period October 10 and 11,
1974.
Copies of both reports have been placed in the files
of the Committee.
In supplementation of the written reports, Mr. Holmes
made the following statement:
Over the period since the Committee last met
the monetary aggregates have generally fallen below
the ranges of tolerance set by the Committee. Conse
quently, the Desk became more accommodative in sup
plying reserves, and short-term interest rates
declined sharply. Longer-term markets also showed
improvement, although the size of the corporate
calendar and continued fears of inflation inhibited
rate declines in that sector. The recent sharp
rebound in stock prices also tended to lift some of
the gloom that has depressed the financial markets
for so long.
In pursuing the Committee's goal of promoting
moderate growth of the aggregates, money market con
ditions were progressively eased as the aggregates
fell short of desired levels. While the average
Federal funds rate declined in each week of the
period, progress was not always smooth, as banks
tended to manage their reserve positions cautiously
and there was considerable uncertainty about the
provision of reserves from market factors.
In order to provide some measure of continuity
to the money market, open market operations were
extensive and frequently involved shifts from re
serve supply to reserve absorption within a statement
10/15/74
-46-
week. Outright operations included the net purchase
of $590 million of Treasury bills, $176 million of
Treasury coupon issues, and $207 million of agency
issues in the market, as well as a small net sale of
bills to foreign accounts and redemptions of maturing
Treasury bills in the regular weekly auctions. Re
flecting reserve variability over the period, the
temporary injection or withdrawal of reserves was
quite large. Repurchase agreements totaled about
$7 billion and matched sale-purchase agreements
came to about $14 billion, including about $4 bil
lion made with foreign accounts.
Short-term interest rates, as noted earlier,
declined markedly over the period, reflecting
market expectations of a weak economy and reaction
to the declining Federal funds rate. In last Friday's
auction, an average rate of 7.72 per cent was estab
lished for the 3-month Treasury bills, down 138 basis
points from the rate established in the auction just
prior to the last Committee meeting. The Treasury
bill rate remained extremely volatile, reflecting
changes in foreign demand and in the supply of bills
by the Treasury, as well as the supply of bills in
dealer hands. Thus the rate fell from over 9 per
cent at the time of the last meeting to about 6 per
cent toward the end of September before rebounding
to about 7-3/4 per cent in Friday's auction.
Other short rates, as the blue book 1/ indicates,
also declined markedly, and there was a substantial
lessening of fears of disintermediation.
There was absolutely no market reaction to the
news that Franklin National Bank had been declared
insolvent and taken over, with FDIC assistance, by
the European-American bank. While that smoothand long awaited--transition had no market impact,
it did have a pronounced effect on our reserve
statistics. The takeover by the FDIC of the New
York Reserve Bank's loan to Franklin had the effect
of increasing non-borrowed reserves by $1.7 billion,
with a like decline in member bank borrowing and net
borrowed reserves. There is no reason to believe
that those technical adjustments have had any effect
on the market.
1/ The report, "Monetary Aggregates and Money Market Conditions,"
prepared for the Committee by the Board's staff.
10/15/74
-47-
As far as the Treasury is concerned, it will be
announcing shortly its plans to raise over $4 billion
in cash by early November. This will involve an
addition to the bill supply (tax-anticipation bills)
but could include an intermediate issue. One can only
hope that if an intermediate issue is included in the
Treasury's cash plans, it will not complicate the
Treasury's November refunding--the terms of which will
be announced on October 30.
There are two other developments that I should
mention to the Committee. First, the shift of re
serves to the oil-producing countries--a matter that
has been of considerable concern to the Committeecoupled with a virtual saturation of the Euro-dollar
market, has meant that more of the Desk's activity
for foreign official account has been for customers
who are extremely interest rate conscious. Thus we
have been making repurchase agreements for some of
our customers--since the rate is well above the
Treasury bill rate--and there is increased interest
in bankers' acceptances. There has also been
interest in Federal funds sales by foreign official
accounts. These developments should be closely
watched by the Committee.
Secondly, there surfaced last Friday the
possibility that a number of commercial banks may
be in the process of reviewing their policies with
respect to loans to Goverment security and .accep
tances dealers. With banks under considerable
pressure to contain their lending activity and
with expansion raising questions of capital ade
quacy, there is some risk that their traditional
lending to dealers may be curtailed. While I am
not suggesting that dealers should be in any sort
of a preferred position, adequate financing is a
prerequisite for a viable market on which we and the
Treasury are so dependent. Again, this is a matter
that will bear close watching.
In response to a question by Chairman Burns,
Mr. Holmes said the foreign official accounts with which it
-48-
10/15/74
was making matched sale-purchase agreements were mainly
OPEC countries.
By making repurchase agreements, those
accounts were achieving a higher rate of return than they
would if they were investing in Treasury bills.
Traditionally,
the System had invested funds of foreign official accounts in
Treasury bills and, to a much smaller extent, in bankers'
acceptances.
Those new and unusual developments should be
watched closely.
Mr. Axilrod commented that he and Mr. Bryant had
initiated a study of the problem in order to determine the
implications, if any, for open market operations.
Mr. Morris observed that in his opinion System oper
ations since the last meeting of the Committee had resulted
in pressures in financial markets that were greater than
intended.
Specifically, data for the statement week ending
September 25 clearly suggested that the aggregates were growing
at rates below the ranges specified for the September-October
period, and yet in the following statement week--the week
ending October 2--the Federal funds rate averaged 11.04 per
cent even though the lower limit of the specified range for
the funds rate at that time was 10-1/2 per cent.
According
-49-
10/15/74
to the blue book, the Desk moved cautiously in the early part
of the inter-meeting period, in part to avoid encouraging an
unduly rapid decline in market rates.
In his view, operations
should not be influenced to that extent by a concern about
unduly rapid declines in market interest rates.
More generally,
he believed there was a systematic propensity to avoid moving
the funds rate--in either direction--to the extent necessary
to control the aggregates.
In the recent period, consequently,
the Committee had lost ground in pursuit of its objectives for
the aggregates.
Chairman Burns commented that on October 4 the Com
mittee had concurred in his recommendation to reduce the lower
limit of the funds rate range to 10-1/4 per cent, and in the
last few days the rate had been 10 to 10-1/8 per cent.
Early
in the inter-meeting period, he had felt that the funds rate
might appropriately have been somewhat lower, and one could
argue--as Mr. Morris had--that the decline in the funds rate
in the early part of the period should have been greater
than it was.
But there could be differences in judgment in
the conduct of operations.
By the end of the inter-meeting
period the funds rate was roughly at the lower limit of its
specified range, and for that reason, he did not believe that
10/15/74
-50-
ground had been lost.
Since the September meeting, interest
rates on Treasury bills, commercial paper, and negotiable CD's
all had declined by substantial amounts.
Mr.
Eastburn remarked that in his judgment the basic
issue was a reluctance on the part of Committee members to
allow movements in the Federal funds rate of the sort necessary
for achievement of the goals for the monetary aggregates.
Mr. Coldwell, noting that the weekly average funds rate
had declined by more than 100 basis points since the last meeting,
said he would compliment the Account Management for the smooth
fashion in which the rate had declined.
At the last meeting,
several members of the Committee had emphasized the importance
of conducting operations so as to avoid leading the market to
expect a rapid shift in policy, and that had been accomplished
to a considerable extent.
Mr. Sheehan said he agreed with Mr. Morris.
Two or
three times during the past year, he felt that the Desk had
not acted briskly enough because of its excessive sensitivity
to market conditions.
Concerning operations in the period
since the last meeting, he had been worried that the Desk
had appeared to be unwilling to force the Federal funds rate
down because of its concern that the market might over-react
and push other market rates down too rapidly.
10/15/74
-51-
Mr. Black observed that the real problem, in his opinion,
was that the market was not yet ready to accept large fluctua
tions in interest rates.
Such acceptance would need to develop
before the System could stabilize rates of growth in the monetary
aggregates.
He hoped that at some time in the future the market
could be educated to accept greater fluctuations in
rates.
interest
Concerning the Desk's conduct of operations in
recent period, he agreed with Mr.
the
Coldwell.
Chairman Burns commented that the present would not be
a good time to undertake any experiments in educating the market,
because they might lead to undesirably sharp fluctuations in
interest rates.
Mr.
Kimbrel, noting that he was the Committee member
who had participated in
the morning call during the recent
period, remarked that he had concurred completely in the
operations of the Desk.
In his opinion, the Manager was to
be commended for conducting operations smoothly and efficiently.
In view of the sensitive nature of the markets and the situation
of the Franklin National Bank--which was in the process of adjust
ment--he would have been very reluctant to have eased reserve and
money market conditions more rapidly.
not have done anything differently.
In retrospect, he would
-52-
10/15/74
Mr.
Wallich commented that he, like other members,
believed that the Committee had intended to achieve its goals
in the inter-meeting period without signaling a shift in policy,
and that objective had been accomplished.
Early in the period
he had been a little impatient for more of a decline in the
funds rate than actually had occurred.
However, the rate
eventually was reduced, and it was uncertain how close the
System had come to signaling a policy shift.
The stock mar
ket had rallied strongly, for some reason, and short-term
market interest rates in general had declined significantly.
Concerning the broader issue of the width of the range of
tolerance that the Committee established for the funds rate,
he would say that the range was too narrow.
The System ought
to educate the market about its willingness to tolerate larger
fluctuations in rates, although it ought not to do so at this
time.
When that was understood in the market, arbitrage would
tend to limit the fluctuations in rates.
Mr. Mayo remarked that on several past occasions the
Desk, in his opinion, had been slow in responding to the
developing situation, but in the period since the last meeting
the Desk had done a splendid job of carrying out the Committee's
instructions.
Judgments concerning day-to-day operations could
-53-
10/15/74
differ, and it would be a mistake for the Committee to become
involved in those very short-run operating decisions.
Although
he believed that the money supply had not increased sufficiently
over recent months, he was not overly concerned because of the
probabilities that the rate of growth would pick up over the
next few months, thereby compensating for the recent shortfall.
Mr. Clay observed that the Committee's objective in
the recent period--as he interpreted the discussion at the
last meeting--was to attempt to preserve its posture with
regard to slowing the rate of inflation and moderating
inflationary expectations, while at the same time easing
policy to a degree in order to provide some stimulus to
economic activity 6 months or so in the future.
It was
important, therefore, that the easing be accomplished as
quietly as possible, and in his opinion, the Desk had done
a magnificent job.
With respect to the sluggish rates of
growth in the monetary aggregates, several influences had
been at work.
Economic activity appeared to have weakened
more than had been projected; the demand for money was re
sponding, with the usual lag, to the earlier increases in
short-term interest rates; and because of the comparatively
high prime rate at major banks, some borrowers were turning to
10/15/74
-54-
other sources of funds.
in
Banks were likely to remain cautious
easing lending terms until they had
been able to improve
their liquidity postures and reduce their reliance on borrowed
funds.
Given those influences, efforts to achieve faster rates
of growth in the aggregates probably would have required more
vigorous efforts to ease bank reserve and money market conditions
than many members of the Committee would have been willing to
accept.
Mr. Holmes commented that in the recent period the
Desk had paid a great deal of attention to market expectations
because of the Committee's desire to ease reserve and money
market conditions somewhat without giving the market a strong
signal of a policy shift.
It was significant that during the
first 3 weeks after the September meeting, when the funds rate
was rather sticky, other short-term rates declined appreciably.
The market rate on 3-month Treasury bills, for example, declined
by about 3 percentage points.
As bill rates moved up in early
October, there was more leeway to allow the funds rate to decline
without generating undesired expectations.
At times during the
period, nevertheless, he felt that the market was close to
developing such expectations.
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10/15/74
Mr. Mitchell observed that, in view of the growth in
OPEC funds, he was particularly concerned about expanding
foreign participation in U.S. debt markets.
He asked whether
System policy could be thwarted by the influence of that
participation on either the rate of growth in M1
or the
behavior of the funds rate.
Mr. Holmes replied that foreign participation in U.S.
markets--although it had become exceptionally large and had
caused some day-to-day problems--had not interfered with the
implementation of monetary policy.
As he understood it, the
shifts in OPEC funds had no impact on the rate of growth in
M1.
However, inflows of funds were large, and managing the
shifts into the United States without disrupting the market
would be an increasing, although not an impossible, challenge.
Treasury special certificates might have to be issued, as in
past periods of large flows of funds.
That would depend in
part on whether oil-consuming countries lost reserves as
rapidly as oil-producing countries gained them, so that the
shifts in market instruments from gainers to losers of re
serves could be orderly.
Mr. Axilrod remarked that the staff was preparing a
paper dealing with the question raised by Mr. Mitchell, and
10/15/74
-56-
some rather technical issues were involved.
For example, if
a country gained reserves in a manner that increased its
balance at the New York Bank, bank reserves would be absorbed
unless the Desk invested the funds promptly.
If the period
was one in which the Desk wanted to provide rather than to
absorb reserves, it would be essential to invest the foreign
country's funds promptly.
Doing so, however, might so reduce
the collateral available in the market that the Desk would
encounter difficulties in achieving its objective of pro
viding still more bank reserves.
Thus, the difficult question
arose as to whether shifts in dollar reserves among foreign
countries should be managed wholly through the commercial
banking system in order to eliminate their potential effects
on bank reserves.
By unanimous vote, the open
market transactions in Government
securities, agency obligations, and
bankers' acceptances during the pe
riod September 10 through October 14,
1974, were approved, ratified, and
confirmed.
Mr. Axilrod summarized the following statement on
prospective financial relationships:
10/15/74
-57-
The alternatives 1/before you once again imply a
further reduction of interest rates if the Committee
wishes to maintain the 5-3/4 per cent longer-run
growth rate for M1 adopted at the last meeting. As
the blue book notes, this is in part because M1, in
September and early October has been weaker than
earlier expected. It is also because, looking
ahead, GNP growth is projected to be weaker, par
ticularly by the first quarter.
In the process of moving back toward the Com
mittee's longer-run target, and recognizing the
erratic nature of M1 behavior, there will probably
be some months of substantial M1 growth to offset the
recent very low growth rates. The forecasting art
is certainly not sufficiently well developed so that
we can tell precisely when such months will occur,
or if indeed they will. But all of the alternatives
presented assume a considerable rebound in money demand
in November and December.
If there were no such re
bound in demand, following 4 months of low M1 growth
from June to October, it would appear to cast fur
ther doubt on the fundamental strength of the
economy and of transaction demands for money.
History may be of some help in gauging the
likelihood of a surge in M, growth toward year-end.
In 1972 and 1973, there were very large increases in
M 1 growth in the last 2 months of the year, averaging
10-11 per cent at an annual rate, but the expansion
in nominal GNP in the fourth quarter of those years
was about 4 to 5 percentage points stronger than
expected this year. In 1970 and 1971, there was
very little M1 expansion in the last 2 months of the
year. This appears to suggest that the odds of a
surge in M1 growth are not so great this year as in
the past one, although it does not argue against some
rebound, given the projected fourth-quarter GNP growth.
If there is no strong rebound in M1 demand, providing
the reserves to accommodate substantial growth will be
accompanied by greater declines of interest rates than
now expected.
The alternative B specifications indicate that the
Federal funds rate might decline to as low as 8-3/4 per
cent between now and mid-November, although a more modest
1/ The alternative draft directives submitted by the staff for
Committee consideration are appended to this memorandum as Attach
ment A.
10/15/74
-58-
decline to 9-3/4 per cent is shown as the center of
the range. A substantial decline in the funds rate
over the next few weeks is not likely to be inter
preted by the market as pro-inflationary. It would
be accompanied by a fairly significant downward
adjustment in private short-term market rates and
also by some decline in longer-term market rates.
It would work to take pressure off key institutional
rates; it would hasten declines in the prime loan
rate, and would fairly soon be reflected in some
easing in primary mortgage market rates. Thus, it
would tend to support the weak housing sector of the
economy and would also moderate pressure on busi
ness, financial firms, and investors who rely on
bank loans to finance inventories of commodities
and holdings of securities.
The Treasury will be raising a substantial
amount of new cash in the period immediately ahead
and will announce terms of the mid-November refund
ing on October 30, as Mr. Holmes has mentioned.
Thus, the Treasury will be pretty much continually
in the market between now and the next meeting.
This suggests a cautious approach to any money
market tightening, as might be required if the Com
mittee opts for alternative C. On the other hand, I
do not believe it necessarily requires unusual cau
tion on the easing side. Because of the continuous
flow of financings--both for new cash and refundingsome of the benefit of ny easing will inevitably
accrue to investors and some to the Treasury. How
ever, if any action were to be taken that significantly
altered the trend in policy, it might be more desirable
to have it accomplished a few days before the October 30
announcement rather than after. As a minor point, that
date might be moved closer to the early November auction
date for the refunding, if the Treasury were to utilize
a yield auction rather than to stipulate a coupon rate
in advance.
Mr. Bucher asked whether there were any early indications
of the nature of the next adjustment of the money supply series
10/15/74
-59-
to the quarterly benchmark,
and whether, because they were
now made quarterly rather than annually, the adjustments
were likely to be smaller than they had been in
the recent
past.
Mr. Axilrod replied that as yet he had no indications
of the nature of the adjustment to the June benchmark, but
data would be available in the near future.
He hoped that
the use of quarterly benchmarks would reduce the size of the
adjustments.
Mr. MacLaury, noting Mr. Axilrod's statement to the
effect that all three of the alternatives presented assumed
a considerable rebound in money demand in November and December,
asked whether there really was much basis for expecting a sub
stantial pick up in monetary growth.
Mr. Axilrod's reference
to experience in the 1970-71 and 1972-73 periods seemed to
suggest that greater declines in
essary if
the funds rate would be nec
the money supply were to grow at the rates indicated
in the blue book alternatives.
Mr. Axilrod replied that on an assumption of prevailing
money market conditions,
essentially as under alternative C,
various models and judgmental projections suggested that
M1
10/15/74
-60-
would grow in
cent.
the fourth quarter at an annual rate of 6 per
For that rate to be achieved,
an early and substantial
pick up in monetary growth would be required.
In his statement,
he had intended to suggest that, given the uncertainty con
cerning forecasts of GNP,
there was some reasonable probability
that such a pick up would not occur.
If a strong rebound in
the demand for money did not occur, achievement of the mone
tary growth rates under,
decreases in
say, alternative B would require sharper
interest rates than those now associated with that
alternative.
Mr. Partee added that on a longer-run basis the
staff's projection of monetary growth was consistent with
its projection of nominal GNP.
It was possible, however,
that GNP would grow at a slower rate than projected or that,
in the short run, the longer-term relationship between
monetary growth and GNP growth would not prevail.
When
business activity was weakening, there might be a greater
tendency for monetary growth to fall short of the rate
indicated by the longer-term relationship.
If, for example,
Christmas sales were poor, monetary growth might remain
sluggish.
-61-
10/15/74
Chairman Burns then called for the Committee's dis
cussion of monetary policy and the directive.
He might begin
the discussion by expressing some of his own views.
It was
clear to him--as he believed it was to most, if not all, members
of the Committee--that business activity was in a recession,
although an unusual one.
He knew of no earlier instance when
over-all business activity had been declining for a number of
months and yet business capital investment had continued to
expand.
And if the advance indicators were reliable now, as
they had been in the past, the volume of capital investment,
at the worst, would flatten out.
Under those circumstances,
he would judge that the recession--even though likely to
deepen and to cause some hardship--would not be as severe as
suggested by some commentators.
At the same time, inflation
was continuing at a two-digit rate.
It remained a serious
worldwide problem that threatened not only the economic system
but social and political institutions as well.
If the rapid
inflation were not brought under control, those institutions
might be severely tested.
Continuing, the Chairman observed that the problem
of inflation had been caused in large part by excessively
expansive fiscal and monetary policies over a number of years.
10/15/74
-62-
Therefore, any easing of monetary policy at this time should
be undertaken very cautiously; monetary policy should remain
moderately restrictive.
Continued pursuit of such a policy
was likely to have a favorable influence on both the
Admin
istration and the Congress in their dealing with the problem
of inflation.
Although fiscal policy might not prove to be
any tighter, other important issues were involved.
In his
recent speech on the economy, the President had emphasized
policies affecting foods, fuels, antitrust and other regula
tory activities, and labor-management relations.
Maintenance
of a basically restrictive monetary policy might have a bene
ficial effect on the vigor with which anti-inflationary policies
were pursued in those areas.
At the same time, the Chairman said, a decision at
this meeting to ease money market conditions somewhat further
would be appropriate.
Growth in the monetary aggregates had
been sluggish in recent months; the home building industry
was experiencing severe difficulties, in large part because
of high interest rates and the limited availability of bank
credit to builders; and security markets were not functioning
as well as desired.
It was important, however, that the
Committee avoid easing policy too much.
-63-
10/15/74
Mr. Bucher remarked that his own views were expressed
exactly by the remarks the Chairman had just made.
Mr. Hayes observed that the Committee might be con
fronted with a difficult dilemma.
The longer monetary growth
remained sluggish, the more appropriate it would be to take
measures to encourage a resumption of more satisfactory
growth even though little if any progress had been made
in dampening inflation and inflationary expectations.
The
President's economic program, while pointing the way in many
useful directions, offered little hope of real progress toward
effective fiscal restraint or other significant measures to
counter inflation.
Monetary policy, therefore, remained
exposed--as much as before, and perhaps more so because there
was less reason to hope that it would be strongly supported
by other policies.
Policy had to remain basically restrictive,
unless a real risk of a cumulative business downturn became
evident or liquidity pressures became greater.
International
developments also had reflected some disappointment with the
President's program and had demonstrated that the dollar, to
a degree, was vulnerable to the easing in interest rates that
had been occurring in this country.
10/15/74
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Continuing, Mr. Hayes remarked that long-term credit
demands remained surprisingly strong and were likely to con
tinue to spill over into short-term markets.
Bank loan demand
had remained especially strong in the New York District, and
it was not clear whether the lower growth of bank credit else
where in the country was due more to declining demand or to
more stringent lending policies on the part of the banks.
The
Committee continued to be up against the old danger that modest
slackening of monetary restraint might be over-interpreted by
the market and might lead to an unwanted acceleration of infla
tionary expectations.
The recovery in the stock market could
be welcomed, because the extreme decline had been an adverse
economic influence. But there was a risk that the Committee might
be thought to be about to embark on a policy of aggressive ease,
and that was something the members should try to avoid.
Concerning the specifications, Mr. Hayes said he was
reconciled to a longer-term M
target of 5-3/4 per cent, as
under alternative B, in view of the slowdown in monetary
growth in the third quarter.
The short-run ranges of tol
erance for M 1 under alternative B also were acceptable, but
he would like to see the Federal funds rate--which had dropped
precipitously--maintained close to its current level.
For the
-65-
10/15/74
funds rate, he preferred a range of 10 to 11 per cent, which
had the same mid-point as the wider range suggested under
alternative B, but he could accept a range of 9-1/2 to 11
per cent.
Mr. Hayes commented that a reduction in reserve re
quirements might be a partial substitute for open market
operations in the approaching period of seasonal reserve
needs, but it should be made clear that any reduction was not
to be construed as an overt signal of additional ease.
Con
cerning the discount rate, some directors of the New York
Bank recently had indicated a belief that the time was close
for consideration of a reduction.
tion now would be premature.
However, he thought a reduc
The decline in short-term interest
rates that had occurred over the past few months had been
useful in relieving liquidity pressures and disintermediation
problems, and it might be desirable for the System to accom
modate a further decline if the behavior of credit demands
and that of the monetary aggregates seemed to warrant it.
But that was quite different from giving an overt signal, as a
reduction in the discount rate would do, especially when the
gap between that rate and market rates remained wider than it
normally had been in recent years.
It was of crucial importance
-66-
10/15/74
that the System not undermine the belief that it meant busi
ness about combatting inflation.
In response to a question by the Chairman, Mr. Hayes
said he foresaw an unemployment rate of about 6.5 per cent in
the middle of 1975.
Mr. Mitchell observed that he was concerned about the
possibility of the recession becoming serious.
While noting
the Chairman's judgment that a serious recession would not devel
op if, at the worst, business capital investment flattened out,
he believed that a decline in investment would be induced by
the high level of long-term interest rates now prevailing.
Moreover, the construction industry had been severely weakened.
Because of the length of time required to change attitudes
throughout the building industry and in the thrift institu
tions, any expansive policy decisions taken by the Committee
today would not affect construction employment for a year to
a year and a half.
Consequently, it appeared critical to
attempt to bring long-term interest rates down to levels that
would improve the effectiveness of the longer-term markets
for funds.
He hoped that a marked change in monetary policy
would not be required for the purpose and that other, selective,
instruments could be used to stimulate a substantial flow of
-67-
10/15/74
funds into the thrift institutions.
To achieve that objective
without the use of selective instruments would call for a
somewhat easier monetary policy than implied by alternative B.
In addition, it was essential to raise the rate of growth in
M1 .
While he was not particularly concerned about the rate
of monetary growth, the public was.
For the time being, how
ever, he could accept alternative B, but with a Federal funds
rate range of 9 to 11 per cent instead of 8-3/4 to 10-3/4 per
cent.
Chairman Burns, responding to questions by Messrs.
Mitchell and Sheehan, observed that--in the context of his
earlier remarks--he would regard a recession as serious if
the rate of unemployment clearly rose above the level of
about 7 per cent that had been reached in the recession of
1957-58.
One might or might not wish to make some allowance
for the changes in the structure of the labor force that had
occurred since then, which tended to raise the rate of unemploy
ment, but he doubted that the allowance would be as much as
1 percentage point.
With respect to Mr. Mitchell's remarks,
he agreed in general, but he doubted that an easing of mone
tary policy could have a significant influence on long-term
rates.
To bring those rates down significantly, some evidence
-68-
10/15/74
that inflation was being brought under control probably would
be necessary.
Mr. Mitchell remarked that while it would be unreasonable
to expect long-term rates to decline to the neighborhood of 6
per cent, it was also unreasonable to expect residential con
struction activity to recover with mortgage rates near 10 per
cent,
Chairman Burns commented that the $3 billion of Govern
ment funds that recently had been released to GNMA to provide
support to the market for conventional mortgages probably would
be exhausted quickly, and the President was likely to authorize
release of additional funds.
Moreover, the Administration was
considering programs to improve the flow of funds into the
thrift institutions.
Even without such programs, the worst
might have been past; inflows into the savings and loan asso
ciations had picked up significantly in September--to a seasonally
adjusted annual rate of 6.5 per cent--and the recent and pros
pective declines in market interest rates might sustain the
improvement.
Eventually, the improved inflows would provide
stimulus to home building, although the S&L's were likely to
strengthen their liquidity positions for a time before they
became eager to make new mortgage commitments.
-69-
10/15/74
Mr. Morris said he believed that monetary policy had
to be formulated on the assumption that the deeper the recession
proved to be, the greater were the probabilities that Govern
ment policies adopted to combat it would produce too sharp a
recovery.
In order to restrain the contraction in business
activity to the sort of mild recession that would be productive
in
reducing the rate of inflation over the longer run, the
Committee had to be willing to tolerate enough of a reduction
in
the Federal funds rate to raise the rate of monetary growth.
Continuing, Mr. Morris remarked that he favored the
rates of monetary growth under alternative B.
If the longer
run M 1 target of 5-3/4 per cent were achieved, the course of
economic activity would likely be better than that projected
by the staff.
But if expansion in M 1 over the months ahead
fell short of the projected path--and growth over the second
half of this year proved to be at an annual rate of only 1 or
2 per cent, rather than a little over 4 per cent--the System
would encounter severe and deserved criticism.
In his judgment,
the alternative B targets for the monetary aggregates could not
be achieved with the range of tolerance indicated for the funds
rate.
Accordingly, he would specify a lower limit of 8 per
cent, rather than 8-3/4 per cent, and would instruct the Desk
-70-
10/15/74
to give high priority to achieving the desired rates of growth
in the aggregates.
Mr. Mayo commented that in his view the longer-run
M1 target of 5-3/4 per cent under alternative B was still
appropriate.
To a degree, achievement of that target would
make up for the recent shortfall in monetary growth, and yet
it was basically the kind of restrictive policy that the
Chairman had described earlier.
In his opinion, the impor
tance of the shortfall had been over-emphasized in terms of
the System's ability to achieve its longer-run objectives,
but he recognized that the Committee had to pay more attention
to short-term fluctuations in monetary growth than he would
like,because of press interpretations of their significance.
However, even if the rate of growth in M1 fell somewhat short
of the alternative B projections of 9 and 8.2 per cent for
November and December, respectively, the recovery from the
low rates of recent months would be publicly acceptable.
Con
sequently, he subscribed to the specifications and the language
of alternative B, although he would reduce the lower limit of
the funds rate range.in order to provide the Desk with additional
leeway.
of the
The System should attempt to accommodate continuance
downtrend in interest rates--not encouraging a rapid
10/15/74
decline nor, what would be worse, preventing a decline al
together.
Mr. Coldwell remarked that the Committee had been
pursuing a gradual approach to easing policy, attempting to
maintain as much restraint as possible without aggravating
recessionary tendencies, and such an approach involved the risk
of deepening the recession as well as the risk of promoting too
rapid a recovery.
While he.was uneasy about the economic outlook,
he also would be uneasy about any System action that might be
interpreted by the market as a shift away from restraint, and
until it was clear that Federal expenditures would be held down,
he would hold to a policy of restraint.
In past economic down
turns, policy often had been eased too early and too massively.
In continuance of the gradual approach, Mr. Coldwell
said he favored alternative B, except that he would specify a
range of 9 to 10-1/2 per cent rather than 8-3/4 to 10-3/4 per cent
for the Federal funds rate.
Believing that the System.should not
take any overt actions to ease at this time, he would not lower the
discount rate and would reduce reserve requirements only if it were
emphasized that the purpose of the reduction was to meet the sea
sonal need for reserves.
With respect to the draft of the directive,
he would modify the paragraph concerning the President's program
by deleting the reference to the impact of fiscal restraint,
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10/15/74
because he thought there had not been any fiscal restraint,
and he would delete the word "harsh" in describing the impact
of monetary restraint.
Thus, the first sentence would read
"On October 8 the President announced a program to combat
inflation and to mitigate the impact of monetary restraint on
certain sectors of the economy."
Mr. Holland commented that he also had a proposal con
cerning that sentence of the draft directive.
The President's
program was intended to mitigate the impact of inflation as
well as the effects of policy, and it would mitigate only the
harshest impacts.
Therefore, he would say ". . .the President
announced a program to combat inflation and to mitigate the
harshest impact on certain sectors of the economy."
Mr. Hayes remarked that he preferred not to characterize
the impact of monetary policy as harsh.
Chairman Burns observed that the President's recommen
dation that total Federal budget outlays in fiscal 1975 be
held to less than $300 billion represented fiscal restraint.
He suggested that the sentence read "On October 8 the President
recommended a program to combat inflation and to mitigate the
impact of monetary and fiscal restraint on certain sectors of
the economy."
He asked the members to indicate whether that
language would be acceptable.
10/15/74
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A majority of the members indicated that the language
proposed by the Chairman would be acceptable.
Mr. Sheehan commented that he agreed with much of what
Messrs. Mitchell and Morris had said.
With respect to business
capital investment, he disagreed with the Chairman's view that
it would continue to buoy the economy; business confidence was
very weak, and some investment projects could be canceled
merely by decisions of boards of directors.
He would be satis
fied with the specifications of alternative B, because he believed
that in the event the aggregates appeared to be growing at rates
below the specified ranges, the Chairman would recommend
that
the lower limit of the funds rate range be reduced, as he had
done in the period since the September meeting.
He felt that
the System was particularly vulnerable because of the way in
which members of the Congress perceived current monetary policy.
Mr. Leonard remarked that he could associate himself
with the comments that the Chairman had made at the outset of
today's discussion of policy.
He believed that the third-quarter
rate of increase in M1 --now indicated to be 3.6 per cent on the
quarterly average basis--would be revised upward.
With respect
to the future, he could support alternative B; while it implied
M, growth from the third to the fourth quarter at a rate that
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10/15/74
he believed was too low,
the shortfall would be about made up
by growth from the fourth quarter to the first quarter of next
year at a rate that he regarded as too high.
Chairman Burns commented that M1 growth on the quarterly
average basis was 5.8 per cent in
the first
year and 7.3 per cent in the second quarter.
quarter of this
Even if the rate
for the third quarter was not revised upward from 3.6 per cent,
the average for the second and third quarters together would be
close to 5,5 per cent.
While he believed that the shortfall
should be compensated for, its
importance should not be exaggerated.
Mr. Kimbrel observed that some recent developments sug
gested that the economy was weaker than it had been thought to
be, but as long as the Federal budget remained in deficit,
there was little danger of a cumulative decline.
While the
weakness was onerous in terms of its effect on employment, it
would improve the outlook for a return to price stability.
Continuance of a policy of monetary restraint was necessary,
and he hoped that the System would not give the impression that
it had abandoned its role in fighting inflation even before the
President's recommendations were acted on.
Time was on the
side of continued restraint in that banks were likely to be
rebuilding their liquidity, but they were earnings-oriented and
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10/15/74
would be quick to expand their operations if they believed
that the System had shifted to a policy of ease.
Mr. Kimbrel said he could accept the specifications of
alternative B, except for the 8-3/4 per cent lower limit of the
range for the funds rate.
A drop in the rate below 9 per cent,
coming after the decline that had already occurred,would be
interpreted by the market as a rapid shift to a policy of ease.
He would not like to see the rate fall below 9 per cent in the
period until the next meeting of the Committee.
The Chairman then asked Mr. Partee for his policy
recommendations,
Mr. Partee said he had nothing to add to his earlier
remarks regarding the general economic and financial outlook.
He would be prepared to accept the policy course set forth by
alternative B, but would be very quick to depart from it if it
appeared that in the October-November period the aggregates were
growing at rates below their specified ranges.
Mr. Eastburn remarked that in attempting to step up
monetary growth the Committee might stimulate a rate some months
ahead that would be too rapid, and it would then be faced with
the issue of whether to tighten money market conditions at an
unfavorable time.
He favored alternative B, with the funds rate
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10/15/74
range as indicated under that alternative, and like Mr. Partee,
he would be quick to depart from it if it appeared that growth
in the aggregates was not picking up.
In order to allow for
the acceptance of unexpected expansion in M1,
he would widen
the 2-month range from 4-3/4 to 6-3/4 per cent, as indicated
under alternative B, to 4-3/4 to 8 per cent.
Concerning the discount rate, Mr. Eastburn observed that
it was early for a reduction.
However, the Treasury would be
in the market for a considerable period of time starting shortly
and ending with its mid-November financing, and therefore, he would
be inclined to recommend a one-quarter point reduction earlier than
ordinarily would be called for to fine-tune the rate in the manner
that he desired.
He asked Mr. Holmes whether the market had al
ready discounted a reduction or would be surprised by one.
Mr. Holmes replied that he thought there would be only
a mild reaction to a reduction in the discount rate at this
time, that the cut would be taken as confirmation of the easing
that had already occurred.
The reaction would be stronger if
the cut came when the funds rate was declining rapidly or if
it was accompanied by a reduction in reserve requirements.
Mr. Wallich commented that actions taken to raise the
rate of monetary growth after a period of shortfalls should not
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10/15/74
be viewed as an easing of policy.
The Committee's task at this
time was to raise M1 growth from the low rate of recent months,
while taking account of the danger,mentioned by Mr. Eastburn,
that an upsurge in growth would put the Committee in the uncom
fortable situation of having to tighten money market conditions
while economic activity was in recession.
Raising the rate of
M 1 growth was particularly important, because prospective rates
of growth in
M2 and in RPD's exceeded that in M1 by less than
the usual amounts.
He remained concerned about the possibility
of giving false signals to the market.
However, that danger
might have lessened; as money market conditions had eased in
recent months, nothing dramatic had occurred in the markets,
suggesting that participants understood current policy.
Accord
ingly, he was less concerned about the amount of decline in the
funds rate constraint.
He favored alternative B, and would be
willing to shade the lower limit of the funds rate range down
from 8-3/4 per cent to 8-1/2 or 8-1/4 per cent.
Mr. Holland observed that he agreed with the Chairman's
comments concerning the economic situation and monetary policy.
He favored alternative B, and he believed that the Manager
ought not to wait until new data for the aggregates became
available but, within the framework of that alternative, should
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10/15/74
proceed actively to reduce the funds rate; he should aim to get
the rate down into the range of 9-1/2 to 9-3/4 per cent, so
long as the aggregates did not appear to be growing at rates
at or above the upper limits of their specified ranges.
Chairman Burns expressed the view that the framework
of alternative B implied the course of action suggested by
Mr. Holland.
He asked Mr. Holmes whether that was his under
standing as well.
Mr. Holmes replied that it was.
Mr. MacLaury remarked that the prospective slack in the
economy was counter-productive in that the decline in activity
would be excessive in relation to its effect in reducing the
rate of increase in prices and would lead to a counteraction.
Like some other
speakers, he believed that the current stance
of monetary policy should not be characterized entirely in
terms of the behavior of interest rates.
The Committee had
been focusing on the behavior of the aggregates, and in fact,
he understood the Chairman's public statements about avoiding
a credit crunch to mean that growth in the aggregates would be
maintained.
For that reason alone, the Committee had a strong
interest in raising the rate of monetary growth.
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10/15/74
Accordingly, Mr.
MacLaury said, he favored the specifi
cations of alternative B.
Like Mr. Morris, however, he would
reduce the lower limit of the funds rate to 8 per cent--or, at
least, to 8-1/4 per cent--and would expect that the funds rate
target would be moved down.
According to the blue book, even
alternative A would result in fourth-quarter growth in M1, on
the quarterly average basis, of only about 4.5 per cent; to
him, that did not appear to be excessive monetary ease.
Mr. Black observed that the objectives of controlling
inflation and cushioning the decline in economic activity
might appear to be conflicting, but he did not believe that
they were.
For a long time, it had been the Committee's
objective to foster moderate monetary growth, and that objective
continued to be appropriate.
To achieve it--to raise the rate
of growth in the aggregates--required some further easing in
interest rates.
Accordingly, he favored alternative B.
Mr. Winn remarked that the meaning of M1, like that of
the unemployment rate, might have undergone some change.
To
some extent, corporations now held CD's in place of demand
deposits, and the slowdown of M growth in recent months might
need to be interpreted differently than in the past.
the specifications of alternative B.acceptable.
Mr. Williams said he favored alternative B.
He found
10/15/74
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Mr. Clay observed that he agreed with the Chairman's
remarks opening the policy discussion today, except for the
statement that a decision to ease money market conditions some
what further would be appropriate.
He would be very cautious
in reacting to the recent shortfalls in M 1 growth, believing
that they were not entirely due to the weakness in economic
activity but at least in part were a lagged response to the
high levels of short-term interest rates prevailing in the
spring.
The rate of monetary growth was likely to pick up,
and Committee members should be concerned about the possibility
of provoking a rate of growth that was too rapid, thereby
earning the criticism that policy was conducted on a stop-and
go basis.
He would like to get the full benefits of the policy
course that the Committee had been following, even though he
recognized that that course caused problems for some individuals
and businesses.
The decline in the Federal funds rate that had
already occurred--from an average of 12.92 per cent in July to
an average of about 10.5 per cent in the week ending October 9was very dramatic.
Accordingly, Mr. Clay said, he favored the language of
alternative C and, with some modifications, the specifications
of that alternative.
He would raise the M1 short-run range of
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10/15/74
tolerance slightly--to 4-1/2 to 6-1/2 per cent--and would lower
the funds rate range slightly, to 9 to 11 per cent.
While he
favored the longer-run targets of alternative C, he could
accept slightly higher rates--namely, 5-1/2, 6-1/2, and 6-1/2
per cent for M1, M2, and the credit proxy, respectively.
In
his view, the tendency always was to react too soon to weakness
in economic activity and not soon enough to inflationary develop
ments.
Mr. Bucher remarked that he favored the specifications
of alternative B.
He would be prepared to reduce the lower
limit of the funds rate range in the event that growth in the
aggregates appeared to be at rates below the short-run ranges
of tolerance.
Chairman Burns said he believed, on the basis of the
discussion, that a majority of the members favored alternative B,
and in his own view, the specifications of that alternative were
close to the mark.
He would raise the upper limits of the short
run ranges of tolerance for the aggregates by 1/2 of a percentage
point; thus, the ranges would be 4-3/4 to 7-1/4 per cent, 5-3/4
to 8-1/4 per cent, and 5-1/2 to 8 per cent for M1,
respectively.
M2, and RPD's,
For the Federal funds rate, he would narrow the
range while retaining the mid-point indicated under alternative B;
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10/15/74
he would recommend a range of 9 to 10-1/2 per cent, rather than
the alternative B range of 8-3/4 to 10-3/4 per cent.
During the
course of the period before the next meeting, he would follow
the behavior of the aggregates very closely, and in the event
that growth continued to fall short of the specified ranges,
he would make appropriate recommendations to the Committee.
The Chairman asked the members to indicate informally
whether they could accept the short-run ranges for the aggre
gates that he had suggested.
A majority of the members indicated acceptance of
those ranges.
The Chairman then asked the members to indicate whether
they could accept the range that he had recommended for the
Federal funds rate.
A majority of the members indicated acceptance of that
range.
Chairman Burns proposed that the Committee vote on a
directive consisting of the staff's draft of the general para
graphs, as altered earlier, and alternative B for the operational
paragraph.
It would be understood that the directive would be
interpreted in accordance with the following specifications.
The longer-run targets--namely,
the annual rates of growth for
10/15/74
-83-
the period from August 1974 to March 1975--would be 5-3/4,
6-3/4, and 6-3/4 per cent for M1, M2,
proxy, respectively.
and the bank credit
The associated ranges of tolerance for
growth rates in the October-November period would be 5-1/2 to
8 per cent for RPD's, 4-3/4 to 7-1/4 per cent for M1, and
5-3/4 to 8-1/4 per cent for M2.
The range of tolerance for
the weekly average Federal funds rate in the inter-meeting
period would be 9 to 10-1/2 per cent.
Mr. Clay indicated that he planned to dissent from the
proposed directive.
With Mr. Clay dissenting, the
Federal Reserve Bank of New York was
authorized and directed, until other
wise directed by the Committee, to
execute transactions for the System
Account in accordance with the follow
ing domestic policy directive:
The information reviewed at this meeting suggests
that real output of goods and services declined somewhat
further in the third quarter and that price and wage
increases continued large. In September industrial
production increased somewhat, reflecting settlement of
work stoppages that had reduced output in August. An
upsurge in the labor force, following several months
of relatively slow growth, raised the unemployment rate
from 5.4 to 5.8 per cent. The rise in wholesale prices
of industrial commodities moderated, although it re
mained substantial, and prices of farm products and
foods declined after having increased sharply in July
and August.
10/15/74
-84-
On October 8 the President recommended a pro
gram to combat inflation and to mitigate the impact
of monetary and fiscal restraint on certain sectors
of the economy. The tax and expenditure proposals
included in the program would, on balance, have
approximately a neutral effect on the size of the
Federal deficit.
In recent weeks the dollar has declined against
leading foreign currencies. The U.S. foreign trade
deficit increased substantially in August, as imports
of petroleum and industrial materials rose while
exports held steady.
The narrowly defined money stock rose slightly
in September and grew at an annual rate of about 2
per cent over the third quarter, compared with a rate
of 6 per cent in the first half of the year. The
money supply measure more broadly defined to include
bank time and savings deposits other than money market
CD's--as well as the measure that includes deposits
at other thrift institutions--also rose only slightly
in September. Over-all business credit demands slack
ened last month, and outstanding business loans at
banks leveled off. Since early September interest
rates on short-term market instruments have fallen
considerably, while yields on Treasury and State and
local government bonds have declined modestly. Yields
on corporate bonds have risen somewhat further, on
balance, reflecting the large volume of offerings in
prospect.
In light of the foregoing developments, it is the
policy of the Federal Open Market Committee to foster
financial conditions conducive to resisting inflationary
pressures, supporting a resumption of real economic
growth, and achieving equilibrium in the country's
balance of payments.
To implement this policy, while taking account of
the forthcoming Treasury financing and of developments
in domestic and international financial markets, the
Committee seeks to achieve bank reserve and money market
conditions consistent with resumption of moderate growth
in monetary aggregates over the months ahead.
10/15/74
-85-
Secretary's note: The specifications agreed
upon by the Committee, in the form distri
buted following the meeting, are appended to
this memorandum as Attachment B.
The Chairman asked Mr.
Broida to comment on the matter
of the Committee's 1975 meeting schedule.
Mr. Broida noted that the tentative meeting schedule
set forth in a memorandum from the Secretariat dated October 8,
1974 1/ involved meetings on the third Tuesday of every month
except February, when the meeting would be on the third Wednesday,
because of a holiday on the third Tuesday.
It was agreed that the tentative schedule proposed in
the memorandum of October 8 was satisfactory.
It
was agreed that the next meeting of the Committee
would be held on November 19, 1974, at 9:30 a.m.
Thereupon the meeting adjourned.
Secretary
1/ A copy of the document referred to has been placed in
Committee's files.
the
ATTACHMENT A
October 11, 1974
Drafts of Domestic Policy Directive for Consideration by the
Federal Open Market Committee at its Meeting on October 15, 1974
GENERAL PARAGRAPHS
The information reviewed at this meeting suggests that
real output of goods and services declined somewhat further in
the third quarter and that price and wage increases continued
large. In September industrial production increased somewhat,
reflecting settlement of work stoppages that had reduced out
put in August. An upsurge in the labor force, following several
months of relatively slow growth, raised the unemployment rate
from 5.4 to 5.8 per cent. The rise in wholesale prices of
industrial commodities moderated, although it remained substan
tial, and prices of farm products and foods declined after having
increased sharply in July and August.
On October 8 the President announced a program to combat
inflation and to mitigate the harsh impact of monetary and fiscal
restraint on certain sectors of the economy. The tax and expen
diture proposals included in the program would, on balance, have
approximately a neutral effect on the size of the Federal deficit.
In recent weeks the dollar has declined against leading
foreign currencies. The U.S. foreign trade deficit increased
substantially in August, as imports of petroleum and industrial
materials rose while exports held steady.
The narrowly defined money stock rose slightly in
September and grew at an annual rate of about 2 per cent over
the third quarter, compared with a rate of 6 per cent in the
first half of the year. The money supply measure more broadly
defined to include bank time and savings deposits other than
money market CD's--as well as the measure that includes de
posits at other thrift institutions--also rose only slightly
in September. Over-all business credit demands slackened last
month, and outstanding business loans at banks leveled off.
Since early September interest rates on short-term market
instruments have fallen considerably, while yields on Treasury
and State and local government bonds have declined modestly.
Yields on corporate bonds have risen somewhat further, on
balance, reflecting the large volume of offerings in prospect.
In light of the foregoing developments, it is the
policy of the Federal Open Market Committee to foster financial
conditions conducive to resisting inflationary pressures, sup
porting a resumption of real economic growth, and achieving
equilibrium in the country's balance of payments.
OPERATIONAL PARAGRAPH
Alternative A
To implement this policy, while taking account of the
forthcoming Treasury financing and of developments in domestic
and international financial markets, the Committee seeks to
achieve bank reserve and money market conditions consistent
with substantial growth in monetary aggregates over the months
ahead.
Alternative B
To implement this policy, while taking account of the
forthcoming Treasury financing and of developments in domestic
and international financial markets, the Committee seeks to
achieve bank reserve and money market conditions consistent
with resumption of moderate growth in monetary aggregates over
the months ahead.
Alternative C
To implement this policy, while taking account of the
forthcoming Treasury financing and of developments in domestic
and international financial markets, the Committee seeks to
achieve bank reserve and money market conditions consistent
with modest growth in monetary aggregates over the months
ahead.
ATTACHMENT B
October 15, 1974
Points for FOMC guidance to Manager
in implementation of
directive
in implementation of directive
A.
Specifications
(As agreed, 10/15/74)
Longer-run targets (SAAR):
(September plus fourth and first
quarters, combined)
5-3/4%
6-3/4%.
Proxy
B.
6-3/4%
Short-run operating constraints:
1.
2.
Range of tolerance for RPD growth
rate (October-November average):
5-1/2 to 8%
Ranges of tolerance for monetary
aggregates (October-November average):
4-3/4 to 7-1/4%
5-3/4 to 8-1/4%
3.
4.
Range of tolerance for Federal funds
rate (daily average in statement
weeks between meetings):
9 to 10-1/2%
Federal funds rate to be moved in an
orderly way within range of toleration.
5. Other considerations: account to be taken of Treasury financing and
of developments in domestic and international financial markets.
C.
If it appears that the Committee's various operating constraints are
proving to be significantly inconsistent in the period between meetings,
the Manager is promptly to notify the Chairman, who will then promptly
decide whether the situation calls for special Committee action to give
supplementary instructions.
Cite this document
APA
Federal Reserve (1974, October 14). Memorandum of Discussion. Memoranda, Federal Reserve. https://whenthefedspeaks.com/doc/memorandum_19741015
BibTeX
@misc{wtfs_memorandum_19741015,
author = {Federal Reserve},
title = {Memorandum of Discussion},
year = {1974},
month = {Oct},
howpublished = {Memoranda, Federal Reserve},
url = {https://whenthefedspeaks.com/doc/memorandum_19741015},
note = {Retrieved via When the Fed Speaks corpus}
}