the fomc in 1979: introducing reserve targeting · house concurrent resolution 133 that the board...

RICHARD W. LANG

~‘IAJORchanges in the implementation of mone-tary policy occurred in 1979. In accordance with theFull-Employment and Balanced Growth Act of 1978,the Federal Open Market Committee (FOMC) wasrequired to announce long-run ranges for monetarygrowth in 1979 in a new format. In addition, theFOMC had to adjust its one-year range for Ml growthto take into account the introduction of two financialinnovations in late 1978 — the automatic transferservice (ATS) between savings and checking ac-counts at banks nationwide and negotiable orders ofwithdrawal (NOW) accounts in New York State.

The most important change in the implementationof monetary policy, however, occurred in the FOMC’sshort-mn operating procedures. On October 6, 1979,the Federal Reserve announced a series of actions to“assure better control over the expansion of moneyand bank credit, help curb speculative excesses infinancial, foreign exchange, and commodity markets,and thereby serve to dampen inflationary forces,”1 Themost significant of these actions was the FOMC’s ap-proval of a change in the day-to-day procedures usedto conduct monetary policy.

This action involves placing greater emphasis inday-to-day operations on the supply of bank re-serves and less emphasis on confining short-termfluctuations in the federal funds rate.2

This announcement introduced a different strategy forthe conduct of open market operations — a strategy oftargeting on bank reserves rather than the federalfunds rate.

Note: Unless specified otherwise, citations throughout thi5paper are from either the “Record of Policy Actions of the

Federal Open Market Committee” or “Statements to Congress,”Federal Reserve Bnlletjn (February 1979 through March 1980).1

”Announcements: Monetary Policy Actions,” Federal ReserveBulletin (October 1979), p. 830.

This article discusses these modifications to theimplementation of monetary policy and summarizesthe decisions of the FOMC in 1979. The Committee’sdomestic policy directives are summarized in table 1.Excerpts from the monthly “Record of Policy Actionsof the FOMC,” which provide a more detailed meet-ing-by-meeting summary of FOMC discussions, ap-pear in a supplement to this article.

LO?GRUN RANGES OFMONETARY GROWTH

Since 1975 the FOMC has publicly announced one-year growth ranges for the monetary aggregates (Ml,M2, and M3). At that time, Congress requested inHouse Concurrent Resolution 133 that the Board ofGovernors consult with congressional committees ona quarterly basis about the Federal Reserve System’sobjectives and plans for the ranges of growth of mone-tary and credit aggregates over the next 12 months.Such consultations became a requirement with theFederal Reserve Reform Act of 1977. The format ofthese one-year ranges was altered in 1979, however,under the requirements of the Full Employment andBalanced Growth Act of 1978 (also called the Hum-phrey-Hawkins Act). At the same time, the FOMChad to formulate monetary growth ranges that tookinto account the introduction of nationwide ATS ac-counts and New York NOW accounts.

The Humphrey-Hawkins ActBefore 1979 the FOMC reviewed and adopted one-

year growth ranges for several monetary and creditaggregates each quarter and presented them to Con-

,gress. The period to which these growth ranges ap-plied began with the previous quarter and ended inthe same quarter of the following year. For instance,

The FOMC in 1979: IntroducingReserve Targeting

2lbid.

2

FEDERAL RESERVE BANK OF ST. LOUIS MARCH 1980

Organization of the Committee in 1979The F’ede ‘al Open ‘U arket Con roil lee ( VU” I (‘) coil — if the flu net a i’~‘ ag’Sre’.!itc’s. 5pt‘cia’ Fat mrs. (I it h ‘is

sists of the st’vt’il ,ieiiiiier, ii the Federal T’ic’cerve ‘oi,,litinii iii dn:iiesti’’ filI1tTt’i:il ijiai’kc’t~ anti fore’itziiBoard ,~fC;us er,ii’rc Ul:(l fh c’ of the twelve l’edera! lIe— t’st’hantre nianket’. wire alsi) taken mlii account.serve Bank preid’rits. The Ch’airiuuati cii the Board ofC.e,vt-:’r’.’uu is ‘tisu,, bs ti~tditjon. hainuan ‘if the (:011)~ ‘lit’ \h.n,nw’r’n.ik’~ dl cle’t’isiniis n’’’’ardin~ theiniUe’c The ~)re’eft’i,t ui the Ness ‘flirk Federal f~ liti,iunz. l’’pt s,,und ajiur,iuuit if da9~bus Hg .oid w1linc~cent’ Hand, is a i~nn,unent nii’tn,br’i’ of the C ‘nnun’ittet’ of ‘,ec’nuiIit’’. in fu,lIilling die (:uuni’uuuttt’c’’s tli’t’etivt’.

mud. a~snby traditiun its siee chainnan. Al] FedeijI Each tmuumri,1!,~ the \Iauimgcr and his LII ])iitui tueHewn’ B~u,k pa’siuh i ts at1 end tilt’ met ti’’gs au,’1 open n:nket OPt rati,uns for ikit day. ‘Ii:is Plan

their it’s In~tcmlv thoM’ presidents ~ducuare dc’t t’l’IPC’.i ‘01 the ku~uS Of tlmt’ C uuiu,u’,nttec’ ‘s dnu’t’ctive’membeis of (lie (:onunnittee neat cast vu,(u:s, Four nov01- anal the iatt’’t ulei’el~puu,t’~t5,ilfet’ting un’tuuie’y and creditlut’rships u’i,liLtt’ it!.ou:,~ the Bai,k pre~ielt’nits ;t:iel o’t’ n,a,’hu’l eouid~tiuunc. monme’i.irv ,1tzcru’cg’ile growth. antiheld !or ouue—~tar terms I,etou,uuuuiur \tarc’h I of each bank reSer~C’ e’ouiditio’is. ‘l’I’e ,\u’L’rmliuut \I’inuager. in aseal’. ‘ . t’,unft’rc’uic’t’ c’ttIi, thin iniforuns sta4’ n,c’mhei ‘, if the Btuin’d

of c;A (IOnic auie1j unit’ ,itin~ ~w( ~ ‘~})u~~1ii’t’st’nt

\lc’uniut’rs of the Board of Goyt’rnous tt the ‘e’JnI— inarhet c’ennidititnnus and pen n,’trkt-t oper1itions that henmiung of 97~,ilic’ltneled (.haiu nail C. W’i]]i.tnnj \lilIer. pr.iptu..c’’. to execute’ that d:ts , Other members f tlut’l4iilip F. Cu d lsveli . j . Charles Parlee. Nau ,c’~ II. l”UMC arc informed 0f tic dails plan by wire.Tee~urs. anti Uenry C. Wallk’li. There were twovac’aT (‘it’s on tht’ Bond .)s a result of the nli’’ttin of ‘line dir~lives issuic’d I)S (lie FOMC~arid a ~inniuiiarvVice ( :]uaiu man Stephen S. Gardner alL’ thc resici’a— ‘ii (bc reasons for l’~)\l(’actions are pre’c nile’1 to thetoni of C,tm’sc’rntur I’hillip C, Jae~ iii in Novenn’iiit’r 111Th. public in lie “Reeu,rd if i”ulie~ ‘\tthns ‘‘~ tie Fcdc~dhi LLuldhl 0,, to l’a’il &. \‘o~her, prt’.’oh it uf the Fed— Open Market Fu,nunuittee, he “Record’’ is ieleascd at’rai Reserve Bank of New ‘\ turk, the folioss jig pit’’i few div5 .ifter the ioilunwiuug l’()\TC mec’tiuig. S.uomi afterdents sers enl on iL (.omr,,it tee nluri,g Jatiniar~ oil its release, the ‘tee” rd appe ,rs in tic’ ii d

ti’ol Rc ‘c rUt’

I elurutan 197th Ernest T. B,tuuclu,n’,umi (I )ail.t’). Divici Ilnll,’lin and. in ,ielelitiuuni. ‘‘Betcircls’’ bun lime entirc scar1’. F.astinnrr. (f’iiiiadelplnn.i). \laik it. \\‘iile s ( \li:,— an piibli5l~i’cljut tic’ ANrIIUIJ Rejnirt i)f I/IC Board ofne’apolis). aid \Villus j, \\‘inn ((‘It’s elarid). ‘l’lie (.om— (‘mi’n’iuirs. ‘LIe ‘‘lice tird for cat1) meeting dnring 1979nnittce s\ as reorL’anl/ttl iii \].ureh 01d the Iniur u’ntatiniz generail\ intluded:positions Wire filit’el im~: mliii 3, BuIlt s (San l’fltIiL’iS(’O). 1) A stall suurnroars of reeei’,t C’u,toionile develop—ilohcrt I’. Black I Riehnnnntl) . Mu,inrnc’ Kimlirel ( Atlait— u..’nts — suCh (‘liW .tze, ii ~)l’I((‘5, etnpiosta). and Ruben P. Mann (Chi’a2ti). hi h,i~.i’:’i,unt’t nit’nt, indo,inial prunt!’nt’tio:i. anti t’on,nonents ifI lice v. a.~appointt’nl to i lie’ Board, filth ig Out’ if ti ic the i ,ittional in’ owt’ at t ‘,unts — ant props t ion.s

Iwo sne’:’neies, and Frederick El. Scliuiliz ,“as a])— tif sLeneI:ul pm-ut’’. nntjTht. alit’ enipln~nmentdc~elp.uintcd tim the Inuand as ‘~mee’ chamrm,tn. filling the tipinc’nts br tIt’ ‘. tar ahead:otlier’at’nnt positnmn. l)uuitt’,,\u’2lnsL (.hairn’an \tiilerm esigr’eef nit! ss~t, replacer] 1m’ \lr. \‘oh’ker. 2) A si;n,uuiutrs til ! c’t’ent mt trout it)’ial fui~.tinc’ial d~

s c’lunpnit”nts a:nl tIle I ‘,S foreign trade ta,lauee.‘rue ( ‘ouunittt’e men ,nine tiiuuut’u tlnu’int2 197~J to 3) A snnwian’~ of i’ccu’nt t ut’dmt market conditions

discuss. aii’innt~ ,th~i tinuics. cc ilr,otuuI’ tn’ne.i’ and to a—cl it’t’t’nt intt’ie,t rate u)lti~’t’nii’nt’<ciech it’ upon tIe fn~w’ecoon st’ of i pin market utuera.’(ions.’ As in pres iolu,s ~e.trs. lioss c’\’c’r. Ic kphouue cur -~ A swuniau’\ of open market :1Pt’Pttm0~5 crow titcdi ni Lu usu1tttmou \~ie lit Id ott (5100 ills itt ‘(eli of iiitoii ti’s (12 (ttt 1d i usc~t inc

se’l,edn~ed“a ejng’.1 Durin’4 eadi n’gnlan~ stile dfflt’tl numney ,trU’t ennduiuuns ‘i’uee tiit’ P~’’ntnt’n,ec’nnL’, ‘i dirt etuve’ ssas issletI to flue i”c’rit’ral llt’Sel’VL nit’etitic;Bank of New York’, Each diree’tist’ contained a shout 5) A snnuun,alv iii the’ Con’nnttt c’s r,liseossiui, oflevies’- of cc nunnuuuie dest’lumpuu:ents~ tie ce’.uer ii utrrent ‘intl pun. pi u~tneecou,’,numt aiR! financialeeuluitiiulic’Lti’.LlS su u;cimt by tile’ ( tuueu nitt’’’ aid h,, to~~htions an iii ol tie rc’u it pout \ ci u:siift’rat ii ins,stint lions tin tint’ \Lnuacc’r cut the’ Svstt’un Opt’n \t,uU’l iu,t’lwlln’2 n,tnuc nuarket e’oualitiuuns anud the nuuu’,c’-

,\eet,’innt .it tine Nu’ss ‘~ uk Ba’,k br tie c’on,d,nt’t nf u,uent ot uluuiut’tau’) au’2n’’1.iles:OJX’t u,,Ltil’t’t npcratlo]is. ‘I first’ instrnetion’s we’re statc ci 6) Conc’luncnons ob the t’(j\l(in ic’un,c if joc’i,c~ unark’et ctouditinu,s and shout tt’nn —. ‘ ‘ ‘ ‘A ptiltes tlu:’ec’tus t’ ussunt’d us tIM’ (.uunnnottt t’ tinat’” tiE inoss tlt ol \l I a’,ti \L,’.slncu, were considered — j ‘ ,

the I’ t’c.~ci”i’ l,t’st’n’s’e Ban. of Nc’s’. oilsto tue ctu,u,ntc’nt ss il, dc’surt’tI longer i ui cross tIm mates5) A lust of ihu tuut’mhc’u’s sotuiig positions aunt’ an’.’

iNn fwuuua! ni t’th,cs were held ii’, J1 ,uiary, 3m e’, auni dis,sc’nliuig t’omuueu,b;Deccnuuht’n 1979. ij ) —‘ elest’n ipt iou of aui~ act itinus anud e’tl:,,’ltltatIOJis

2( ,,usuilaii.,” usc a’ Ii~~kliuj, lau:tuaiy I2,~clartli 2. \~m’1 thai unas have oc’c’ulrret! hiu’tss ten, tint’ rt’gui]am~27. June 5. J nfy 27. August .30, amid tk’tolmer 22. selne~!unled nut’etiui gs.

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Table 1 (continued)Supplementary Footnotes — Dissents to FOMC Actions“Mr. ~old,,veIL disst uteri fn’t,m this act‘Liii lmec-auise’ hi, lIre (erred to direct opt, o market operatkiuns earl)’ iii the eominm period

tursvarel a slight {irnuirng if, nut icy market eoruchition~. lIe’ ft.]t that thi greatest current danger was au intensification ofiii flation au’s’ press In It’s an ci t fuat t lie’ leui ig ei’—ra n igc p rospec I

tftir in f Ialii on use’re u in, ‘tc’ci’ptable.

u.\li.ssrs Voider, C :oidw ‘II, K lint ire’l, and ~VaIIic’h di,ssc nuted from tb’ act ie,un I uee’umc thes’ favored a stimt’what mote’ restiic—ise policy posture’ in sic’s” enf iruliatiutuary forc’t’~r,’it,ftirt’i’eh by pressure on capacity in some industries’ and mu view of theear—fe’ I en pi itt‘nit i:u I ft ir t’~ t:es’ive’ inlvc’n tn ) tieq tuctuuls, 9te~ 1 cii t’~eel that, cit’s pitt’ u ine,’ei’tamtc’ aI out prosPt ‘ci ior economic

actIsit liter this ye’au - soul ic ad‘fit it u rua I luu’iu ing mr mu lies manket c ‘ondititni us at this tin] p was apprtipr Fate’ t n i help ctrntaiinfiat in) iuars’ pit ‘‘si I re,, and majumtai ii ar ut sure I e tn Iidenc’e in the dollar in Ii ireigi i cxc’luarnge markets,

\ln,,ssrs. Vtite’ker. Coicfwetl. anti Wallich di,scuited from thi, act luau because time’) coiutiuineth to favt,r a somt what rntcire rc’stric—ti, c’ ~0! It ‘V post ire in ‘, iess’ of utni in ug 10flatit uu ary force’s rep ifriireci liv press in no cit capacity inn sonue inntlust cii’,. ‘1 hey believedthat, tit’sp Iti ul ccciam it> it’ itnit prospt ct ft,r et ‘tin otun ic act iii t s’ tat ‘‘r this ) e’a C, scsi) te ails fit ion al firiumi u g in unlone)’ i narket con—clitions at this time weutuld help in limiting inflatiomirv pressures by curbing inflationary expectations quickly.

Me, sri Built’,, and fln’t ut. ch,.st’nt e tI freuni tiui, action in slew i if indicatit,ns that a cyclical peak might be’ n iear at hand. Thus,lue’~’Lu,’ intel a ii ‘ss re’stmitt ftp po] it’>’ pti.st nure, e’speciai I> in s i esv of the dc’ laved impact on the’ ecu Inonny. In t lie present ttui—

curtain cmlvi roan ionL I hey bela—veil that in ant’ pri am ipt easinu t~in, mum t iocv nlarket cootli litiris. am’ ig ‘ii th a greater emphasis tinLhe behavior of tl nt louIi ctary aggregatc’s in gnu idi u ug the ciun dunet t,f t pi ‘nat onus, woiuki i.e tinnce the ri k of a con it liii n jig sh,urtfailinn nuor elary grtiss’t h ant] svoi dci Lend to p n’oviele iuc’i’chi’ei 51 ippo rt to the ceoi otiny later in the’ year.

Mr. Waflieh elisseoted from this action because’, in icsv euf tine ,‘trt,nig iniflat iuina,’v pre.s’i nt’s imi tlit’ t’c’OlloInny, he’ continence]to fai’or a more rest, ic’tive polic> posture. Belies imict that iunflatin miii) expe e.tatjon.s hat] increasetl jul recOunt months while inter—eat mate’s luae I ehau get I little’. he thumnngut t I tat ae!di t inn al Iliumung iii nuney mark-eL cmii idi tmits wea Id has,’ a favorable effect onsuch expectations amh would have little effect onu the’ course ml Cr’ah ouutpunt.Mr. Black ilis’eu ned train this act iti,u because i, ie’sv of tine rapit] ]ui’ n,ctarv grtisvtii 0i ree’i nt imutiuiths, he pi’e’ferreci to specifylouver ranges femr urosvtlm of Ml aix] \12 oucc tile’ Aurainst—Scp tt’iumi icr perinud in t,relrr to alert ase’ lIme- iireilialn lity tf holdinggrtiwth withiru tint C ‘olrnn dt teA lot lgc-r— ruin rain ge.s. Whn’ie he agreen I that ojn:tu niarkt‘I e ipera t m~In’s ,h iidel be e Iin’c’ctetl towardat t am uiu ‘g a sligiut inc ic ust’ in Ihi’ feW‘cal fit iris mate initially iii the ci ‘nung in tool it ‘eln Jig pc-nod, he belies e d tl tat tine cii Tee—t lie aelespte’ei by the Ct,mnunittee allowed feur teic rapid monetary gn uuwth before a funrtlier increase mu the fluids rate would betrigge red.

Xli’, Rice disseuittd frt,rn tinia actiou i luecause he belies en that an aelctit iennal firnning iii money uunarket ctjnelition,s aI I his I inieto rest ‘jet gn’t wI Ii of rrue)iut y anuel cit ‘dimt, inn the lace- of the’ e’s’iel to u cc’ e,f we’a ken om ,g ici I CS iuucinu ic’ ,teti situ’, woi u Id risk deepeumingthe recession. In his sic’s’. th,’ effort tut ha!auc’t’ the’ giual if retfiie’ing th rate ut infiatiuiu, with the’ ohjt’e’tis e’ ol uuuinunmxiulg theinnipaet t If the’ rece ‘ssitill caile’ct ft ‘r a pi u Ii C)’ cliiecU ci ttusvai’d tin,’ irn’,i iu it en ‘an, cc n if jire’s a ‘liii g non’ey nua rkel cci it lmtit ~ns Hi ilCSSgrosvih of hut’ monet arv aggregatt’a over the .\ugu.u.st—Septemhc r pn’riod appeared to he sit’ nstamitiaily faster or slower than timerates currently expected.

‘s ln’ssn ,, halk~,B luck, and C ‘ol thu’, il Lure ‘e’cl wit ii thi’ niaj turn ty that oj en’ Inan’kc’t opt’ rat ii anus slut stilt1 lie’ ti i re’c’teel toward at I “in‘iu u g

a slight iuiuease’ in the’ fedt’ral finntl, rate inuitialhs’ iu, the enirniung inte’nne’c’tiog period, lout tin’s ihus”en,tetl ticcauusc they be—lies’eil that. gist ii I lIt- e.’xce’s,is nun itt ar’s’ gross’tln inn me ‘ccitt uuno ,ths relative tti he Ciimi nit tee’ s lenu ge‘i—ruin u’au ‘ge’s, tint’ din cc’—ive’ ade mteel by tile’ flu niun it tee’ sv, ‘‘itt I a mi tuw fu u r te iii ram ad mci, ue’t ars’ gre lustii belt ire an ad d it it in nat h ,c’re’ase iii tine’ e ii,jec’t is e fcu

time’ In nud ‘ate’ we, mid be triggc-re’tl. ‘I’, erihan it e • the,’ prt i.’reits fur acIui,’~inn the Ciun iii n tiltce’s t ulijec’t ise n f jest raii ,irig “non ctar)griisv I h, tint‘v preferred, rmui“run er, tti pros idi- Ie’esvay for a risc’ in tlue’ ftuu uds rate ten aiu upper hanit eaf 1 2 percent.

1str. B ice’ cliasc’nt ed fr’ im tlui.s act on Imetal tsr h~b. ‘lie’s eel tim t an i a irlit mini aI iinil irig iii iou unit’> market nun it] it ie flu S svimu, It! in uteil—cit tiuc’ cit se ‘I cm~sinig ss’c’ak nuess in e ‘tunic iin Iic ae ti situ am ue I usas unlikely t ci affe ‘ct t he n’,ntt’ of in i ffathun las orabtv wit hi nu six to n iiuue’ouonths. fri his jiaclgnuue nut mnone’tans eruisvth meist likely would ‘loss’ in tint’ nuutuniths innue’eliate’l) ahead itemu if eurre.’i,t ilutilteynnam’k,-t t oi iri it let,., ss’e’re u nail it au its I, au it! gru nss’t ii of thit’ nile in set arv augn e eat c’s clue’ the “tar endinu g mu t he foinrt h ciuarter of979 p ri ihahhs’ weini in fall us it bin the Cia unnit tee’s long,’ r— remul rangi ‘s,

‘Ntessrs. Wailicli and \ViiIc’s dis,c’nutenl lromn tins actienui iue’cacusc’, with the’ C,uninnitti’e’s oluie’c’tis e’ of slnsviuiuz the rate’ of infia—in, n nu nil! iel. the>’ p rt’fe’cnn] Ieu s’ tim Iv In isser ange’ I, ir growth e if t lie’ oman’ e ‘tar’ angrcgat i’m. Xli. \Vm Ik’s Int’l ic’s ed that the’

u’ai ‘ge adopti’d tor ‘ii I , after all uiss’au ice’ ftir the c Ifeel, of A‘I’S a]itt a p issi bk Lu ‘1h~idoss u ‘isa me1 ~itilt in t I.e pinhi it’ thouma nit1

for uuu’ I,0~’.rt’l urcse’iutecf an i i’t’i’e’ase’ fn’u ueu i t he’ n’au ugi’s that luaei lu e ‘cmi at te it eel du urine I dJTh lit r, liS’ ‘illicIt time flu glut t I tat, after alle isv—auac’ for the c’~panusieio in rc’p’inchase agrc’enie’oIs anef Einrotiullars mu acielitiumu tim the’ uutlit’r forces aftec’Iing gr’isu’th tif Mi, thurai ign- at lopt ccl re-p.”t’si’ lu Icci too non tb ol a nu iuu i ‘cease freiui u the n au ge, set tail icr.1Mr ~VaUic’hdissented fronun tiuis action ht’cansc. with tine’ Ctinnniuittc’e’s nmhjectis’e eif slnwiiug the’ rile’ oi in,flatiunnu ill ununuef, liehe] ie’s’e if that tine’ rau ge’ at opted fu ir lii I aft e’ r nlltysvau tee’ fti r t but’ elfe ct s rut ‘\‘l’Sa id NOW acce iii nit s, is as Iou high, In hiscipinnion, greiwth of the auolue) stock, after alleiss’au,c’i for the’ t’uparusionu in) n’epurcllase agreemenits aeuel I im’odohlars as uveil asfui r the nfl, ‘ct s of Al’S ai el N O\A” aeon ‘us, had b~e’nu e’on u shIerably urn i rt’ rapid t hall lie] ie ati ‘if lus the I mehas Ic ir eif ~AI

these’ onc-vt’ar ranges. the first qumarte’r of onne >‘ear to the’ first quarter offlit’ mcxl, bill that iii tite’ secou nd qn i,tu’t er MI aetunalh’

This method of ectalulishinng omue’—\ eat’ nio,ne’tmirv iiicrt’asc’d at ann S perc-eint anuuual u’att’. The l”OMCgre mw’thm ranges n‘sill Ied in I uase’ dii It” and all e’ga— w’ciul ci c’stabi i sin a n it’s’ Ml gre iss tim ran u ge at th nc be—tiotis that tIne F( )NI( iru iplk’it lv tnn~uio\ ed a giu minug Ut the third qnmartt’r us hi cli us otild lue’ ii ieas—“forgivenness I in ‘Cl lilt” Ifl adoptin t g tlnc’ce ran ge’s. ‘1cm nere’d I tori i thtc’ sceon td quarter of time’ \‘ear to theilluslrate tini.s_ suppose’ that cit tire’ lie’ginnnnig of the’ st’e’tuitel quarter of tint’ follemss’mg \ear. lh using time’seceincl ejuartc’r time’ 10MG adoptc’el a On,e’—s’eau’ range’ second e1tnau’te’i’ s average’ it’s ci of NI I as the baseEar Ml growth of 4 to 6 percent Ion the period I runt from w’inic.’li tint’ nt’ss’ onut’—\ ear grow’tlu rates of Ml

5

FEDERAL RESERVE BANK OF ST. Louts

would be calculated, the level of Ml in the base pe-riod would “drift” from quarter to quarter. Further-more, since the FOMC frequently kept the samenumerical one-year ranges (e.g., keeping a 4 to 6percent range from second quarter to second quarter)despite deviations of Ml growth from that range inthe previous quarter, deviations of monetary growthfrom their original ranges were essentially ignoredor “forgiven.”

The Humphrey-Hawkins Act requires the FOMCto establish calendar-year growth ranges for monetaryand credit aggregates in February of each year. TheFOMC has chosen to establish these ranges from thefourth quarter of the previous year to the fourth quar-ter of the current year. The FOMC must review theseranges in mid-year, although it may reconsider theone-year ranges at any time.4 The Committee, how-ever, may not change the period to which the one-year ranges apply. Thus, the base period (the fourthquarter) remains the same.

By requiring the FOMC to establish calendar-yearmonetary growth ranges measured from an unchang-ing base, the Humphrey-Hawkins Act eliminates “basedrift” and the “forgiveness principle” within eachcalendar year. Nevertheless, these problems still canoccur from one year to the next because theHumphrey-Hawkins Act requires the FOMC toestablish new one-year ranges each calendar year.Thus, the FOMC would use the most recent fourthquarter average level of the monetary aggregate asthe base.

ATS and New York NOW Accounts

Financial innovations in 1978 presented the FOMCin 1979 with the difficult problem of assessing theirimpact on the growth of various measures of money.Starting November 1, 1978, commercial banks andmutual savings banks were permitted to offer indi-vidual customers an automatic transfer service (ATS)between savings and checking accounts. This serviceprovides for the transfer of funds from a savings ac-count to cover checks written against an individual’schecking account. Consequently, the new ATS savingsaccounts enable individuals to earn interest on fundsthat previously might have been held in their check-ing (demand deposit) accounts. Because of the in-

4At the time of the mid-year review of the one-year ranges,the FOMC also establishes tentative ranges for the monetaryaggregates for the next year — measured from the fourthquarter of the current year to the fourth quarter of the follow-ing year.

6

MARCH 1980

centive to earn interest on checkable bank balances,the Federal Reserve expected that many individualswould use ATS savings accounts as a substitute forholding balances in their checking accounts. Thus,during a transition period in which demand depositswere being transferred into ATS accounts, the growthof ATS balances (which were not included in Ml)was expected to reduce the growth of Ml (demanddeposits plus currency).5

A similar but smaller effect was expected to resultfrom the introduction of NOW accounts in New YorkState. NOWs can be used by individuals in the samemanner as checks to make transactions, but balancesin NOW accounts earn interest as do savings accountsand were not included in Ml,6 Upon congressionalapproval, NOW accounts were extended to New YorkState in November 1978; they had been introducedmuch earlier in the New England states. The growthof these accounts in New York also was expected toreduce Ml growth during a transition period.

Chairman C. William Miller outlined the effectof ATS accounts on the growth of Ml and the broadermonetary aggregates on July 28, 1978 when he an-nounced to Congress the one-year ranges establishedat the July 1978 FOMC meeting. He noted that, dur-ing the transition period in which bank customersadjust to ATS, Ml growth would be lowered whileM2 and M3 growth would be little affected,7

Although discussed at the July meeting, thescheduled introduction of ATS accounts in Novem-ber 1978 first affected the FOMC’s decision about theone-year monetary growth ranges at the October 17,1978 meeting. A majority of the Committee voted toretain the existing ranges for M2 and M3 for the pe-riod from third quarter 1978 to third quarter 1979(111/78 to 111/79)~ The Committee also indicatedthat it expected Ml growth to be within a range of 2to 6 percent during that period, “depending in parton the speed and extent of transfers from demand tosavings deposits resulting from the introduction ofATS”8 This expected range of Ml growth was bothlower and wider than the one adopted in July. The

7Chairmaa C, William Miller, “Statements” (August 1978),

p. 646.~“Record” (December 1978), p. 953.

5For a more detailed analysis of the effect of ATS on themoney supply process, see John A. Tatom and Richard W.Lang, “Automatic Transfers and the Money Supply Process,’this Review (February 1979), pp. 2-10.

6NOW balances at commercial banks were included in oldM2, while NOW balances at thrift institutions were includedin old M3,


FOMC, however, placed less emphasis on Ml thanon M2 and M3.9

When the one-year ranges were established at theFebruary 6, 1979 meeting under the requirementsof the Humphrey-Hawkins Act, the FOMC felt moreconfident about the magnitude of the effects of bothATS and New York NOW accounts on Ml growthand again gave equal emphasis to Ml growth. A staffanalysis indicated that the growth of ATS and NewYork NOW accounts would lower Ml growth over1979 by about 3 percentage points.’0 The FOMC usedthis estimate in formulating its range for Ml growthover the period from IV/78 to IV/79.

The FOMC’s discussion at the February meetingstressed that monetary growth ranges be chosen thatwere consistent with a reduction in the rate ofinflation.” The Committee decided at this meetingto lower the monetary growth ranges. The ranges alsowere widened to 3 percentage points, compared withtheir previous width of 2,5 percentage points)2 Thiswidening reflected, in part, “the special factors [ATSand New York NOW accountsj expected to influencemonetary growth and the uncertainties with respect tothe magnitude of their impact.”18 The M2 and M3ranges were lowered to 5 to 8 percent and 6 to 9 per-cent for the period IV/78 to IV/79, respectively, fromprevious ranges of 6.5 to 9 and 7.5 to 10 percent forthe period 111/78 to 111/79 (table 1). The FOMCadopted an Ml range of 1.5 to 4.5 percent from IV/78to IV/79 and noted that this “range allowed for thepossibility of a significant deceleration of growth fromthe pace of recent years” even after allowance for theestimated 3 percentage-point slowing in Ml growthdue to the effects of ATS and New York NOWaccounts.’4

Two Committee members, however, felt that the13 to 4.5 percent Ml range allowed for too rapidMl growth. In fact, they felt that this range repre-sented a higher, not a lower, range than the previouslyadopted Ml ranges.

Messrs. Wallich and Willes dissented from this

action because, with the Committee’s objective of9Chairman C. William Miller, “Statements” (November 1978),p. 846; and Lang, “The FOMC in 1978,’ p. 14.

10”Record” (April 1979), p. 330.

“Ibid.~ the case of Ml, recall that the 2 to 6 percent range from

111/78 to 111/79 was not typical of ranges in earlier periods,The Ml range in effect for most of 1978 was 4 to 6½percent.

~“Record” (April 1979), p. 331.

l4Ibid

slowing the rate of inflation in mind, they pre-ferred to specify lower ranges for growth of themonetary aggregates. Mr. Willes believed that therange adopted for Ml, after allowance for the effectsof ATS and a possible further downward shift in thepublic’s demand for money, represented an increasefrom the ranges that had been adopted during 1978.Mr. Wallich thought that, after allowance for theexpansion in repurchase agreements and Eurodollarsin addition to the other forces affecting growth ofMI, the range adopted represented too much of anincrease from the ranges set earlier.’5

To understand why the 1979 Ml range could beviewed as higher than previous ranges of growth, onemust consider what it would have been without theeffect of ATS and New York NOW accounts. TheFOMC used an estimate that growth of these accountswould lower Ml growth by 3 percentage points. Thismeans that 3 percentage points were subtracted fromthe lower and upper ends of an initial Ml range toobtain a lower limit of 1.5 percent and an upper limitof 4.5 percent. The initial range implicit in this calcu-lation is 4.5 to 7.5 percent. One can view this 4.5 to7.5 percent range as the Ml range that would haveprevailed if ATS and New York NOW accounts hadno effect at all on Ml growth. The upper end of thisrange represented almost the same rate of Ml growthas actually occurred in the previous two years — Mlincreased 7.9 percent from IV/76 to IV/77 and 7.2percent from IV/77 to IV/78.

Furthermore, this 4.5 to 7.5 percent range repre-sented an increase in the upper limit of the Ml rangecompared with those adopted in 1977 and 1978, whenthe upper limits were no higher than 6,5 percent. Ifthe FOMC had adjusted the Ml range that hadbeen in effect during most of 1978—4 to 6.5 percent’°— for the estimated 3-percentage-point effect of ATSand New York NOW account growth, the resultingMl range would have been 1 to 3.5 percent fromIV/78 to IV/79 instead of the 1.5 to 4.5 percent Mlrange actually adopted.

Mid’Year ReviewThe Humphrey-Hawkins Act required the FOMC

to transmit to Congress in July a review of its 1979monetary growth ranges as well as a preliminary in-dication of its ranges for 1980. At the July 11,1979 meeting, a staff analysis indicated that “shiftsin funds from demand deposits to savings accountswith automatic transfer services and to NOW ac-

‘~Ibid,,pp. 331-32.t6See footnote 12 and the earlier discussion of the Ml range

adopted at the October 17, 1978 meeting.

7

FEDERAL RESERVE BANK OF ST. LOUIS

counts had retarded the annual rate of growth of Mlby the assumed amount of about 3 percentage pointsin the first quarter of 1979 but by only about 1.5 per-centage points in the second quarter ‘~ Uncer-tainty about the further growth of ATS accounts wascompounded by an April federal court ruling thatbarred these accounts as of January 1, 1980, unlessCongress enacted legislation authorizing them.’8

At the July meeting, most Committee membersfavored ranges that reflected a continuation of thepolicy stance adopted in February.’9 The Committeedecided to retain the same ranges for 1979 that it hadadopted in February and tentatively indicated thatthese ranges also would be appropriate for 1980(table 1). Although the FOMC continued to use theestimate that the growth of ATS and New YorkNOW accounts would reduce Ml growth by about3 percentage points in 1979, it “also agreed that actualgrowth in Ml might vary in relation to its range tothe extent of any deviation from that [3 percentage-point] estimate.”2°In this regard the Committee notedthat monetary growth in 1980 “might be within thesame ranges” as in 1979, but that this was especiallytentative in light of the uncertain legislative andjudicial position of ATS and other interest-earningtransactions accounts 21

The Ml range for 1979 was indeed modified laterin the year. At the special meeting held on October6, 1979, the “Record of Policy Actions” noted thatthe recent growth of ATS and New York NOW ac-counts implied that their effect on Ml growth wassmaller than the original 3 percentage-point estimate.

It now appeared that expansion of such accountswould reduce measured growth of Ml over the yearby about 1.5 percentage points. After allowance forthe deviation from the earlier estimate, the equiv-alent range for Ml was 3 to 6 percent.

22

The revised 3 to 8 percent range for Ml growthfrom IV/78 to IV/79 (table 1) again translates intoan initial range of Ml growth of 4.5 to 7.5 percent(obtained by adding 1.5 percentage points to the

MARCH 1980

FOMC’s revised Ml range). In effect, the FOMC inOctober 1979 continued to use an estimate of the re-duction of Ml growth due to the growth of ATS andNew York NOW accounts to mark down the 1979 Mlrange from an initial range of 4.5 to 7.5 percent. Thislatter range was higher and wider than the Ml rangesadopted in 1978, and can be interpreted as the rangethat would have prevailed if the growth of ATS andNew York NOW accounts had no effect at all on Mlgrowth.

Actual Money Growth and theOne-Year Ranges

Crowth rates of the monetary aggregates were be-low their one-year ranges in the first quarter of theyear, but were above these ranges in the second andthird quarters. Thus, after falling below their rangesin the first quarter, the levels of the monetary aggre-gates were within their ranges by the end of the sec-ond quarter and were above or near the tops oftheir ranges by the end of the third quarter (charts1 and 2).

Rapid growth of Ml in the third quarter broughtthe level of Ml above the original 1.5 to 4.5 percentrange. After readjusting the Ml range for the lowerestimate of the effect of ATS and New York NOWaccounts, however, the level of Ml was near the topof the revised 3 to 6 percent range at the end of thethird quarter (chart 1). Nevertheless, it was clear tothe FOMC in early October that a continuation ofmonetary growth at third-quarter rates would result ingrowth rates for the year that would exceed the1979 ranges.~

The Committee’s desire to hold growth of themonetary aggregates within their 1979 ranges was theprincipal reason for the October 8 changes in short-run operating procedures.24 This shift in procedures,discussed below in detail, apparently succeeded inslowing growth of all the monetary aggregates in thefourth quarter. As a result, both Ml and M3 in 1979were kept within the FOMC’s adopted ranges ofgrowth, while M2 was slightly above the upper limitof its range. From IV/78 to IV/79, Ml increasedabout 5.5 percent, M2 about 8.3 percent, and M3about 8 percent.

It must be emphasized, however, that the 5.5 per-cent Ml growth in 1979 is not comparable to Ml

2~jbid p. 974.

24 Ibid.

17”Record” (September 1979), p. 752.

‘8Congress temporarily extended authorization of ATS ac-counts through March 1980 in order to allow mnre time toconsider permanent legislation.

19”Record” (September 1979), p. 753.

2OIbid,, p. 754.2tThe retention of the 1.5 to 4.5 percent range for Ml growth

again was cause for dissent by Covernor Wallich. He stillfelt that this range was too high given the Committee’sobjective of slowing inflation. (Mr. Willes was not a votingmember at this meeting.) Ibid.

22”Record” (December 1979), p. 973.

8


Chart 1Ml Range for Period IV/78 to IV/79

MI Range as Revised October 6, 1919Ratio Scale

Billions of Dollars390

1919 1980APE. MAY JUNE JULY AUG SEPt Oct NOV. DEC. JAN. PEE MAO. APR- MAY JUNE JULY AUG. SEPT. OCT. NOV. DEC. JAN PEE, MAE.

1918Note: Dato,,ed o,, ,,o,, ,flpod[o,t.do,dJ,eo,po,oteth,bettchmo~kod~e.tments~eEeo,’dbytheEoo,dofOOeerno,so,Jc,,,,ory~0~98O,

growth in previous years. For example, to compare Mlgrowth rates for 1979 and 1978, one must adjust the1979 growth rate by the estimated effect of ATS andNew York NOW accounts. Assuming that Ml growthin 1979 was reduced by 1.5 percentage points — thefigure used by the FOMC in October to adjust theMl range — one must add this amount to the 5.5percent rate of growth in 1979. This results in a 7percent growth rate, about the same as the 7.2 percentrate in 1978.

SHORT-RUN OPERATING PROCEDURESPrior to October 6, 1979, FOMC short-mn operat-

ing procedures were carried out as in the previousseveral years.25 At each meeting, the FOMC set anintermeeting range for the federal funds rate alongwith two-month tolerance ranges for Ml and M225

Lang, “The FOMC in 1978,” pp. 2-10. For an historical per-spective on the FOMC’s short-run operating procedures, seeHenry C. Wallich and Peter M. Keir, ‘The Role of OperatingCuides in U.S. Monetary Policy: A Historical Review,” Fed-eral Reserve Bulletin (September 1979), pp. 679-91.

Rollo Scale

9


Oorl 2Ranges for M2, M3, and Bank Credit for

Period IV/78 to IV/79

850

830Ratio Scot.

Bullets at Dotter,0720

0680

E5EEs ScaleBillion ‘B Dolt,,,

970

950

930

910

890

870

1640

1600

1560

1520

1140

1110

1080

~050

0020

990

960

930

0980APE. MAY JUNE JULY AUG. SEPT. OCT. NOV. DEC. JAN. PRO MAE. APR. MAY JUNE JULY AUG. SEPT OCT. NOV. SEC. JAN. PEE. MAE,

8978 1979Net,: DoMe,,4 ,,,t,,,,,,J]y,A’e.IS ott4Jt~e,pe,o’,,ht b’odYoo’kod}o.~’’’N”J’”,Jbptb’Ee’’detOe’.p”tJ’’’’’y 15,005.

8480

8440

8400Belie Scat.

Billions at Dotter,1170

growth (table 1 and charts 3 and 4). Within the fed-eral funds rate range, the Committee specified aninitial level of the funds rate that was thought to beconsistent with the short-mn ranges set for Ml andM2. The two-month ranges for Ml and M2, in turn,were intended to provide an indicator to determinewhen changes in the federal funds rate should bemade (subject to its own range). These short-runranges were specified over moving two-month periods.

For example, the FOMC at its February 6, 1979

meeting specified ranges for Ml and M2 growth overthe February-March period. At the March 20 meet-ing it then set new ranges for the March-April pe-riod (table 1). If the two-month growth rates of Mland M2 appeared to deviate from their respectiveranges — either from the midpoints of their rangesor from their upper or lower limits — the level of thefederal funds rate could be changed within its range,or the Committee could reconsider the range.2°20

For more details, see Lang, “The FOMC in 1978,” pp. 2-10.

Eatte Scot.Billion ,t Dollar,970

950

930

980

890

870

850

820ReEl. Scat.Elitist, at Dellor,1720

0680

8640

1600

5560

520

480

5440

1400Ratio Scat,Blttleo, nE Dotter,5170

5140

1180

8080

1050

8020

990

960

930

10


Prior to October 6, the domestic policy directivesfollowed the same general format as in 1978 withregard to short-run operating procedures. Less thanthree weeks after adopting such a directive atits September 18 meeting,27 this format was aban-doned when the FOMC instituted its new short-mnoperating procedures. The new procedures wereadopted at a special FOMC meeting called by Chair-man Volcker, “to consider actions that might betaken, in conjunction with actions being contemplatedby the Board of Governors, to improve control overthe expansion of money and bank credit in the lightof developing speculative excesses in financial andcommodity markets and additional evidence of stronginflationary forces in the economy.”28

Mter the September 18, 1979 meeting, incomingdata indicated that the economy was strongerthan had been expected, while both consumerand producer price indexes continued to recorddouble-digit increases. In the foreign exchange mar-kets, the dollar declined substantially despite largepurchases of dollars by the United States and by for-eign central banks. This decline was attributed to thecontinuing rapid U.S. inflation rate.2° Furthermore,speculation in gold markets had increased betweenAugust and October 1979 and had apparently spreadto other metal and commodity markets, as evidencedby a more than 50 percent increase in September in anindustrial commodity price index. This was attributedto “a general rise in inflationary expectations thattended to feed on themselves.”30 Against this back-ground (see Supplement, meeting of October 6, 1979),the Federal Reserve announced several policy actions— a 1 percentage-point increase in the discount rate,a new marginal reserve requirement on certainmanaged liabilities of member banks, and a change inthe FOMC’s short-run operating procedures.3’

The FOMC was especially concerned with the ex-pansion of both the monetary aggregates and bankcredit, which had been increasing at rapid rates afterthe first quarter of 1979 (charts 1 and 2). The issueof how to slow monetary growth to keep thc aggre-

2~”Record”(November 1979), pp. 912-13.25

”Record” (December 1979), p. 972.29

Covemor Henry C. Wallich, “Statements” (November 1979),p. 899.

TOlb idT1

For a more detailed description of the new marginal reserverequirements on managed liabilities, see “Annonncements:Monetary Policy Actions,” Federal Reserve Bulletin (October1979), pp. 830-32.

ChorE 3FOMC Short-Run Ranges for Monetary Aggregates

5979

018 ToIcroecE ROE000

o ~—-————————-————————~~—----—-—

P5R:YM ~Ufl APE’~A5~:JsN0 -e ~ ~Utl.’’h,O.!,b~:5::U7YPO,JCe,,5,J.+h,FOo[::o Ie,~~e.p.dC,d’eI,,,e,,oo._,o,

‘.1 So,:.’s’Y’]e,,o,~Y b,,e,po,dJ:,”,J,lYp,Y,d, ,‘:0.’th, Mle~JM2 ~,o,,,e,,,J:,dLs,h,FOoC.

‘15‘,T

gates within their 1979 ranges was the catalyst forthe change in the FOMC’s short-mn operatingprocedures.

The principal reason advanced for shifting to an

operating procedure aimed at controlling the supplyof hank reserves more directly was that it wouldprovide greater assurance that the Committee’s ob-jectives for monetary growth could be achieved.32

The Committee recognized that the relationship be-tween bank reserve and monetary growth wasnot precise; there was no guarantee that the shift inemphasis would be successful in reducing monetarygrowth over the last few months of 1979. The Com-mittee also recognized that this change in short-runprocedures could be accompanied initially by sub-stantial increases in interest rates and that movementsin interest rates would be more uncertain.33 Aftersome debate between members who favored thechange in short-mn operating procedures andthose who preferred continuing to direct open mar-ket operations toward controffing the level of thefederal funds rate, the Committee unanimously ap-proved a modification of the domestic policy direc-tive. Greater emphasis was placed on controlling the

T2”Record” (December 1979), p. 974~

~~Ibid., p. 976.

85

Percent Ml tElorioto RatIo, PercentI, : : 85

551’ I I /

it —‘— :80

// / / : // / , /

VI’ —

11


volume of bank reserves and less oncontrolling fluctuations in the federalfunds rate.34

Effect on the DomesticPolicy Directive

The wording of the domestic policydirective was altered substantially by theFOMC’s new operating procedures. Thedirective adopted at the October 6 meet-ing stated:

In the short run, the Committeeseeks to restrain expansion of reserveaggregates to a pace consistent withdeceleration in growth of Ml, M2, andM3 in the fourth quarter of 1979 torates that would hold growth of thesemonetary aggregates over the wholeperiod from the fourth quarter of 1978to the fourth quarter of 1979 withinthe Committee’s longer-run ranges, pro-vided that in the period before thenext regular meeting the weekly aver-age federal funds rate remains withina range of 11½to 15½percent. TheCommittee will consider the need forsupplementary instructions if it appearsthat operations to restrain expansionof reserve aggregates would maintain the federalfunds rate near the upper limit of its range.

35

This section of the directive — which deals with theFOMC’s short-mn objectives — was not specific aboutthe short-run growth rates of Ml and M2 that theFOMC desired to achieve. The “Record of Policy Ac-tions” of the October 6 meeting, however, was moreprecise.

Specifically, the Committee instructed the Managerto restrain expansion of bank reserves to a paceconsistent with growth from September to Decemberat an annual rate on the order of 4.5 percent in Mland about 7.5 percent in M2 and M3, provided thatin the period before the next regular meeting thefederal funds rate remained generally within a rangeof 11½to 15½percent. Because such rates ofexpansion would result in growth of the monetaryaggregates in the upper part of their ranges forthe year, the Committee also agreed that overthe three-month period somewhat slower growthwould be acceptable.3°

Wording almost identical to that in the October 6directive appeared in the directive adopted at the

~~Ibid., pp. 974-76.

~~Ibid., p. 977.~°Ibid.,pp. 975-76.

us

‘4

So

Chart 4FOMC Ranges for the Federal Funds Rote

‘tEa4 ‘Il5 ‘‘N,.

.11: A’’’’h’.’’i,a dl’i,aISTSlh,PSMC.rI,bIirh,d,le,MI,,th.Eade’Ife,d,,’t,.

86

‘4

I,

Ii

I’

tRot

November 20, 1979 meeting.37 Again, more specificshort-mn objectives for Ml and M2 growth werestated in the “Record” of that meeting (table 1).38At the January 8-9, 1980 meeting, however, specificshort-mn objectives for Ml and M2 growth were ex-plicitly incorporated into the domestic policy directive.

In the short run, the Committee seeks expansionof reserve aggregates consistent with growth overthe first quarter of 1980 at an annual rate between4 and 5 percent for Ml and on the order of 7 per-cent for M2, provided that in the period beforethe next regular meeting the weekly average federalfunds rate remains within a range of 11½to 15½percent.39

Although only three new domestic policy directiveshad been released by the time this article was writ-ten, a few observations can be made about theFOMC’s new operating procedures. First, theFOMC no longer targets on a specific levelof the federal funds rate as its short-mn operatingobjective. Second, the 4 percentage-point range ofthe federal funds rate that has been maintained inthe directive since October 6 is substantially larger

““Record” (January 1980), p. 46.T8Ibid., p. 45.

°°“Record’t(March 1980), p. 236.

Peat.et86

us

is

JAN

iii! jI I.:11 I li’1

jlj II :iiIjj ~:liii

12


than the one-half to three-quarter percentage-pointranges established previously (table 1). The absenceof a specific federal funds rate objective and thewider range have been evident in both inter-day andintra-day fluctuations of the federal funds rate, whichchanged radically after October 6.

In the FOMC’s new directives, desired growth ratesof Ml and M2 over two- or three-month periods areestablished in terms of specific rates of change, or, inthe case of the January 1980 directive, a 1 percentage-point range. In contrast, short-mn ranges of Ml andM2 growth typically were specified in terms of 3percentage-point ranges prior to October 6. Further-more, the short-mn Ml and M2 ranges previouslywere specified as “tolerance ranges” to be used by theManager of the System Open Market Account onlyas an indicator “for determining when changes in thefunds rate were appropriate 40 Under currentshort-mn operating procedures, however, the Manageris directed to achieve growth rates of bank reservesconsistent with specified growth rates of Ml and ?s12,provided that the federal funds rate remains within abroad range.

The Manager of the System Open Market Account,who is responsible for achieving the FOMC’s objec-tives, has had to change the focus of domestic openmarket operations from attaining specific levels of thefunds rate to maintaining growth of “reserve aggre-gates” consistent with specified rates of Ml and M2growth. These reserve aggregates, however, are notspecified in either the directive or the “Records ofPolicy Actions.” The FOMC votes on growth rates ofthe monetary aggregates, not the reserve aggregates.Consequently, it is left to the staffs of the Board ofGovernors and the New York Federal Reserve’s OpenMarket Desk to establish guidelines for the growthof these reserve aggregates.

Domestic Open Market Operationsand Reserve Targeting

Until recently, information was sketchy about theFederal Reserve’s new procedures for implementingmonetary policy. Although various Federal Reserveofficials had mentioned that the Open Market Deskwas tracking a “family” of reserve aggregates ratherthan a single aggregate, it was not clear which meas-ures were included in this “family” nor how the Deskrelated growth of these aggregates to the FOMC’smonetary growth objectives. A staff paper released bythe Board of Governors on January 31, 1980 clarified

~°“Record”(August 1978), p. 663.

these matters substantially.41 The staff paper outlinedthe new operating procedure in eight principal steps,highlights of which are presented in exhibit 1.

The process of translating the FOMC’s desiredrates of short-mn monetary growth into weekly tar-get levels of total reserves, monetary base, and non-borrowed reserves are described in steps 1 through4 of exhibit 1. Although the staff paper makes itclear that the “overall” objective of the Open Mar-ket Desk is to control the growth of total reserves(step 5, exhibit 1), it also makes clear that the im-mediate short-mn operating objective is to control thegrowth of nonborrowed reserves (step 6, exhibit 1).Thus, the Manager of the Desk directs the purchaseand sale of government securities in order to attainsome pattem of changes in (or path of) the level ofnonborrowed reserves between FOMC meetings. At-taining the desired path for nonborrowed reserveswill not necessarily yield the desired path for totalreserves, however, since the actual path of total re-serves also depends on the behavior of member bankborrowing at the discount window. For example, ifborrowings are larger than the level assumed in con-structing the path for nonborrowed reserves, thentotal reserves will be above the desired path eventhough nonborrowed reserves are on their desiredpath.

In the event that total reserves are above theDesk’s desired path, the staff paper indicates that cer-tain adjustments could be made to bring the growthof total reserves back to the desired path — either alowering of the nonborrowed reserve path or an in-crease in the discount rate (step 7, exhibit 1). Thefirst adjustment may be made by the staff of theBoard of Governors in conjunction with the Managerof the System Open Market Account. The secondadjustment, however, must be initiated by the Boardsof Directors of the district Federal Reserve Banks,subject to the approval of the Board of Governors,According to the staff paper, neither adjustmentwould be made until the growth of total reserveshad been overshooting the desired path for sometime,

The staff paper’s analysis of the effects of openmarket operations on reserve and money growth un-der the new operating procedures is essentially thesame as such analyses under the old procedures.According to this staff paper, control of nonborrowedreserves and the discount rate affect the growth of

4r’The New Federal Reserve Technical Procedures for Con-trolling Money,” Board of Governors of the Federal ReserveSystem, January 31, 1980.

13


Exhibit 1Excerpts from “The New Federal Reserve Technical Proceduresfor Controlling Money”

(1) The psoiic-v process first involves a deci~i’suh~-the Opel thud period !i.’tss (‘en jut-I imcs. To understandFOMC oiu list’ rate of inc-lease ii) moist-v it v, sb,-’. Lu, ho” this w’oosicl It itd It) t’isislroi of Iota] Ft srrves antiachieve 15500cc supply ~uopposethat the denu~wd for liueoiw\

rail strois~c-r than cs as h)ciioz lisrL’o’Ii’d — a’, it (1101 in(21 After th

1nbjet’Ust’ for nucoises’ siupplv (ZiO\vtiO c’ai’]~ Oc’toht’r of last \-ear. The isic-re-,t,s tI da’iisancl for

is set, reserve p’cths especIal to achieve studs gross lb 800hi’’\ ~‘~d also) for bank rescrvt-,~to srspporl 11w roouscvalt’ vs

8ab]ishc’d for a fLussilt of n-sc ne nli’asl in’>. Thesa’ wouiil Lii tho- first iroslaruct’ FIt’ acc-oitsparsic’d is’ naore

int’Lustlres t,tasist i S tttal ‘v-en (‘5. tlW 8 Ofliset.si’} b’tse iotelosivt’ t-Horts on the part of 1 anks to obtain(cssc,utiaiiv to!ai rest-n t,-~ io~nsenslser bank’. p

1ns c’r,r ri_sErvo’s is, tIut Iccierni 1usd’ rusarket. thereby hr usdiissr

rein y los t-irc-:sl.’I urois ) ,an’.! ,e~~busre.’ ‘d u’t’,er’ t ~. ltstab- In bid np th’ fedora1. liunds i’.stt’. and liv list ‘eased

hsisrnerit (81 list’ paths inv’As t. prssjcctmu how 1551.015 borrosslisg at the I’ederal Us-servo disefluht ~ i0d~W.iof th~targc Lcd iss’10c5 ~o-owth is likeis to Ida’ the As a oc’sntt cit list’ latter, total ri-sent’’ and the iliolse—form of i ui-c: Se’ . of cli 1)051(55 t i,nu oolen slit r iu:sbt sI— to’, l,zu se 55 mild Or si ‘a lsilr’ russ ‘,t order than I argel ‘.d,tior,s, and of clt’ptosits at nst-:sul’er instituitioits (takuo,g \Vhi-lhc’r tital resent’s It-nd to n-main ahose taraetaccount sf cliflt’ieistial rt’sevve I’t-qiuirt mints iS Si’s’ 001 ~ a~ susta~isc’d pc-nod ck-pt’otcls in part cois thederro,uscl dtpoosit.s altl ~ ~ ‘~‘‘ tic dcmosatsd as.

1‘~‘~ tSti ‘ure of tin’ bttk,’ in re~ervc rleutlLitd — — ‘a hi_’ther or

and sa~logs di’pnsit s’nuspsomsents of M2 ) . \Ioreover. sot it ‘“as Ir-ansitos’s-. foi esansple — and iii part emestimatt’s are snaule of reserves liktl~ to lie abssn bed the dc’tzree to svim Ii c’ssseruiiug ,utar~-I c’ronditio~ssliv c’xp.msIn!s in other bank lia’sditit s srshjc’ct tt) i’t’st’I SC relIcs-I no’ josdujet acljustoso-usts ois the part of batsksrc’ol’lii’c’ilsents. sun-It us Iso-ge (.I)s. at a pave that _8PI’aJ’S ‘‘usc] tin- pisbhc. ‘t’ito Sc respoissi-’. Os, the part of b’n,ks.c-orssisteist ‘a ith issomtn .sispph cshj.-c-t I s’es and also, takes far i’s:snsp]r’. could iisetridc- sales of ‘.ec-nritit to tist’account of tolt’tutl.olc a it.uogc’’. in loIn!,’ credit, , - ‘ p~1~k((iv ‘cbs c’.\tiisduUsin” deposits) anti chaotic-s[Elstirrsatc.’s -aie alss~made iof the amoiis,sL of excess i s bc ding policies.reserves hank sare Ii!, clv to hold.

(3) The projt’t’ti cl mis of t’urrent’\ also] dr’usaosd (7) Should total resc’o’s’t s hc’ shsoss iisg sustaineddeposits. gus i-is the rt’sei Sc’ i’c-qoust-susc’nts for do-posits slrt’m’gth. c’losc’r control ~ lIons could lit obtainedamscl banks’ t-’a’ss ]escl’scs. ‘, ic’ltls .155 t’stiot,itc’ of ti’ Isv Inn ‘nut’ the noosi son’~o~.-d rc sc-nt’ path (to atincrease los total 1’s-wives and thit’ snorsetso’s lo~,o-i_os 10-1551)1 to offset Ihc’ t-spansin:s in r:st’nshc-r hassk borsislc’ul nilis F’O\I( ‘ us,ouet,ov I,trgc ‘~, ‘liii- ,sss’~i’uu,fof ‘-~~‘ sw) arsd_/or in. i-.si,inuz the oli-,t-oosnst m’Lste. A o’isc’nnrohorrnwed leSt-fl (‘5 — — that i.s total rest’, vs Ic—s ii, the di.st-oso,r r.tte ~soti1d, for an’ dive-v supply ofrsseml ci b.usk boon on in~— is soblaissesl Iss iisititm’ no’sl001 u-us’. t-d it-servo-.’,, initiali’ tc’usd to raj,.,e nsarketass000msg a lCVcl of bsn-rcn~us’g scar ds.ot ‘~oio’~auiisa jut o’u’s’,t rate-s. thcsc-bv ‘a rorkissg hi) spec-ti op tist’ td~ui’.t—iii Use oss’’’,t mit-cut p’’n’icl... -- nicsst pi-oc-ess sot thc pd ‘lie and loassks and eslc’osui’auing

.5 (HOld’ P~rouispt nose back Ito the p~stis for lotal(-f) Initial paths c staislisioc’cl loi’ the fss:Isii\ cit ic rt’sc’n’c’s [us

1hit- msscsuuetarv last’. hun’,, nht-tlser adhost-

serse isst’asiii’c’s no’, say, ‘a 1—ii_t,iuth Pt r;nd arc’ then isseist” -use nsade its Il-i’ uussushsorriossc’d pulls —— list’ ouRtu’aussiati’d lists) rest’s “c It-s els (‘ta\ cr Usd shisurtti’ periods

1xtth tlsat c-ar] he i-oislu’nlk’d dir-otIs throusgh npc-us

belss ten niectings rssarket sipeu-atiosss — ar,d,’ui ii, thc discount sate’ uk’

— . . - - pc ads is part s,:s enst’i’gnsd ioc’has io- los bamsks’ aid the(.~) I otal rest’s’ c’s pros sd0

lIst’ basis br dt-r’nsstc . . -— ‘mlslie. nub -r ps’~’’

t’’1 c-i rc-usost auss 1’._ isooss-es em - both

arid ,hc-o’t’hs ore hose c-1,o,.t-is ida ed Ito the atsgi t-z.stvs ‘ ., I .

— —— . - - fist’ tsiisssssr col niaus’.u’t It ~ tO St list’ II, 050850’s’ alsothan ,o:uth,oo’rnn i-I i’ecc rye’.. I laos him! rrs’iiv~sr/ses ut sd Sc’ cr,’,tiaisd. ‘list] tbuc’ uh,htv too c-toil nol Isotal r’-s’’r’, c’s,-rnt //to jn’irse’opnl air’,lt or - Eu’s’ fn’/. s/Er’’. Ii,e.s c S or. ., . . -

~n tise shsoi t i-suit ss-ut f-un duo’.,’ ts-b’:.ss.s c liii, ts. sri’tosils J55J!s155°rS’O”c’tl sc-,es’ t’, arc- c~iuss-tt’. usssk-r esssst irs,

-‘ ‘ , sisflsis’osc-t-d by thc’ two—’’ eL l.~ helnet-is ls,,msk dc—too-cs,] giu opeus inaiki-t out-sn iou us, stos:gh il.’’, i ,,u0’n’ ‘

posits anti , equsu-i-d ,o-sc’u so’s sot’! md tilt-si’ du’po”:tsad~ustcd In I i’spoisss’ to c-oas .gec in I sa,sk uleus .,os;sl Iorn—sen vs odsialneti tIsl’ss’uiths hen-s-on usa at tisi’ ili’.c-o lostwindow. {i’:,oipha.si.s added,] ‘ C ‘~) Other iiltt’5iui( t’Ins~.Ldtui’.Iui,es5ts in he iuadc- to

the reserve paths a’ a fansit~’. I lt~-sr’ i’,a~’ sc’ sc (-cit16) because ns isbso:r.,ow’ed resc-0’’’c-s are issue t-hs’.el~ who-u, it bc’t’ouses c-lea;’ that is,’ nsrubtiplio’i 1eialitI’s.sliup

undt’s’ c-s’rsIo’oi of list’ ‘i’ —ti-i: utuo’i \la:i.i:i-r so op’s b,etss’c’c’ss wsen c- antI isls’ssc-s Is—I’. ‘ ,ts’ic’tl freons ‘‘ni eta—issarket spi’iatiooiss (tiseosughi ssHt’t’I I.’oLs:.tsLuii ausgi’ cot tiiosss, . . (.iseru list’ s,sIs,:.di~ laugs “eel’. Is-—weekor i or I sot ansi’ si the

0ut-

1‘flu 55’ 01 suns ens is soW t

1ai-:t Si> ]fut-tr,st is ass irs factors p H t’t lii ‘~ list’ i c’sc’s ye nssslt i~iii

affec’tii,g it-send’s. ‘,suc’h as ffcsat ) I-i- \~Onlsliususa’i\ des iat isois li’s,uss o’~pec’Iatisoss irs moist’ -‘liu’ec’tooss ‘air’ aau,

5at a :sossfsos—rosct cf rest-u s.c t.urgc’t (ss’nsoisalh_ ous.— pc’s susil set so’s i-si! ui’i-i, s ‘a sosslul in’ ma-edal dos’s’ it

at ui ted oi’ coperat I nj pit. pt e, ) 0 ‘IaI lit_I Issr’ Iii’ ‘a ould Is~’c-k it ul rat a ci lane’’ in (it sd isa’, 0 ito

14


total reserves and money by influencing the demandfor bank reserves and the demand for money (steps6 and 7, exhibit 1). Open market operations that re-duce nonborrowed reserves tend to increase inter-est rates, which (after a lag) reduce the demand formoney, thereby reducing the demand for bank re-serves used to support money. A rise in the discountrate tends to increase other market interest rates,which (after a lag) again reduce the demand formoney and the demand for bank reserves., Deviationsin the growth of total reserves or money from desiredrates are controlled, then, by inducing changes ininterest rates which affect the demands for moneyand bank reserves. This analysis of controlling money

growth is comparable to Board staff analyses of theFOMC’s pre-October 6 procedures for controllingmoney growth,

An example of this comparability appears in anarticle by Governor Wailich and Peter Keir whichappeared in the September 1979 Federal Reserve Bul-letin,42 Written before the introduction of reserve tar-geting, this article discussed control of the monetaryaggregates via interest rate changes under the oldoperating procedures. In particular, the authors ex-

plain the problems of correcting deviations of moneygrowth from desired rates in terms of the pre-October

6 procedures~

When incoming data show a sudden marked ac-celeration or slowing in money growth rates, theCommittee must decide whether the change is atemporary aberration likely soon to be reversed,or a more fundamental change in money demandsthat stems from a basic adjustment in the perform-ance of the economy, If the Committee acted im-mediately to counter an observed change in moneygrowth, and the change then proved to be temporary,the action could be destabilizing and require a sub-sequent offsetting adjustment. Since Committeeaetion.s affect the public’s willingness to hold moneywith a log through their influence on interest rates,such attempts at fine tuning could produce perverseresults, [Emphasis added,]

To minimize this risk, the FOMC typically hasadopted an intermediate position.43

Thus, the overall framework for analyzing the effectsof open market operations on reserve and moneygrowth — that open market operations change inter-est rates, which affect the demand for money, therebyinfluencing the demand for bank reserves used tosupport money—has not changed. What has changedunder the new operating procedures is the FOMC’s42Wailich and Keir, “The Role of Operating Guides in US.

Monetary Policy,” pp. 679-91.srlbud, p. 688.

emphasis on restricting interest rate fluctuations and,consequently, the Desk’s ability to respond to devia-tions of money growth from its desired path.

The interest rate constraints placed on the Deskunder the old procedures are described by Wallichand Keir:

When the performance of the money supply ap-pears to be deviating from the Committee’s statedtwo-month ranges, the Manager of the System Ac-count is still constrained in his efforts to offset thesedeviations by a federal funds rate proviso He caninitiate countering open market purchases or salesonly so long as these operations, or other marketfactors, do not push the weekly average federal fundsrate outside its specified range, generally 50 to 100basis points wide. If growth rates for Ml and M2

appear to be remaining outside the Committee’sdesired ranges, and the Manager’s actions to counterthis deviation have moved the funds rate to theupper or lower limit of its range, he must requestnew instructions from the Committee.44

Prior to October 6, the Committee generally was un-willing to allow large movements of the federal fundsrate that would have been sufficient to achieve de-sired rates of monetary growth within relatively shortperiods of time. (Recall that the FOMC’s two-monthranges of Ml and M2 growth were not themselvestreated as short-run targets, but as indicators for de-termining when to change the federal funds rate.)

Confronted with an unexpected overshoot or under-shoot of its money growth targets, the Committeehas taken action that neither fully ignores nor fullyresponds to the miss, until the underlying growthtendency can be differentiated from the “noise” ofaberrations in the data. This approach poses somerisk that needed countercyclical policy actions willbe less timely than desired, But the Committee be-lieves that the accentuated volatility in short-term in-terest rates likely to result from efforts at instanta-neous fine tuning of the aggregates poses a greaterrisk.4°

Like the old procedures, the new procedures alsodo not attempt to “fine tune” the short-run growth ofthe monetary aggregates. As pointed out in the staffpaper (exhibit 1), neither deviations of reserve growthnor deviations of money growth from their desiredpaths will necessarily be responded to immediately.Adjustments of the nonborrowed reserve path or thediscount rate would occur only after overshooting orundershooting of the desired paths persisted. Whatis different about the new procedures is that the Deskno longer operates under as restrictive a federal fundsrate constraint. The range for the federal funds rate

“ibud., p. 686.~ p. 688.

15


I

has been widened to 400 basis points — comparedwith the typical pre-October 6 range of 50 to 100 basispoints — and the FOMC no longer specifies a targetlevel of the funds rate (table l).46 Consequently, theDesk has greater flexibility in offsetting deviations ofreserve and money growth from their desired paths.

In effect, these new procedures allow the Managerof the System Open Market Account to stabilizegrowth of nonborrowed reserves within narrowerlimits. The old procedures, in contrast, forced theManager to keep the federal funds rate within nar-row limits, which resulted in wider fluctuations inthe growth of non-borrowed reserves.

The Desk’s implementation of the FOMC’s policydirectives prior to October 6 were described in 1977by the Manager of the System Open Market Accountas short-mn accommodation of the public’s demandfor money.

The FOMC’s instructions to the Manager of theSystem Open Market Account regarding the manage-ment of bank reserves provide — to a considerableextent — for the accommodation of the public’s de-mand for money in the short run, while at the sametime prescribing a response when growth of moneyappears inconsistent with the Committee’s long-termobjectives.47

For example, upward pressure on the federal fundsrate was viewed as reflecting an increase in the de-mand for money. The Desk “accommodated” this in-creased demand by supplying bank reserves to keepthe funds rate constant. If the old short-run operat-ing procedures could be described as “accommoda-tive,” the current procedures — under which the Deskattempts to stay on some growth path of bank re-serves — can be described as “less accommodative” ofchanges in the demand for money.

THE YEAR AHEAD

The major changes in the implementation of mone-tary policy in 1979 will continue to influence mone-tary policy actions in 1980. Chairman Voicker, as

46h fact, on March 7, 1980, the FOMC widened the fundsrate range to 650 basis poh~s— 11½to 18 percent. See,“Record of Policy Actions,” Federal Reserve Press Release(March 21, 1980), p. 16; forthcoming in the Federal Re-serve Bulletin (April 1980).

4~”TheImplementation of Monetary Policy in 1976,” FederalReserve Bulletin (April 1977), p. 326, This article wasadapted from a report submitted to the FOMC by Alan H.Holmes and Peter D. Stern!ight, Manager and Deputy Man-ager of the System Open Market Account, respectively. JohnS. Hill and Christopher J. McCurdy were primarily respon-sible for its preparation.

16

quired by the Humphrey-Hawkins Act, announcednew one-year ranges for monetary growth on Febru-asy 20, 1980, for the period from IV/79 to IV/80.These new ranges were formulated in terms of therecently redefined monetary aggregates — M1A, M1B,new M2, and new

The M1A definition of the money stock is the sameas old Ml except that it excludes demand depositsheld by foreign commercial banks and official institu-tions. The M1B definition includes M1A plus othercheckable deposits.4° These deposits include NOWand ATS accounts, credit union share drafts, and de-mand deposits at thrift institutions,

The construction of MlB as an alternative to M1Awas an attempt to avoid the problem of interpretingold Ml growth when financial innovations such asATS and New York NOW accounts occurred. Thedifference in growth between M1B and M1A is in-dicative of the problems the FOMC faced in evaluat-ing old Mi growth in 1979 relative to previous years.From IV/78 to IV/79, M1A increased 5.5 percent—the same as old Ml — which represented a reductionin growth from its 7,4 percent increase in the previousyear.5°In contrast, M1B increased in 1979 at aboutthe same rate as in the previous year — 8 percentfrom IV/78 to IV/79 compared with 8.2 percentfrom IV/77 to IV/78. The difference in growth be-tween M1A and M1B reflected the growth of NewYork NOW accounts and nationwide ATS accounts,for which the FOMC in 1979 attempted to adjustwhen adopting a one-year range of growth for oldMi.51 As this article went to press, Congress approvedproposed legislation to allow nationwide use of NOWaccounts. This could cause M1A and M1B again togrow at substantially different rates over a transitionperiod. The possibility of nationwide NOW accountswas the primary reason that the Board of Governorsadopted these two measures of Mi.52

The redefinition of the monetary aggregates alsoalters the FOMC’s choice of short-run operating tar-

45”Monetary Policy Report to Congress,” Federal Reserve Bul-letin (March 1980), pp. 177-78; and “The Redefined Mone-tary Aggregates,” Federal Reserve Bulletin (February 1980),pp.97-114.

49For a detailed description of all the new monetary aggregatesand their relationship to the old measures, see “The Rede-fined Monetary Aggregates;” or R, W. Hater, “The NewMonetary Aggregates,” this Review (February 1980), pp.25-32.

~°OldMl growth in 1978 was also about the same as M 1Agrowth —7.2 percent from P//77 to IV/78,

S1”The Redefined Monetary Aggregates,” p. 102.

S2Ibid,, p. 100.

FEDERAL RESERVE BANK OF ST. LOUIS

gets in 1980. Because data on M1A and M1B areavailable weekly, while data on new M2 and M3 areavailable only monthly, the FOMC’s short-run rangesof monetary growth are being specified in terms ofMM and M1B.59 Consequently, the Desk must nowformulate intermeeting paths of total and nonbor-rowed reserves consistent with the FOMC’s short-mnranges of M1A and M1B growth.

The introduction of reserve targeting in 1979 marks

53”Record of Policy Actions of the FOMC: Meeting Held onFebruary 5, 1980,” Federal Reserve Press Release (March21, 1980), p. 14, forthcoming in the Federal Reserve Bulle-tin (April 1980).

This supplement consists of selected excerpts fromthe “Record of Policy Actions” for each of the FOMCmeetings in 1979, Each “Record” includes analyses ofcurrent and projected economic developments, discus-sions of current policy actions, and long- and short-run operating instructions issued by the FOMC to theTrading Desk. The complete text of each “Record ofPolicy Actions” appears in issues of the Federal Re-serve Bulletin and “Records” for the entire year arepublished in the Annual Report of the Board ofGovernors.

Meeting Held on February 8, 1979By late December, staff projections suggested that

growth in M2 over the December-January periodwould be at an annual rate well below the lower limitof the range of tolerance specified for that aggregateand growth in Ml would be in the lower portion of itsrange of tolerance.

These developments pointed to a reduction in the ob-jective for the federal funds rate toward the 9% percentlower limit of the specified range. However, on December29 the Committee voted to modify its directive by callingfor open market operations directed at maintaining theweekly average federal funds rate at about 10 percent orslightly above, This action was taken in view of uncer-tainties surrounding the interpretation of the behavior ofthe monetary aggregates and in light of domestic economicconditions and developments in domestic and interna-tional financial markets. On January 12 the Committeeheld a telephone conference to review the situation and

MARCH 1980

the beginning of a different approach to the imple-mentation of monetary policy. The effectiveness of thenew short-run operating procedures in controllingmonetary growth, and these procedures’ effects (orside-effects) on the economy, can be evaluated ade-

quately only over a longer period of time. Growth ofthe monetary aggregates decelerated between Octoberand January of this year, in line with the FOMC’s ob-jectives. Nevertheless, analysts undoubtedly will give

greater weight to monetary growth in 1980 — relativeto the FOMC’s new one-year ranges — in evaluatingthe effectiveness of the new operating procedures.

to consider whether supplementaryneeded, but no change was made inthe Manager.

Most market interest rates declined on balance duringthe interrneeting period. Factors apparently contributingto this development included a market sentiment thatfurther tightening in monetary policy had become lesslikely in light of the behavior of the monetary aggregatesand the better performance of the dollar in foreign ex-change markets. Another influence appeared to be the re-cent modest growth of total business credit demands.

With respect to the economic situation and outlook,most members of the committee expressed little or no dis-agreement with the staff projection of a marked slowingin the expansion by the second quarter of 1979 and of asustained slow rate of growth over the rest of the yearaccompanied by some increase in the rate of unemploy-ment, However, a few members questioned whether avery slow pace of growth was sustainable and suggestedthat the onset of a recession before the end of the year,with a larger increase in the unemployment rate, was themore likely development. Other members thought thatover the past few months the probabilities of the develop-ment of a recession before the end of this year had de-clined somewhat, It was also observed that expansionmight prove to be stronger than projected by the staff,especially if businessmen believed that effective steps werebeing taken to moderate the rate of inflation.

The members continued to anticipate a relatively rapidrise in average prices. Inflation was viewed as a distortionthat could contribute to the development of a recession,and it was noted that forecasters typically had underesti-mated the strength of inflationary forces. In this connec-

17

Supplement: FOMC Discussions in 1979

instructions werethe instruction to


lion, it was observed that the economy was operating ata higher rate in relation to its potential than had beenthought earlier.

In the Committee’s discussion, stress was placed onthe importance of adopting [one-year] ranges for mone-tary growth over the year ahead that would be consistentwith a reduction in the rate of inflation, thereby reinforc-ing the governmental actions over recent months in pur-suit of that objective.

In the discussion of policy for the period immediatelyahead, most members of the Committee favored directingoperations initially toward maintaining the money marketconditions currently prevailing, as indicated by a federalfunds rate of 10 percent or slightly higher, but some senti-ment was expressed for a slight additional firming inmoney market conditions. The views of the members dif-fered primarily with respect to the influence that theincoming evidence concerning growth of the monetaryaggregates should have on the objective for the funds ratelater in the period before the next meeting.

Meeting Held on March 20, 1979In January and February growth of total credit at U.S.

commercial banks accelerated considerably from its re-duced pace during late 1978. Expansion in business loanswas unusually strong, and banks also added substantiallyto their holdings of securities.

Ml declined in both January and February, M2changed little, and M3 grew at a relatively slow rate. Withinterest rates remaining high, the behavior of all threemonetary aggregates was affected by unusually large shiftsof funds from deposits to money market mutual funds andother liquid assets. The weakness in Ml also reflected theeffects of continuing movements of funds from demanddeposits to savings deposits associated with the recentlyauthorized automatic transfer service (ATS) and negoti-able orders of withdrawal (NOW) accounts in New YorkState.

At the beginning of March, projections suggested thatover the February-March period Ml would grow at a ratemoderately below the lower limit of the range establishedby the Committee and M2 would grow at a rate justbelow the lower limit of its range. In a special telephonemeeting on March 2, the Committee instructed the Man-ager to continue aiming for a weekly average federal fundsrate of 10 percent or slighfly higher.

Most market interest rates rose moderately on balanceduring the intenneeting period, after having declined inJanuary.

In the Committee’s discussion of the current economicsituation, attention was drawn to the more rapid expan-sion in output of goods and services in the fourth quarterof 1978 than had been anticipated. The Commerce De-partment had just released a second upward revision inits estimate of growth in real gross national product inthat quarter, and it was observed that the rate of resourceutilization therefore was higher than had been thoughtearlier, accounting in part for the recent intensification ofupward pressures on prices.

At the same time, it was noted, developments since theturn of the year were apparently mixed, contributing toincreased uncertainty.

Many members of the Committee thought that the staffwas overly optimistic in projecting continued, if sluggish,growth in real CNP throughout the second half of 1979;they believed that the chances of a recession beginningbefore the end of the year or in early 1980 were fairlyhigh. The recent increase in the price of oil, the accelera-tion of the overall rise in prices, and the sluggish growthof the monetary aggregates over the latest five monthswere cited among the factors that increased the probabil-ity of a recession. The observation also was made that ifa recession developed, it was likely to be moderate andshort-lived.

The members expressed some differences of opinion con-cerning prospects for prices. A significant easing fromthe rapid rise of recent months was suggested, to the ex-tent that recent increases in prices represented temporaryfactors or were made in anticipation of possible priceand wage controls. Moreover, slackening of economic ac-tivity later in the year could be expected to slow the risein prices generally. The view was also expressed, how-ever, that inflation would remain rapid even during arecession. In any case, it was observed, a long lag couldbe expected in the response of prices to the additionalmeasures of restraint imposed toward the end of 1978.

In contemplating policy for the period immediatelyahead, the Committee continued to face unusual uncer-tainties concerning the forces affecting monetary growth.A staff analysis had suggested that Ml was likely to ex-pand in March, contributing to a pickup in growth ofM2. Nevertheless, Ml was expected to register a declinein the first quarter, on a quarterly average basis. It wasestimated that shifts of funds from demand deposits tosavings accounts with automatic transfer services and tothe NOW accounts in New York had depressed growth ofMl by about 3 percentage points in the quarter. Moreover,it appeared that growth of both Ml and M2 had beenaffected by a downward shift in the public’s demand formoney in relation to income, although the magnitude ofthat effect was uncertain.

In the Committee’s discussion, several members stressedtheir concern about the shortfall in monetary growth rela-tive to the longer-mn ranges that the Committee hadadopted at its meeting on February 6, 1979, especiallyin view of the risks that a recession might develop in theperiod ahead. Supporting the goal of bringing growth ofthe monetary aggregates up into those ranges over a num-ber of months, particularly because of the uncertaintyabout the outlook for economic activity, they favored di-recting operations in the period just after the meetingtoward maintaining the money market conditions currentlyprevailing — as indicated by a federal funds rate of 10percent or slightly higher — or toward a little less finn-ness in those conditions. The objective of operations laterin the period before the next regular meeting of theCommittee would be determined on the basis of the in-coming evidence on the behavior of the monetary aggre-gates, although it \vas suggested that the Committee con-sult again before any change was made in the operational

objective for the funds rate.

18


Other members of the Committee emphasized the re-cent acceleration 0f the rise in prices, and they believedthat action should be taken to demonstrate that inflationrepresented the greatest risk to economic stability over aperiod of time. Accordingly, they advocated directing ini-tial operations in the period ahead toward a slight finningin money market conditions, represented by an increasein the objective for the federal funds rate to about 10¼percent. Their prescription for operations later in the pe-riod called for holding the objective for the funds ratewithin a relatively narrow range.

The Manager was instructed to direct open market opera-lions initially toward maintaining the federal funds rateat about the current level, represented by a rate of about10 percent or slightly higher.

Meeting Held on April 17, 1979

Total credit at U.S. commercial banks expanded at amuch slower pace in March than in January and February,as growth in real estate and business loans moderatedconsiderably and banks reduced their holdings of securi-ties. However, commercial paper issued by nonfinancialfirms increased sharply, and the overall rate 0f short-termbusiness borrowing was maintained. For the first quarteras a whole, nonfinancial businesses substantially increasedtheir borrowing in short- and intermediate-term markets.At the same time, they reduced their public offerings ofbonds to the smallest quarterly total since 1973.

The narrowly defined money supply, Ml, grew some-what in March after having declined in both January andFebruary. The broader monetary aggregates, M2 and M3,expanded at relatively slow rates during the month, al-though growth in both measures picked up somewhat fromthe pace earlier in the year.

In late March and early April staff projections suggestedthat over the March-April period Ml would grow at arate close to the lower limit of the range established bythe Committee and M2 at a rate just below the midpointof its range. These projections were not viewed as suffi-ciently weak in relation to the Committee’s ranges to callfor a change in the federal funds rate objective of 10percent or slightly higher.

Short-term interest rates fluctuated over a fairly widerange during the intermeeting period and generally rosea little on balance.

In the Committee’s discussion of the current economicsituation and outlook, attention \vas drawn to the indica-tions of considerably slosver growth in real output of goodsand services in the first quarter of 1979 than had appearedlikely earlier. It was noted that residential constructionand consumer spending for goods had weakened morethan had been anticipated, and that such expansion ashad occurred in the first quarter apparently reflecteda substantial acceleration in the growth of businessinventories.

The members in general anticipated relatively slowgrowth in economic activity for the near term, and somebelieved that growth could remain at a sluggish pace formany quarters. Many continued to believe that the proba-bilities of a downturn in activity before the end of 1979

were fairly high, especially in view of the unusually longduration of the current business expansion- It was also sug-gested by some that a pickup in activity, based in part ona surge in business demands for equipment and for inven-tories, might occur and persist for a time before an even-tual downturn.

As at other recent meetings, great concern was expressedabout inflation. It was observed that the rate of increase inprices had tended to accelerate from year to year recentlyand that there were few if any indications of a near-termreversal in that momentum.

In contemplating policy for the period immediatelyahead, the Committee continued to face uncertainties con-cerning the forces affecting monetary growth. A staffanalysis had suggested that Ml, after having registereda decline in the first quarter, would expand over theApril-May period, reflecting in part rapid growth in nom-inal GNP. It was anticipated that shifts of funds fromdemand deposits to savings accounts with automatic trans-fer services and to NOW accounts in New York State

would have a somewhat less dampening effecton growth of Ml in the period immediately aheadthan in the first quarter. Moreover, it was assumedthat the public’s demand for money in relationto income would continue to shift downward, but ata sharply slower pace than in recent months. Thus, therise in the income velocity of Ml was expected to berelatively rapid, but less than the unusually rapid rate ofthe two most recent calendar quarters.

In the Committee’s discussion at this meeting, as at themeeting on March 20, 1979, several members stressedtheir concern about the degree of the shortfall in mone-tary growth relative to the longer-run ranges that the Com-mittee had adopted at its meeting on February 6. It wasobserved that restrictive policy actions taken in late 1978had contributed to the recent slowing of monetary growth(after allowance for the impact of special factors) andapparently also to a moderation of the expansion in eco-nomic activity. Now, some easing in money market condi-tions might be appropriate, with the objective of raisinggrowth of the monetary aggregates over a number ofmonths into the longer-run ranges and of helping to sup-port economic activity later in the year.

However, an easing in money market conditions wasgenerally regarded as premature in the current environ-ment of rapidly rising prices, although it was felt thatnsonetary policy could bave little if any immediate effecton prices of food, energy, and housing items, which hadbeen largely responsible for the recent acceleration of theoverall rise, Given the staff expectation of a near-termstrengthening of monetary growth, most members advo-cated or found acceptable a policy of directing operationsearly in the period immediately ahead toward maintainingthe money market conditions currently prevailing .

and of having the objective for operations laterin the period before the next regular meeting determinedon the basis of incoming evidence on rates of growth of themonetary aggregates over the April-May period in relationto the growth rates currently anticipated.

A few members advocated an immediate increase in the

19


objective for the federal funds rate to 10¾percent or10½percent and a range for subsequent operations provid-ing for a further increase in the funds rate if incomingevidence suggested relative strength in growth of the mon-eta~yaggregates. They stressed the recent acceleration inthe rise in prices and high rates of resource use, and theycontinued to believe that action should be taken to dem-onstrate that inflation represented the greatest risk to eco-nomic stability over a period of thne, In their view, in-flationary expectations had increased over recent monthswhile interest rates on balance had changed little. In thecurrent circumstances, moreover, they attached little sig-nificance to the behavior 0f the monetary aggregates.

Meeting Held on May 22, 1979Total credit outstanding at U.S. commercial banks grew

rapidly in April, as it had on balance during the firstquarter of the year. The April growth was lead by a re-bound in expansion of business loans, which had slack-ened in March from rapid rates in January and February.Commercial paper issued by nonfinancial firms increasedsharply in April for the second consecutive month.

The narrowly defined money supply, Ml, expandedsharply in April, after having declined on the average inthe first quarter. A substantial part of the April increasewas attributable to delays in the Treasury’s processing ofchecks in payment of federal income taxes and to bunch-ing of tax refunds, Reflecting in part the behavior of Ml,growth of M2 and M3 accelerated to rapid rates in Aprilfrom relatively slow rates in the first quarter.

In late April projections suggested that over the April-May period Ml and M2 would grow at rates that wereclose to or above the upper limits of their respectiveranges. In accordance with the directive issued at themeeting on April 17, operations were directed toward anincrease in the federal funds rate to a level of about 10¼percent. Subsequently, in early May, the two-month ratesof growth projected for Ml and M2 ‘vere somewhatstronger. However, financial markets appeared to be in asensitive state, and recent developments affecting suppliesand distribution of energy were adding to uncertaintiesabout economic prospects. Moreover, it appeared that therapid pace of monetary growth was attributable in part totransitory forces. In the circumstances, and in view of thedirective’s instruction to give due regard to developingconditions in domestic financial markets, the objective forthe federal funds rate was maintained at 10¼percent.

Short-term interest rates in general changed little onbalance during the intermeeting period.

In the Committee’s discussion of the economic situa-tion and outlook, the members in general agreed that thepace of expansion in economic activity had slowed signifi-cantly, apart from the effects of severe weather in the firstquarter and of the work stoppage in the trucking industryearly in the current quarter. . . . A number of membersnow thought that a cyclical peak in activity might well beregistered in the current quarter.

Despite the current risks of recession in activity, theslowing of the expansion from the excessively rapid pacein late 1978 was regarded as a desirable development, in

view of the inflationary pressures that had been accumu-lating. It was noted that some reduction in growth ofnominal CNP had been an objective of the restrictive pol-icy actions taken last autumn, although the reduction hadso far been reflected in growth of real CNP rather than inthe rate of inflation.

Members continued to express great concern about in-flation. , . . According to a number of economic projec-tions, moreover, deceleration of inflation would be a slowand lengthy process. The observation was made that ifthe rate 0f inflation was not sharply reduced in the monthsimmediately ahead, renewed expansion in business activ-ity would begin with prices rising at a relatively fast pace.

In contemplating policy for the period immediatelyahead, the Committee took note of a staff analysis sug-gesting that over the May-June period growth of Mlwould be quite slow, in part because of the unwinding ofthe transitory effects of federal income tax payments andrefunds that had contributed to its exceptionally rapidgrowth in April. It was expected that growth of M2 overthe two-month period would be retarded by the slowgrowth of Ml but that growth of the interest-bearing com-ponent would remain relatively strong.

Most members of the Committee believed that, despiteincreasing signs of weakening in economic activity andthe risks of recession, a general easing in monetary re-straint at this time would be premature in view of thecontinuance of strong inflationary pressures. Given the staffexpectations of slow growth in Ml and M2 over the May-June period, they favored a policy of directing open mar-ket operations early in the period immediately ahead to-ward maintaining the money market conditions currentlyprevailing . . . and of having the objective for operationslater in the period before the next meeting determined onthe basis of incoming evidence on the behavior of themonetary aggregates in relation to that currently antici-pated. In view of uncertainties concerning interpretationof credit conditions and monetary growth in the currentenvironment, they also favored specifying unusually wideranges for growth of Ml and M2 over the May-Juneperiod and giving greater weight than usual to moneymarket conditions in the conduct of operations until thenext meeting.

Subsequent to the meeting, on June 15, incoming dataindicated that Ml and M2 were growing at exceptionallyrapid rates in early June, and projections suggested thatfor the May-June period both monetary aggregates wouldgrow at annual rates above the tipper limits of the rangesthat had been specified by the Committee, . . . However,in vie\v of many indications of weakening in economicactivity, the difficulties 0f interpreting the behavior of theaggregates in the light of these circumstances, the condi-tion of financial markets, and the general uncertainty aboutthe economic outlook, Chairman Miller recommended thatthe Manager be instructed to continue to aim for a federalfunds rate of about 10¼percent.

Meeting Held on July 11, 1979Total credit outstanding at U.S. commercial banks con-

tinued to expand rapidly in May and June, but the rate

20


of growth for the two months combined was down some-what from the average pace in earlier months of theyear. Increases in bank loans during May and June wereconcentrated in the business and real estate categories.Commercial paper issued by nonfinancial firms rose con-siderably further over the two months.

The narrowly defined money supply, Ml, increasedsharply in June and the broader measures of money, M2and M3, also grew rapidly..

Federal funds traded somewhat above the Committee’sobjective in late June and early July, in response to pres-sures associated with unusual churning in the money mar-ket around the midyear bank statement date and theJuly 4 holiday.

Most interest rates other than the federal funds ratefell substantially on balance during the intermeeting pe-riod. The declines appeared to be in response to the grow-ing evidence that economic activity had been weakening.

With respect to the economic situation and outlook, nomember of the Committee expressed disagreement withthe staff appraisal that real gross national product had de-clined somewhat in the second quarter and that furtherdeclines were likely for the remaining two quarters of theyear. The suggestion was made that the recession wasmost likely to be mild and short-lived. However, it couldprove to be more severe than currently expected becausethe recent increases in prices of energy items and inflationgenerally were reducing disposable income and erodingthe financial position of the household sector.

Another reason advanced for thinking that the recessioncould be more severe was the possibility that the down-turn in economic activity would become widespreadamong industrial countries.

Members continued to express great concern about in-flation. It was suggested that the unexpectedly large in-creases in OPEC oil prices in late June had seriouslyharmed the government’s anti-inflation efforts. Thus, wind-ing down the rate of increase in prices might well takeconsiderably longer than had been thought earlier andwould be more costly in terms of its impact on output,employment, and real income.

In the discussion of policy for the period immediatelyahead, members of the Committee in general favored di-recting open market operations initially toward maintain-ing the money market conditions currently prevailingon the expectation that over the July-August period growthof Ml and M2 would be both moderate and consistentwith their longer-run ranges. Some sentiment was ex-pressed for a near-term reduction in the federal fundsrate because of the downturn in economic activity, but itwas agreed that current conditions in foreign exchangemarkets militated against a prompt reduction.

About a week after the meeting, on July 19, projectionssuggested that over the July-August period Ml wouldgrow at an annual rate moderately above the upper limitof the range of 2½to 6½percent that had been specifiedby the Committee and that M2 would grow at a rate aboutequal to the upper limit of its range of 6¼to 10½per-

cent; in those circumstances, the Manager began to aimfor a weekly average federal funds rate at about the 10½percent upper limit of its range. On July 27, with the pro-jections suggesting that growth of both Ml and M2 overthe July-August period would exceed the upper limits oftheir ranges and with the objective for the federal fundsrate at the upper limit of its range, the Committee votedto modify the directive adopted at the meeting on July11. Specifically, the Committee raised the upper limit ofthe intermeeting range for the federal funds rate to 10¾percent and instructed the Manager to aim for a ratewithin a range of 10¼to 1Q¾percent, depending on sub-sequent behavior of the monetary aggregates, on conditionsin foreign exchange markets, and on the current Treasuryfinancing.

Meeting Held on August 14, 1979

Expansion of total credit outstanding at U.S. commercialbanks, which had picked up in June, moderated in Julyto about the April-May pace. Growth in loans also mod-erated in July after an acceleration in June. Banks con-tinued to add sizable amounts to their holdings of securi-ties, especially U.S. government obligations. Growth incommercial paper issued by nonfinancial firms exceededthe strong second-quarter pace, owing in part to large salesby foreign issuers.

The monetary aggregates — Ml, M2, and M3 — con-tinued to expand rapidly in July.

In the Committee’s discussion of the economic situationand outlook, none of the members expressed disagreementwith the staff appraisal that real gross national productwas continuing to decline in the current quarter. How-ever, members expressed considerable uncertainty aboutthe duration and extent of the decline in activity.

Members continued to express great concern about in-flation. It was observed that for a long period elementsin the economic situation had seemed to justify expecta-tions of a reduction in the rise in prices. Such expectationshad been disappointed. Moreover, little reduction couldbe expected in the short run because recent increases inenergy prices had not yet fully worked through the pricestructure. It was noted that the decline in the rate ofinflation projected for the quarters immediately ahead wassmall, and much smaller than that associated with the pre-vious recession. Thus, inflation might still be at a high ratewhen economic activity turned up again. Inflationary ex-pectations appeared to have worsened in the sense that,more than ever before, consumers and businessmen seemedto take the inflationary environment into account in mak-ing spending and investing decisions.

In considering policy for the period immediately ahead,Committee members focused on the problems posed byemerging recession and its potential for substantial in-creases in unemployment, concurrent with strong mone-tary growth, high actual and expected rates of inflation,and an exposed position of the dollar in foreign exchangemarkets pending anticipated improvement in the U.S. for-eign trade and current accounts.

There was little disagreement with the proposition that

21


for the near term modest measures should be taken todirect policy toward slowing growth 0f the monetary ag-gregates. Control of monetary growth was regarded asessential to restore expectations of a decline in the rateof inflation over a period of time.

In support of modest measures directed toward restraint,it was suggested that monetary policy recently had notbeen so restrictive as it might have appeared. Monetarygrowth since the beginning of the year had been con-siderably greater than that indicated by Ml, owing torapid expansion in close substitutes for demand depositsand currency. In addition, the increase in interest rateshad been less than that in expected rates of inflation.

On the other hand, it was noted that interest rates wereclose to historic highs. Some doubt was expressed, more-over, that further restraint could have a significant effecton inflation, particularly in view of the role of energy inthe rapid rate of increase in prices recently. In the faceof clear evidence of weakening in economic activity, itwas observed, the need to balance the objective of con-taining the recession with the goal of moderating infla-tion called for a steady policy for the time being.

In considering policy specifications for the period im-mediately ahead, the Committee took note of a staff analy-sis suggesting that the current growth rate of nominalGNP and other influences, including possibly a temporaryaccumulation of precautionary balances by the public inresponse to unusual uncertainties, were tending to sup-port the demand for money. On the assumption of con-tinuance of prevailing money market conditions, therefore,growth of both Ml and M2 over the August-Septemberperiod most likely would be high relative to the Com-mittee’s longer-run ranges, although growth could be ex-pected to slow substantially from the rapid rates of recentmonths.

At the conclusion of its discussion of policy, the Com-mittee decided to instruct the Manager for Domestic op-erations to direct open market operations initially towardan increase in the weekly average federal funds rate toabout 11 percent.

Subsequent to the meeting, in late August, incomingdata indicated that Ml and M2 were growing at rapidrates in August. On August 30, projections for the August-September period suggested that growth of Ml would beat an annual rate well above the upper limit of the rangethat had been specified by the Committee and that growthof M2 would be at about the tipper limit of its range.Over the preceding week, the Manager for Domestic, op-erations had been aiming for a weekly average federalfunds rate approaching the 11¾percent upper limit of itsspecified range, and in the statement week ending August29, the rate averaged 11.16 percent. In these circum-stances, Chairman Volcker recommended that the tipperlimit of the range for the funds i-ate be raised to 11½percent, but with the understanding that not all of theadditional leeway would be used immediately; use of theleeway ‘vould depend on subsequent behavior of themonetary aggregates and on developments in foreign ex-change markets, The Committee voted to amend thedomestic policy directive in accordance with the Chair-man’s recommendation.

Meeting Held on September 18, 1979

Total credit outstanding at U.S. commercial banks grewmore slowly in August than in most earlier months of theyear. Banks’ holdings of Treasury obligations declinedand growth in their total loans moderated. However, busi-ness loans continued to expand rapidly in August andcommercial paper issued by nonfinancial firms again in-creased sharply.

The monetary aggregates — Ml, M2, and MS — con-tinued to expand at relatively rapid rates in August andearly September, although somewhat less rapidly than inJune and July.

Short-term interest rates rose substantially during theintermeeting period, in response to strong business de-mands for credit as well as to the System’s actions firmingmoney market conditions and to expectations of furthermonetary restraint. Bond yields also increased somewhat.

In the Committee’s discussion of the economic situationand outlook, none of the members expressed disagreementwith the staff appraisal of some further contraction inreal gross national product after the current quarter’s in-terruption of the decline. However, members continuedto express uncertainty about the duration and extent ofthe contraction in activity.

Members continued to express great concern about therapid rise in prices. It was observed that inflation wasmore persistent now than it had been in earlier periods ofsome ‘weakening in demands and that there was still atendency to underestimate its strength. Furthermore, thecurrent and foreseeable rate of inflation could itself leadto additional shocks to the economy.

In contemplating policy for the period immediatelyahead, Committee members took note of a staff analysissuggesting that growth of Ml \vas likely to taper off dur-ing the September-October period in response to thelagged effects of the substantial increase in interest ratesduring the summer and the prospective weakening of ex-pansion in nominal GNP. However, growth over the twomonths would still be relatively high.

Members who favored policy measures directed towardsome additional firming in money market conditionsstressed the importance of achieving a significant reduc-tion in the pace of monetary expansion over the monthsahead. Such a reduction \vas necessary if growth over theyear ending in the fourth quarter of 1979 was to be heldwell within the longer-run ranges that had been reaffinnedby the Committee in July. Additional measures to restrainmonetary growth, moreover, would tend to lower expectedrates of inilation and, consequently, would have a con-structive influence on a range of decisions affecting pricesand wages as well as the value of the dollar in foreignexchange markets.

It was suggested, in addition, that monetary policy hadnot been as restrictive as it might have appeared. Despitethe level of interest rates, credit demands and credit ex-pansion remained strong. Interest rates after allowance forexpected rates of inflation \vere not high. Furthennore,monetary growth this year had been greater than indicated

22


by Ml alone, owing to rapid expansion in close substi-tutes for demand deposits and currency.

In support of a policy directed toward maintenance forthe lime being of prevailing money market conditions,members emphasized the substantial rise in interest ratesover the past two months and the tendency of changes inrates to affect monetary growth and economic activity onlyafter a considerable lag. In this connection, it was ob-served that growth of demand deposits had slowed mark-edly in July and August, while expansion of Ml had beensupported by an unexplained pickup in growth of cur-rency in circulation. Growth of the monetary aggregateswas likely to taper off in coming months, and additionalfirming in money market conditions might slow growth toan unwanted degree. In the current circumstances, theCommittee should avoid policy actions that might inten-sify the developing weakness in economic activity.

At the conclusion of its discussion of policy, the Com-mittee decided to instruct the Manager for Domestic Op-erations to direct open market operations initially towarda slight increase in the weekly average federal funds rateto about 11¼percent.

Meeting Held on October 8, 1979This meeting of the Committee was called by the Chair-

man to consider actions that might be taken, in conjunc-tion with actions being contemplated by the Board ofGovernors, to improve control over the expansion of moneyand bank credit in the light of developing speculative ex-cesses in financial and commodity markets and additionalevidence of strong inflationary forces in the economy.Special attention was given to the conduct of open mar-ket operations in order to contain growth in the monetaryaggregates within the ranges previously adopted by theCommittee for the \-ear ending in the fourth quarter of1979.

The information available at the time of the meetingsuggested somewhat stronger economic activity in the thirdquarter than had been indicated at the time of the Com-mittee’s meeting on September 18, and real output ofgoods and services was estimated to have recovered a sig-nificant part of the second-quarter decline. According tostaff projections, however, a decline in activity in thefourth quarter still appeared probable. Prices on the aver-age were continuing to rise somewhat more rapidly thananticipated earlier, in part because of additional large in-creases in energy items and renewed upward pressures onfoods. Moreover, developments in spot and futures mar-kets for a number of commodities were indicative of anintensification of speculative activity and of the possibilityof a further surge in prices.

In foreign exchange markets the weighted average valueof the dollar against major foreign currencies had de-clined substantially since the Committee’s meeting in mid-September, and monetary autborities had purchased, net,a large amount of dollars.

Interest rates had remained under considerable upwardpressure since mid-September, and most yields had risento new highs for the year.

The monetary aggregates — Ml and M2 — continued

to expand at rapid rates in September, and growth in bankcredit appeared to have accelerated appreciably from itspace in the prior two months.

In the Committee’s discussion of policy for the periodimmediately ahead, the members agreed that the currentsituation called for additional measures to restrain growthof the monetary aggregates over the months ahead. Themembers felt that growth of the aggregates at rates withinthe ranges previously established for 1979 remained areasonable and feasible objective in the light of the avail-able information and the business outlook, Given that ob-jective, most members strongly supported a shift in theconduct of open market operations to an approach placingemphasis on supplying the volume of bank reserves esti-mated to be consistent with the desired rates of growthin monetary aggregates, while permitting much greaterfluctuations in the federal funds rate than heretofore, Afew members, while urging strong action to restrain mon-etary growth, expressed some preference for continuingto direct daily open market operations toward maintenanceof levels of the federal funds rate and other short-term in-terest rates that appeared to be consistent with the Com-mittee’s objectives for growth in the monetary aggregates.The advantages and disadvantages of the different ap-proaches were discussed.

The principal reason advanced for shifting to an operat-ing procedure aimed at controlling the supply of bankreserves more directly was that it would provide greaterassurance that the Committee’s objectives for monetarygrowth could be achieved. In the present enviromnent ofrapid inflation, estimates of the relationship among interestrates, monetary growth, and economic activity had becomeless reliable than before, and monetary growth since thefirst quarter of 1979 had exceeded the rates expected de-spite substantial increases in short-term interest rates.Committee members recognized that for a number of rea-sons the relationship between growth of various reservemeasures and growth of the monetary aggregates was notprecise; thus the shift in emphasis to controlling reservesimproved prospects for achievement of the Committee’sobjectives for monetary growth over the next few monthsbut did not assure it.

Committee members suggested that the shift in operat-ing techniques, along with the other actions being con-templated by the Board of Governors, would tend toincrease confidcnce at home and abroad in the System’s de-termination to achieve its objectives for monetary growthand to avoid further deterioration in the inflationary out-look, Partly because it would increase uncertainty aboutthe near-term course of interest rates, the new operatingtechnique should induce banks to exercise greater cautionin extending credit and might dampen speculative beha-vior by increasing its risks and costs. Altogether, theSystem’s action would tend to moderate inflationary ex-pectations, thereby exerting a constructive influence overtime on decisions affecting wages and prices in domesticmarkets and on the value of the dollar in foreign ex-change markets.

The observation was made that the new emphasis inopen market operations might be accompanied by largerincreases in interest rates in the immediate future than

23

I~ALRESERVIANKOFST LOUIS MARCH 1980

would otherwise occur. On the other hand, the emphasison reserves also could be expected to produce a shifttoward easier conditions in money markets more promptlywhenever the demand for money and credit abated sig-nificantly in response to a weakening in economic activity.The point was made that an easing in money market con-ditions under circumstances in which growth of monetaryaggregates was restrained, economic activity was weak-ening, and the rise in prices was moderating should notadversely affect inflationary expectations and the value ofthe dollar in foreign exchange markets.

At the conclusion of the discussion and after full consid-eration of the advantages and disadvantages of alternativecourses of action, the Committee agreed that in the con-duct of open market operations over the remainder of1979 the Manager for Domestic Operations should placeprimary emphasis on restraining expansion of bank re-serves in pursuit of the Committee’s objective of decel-erating growth of Ml, M2, and MS to rates that wouldhold growth of these monetary aggregates over the yearfrom the fourth quarter of 1978 to the fourth quarter of1979 within the Committee’s ranges for that period.

Subsequently, on October 22, 1979, the Committee helda telephone conference to review the situation and to con-sider whether supplementary instructions to the Managerwere needed. Since October 6, expansion of total reserveshad exceeded the pace consistent with the Committee’sobjective for growth of the monetary aggregates duringthe fourth quarter. At the same time, the federal fundsrate had begun fluctuating close to the upper limit of the11½to 15½percent range established by the Committee.It was recognized that the desired restraint in the expan-sion of total reserves might involve continued pressure onmoney market conditions, including higher levels of mem-ber bank borrowings from the Federal Reserve than hadbeen anticipated, as banks made orderly adjustments thatwould in time slow monetary growth. It was not clear,however, that retention of the 15½percent upper limit 0fthe range for the federal funds rate would be inconsistentwith the desired restraint on monetary growth. Moreover,unsettled conditions in financial markets also suggested nochange in the upper limit of the range for the federalfunds rate. Consequently, no change was proposed inthe domestic policy directive issued at the meeting onOctober 6.

Meeting Held on November 20, 1979Over the first half of October, measures of bank reserves

in general grew faster than had been anticipated at thetime of the meeting on October 6, both because demandsfor reserves were unexpectedly strong and because Systemoperations provided more reserves than had been expected.Subsequently, System operations were directed more firmlyat restraining growth of reserves. As such operations lim-ited growth of nonborrowed reserves while demands forreserves remained strong, member bank borrowings roseto a daily average of about $3 billion in the last twostatement weeks of October and the federal funds raterose to an average a little above 15½percent in the finalweek. In the first half of November, demands for reserveseased, and member bank borrowings subsided to a daily

average of about $2 billion and the federal funds ratedeclined to an average of about 13¼percent.

Growth of MI, which had accelerated in Septemberand had been exceptionally rapid in the third quarter asa whole, slowed to an annual rate of 2¼percent in Oc-tober. Growth of M2 slowed less than that of Ml, to arate of about 8¼percent in October, as overall expan-sion in the interest-bearing components remained strong.A marked rise of net flows into money market certificatesand other time deposits at commercial banks, fostered bysubstantially higher deposit yields, offset a sharp reductionin savings deposits.

Growth in loans and investments at commercial banksmoderated appreciably in October,

Since early October interest rates had risen sharply inboth short- and long-term markets and had been unusuallyvolatile.

In foreign exchange markets the downward pressure onthe dollar that had developed in September was reversedin early October, and by the end of the month, the trade-‘veighted value of the dollar against major foreign cur-rencies had risen about 3½percent. Around mid-Novem-ber, however, the dollar came under renewed downwardpressure and lost a portion of its October gain, in partreflecting developments relating to Iran.

In the Committee’s discussion of the economic situationand outlook, the members in general agreed with the staffappraisal that the unexpectedly strong rebound in realgross national product in the third quarter would be fol-lowed by some contraction in activity and by a rise inunemployment, although uncertainty was expressed aboutthe depth and duration of the anticipated downturn aswell as about its precise timing. Some members cited theonset of the heating season with energy prices so muchhigher than a year earlier, the overall rate of inflation,the recent sharp rise in interest rates, and the developingstringency in some financial markets as influences thatmight cause the contraction to be relatively severe.

Continuation of the rapid rise in prices of goods andservices remained a major concern of Committee mem-bers, some of whom thought that the risks were on theside of a rise greater than that currently anticipated. Theprospects for supplies and prices of oil, which would havea substantial effect on the economy, were regarded as es-pecially uncertain, in view of the political situation in Iranand of the meeting of petroleum-exporting countries sched-uled to begin on December 17.

In contemplating policy for the period immediatelyahead, the Committee took note of a staff analysis indi-cating that the behavior of the monetary aggregates sinceSeptember had been reasonably consistent with the policyadopted on October 6 . .

In the Committee’s discussion of policy for the periodimmediately ahead, the members indicated that in thepresent circumstances pursuit of the goal of restraininggrowth of the monetary aggregates from the fourth quar-ter of 1978 to the fourth quarter of 1979 within theranges previously established for that period remainedfeasible and desirable; they agreed that in pursuit of that

24


underlying goal, the broad objectives for monetary growthduring the current quarter adopted at the meeting on Oc-tober 6 were still appropriate. In contemplating objectivesfor rates of monetary growth over the weeks through theend of 1979 and into January 1980, the members differedsomewhat in their views concerning the extent to whichoperations should be directed toward promoting accelera-tion in growth of MI from the recently reduced rates. Afew members favored operations consistent with the Oc-tober 6 decision to seek a 4¼percent annual rate ofgrowth in Ml over the September-December period. Afew members favored acceptance of a significantly slowerrate of growth for the quarter. Most members, however,advocated a compromise between those two prescriptions.It was recognized that, while the decision affecting such ashort period would have quite minor implications for mon-etary growth over the year ending in the fourth quarter of1979, it would affect credit and money market conditionsin the weeks ahead and the path of monetary growth en-tering the new year.

Views with respect to an acceptable range of fluctua-tion for the federal funds rate did not vary greatly. It wasagreed that the range should continue to be relativelywide, and most members indicated a preference for re-taining the range of 11½to 15½percent adopted at theOctober 6 meeting.

Meeting Held on January 8-9, 1980Over the first four weeks after the November meeting,

both total and nonborrowed reserves grew at about therates projected at the time of the meeting. Member bankborrowings averaged about $1% billion, compared withan average of slightly less than $2 billion in the preced-ing three weeks, and the federal funds rate continued toaverage around 13½percent. Toward the end of the four-week period, however, the demand for reserves appearedto be easing relative to the path consistent with desiredmonetary growth. In the three weeks remaining before thismeeting, member bank borrowings declined to a dailyaverage of about $1.1 billion. Despite the decline in bor-rowings, the federal funds rate edged up to an average ofabout 14 percent in late December and early January, atleast in part because of exceptionally large demands forexcess reserves around the year-end holidays.

Expansion in the major monetary aggregates remainedat a reduced pace in November and December, after hav-ing slowed markedly in October.

Growth in total loans and investments at commercialbanks slowed sharply in the fourth quarter. Slower expan-sion was especially pronounced in business loans. Growthin real estate loans remained close to the pace in the firstthree quarters of the year.

Since the November meeting of the Committee, interestrates had fluctuated over a relatively wide range, although

they had been somewhat less volatile than in the previousintermeeting period. On balance, most interest rates haddeclined.

Staff projections suggested that growth of nominal grossnational product would slow considerably in the currentquarter and then pick up gradually over the remainderof 1980. The projections suggested, however, that a con-traction in real GNP would develop in the current quarterand would continue later in the year, although at a di-minishing pace in the second half, and that the rate ofunemployment would increase substantially. The rise inaverage prices was projected to accelerate slightly duringthe early part of 1980, mainly because of increases inenergy costs, but to subside later.

In the Committee’s consideration of the economic out-look, several members stressed the elements of uncertaintyin the current situation. The observation was made that therelationships of the past appeared to provide less guidancethan usual in appraising the current situation and outlook.In the later part of 1979, for example, overall activity hadbeen unexpectedly strong and the widely anticipated re-cession had not developed, although automobile produc-tion and housing starts had declined. In the judgment ofa number of members, a downturn now seemed to begetting under way, but there was also recognition that itcould be delayed for another quarter or two.

Inflation remained a major concern. In part because ofearlier increases in oil prices and in mortgage interestrates, the consumer price indexes to be published in thenext few months probably would continue to show excep-tionally large advances.

In the discussion of policy for the near term, the mem-bers in general considered rates of monetary growth forthe three months from December to March within theframework of some reduction in ranges for growth overthe whole of 1980 from those for 1979 in pursuit of theCommittee’s objective of reducing the rate of inflation.The Committee also took note of a staff analysis indi-cating that the demand for money could be relativelyweak in the first quarter of 1980, if growth of nominalGNP did in fact slow sharply, and could strengthen asthe year progressed.

Differences in views concerning the particular rates ofmonetary growth to be specified for the period from De-cember to March were not great. Preferences were ex-pressed for growth indexed by expansion in Ml at an an-nual rate of 4 percent, a rate of 5 percent, and somethingbetween the two.

With respect to the acceptable range of fluctuation forthe federal funds rate, almost all members preferred toretain the range of 11½to 15½percent, originally adoptedat the meeting on October 6, 1979, and continued at themeeting on November 20. One member suggested raisingthe range slightly, to 12 to 16 percent.

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the fomc in 1979: introducing reserve targeting · house concurrent resolution 133 that the board...

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