INIONETARY policy in 1975 was directed at aidingeconomic recovery from the most severe recession inthe post-World War II years without rekindling thefires of inflation. As in recent years, the Federal OpenMarket Committee pursued short-run objectives ofmonetary policy formulated in terms of both an in-terest rate and money growth rate targets.’ Thesedual objectives were pursued through open marketoperations — that is, the buying and selling of U. S.Government and Federal agency securities and

bankers’ acceptances.2

As 1975 began, the prospects for a renewal in eco-

nomic growth were dim. The year 1974 had closedwith economic activity plummeting, unemploymenthigh, and prices increasing at a double-digit rate.Faced with this situation Congress gave particularattention to the formulation of monetary policy as atool of economic recovery. Congressional interest re-sulted in passage of a Concurrent Resolution, whichcalled for the adoption and public disclosure of long-run target growth ranges for monetary aggregates bythe FOMC. In addition, Congress called for the initia-tion of quarterly consultations on monetary policy be-tween Congressional Committees and the Board ofGovernors of the Federal Reserve System.

Monetary developments during 1975 occurred amidother significant economic developments. The econ-omy continued to adjust to shocks experienced in1973 and 1974. These shocks included the sharp risein the cost of energy, crop failures, price controls, and

1Thronghout this article the Federal Open Market Committee

will be referred to as either the “Committee” or the “FOMC”.

2The other tools of monetary policy are not controlled by theFOMC. Reserve requirements are set by the Board of Gov-ernors of the Federal Reserve System. Discount rates areestablished by the Boards of Directors of the twelve regionalFederal Reserve Banks.

Page 8

the implementation of environmental, safety. and con-sumer protection programs.~ Congress approved taxcuts and rebates along with special Social Security

payments designed to revive the lagging economy. Inaddition, Treasury operations to finance the resultant$80 billion deficit svere expected to have a stimulativeimpact on the economy.

This review of monetary policy in 1975 begins witha consideration of various approaches to monetarypolicy that were put forward as appropriate for deal-ing with economic conditions in early 1975, The short-run implementation of monetary policy by the FOMC\sith respect to both its stated policy goals and itsoperating targets will be reviewed next. Finally, amajor constraint on monetary policy actions will bediscussed.

MONETARY POLICY PRESCRIPTIONS

The appropriate course for monetary policy in 1975was widely discussed. Most economists seemed toconcur that monetary restraint in late 1974 had beenexcessive and, in part, responsible for the deepeningof the recession. For example, Paul Samuelsoncharged that “if we do go into a depression, the Fedwill justly bear much of the blame,”~Milton Fried-man declared that “From June 1974 to January 1975,M, has grown at the average rate of 1.1% per year.This has surely contributed to the recent deepeningof recession.”5

3See Norman N, Bowsher, “1975 — Year of Economic Turn-

around,” this Review (January 1976), pp. 2-8.4

Paul A. Samuelson, “A Bums Depression?” Newsweek,March 3, 1975, p. 63.

5U. S. Congress, Senate, Committee on Banking, Housing andUrban Affairs, Monetary Policy Oversight, 94th Cong., 1stseis., February 25 and 26, 1975, p. 59.

The FOMC in 1975: Announcing Monetary TargetsNANCY JL&NAICOPLOS

FEDERAL RESERVE BANK OF ST. Loins MARCH 1976

Prescriptions for monetary policy in 1975 were farranging, but can be broadly divided into three ap-proaches. One school of thought holds that steady,moderate, monetary growth was the appropriate pol-icy. Milton Friedman expressed this long-held viewbefore the Senate Banking Committee: “I believe thatwe need stability in monetary growth, not wide fluc-tuations from one side to the other. . . . For M~,3% to5%, or even the broader 2% to 6% earlier specifiedby the Joint Economic Committee is about right.”6 Hefurther stated that the Federal Reserve could notachieve steady growth of the money stock “if it insistson operating as it now does by controlling an interestrate such as the Federal Funds rate.” Arthur Burns,chairman of the FOMC, explicitly rejected thisapproach:

There is a school of thought that holds that theFederal Reserve need pay no attention to interestrates, that the only thing that matters is how this orthat monetary aggregate is behaving. We at the Fed-eral Reserve cannot afford the luxury of any suchmechanical rule. As the Nation’s central bank, wehave a vital role to play as the lender of last resort.It is our duty to avert liquidity or banking crises. Itis our duty to protect the integrity of both the do-mestic value of the dollar and its foreign-exchangevalue. In discharging these functions, we at timesiseed to set aside temporarily our objectives withregard to the monetary aggregates.

In particular, we pay close attention to interestrates because of their profound effects on the work-ings of the economy.8

Other analysts of monetary policy focused attentionexclusively on interest rates. Franco Modigliani, pro-fessor of economics at the Massachusetts Institute ofTechnology, recommended this course before theJoint Economic Committee in February:

I think the mistakes of last year came from the factthat the Fed was looking at the money supply in-stead of looking at what really bites the economy.No one, no one except a few fools perhaps on WallStreet are directly affected by the money supply,but people do pay higher interest rates, people dohave to pay higher mortgage rates, and that is svheremonetary policy bites, not through the change of themoney supply.°

A third policy approach supported a rapid expan-sion of the money stock to stimulate economic recov-

6lbid., pp. 59-60.

‘Ibid., p. 60.~“5tatements to Congress,” Federal Reserve Bulletin (Feb-ruary 1975), p. 64.

°U. S. Congress, Joint Economic Committee, The 1975 Eco-nomic Report of the President; 94th Cong., 1st sess., February5, 6, 7, and 14, 1975, p. 542.

cry — a discretionary policy focused on the monetaryaggregates. First National City Bank of New Yorkexpressed this view:

This year is going to be bad enongh as it is withouta perverse monetary policy. And in the current en-vironment, anything less than 8% growth is likely tohe perverse. An 8% floor sounds rather expansive,but given the slack in the economy, it is unlikely torekindle inflationary fires within the next two years.An easing back in monetary expansion below 8%would be appropriate in 1976 and further in 1977 todamp down inflation over the longer run,10

Joining the widespread public attention being givento the appropriate course of monetary policy in 1975were several committees of Congress. Both the Senateand House Banking Committees held hearings on theconduct of monetary policy. In light of the concernover the state of the economy in general, and mone-tary policy in particular, House Concurrent Resolu-tion 133 was passed on March 24, 1975 expressing theview of Congress as to the appropriate course ofmonetary policy during 1975. The resolution did notimpose binding prescriptions, but expressed the Con-gress’s desire for the Board of Governors and theFOMC to:

(1) encourage lower long term interest rates and ex-pansion in the monetary and credit aggregates ap-propriate to facilitating prompt economic recovery,and

(2) maintain long run growth of the monetary andcredit aggregates commensurate with the economy’slong run potential to increase production, so as topromote effectively the goals of maximum employ-ment, stable prices, and moderate long term interestrates,n

The resolution called for the Board of Governors toconsult with Congressional Committees quarterly asto its “objectives and plans with respect to the rangesof growth or diminution of monetary and credit aggre-gates in the upcoming twelve months.’°2

Pursuant to this resolution Chairman Burns metwith Committees of Congress on May 1, July 24, andNovember 4 to discuss the condition of the national

iO”Scotching the recession — the missing monetary factors,”First National City Bank Economic Week, January 20,1975, p. 2.

lii,) S. Congress, Senate, Conimittee on Banking, Housingand Urban Affairs, First Meeting on the Conduct of Mone-tary Policy, 94th Cong., 1st seis., April 29 and 30; and May1, 1975, p. 3.

l~1bid Chairman Burns testified before the Senate and HouseBanking Committees in alternate quarters during the re-mainder of 1975.

Page 9

FEDERAL RESERVE BANK OF ST. LOUIS MARCH 1976

economy and the course of monetary policy.13 De-parting from tradition, Chairman Burns announcedlong-term target ranges for the growth of monetaryand credit aggregates at the May hearings (seeChart I):

The Federal Reserve System is presently seeking amoderate rate of expansion in the monetary andcredit aggregates. We believe that the course we arepursuing will promote an increase in M, of bebveen5 and 7½per cent over the 12 months from March1975 to March 1976.

A growth rate of M1 in the range of 5 to 7½percent would, we believe, be accompanied by higherrates of increase in the other major monetary andcredit aggregates — ranging from 8½to 10½per centfor M~,10 to 12 per cent for M~,and 6½to 9½percent for the credit proxy.14

In announcing the long-rnn target growth, ChairmanBurns cautioned that the appropriate growth rangesdepended upon the underlying economic conditions.And, as the economic conditions changed, the tar-geted growth ranges might have to be modified in amonth or two.

At the July hearings Chairman Burns announcedthat the target ranges had been modified slightly toapply from second quarter 1975 to second quarter1976, rather than from March to March. The changefrom a monthly to a quarterly base was made “be-cause a 3-month average is less subject to erraticmovements than is a single-month base.”5 The effectof moving the base period forward, while retaining

the original growth range, was to accept, rather thanto attempt to offset, a faster rate of monetary growthduring the second quarter than had been implicit inthe original 12-month target. Testifying before theSenate Budget Committee in September, ChairmanBurns discussed the appropriateness of the targetranges:

These growth ranges are appropriate under currentconditions, when the economy is struggling withwidespread unemployment of labor and industrialcapital. However, these growth ranges are on thegenerous side by historical standards, and our eco-nomy would have little or no chance of regaininggeneral price stability if they were maintained inde-finitely. Even so, the Federal Reserve System hasfrequently been urged to raise its present target

13”Statements to Congress,” Federal Reserve Bulletin (May1975), p. 282; (August 1975), p. 491; (November 1975),p. 744.

H”Statements to Congress,” Federal Reserve Bulletin (May1975), p. 286.

‘~Ibid,(August 1975), p. 495.

rates for the money supply. We have resisted thesesuggestions because, in our judgment. such a policywould soon lead to accelerated inflation and therebyfrustrate the process of economic recovery.’6

At the November hearings Chairman Bums againannounced changes in the long-run money growthtargets. The applicable time span had been set by theFOMC at third quarter 1975 to third quarter 1976,The growth ranges for M, and M, were widened to7½to 10½percent and 9 to 12 percent, respectively.Chairman Bums commented on the consequences ofthese changes in his statement to the CongressionalCommittee as follows: “This updating of the base, Ishould note, implies a slightly higher level of moneybalances a year from now than would be the case ifthe second-quarter base were retained.”

In considering the implementation of these long-run targets since their announcement in May, Chair-man Burns stated in November that “. . . growth ofthe monetary aggregates has been broadly in line withthe ranges we adopted earlier. However, month-to-month and quarter-to-quarter changes in the aggre-gates have been very large, reflecting unusual factorsinfluencing the public’s demand for money.”18 Addi-tional explanation of the short-run swings in thegrowth of the aggregates outside the long-run targetranges had been offered by Chairman Burns in

October as well:

Month-to-month changes in the monetary aggregateshave deviated this year from the longer-run targetranges, and they can be expected to do so in thefuture. Since the demands of the public for moneyare subject to rather wide short-term variations,efforts by the Federal Reserve to maintain a con-stant growth rate of the money supply could lead tosharp swings in interest rates and risk damage tofinancial markets and the economy.’°

IMPLEMENTATION OF

MONETARY POLICY

The FOMC, whose organization and operating pro-cedures are outlined on p. 12, met each month in1975 to review the results of their previous decisionsand decide on the future course of monetary policy.Summaries of the goals and operating objectivesadopted at each meeting, as well as a record of dis-senting votes, are presented in Exhibit I on pp. 16-17.

iBIbid, (October 1975), p. 627.

~~Ibid. (November 1975), p. 747.

lOlbid. (October 1975), p. 627.

Page 10

FEDERAL RESERVE BANK OF ST. LOUIS

Targeted Versus Actual M1 Growth Using Base Periods Announced During 1975~’1~~~1~•VAd~

MARCH 1976

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Page 11

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FEDERAL RESERVE BANK OF ST. LOUIS MARCH 1976

Chart II

FOMC Ranges of Tolerance for Monetary Aggregates

Actua!~Hnowlh R Ia

~/

0JAN. FEB. MAR. APR, MAY JUNE JULY AUG. SEPT, OCT. NOV. DEC.

I The rates are two-month simple onnuol rates of change from the month prior to the meeting to the month Following theneeting. Rotes ore bosed on the most current seasonally odLusoed monthly dota.

Li The shaded areas are two-month tolerance ranges shown in the month that the ranges were adopted by the Federol OpenMarket Comittee. Ranges represent two-month simple annual rotee of change from the month prior so the meeting to the

month following the meeting.

0

-s

10

5

0

cessful in achieving the interest rate targets thaml themonetary growth targets. The System attained thetwo-month money growth targets specified in the firsthalf of 1975 more frequently than those specifiedduring meetings held in the second half.

The aim of short-run monetary action appeared tohe strongly expansionary in the first four months of

1975, when economic activity was contracting sharply,while during the recovery in the remainder of the

year actions appeared to take on a more moderatestance. This is indicated by the operating instructionslisted in Exhibit I. The following sections provide a

detailed review of the data and analyses which theFOMC used in formulating short-run monetary policy

Percent15

1915

Percent15

010

S

0

.5

Percent20

15

10

S

S

Tolerance Ranges Percent— 20

FOMC Rmiqe Li

v .

15

Page 13

FEDERAL RESERVE BANK OF ST. LOUIS MARCH 1976

A51111 ~IIYI It

each month in 1975. The FOMC’s short-mn targetsare examined in relation to the changes in the Federalfunds rate and money growth rates which actuallyoccurred.

January -.-~ April: Monetary Expansion

Staff projections for each of the FOMC meetings inJanuary through April suggested declines in real eco-nomic activity through the first half of 1975 andmoderation of price increases. By the March meeting,

an upturn in economic activity later in the year wasbeing predicted. During these four meetings the Com-mittee’s short-run policy was to cushion the recessionand stimulate recovery, although by the March meet-ing the domestic policy directive no longer containedthe clause directing action to cushion the recession.The Committee issued operating directives at theJanuary through March meetings which were aimedat achieving interest rate and money growth ratetargets. The directives specifically said that “the Com-mittee seeks to achieve hank reserve and money mar-ket conditions consistent with more rapid growth inmonetary aggregates over the months ahead than hasoccurred in recent months.”2’ (emphasis added)Expansion of monetary aggregates was substantial inMarch and by Api-il the target for the aggregates was

qualified as “somewhat more rapid growth.”

Over this four-month period the short-term targetranges for the Federal funds rate were never wider

than one percentage point. The target growth rangesfor the aggregates, on the other hand, were specifiedto be as wide as 3 percentage points, but never nar-rower than 2 percentage points.

2iUnless stated otherwise all citations in the following sectionare taken from the Record of Policy Actions of the FederalOpen Market Committee, Federal Reserve Bulletin (April1975-February 1976).

Short-run target ranges were established at theJanuary meeting in view of

a staff analysis [which] suggested that — althoughM, was not expanding in January — the demand formoney would pick up in February, in part as a resultof the lagged effects of earlier declines in interestmates.

The Committee agreed that money market conditionswould have to ease in the short run. The toleranceranges for M, and M2 for the January-Februaryperiod were set at 3½to 6½percent and 7 to 10 per-cent, respectively. The Federal funds rate would beallowed to vary within a range of 6½to 7¼percent.

By February 5 it was evident that the growth of themonetary aggregates would be well below the lowerlimits of the tolerance ranges, suggesting that theadopted Federal funds target was too high relative to

the desired growth rate of the monetary aggregates.On the Chairman’s recommendation the lower limit ofFederal funds rate range was reduced to 8¼percent.

Both M, and M~actually fell well below their Janu-ary- February tolerance ranges.

At the February 19 meeting the FOMC agreed that

further easing in money market conditions in theshort run probably would be appropriate if M5 were

to grow at a rate consistent with the Committee’slonger-run objectives for monetary growth. The toler-ance range for M, was raised for the February-Marchperiod; however, the actual growth of M, fell belowthis range. The tolerance range for M2 was lowered,although the Committee had called for further easingconditions in the February-March period. Given thislower range, M2 grew at a rate near its upper limit.The Federal funds rate range, whose limits were setbetween 5¼and 8¼percent at the February meet-ing, was lower than that previously specified, and theaverage weekly rate remained within these limits dur-ing the intermeeting period.

Again at the March FOMC meeting, the Commit-tee agreed that further easing of money market con-ditions would be necessary in view of analysis avail-able to them which suggested that “the demand formoney would be weak in the near term in associationwith the expected weakness in economic activity....”The lower limit of the M5 range was changed for theMarch-April period (decreased from 5½to 5 percent),while the upper limit remained at 7 percent. Thetolerance range for M2 was raised and the Federalfunds rate range was lowered for the intermeetingperiod. Three members of the FOMC dissented from

this action believing that more aggressive easing ac-

FOMC Range for Federal Funds Rate

0l5 flY

Page 14

FEDERAL RESERVE BANK OF ST. LOUIS MARCH 1976

tions were called for — a higher upper limit for theaggregates and a lower limit for the Federal fundsrate.

On March 27, in contrast with earlier analysis. datasuggested that the growth rates of the aggregateswere not as low as expected and would exceed theupper limits of the tolerance ranges, implying that theupper limit of the Federal funds rate range was nowtoo low for achievement of the desired growth rate ofthe aggregates. In these circumstances the Federalfunds rate would normally be allowed to rise to theupper limits of its range of tolerance — 5¾percent.However, the Chairman recommended, and the mem-bers of the Committee — with one exception —

concurred, that “in view of the weakness in the econ-omy and of the sensitive conditions in financial mar-kets, particularly the bond markets, the Manager beinstructed to treat 5½per cent as the approximateupper limit for the weekly average funds rate for thetime being.” Both M1 and M, stayed within theirMarch - April tolerance ranges.

At the April meeting the staff analysis suggestedthat the aggregates would temporarily grow at rela-tively rapid rates in the April - May period because ofthe tax rebates scheduled to begin in May. The rangesof tolerance for both M, and M2 were raised and therange for the Federal funds rate svas widened byraising the upper limit to 5¾percent. The growth ofthe aggregates and the weekly average Federal fundsrate stayed within the tolerance ranges established atthe April meeting.

Viewing the January through April period in retro-spect, it is apparent that in only one out of four casesdid the growth of both M1 and M2 fall outside thetwo-month tolerance ranges specified at the FOMCmeetings. In the case of the deviation, action wastaken subsequent to the regular January meeting toattempt to correct the expected short-fall in bothaggregates, but the action proved to be insufficient.FOMC operating instructions in this period calledfor more rapid growth of the aggregates. Evidenceindicates that the growth rates of the aggregatesdid increase, on balance.

Accompanying the FOMCs policy of monetaryexpansion during this period was the use of other toolsof monetary policy. The discount rate charged by eachof the Federal Reserve Banks, which was 7¾percentat the beginning of the year, was lowered in January,February, and again in March when it was set at 6¼percent at all twelve Federal Reserve Banks. TheBoard of Governors announced a reduction in reserve

requirements on net demand deposits in Januarywhich was estimated to release $1.1 billion of re-serves. This reduction was designed “to permit fur-ther gradual improvement in bank liquidity andto facilitate moderate growth in the monetaryaggregates.”22

May through July: Fiscal ConsiderationsAt meetings from May through July the FOMC

gave special attention to the expected effects of fiscaloperations in the formulation of monetary policy. Thetax rebates and social security payments were ex-pected to increase temporarily the growth rates of theaggregates during the period.

In May the Committee decided that in order “toallow for the expected temporary bulge in moneyholdings . . . relatively rapid growth in M1 and M,over the May - June period — at annual rates withinranges of tolerance of 7 to 9½per cent and 9 to 11½per cent, respectively — would be acceptable.” TheFederal funds rate range was lowered to 4½to 5½percent. Members of the Committee were concernedthat “upward pressures on interest rates would beparticularly undesirable at present, in light of thesensitive state of financial markets and of uncertaintieswith respect to the timing and strength of the eco-nomic recovery that now appeared to be in process ofdeveloping.” Taking this into consideration, the direc-tive issued by the Committee in May relegated thegrowth ranges of the aggregates to a proviso clause,putting more emphasis on money market conditions(short-term market interest rates or, specifically, theFederal funds rate):

the Committee seeks to maintain about the prevail-ing money market conditions over the period imme-diately ahead, provided that monetary aggregatesgenerally appear to he growing within currentlyacceptable short-run ranges of tolerance, (emphasisadded)

The aggregates M, and M, both exceeded theupper limits of their May - June tolerance range —

M1 increasing at a 12,8 percent annual rate and M2 ata 15 percent annual rate, The Federal funds ratestayed within its tolerance range during the inter-meeting period.

At the June meeting the Committee decided someshort-run finning action might be appropriate in viewof the rapid growth of the monetary aggregates in theprevious period, and the continuing effects of tax re-

22”Announcements”, Federal Reserve Bulletin (January 1975),p. 51.

Page 15

ianuary20-21 . . . while resisting inflationary pressures andworking toward equilibrium in the country’s bal.once of payments, to foster financial conditionsconducive to cushioning recessionary tendenciesand stimulating economic recovery.

while taking account of the forthcoming Treasuryfinancing, developments in domestic and internationalfinancial markets, and the Board’s action on reserve re-quirements, the Committee seeks to achieve bank reserveand money market conditions consistent with more rapidgrowth in monetary aggregates over the months aheadthan has occurred in recent months.

None

Dissents

Absent and not voting: Mr. Hayes. (Mr. Debs votedas alternate f or Mr. Hayes.)

Februory 19 . . - to foster financial conditions conductive to . . . while taking account of developments in domestic Nonecushioning recessionary tendencies and stirnu- and international financial markets, the Committee seekslating economic recovery, while resisting infla- to achieve bank reserve and money market conditions Absent and not voting: Mr. Sheehan.tionary pressures and working toward equitib- consistent with mare rapid growth in monetary aggregatesrium in the country’s balance of payments. over the months ahead than has occurred in recent months.

March 18 . . . to foster financial conditions conducive to Na Change Messrs. Sucher, Eastburn, and Sheehan dissented fromstimulating ecanomic recovery, while resisting this action because they believed that the economicinflationary pressures and working toward equi- situation ond outlook together with recent slow growthlibrium in the country’s balance of payments. in the monetary aggregates called for more aggressive

efforts in the near term to achieve the Committee’slonger-run objectives far the aggregates.

April 14-IS No Change . . . while taking account of the forlhcoming Treasuryfinancing and of developments in domestic and interna-tianal financial markets, the Committee seeks to achievebank reserve and money market conditions consistent withsomewhat more rapid growth in monetary aggregates averthe months ahead than has occurred an average inrecent months,

Mr. Ea,tburn: While he believed that firmer moneymarket conditions might prove to be necessary lateron in the year, he thought any such firming would beinappropriate at this time, given the sensitive stateof financial markets, the continued weakness in theeconomy, and his preference for seeking more rapidgrowth in the monetary aggregates in the near termthan would be desirable over the longer run.

Absent and not voting, Messrs. Bucher and Sheehan.

May 20 Na Change . . . white taking account at developments in domesticand international financial markets, the Committee seeksto maintain about the prevailing money market conditionsover the period immediately ahead, provided that mone-tary aggregates generally appear to be growing withincurrently acceptable short-run ranges of talerance.

None

Absent and not voting, Mr. Sheehan.

June 16-17 No Change . . . while taking account of developments in domesticand internatianal financial markets, Ihe Committee seeksto achieve bank reserve and money market conditionsconsistent with moderate growth in monetary aggregatesover the months ahead,

Messrs. Bucher and Cotdwell dissenled from this actionbecause they believed that a tightening in moneymarket conditions and the associated increase inshart-term interest rates would be premature at thistime.

Absent and not voting: Mr. Hayes. (Mr. Debs votedas alternate for Mr. Hayes.)

0

Date ofFOMC

Meeting Policy Consensus

EXHIBIT I

Operating Instructions

- - while taking account at the forthcoming Treasuryfinancing and of developments in domestic and inter-national financial markets, the Cammittee seeks to maintainabout the prevailing bank reserve and money marketconditions aver the period immediately ahead, providedthat growth in monetary aggregates appears to beslowing substantially from the bulge during the secondquarter.

Mr. Holland . . . preferred to maintain bank reserveand maney market conditions in the inter-meetingperiod closer to those now prevailing, in the ex-pectation that by the next meeting the unwinding ofthe recent bulge in monetary aggregates caused byunusual Treasury payments would have proceededfar enough to permit monetary policy decisions to berelated more closely to underlying trends in theaggregates.

Absent and not voting: Messrs. Hayes and Mitchell.(Mr. Debs voted as alternate tar Mr. Hayes.)

August 19 . . . to foster financial conditions conducive to - . . while taking account of developments in domestic Nonestimulating economic recovery, while resisting and international financial markets, the Committee seeksinflationary pressures and contributing to a sus- to achieve bank reserve and money market conditionstamable pattern of international transactions, consistent with moderate growth in monetary aggregates

over the months ahead.

September 16 No Change Na Change None

October 21 . . . to foster financial conditions that will en- Na Change Nonecourage continued economic recovery, whileresisting inflationary pressures and contributing Absent and not voting: Mr. Bucher.to a sustainable pattern of international trans-actions.

November 18 No Change . . . while taking more than usual account of develop-ments in domestic and international financial markets,the Committee seeks to achieve bank reserve and moneymarket conditions cansistent with moderate growth inmonetary aggregates over the months ahead,

Messrs. Volcker and Jackson dissented from this actionbecause they thought prevailing money market condi-tions should be maintained for the time being, in partbecause of the current uncertainties about the short-runrelationship between monetary growth and inlerestrates.

Mr. Eastburn dissented because he believed that theSystem should be mare aggressive in supplying reservesin order to compensate for recent short-falls in the rateof monetary expansion from the Committee’s longer-run growth ranges.

December 16 No Change . . - while taking account of developments in domesticand international financial markets, the Committee seeksto maintain prevailing bank reserve and money marketconditions over the period immediately ahead, providedthat monetary aggregates appear to be growing at aboutthe rates currently expected.

None

Absent and not voting: Mr. Bucher.

July 15 No Change

-:5

FEDERAL RESERVE BANK OF ST. LOUIS MARCH 1976

bates and one-time payments to social security recipi-ents in the second half of June. A higher Federalfunds range was specified. The June-July toleranceranges for M1 and M2 were not very different fromthe ranges specified at the May meeting. The lowerlimit of the M1 tolerance range was lowered by ½percentage point while the npper limit of the M2tolerance range was raised by ½percentage point.Two members of the Committee dissented from theseactions because they believed the tightening of moneymarket conditions would be premature.

On June 26, as it appeared that the aggregateswould exceed the upper limits of their toleranceranges and the Federal funds rate would approach itsupper limit, Chairman Bums recommended, “that theupper limit of the funds rate constraint be raised to6¾per cent, on the understanding that the additionalleeway would be used only in the event that anotherweeks data confirmed excessive strength in the mone-tary aggregates.” Three members of the Committeedid not concur with the Chairman’s recommendation.The aggregate M1 remained within its June-Julyrange. but M2 exceeded the upper limits of its toler-ance range. The Federal funds rate deviated slightlyfrom its range following the June 26 modification.

At the July meeting staff analysis stated that“growth in monetary aggregates would slow consid-erably in July from the extremely rapid pace in Mayand June associated with the Federal income tax re-bates and social security payments.” The FOMC de-cided again to put the growth of the aggregates in aproviso clause in the July directive, specifying that,

the Committee seeks to maintain about the prevail-ing bank reserve and money market conditions overthe period immediately ahead, provided that growthin monetary aggregates appears to be slowing sub-stantially from the bulge during the second quarter.(emphasis added)

The tolerance ranges for M1 and M2 were loweredfor the July - August period and the Federal fundsrate range was raised, with limits set at 5½and 6%percent. The aggregate M2 fell below the lower limitof its tolerance range while M1 grew near the mid-point of its range and the Federal funds rate remainedwithin its tolerance range during the intermeetingperiod.

Growth of both M1 and M2 only once exceeded thelimits of the two-month tolerance ranges specified atthe three FOMC meetings in the period from Maythrough July.

August — December: Moderation

Staff projections of output and prices were modifiedsomewhat as time progressed from the August to theDecember FOMC meeting. In August and Septem-ber, projections suggested strong expansion of outputin the fourth quarter and a somewhat more rapid rateof price increase in the third and fourth quarters. ByOctober, however, the projections suggested less rapidexpansion in output during the fourth than in thethird quarter, and further moderate growth in thefirst half of 1976. Additionally, the projections avail-able at the October meeting suggested that price in-creases through mid-1976, although still rapid, wouldbe below the rate in third quarter 1975. At the No-vember and December meetings staff projections in-dicated a slowing in the rate of price increase throughthe first half of 1976. The desire for short-run rapidgrowth in the aggregates evidenced in Committeedirectives earlier in the year gave way to directivescalling for “. . . bank reserve and money market con-ditions consistent with moderate growth in monetaryaggregates over the months ahead.” (emphasisadded)

Short-run tolerance ranges established by theFOMC took on new characteristics in the Augustthrough December period. At several meetings theFOMC specified both inner and outer ranges of toler-ance for the Federal funds rate. The outer rangeswere as wide as 1¾percentage points or as narrow asone percentage point. The new development, how-ever, was the specification of inner ranges, areaswithin the outer ranges where the Committee desiredto keep the Federal funds rate. For example, at theAugust meeting the outer range was established be-tween 5% and 7 percent. The inner range was setbetween 6½and 6¾percent — a very narrow target.In fact, at the December meeting the inner range wasnot even a range, but a specific level at which theCommittee wished to stabilize the Federal funds rate::unless rates of growth in the monetary aggregatesappeared to be deviating significantly from the mid-points of their specified ranges.” During this periodthe width of the two-month tolerance ranges forgrowth of the aggregates were rather broad, varyingfrom 2½to 4 percentage points.

At the August meeting the Committee decided thatmoderate growth of the aggregates would be appro-priate short-run policy. In the course of the Com-mittee’s discussion, it was suggested that

financial markets had overreacted to the minor tight-ening in bank reserve and money market conditions

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FEDERAL RESERVE SANK OF ST. LOUIS MARCH 1976

that had occurred over the past 2 months; that finan-cial markets in general were unsettled, in part be-cause of the financial problems of New York Cityand the possible repercussions of those problems;and that interest rates were high for this stage of thebusiness cycle.

The tolerance range for M1 was raised to 4½to 7percent for the August-September period, an upwardmovement from the 3 to 5½percent range establishedat the previous meeting. The upper and lower limitsof the tolerance range for M2 were also raised, butonly by ¼percentage point at each end, The newrange was set between 8¼and 1O~/4 percent. TheFederal funds rate range was raised and made sub-ject to the provision “that operations would not bedirected toward establishing reserve conditions con-sistent with a movement in the rate above or belowthe current 6½to 6¼per cent area unless it appearedthat in the August - September period growth in themonetary aggregates would be substantially strongeror weaker than now expected.”

On September 5, “the available data suggested thatin the August-September period M1 would grow at arate in the lower part of the range of tolerance thathad been specified by the Committee and that M2would grow at a rate just below the lower limits of itsrange.” To lower the Federal funds range outside thenarrow range established, however, was viewed asinappropriate: “In view of the likelihood of substan-tial strengthening in demands for money and creditover coming months, it appeared that a decline in theFederal funds rate at this time might have to be re-versed shortly — a sequence that could seriouslycompound uncertainties in financial markets.” TheChairman recommended and members concurred that“the Manager be instructed to continue to maintainreserve conditions consistent with a Federal fundsrate in the 6½to 6¾per cent area, while leaningtoward the lower figure.” The growth of both M1 andM2 fell below the lower limits of the tolerance rangesin the August - September period as the preliminarydata had suggested, while the Federal funds rate re-mained within its outer range during the entire inter-meeting period and within the inner range in two ofthe four weeks.

A moderate growth in the aggregates was againspecified as the appropriate two-month policy at theSeptember meeting in view of “. . . indications thateconomic activity was now on the increase and of thelikelihood that expansion in nominal GNP over com-ing quarters would be associated with considerablestrengthening in the demand for money and credit.”

The tolerance range for M1 was raised, but that forwas lowered. The lower limit of the Federal funds

rate range was raised slightly. The upper limit re-mained at 7 percent on the condition “that if develop-ments with respect to the aggregates suggested theneed to move the Federal funds rate above 6% percent, open market operations toward that end wouldnot be undertaken until after the Chairman had con-sulted with the Committee.”

While concern at the September FOMC meetinghad been centered on the upper limit of the Federalfunds range, on October 2 the Chairman recom-mended reduction of the lower limit of the Federalfunds rate range to 5% percent in view of the slowgrowth of the aggregates, a course of action he hadrecommended against in the previous month becausethe circumstances were believed to be only tempo-rary. Over the September-October period M1 andM2 again fell well below the lower limits of the toler-ance range, suggesting that the Federal funds rangehad not been lowered far enough. The Federal fundsrate deviated slightly from its range near the end ofthe intermeeting period.

At the October meeting some members

expressed doubt concerning the strength of recoveryin economic activity over the quarters immediatelyahead, in part because of the possible repercussionsof New York’s financial problems and because of therelatively high levels of market interest rates prevail-ing at this early stage of the recovery. It was noted,moreover, that inflation remained a serious problem.

The Committee again decided that moderate growthof the aggregates was the appropriate policy for thenext two-month period. Tolerance ranges for M1 andM2 were lowered for the October - November periodand the Federal funds rate range was lowered also.The Federal funds rate range was specified with thecondition that “unless new data suggested that growthin the monetary aggregates in the October - Novem-ber period would exceed the rates now expected, op-erations would be directed toward moving the Fed-eral funds rate down to 5½per cent by the end of thestatement week following this meeting.” Both M1 andM2 stayed within their tolerance ranges in theOctober - November period. The Federal funds rateremained near the lower limits of its range in theintermeeting period.

During October the Board of Governors announceda reserve requirement change which would “help tomeet the seasonal need for bank reserves over thecoming weeks and to facilitate moderate growth inthe monetary aggregates.”

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FEDERAL RESERVE BANK OF ST. LOUIS MARCH 1976

Staff analysis at the November FOMC meetingsuggested that “. . . in view of the projected expan-sion in GNP, M1 was likely to grow substaniallyfaster over the months ahead than it had over theimmediately preceding months.” Committee membersexpressed differing views over which of the dualoperating targets, interest rates or money growth,should be the primary focus of attention. Some con-tended that “, . - changing relationships tended tomake monetary growth rates unreliable guides tomonetary policy at present.” Others, “who preferredto continue to base operating decisions in the periodimmediately ahead primarily on the behavior of themonetary aggregates, expressed concern about theirsluggish growth over recent months.”

The November directive issued by the FOMCcalled for moderate growth of the aggregates

while taking more than usual account of develop-ments in domestic and international financialmarkets The tolerance ranges for M1 and M2were raised substantially. The limits of the range for

were set at 6 and 10 percent, compared to the3 to 7 percent range established at the previous meet-ing. Likewise, the M2 range was set at 7½tolO½percent, much higher than the 5½to 8½percentrange set for the previous two-month period. TheFederal funds rate target was specified as a rangesomewhat lower than during the previous period;however, System operations were to be directed athitting the midpoint of that range (5 percent). Dur-ing the November - December period the growth ofboth M, and M2 fell below the lower limit of theirtolerance ranges. In contrast, the Federal funds rateremained within its 4½to 5½percent range.

The Board of Governors announced a change inRegulations D and Q effective on November 10. Thischange permitted corporations, partnerships, andother profit-making organizations to maintain savingsaccounts at member banks subject to a $150,000 ceil-ing on the size of the accounts. In light of this andother developments, staff analysis at the DecemberFOMC meeting provided technical advice about theuse of monetary measures:

in the period immediately ahead growth in thedemand for money would be constrained by con-tinuation of the shift in business deposits from de-mand accounts to savings accounts in response to therecent changes in regulations. Because the magni-tude and duration of the shift were highly uncertain,however, estimates of the effects on M1 were subjectto a large margin of error. It was also noted thatprojections of monetary growth for the month ofDecember were more uncertain than those for other

months because many business and financial institu-tions customarily made adjusunents to cash and debtpositions for purposes of year-end statements.

Members of the Committee again were somewhatdivided over which of the operating targets shouldreceive more emphasis — money market conditionsor monetary aggregates. The target ranges for M1 andM1 were lowered for the December - Januaryperiod.22 Operations were to be directed at maintain-ing the Federal funds rate at 5¾percent, its currentlevel, unless the aggregates deviated significantly fromthe midpoints of their ranges. If necessary the Federalfunds rate would be allowed to vary between 4½and5½percent.

By January 12, 1976, “the available data suggestedthat in the December-January period both M1 andM2 would grow at rates below the lower limits of theranges of tolerance that had been specified by theCommittee.”

The significance of the apparent weakness in theaggregates was highly uncertain, because of the ef-fects of the recent introduction of business savingsaccounts at commercial banks and because the re-vised seasonal adjustment factors employed werestill under review. The problems of seasonal adjust-ment were particularly acute for the months of De-cember and January. For these technical reasons,and in view of more favorable recent economic sta-tistics — including the latest data on employmentand retail sales — Chainnan Burns recommendedthat the Manager be instructed to hold the weeklyaverage Federal funds rate at the approximate levelof 4% per cent until the Committee’s next meeting.All members of the Committee, svith the exceptionsof Messrs. Eastburn and MacLaury, concurred in theChairman’s recommendation.

The reported data later indicated that both M1M2 grew at rates below the lower limits of the targetrange, while the Federal funds rate remained withinits range during the intermeeting period.

The aims of short-run monetary actions in the Au-gust to December period were stated in terms of amoderate position (see Exhibit I). However, toleranceranges for the monetary aggregates established toachieve these aims were not successfully attained dur-ing much of this period. Both M1 and M2 grew atrates below the limits of their two-month toleranceranges in four out of five cases in the August toDecember period. Failure of the monetary aggregatesto grow within the desired ranges in the November-December and December-January periods correspond-

23These targets were formulated taking into account the newseasonal factors which were to be published in January.

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FEDERAL RESERVE BANK OF St LOUIS MARCH 1976

ed with the special attention given to money marketconditions in the November directive. In addition,data which became available after the August and De-cember meetings, as cited above from the “Record ofPolicy Actions,” gave advance indications that the ag-gregates were growing below or at the low end oftheir tolerance ranges. On these two occasions Chair-man Burns recommended against lowering the Fed-eral funds rate range for reasons that have previouslybeen mentioned. Following the September FOMCmeeting, •steps were taken to reduce the lower limitof the Federal funds rate range by ¾percent, whendata available subsequent to the meeting indicatedthat the aggregates would grow below the lower limitsof their tolerance ranges. However, these steps werenot enough, since later data indicated that both M,and M2 fell below the September-october toleranceranges specified by the Committee.

A CONSTRAINT ON MONETARYPOLICY ACTIONS

The year began with concerns about the implica-tion for money growth of a projected Federal deficitof over $80 billion. If the Federal Reserve were tomonetize even 15 percent of the deficit — much lessthan they had on average since 1965 — a 15 percentrate of growth for M1 was implied.24 As the yearprogressed, however, it became evident that privatecredit demands were extremely weak, allowing agreater portion of the Government’s debt to be pur-chased by the private sector without raising interestrates. The portion of the debt monetized was consid-erably less than at first was expected.

Thus the financing of the deficit did not confrontthe Federal Reserve with the choice between exces-sive expansion in the money supply or substantialincreases in interest rates. However, the sheer volumeof Treasury operations did result in a number ofcomplications for Federal Reserve policy. Respond-ing to pressure from Congress, the Treasury sought tominimize its noninterest earning deposits at commer-cial banks, and sought, instead, to keep a larger per-centage of its deposits at Federal Reserve Banks. Theconsequences of this action were pointed out by UnderSecretary of the Treasury Edwin H. Yeo:

While this action of reducing balances [at commer-cial banks] has resulted in a reasonable equilibriumbetween the value of balances and the value of serv-ices, it has been accomplished at the expense ofseriously complicating the Federal Reserve System’s

24Susan R. Roesch, “The Monetary — Fiscal Mix ThroughMid-1976,” this Review (August 1975), pp. 2-7.

management of bank reserves and other monetaryaggregates. . . What has happened is that the swingsin the Treasury’s cash balance at the Federal Re-serve Banks have forced the Federal Reserve Sys-tem to drastically increase its open market opera-tions in order to nullify the impact of the swings onbank reserves. This has created confusion in themarket as to which Federal Reserve actions are tooffset swings in Treasury cash and which are tocarry out monetary policy.25

As Chart IV indicates the changes in Federal Re-serve holdings of Government securities closely par-allel the changes in Treasury balances at Federal Re-serve Banks. These two items have offsetting effectson bank reserves. Increases in Federal Reserve hold-ings of Government securities increase bank reserves,while increases in Treasury deposits at Federal Re-serve Banks decrease bank reserves.

Not only did the necessity of offsetting Treasuryactions complicate the implementation of monetarypolicy, but the size of Treasury operations resultingfrom the tremendous deficit added further to theproblems. On two occasions the size of open marketoperations required to offset Treasury operations madeit necessary for the Manager to request increases inthe limits on changes in holdings of U. S. Governmentand Federal agency securities (April 30 and October3). On two other occasions the Manager requestedincreases in the ceiling on Federal Reserve holdingsof short-term certificates of indebtedness purchasedfrom the Treasury (March 10 and August 6). This wasnecessary to allow the Treasury to borrow from theFederal Reserve when its cash balances ran low.

2S~’5tatement of the Honorable Edwin H. Yeo, III, UnderSecretary of the Treasuey for Monetary Affairs, before theSubcommittee on Domestic Monetary Policy of the HouseCommittee on Banking, Currency and Housing,” The De-partment of the Treasury News, September 25, 1975.

Federal Reserve Credit and Ireasur y Depositsat Federal Reserve Bank,

‘5

Ed ER,,, C,2

A/\ /ii

~5

eb,i~,

Sets

975

Page 21

FEDERAL RESERVE BANK OF ST. LOUIS MARCH 1976

SUMMARY AND CONCLUSION

Monetary policy in 1975 did achieve the longer-runpolicy goals set forth by the FOMC in its Januarydirective: “. . . to foster financial conditions conduciveto cushioning recessionary tendencies and stimulatingeconomic recovery.” The recession “bottomed-out” andeconomic activity rebounded during 1975. In addition,the renewal of economic activity has been achieved,so far, without an acceleration in the rate of inflation.

Directives issued by the FOMC indicated that theshort-run aims of monetary actions were expansionaryin the first four months of 1975 and more moderateduring the remainder of the year. These short-runaims were formulated in terms of tolerance rangesfor the Federal funds rate and growth rates for mone-tary aggregates. If these aims are evaluated with re-spect to the attainment of Federal funds rate levelswithin specified ranges, the FOMC was extremelysuccessful in achieving its short-run aims. On theother hand, the FOMC was less successful in attain-ing the growth of the monetary aggregates withintheir desired ranges. In six of the twelve cases, thegrowth rates of both M1 and M2 were outside theirtolerance ranges — above the ranges in one instanceand below the ranges on five occasions.

Among the most significant developments regardingthe implementation of monetary policy during 1975were those which centered around the relative impor-tance of the interest rate and money growth rate tar-gets. While the money growth ranges were generally

two or three percentage points in width at the be-ginning of the year, by the end of the year theytended to be three or four percentage points in width.In contrast, the Federal funds rate ranges at the endof the year actually consisted of two ranges — anouter range (generally one percentage point in width)and a narrower inner range (¾percentage point ornarrower). Institutional changes, which allowed busi-nesses to establish savings accounts at commercialbanks, and problems relating to seasonal fluctuationscaused some members of the FOMC at the end of1975 to question the relevance of M, data and to paymore attention to money market conditions in theimplementation of monetary policy.

The formulation and implementation of monetarypolicy received wider attention in 1975 than in pre-vious years. Congressional concern over monetary poi-icy was expressed in House Concurrent Resolution133 and in subsequent quarterly consultations be-tween Chairman Burns and the Congressional Com-mittees. In response to Congressional interest, theFOMC began to formulate long-term targets for themonetary aggregates and shortened the disclosureperiod of the FOMC “Record of Policy Actions” from90 to 45 days. While the new long-term targets, andmuch of the public discussion of monetary policy in1975, centered on the growth of the monetary aggre-gates, the FOMC pursued operating procedures spe-cified in terms of both aggregates and money marketconditions. Although attention was given to the aggre-gates, the record shows that the concern of the FOMCwas directed primarily at money market conditions,

Page 22