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862d Session* }
JO INT C O M M IT TE E PRIN T
STUDY PA P E R NO. 19
DEBT MANAGEMENT IN THE
UNITED STATES
BY
W a*rren L. S mith
MATERIALS PREPARED IN CONNECTION W ITH THE
STU DY OF EM PLOYM ENT, GROWTH, AN D
PRICE LEVELS
FOR CONSIDERATION BY THE
JOINT ECONOMIC COMMITTEE
CONGRESS OF THE UNITED STATES
Printed for the use of the Joint Economic Committee
UNITED STATES
GOVERNMENT PRINTING OFFICE
WASHINGTON : 1960
50438
For sale by the Superintendent of Documents, U.S. Government Printing Office
Washington 25, D.C. - Price 40 cents
JOINT ECONOM IC C O M M ITTE E
(Created pursuant to sec. 5(a) of Public Law 304, 79th Cong.)
PAUL H. DOUGLAS, Illinois, Chairman
W R IG H T P A T M A N , Texas, Vice Chairman
SENATE
HOUSE OF R E PR ESE N TA TIVE S
JOHN SP AR K M A N , Alabama
J. W IL L IA M FU LB RIG H T, Arkansas
JOSEPH C. O’M A H O N E Y , Wyoming
JOHN F. K E N N E D Y , Massachusetts
PRESCO TT BUSH, Connecticut
JOHN M A R SH A L L BU T L E R , Maryland
JACOB K. JAVITS, New York
Stu d y
of
E
mploym ent,
R ICH AR D BO LLIN G , Missouri
H ALE BOGGS, Louisiana
H E N R Y S. REUSS, Wisconsin
F R A N K M . CO FFIN , Maine
T H OM AS B. CURTIS, Missouri
C LA R E N C E E. K IL B U R N , New York
W IL L IA M B. W ID N A L L , New Jersey
G row th,
and
P r ic e
(Pursuant, to S. Con. Res. 13, 86th Cong., 1st sess.)
Otto E ckstein, Technical Director
John W . L ehman , Administrative Officer
James W . K nowles, Special Econom ic Counsel
II
L evels
This is one of a series of papers being prepared for considera
tion by the Joint Economic Committee in connection with
their Study of Employment, Growth, and Price Levels. The
committee and the committee staff neither approve nor dis
approve of the findings of the individual authors.
m
LETTERS OF TRANSMITTAL
Jan ua ry 18, 1960.
To Members oj the Joint Economic Committee:
Submitted herewith for the consideration of the members of the
Joint Economic Committee and others is a paper on “ Debt Manage
ment in the United States.”
This is one of a number of subjects which the Joint Economic Com
mittee requested individual scholars to examine and report on in
connection with the committee’s study of “ Employment, Growth, and
Price Levels.”
The findings are entirely those of the author, and the committee and
the committee staff indicate neither approval nor disapproval of this
publication.
Paul H . D
ouglas,
Chairman, Joint Economic Committee.
15, 1960.
January
Hon.
P
aul
H.
D
ouglas,
Chairman, Joint Economic Committee,
U.S. Senate, Washington, D.C .
D e a r S e n a t o r D o u g l a s : Transmitted herewith is one of a series
of papers prepared for the study of “ Employment, Growth, and Price
Levels” by outside consultants and members of the staff. The
author of this paper is Warren L. Smith of the University of Michigan.
All papers are presented as prepared by the authors.
O tto E
c k s t e in
,
Technical Director,
Study of Employment, Growth, and Price Levels•
CONTENTS
STUDY PAPER NO. 19, “DEBT M ANAGEM ENT IN THE U N IT E D
STATES,” BY WARREN L. SM ITH
Page
Summary_______________________________________________________________
1
Chapter I. The Federal debt in perspective______________________________
17
Introduction________________________________________________________
17
18
Budget and debt accounts__________________________________________
The Federal Reserve and debt management_________________________
24
Net claims against the Federal Government_________________________
26
Debt management and monetary policy_____________________________
27
Changes in the public debt since World War II_____________________
28
Appendix to Chapter I: The economic significance of the trust funds-40
43
Chapter II. Present debt management techniques_______________________
Regular bill financing_______________________________________________
43
Tax anticipation financing__________________________________________
44
Other cash offerings________________________________________________
46
Refunding operations_______________________________________________
52
Concluding comment_______________________________________________
55
Chapter III. Recent debt management experience and problems_________
56
Survey of recent debt operations____________________________________
56
The competitive position of Government securities_________________ _
61
Other recent problems______________________________________________
72
Chapter IV. Economic effects of debt operations________________________
80
Interest cost to the Treasury_______________________________________
81
Effects on the level of private expenditures_________________________
90
Debt management as a species of selective control__________________
101
The outstanding debt as an automatic stabilizer____________________
102
Combining interest cost and stabilization effects____________________
107
113
The handling of budget deficits and surpluses_______________________
Appendix to chapter IV ____________________________________________
116
Chapter V. Federal Reserve open market operations____________________
118
An evaluation of the bills-only policy_______________________________
120
130
Advantages of a more flexible open market policy___________________
Conclusion_________________________________________________________
133
Chapter VI. Some suggestions concerning debt management policy______
135
A suggested approach to debt management_________________________
135
Relation of debt management to other policies______________________
137
Possible innovations in debt management technique_________________ 142
The interest rate ceiling____________________________________________
153
C harts
Chart I—1. Percentage distribution of publicly held marketable debt, fiscal
years 1946-58_________________________________________________________
39
Chart III-l. Yields on Treasury, corporate, and municipal bonds, 1947-5967
Chart IV-1. Illustrative interest-rate patterns___________________________
84
Chart IV-2. Term structure of interest rates: March 1958 and August
1959__________________________________________________________________
87
Chart IV-3. Short-term and long-term markets_________________________
93
Chart IV-4. Short-term and long-term markets_________________________
94
Chart IV-5. Long-term debt____________________________________________ 108
Chart V -l. Relation between weekly changes in Treasury bill rate and
weekly changes in free reserves, January 1, 1958, to May 13, 1959_____ 127
Chart V-2. Relation between weekly changes in Treasury bill rate and
weeklv changes in vield on long-term Treasurv bonds, January 4, 1958,
128
to May 30, 1959_-‘__________ ______________ 1________________________
TO
VIII
CONTENTS
T ables
Table 1-1. Ownership of U.S. Government securities, fiscal years 1946-59__
Table 1-2. Administrative budget, public debt change, and resulting
change in Treasury’s cash balance, fiscal years 1947-59_______________
Table 1-3. Relations between surplus or deficit in administrative budget
and surplus or deficit in cash budget: Fiscal years 1947-59_____________
Table 1-4. Federal Government cash transactions with public: Fiscal
years 1947-59________________________________________________________
Table 1-5. Summary of operations affecting public holdings of Federal
securities: Fiscal years 1947-59______________________________________
Table 1-6. Publicly held debt and gross national product: 1947-58______
Table 1-7. Net public and private debt outstanding: 1947-58___________
Table 1-8. Net interest paid by the Federal Government in relation to
national income: 1947-58_____________________________________________
Table 1-9. Ownership of the publicly held Federal debt: Fiscal years
1946-59______________________________________________________________
Table 1-10. Composition of the publicly held Federal debt: Fiscal years
1946-5 9
Table I I -l. Regular Treasury bills outstanding: July 31, 1959__________
Table II-2. Sales and redemptions of tax anticipation bills and certificates,
fiscal years 1953-59___________________________________________________
Table I II -l. Summary of operations affecting the publicly held debt by
quarters, 1951-59_____________________________________________________
Table III-2. Comparison of surplus or deficit in cash budget and in national
income and product accounts budget, 1957-59_________________________
Table III-3. Operations of U.S. savings bond program: Fiscal years
1947-5 9
Table IV -l. Factors affecting money supply: December 3 1 ,1954-September
25, 1957____________________________ _________________________________
Table IV -2. Changes in commercial bank holdings of marketable Treasury
securities by maturity classification for specified periods_______________
Table IV -3. Changes in holdings of Government securities by various
investor groups, December 31, 1955-June 30, 1957____________________
Page
18
19
20
21
23
28
29
31
34
38
44
45
57
74
78
103
105
114
STUDY PAPER NO. 19
DEBT MANAGEMENT IN THE UNITED STATES1
SUMMARY
The Treasury's problems in managing the public debt have been
the subject of much attention and concern recently. “ Debt manage
ment,Mas we shall define the term, is different from both fiscal policy
and monetary policy, although it is closely related to both. To a
considerable extent, fiscal policy sets the framework within which
debt management is conducted, while the kind of monetary policy
being followed affects the Treasury’s problems of debt management.
At the same time, the debt management policies of the Treasury may
interfere with the freedom of the Federal Reserve in conducting mone
tary policy, and the structure of the debt may significantly influence
the way in which monetary controls function. Moreover, under our
definition, the Federal Reserve has some powers and responsibilities
which come under the heading of debt management.
I. THE FEDERAL D EBT IN PERSPECTIVE
The size of the debt
There are several concepts of the public debt which are employed
in discussions of debt management. On June 30, 1959, the “ total
gross debt” or “ total Federal securities outstanding” amounted to
$284.8 billion. The gross debt reached a level of $279 billion in
February 1946 at the zenith of borrowing connected with the financing
of World War II, then declined to $252.4 billion in June 1948 as a re
sult of the immediate postwar budget surpluses and debt retirement.
From mid-1948 to mid-1949 the gross debt grew by $32.4 billion.
However, the gross public debt does not represent the true debt of
the Federal Government. A t the end of the fiscal year 1959, $54.6
billion of Treasury securities was held by Government agencies and
trust funds, i.e., within the Federal Government itself. A further $26
billion was held by the Federal Reserve System. Since purchases and
sales of Government securities by the Federal Reserve are made for
the purpose of controlling bank reserves and the money supply in the
interest of maintaining financial and economic stability and since ap
proximately 90 percent of the interest payments made to the Federal
Reserve are returned to the Treasury at the end of each year, this
portion of the debt is also essentially intragovernmental. The debt
that is significant for most aspects of economic analysis is the publicly
held debt— that is, debt held by households, business firms, commercial
banks, and other financial institutions of the country. Changes in the
amount and composition of the publicly held debt affect interest rates
and the liquidity of spending units, and these effects may influence
1 1 am indebted to Messrs. James E. Sutton and Kyung Mo Huh for research help in
the preparation o f this paper* I have also benefited from discussions with Prof. David I.
Fand.
1
2
DEBT MANAGEMENT IN THE UNITED STATES
the level and composition of private expenditures. The publicly held
debt amounted to $204.2 billion on June 30, 1959, and increased by
only $9 billion between mid-1948 and mid-1959, compared with the
$32.4 billion increase in the gross public debt.
Definition of debt management
We shall define debt management to include all actions of the Gov
ernment, including both the Treasury and the Federal Reserve, which
affect the composition of the publicly held debt. When defined in
this way, debt management includes: (1) decisions by the Treasury
concerning the types of debt to be issued to raise new money, (2) de
cisions by the Treasury concerning the types of debt to be issued in
connection with the refunding of maturing securities, (3) decisions by
the Federal Reserve concerning the types of debt to be purchased and
sold in the conduct of open market operations.
It should be noted that under this definition of debt management,
the amount of new securities to be sold by the Treasury to cover
budget deficits or to be retired with the proceeds of budget surpluses
is not a matter of debt management but of fiscal policy. Moreover,
decisions by the Federal Reserve which change the publicly held
money supply, including changes in reserve requirements and the
amount (but not the composition) of open market purchases and
sales, fall under the heading of monetary policy.
The debt in relation to other economic magnitudes
N ot only has the publicly held debt not grown greatly in absolute
amount in the last decade, but it has actually declined substantially
in relation to other relevant economic magnitudes. The publicly
held debt was equal to 86.9 percent of G N P at the end of 1947;
by 1958, due to the rise in G N P, the percentage had fallen to 44.2.
Of course a substantial part of this decline in the percentage is the
result of inflation, but the fact remains that the debt is much smaller
relative to our productive capacity than formerly, and to the extent
that this is a measure of our ability to carry the debt, it should sit
much more lightly on our shoulders than it did a decade ago. Fur
thermore, between 1947 and 1958 total net public and private debt
outstanding rose from $394.8 billion to $743.9 billion. As a result of
this large increase, the publicly held Federal debt declined from 50.8
percent of the total in 1947 to 27.7 percent in 1958. Thus, the relative
importance of the Federal debt in our debt structure has declined
very substantially.
Interest on the debt
Net interest paid by the Federal Government as shown in the
national income accounts is the best measure of the interest cost to
the Treasury, since it excludes the intragovemmental transfers
involved in payments of interest to the trust funds. Net interest
paid increased from $4.2 billion in 1947 to $5.5 billion in 1958 as a
result of a steady upward trend in interest rates; however, due to
rising incomes, net interest payments fell from 2.1 percent of national
income in 1947 to 1.5 percent in 1958. Increases in interest pay
ments have weak effects on the level of income, because the marginal
propensity to spend out of interest receipts is relatively low and
because such payments are subject to rather high marginal rates of
taxation.
DEBT MANAGEMENT IN THE UNITED STATES
3
Nevertheless, interest costs on the public debt do represent a
sizable sum and are a matter for concern. And since the adminis
trative budget is frequently used as a tool of fiscal policy, for some
purposes the interest included in this budget is the important thing.
For fiscal 1960, interest payments in this budget are estimated at $9
billion, more than 11 percent of total budget expenditures, nearly
three times the estimated expenditures of the Department of Health,
Education, and Welfare, and nearly 40 percent larger than those of
the Department of Agriculture.
With the present emphasis on balancing the budget without
raising taxes, a rise in the interest burden tends to cut into other
badly needed types of Federal expenditures. Thus, there is good
reason for trying to avoid unnecessarily heavy interest costs on the
public debt. That is, unless the increased interest payments serve
some useful economic function, we should try to reduce them.
Volume of debt operations
In addition to exaggerating the size of the debt itself and of the
interest payments on it, the statistics commonly used overstate the
magnitude of current debt operations. For example, in the calendar
year 1958, the total amount of certificates, notes, and bonds issued
by the Treasury both for cash and in exchange for maturing securities
amounted to $61.2 billion. However, out of this total, $22 billion
represented securities issued to the Treasury trust accounts and
Federal Reserve banks— almost entirely automatic (and fictitious)
transactions involving no problems of debt management— so that the
amount of securities issued to the public amounted to only $39.2
billion. Similar large differences are present in other years. Proper
evaluation of the current problems of managing the debt requires that
the transactions within the Government be eliminated from the
calculations.
Ownership of the debt
Holdings of Treasury securities by various investor groups have
undergone substantial changes in recent years. W ith respect to debt
ownership, investors may be divided into three broad categories.
1.
Investors whose holdings have declined steadily.— This category
includes insurance companies and mutual savings banks. Holdings
of mutual savings banks declined by $4.7 billion from 1948 to 1959,
while holdings of insurance companies declined by $10.8 billion during
the same period. As a result of the prosperous conditions and heavy
savings of the war period, these institutions grew rapidly during the
war, and due to the limited private demand for funds, as well as pres
sures to assist the Treasury in war financing, most of the inflow of
funds was invested in Government securities. In response to the
heavy demands for funds which have characterized the postwar period,
both of these types of institutions have steadily liquidated Govern
ment securities in order to shift their funds into more lucrative private
investments— chiefly mortgages in the case of mutual savings banks
and corporate bonds and mortgages in the case of life insurance com
panies. Liquidation of governments by these institutions has
not shown any particularly strong tendency to speed up during periods
of tight credit. The rate of liquidation appears to have slowed down
somewhat as total portfolios have become smaller.
4
DEBT MANAGEMENT IN THE UNITED STATES
2. Investors whose holdings have increased steadily.— Several classes of
investors have steadily added to their holdings of Government secu
rities in recent years. These include State and local governments,
savings and loan associations, and foreign accounts and international
agencies.
3. Investors whose holdings have fluctuated substantially.— Invest
ments in Government securities by commercial banks and by nonfi
nancial corporations have exhibited substantial fluctuations from
year to year with no discernible trend during the last decade. Fluc
tuations in the holdings of these two groups have shown a systematic
pattern related to changes in monetary policy and credit conditions,
which has made the task of conducting monetary policy more difficult
for the Federal Reserve.
Composition oj the debt
In June 1959, out of a total publicly held debt of $204.2 billion, $5
billion represented convertible bonds and $54.2 billion represented all
other nonmarketable and miscellaneous debt, chiefly savings bonds.
The remaining $145 billion was marketable securities including Treas
ury bills, certificates of indebtedness, notes, and bonds. While there
are problems connected with the savings bond program, our main
concern is the management of the marketable portion of the debt.
The percentage of the debt maturing in 1 year had risen from 24.6 in
1946 to 35.4 in 1959, while at the other end of the scale the percentage
maturing beyond 10 years had fallen from 33.9 to 17.7. The maturity
composition tends to shorten if nothing is done merely due to the pas
sage of time, while debt operations in the form of cash borrowing,
refunding operations, and debt retirement, introduce elements of
irregularity into the behavior of the composition. Each time the
Treasury refunds a maturing security by offering a new issue in ex
change, the average maturity of the debt increases at least a little
because securities having a maturity of zero are removed from the
debt and replaced by other securities. Cash borrowings may increase
or decrease the average maturity of the debt, depending on whether
the securities being issued have a maturity longer or shorter than the
existing average. Cash retirement of maturing securities lengthens
the average maturity, because the securities removed from the debt
have a maturity of zero. Consequently, the irregular pattern of debt
operations makes the maturity structure and the average maturity
behave in somewhat unpredictable fashion. Nevertheless, it is quite
clear that the maturity of the debt, however measured, has declined
substantially in recent years.
II. PRESENT DEBT MANAGEMENT TECHNIQUES
Bill financing
The Treasury bill, which may have a maturity up to 1 year, has
proved to be a very effective and useful debt instrument. Bills are
sold at auction on a discount basis, and the bill auctions seem to
interfere very little with the Federal Reserve’s freedom of action.
Until recently regular bill offerings were made only with maturity of
3 months. The Treasury has within the last year extended bill
maturities first to 6 months and then to 1 year. A t the present time,
the Treasury has outstanding 13 issues of 3-month bills, 13 issues of
6-month bills, these 2 sets forming a pattern in which 1 issue matures
DEBT MANAGEM ENT IN THE
UNITED STATES
5
and is replaced by a new bill offering each week. In addition, there
are now four issues of 1-year bills maturing once each quarter in
January, April, July, and October. The total amount of these
regular bills was $31 billion at the end of July 1959, and this portion
of the debt has been placed on a periodic rollover basis, which is
efficient and economical and minimizes interference with Federal
Reserve monetary policies. In addition to regular bill issues, the
Treasury has recently been relying mainly on bills in its tax
anticipation financing to meet seasonal gaps between receipts and
expenditures.
Fixed price issues
The Treasury also borrows by issuing certificates of indebtedness,
notes, and bonds, both to raise new cash to cover budgetary deficits
and to refund maturing securities. Although refunding could be
handled by selling new securities for cash and using the cash to retire
the maturing securities, in practice refunding is almost always handled
by means of exchange offerings. Certificates, notes, and bonds are
sold on a fixed-price basis.
Several decisions must be made before a fixed-price issue can be
offered to the public. These include the choice of a maturity, other
provisions such as call or redemption options, and the selection of the
coupon rate to be placed on the securities. In deciding upon the
maturity and terms of a particular offering, the Treasury is guided
by the advice from market experts— particularly the advisory com
mittees of the American Bankers Association and the Investment
Bankers Association—by potential investors, and by its own
independent study of market conditions The choice of the coupon
rate is made by examining the yield curve at the time of the offering.
However, it is necessary to set the interest rate on the new security
somewhat above the yield on outstanding debt of the same maturity
in order to induce the market to absorb a substantial offering.
Underwriting of short-term cash offerings
The Treasury does not make use of formal underwriting in marketing
its issues, such as is provided by investment banking syndicates in the
case of corporate offerings. However, it is customary in the case of
short-term cash offerings, such as certificates and shorter term notes,
to permit commercial bank subscribers to pay for the issue by means
of credits to Treasury tax and loan accounts, which means that banks
are, in effect, able to obtain the securities by paying only a portion
of the price equal to their reserve requirements until such time (com
monly 2 to 3 weeks later) as the Treasury transfers the funds to its
accounts at the Federal Reserve banks. The use of Treasury tax
and loan account credits provides a kind of indirect underwriting.
The banks serve essentially as underwriters, reselling or distributing
securities to other investors. The Treasury limits or discourages
bank subscriptions on longer term issues apparently on the ground
that such securities are unsuitable investments for banks. In re
stricting bank subscriptions to longer term issues, the Treasury is
probably denying itself important support that could be of great
help at times. The main underwriting device used by the Treasury
to market long-term debt is to offer a rate sufficiently attractive to
achieve the required sales.
6
DEBT MANAGEM ENT IN TH E
UNITED STATES
Refunding operations
Maturing securities are short-term liquid instruments and are
likely to be in the possession of investors who are holding them for
liquidity reasons. The securities being issued in exchange, on the
other hand, if they are of intermediate or long maturity, are more
likely to appeal to investors who want either permanent investments
or prospective short-term speculative gains. The success of a re
funding operation often depends, therefore, on the extent to which
maturing securities have been shifted from their normal owners to
investors desiring to obtain the new securities. This may require
that the terms of the new security be sufficiently attractive to create
a premium on the “ rights” (i.e., the maturing issue) in order to induce
the transactions in these “ rights” that are needed to put them in
the hands of investors who want the new issue.
Government security dealers buy and sell “ rights,” thus facilitating
their distribution, and as soon as the subscription books open, the
securities begin to trade on a “ when issued” basis. During the sub
scription period dealers buy “ rights” and sell “ when issued” securities.
These dealer operations, which contribute to the success of the ex
change and the proper placement of the new offering, are the closest
thing there is to systematic underwriting in connection with refunding
operations.
III. R E CEN T D EBT M AN A G E M EN T PROBLEMS
Shortening of debt maturities
The shortening of debt maturities has been a matter of concern to
Treasury officials, and debt management policy in the last few years
has concentrated on trying to lengthen maturities. The orthodox
theory of debt management calls for the issuance of long-term securi
ties during periods of inflation in order to preempt funds from the
capital market and reduce liquidity, and the issuance of short-term
securities in recession periods in order to increase liquidity and leave
the maximum amount of funds available for long-term investment.
However, the Treasury has had little success in following the precepts
of orthodox debt management theory and has been forced— or in
duced— to sell long-term securities in recessions. Thus, such debt
lengthening as has occurred in the last few years has taken place
largely in the recession or early recovery periods of 1953-55 and
1957-58.
The competitive position of Government securities
In recent years, the Treasury has had considerable difficulty in
selling long-term bonds. During the period of nearly 7 years since
the present administration came into office with the intention of
extending debt maturities, only $9.4 billion of bonds with a maturity
of more than 10 years has been sold to the public altogether, both for
cash and in exchange operations. Thus, the average is less than $1.5
billion per year. Nearly all the investor groups— including savings
banks, life insurance companies, pension funds, etc.— who have
traditionally shown an interest in Treasury bonds, have been reducing
their holdings steadily or at most increasing them only very slowly.
Certainly one important aspect of our debt management difficulties
appears to be the declining popularity of Government securities, par
ticularly of the longer term variety.
DEBT MANAGEM ENT IN TH E UNITED STATES
7
There are several possible explanations of the apparent deterioration
of the competitive position of long-term Treasury securities. One is
the greatly increased variability in the prices of Government securities
as monetary policy has been employed more vigorously. This in
creased variability has lowered the liquidity, particularly of longer term
Treasury securities, and reduced their attractiveness to many in
vestors. Another reason is the increased attractiveness of corporate
securities as investors’ assessments of the risks associated with these
securities have been reduced as a result of continued relatively pros
perous business conditions. The increased importance of FHAinsured and VA-guaranteed mortgages has also cut into the market
for longer term Government securities, since these mortgages are
about as safe investments as Governments and yield the investor
higher net returns. The fact that yields on Government securities
have risen relative to those on private debt during the last decade, at
the same time that the size of the publicly held Federal debt has been
declining relative to the amount of private debt outstanding, appears
to corroborate the view that Government securities have become less
attractive to investors.
Other 'problems
Interest rates have shown an increasing tendency to undergo rapid
changes at turning points in business activity, as investors have be
come more aware of the implications of flexible monetary policy.
This is rather troublesome to the Treasury, particularly at times when
an improvement in business activity begins while the Treasury is still
operating at a large deficit requiring heavy cash borrowing, as in
mid-1958. In addition, speculation in Government securities has had
a disorganizing effect on the Government securities market, especially
in the case of the 2%-percent bonds of February 1965, which were
issued in exchange for maturing securities in June 1958, at approxi
mately the time that the outlook for business activity and monetary
policy was changing from recession to recovery.
IV . PRINCIPLES OF D E BT M AN A G E M EN T
Economic effects of debt operations
As indicated earlier, we define debt management to include all
operations which affect the composition of publicly held debt. On this
definition, all debt management operations are reduced, in effect, to
the sale of one type of security and the use of the proceeds to retire
another type. Intelligent debt management requires that operations
of this kind be conducted with a view to their effects on the economy.
Suppose, for example, that the Treasury sells long-term bonds and
uses the proceeds to retire short-term debt. According to the orthodox
and widely accepted theory of debt management, such an operation
would have restrictive or anti-inflationary effects, which may be classi
fied under two headings: interest-rate effects and liquidity effects.
1.
Interest-rate effects.—A sale of long-term bonds and use of the
proceeds to retire short-term debt would force up long-term interest
rates and lower short-term interest rates. There would be secondary
readjustments in the rate structure which would depend upon the
nature of investors7 expectations, but the net result would very likely
be somewhat higher long-term rates and somewhat lower short-term
50438— 60------ 2
8
DEBT M ANAGEM ENT IN TH E
UNITED STATES
rates. Whatever restrictive effect such n operation might have by
way of interest rates would depend upon the restrictive effects of
rising long-term interest rates exceeding the stimulative effects of
falling short-term interest rates. Such evidence as is available sug
gests that interest sensitivity of expenditures is rather low. Since it is
doubtful whether within moderate limits an increase in the general
level of interest rates has strong effects, it becomes even more dubious
whether the net effect of raising one rate and lowering another would
amount to much. In fact, the presence of a net restrictive effect
assumes that the interest elasticity of expenditures with respect to
long-term interest rates is greater than the elasticity with respect to
short-term interest rates, and, while one might suspect that this is
true, there is really little evidence to support it. As far as the interestrate effects are concerned, debt management involves second-order
adjustments of variables whose first-order importance is open to
question.
2.
Liquidity effects.— Since the liquidity of an asset depends upon
the variability of its price and since prices of short-term securities
ordinarily fluctuate less than prices of long-term securities, an opera
tion of the type we are considering would decrease liquidity somewhat
by reducing the liquidity of the buyers of long-term securities and in
creasing the liquidity of sellers of short-term securities by a lesser
amount. Apart from the interest-rate effects referred to above, how
ever, it is not entirely clear why such changes in liquidity would
produce changes in income-generating expenditures. Moreover, the
importance of such restrictive effects as may be present is doubtful,
since the total volume of liquid assets in the economy, as ordinarily
defined, is not changed. It is merely the degree of the liquidity of
assets that is affected. Empirical studies that have been made of the
determinants of expenditures, including consumption and investment,
have not produced clear evidence that the stock of liquid assets is an
important variable affecting spending under normal conditions. This
being the case, it is even more doubtful whether changes in the degree
of liquidity of a given stock of assets are likely to have important ef
fects. Again, as in the case of interest rates, the liquidity effects
produced by debt management are of the second order of importance.
Thus, neither the interest rate nor the liquidity effects of marginal
changes in the debt structure appear to be very important. More
over, to the extent that such changes do have a net effect on the pub
lic/s aggregate spending, it would appear that similar effects could be
produced by the use of monetary policy. For this reason, it is difficult
to see what can be accomplished by contracyclical debt management
policy that cannot be accomplished more efficiently by Federal Reserve
monetary policy. Debt management is a cumbersome instrument of
stabilization policy, because it is difficult to time in a flexible way, and
because the Treasury is almost unavoidably concerned about its suc
cess in raising money.
Debt management as a form of selective control
It seems better to think of marginal changes in the debt structure as
a species of selective controls, since a change in the structure of interest
rates (and also the structure of liquidity) probably has some effects on
the pattern of expenditures; that is, the expenditures stimulated by a
fall in short-term interest rates are likely to be different from those
DEBT MANAGEM ENT IN TH E UNITED STATES
9
discouraged by a rise in long-term interest rates. Unfortunately,
however, our knowledge concerning the effects on the expenditure
pattern of changes in the interest rate structure is quite unsatisfactory.
Moreover, to the extent that we may desire to use changes in the rate
structure as a selective control, it is much more sensible to leave such
operations to the Federal Reserve. It may be noted that under our
definition, to the extent that the Federal Reserve departs from the
prevailing bills-only policy and engages in operations which change
the maturity structure of its portfolio in order to produce selective
effects, it is engaging in debt management.
The existing debt as an automatic stabilizer
It is useful to distinguish between the debt structure at any par
ticular time and marginal changes in the debt structure. The above
discussion deals entirely with marginal changes and suggests that
their importance may not be particularly great. However, the debt
structure at any particular time conditions the way in which the
economy and particularly the financial system react to external
disturbances. For example, if the public debt consists entirely of
short-term securities, monetary controls may not take effect very
strongly, because it is easy for financial institutions and other economic
units to mobilize funds for spending through transactions in short-term
securities. Since these securities are close substitutes for money, it is
likely to be possible to find buyers for them among holders of idle cash
balances without producing sufficient changes in interest rates to have
a strong restrictive effect on expenditures.
If investors hold predominantly long-term securities, their ability
to shift their holdings to someone else when they need funds to lend
or spend is likely to be somewhat less. The fact that long-term
securities fluctuate in price more than short-term securities as interest
rates change means that there is somewhat more friction set up to
slow down this process of shifting. Thus, a debt consisting predomi
nantly of long-term securities may act as a kind of automatic stabilizer,
contributing to the stability of the economy and the effectiveness of
monetary policy.
This suggests that those responsible for debt management should
concentrate more on trying to maintain a debt structure which con
tributes to economic stability without worrying so much about the
timing of the marginal adjustments necessary to achieve and maintain
this structure. It is impossible, however, in our present state of
knowledge, to specify a principle which would help us determine the
optimum debt structure. But at the present time it is quite clear
that we have too much short-term debt and that the debt should
be lengthened.
While the structure of the debt is a matter of some importance,
its influence should not be exaggerated. As suggested above, long
term debt may make the economy more resistant to external dis
turbances because it is more resistant to shifting, but we must re
member that long-term debt can be shifted also. If expenditures are
insensitive to interest rate changes, captial losses on sales of long
term debt by financial institutions can be compensated for by charging
a higher interest rate on private debt. There is probably something
to the “ locked-in” effect, and the likelihood that investors will be
10
DEBT MANAGEM ENT IN TH E UNITED STATES
locked in will be somewhat greater if they hold long-term debt.
But it is a matter of degree.
Interest cost of the debt as a policy consideration
As indicated earlier, the interest cost on the public debt is a matter
of some importance, and unless the economic effects produced by the
debt are worth the cost, there is no reason why interest has to be
paid since it is always possible to turn debt into money. Conse
quently, debt management policy must in some sense measure the
interest cost on the debt against its economic effects.
The problem of selecting the techniques for debt management which
would reduce the Treasury's interest cost to a minimum is a difficult
one, because it is necessary for the Treasury in this connection to look
ahead and try to foresee future changes in interest rates. For ex
ample, from the point of view of minimizing interest costs, it would
not necessarily be wise for the Treasury to dngage in long-term
borrowing at a particular time merely because long-term interest
rates were below short-term interest rates. If the interest rate level
was expected to fall shortly, it would be better to postpone long
term borrowing until the level had fallen, because long-term borrowing
fixes interest cost for many years into the future.
The interest rate structure in periods of recession and easy money
tends to be one in which the short-term interest rate is substantially
below the long-term. As business conditions improve, credit tightens
and interest rates rise, short-term interest rates normally rise sub
stantially more than long-term interest rates so that in times of pros
perity and tight credit it often happens, as has been the case recently,
that short-term interest rates are higher than long-term. Although
the movements of the interest rate structure are quite complex
and difficult to predict in detail, when interest rates move in this way
one thing is reasonably clear, namely, that from the standpoint of
minimizing interest costs the Treasury should attempt to sell long
term securities and lengthen the debt in periods of recession when
interest rates are low. Strictly speaking, of course, it should probably
be raising some funds in many maturity sectors at most times since
cost minimization requires the equalization of marginal costs of
raising funds in all sectors, but minimization of interest costs would
appear to require an increased emphasis on long-term borrowing when
interest rates are low.
Combining economic stabilization and cost minimization
While our knowledge of the economic effects of the debt and of the
costs associated with various time patterns of debt operations is not
sufficient to permit the promulgation of highly specific rules governing
debt management, the above considerations suggest that it would be
desirable to lengthen debt maturities in order to achieve and maintain
a more satisfactory structure and that the timing of marginal changes
in the debt structure is not of major importance. There is something
to be said for emphasizing debt lengthening operations in periods of
recession when interest rates are low in order to keep down the
Treasury's interest costs. Moreover, there would be advantages in
reducing the emphasis on long-term borrowing in periods of prosperity
and inflation in order to minimize interference with Federal Reserve
policy, since short-term borrowing is less likely to require support from
the Federal Reserve or relaxation of a restrictive monetary policy.
DEBT MANAGEM ENT IN TH E UNITED STATES
11
Federal Reserve open-market policy
If debt management conducted along the above lines should inter
fere with the achievement of economic growth and stability, the Fed
eral Reserve should be prepared to intervene by means of open-market
purchases or sales in whatever maturity sector seemed most appro
priate. Since 1953, the Federal Reserve has adhered to the so-called
“ bills-only” policy under which it has confined its open-market opera
tions to short-term securities. This policy was adopted partly to
minimize the extent of interference with market forces and partly to
encourage the development of a stronger Government securities mar
ket. The philosophy of minimum intervention is inappropriate under
present conditions, and the “ bills-only” policy has not succeeded in
strengthening the Government securities market. Accordingly, it
would appear desirable for the Federal Reserve to abandon the “ billsonly” policy and be prepared to intervene in any maturity sector of the
market when such intervention would help to minimize undesirable
speculative activity, prevent meaningless short-run fluctuations in
Government security prices, or help to achieve economic growth and
stability. Most of the Federal Reserve’s open-market operations
which are merely designed to keep the money market on an even keel
would, of course, continue to involve purchases and sales of short-term
securities.
V . SUGGESTIONS FOR IM PROVIN G DEBT M AN A G E M EN T
The analysis presented herein suggests (1) that the Treasury seek
to extend the maturity of the public debt, (2) that efforts in this regard
be conducted with a view to keeping down interest costs, which means
emphasizing long-term borrowing in periods of recession and low interes rates, (3) that the Federal Reserve be prepared to intervene in a
flexible and effective manner if the effects of Treasury debt operations
along these lines should prove undesirable, and (4) that the Federal
Reserve be assigned full responsibility for managing the interest rate
structure for the purposes of achieving economic stability and a
smoothly functioning capital market. This does not mean that the
Treasury should make no effort to borrow at long term during pros
perous periods. It is merely suggested that if other policies are prop
erly coordinated with debt management, long-term borrowing in
recessions is likely to do little harm and will save the Treasury interest
money.
Relation of debt management to other policies
The magnitude of the Treasury’s debt management problems de
pends to a considerable extent upon the kinds of monetary and fiscal
policies that are being followed. Three aspects of this relationship
are worthy of consideration.
1.
The mix of monetary and fiscal policies.—Within limits, monetary
policy and fiscal policy are substitutes for purposes of economic
stabilization. However, the allocation of resources between con
sumption, private investment, and the production of Government
services win be affected by the combination of monetary and fiscal
policies chosen. For example, if we want to achieve a more rapid rate
of growth, reduction in interest rates to encourage investment, com
pensated for by increases in taxes which reduce consumption, will
12
DEBT M ANAGEM ENT IN TH E UNITED STATES
contribute to our objectives. Consequently, under present conditions,
there is much to be said for an easier monetary policy and a tighter
fiscal policy. In addition to encouraging growth, such a change in
our policies would reduce the magnitude of our debt problems in two
ways: (1) larger surpluses and/or smaller deficits in the cash budget
would result in a lower rate of growth (or perhaps even a decline) in the
size of the publicly held debt, and (2) lower interest rates resulting from
easier monetary policies would save interest costs to the Treasury and
would make effective debt management easier to achieve,
2. General versus selective monetary controls.— Under present con
ditions, there is much to be said for greater reliance on selective credit
controls directed at some of the sectors of the economy which have
exhibited excessive instability. For example, serious consideration
should be given to selective controls in the area of consumer credit
including housing, and perhaps more effective control over bank lend
ing to stabilize inventory fluctuations. In addition to helping us to
maintain stability of growth and employment, these controls might
mitigate the inflation problem by reducing the magnitude of shifts in
demand. In addition, more reliance on selective controls should
simplify our debt management, since most types of selective controls
exert their impact by reducing the demand for credit directly, rather
than through interest rates. That is to say, a monetary policy relying
more on selective controls would presumably require smaller increases
in interest rates to achieve a given restrictive effect than would a
policy relying entirely on general controls. If this should prove to
be the case, there would be some saving in interest costs to the Treas
ury.
It is very important to emphasize, however, that we should not
adopt policies of the kinds just discussed merely because they save
the Treasury interest money, reduce the public debt, and simplify
the problems of debt management. We should select the proper
combination of fiscal and monetary policies, on the one hand, and the
proper mix of selective and general monetary controls, on the other,
on the basis of the impact these policies have upon the economy.
Debt management, while a matter of some importance, is distinctly
subsidiary to the selection of proper monetary and fiscal policies.
It just happens that under present conditions, the adjustments in
the policy mix that seem to be called for would incidentally reduce
interest costs and simplify our debt management problems somewhat.
3. Open-market operations versus reserve requirement changes.— In
the conduct of its general monetary policy directed at control of the
money supply, the Federal Reserve has a choice between the use of
open-market operations and changes in reserve requirements. In
recent years, the System has relied on open-market operations for
short-run stabilization of the economy, but appears to be engaged in
a program of secular reduction of member bank reserve requirements.
Reserve requirements have been lowered several times during the
recessions of 1953-54 and 1957-58, while they have not been increased
since 1951. Thus, reserve requirements have been adjusted down
ward particularly during recession periods, apparently for the purpose
of supplying the reserves needed to support economic growth.
The use of open-market purchases of Government securities to
supply reserves to the banking system has an advantage, from the
standpoint of the Treasury, over reductions in reserve requirements,
DEBT MANAGEM ENT IN THE
UNITED STATES
13
since open-market purchases absorb securities into the Federal Re
serve System's portfolio and since most of the interest on that port
folio is returned to the Treasury at the end of the year. There are,
of course, other differences between open-market purchases and lower
ing of reserve requirements. Lower reserve requirements tend to
result in larger profits for the commercial banking system. In addi
tion, lower reserve requirements increase the amount of money and
credit that can be created per dollar of additional reserves and thereby
increase the leverage of Federal Reserve policy somewhat. Aside
from these factors, it is difficult to see that there are any significant
observable differences in the impact of these two credit control
weapons. On the other hand, it appears that there would be signifi
cant savings in interest to the Treasury if the Federal Reserve would
desist from further lowering of reserve requirements and supply the
reserves needed to support growth by open-market operations. Unless
it can be demonstrated that the other effects on bank earnings or on
the leverage of monetary policy would be unduly harmful, there is
much to be said for relying on open-market operations to supply
reserves in future years, leaving reserve requirements at their present
levels.
Possible improvements in debt management technique
The techniques used in debt management should be, insofar as pos
sible, the ones which permit the Treasury to sell the desired securities
at minimum cost under any given circumstances. Several changes in
technique which might be worthy of consideration can be suggested.
1. Auctioning of longer term securities.— The auction technique has
proved to be highly successful in connection with the sale of Treasury
bills, and there might be some advantages in extending it to long-term
securities. One possible advantage would be that each block of securi
ties would presumably be sold at the highest price its buyer would be
willing to pay, and as a result the Treasury's interest cost might be
reduced. There are other advantages and some disadvantages, one
of which might be the greater risk imposed on the investor, which
might mean that the auctions would be dominated by skilled market
professionals so that the market would be narrowed and collusive
bidding might develop. Despite difficulties, the device seems promis
ing enough to be worth extending to securities of longer maturity than
bills, at least on an experimental basis.
2. Frequent small offerings.— It is possible that small offerings of
longer term securities made at frequent intervals would help the
Treasury to secure a larger share of the current flow of saving. There
are difficulties related to the fact that, in order to keep the number of
issues from multiplying inordinately, it would be necessary to reopen
existing issues, but there should be ways of solving this problem. At
first glance, it might appear that such an approach to debt manage
ment would mean that the Treasury would be interfering with the
Federal Reserve's freedom of action most of the time. However, the
opposite might well be true— that the smallness of the offerings would
result in a minimum of interference.
3. More effective underwriting.— One of the Treasury's difficulties
has been that it has had inadequate underwriting support, much less
than is used in private fmancing. One possibility deserving of con
sideration would be to have the Federal Reserve banks perform the
14
DEBT MANAGEM ENT IN TH E UNITED STATES
underwriting function for the Treasury, buying up part of a Treasury
issue of long-term securities and reselling it to the public over a period
of time. A procedure along these lines has been used successfully
in England, where the amounts of long-term issues not subscribed by
the public are subscribed by the Issue Department of the Bank of
England and then gradually resold to the public. In the event it is
felt that the Federal Reserve should confine itself primarily to eco
nomic stabilization, perhaps some other institutional arrangement
could be made.
4. Advance refunding.— Advance refunding means offering to hold
ers of an existing security the option of turning it in for a newly issued
security before maturity. As longer term securities approach matu
rity, they frequently fall into the hands of in vestorswho are interested
in them as liquidity instruments, and when they mature it is difficult
to interest such investors in exchanging them for long-term securities.
Judicious advance refunding would catch these securities before they
left the hands of those who were holding them as investments and
offer a new longer-term security in exchange at that point. Legisla
tion passed in the last session of Congress eliminated technical ob
stacles and paved the way for the introduction of advance refunding.
The Treasury has expressed strong interest in advance refunding as a
means of dealing with a large volume of intermediate-term debt sched
uled to mature in a few years. Used carefully and in moderation,
advance refunding could be a useful way of attaining a more viable
debt structure.
5. Call features.— The presence of a call feature in a Treasury secu
rity gives the Treasury greater possibilities of being able to take ad
vantage of favorable movements of interest rates in future years.
The Treasury has issued no callable securities in the last few years.
In view of the fact that call features are commonly included in corpo
rate securities, it seems quite possible that inclusion of such a feature
might frequently be well worth the extra immediate cost involved.
6. Better selling organization.— A more vigorous program for pro
moting the sale of Government securities by the Treasury might pay
big dividends in broadening the market and reducing the Treasury’s
interest cost. The recent spectacular success of the 5 percent note
maturing in August 1964, which attracted over 100,000 subscriptions
of less than $25,000 each, aggregating nearly $1 billion, suggests that
there is a market that has not been adequately tapped. The develop
ment of a more extensive selling organization by the Treasury to
attract the interest of small investors as well as of smaller financial
institutions far removed from the main centers of finance, would
probably be well worth the cost. The facilities of the Federal Reserve
banks might also be used.
7. Purchasing-power bonds.— It has been suggested recently that
the Government might issue bonds whose redemption value (and
interest payments, if any) are tied to the Consumer Price Index.
The best candidate for this would be savings bonds, which have been
a source of substantial cash drains to the Treasury in the last few
years. The issue here is not one of saving interest cost, since there is
no assurance that savings would result. Rather, it is a question of
balancing equity considerations against the dangers of setting up
expectations which might intensify the problem of inflation. On
balance, there is much to be said for the view that it is a proper funo
DEBT MANAGEM ENT IN THE UNITED
STATES
15
tion of the Government to provide the small, unsophisticated investor
with a form of investment which contains protection against the
erosion of his wealth through inflation.
V I.
THE IN T E R E ST -R A TE
CEILING
In recent months there has been much discussion of the desirabil
ity of raising or eliminating entirely the interest-rate ceiling of 4}i
percent applicable to marketable Treasury securities having a matu
rity of more than 5 years. The controversy concerning the interestrate ceiling is the culmination of a period of nearly 10 years during
which interest rates have drifted steadily upward with only brief
interruptions. The tight-money periods of early 1953, 1955-57, and
1958-59 have greatly overbalanced the effects of easier money in the
intervening periods. Even during 1958, while the economy was still
in the midst of a recession, speculative activity in the Government
securities market at midyear was permitted to drive interest rates up
sharply, and restrictive monetary policy has driven them even higher
in recent months. Clearly, tight money has not been effective in
achieving its objective of stopping inflation. At the same time, even
in such prosperous years as 1956 and 1957, growth has been slow or
nonexistent.
There has been a tendency recently to view high and rising interest
rates as a result of the worldng of inexorable economic laws. There
is insufficient recognition of the fact that there are other methods
besides general monetary policy which can be used to control infla
tion; for example, we could place more reliance on fiscal policy and
selective credit controls, a combination which would achieve a given
restrictive effect with lower interest rates. Nor is enough attention
given to the contention that general monetary controls have an
uneven impact and that under present conditions such controls may
slow down economic growth without stopping inflation.
The interest-rate ceiling is an arbitrary limitation with no analytical
justification, and it should accordingly be repealed in order to give
the Treasury more freedom to manage the debt effectively. At the
same time, however, it is very important that our present, stabilization
policies be thoroughly reexamined.
CHAPTER I
THE FEDERAL DEBT IN PERSPECTIVE
,
INTRODUCTION
There are several different concepts cf the public debt which are
employed in discussions of debt management. On June 30, 1959, the
“ total gross debt” or “ total Federal securities outstanding,” amounted
to $284.8 billion.1 The gross debt reached a peak level of $279.8
billion in February 1946 at the zenith of borrowing connected with the
financing of World War II, then declined to $252.4 billion in June
1948, as a result of the immediate postwar budget surpluses and debt
retirement.2 From mid-1948 to mid-1959, the gross debt grew by
$32.4 billion.
However, the gross public debt does not represent the net debt of
the Federal Government. As shown in table 1-1, at the end of the
fiscal year 1959, out of the gross public debt of $284.8 billion, $54.6
billion was held by Government agencies and trust funds, i.e., within
the Federal Government itself. The debt that is significant for most
aspects of economic analysis is the amount of debt held by the public—
that is, by the households, business firms, commercial banks, and other
financial institutions of the country.3 Changes in the amount and
composition of the debt held by the public affect interest rates, credit
availability, and the liquidity of spending units in ways to be discussed
at length later on, and these effects may influence the level and compo
sition of private expenditures.4 On the other hand, debt held by
Government agencies and trust funds is really fictitious debt; not only
is it not a part of the asset structure of the private sector of the
economy, but in addition, the interest on such debt represents merely
a transfer within the Federal Government.5
1 On this date, the total gross debt of $284,817 million included public debt of $284,706 million and guaran
teed securities of $111 million. The Second Libery Bond Act (31 U.S.C. 757b), as amended by an act passed
June 30,1959, provides that the face amount of securities issued under authority of that act and the face
amount of obligations guaranteed as to principal and interest by the United States shall not exceed a total
of $285 billion outstanding at any one time, except that under the act of June 30,1959, the total was tempo
rarily increased to $295 billion for the period beginning July 1, 1959, and ending June 30,1960. Obligations
issued on a discount basis and subject to redemption prior to maturity at the option of the owner (e.g.,
U.S. savings bonds) are included in the statutory debt limitation at current redemption value. On June
30, 1959, the total amount of debt subject to the statutory debt limitation was $284,398 million. (Treasury
Bulletin, September 1959, p. 1 and p. 24.)
2In February 1946, the Treasury held a total of $24.4 billion in war-loan deposits at commercial banks.
Most of this represented borrowing in excess of the needs of war finance, and by the end of 1946, the Treasury
had drawn down its war-loan deposits to $2.6 billion. Nearly all of this reduction was used to retire debt
held by commercial banks, such retirement amounting to $18.8 billion. In a sense, this was fictitious debt
retirement, since the Treasury had overborrowed from commercial banks and used its excess balances in
the banks to retire excess debt. (See Henry C. Murphy, “ The National Debt in War and Transition”
(New York: McGraw-Hill, 1950), pp. 227-229). However, in the fiscal years 47 and 48 1948, the Treasury
had substantial budget surpluses which it devoted to debt retirement.
3It is customary to include State and local government units in the private sector of the economy on the
grounds that their economic decisions, unlike those of the Federal Government, are affected by many of
the same factors that influence private economic units.
* See ch. IV.
6See the discussion of the trust funds in the appendix to this chapter.
17
18
DEBT MANAGEM ENT IN TH E UNITED STATES
T a b l e 1 -1 .- —O w n e rs h ip o f U .S . G overnm ent se c u ritie s, f is c a l y e a rs 1 0 4 6 -5 9
[Billions of dollars]
Total gross
debt1
End of fiscal year
1946________________________
1947________________________
1948________________________
1949________________________
1950________________________
1951________________________
1952________________________
1953________________________
1954________________________
1955________________________
1956________________________
1957________________________
1958________________________
1959__________________ ____ Net change 1946-59........
Less: Held Equals: Held
by U.S.
outside Fed
Government eral Govern
ment
agencies and
trust funds
Less: Held
by Federal
Reserve
System 2
Equals: Held
by public3
269.9
258.4
252.4
252.8
257.4
255.3
259.2
266.1
271.3
274.4
272.8
270.6
276.4
284.8
29.1
32.8
35.8
38.3
37.8
41.0
44.3
47.6
49.3
50.5
53.5
55.6
55.9
54.6
240.8
225.6
216.6
214.5
219.6
214.3
214.9
218.5
222.0
223.9
219.3
215.0
220.5
230.2
23.8
21.9
21.4
19.3
18.3
23.0
22.9
24.7
25.0
23.6
23.8
23.0
25.4
26.0
217.0
203.7
195.2
195.2
201.3
191.3
192.0
193.8
197.0
200.3
195.5
192.0
195.1
204.2
14.9
25.5
-10.6
2.2
-12.8
1Includes guaranteed securities.
2 Includes securities owned outright and held under repurchase agreements.
3 Includes State and local governments.
Source: Treasury Department.
The consolidated accounts of trust funds and other government
agencies have consistently had current operating surpluses— excesses
of current receipts over current expenditures— in every fiscal year
since World War IT up to 1959. In fiscal 1959, Government agencies
and trust funds (including Government-sponsored enterprises) had a
deficit on current account of $2.6 billion. The trust account deficit
of $1.5 billion was the result of temporary factors. The accounts are
expected to show a small surplus in fiscal 1960, and the expectation
over the next decade is for the reappearance of substantial surpluses
in these accounts.6 Government agencies and trust funds invest the
excess of their current receipts over current expenditures in Govern
ment securities. As a result of such surpluses, these units increased
their holdings of Government securities by $25.5 billion in the 13-yea.r
period from mid-1946 to mid-1959, as shown in table 1-1. In conse
quence, the amount of Federal securities held by investors other than
the Federal Government itself declined by $10.6 billion despite the
fact that the gross public debt increased by $14.9 billion.
BUDGET AND DEBT
ACCOUNTS
When the Government operates at a deficit— i.e., with expenditures
in excess of tax collections— the deficit must, in general, be financed
either b}7 drawing down existing cash balances or by borrowing. On
the other hand, when there is a budget surplus, the surplus must be
used either to build up cash balances or to retire debt. Thus, there is
6 The deficit in the consolidated accounts of the trust funds in fiscal 1959 was partly due to the liberalization
of old-age and survivors and disability insurance benefits under the Social Security Act amendments of
1958. This deficit in the old-age and survivors and disability insurance program is expected to be elim
inated and replaced by surpluses in future years as contribution income increases. The temporary deficit
in the old-age and survivors insurance trust fund happened to coincide with the decline in unemployment
tax collections and the increase in unemployment benefit payments caused by the recession. Thus in fiscal
1959 the old-ase and survivors insurance trust fund incurred a deficit of $1.3 billion and the unemployment
trust fund a deficit of $1.1 billion. (Treasury Bulletin, September 1959, pp. 8-9.) For projections of trust
fund receipts and expenditures, see Otto Eckstein, “ Trends in Public Expenditures in the Next Decade”
(Committee for Economic Development, 1959), pp. 42-43.
DEBT MANAGEM ENT IN THE
UNITED STATES
19
a necessary interlocking relationship between the budget surplus or
deficit, the change in the Treasmy’s cash balance, and the change in
debt. However, there are various concepts of budget and debt that
may be employed.
Administrative budget and gross public debt
In the thirteen fiscal years from 1947 through 1959, the Treasury
has had a cumulative administrative budget deficit of $25.2 billion,
as shown in Table 1-2. Of this deficit, $15.3 billion was financed by
borrowing— an increase in the public debt— while $9.9 billion was
financed by drawing down cash balances from the swollen levels
reached in the immediate postwar period. The budget situation has
ranged from a surplus of $8.4 billion in 1948 to a deficit of $12.5 billion
in 1959. The administrative budget does not include receipts and
expenditures of Government agencies and trust, funds; accordingly,
it ties in with the change in the gross public debt which reflects
borrowing from agencies and trust funds as well as from nongovern
mental sources.
T a b l e 1-2.— A d m in is t r a t iv e budget , p u b lic debt ch an g e , a n d re s u ltin g ch ange i n
T r e a s u r y ’s ca sh b a la n ce , f is c a l y e a rs 1 9 4 7 - 5 9
[Billions of dollars]
Fiscal year
Administra
tive budget
surplus (-f)
or deficit (—)
Increase (+)
or decrease
(—) in Treas
Increase (+) ury cash balor decrease lance, due to
(—) in public administra
debt1
tive budget
and public
debt trans
actions 2
1947..........................................................................................
1948............................. .................................................. .........
1949 .............................................. .........................................
1950...................................... ....... ................................... .......
1951...................... -....................................................... .........
1952......................................................................................... .
1953.................... — ............................................ — ..........
1954...... ........... ..................... ................................................
1955............... ..........................................................................
1956......................—....... ......................... ...............................
1957........................................................................ ................
1958......................................... ................................ ...............
1959............ .............................. ......................... ....................
0.8
8.4
-1.8
—3.1
3.5
-4.0
-9 .4
-3.1
-4 .2
1.6
1.6
-2.8
-12.5
-11.1
-6 .0
.5
4.6
-2.1
3.9
7.0
5.2
3.1
—1.6
-2 .2
5.8
8.4
-10.4
2.4
-1 .3
1.5
1.4
-. 1
-2 . 5
2.1
-1.1
(3)
-.6
3.0
-4 .2
Total..................... ....................................................... -
-25.2
15.3
—9.9
» Does not include guaranteed securities.
2 Does not include effects on cash balance of Government agency, and trust fund transactions clearing
through the Treasurer’s account.
5Less than $50,000,000.
Note —Detail may not add to totals due to rounding.
Source: Treasury Department.
Cash budget and net cash borrowing
Just as the gross public debt overstates the true size of the debt of
the Federal Government, the administrative budget ordinarily gives
a somewhat distorted picture of receipts and expenditures. The
reason for this is that the tax and other current receipts and the
expenditures of the trust funds and other Government agencies are
not included in the administrative budget. As shown in table 1-3,
during the 13-year period from 1946 to 1959, the cumulative current
20
DEBT M ANAGEM ENT IN TH E UNITED STATES
surplus of Government agencies and trust funds amounted to $21.7
billion. Since the administrative budget deficit amounted to $25.2
billion during this period, the combined deficit in the administrative
budget and Government agencies and trust funds amounted to only
$3.5 billion during this 13-year period. To get the cash budget
surplus or deficit, which is a commonly-used measure of the economic
impact of Government activity, it is necessary to adjust the total
receipts and expenditures of the administrative budget and trust
funds combined for certain noncash transactions. These adjustments
include the excess of the accrued discount on savings bonds and
Treasury bills, which is included in the administrative budget, over
the actual cash payments of interest on maturing bonds and bills,
which is included in the cash budget, together with certain payments
or receipts which are made directly in securities rather than in cash.
For the 13-year period covered by table 1-3, there was a cumulative
noncash deficit of $9.8 billion. Since there was a deficit on all trans
actions of $3.5 billion, and a deficit of $9.8 billion on noncash trans
actions, the difference between the two, or the balance for cash
transactions, comes to a surplus of $6.3 billion.7
T able
1 -3 .— R e la t io n s between s u r p lu s or deficit i n a d m in is tr a tiv e budget a n d
s u r p lu s or de ficit i n ca sn budget , f is c a l y e a rs 1 9 4 7 - 5 9
[Billions of dollars]
Fiscal year
Adminis Plus: Gov Less: non
ernment cash trans Equals:
trative
budget
agency or
action
cash
surplus or trust fund surplus or surplus or
deficit (—) surplus or deficit (—) 2 deficit (—) a
deficit (—) 1
1947...............................................................................
1948...............................................................................
1949...............................................................................
1950........................ .......................................................
1951................................................................................
1952................................................ ..............................
1953___ ____ — .............................................................
1954— ............................................ ..............................
1955....................................................................... .........
1956____________________________ ______ ________
1957............................................................. — ..............
1958................................................. ...............................
1959-____ ______________________
_____ ___
0.8
8.4
—1.8
—3.1
3.5
—4.0
-9 .4
—3.1
—4.2
1.6
1.6
—2.8
-12.5
Total_____________________________________
-25.2
0.9
2.6
2.2
—.2
3.9
3.9
3.8
2.4
.9
1.9
1.4
-2 .6
—5.0
2.1
—.7
—1.2
—.3
—.3
—.5
—.6
—.6
—.9
.8
—.5
-2 .2
6.6
8.9
1.1
-2 .2
7.6
.1
—5.2
—.2
—2.7
4.5
2.1
—1.5
-13.0
21.7
-9 .8
6.3
.9
1Includes operations of Government-sponsored enterprises.
2 Includes (a) excess of accrued discount on savings bonds and Treasury bills over cash payments of
interest on savings bonds and bills redeemed; (6) net issuance of securities to cover expenditures or refunds
of receipts, including adjusted service bonds, Armed Forces leave bonds, special notes issued to the Inter
national Bank and the International Monetary Fund, and excess profits tax refund bonds, and (c) adjust
ment for checks in transit, etc., to put receipts and payments on a cash basis.
* Reflects cash receipts and payments in budget accounts, trust and deposit fund accounts, and Govemment-sponsored enterprises. Also includes receipts from exercise of monetary authority, chiefly seigniorage
on silver.
N o te .— D etail m ay not add to totals due to rounding.
Source: Treasury Department.
7 In addition to cash receipts from taxes and cash payments to the public reflecting Government expendi
tures, the cash budget as presented in tables 1-3 and 1-4 includes a small amount ($600,000,000 for the 13-year
period) of receipts from the exercise of monetary authority (chiefly seigniorage on silver purchases).
DEBT MANAGEMENT IN THE UNITED
STATES
21
T a b l e 1—4. — F e d e r a l G o vernm ent c a s h tra n s a c tio n s w ith p u b lic , f is c a l y e a r s 1 9 4 7 —5 9
[Millions of dollars]
Fiscal year
Plus: nut
Equals:
Cash
cash borrow increase or
surplus or
ing from
decrease (—)
deficit (—) 1 the public,
Treasury
or repay
cash
ment (—) 2
balance3
1947................................ .............. ............................ .................
1948.................. ............................................................................
1949....................... ..................................... ......................... ........
1950............................................ .......... ............ ........................
1951.................. ..................................................... ......................
1952................................................................................... ..........
1953.......... ....................................................................................
1954.......................................... ....................... .................... ......
1955................................................................................... ...........
1956............................................................. ..................................
1957...............................................................................................
1958................................. ..............................................................
1959............................................................. ...... ............................
6.6
8.9
1.1
—2.2
7.6
.l
-5 .2
—.2
—2.7
4.5
2.1
—1.5
-13.0
Total................. ............................................................
6.3
—19.4
—7.3
—2.5
4.2
—5.8
—. 5
2.9
2. 5
1.8
-4 .4
—3.1
5.8
8.6
4—12.7
1. 6
—1. 5
2.0
1.8
—.4
—2.3
2.4
—.9
.1
—1.0
4.3
-4 .4
-17.1
4-1 0 .8
1Reflects cash receipts and payments in budget accounts, trust and deposits fund accounts, and Govern
ment-sponsored enterprises. Also includes receipts from exercise of monetary authority, chiefly seigniorage
on silver.
2 Includes net borrowing by Treasury through public debt transactions and net borrowing by Govern
ment agencies and Government-sponsored enterprises through sales of their own securities. Excludes
changes in public debt that do not represent direct cash borrowing from the public.
3 Reflects changes in balance in Treasurer’s account and in cash held outside Treasury.
4Includes withdrawal of $1,800,000,000 from Exchange Stabilization Fund in 1947 to pay subscription
to capital of International Monetary Fund.
N ote .— D etail m ay not add to totals due to rounding.
Source: Treasury Department.
A cash deficit must be covered by cash borrowing from the public
or by drawing down the Treasury’s cash balance, while a cash surplus
must be used to retire debt for cash or to build up the Treasury’s cash
balance. Table 1-4 indicates that for the period 1947-59, the Treas
ury used its cash surplus of $6.3 billion, together with a reduction of
$10.8 billion in its cash balances to retire debt for cash in the amount
of $17.1 billion.
The contrast between table 1-2, covering the administrative budget
and change in the public debt, and table 1-4, setting forth the Treas
ury’s cash operations, is especially notable. While the administrative
budget for the period 1947-59 shows a deficit of $25.2 billion, the cash
budget shows a surplus of $6.3 billion. Similarly, while the public
debt increased by $15.3 billion, the Treasury actually engaged in net
debt retirement for cash in the amount of $17.1 billion. The cash
budget is probably a considerably better measure of the short-run
economic impact of Federal Government activities than is the admin
istrative budget.8 And net cash borrowing or debt retirement is even
more certainly the best available measure of net impact of Federal
borrowing and debt retirement activities on the capital markets,
8 The budget as shown in the national income accounts differs from the administrative budget and the
cash budget with respect to both coverage and timing; this budget is probably the best measure available
of the fiscal impact of Government activities. Actually, however, there is no single entirely satisfactory
measure of this impact. The fiscal impact of some types of Government expenditures may come shortly
after orders are placed with private business concerns for the production of goods and services, rather than
at the time payment is made (which is the point at which the expenditures would be reflected in the admin
istrative or cash budgets) or at the time the goods are shipped (when the expenditures would be entered
in the national income and product budget). On the problem of measuring the fiscal impact of Govern
ment activity, see Murray L. Weidenbaum, “ The Federal Government Spending Process,” in “ Federal
Expenditure Policy for Economic Growth and Stability,” papers submitted by panelists appearing before
the Subcommittee on Fiscal Policy of the Joint Economic Committee (Washington: U.S. Government
Printing Office, 1957), pp. 493-506.
22
DEBT M ANAGEM ENT IN TH E UNITED STATES
although, of course, the volume of refunding operations is also very
important in this connection, as we shall see.
Examination of the statistics covering Government operations
011 a cash basis does not lend support to the view that the Government
constantly engages in deficit spending and that continuous Govern
ment borrowing that has expanded the Federal debt is responsible for
serious problems of debt management. On a cash basis, the Treasury
has had surpluses in 7 of the 13 fiscal years since 1946, and, as we have
seen, has a modest net cash surplus for the entire period. Prior to
the fiscal year 1959, when the working of the automatic fiscal stabi
lizers and the discretionary increases in Federal spending to counteract
the recession resulted in an unprecedented peacetime cash deficit of
$13 billion, the cash budget showed a substantial surplus of nearly
$20 billion for the postwar period beginning in mid-1946. Similarly,
much of the $15 billion growth in the public debt since 1946 is fictitious,
representing growth in holdings of public debt securities within the
Federal Government itself resulting from large cash surpluses of
Government agencies and trust funds. On a cash basis, the Federal
Government has retired debt in 7 of the 13 years we are considering.
Total net cash debt retirement has amounted to $17 billion, and for
the period prior to the heavy deficit of fiscal 1959, such debt retirement
amounted to nearly $26 billion.
Cash borrowing and debt held outside the Federal Government
Although the Treasury retired debt to the extent of $17.1 billion
between 1946 and 1959, table 1-1 indicates that the amount of Federal
securities held outside the Government itself declined by only $10.6
billion. Table 1-5 presents a reconciliation between cash borrowing
or debt retirement on the one hand and the change in nongovern
mental holdings of Federal securities on the other. Transactions in
Government securities not involving cash payment between the
public and the Government resulted in an increase in outstanding
debt of $9.1 billion. Part of this is accounted for by an excess of
interest accruals on savings bonds and Treasury bills over actual cash
interest payments on such securities. These two classes of securities
are sold on a discount basis; that is, the interest earned by investors
on these securities takes the form of an excess of the amount paid to
the holder when the securities mature or are redeemed (in the case of
savings bonds) over the amount paid by the investor to the Govern
ment at the time the securities were originally sold. The actual cash
payments of interest at the time the securities mature or are redeemed
by the Government are included as an expenditure in the cash budget,
and correspondingly, net cash borrowing or retirement of securities
reflects only the amount of interest actually paid. However, the
debt outstanding also grows as interest accrues on these securities,
and the excess of interest accruals over cash interest payments must
be added to net cash borrowing in order to arrive at the change in the
nominal value of Federal securities outstanding. The remaining
amount of noncash transactions affecting the size of nongovernmental
holdings of Federal securities is accounted for by expenditures paid
through the direct issuance of securities rather than in cash. The
two main components were the issuance of special notes to the Inter
national Monetary Fund in payment of a portion of the U.S. subscrip
tion of capital to that institution and the payment of terminal leave
DEBT MANAGEMENT IN THE UNITED STATES
23
to members of the Armed Forces through the issuance of Armed Forces
leave bonds.9
T a b l e 1-5 .— S u m m a r y o f o p e ra tio n s affe ctin g p u b lic h o ld in g s o f F e d e r a l s e c u r it ie s ,
f is c a l y e a rs 1 9 4 7 - 5 9
[Billions of dollars]
Fiscal year
Plus: Non
Net cash bor cash trans
rowing from actions in
the public, or creasing or
decreasing
repayment
( - ) debt i
(-)
(1)
(2)
Equals: In
crease or de
crease (—)
in securities
held outside
Federal gov
ernment 2
Less: In
crease or
decrease (—)
in Govern
ment agency
securities
held outside
Federal Gov
ernment 3
Equals: In
crease or de
crease (—)
in public debt
securities
held outside
Federal Gov
ernment *
(3)
(4)
(5)
0.2
.1
-.1
-.2
1947_________________ ____—
1948_____ _____ ____________
1949________________________
1950________________________
1951 .. __________________
1952_______ ________________
1953 ___________ ____ _______
1954______ _________________
1955____________________ ____
1956_____ __________________
1957___________________ _____
1958______________ __________
1959________________________
-19.4
—7.3
-2.5
4.2
—5.8
-.5
2.9
2.5
1.8
—4.4
—3.1
5.8
8.6
4.4
-1.6
.3
.6
.5
.7
.7
.6
.6
.6
- .3
—.2
2.2
-15.0
-8.9
—2.2
4.9
-5.3
.2
3.6
3.1
2.5
-3.7
-3.4
5.6
10.7
—.4
.6
.9
.9
.1
1.0
—15.2
—9.0
—2.1
5.1
-5.3
.6
3.6
3.5
1.9
—4.6
—4.3
5.5
9.7
Total.......................... ......
-17.1
9.1
-8.0
2.6
-10.6
- .4
1Includes excess of accrued discount on savings bonds and Treasury bills over cash payments of interest
on savings bonds and bills redeemed; also includes net issuance of securities to cover expenditures or refunds
of receipts, including adjusted service bonds, Armed Forces leave bonds, special notes issued to the Inter
national Bank and the International Monetary Fund, and excess profits tax refund bonds.
2Includes public debt securities and securities issued by Government agencies and Government-spon
sored enterprises.
3 Estimated as a residiual by subtracting amounts shown in column (5) from column (3).
* Changes in holdings of public debt (including guaranteed) securities by the public (including State and
local governments) and the Federal Reserve System.
N o t e .— Detail may not add to totals due to rounding.
Source: Treasury Department.
When the increase in outstanding debt due to noncash transactions
of $9.1 billion is added to the $17.1 billion of net cash debt retirement,
the net result is a declinc of $8 billion in securities held outside the
Government. However, the statistics on cash borrowing and on
noncash debt transactions include security issues of Government
agencies, which are not included in the public debt. Net borrowing
from the public by Government agencies during the 13-year period
is estimated at $2.6 billion. Thus, there was a reduction of non
governmental holdings of public debt securities of $10.6 billion, as
shown by the Treasury surveys of ownership as reflected in table 1-1,
and an increase of $2.6 billion in nongovernmental holdings of Gov
ernment agency securities, resulting in a net reduction in holdings of
public debt and Government agency securities of $8 billion, as shown
in table 1-5.
A comparison of columns (1) and (5) of table 1-5 indicates that
there is a rough correspondence between net cash borrowing or debt
retirement and changes in nongovernmental holdings of Government
securities. We shall be concerned chiefly in this study with changes
9 When these securities arc redeemed for cash, the amounts appear as expenditures in the cash budget.
50438 —00------ 3
24
DEBT MANAGEMENT IN THE UNITED STATES
in the size and composition of the publicly held direct Federal debt.
We will give little attention to security issues of Government agencies.
THE FEDERAL RESERVE AND DEBT MANAGEM ENT
While there may be some question about the appropriate statistical
concepts of the budget and the Federal debt, the above discussion
makes clear that the budget does set the basic framework for debt
management. That is, except to the extent that the Treasury’s
cash balances may be varied, the amount of net borrowing or debt
retirement that the Treasury must engage in is determined by the
budget deficit or surplus.10 Thus, the net change in the nominal value
of securities held outside the Federal Government during most periods
is at least a rough reflection of the budgetary situation.
The economic effects of the public debt depend upon the size and
composition of the debt held by the private sector of the economy. A
change in either the size or the maturity composition of the stock of
Federal securities held by households, firms, or financial institutions
produces changes in the liquidity position of such spending units, as
well as in the level and structure of interest rates. These changes
in turn may cause revisions in the volume or composition of incomegenerating expenditures by such economic units. These economic
effects of debt management are the main subject of our study.
Changes in the volume and composition of the debt, through the
changes they may produce in the level and structure of interest rates
also affect the interest cost to the Treasury of servicing the debt.
In addition to the economic effects, the interest cost to the Treasury
is a factor to be taken into account in deciding what is the proper
debt management policy to be followed by the Treasury.
As shown in table I -i , as of mid-1959, the Federal Reserve System
held $26 billion of Federal securities in its portfolio. Open market
operations by the Federal Reserve, which constitute the chief means
used by the System in effectuating monetary policy, produce changes
in the size and composition of this portfolio. Although the Federal
Reserve banks are privately owned, the System functions as an
agent of the Federal Government and is therefore motivated differ
ently from other private economic units. Consequently, debt held
by the Federal Reserve should not be regarded in the same light as
debt held by other private investors. Changes in the Federal Reserve
portfolio are made deliberately for the purpose of influencing the
behavior of the private sector of the economy in order to maintain
economic stability and growth or to promote other desiderata of
public policy. Moreover, interest paid by the Treasury on securities
held in the Federal Reserve portfolio is not really a net burden on the
Treasury and the taxpayers except to a minor extent. This is because
under prevailing practice, 90 percent of any additional interest pay
ments made by the Treasury to the Federal Reserve is returned to
Changes in cash balances are large enough to be a significant factor at times, however. For example, as
indicated in table 1-4, in the fiscal year 1959, the Treasury needed to borrow for cash only $8.6 billion to
finance a cash deficit of $13 billion, because it was able to reduce its cash balances by $4.4 billion to finance
the remainder of the deficit. This was possible because, in the previous fiscal year 1958, the Treasury
borrowed $5.8 billion for cash while the cash deficit was only $1.5 billion, permitting cash balances to be
built up by $4.3 billion.
DEBT MANAGEMENT IN THE UNITED STATES
25
the Treasury at the end of the year in the form of a pseudo-franchisetax payment by the Federal Reserve.11
The last column of table 1-1 shows the amounts of Federal securi
ties held by the public, including household, business firms, financial
institutions, nonprofit institutions, and State and local governments.
This concept of the public debt is obtained by subtracting from the
total gross debt, the amounts held by U.S. Government agencies and
trusts funds and by the Federal Reserve banks. This is the amount
of debt that must find lodgment with private investors, which may in
fluence economic behavior through its effects on liquidity and on in
terest rates, and which involves a significant net interest burden on
the Treasury.
We shall refer to the amount of the debt held outside the Governernment agencies and trust funds and the Federal Reserve System as
the publicly held debt. In principle at least, both the size and the
composition of the publicly held debt can be changed just as effec
tively by Federal Reserve operations as by Treasury operations. The
Treasury can affect the composition of the debt by the choice of the
types of securities it issues to finance a deficit or in connection with the
refunding of maturing securities. The Federal Reserve can exercise
similar effects when it decides what maturities of securities to buy or
sell when its policy criteria indicate that a change in bank reserves is
called for the interest of economic growth and stability; also it can
change the maturity composition of the publicly held debt without
changing the size of that debt or the money supply by simultaneously
selling securities of one maturity and buying securities of another
maturity.12
While the responsibility for managing the size and composition of
the publicly held debt is divided between the Treasury and the Fed
eral Reserve, there are differences in the powers of the two agencies.
The Treasury collects taxes and serves as the agent for the Federal
Government in spending money on goods and services, making trans
fer payments to households and the foreign sector, and making sub
sidy payments to the business sector of the economy. Since the Fed
eral Reserve’s expenditures on goods and services are of trivial im
portance, the Treasury possesses an effective monopoly at the Fedearl
level in conducting fiscal operations. On the other hand, the Federal
Reserve has a virtual monopoly on the creation of money and the con
trol of the supply of money, under its delegation of authority from
Congress. It is true that the Treasury has some powers of money
creation as a byproduct of its authority to buy and sell gold and
silver. However, gold and silver operations are ordinarily of limited
importance and are, for the most part, passive rather than active in
nature— that is, the Treasury responds to the impulses of private
buyers and sellers of gold and silver and does not normally attempt
to encourage or discourage such activities by, for example, changing
» The System pays into the Treasury each year an amount equal to 90 percent of the net earnings of the
Federal Reserve banks after payment of a 6-percent dividend on capital stock and an allowance designed
to build up surplus to 100 percent of subscribed capital. This payment takes the form of interest on that
portion of outstanding Federal Reserve notes not secured by gold certificates. See “ Investigation of the
Financial Condition of the United States,” hearings before the Committee on Finance, U.S. Senate (Wash
ington: Government Printing Office, 1957), pt. 3, pp. 1580,1582-1585.
12
There are, of course, practical limits, under present institutional arrangements, to the ability of the
Federal Reserve to change the size andcomposition of the publicly held debt, since the System is not able to
issue its own securities and is therefore limited in its sales of securities of various maturities to the amounts
contained in its portfolio. However, the existence of practical limitations does not alter the principles
involved, fand, if'desirable, there are various ways in which the limitations could be removed.
26
DEBT MANAGEMENT IN THE UNITED STATES
the prices at which it buys or sells these commodities. The Federal
Reserve deliberately produces changes in the money supply of the
economy through the use of open market operations, supplemented by
changes in reserve requirements and discount rates.
Although both Treasury and Federal Reserve operations may change the size
and composition of the publicly held debt, the differences in the authority of the
two agencies mean that the side effects of their operations may be somewhat
different. Leaving aside for the moment changes in Treasury cash balances, the
Treasury can change the size of the publicly held debt only by borrowing from
the public to finance a budget deficit or by retiring publicly held debt out of a
cash surplus. Such operations leave the money supply unchanged. On the other
hand, when the Federal Reserve changes the size of the publicly held debt by
buying or selling Government securities in the open market, it necessarily changes
the volume of bank reserves by an amount equal to its purchases or sales, and,
due to the existence of a fractional reserve banking system, tends to produce an
even larger increase or decrease in the money supply through the multiple expan
sion of bank credit. The Treasury can produce these same effects if it uses
existing balances on deposit at the Federal Reserve banks to pay for expenditures
or collects excess taxes and uses them to built up its balances at Federal Reserve
banks. However, its ability to engage in such operations is limited in one direc
tion by the amount of deposits it holds and in the other by its willingness to use
tax proceeds to add to its cash balances. While such operations by the Treasury
affecting the money supply may be important at times, it is nevertheless true
that the chief authority and responsibility for controlling the money supply rests
with the Federal Reserve.
An examination of table 1-1 indicates that the behavior of the publicly held
debt during the postwar period has been considerably different from the behavior
of the total Federal debt. Between mid-1946 and m id- 1959, the total gross debt
increased by $ 14.9 billion, but as a result of increased holdings of Federal securities
by Government agencies and trust funds and the Federal Reserve, the publicly
held debt actually declined by $ 12.8 billion. Between the end of fiscal 1948,
when the heavy immediate postwar debt retirement had been completed, and the
end of fiscal 1959, the total gross debt increased by $ 32.4 billion. However, due
primarily to large and consistent trust fund surpluses, holdings of Federal securi
ties by Government agencies and trust funds increased during this period by
$ 18.8 billion, while the Federal Reserve, in its role as monetary manager, increased
its holdings of Government securities by $ 4.6 billion. Thus, the publicly held
debt increased by only $9 billion during this period. At the end of fiscal 1958,
before the large deficit of 1959, the publicly held debt was practically the same as
at the end of fiscal 1948. That is, while there were changes from year to year,
the net change in the publicly held debt over the decade 1948 to 1958 was prac
tically zero. Moreover, as we will see later in this chapter, the size of the publicly
held Government debt in relation to other relevant economic variables, such as
national income and product and the stock of private debt, is actually sub
stantially lower than it was a decade ago.
N ET CLAIMS A G A IN ST TH E FEDERAL GO VERNM EN T
We may define the net claims of the nonbank public against the
Government as the public's holdings of Government securities plus
its holdings of deposits and currency minus its indebtedness to the
banking system. A budget deficit will increase the net claims of the
nonbank public against the Government by exactly the amount of
the deficit; similarly a budget surplus will reduce net claims. If the
Treasury sells Government securities to the public to finance a deficit,
the public's holdings of Government securities are increased directly,
and when the Treasury spends the funds so raised, the public's money
holdings are restored to their original level without any change in the
public's indebtedness to the banking system. If the deficit is fi
nanced by borrowing from the banking system, which creates new
deposits in buying the securities, the expenditure of the funds so
raised adds to the public's money holdings without changing its in
debtedness to the Danks. If the banks have to contract private
DEBT MANAGEMENT IN THE UNITED STATES
27
lending in order to accommodate the Treasury, the money supply is
not increased, since the reduction of deposits involved in the con
traction of private lending exactly matches the expansion of deposits
to accommodate the Treasury; however, net claims are nevertheless
increased as a result of the reduction of the public’s indebtedness to
the banks. If the Treasury finances the deficit by drawing down its
existing cash balances, the public’s deposits are increased directly and
nothing else is changed, thus increasing net claims. If the Treasury
borrows from the Federal Reserve, which creates new reserve bank
credit by buying the securities, the money supply is increased di
rectly; moreover, in this case bank reserves are increased permitting
multiple-credit expansion, although this expansion has no effect on
net claims because the expansion of the money supply is balanced by
either an increase in the public/s indebtedness to the banks or a
reduction in the public’s holdings of Government securities.
Thus it is apparent that no matter how a budget deficit is financed,
it produces an equivalent increase in net claims. Similarly, it can
easily be shown that a budget surplus must necessarily reduce net
claims. Thus, the main factor determining the change in the nom
inal value of the stock of net claims during any period is ordinarily
the budget. On the other hand, the composition and the market
value of the stock of net claims are influenced by a great many factors
other than the budget.
DEBT M AN A G E M EN T AND M O N E TARY POLICY
It is not easy to draw a sharp line of distinction between debt
management and monetary policy. One way to define debt man
agement would be to say that it includes all measures that affect the
size and composition of the stock of outstanding claims against the
Federal Government (including the Federal Reserve System). On
this definition, debt management would encompass all cash borrow
ing, debt retirement, and refunding operations of the Treasury, and
also all open market operations of the Federal Reserve System.
Under our present arrangements, the only measures left under the
heading of monetary policy would be changes in member bank reserve
requirements and in the discount rate.
It is possible to define debt management somewhat more narrowly,
however, as including all measures which affect the composition of
the publicly held debt. Under this definition, measures which affect
the size of the publicly held debt are included under the headings of
monetary or fiscal policy. Thus, borrowing to finance a budget deficit
and the use of a budget surplus to retire debt are regarded as b y
products of fiscal policy, while decisions by the Federal Reserve con
cerning the scale of open market purchases and sales are treated as
part of monetary policy. Thus, debt management includes the
following kinds 01 decisions:
1. Decisions concerning the types of securities the Treasury should
sell to finance budget deficits (or to build up cash balances).
2. Decisions concerning the types of securities the Treasury should
retire out of the proceeds of budget surpluses (or by drawing down
existing cash balances).13
13 In practice, the Treasury ordinarily retires securities which are maturing at the time (i.e., securities
having a zero maturity). However, there is no reason why this need be the case; cash surpluses could be
used to buy up debt of various maturities in the market.
28
DEBT MANAGEMENT IN THE UNITED STATES
3. Decisions concerning the types of securities the Treasury should
issue in refunding operations.
4. Decisions concerning the types of securities the Federal Reserve
should buy or sell to effect such changes in member bank reserves as
are called for by monetary policy.
5. Decisions concerning such swapping operations— that is, simul
taneous purchase of one type of security and sale of another— as the
Federal Reserve may engage in.
We shall adhere pretty much to this definition of debt management.
Occasionally, however, we shall find it necessary to deal with subjects
which are not covered by it, as when we discuss the possibility that the
Treasury might at times accumulate or decumulate cash balances and
when we take up the relative merits of open market operations and
changes in reserve requirements as means by which the Federal Re
serve might effect changes in member bank reserves.
CHANGES IN TH E PUBLIC DEBT SINCE W ORLD
W A R II
It was pointed out earlier that the gross public debt, which is the
most commonly used debt concept, contains important elements of
fictitious debt and that exclusive attention to it gives an exaggerated
impression of the size of the debt, its tendency to grow continuously,
and the problems of managing it. We argued that for most purposes
the publicly held debt is the appropriate concept to use, since this is
the debt which must find lodgment with private investors and on which
the Treasury must pay interest.
In studying problems of debt management, it is important not only
to employ the proper debt concept but also to consider the debt in
proper perspective— that is, in relation to other relevant economic
variables. Accordingly, we shall consider in this section the size of
the publicly held Federal debt in relation to gross national product
(GNP) and in relation to other kinds of debt, as well as the interest
cost of carrying the debt in relation to the national income. We shall
also study the behavior of these relationships since World War II and
offer some comments on their probable future behavior. In addition,
we shall examine in a general way the changes that have occurred in
the ownership of the debt and in its composition during the same
period.
T a b l e 1-6 .— P u b lic ly held debt a n d gross n a tio n a l p ro d u ct , 1 9 4 7 - 5 8
Calendar
year
1947________
1948___ ____
1949..............
1950...........
1951..............
1952...... .......
Gross
national
product
Publicly
held debt
at mid
year i
Ratio of
debt to
GNP
Billions
Billions
Percent
$234.3
259.4
258.1
284.6
329.0
347.0
$203.7
195.2
195.2
201.3
191.3
192.0
86.9
75.3
75.6
70.7
58.1
55.3
Calendar
year
1953_______
1954_______
1955_______
1956___ ____
1957-.— .......
1958..............
Gross
national
product
Publicly
held debt
at mid
year 1
Ratio of
debt to
GNP
Billions
Billions
Percent
$365.4
363.1
397.5
419.2
442.5
441.7
$193.8
197.0
200.3
195.5
192.0
195.1
53.0
54.3
50.4
46.6
43.4
44.2
1 Federal securities held outside U.S. Government agencies and trust funds and the Federal Reserve
System.
Source: Department of Commerce and Treasury Department.
DEBT MANAGEMENT IN THE UNITED STATES
29
Debt in relation to GNP
The publicly held debt is much smaller today relative to the gross
national product than was the case right after World War II. This
is shown in table 1-6, which indicates that in 1947, the midyear value
of the debt was about 87 percent of the GNP for the year, whereas by
1958 the debt was only about 44 percent of GNP. Except in the 3
recession years 1949, 1954, and 1958, the debt has fallen relative to
GNP in each year. The decline has been almost entirely due to the
rise in GNP; the publicly held debt at the end of fiscal 1958 was almost
exactly the same as it was a decade earlier.
Thus, to the extent that the GNP measures the capacity of the
economy to carry the debt, these relations suggest that the debt
should set somewhat more easily on our shoulders today than it did
a decade ago. However, it should be noted that nearly half of the
growth of GNP between 1947 and 1958 is accounted for by rising
prices. The GNP for 1958 valued at 1947 prices is estimated at
$331.2 billion.14 The 1958 debt of $195.1 billion is 59 percent of this
figure. Thus, when GNP is valued at constant prices, the ratio of
debt to GNP has fallen only from 87 percent to 59 percent, so that
more than a third of the decline in the ratio of debt to income since
1947 is due to the rise in prices.
T a b l e 1-7 .— N e t 'p ublic a n d p riva te debt o u tsta n d in g , 1 9 4 7 - 5 8
[Billions of dollars]
End of year
1947_________ ____
1948............... ..........
1949______________
1950..............-..........
1951______________
1952______________
1953............. ...........
1954______ _______
1955______________
1956______________
1957_____ ________
1958_____ ________
Total
public
and pri
vate
debt1
Total
Federal
Federal
Govern
ment
394.8
410.3
429.5
469.5
500.2
530.5
560.5
586.9
647.4
682.3
711.8
743.9
200.7
193.2
199.7
197.9
194.7
198.2
202.2
205.3
206.7
200.5
200.2
206.4
200.0
192.2
198.9
196.7
193.4
196.9
201.0
204.3
204.3
197.8
195.6
202.3
Publicly held1
Federal
agency
State
and
local
govern
ment
Corpo
rate
Individ
ual and
noncor
porate
0.7
1.0
.8
1.2
1.3
1.3
1.2
1.0
2.4
2.7
4.6
4.1
14.4
16.2
18.1
20.7
23.3
25.8
28.6
33.4
38.4
42.7
46.7
50.9
108.9
117.8
118.0
142.1
162.5
171.0
179.5
182.8
212.1
231.8
243.9
246.9
70.8
83.1
93.7
108.8
119.7
135.5
150.2
165.4
190.2
207.3
221.0
239.7
Ratio of
Federal
to total
debt
(per
cent)
50.8
47.1
46.5
42.2
38.9
37.4
36.1
35.0
31.9
29.4
28.1
27.7
i Federal securities held by Government agencies and trust funds and by the Federal Reserve System
not included.
N o t e .— Detail may not add to totals due to rounding.
Source: Department of Commerce and Treasury Department.
Public debt in relation to total debt
As indicated in table 1-7, the publicly held Federal debt has de
clined substantially during the postwar period in relation to total
public and private debt. Federal debt— including debt of Federal
agencies— was 51 percent of total net public and private debt in
1947; by 1958 this ratio had fallen to 28 percent. The decline in
the ratio was due almost entirely to a tremendous growth of private
debt and debt of State and local governments. With prosperity
14 This estimate is based on data taken from U.S. Income and Output: A Supplement to the Survey of
Current Business (Washington: Government Printing Office, 1958), and Survey of Current Business, July
1959.
30
DEBT MANAGEMENT IN THE UNITED STATES
broken only by three relatively mild and brief recessions, the demand
for funds to finance spending by individuals, by businesses, and by
State and local governments was very strong during this period,
and the result was an unprecedented growth of indebtedness of all
kinds.
The heavy demands for funds that have been responsible for the
rapid growth of debt have complicated considerably the Treasury’s
problems in managing the debt, since the Treasury has in its refunding
and cash borrowing operations had to compete most of the time
with heavy demands for funds on the part of other borrowers. How
ever, if the trend of the postwar period continues, it may presage
a considerable lessening of the burdens of debt management on the
Treasury. If prosperous conditions continue to predominate, a
continued rapid growth of non-Federal debt seems very likely.
And if the cash budget is approximately balanced on the average
over the years or if surpluses predominate over deficits, the Federal
debt will remain approximately constant in size or perhaps even
decline.15 Since Treasury securities have advantages over private
debt with respect to liquidity and safety, continued growth of nonFederal relative to Federal debt should in the course of time make it
progressively easier for the Treasury to find investors who are willing
to hold its securities. This suggests that the difficulties that, have
been experienced in managing the debt in the last few years may be
associated with the process of absorbing into the financial structure
the swollen debt inherited from World War II. If healthy growth
continues, debt management should become a less serious problem.
Of course, if another war or defense emergency should require a
large amount of borrowing, this would accentuate the problem.
And, if a run of hard times should necessitate heavy deficits to
maintain full employment, with the debt growing from year to year,
this would also serve to complicate the problems of debt manage
ment at a later time, since it would mean a slowing down of the growth
of non-Federal debt and an acceleration of the growth of Federal
debt.16
Interest on the debt
Table 1-8 indicates that net interest paid by the Federal Govern
ment has increased from $4.2 billion in 1947 to $5.5 billion in 1958,
an increase of 33 percent.17 This increase in the interest burden has
occurred in spite of the reduction in the size of the publicly held
debt between 1947 and 1958 and is the result of a relatively steady
upward trend of interest rates. The rise in interest payments has
not kept pace with the growth of national income, and, as a result,
net interest payments were only 1.5 percent of national income in
1958, as compared with 2.1 percent in 1947. Interest payments
have also grown much less rapidly than most other types of Govern
15If the Federal Reserve buys Government securities in the process of supplying reserves to support the
growth of the economy, this will also help to reduce the size of the publicly held debt.
16 For a discussion of the situation in which the debt grows because continuing deficits are necessary to
sustain high-level employment, see E. D. Domar, “ The ‘Burden of the Debt’ and the National Income,”
American Economic Review, X X X IV (December 1944), pp. 798-827, reprinted in E. D. Domar, “ Essays
in the Theory of Economic Growth” (New York: Oxford University Press, 1957), pp. 35-69.
17 Net interest payments by the Federal Government as recorded in the national income accounts contain
some other Government interest receipts and payments besides those associated with the public debt,
although these elements are relatively unimportant. On the composition of this item, see “ National In
come,” a supplement to the Survey of Current Business, 1954 edition (Washington: Government Printing
Office, 1954), p. 103, and “ U.S. Income and Output,” a supplement to the Survey of Current Business
(Washington: Government Printing Office, 1958), pp. 94-95.
DEBT MANAGEMENT IN THE UNITED STATES
31
ment expenditures; in 1947 interest payments were 33.8 percent of
total Federal Government expenditures of $31.1 billion as shown in
the national income accounts, whereas in 1958 they were only 6.3
percent of total expenditures of $87.5 billion. Thus, the interest on
the debt, like the debt itself, has fallen relative to other relevant
economic magnitudes.
T a b l e 1-8.— N e t interest p a id b y the F e d e r a l G overnm ent i n
in co m e , 1 9 4 7 - 5 8
Calendar year
1947_______ ________________
1948....... ........ ........... ...............
1949________________________
1950............................................
1951............................................
1952....... ................................
1953................................ ..........
1954....... .................. ........ .........
1955.............................................
1956.......... ........ ....... .................
1957............. .................. ............
1958_____ _____________ _____
National
income
Millions
$198,177
223,487
217,690
241,876
279,313
292,155
305,573
301,794
330,206
350,836
366,503
366,183
re la tio n to n a t io n a l
Net interest Ratio of net Payment by Computed
Federal
paid by
interest to
interest rate
Federal
national
Reserve to
on Federal
debt 2
Government
income
Treasury i
Millions
$4,167
4,264
4,400
4,509
4,709
4,729
4,846
5,006
4,920
5,238
5,632
5,545
Percent
2.1
1.9
2.0
1.9
1.7
1.6
1.6
1.7
1.5
1.5
1.5
1.5
Millions
$75
167
193
197
255
292
343
276
252
402
543
524
Percent
2.107
2.182
2.236
2.200
2.270
2,329
2.438
2.342
2.351
2.576
2.730
2.638
1Payments of interest on Federal Reserve notes.
2 Derived by calculating interest that would be paid if each interest-bearing issue outstanding at end of
year should remain outstanding for a year at the applicable interest rate and dividing the interest charge
so computed by corresponding principal amount of debt outstanding.
Source: Department of Commerce and Treasury Department.
The payments by the Federal Reserve to the Treasury, which take
the form of interest on Federal Reserve notes and which are estab
lished at such a level as to channel into the Treasury 90 percent of
earnings after deduction of dividend payments and a modest con
tribution to the System’s surplus account, are also shown in table
1-8. These payments have increased greatly since 1947 and consti
tute a significant offset against interest payments by the Treasury.
The last column of the table shows the computed interest rate on
the debt.
Movements in total interest payments over the business cycle are
a result of several forces. For example, in a boom period, rising
demands for credit will tend to raise interest rates generally, and this
tendency will be accentuated if the central bank follows a restrictive
monetary policy. Rising interest rates will tend to increase the
interest burden to the extent that refunding of debt is necessary.
However, if a restrictive fiscal policy results in budget surpluses which
are used for debt retirement, this will tend to reduce the interest
burden. Finally, since short-term interest rates usually rise more
sharply than long-term interest rates during boom periods and since
short-term debt turns over more rapidly than long-term debt, a
policy of shifting toward short-term borrowing will tend to raise
interest payments. Similar factors are at work in the opposite
direction during recessions.18
During the period of rising GNP from the second quarter of 1954
to the third quarter of 1957, net interest paid by the Federal Govern
,fl For a more extended discussion, see ch. IV.
32
DEBT MANAGEMENT IN THE UNITED STATES
ment (seasonally adjusted annual rate) increased from $5 billion to
$5.7 billion, an increase of $700 million. This increase was due to the
fact that the cost-increasing effects of generally rising interest rates
and of a shift toward shorter term borrowing more than outweighed
the effects of debt retirement.
Government interest payments are not included in national income
in the national income accounts but are included in personal income.19
Interest on Federal securities is subject to the Federal income tax.
Accordingly, interest payments represent a form of taxable transfer
payment, and, as such, an increase in these payments has an expan
sionary effect on the level of income, employment, and prices. The
following expression derived from a simple static expenditure model
of the Keynesian type gives an approximation of the effect on the
level of income that would be produced by an autonomous increase
in Government interest payments:
where AY is the change in national income or product, AR is the
change in interest payments, cr is the marginal propensity to consume
(spend) of interest recipients, tr is the marginal propensity to be taxed
of interest recipients, cgis the marginal propensity to consume (spend)
of income recipients in general, and tg is the marginal propensity to
be taxed of income recipients in general. For example, if cr is 60 per
cent, tr 30 percent, cg 80 percent, and tg 25 percent, a rise in the rate
at which the Government pays out interest of $100 per year would
eventually, after all repercussions had worked themselves out, raise
the level of income by about $105, that is, the multiplier applicable
to such payments would be just slightly larger than one.
Although a multiplier calculated from a simple static model of this
kind should not be taken very seriously, it does suggest that the
income effects of increased interest payments are not very important.
Treasury estimates of the distribution of interest payments included
in budget expenditures in fiscal 1958, indicate that of the total pay
ments (other than to Federal Reserve banks and Government invest
ment accounts) of $5.3 billion, $1.9 billion went to individuals, $0.4
billion went to State and local governments, and the remaining $3
billion went to other types of investors, most of whom are subject to
the 52 percent corporation income tax on their investment income.20
Since holdings of Government securities appear to be somewhat con
centrated in the hands of persons of relatively high income, and since
a good deal of the income filters through institutions so that it is
taxed at both the corporate and personal level, the marginal pro
pensity to be taxed is probably quite high and the marginal propensity
to consume quite low for such interest payments. Thus, the static
multiplier is probably scarcely equal to one if that large. Moreover,
the lags involved in the flow of this income through intermediaries
are probably so long that such effects as are felt are likely to be very
long delayed. For these reasons, while a rise in Government interest
1:3For an explanation of the treatment of Government interest payments in the national income accounts,
see “ National Income,” a supplement to the Survey of Current Business, 1954 edition, op. cit., p. 54.
20 See “ Public Debt Ceiling and Interest Rate Ceiling on Bonds,” hearings before the Committee on
Ways and Means, House of Representatives, 86th Cong., 1st sess., June 10, 11, and 12, 1959 (Washington:
Government Printing Office. 1959), p. 44.
DEBT MANAGEMENT IN THE UNITED STATES
33
payments which is induced by a tightening of credit during a period of
inflation is itself an inflationary factor, its effects are likely to be so
small as to be insignificant.20a
The fact that Government interest payments are probably, in
general, subject to rather high marginal tax rates also means that a
significant portion of the potential drain on the budget produced by a
rise in such payments is offset by increased tax collections, Thus, if
the marginal tax rate is in the neighborhood of 40 percent, a rise of
$700 million per year in interest payments such as occurred in the
1954-57 period would have a net budgetary impact of perhaps $400
million to $450 million.
To summarize, (1) interest payments are only about 1.5 percent of
national income, (2) increases in such payments have rather weak
effects on the level of income, and (3) the budgetary impact of such
increases is considerably weakened by the fact that they are subject
to relatively high marginal tax rates. Nevertheless, interest costs on
the public debt do represent a sizable sum and are a matter for some
concern. And since the administrative budget is frequently used as
a tool of fiscal policy, for some purposes the interest included in this
budget (which includes interest payments to Government agencies
and trust funds) is the important thing. For fiscal 1960, interest
payments in the administrative budget are estimated at $9 billion,
more than 11 percent of total budget expenditures, nearly three times
the estimated expenditures of the Department of Health, Education,
and Welfare, and nearly 40 percent larger than those of the Depart
ment of Agriculture. With the present emphasis on balancing the
budget without raising taxes, a rise in the interest burden tends to
cut into other badly needed types of Federal expenditues. Thus,
there is good reason for trying to avoid unnecessarily heavy interest
costs on the public debt. That is, unless the increased interest pay
ments serve some useful economic function, we should try to reduce
them.
20a In addition to the income effect of increased Government interest payments, rising interest rates may
have further inflationary effects to the extent that industries which experience increases in interest costs
pass these increases through into prices. However, this effect is also likely to be rather weak, because inter
est commonly is not an important element of cost.
34
DEBT MANAGEMENT IN THE UNITED STATES
T a b l e 1-9 .— O w n e rs h ip o f the p u b lic ly held F e d e r a l debtj f is c a l y e a rs 1 9 4 6 - 5 9
[Billions of dollars]
Held by
Fiscal year
Total
Pub
State
Individuals1
licly
Com Mutual Insur Other
and
Miscel
held mercial savings ance corpo local
laneous
debt banks banks com rations govern
Savings Other invest
panies
ments Total bonds securi ors 2
ties
1946........................
1947........................
1948—.....................
1949.......................
1950........................
1951.......... .............
1952........................
1953........................
1954........................
1955........................
1956........................
1957........................
1958........................
1959........................
217.0
203.7
195.2
195.2
201.3
191.3
192.0
193.8
197.0
200.3
195.5
192.0
195.1
204.2
84.4
70.0
64.6
63.0
65.6
58.4
61.1
58.8
63.6
63.5
57.3
56.2
65.3
61.3
11.5
12.1
12.0
11.6
11.6
10.2
9.6
9.5
9.1
8.7
8.4
7.9
7.4
7.3
24.9
24.6
22.8
20.5
19.8
17.1
15.7
16.0
15.3
14.8
13.3
12.3
11.7
12.0
17.8
13.7
13.6
15.8
18.4
20.1
18.8
18.6
16.6
18.8
17.7
16.1
13.9
20.0
6.5
7.1
7.8
8.0
8.7
9.4
10.4
12.0
13.9
14.7
15.7
16.9
16.9
18.3
63.3
66.6
65.8
66.6
67.4
65.4
64.8
66.1
64.8
65.3
66.9
66.7
64.7
65.8
43.5
45.5
47.1
48.8
49.9
49.1
49.0
49.3
49.5
50.2
50.3
49.1
48.0
47.0
19.9
21.1
18.6
17.8
17.6
16.3
15.7
16.9
15.3
15.1
16.6
17.7
16.7
18.7
8.6
9.6
8.7
9.6
9.7
10.7
11.6
12.8
13.7
14.4
16.3
16.0
15.2
19.4
Changes:
1946-59.............
1948-58.............
-12.8
-0.1
-23.1
0.7
-4 .2
-4 .6
-12.9
-11.1
2.2
0.3
11.8
9.1
2.5
-1.1
3.5
0.9
-1 .2
-1 .9
10.8
6.5
1Includes partnerships and personal trust accounts.
2Includes savings and loan associations, nonprofit institutions, corporate pension trust funds, dealers and
brokers, and investments of foreign balances and international accounts in this country. Beginning in
1947, includes investments by the International Bank for Reconstruction and Development and the Inter
national Monetary Fund in special noninterest-bearing notes.
N o t e .—Detail may not add to totals due to rounding.
Source: Treasury Department.
Changes in ownership of the debt
Table 1-9 shows the pattern of ownership of the p u b lic ly held Fed
eral debt, as estimated by the Treasury, at the end of each fiscal year
since 1946. Although debt ownership changes continually and some
features of the pattern of change are obscured by taking only one
observation each year, the main changes in the distribution of securi
ties among investor classes are brought out by the table.
For convenience, let us consider the decade from mid-1948 to mid1958. The total publicly held debt was almost exactly the same at
the end of that decade as at the beginning. The investor groups
shown in table 1-9 can be divided into three categories—those whose
holdings have been declining steadily, those whose holdings have been
increasing steadily, and those whose holdings have exhibited substan
tial fluctuations. Let us consider each of these groups in turn.21
1.
Investors whose holdings^have declined steadily. —This category
includes insurance companies and mutual savings banks. Both of
these groups have reduced the size of their portfolios of Treasury
securities in almost every year since the war, the total reduction during
the decade 1948-58 being $11.1 billion for insurance companies and
$4.6 billion for mutual savings banks. As a result of the prosperous
conditions and heavy savings of the war period, these institutions
grew rapidly during the war, and, due to the limited private demand
for funds as well as pressures to assist the Treasury in war financing,
most of the inflow of funds was invested in Government securities.
« For an excellent discussion of the investment practices of various types of investors as they relate to
Treasury securities, see T. C. Gaines, “ Techniques of Treasury Debt Management” (unpublished Ph. D.
dissertation, Columbia University, 1959), chs. VII and VIII.
DEBT MANAGEMENT IN THE UNITED STATES
35
At the end of 1947, 39 percent of the assets of life insurance companies
were in the form of Government securities, and mutual savings banks
held governments to the extent of 64 percent of their total loans and
investments. In response to the heavy private demands for funds
which have characterized the postwar period, both of these types of
institutions have steadily liquidated Government securities in order
to shift their funds into more lucrative private investments—chiefly
mortgages in the case of mutual savings banks and corporate bonds
and mortgages in the case of life insurance companies. As a result of
the liquidations, together with a rapid growth of these institutions,
Government securities made up, by mid-1958, only 6.8 percent of total
assets of life insurance companies, while mutual savings banks had
reduced their holdings of governments to 21 percent of total loans and
investments.
Liquidation of governments by these institutions has not shown any
particularly strong tendency to speed up during periods of tight credit.
The rate of liquidation appears to have slowed down somewhat as
total portfolios have become smaller. Nevertheless, in the case of life
insurance companies particularly, further liquidation of governments
seems quite possible, in view of the fact that, following a substantial
buildup of holdings during World War I, life insurance company in
vestments in Government securities were reduced to less than 2 percent
of total assets by 1930.22
2.
Investors whose holdings have increased steadily.—As can be seen
from table 1-9, State and local governments and miscellaneous in
vestors fall in this category. During the decade 1948-58, the net
increase in holdings of Government securities by State and local
governments was $9.1 billion, and they held a total of $16.9 billion
at the end of the period. Part of this represents investment of
pension funds for State and local government employees, and the
remainder probably reflects temporary investment of excess working
cash balances, the proceeds of bond issues awaiting expenditure, etc.23
Legal restrictions, which in the past have required the investment of
most pension funds in Government securities, have been modified by
many States, and while holdings of governments by these funds
continue to increase absolutely, their share in total assets of the
funds is declining.24
Among the investors included in the miscellaneous group, savings
and loan associations have regularly added to their investments in
Government securities, their holdings (at book value) having in
creased from $1.7 billion at the end of 1947 to $3.4 billion at mid-1958.
During this period total assets of savings and loan associations in
creased by nearly 350 percent, from $11.7 billion to $51.4 billion. As
a result of this rapid growth, their holdings of Government securities,
while increasing absolutely, declined as a proportion of total assets
from 14.9 to 6.6 percent.
Corporate pension trust funds appear to have maintained their
investment in Government securities approximately constant in
recent years. However, they have grown rapidly, and most of the
current inflow of funds has been invested in corporate securities,
22 “ Life Insurance Fact Book, 1959° (New York: Institute of Life Insurance, 1959), p. 66.
23 Gaines, op. cit., pp. 358-363 and 368-370.
24Ibid., pp. 358-363.
36
DEBT MANAGEMENT IN THE UNITED STATES
including equities, and Government security holdings have conse
quently been declining as a percent of total portfolio.25
Investments in Government securities by foreign accounts and
international agencies totaled $9.9 billion as of mid-1959 and have
increased substantially in recent years as foreign countries have been
building up their dollar reserves.26 Although no satisfactory data on
positions of dealers in Government securities for any extended period
are available, it seems likely that these positions fluctuate over a con
siderable range depending upon interest rate expectations but that
they have grown in recent years with the increased volume of trading
in Government securities.27
3.
Investors whose holdings have fluctuated substantially.— Table 1-9
indicates that investment in Government securities by commercial
banks and nonfinancial corporations showed only a small net change
over the decade 1948-58 but that holdings of these two groups under
went substantial fluctuations from year to year. Holdings of secu
rities other than savings bonds by individual investors have also shown
rather large year-to-year fluctuations at times.
As flexible monetary policy has come to be used with increasing
vigor, changes in portfolios of Government securities of commercial
banks and nonfinancial corporations have taken on a fairly distinct
cyclical pattern. Commercial banks increase their holdings in periods
of easy money when reserves are ample and loan demand light. Thus,
they built up their portfolios of Government securities substantially
during the fiscal years 1954 and 1958, when recessions and easy money
prevailed. Then in 1955-57 they liquidated governments to meet a
rising loan demand in the face of a restrictive Federal Reserve policy.
Corporations, on the other hand, tend to build up their holdings in
the early phases of boom periods, as they did in fiscal 1955 and fiscal
1959, as profits and tax accruals rise ahead of investments in inven
tories and fixed capital, thus resulting in increasing liquid reserves
that are available for investment in governments. Then, in the latter
stages of the boom when real investment picks up and credit gets
tight, as in 1956-58, they sell off governments in order to obtain funds
for spending.
Holdings of governments by individual investors showed no net
change over the decade 1948-58, as indicated in table 1-9. Holdings
of savings bonds increased rather steadily during the postwar period
up to 1956 and have since been declining. This decline has probably
been due mainly to the increases that have occurred in rates of return
available on savings deposits and savings and loan shares, which are
very close substitutes for savings bonds.28 Individual investors’ hold
ings of Government securities other than savings bonds— chiefly
marketable issues—have shown fairly substantial year-to-year fluc
tuations but no discernible trend since the war. During the fiscal
years 1956 and 1957 when, as we have seen, commercial banks were
selling governments to obtain funds for lending, individual investors
increased their holdings of marketable issues by some $2.6 billion.
28Ibid., pp. 356-358.
26 On June 30,1959, foreign holdings consisted of $8.2 billion of bills and certificates and $1.2 billion of bonds
and notes. This indicates that foreign accounts hold chiefly short-term securities. On June 30,1953, total
foreign holdings were $5.7 billion; thus they showed an increase of $4.2 billion in the 6-year period ending in
mid-1959. However, the changes were rather uneven: Holdings rose to $7.9 billion at mid-1956, fell to
$6.4 billion at mid-1958, then rose very sharply (by $3.5 billion) in the ensuing year. (Data from various
issues of the Treasury Bulletin.)
37For a further discussion of dealer positions, see ch. V.
28 See the discussion of the savings bond program in ch. III.
DEBT MANAGEMENT IN THE UNITED STATES
37
Conclusions — The changes that have occurred in the ownership of
the publicly-held Federal debt in the postwar period are related to
the changes in the maturity structure of the debt which are discussed
in the next section of this chapter The investor groups whose hold
ings of Treasury securities have been steadily declining (insurance
companies and mutual savings banks) were the largest holders of
long-term securities at the end of the war On the other hand, the
investor groups whose holdings have been increasing (State and local
governments, savings and loan associations, and foreign accounts and
international agencies), and those whose portfolios of governments,
though fluctuating substantially, have remained relatively large (com
mercial banks and nonfinancial corporations) are interested chiefly in
short- and intermediate-term securities as a temporary resting place
for excess cash balances or as liquid assets to contribute flexibility to
their portfolios
The relation between the changes in ownership and the changes in
maturity structure is not a simple one, however. In part, the shift
in ownership of the debt from those who might be interested in it as
a long-term investment (such as life insurance companies) to those
who are interested in governments as liquid assets (such as nonfinan
cial corporations and State and local governments) may be due to
the failure of the Treasury to work hard enough at the sale of long
term bonds. That is, the shortening of maturities that has been per
mitted to take place has made the debt unattractive to long-term
investors and attractive to those who want liquid assets.29 On the
other hand, to some extent at least, the shifting interest of investors
is responsible for the changes that have taken place in the maturity
structure. It should be borne in mind that under the policy of Fed
eral Reserve support of long-term Treasury securities that prevailed
during the war and immediate postwar period, long-term Government
securities were highly liquid assets and were probably regarded as
such by life insurance companies and mutual savings banks who in
vested heavily in them during the war under the pressure of patriotic
motives and for lack of any other place to put their funds. In the
face of the heavy demands for private funds that developed during
the postwar period, it would certainly have required very aggressive
debt management policies on the part of the Treasury and consider
ably higher yields on Treasury securities to have maintained this
market.
Changes in maturity structure of the debt
Table 1-10 gives the composition of the debt by types and maturities
of securities at the end of each fiscal year since 1946. Considering
again the decade 1948-58, we find that the amount of marketable debt
changed only slightly over this period, and that the issuance of
convertible bonds approximately offset the decline in nonmarketable
debt.30
29 Gaines, op. cit., pp. 301-309.
3° The convertible bonds consist of a single issue, the investment series B 2%-percent bonds of 1976-80, of
which $13.6 billion was issued in an optional conversion offering to holders of 2 issues of marketable long
term bonds at the time of the Treasury-Federal Reserve accord in the spring of 1951. Although not marketa
ble, the bonds can be exchanged at the investor’s option for a marketable 5-year, 1^-percent note. By June
30, 1959, nearly $6 billion of the bonds had been converted, leaving $7.7 billion outstanding, of which $2.7
billion was held by Government agencies and trust funds and the remaining $5 billion by the public.
38
DEBT MANAGEMENT IN THE UNITED STATES
T a b l e 1 -1 0 . — C o m p o s it io n o f the p u b lic ly held F e d e r a l debt, f is c a l y e a rs 1 9 4 0 - 5 9
[Billions of dollars]
End of fiscal year
Total
publicly
held debt
Marketable debt
Total
Due
within
1 year
Marketable debt
Due in
1 to 5
years
Due in
5 to 10
years
Nonmar
Con
ketable
vertible and mis
Due after bonds1 cellaneous
10 years
debt 2
1946..........................
1947..........................
1948..........................
1949..........................
1950..........................
1951______ _______
1952...................._
1953....................
1954..........................
1955........................ .
1956............... ..........
1957..........................
1958....................
1959..........................
217.0
203.7
195.2
195.2
201.3
191.3
192.0
193.8
197.0
200.3
195.5
192.0
195.1
204.2
158.9
141.4
133.6
130.4
131.6
114.4
115.2
119.1
121.8
127.9
126.3
127.2
134.6
145.0
39.2
31.2
34.4
39.9
32.5
46.7
33.3
48.9
43.7
32.2
37.5
49.6
43.9
51.3
33.8
41.4
43.2
36.8
46.4
27.0
37.7
25.7
21.4
34.2
30.4
37.3
38.5
51.3
32.0
18.5
9.6
13.9
14.4
14.6
14.0
16.9
29.0
32.2
29.9
13.7
22.0
16.7
53.9
50.3
46.2
39.6
38.2
26.0
30.0
27.6
27.6
29.3
28.5
26.6
30.2
25.7
8.0
8.9
8.9
8.4
8.2
7.8
7.2
6.1
5.0
58.1
62.3
61.6
64.8
69.7
68.9
67.9
65.8
66.8
64.2
61.4
57.6
54.4
54.2
Changes:
1946-59...............
1948-58...............
-12.8
-0.1
-13.9
1.0
12.1
9.5
17.5
-4.7
-15.3
12.4
-28.2
-16.0
5.0
6.1
-3 .9
-7 .2
12%-percent investment series 3 convertible bonds of 1975-80.
2 Nonmarketable debt includes savings bonds, Series A investment bonds, depositary bonds, Armed
Forces leave bonds, and adjusted service bonds. Item also includes guaranteed securities and non-interestbearing debt.
N o t e .— Detail may not add to totals due to rounding.
Source: Treasury Department and Federal Reserve System.
The chief questions of debt management concern the changes in
the maturity structure of the marketable debt. The changes in
maturity structure are much more difficult to categorize in a simple
way than are the changes in ownership discussed in the last section.
This is because the maturity structure is subject to a number of in
fluences that are capable of making it change rather sharply at times.
If we observe the behavior of the average maturity of the debt, com
puted by weighting each issue according to its importance in the total
debt, we find that the averge is continually tending to shorten due to
the passage of time. On the other hand, every refunding operation
tends to lengthen the average at least a little, since every maturing
issue necessarily has a maturity of zero. One substantial refunding
operation involving moderately long-term securities can raise the
average rather substantially.31 Sales of securities for cash will shorten
or lengthen the average maturity according to whether the new securi
ties have a maturity shorter or longer than the existing average. In
any case, there is real doubt whether the maturity structure of the
debt can be satisfactorily expressed by the use of a single number
such as the average maturity. On the other hand, when discrete
maturity categories are used to depict the maturity structure, as in
table 1-10 and chart 1-1, erratic changes can take place as an existing
issue changes suddenly from one category to another due to the passage
of time.
For example, if the marketable debt were $150 billion with an average maturity of 4 years, the issuance
of $2 billion of 30-year bonds in a refunding operation 'would raise the average maturity by 4,8 months, a
10 percent increase,
-09—88*02
Over 10 Years
§
5-10 Years
I
&
ft
z
— 5 Years
Under I Year
§
“5
SC
K
d
z
1946 1947 1948 1949 1950 1951 1952 1953 1954 1955 1956 1957 1958
Years
Chart 1-1.
Percentage distribution of publicly-held
marketable debt, fiscal years 1946-1958
Source:
Treasury Department
CO
CO
40
DEBT MANAGEMENT
IN
THE UNITED STATES
Nevertheless, it is quite apparent from chart I—1, which shows the
percentage distribution of the marketable debt by maturity classifica
tions, that there has been a gradual shortening of maturities since
the war. The portion of the debt in the over-10-year category has
been declining, while the portion in the under-l-year category has
been increasing. However, there have also been fairly systematic
changes associated with the business cycle, particularly during the
period since flexible monetary policy was inaugurated with the
Treasury-Federal Reserve accord of March 1951. In particular,
some debt lengthening occurred during the period when credit condi
tions were relatively easy in the fiscal years 1954 and 1955. During
the period of credit stringency of 1956-57, on the other hand, the debt
shortened materially, while in 1958, when credit conditions were again
relatively easy, some lengthening occurred. In other words, in re
cessions when credit has been easy the Treasury has taken advantage
of the opportunity to sell longer term securities, while in boom periods,
when the long-term market has been congested with private issues,
the Treasury has been forced— or persuaded— to rely on short-term
financing. However, under the generally buoyant economic condi
tions of the last few years, the booms have considerably overbalanced
the recessions in both length and intensity, and there has been a
secular drift toward a shortened maturity structure. The economic
significance of this tendency will be discussed later.
A ppendix
T he
E conomic
to
C hapter
Significance
of
t h e
I
T rust
F unds
It was suggested above that the portion of the debt held by Government
agencies and trust funds is “fictitious” debt which should be eliminated for pur
poses of the study of the economic problems of debt management. Having taken
this position, we should give brief attention to the role of trust funds in Govern
ment finance.
There are now roughly a dozen trust funds operated by the Federal Govern
ment, and in the fiscal year 1959, their total current receipts (insurance contribu
tions and interest earnings) were $ 17.1 billion, and their total current expenditures
were $ 18.5 billion. The largest and most important of the funds are the old-age
and survivors insurance trust fund, the unemployment trust fund, Government
employees’ retirement funds, the national service life insurance fund, the railroad
retirement account, and the Federal disability insurance trust fund. For pur
poses of analysis, we shall take the largest single fund, the old-age and survivors
insurance trust fund, which as of June 30, 1958, had total assets of $ 22.8 billion,
of which $ 21.8 billion was in the form of Government securities.
Under the present method of financing the old-age and survivors insurance
program, funds to finance benefits payable under the program come from contribu
tions paid by employers and employees and from interest earned on Government
securities held in the trust funds. If receipts from these sources are insufficient
to pay the benefits required, the trust fund sells a portion of its holdings of Govern
ment securities to raise additional funds, or if, as has in fact usually been the case
up to the present time, the contribution receipts and interest earnings are more
than sufficient to cover benefit payments, the excess is invested in Government
securities. These securities may be special securities issued directly to the trust
fund by the Treasury or they may be regular marketable issues which the trust
fund buys in the market.
In principle, the financing provisions are designed to place the system in
“actuarial balance” in the sense that as the program matures, receipts from cur
rent contributions, together with interest earnings on accumulated investments in
DEBT MANAGEMENT IN THE UNITED STATES
41
Government securities are supposed approximately to cover benefit payments .1
Cost estimates, particularly for the long-range future, are subject to considerable
uncertainty, since they depend upon trends in such factors as fertility, mortality,
retirement practices, and family size and composition. The cost estimates
developed therefore take the form of ranges, and in practice, actuarial balance is
said to be achieved if contribution rates are established at levels such that if
future costs follow the average of the high- and low-cost estimates, contribution
and interest income can be expected to meet the costs of the program as they fall
due from the present into the long-range future.2
There has been much discussion concerning the significance of the trust fund
in the financing of social security. Actually, the trust fund per se is a matter
of very little consequence. When contributions plus interest receipts exceed
benefit payments, the excess is either paid back into the Treasury in exchange
for more securities or is used to buy up Treasury securities in the market. The
interest rate paid on the securities held in the fund is completely arbitrary and
meaningless, since if we assume that other Government receipts and expenditures
are unaffected by the arrangements for financing social security, a higher interest
rate means that the fund can accumulate more securities but the Treasury itself,
as a result of the higher interest payments, will be able to retire less debt (or
will have to borrow more in the market) than would have been the case had the
interest rate paid to the fund been lower. For instance, if other Government
receipts and expenditures are in balance and contribution rates are not high
enough to cover benefits, the Government as a whole must borrow the difference.
The interest rate paid by the Treasury on securities held in the trust fund merely
determines the way in which the necessary borrowing will be divided between
the Treasury proper and the trust fund. Similarly, if contributions exceed
benefits, the interest rate paid merely determines how the resulting amount of
potential debt retirement will be divided between the Treasury proper and the
trust fund .3
As far as the impact of the social security system 011 the economy is concerned,
the important thing is the way in which the existence of the system alters the
monetary-fiscal policy of the Government as a whole. If, for example, the sys
tem is operating at a surplus, as it has most of the time up to now, the economic
effects of this surplus are largely eliminated if the inflow of net receipts from the
social security system is used to reduce other types of taxes or to increase other
expenditures.4 On the other hand, if other taxes and expenditures are left as they
would have been in the absence of the system and the funds are used to retire
privately held Government debt, the financing may have an economic impact.
The reason is that, in this case, the Government has a larger surplus (or smaller
deficit) in its total operations than it would have had in the absence of the social
security system, and through the additional debt retirement, the' amount of
funds supplied to the capital market by the Government is increased (or the net
amount of funds taken from the market by the Government is reduced). The
volume of saving in the economy is increased, and if measures are taken to see to
it that private investment (or, for that matter, productive Government invest
ment in schools, highways, and so on) is correspondingly expanded, the rate of
growth of the economy is increased. Since in an economy characterized by price
rigidities and liquidity preference, the flow of additional saving into additional
1It may be noted that this principle of actuarial balance as it has been applied to the old-age and survivors
insurance system differs substantially from the principle of actuarial soundness applicable to a private
insurance program. A private insurance company, if it is to be sound, must have sufficient assets on hand
so that if its operations are terminated it can meet all of its liabilities. However, in the case of a social insur
ance system, it can be assumed that the program will continue and that there will accordingly continue to
be an inflow of funds from current contributions. Thus, the system is said to be in actuarial balance if
receipts from contributions, together with interest earnings on accumulated assets are sufficient over the long
mn to cover the benefits and administrative expenses associated with the program. For a fuller explanation,
see “ Financing Old-Age, Survivors, and Disability Insurance,” A Report of the Advisory Council on Social
Security Financing (Washington: Government Printing Office, 1959) and “Actuarial Cost Estimates and
Summary of Provisions of the Old-Age, Survivors, and Disability Insurance System as Modified by the
Social Security Amendments of 1958” (Washington: Government Printing Office, 1958).
2 On this basis, recent projections indicate that the old-age, survivors, and disability insurance system is
approximately in actuarial balance at the present time. See “ Actuarial Cost Estimates and Summary of
Provisions of the Old-Age, Survivors, and Disability Insurance System as Modified by the Social Security
Amendments of 1958,” op. cit. It may be noted that the estimates are based upon the assumption that the
present benefit scale will continue to prevail in the future, to counterbalance this assumption, it is assumed
that average annual earnings will remain at their current level. If benefits are in fact adjusted upward in
step with increases in earnings (and therefore contribution receipts) the two adjustments will approximately
offset each other.
3 When the matter is viewed in this way, the concept of “actuarial balance” referred to above is seen to be
quite meaningless, since with any set of contribution rates and benefit provisions a balance of this kind can
be achieved by choosing an appropriate rate of interest.
4 This statement must be qualified if the expenditures that are increased are in the nature of Government
investment—such as schools, highways, etc.—which increase the future productive capacity of the economy.
42
DEBT MANAGEMENT IN THE UNITED STATES
real private investment is not automatic, it may be necessary to follow an easier
monetary policy in order to assure the proper adjustments—otherwise, the in
creased saving through the Government may result in unemployment and under
utilization of capacity rather than more investment.
Since the real goods and services necessary for the support of the aged in any
generation must be produced at the time these people are being supported, the
only way that advance provision can be made for their support is by taking meas
ures to increase investment so that real economic capacity is built up above what
it would otherwise have been. The present generation can pay during its working
lifetime for its future social security benefits, if through the application of higher
taxes (or by other means, conceivably) its consumption is reduced, total savings
increased, and through the application of proper overall policies this additional
saving is channeled into investment, so that when this generation retires, there
will be a larger economic capacity from which to produce goods to meet its needs
during retirement.5
Thus, the only way we can make advance provision for future burdens of sup
porting the aged is to take measures to stimulate a higher level of real investment—
which may be done, at least within limits by following a generally tighter fiscal
policy, with higher taxes and/or lower expenditures than would otherwise have
been adopted, together with an easier monetary policy. It makes no difference
whether there is a trust fund or not; nor does it matter for the present purpose
whether the taxes employed are payroll taxes or some other kind of taxes. What
really matters is the additional volume of saving that is generated—including both
saving through the Government budget and private saving—and the adoption of
appropriate ancillary measures to see that this saving is balanced by an appropriate
amount of investment spending.
There may be some merit in having, in some sense, a separate budget for opera
tions of the social security type which impose a measurable future burden upon
the Nation for which we want to make advance provision through an increase
in the rate of growth of capacity. This may help to assure that we will, in fact,
have larger budget surpluses or smaller budget deficits than would otherwise be
the case. However, a meaningful separation is possible only if we assume that
monetary policy and fiscal policy are good substitutes for stabilization purposes,
particularly for the purpose of stimulating recovery from recessions.
In any case, the important point for our present purposes is that Government
securities held in the trust funds are really fictitious debt. It is not necessary to
find lodgment for this part of the debt in the private sector of the economy,
changes in its composition do not affect economic behavior, and interest paid on
it is fictitious transfer of funds within the Government itself which imposes no
burden on taxpayers.
5 Thus, it is the amount of additional real capital accumulated (rather than the stock of financial assets)
that is significant in assessing the extent to which advance provision is made for covering the future burdens
that will be imposed on the economy. Similarly, in principle at least, it is the expected marginal net social
productivity of capital (rather than some arbitary financial interest rate) which should be used in carrying
out the necessary compounding.
C H A P T E R
II
PRESENT DEBT MANAGEMENT TECHNIQUES
This chapter describes the methods or techniques that are currently
(mid-1959) being used by the Treasury in managing the public debt,
together with some aspects of the market for Government securities
which have significance for debt management.
REGULAR BILL FINANCING
Treasury bills may have a maturity not exceeding 1 year and are
issued on a discount basis. When bills are to be sold, the Treasury
announces the offering and invites tenders under competitive bidding.
The bills pay the holder face value without interest at maturity, and
the return on his investment is simply the difference between the
original purchase price and the matifrity value. Bids are collected
through the Federal Reserve banks, and the Treasury accept bids,
starting with the highest price (lowest yield) and going down the
scale as far as is necessary to obtain the desired amount of funds.1
Thus, bills are sold through the use of an auction technique.2
For many years until recently, the Treasury issued regular bills of
only 3-month (usually 91-day) maturity.3 There were 13 issues of
3-month bills outstanding at all times, with one issue maturing each
week and being replaced by a new issue. If the Treasury wished to
raise new money or retire bills, it might increase or decrease the size
of the weekly bill offerings, but essentially the 3-month bills were
“ rolled over” every 13 weeks, i.e., there was a 13-week “ bill cycle.”
The weekly bill auctions interfere very little with the freedom of
action of the Federal Reserve System, even during periods when a
restrictive monetary policy is being applied, and the bill has proven
to be an efficient and economical instrument of Treasury financing.
Accordingly, the Treasury has recently been extending its use of the
bill. Beginning in December 1958, it introduced a new 26-week
“ cycle” of 6-month (usually 182-day) bills. It now sells at auction
each week one issue of 91-day bills and one issue of 182-day bills.4
The first “ round” of the 26-week cycle was completed in June 1959.
At the present time, therefore, there are outstanding at all times 26
evenly spaced bill issued, one maturing each week for 26 weeks into
the future.5 Up to now (mid-1959), the 13-week issues have been
1 Provision is made for noncompetitive tenders (usually for $200,000 or less) from small investors. These
bids do not specify a price and are accepted in full at the average price of the accepted bids. Noncompetitive
bids commonly account for 20 to 30 percent of the bills sold.
* It may be noted that the Internal Revenue Code provides that Treasury bills shall not be regarded as
capital assets, so that the difference between the original purchase price and the sale price (if sold before
maturity) or maturity value is an ordinary gain or loss, not a capital gain or loss, for tax purposes.
3 In addition to the regular bills, tax anticipation bills were—and are—also used. These are discussed
in the next section.
* The auction is held on Monday of each week (after a preliminary announcement of the offering on the
preceding Thursday), and the bills are issued on the following Thursday to replace bills maturing at that
time.
« The issues of 13- and 26 week bills are synchronized so that each Thursday when a new 13-week (91-day)
bill is issued, there is an issue of 26*week (182-day) bills that has been outstanding for exactly 13 weeks and
has 13 more weeks to run. From then until they mature 13 weeks later, these two issues are identical and
are treated as a single issue. Thus, there are 26 (rather than 39) issues outstanding at all times.
43
44
DEBT MANAGEMENT IN THE UNITED STATES
considerably larger than the 26-week issues, the former averaging
$1.0 to $1.2 billion and the latter $0.4 or $0.5 billion.6
T able
II—1.— R e g u la r T r e a s u r y b ills o u tsta n d in g J u l y 3 1 , 1 9 5 9
Number of issues
13.................... ...................... ......... . . . . . . . . . . . . ....................
13................. ..................................... ...................................
1.............................................. ............................................
1........................... ..............................................................
1_________________________________________________________
Maturity
(weeks)
1-13
14-26
29___ ____
Maturity
date
Jan.* 15*i960*
Apr. 15,1960
July 15,1960
Amount
outstand
ing (in
billions of
dollars)
19.4
5.6
2.0
2.0
2.0
31.0
Source: Treasury Department.
The Treasury has also taken further steps to expand its use of the
Treasury bill. In March 1959, it auctioned $2 billion of 289-day bills
to mature on January 15, 1960; in M ay it auctioned $2 billion of 340dajr bills to mature on April 15, 1960; and in July it auctioned $2
billion of 1-year bills to mature on July 15, 1960. Thus, it is now in
the process of establishing an annual cycle of four issues of 1-year bills
which will mature each year at quarterly intervals in the months of
January, April, July, and October. At the end of July 1959, the total
amount of regular bills outstanding was $31 billion; table II—1 shows
the structure of outstanding bill offerings at that time.
The auction technique that is used in selling bills has some apparent
advantages over the fixed-price method that is employed in selling
other kinds of Treasury securities. For example, the auction tech
nique minimizes interference with the freedom of action of the Federal
Reserve and may result in lower interest cost to the Treasury.7
Accordingly, some observers have suggested that it might be desirable
for the Treasury to extend the use of the auction technique to the
marketing of longer term issues. The probable advantages and
disadvantages of such an innovation will be discussed at length in a
later chapter.8
T A X A N TICIP A TIO N FIN A N CIN G
Tax anticipation issues are used to smooth out the uneven flow of
tax revenues. Under present arrangements for the payment of taxes,
Treasury’s tax receipts tend to be heavily concentrated in the second
half of the fiscal year (especially in the months of March and June),
« During the first cycle from December 1958, to June 1959, while the new bills were being introduced, the
Treasury took advantage of the opportunity to raise $1.6 billion of new money by expanding its total bill
issues.
* The saving in interest cost could arise from the fact that, under the auction method, the Treasury acts
as a discriminating monopolist, selling each block of securities at the highest price (presumably) that the
particular, investor is willing to pay for it.
s See cK, VI.
DEBT MANAGEMENT IN THE UNITED STATES
45
whereas expenditures are spread much more evenly over time.9 Thus,
even if the cash budget is balanced or shows a moderate surplus for
the fiscal year as a whole, there is likely to be a substantial deficit in
the first half of the fiscal year (the July-to-December period).10
T able
II—2. S a le s a n d re d em p tio n s of tax a n t ic ip a t io n b ills a n d certificates,
f is c a l ye a rs 1 9 5 8 - 5 9
[Billions of dollars]
Issued
Fiscal year
Total
1953—1st half.______________
2d half-_____ _________
1954—1st half_______ _______
2d half_____ __________
1955—1st half..........................
2d half_______________
1956—1st half.______________
2d h a lf--......................
1957—1st half.______________
2d half_______________
1958—1st half.______________
2d half______ _________
1959—1st half. .
0.8
5.9
2.6
3.7
3.2
8.2
Bills
0.8
2.6
1.5
Redeemed
Certifi
cates
5.9
3.7
3.2
6.7
5.5
4.9
3.0
1.0
4.9
3.0
4.5
6.6
3.0
3.0
3.0
3.6
Total
0.8
8.5
Bills
Certifi
cates
0.8
2.6
5.9
8.2
1.5
6.7
8.9
1.5
3.0
4.4
1.5
3.0
4.5
6.6
3.0
3.6
6.9
6.9
Net change
in bills and
certificates
outstand
ing
0.8
5. i
-5 .9
3.7
—3.7
8.2
—8.2
5.5
—4.0
1.5
—3.0
6.6
-3 .6
Source: Treasury Department.
These seasonal discrepancies between cash receipts and expenditures
create the need for a substantial amount of temporary borrowing, as
indicated in table II-2. In large part, this borrowing takes the form
of the sale of securities in the first half of the fiscal year (the JulyDecember period), with the securities maturing around the time when
heavy taxpayments are due in March and June of the following
calendar year.
Until fairly recently, the bulk of the tax anticipation borrowing was
accomplished through the issuance of certificates of indebtedness, as
indicated in table II-2, although bills were used to some extent.11
Certificates bear a specified coupon rate of interest and are sold on a
fixed-price basis, whereas bills, as indicated in the previous section,
are sold at auction. Prior to the recent successful experience with an
extended use of the auction technique in the sale of regular bills, there
was often considerable hesitancy about using tax anticipation bills
when there was need to raise relatively large sums on rather extended
9The timing of corporation income tax payments has been gradually shifting since 1950, passing through
two 5-year phases in the process. In 1950, a corporation whose fiscal year corresponded with the calendar
year paid its taxes in four equal quarterly installments in March, June, September, and-Deeember of the
following year. During the next 5 years, the portions payable in March and June were each increased by 5
percent each year and those payable in September and December correspondingly reduced, so that by 1955
the tax was payable 50 percent in March and 50 percent in June. Then in 1956, 5 percent of the tax became
payable in September and 5 percent in December of the current year, the installments payable in March
and June of the next year being correspondingly reduced. Each year since 1955 the payments due in Sep
tember and December have been increased by 5 percent and those due in March and June of the following
year reduced by 5 percent. In 1960 the second phase will be completed, and thereafter the tax will be pay
able in four installments of 25 percent in September and December of the current year and March and June
of the following year. The first phase (through 1955) increased the seasonal variability of tax receipts by
concentrating payments in the first half of the year, while the second phase has reversed this tendency.
However, some seasonal variability in corporate income tax receipts will remain after the process is com
pleted. Moreover, there is considerable seasonal variability in receipts from the personal income and
other taxes.
10 For example, in the fiscal year 1956 there was a cash surplus of $4.5 billion which was the net result of a
defict of $7 billion in July-December 1955, and a surplus of $11.5 billion in January-June 1956.
11 From 1941 to 1953, the Treasury sold nonmarketable Treasury savings notes to all types of investors to
provide a medium for the payment of taxes, as well as the investment of short-term funds. However, after
the Federal Reserve began to implement a flexible monetary policy following the accord of March 1951, it
became difficult to adjust the interest rates on savings notes to changing market yields, and sales were
suspended in 1953. No savings notes have been outstanding since 1955.
46
DEBT
managem ent
in
the
u n it e d
states
maturities.12 However, the success of the 6-month and 1-year bills
has apparently created greater readiness to use tax anticipation bills,
since bills have been used entirely for this purpose in recent months.13
other
cash
o f f e r in g s
In addition to its regular bill financing and essentially seasonal
borrowing through the issuance of tax anticipation securities, the
Treasury borrows through the issuance of certificates of indebtedness,
notes, and bonds both to raise new cash to cover excesses of expendi
tures over receipts and to refund maturing securities. Although
refunding operations could be handled by selling new securities for
cash and using the cash to retire the maturing securities, in practice
refunding is almost always handled by means of exchange offerings,
which we will discuss in the next section.
The timing of cash borrowing
In the case of a private business concern, proper timing of its bor
rowing operations in order to take advantage of favorable market
situations or to avoid unfavorable ones is usually regarded as the
essence of sound financial management. However, the Treasury is
subject to certain handicaps, real or alleged, with respect to the timing
of its debt operations. Flexibility in the timing of cash borrowing
operations would mean borrowing in advance of requirements ana
building up cash balances at times and drawing down cash balances
below normal levels in order to postpone borrowing at other times.
Flexibility might also be achieved at times by borrowing directly from
the Federal Reserve System under the provision which permits the
Federal Reserve to hold up to $5 billion of Government securities pur
chased directly from the Treasury.14
To some extent, the debt limit has imposed a real constraint upon
the flexibility of Treasury financing. In order to achieve greater
flexibility in timing through management of its cash balances, the
Treasury would have to permit these balances to vary over a wider
range and probably carry a larger cash balance 011 the average than is
its present practice.15 With given levels of expenditures and tax
receipts, the carrying of larger cash balances would necessarily lead
to some increase in the debt. There have been times in the last few
years when the Treasury has been operating so close to the statutory
debt limit that it would have been virtually impossible to have
achieved much more leeway in debt management by this method.16
Carrying larger cash balances would, of course, cost something since
12 See T. C. Gaines, “ Techniques of Treasury Debt Management” (unpublished Ph.D. dissertation,
Columbia University, 1959), pp. 419-425.
wAs of July 31, 1959, there were three issues of tax anticipation bills outstanding: An issue of $1.5 billion
sold in February to mature on September 21; an issue of $1.5 billion sold in May to mature on December 22;
and an issue of $3 billion sold in July to mature on March 22,1960. It wiU be noted that the first two of these
issues were sold in the last half of fiscal 1959 and will mature in the first half of fiscal 1960—which is contrary
to what we indicated above is the usual practice. However, this borrowing was a product of the heavy
deficit which prevailed in the fiscal year 1959, and further borrowing will be needed to cover these securities
when they mature in September and December. In a sense, this was not really borrowing in anticipation
of taxes, isince at the time the securities were issued there was no prospect that excess tax revenues would be
available to retire them at maturity.
m Sec. 14(b) of the Federal Reserve Act.
is In the last few years, the Treasury has typically carried working balances (on which it writes checks)
In the Federal Reserve banks of $700-$800 million. In addition, it has carried contingency balances in tax
and loan accounts in commercial banks which usually amount to around $4 billion. With cash outlays at
present levels of roughly $95 billion a year, the combined balances in Federal Reserve and commercial banks
are thus equal to only about 3 weeks’ expenditures.
wsee “ Public Debt Ceiling and Interest Rate Ceiling on Bonds,” hearings before the Committee on Ways
and Means, House of Representatives, 86th Cong., 1st sess., June 10,11, and 12,1959 (Washington: Govern
ment Printing Office, 1959), pp. 24-29.
DEBT MANAGEMENT IN THE UNITED STATES
47
interest would have to be paid on a larger debt. However, it seems
certain that, within limits, interest savings achieved through better
timing of borrowings would more than make up for this additional
cost and net savings would result. To the extent that the debt limit
hamstrings the Treasury in this way, it is obviously not serving a
useful function and should be raised to permit the needed flexibility.
In fact, since the Congress controls the Government's receipts and
expenditures, the logic of attempting to apply an independent (and
not necessarily consistent) control over the difference between receipts
and expenditures is open to question.17
However, not all of the inflexibility in the timing of cash offerings
can be blamed on the debt limit. Much of the time the debt has been
sufficiently below the statutory limit to have permitted the Treasury
to hold larger cash balances than it has. Moreover, the debt limit
should not prevent the Treasury from making use of its available line
of credit at the Federal Reserve banks in order to tide itself over until
a propitious time for borrowing from the public. Tins line of credit
has been used only very sparingly and apparently not at all for the
purpose of introducing greater flexibility into debt management.18
Of course, Treasury borrowing from the Federal Reserve and expendi
ture of the proceeds would add to bank reserves and money supply,
but, within reasonable limits, the Federal Reserve could act to offset
these effects through sales of Government securities in the open
market.19
It would appear that some easing of the problems of debt manage
ment at critical times as well as some— probably rather moderate—
saving in interest costs could be achieved by more flexible management
of the Treasury's cash balances, as well as more frequent use of the
power to borrow directly from the Federal Reserve.
Designing offerings
The first step in the borrowing process is to decide the nature of
the securities to be offered. This includes the choice of maturity and
other provisions such as call options 20 and the selection of the coupon
rate to be placed on the securities. In deciding what maturities to
issue, the Treasury proceeds almost entirely on an ad hoc basis, de
ciding each case as it arises. Beginning several weeks before the offer
ing is to be made, discussions are held with Federal Reserve officials
and with various market professionals, including the debt management
17 For critical analyses of the debt ceiling, see M. A. Robinson, “ The National Debt Ceiling: An Experi
ment in Fiscal Policy” (Washington: The Brookings Institution, 1959); also W. W. Heller, “ Why a Federal
Debt Limit?” Paper delivered at the 51st Annual Conference on Taxation of the National Tax Association,
Oct. 28,1958, and reprinted in “ Public Debt Ceiling and Interest Rate Ceiling on Bonds,” op. cit. pp. 274-281.
18See “ Investigation of the Financial Condition of the United States,” hearings before the Committee on
Finance, U.S. Senate, 85th Cong., 1st sess., July 29, 30, 31, Aug. 1, 2, 3, 6, 7, 8, and 9, 1957 (Washington:
Government Printing Office, 1957), pt. 2, pp. 894-895, for an explanation and record of use of direct borrowing
from Federal Reserve banks. This record shows that the power was not used at all from March 1954
through July 1957 and that such use as has been made of it in the past has been chiefly to smooth out the
financial effects of tax collections at quarterly tax dates.
19 Of course, this would mean that the Federal Reserve rather than the Treasury would be selling securities.
However, the flexibility of open market operations is greater than that of debt management, and the System
would have to sell only enough securities to offset the immediate impact of Treasury expenditures, whereas
the Treasury would presumably be borrowing enough to meet expenditures for some time ahead as well as
currently.
20Actually, only 2 issues of callable securities have been sold since 1945. The first was a 2^-percent
bond issued on March 1, 1952, callable on March 15, 1957, and maturing March 15, 1959. This issue was
called and redeemed in 1958. The second was the 3K-percent bond issued in May 1953, which becomes
callable on June 15, 1978, and matures on June 15,1983. One issue, a 4-percent note issued in August 1957,
and maturing in August 1961, became redeemable at the option of the holder on August 1, 1959, on 3
months’ advance notice. Of the $2,509 million originally issued, $473 million was redeemed on that date.
Another 4-percent note issued in September 1957, and maturing in August 1962, becomes redeemable at
the option of the holder on February 15, 1960, on 3 months’ advance notice. The advisability of making
greater use of call provisions exercisable at the option of the Treasury is discussed in ch. VI below-
48
DEBT MANAGEMENT IN THE UNITED STATES
advisory committees of the American Bankers Association and the
Investment Bankers Association. Representatives of the life insur
ance and savings banking industries are frequently called in if a long
term issue is contemplated in order to find out the receptiveness of
these investors. On the basis of the advice received, together with
independent study of market conditions, the Treasury decides “ where
the money is” and accordingly comes to a decision concerning the
maturity of its offering.21
The terms of Treasury offerings frequently coincide rather closely
with the advice it receives from market professionals and potential
investors. The practice of seeking advice from these groups has been
criticized on the ground that they have a vested interest and conse
quently may give the Treasury advice that is biased in their favor.
While it appears that these groups approach their responsibilities
seriously and honestly, and no evidence of any wrongdoing has been
uncovered, there is something to be said for more extensive investiga
tions of the market by the Treasury itself and less reliance on the
advice of these groups.22
Another and more sophisticated criticism of the Treasury’s methods
of arriving at decisions about financing has been advanced. It is said
that the Treasury suffers from the lack of well-formulated principles
governing its debt management operations— its only principle being
the vague one that it wants to “ lengthen the debt” whenever possible.
This lack of a “ principle” or “ rule” governing debt management
means that each operation is approached on an ad hoc basis with the
result that uncertainty about what the Treasury is going to do often
disrupts the market and sometimes virtually paralyzes it for some
time before the decision is made. The Treasury’s indecisiveness also
means that, instead of playing an active role in influencing the market
the Treasury is itself frequently dominated by market opinion.23
While there is undoubtedly some truth in this criticism, it may be
noted that the question involved is not “ principles” versus “ lack of
principles” but rather “ rules” versus “ authorities.” That is, even if
the principles guiding debt management policy were as clearly formu
lated as those governing any other aspect of economic policy (including
monetary policy), there would be a great deal of uncertainty about
how they were to be applied in a particular situation. The only way
to avoid the uncertainty would be to adopt a clear-cut (and probably
arbitrary) rule. And, in fact, this is precisely what the author of this
criticism advocates.24
Having decided the maturity sector in which it will make its offering,
the next problem is to choose the coupon rate of interest to be placed
on the offering. This must be done carefully since the Treasury fol
lows the practice (except in the case of bills) of selling its securities at
a fixed price.25 Thus, the interest rate must be set in such a relation
to yields prevailing in the market as to attract enough demand to
21 On the Treasury consultations with various advisory groups, see “ Debt Management Advisory
Groups,” hearings before a subcommittee of the Committee on Government Operations, House of Repre
sentatives, 84th Oong., 2d sess., June 5 and 7,1956 (Washington, Government Printing Office, 1956).
22This criticism is advanced in the questioning of former Under Secretary of the Treasury W. Randolph
Burgess by Senator Kerr in “ Investigation of the Financial Condition of the United States,” op. cit., pt. 2,
pp. 942-950. For a further discussion, see ch. VI below.
23 This criticism is advanced with considerable vigor by Gaines, op. cit., pp. 391-396.
24 Ibid., ch. XII. We will discuss Gaines’s proposal later (see ch. VI).
25 Formerly it was standard practice to offer securities at par. Beginning in 1958, however, the Treasury
has several times offered securities at a premium or discount (but still at a fixed price). For example, in
June 1958, a 3K percent bond maturing in 1985 was priced at 100^ to yield 3.22 percent. Since coupon rates
are varied only by units of lA percent, the practice of offering securities at a premium or discount permits a
more accurate adaptation of the yields on new securities to those on outstanding issues.
DEBT MANAGEMENT IN THE UNITED STATES
49
raise the desired sum of money. If the interest rate is too low, the
offering may be a failure; on the other hand if it is too high, the new
security may rise quickly to a premium after it is sold with resulting
windfall gains to holders of it.26
The Treasury uses the yield curve on^existing'securities at the time
the offering is being designed as a starting point for pricing its issues.27
However, if the market is to be induced to absorb a sizable new issue,
the issue must normally be priced to yield more than existing issues.
Thus, the coupon rate must be set above the corresponding point on
the yield curve, with the necessary differential being a matter of judg
ment that varies with the state of the market. In the case of corporate
bonds, there is a similar tendency for the yields on new issues to be
higher than yields prevailing on existing bonds of similar q lality.
In the corporate market, differentials in yield between new and existing
issues tend to grow larger in periods when interest rates are rising and
credit is tightening, and one would expect a similar pattern in the case
of Treasury issues, although the evidence on this is by no means clear.28
It is difficult to judge whether the Treasury commonly underprices
its issues, as is often alleged.29 Given the rather inflexible attitude
toward financing that prevails, the temptation is obviously to add a
little to the coupon rate to “ sweeten” the issue so that it will sell
successfully. In the case of cash offerings, the fact that issues are
almost invariably heavily oversubscribed might normally be thought
to suggest underpricing. However, in the course of time heavy over
subscriptions and fractional allotments have come to be so common
as to have little meaning. Perhaps more suggestive of underpricing
is the fact that new issues almost always rise to a premium when
first quoted on the market.30
Underpricing is objectionable because it results in unwarranted
windfall gains on the part of successful subscribers and tends to result
in a form of speculative activity known as “ free riding.” However,
for several reasons these phenomena are less likely in the case of cash
offerings than in that of exchange operations. Accordingly, we will
postpone further discussion of them until later.
Underwriting of cash offerings
The Treasury does not make use of formal underwriting in market
ing its issues, such as is provided by investment banking syndicates in
the case of corporate offerings. However, it is customary in the case
of cash offerings to permit commercial bank subscribers to pay for
issues by means of credits to Treasury tax and loan accounts, and
this practice provides a kind of indirect underwriting.31
26 If a new issue is priced too attractively (i.e., with a coupon rate that is too high relative to the fixed
offering price), the result might be either a rise in its price after issuance or a fall in the price (rise in the yield)
of other securities in the same maturity sector, as investors sell these securities in order to subscribe to the
new security. However, the fact that the new offering is likely to be small relative to the volume of similar
securities already outstanding probably makes a rise in its price after issuance somewhat more likely.
27 The process of selecting the coupon rate (and the price if different from par) is often referred to as “pricing
the issue.”
2? Gaines (op cit., pp. 425-433) argues that the opposite is true; i.e., that in the case of Treasury issues the
differentials are smaller when credit is tight than when it is easy. However, it is not clear that the compari
sons he makes are the relevant ones. For a comparison between Treasury and corporate issues in this
respect, see the charts and accompanying discussion in “Investigation of the Financial Condition of the
United States.” op. cit., pp. 716-717.
29 The case most commonly cited as a flagrant example of underpricing is the 3!4 percent bond of 1978-83
issued in May 1953.
30 For evidence on this point, see the table entitled “ Appendix B” in “Investigation of the Financial Con
dition of the United States,” op. cit., pp. 691-692. The tendency for the price to rise to a premium on first
quotation seems to be less pronounced for cash than for exchange offerings, for several reasons discussed
below.
31In the case of Treasury bills, banks may not pay for their subscriptions to the regular 13-week and 26week bills by means of tax and loan account credits. For tax anticipation bills and the longer term “regular”
bills that have recently been issued, such credits are sometimes but not always allowed.
50
DEBT MANAGEMENT IN THE UNITED STATES
Whet) a bank buys newly issued Treasury securities and pays by
means of a credit to the Treasury’s tax and loan account at the bank,
the amount of bank reserves tied up is only a fraction of the amount
of securities purchased, whereas in the case of other loans or invest
ments it might make, it will normally lose reserves equal approxi
mately to the full amount it lends or invests. Since the bank can
ordinarily expect to keep the new Treasury deposits for perhaps 2 or
3 weeks before they are withdrawn and transferred to a Federal
Reserve bank, there is a rather important gain to the bank from
obtaining the securities and the accompanying deposits. For example,
if a bank subject to a reserve requirement of 20 percent, buys $1
million of a new 3 percent Treasury issue, and the Treasury leaves the
funds on deposit for 18 days, the bank earns $1,500 interest (assuming
it holds the securities for the full 18 days) on an investment of $200,000
for 18 days or a rate of 15 percent per annum, provided it can sell the
securities for the same price it paid for them.32
Under this arrangement, it becomes worthwhile for banks, par
ticularly at times when credit is tight and customer loan demand
heavy, to subscribe for new Treasury issues, resell them at a discount,
and reinvest the proceeds in loans or other types of securities.33
Thus, banks are heavy subscribers to Treasury cash offerings, and a
high proportion of such securities are commonly allotted to banks.34
The banks serve essentially as underwriters, reselling— or distrib
uting— the securities to other investors. Since securities sold in
this wTay tend to fall to a discount shortly after issuance, other
investors may fail to place subscriptions, preferring to wait and buy
in the secondary market at a more favorable price. It should be
noted that when the whole operation has been completed and the
Treasury has transferred the deposits to the Federal Reserve bank,
there has been no net increase in bank credit outstanding or in the
money supply.
Since the size of Treasury cash is often large relative to the flow
of freshly available funds in the market, underwriting through com
mercial banks undoubtedly facilitates Treasury financing and results
in a gradual and orderly secondary distribution of new issues into
the hands of nonbank investors. It is especially important in the
marketing of short-term securities, such as certificates and shorter
term notes. In the case of longer term casli offerings, the Treasury
has commonly used various devices to limit or discourage bank
subscriptions, apparently on the ground that such securities are
unsuitable investments for banks.35 In thus restricting bank sub
scriptions to longer term issues, the Treasury is probably denying
itself important underwriting support that could be of great help at
times.
32 If the securities fall to a discount, the returns are correspondingly reduced. In the above example,
disregarding transaction costs, the bank will break even if it can sell the securities at a price of 99.85. It
may be noted that the rise in yield that can occur without wiping out the profit on the transaction depends on
the maturity of the securities. For a 3 percent bond, a price of 99.85 corresponds to a yield of 3.575 percent
for a security with 3 months to run to maturity, 3.150 percent for a 1-year security, 3.033 percent for a 5-year
security, 3.017 percent for a 10-year security, and 3.010 percent for a 20-year security.
33 That is, in the above example, if the bank was short of funds to meet loan demands, it could sell the full
amount of its allotment ($1 million), keep $200,000 of the proceeds as reserve for the Treasury deposits, and
have the remainder available to lend to customers for 18 days. The discount at which it could sell the
securities and still gain from the transaction would depend upon the cost of obtaining the funds from an
alternative source.
34 Allotments to commercial banks have averaged 59 percent of total allotments to all investors other than
Government investment accounts and the Federal Reserve for all cash offerings of certificates, notes, and
bonds since Jan. 1,1953. For specific issues the percentage has ranged from 97 to 12 percent.
35 For example, bank subscriptions to the 3H -percent bond of 1978-83, issued in May 1953, were restricted
to an amount not exceeding 5 percent of their time deposits as of Dec. 31,1952.
DEBT MANAGEMENT IN THE UNITED STATES
f)1
Allotments oj cash offerings
Cash offerings are almost always heavily oversubscribed.36 Thus,
the Treasury is regularly faced with circumstances where there is excess
demand so that it must ration or “ allot” securities. The procedure
followed is usually to allot small subscriptions—up to, say, $10,000,
$25,000, or in some cases, $100,000—in full, and to allot the remainder
on a proportional basis in such a way as to achieve the desired volume
of total sales. In the case of long-term bonds— that is, those with a
maturity of perhaps 15 years or more— the practice has usually been
to grant preferential allotments (that is, a higher percentage) to savingstype investors, such as life insurance companies and savings banks.
These preferential allotments have been designed particularly to dis
criminate against commercial banks. Thus, commercial bank partici
pation in long-term cash offerings has been doubly discouraged—first,
by placing limitations on their ability to subscribe, as indicated above,
and, second, by discriminating against them at the stage of allotting
securities.37 Apparently the feeling is that there is something repre
hensible in the holding of long-term bonds by commercial banks.
However, even if this were true (and it is difficult to see how much of
a case could be made for it as a generalization), preferential allotments
can hardly serve to prevent it, since there is nothing to stop banks from
buying the securities in the secondary market. The Treasury’s atti
tude probably also reflects the view that sales of securities to commer
cial banks are inflationary because they result in an increase in the
money supply. This notion had some validity in the war and immedi
ate postwar period when the Federal Reserve was supporting bond
prices. However, under present conditions in which the Federal
Reserve exerts reasonably effective control over the supply of bank
credit, it makes little sense. From the Treasury’s point of view,
preferential allotments serve chiefly to discourage commercial banks
from participating in long-term cash offerings and deprive the Treasury
of underwriting support for such offerings which might be helpful at
times.88
The great uncertainty concerning allotments is the source of much
irritation among investors and probably has the effect of discouraging
a certain amount of participation. Allotments vary over such a wide
range and are so unpredictable that it is very difficult to tell in advance
how many securities one is going to get. Life insurance companies
and savings banks are particularly inclined to complain about these
uncertainties.39 However, it is doubtful how meaningful these com
plaints are. As pointed out in the previous chapter, savings institu
tions have been steadily reducing their holdings of Government securi
ties in recent years. This suggests that when they purchase new
Treasury securities they typically offset these purchases by sales of
governments from their existing portfolios— although, admittedly, the
sales may be in shorter maturity ranges than the purchases. In addi
tion, if they really want to purchase new issues, there is nothing to
36 The typical cash offering of certificates, notes, or bonds during the period since Jan. 1, 1953, has been
oversubscribed about three times (subscriptions three times actual sales). Subscriptions have never been
less than about Itt times sales, and the ratio has risen as high as six or seven times on a few occasions.
37 Since Jan. 1,1953, allotments to commercial banks on cash offerings have averaged 73 percent of total
allotments to all investors other than Government investment accounts and the Federal Reserve for certifi
cates, 70 percent for notes, and only 37 percent for bonds. For bonds with maturities of over 15 years, bank
allotments have averaged only 23 percent of the total.
38 See the excellent discussion of this matter in Gaines,fop. cit., pp. 443-447.
» See the testimony of George T. Conklin before the Joint Economic Committee, July 28,1959.
52
DEBT MANAGEMENT IN THE UNITED STATES
prevent them from buying in the secondary market after issuance.
Nevertheless, it would undoubtedly be desirable to do something to
lessen the uncertainty about allotments. Under present operating
techniques, however, it is difficult to give any advance assurance con
cerning allotments without having the Treasury lose, at least partially,
its control oyer the total size of its offerings. One of the advantages
of the extension of the auction technique to cash offerings of long-term
securities is that it would eliminate the allotment problem entirely,40
REFUNDING OPERATIONS
At first glance, refunding operations appear to be considerably
different from sales of securities to raise new money because refund
ings involve the exchange of new securities for old securities, whereas
new borrowing involves the exchange of securities for cash. How
ever, while there is something to this distinction, it is easy to exag
gerate it. It must be borne in mind that maturing securities— no
matter what their maturities might have been when originally issued—
have a very short maturity at the time they are refunded. In fact,
strictly speaking, their maturity at that time is zero, which means that
they are virtually identical with money. However, the maturing
securities do represent funds that are at least momentarily committed
to investment in Government securities and consequently are poten
tially somewhat more readily enticed into investment in the newly
issued securities than mere uncommitted cash would be. On the
other hand, the maturing securities maj" be quite different instruments
from the securities being newly issued— especially if the new securities
are of the longer-term variety— and therefore may not be in the hands
of the kind of investors who would be interested in the new security.
The special difficulties that are associated with refunding operations
are largely related to this problem.
Designing offerings
The problems of selecting the maturities to offer and establishing
the appropriate coupon rate on the new securities are not greatly
different from the similar problems arising in connection with cash
offerings. Recently, the Treasury has commonly followed the prac
tice of offering more than one option to holders of the maturing secu
rities. Thus, it frequently offers an intermediate or long-term bond
and also a certificate or short note having a maturity in the neighbor
hood of 1 year. The purpose in this practice is to give interested
investors an opportunity to invest in a longer term security with a
view to achieving as much debt lengthening as possible, while at the
same time making a short-term instrument available in order to keep
down the attrition (i.e., cash turn-ins) and insure the success of the
operation.41 In addition, it is common practice to consolidate several
securities maturing around the same time into a single refunding oper
ation. The combined result of these two practices is to produce, at
times, quite complex refundings, with three or four new issues being
40 See the discussion in ch. VI.
41 Gaines (op. cit., p. 403) critcizes this practice on the grounds that it “has delegated control over the
maturity structure of the debt to the investors in the exercise of their exchange options” and reflects the
absence of “a debt management policy, in the sense of an orderly and conscious program with intended effects
upon economic liquidity, the availability of funds at different maturities, and other significant economic
variables.” The present writer feels, however, that our lack of concrete knowledge about the economic
effects of debt management makes it very difficult to establish a meaningful debt management program
‘along the indicated lines, so that the criticism is somewhat misdirected. See ch. IV for a fuller discussion.
DEBT MANAGEMENT IN THE UNITED STATES
53
offered in exchange for a similar number of maturing issues in a single
operation.42
Trading in *lights” and “when-issued11 securities
Maturing securities, as pointed out above, are short-term liquid
instruments and, as such, are likely to be in the possession of investors
who are holding them for liquidity reasons. On the other hand, the
securities being issued in exchange, if they are of intermediate or
long maturity, are more likely to appeal to investors who want them
either as more or less permanent investments or, under some circum
stances, for prospective short-term speculative gains. Since investors
can obtain the new security at the time of its original issuance only
by presenting a maturing security in exchange, the success of a
refunding operation often hinges on the prior consummation of a
considerable volume of transactions which shift maturing securities
from their normal owners to investors desiring to obtain the new
securities.
The maturing securities possess value both as “ rights” —i.e.,
options to buy the new securities being offered in exchange— and
also as short-term investments. If the new securities being offered
are attractive, the rights value of the maturing securities will exceed
their value as short-term investments, and they will rise to a premium
relative to other outstanding short-term securities. On the other
hand, if the new securities are relatively unattractive, the maturing
securities will sell 011 a yield basis similar to other similar securities.
If the rights do not sell at a premium, there will be no incentive for
their holders to sell them— they would be as well off to hold onto the
rights and turn them in for cash when they mature. For this reason,
the success of an exchange, especially if it involves the offering of
a longer term issue, may require that the terms of the new offering
be sufficiently attractive to create a rights premium in order to induce
the required transactions in rights in advance of the offering.
The rights may go to a premium and a considerable amount of
preliminary trading occur even before the terms of the offering are
announced, provided the market has some confidence that an attrac
tive security will be offered. Such a development is especially likely
to occur if market opinion feels that a longer term bond, subject to
substantial potential price appreciation, will be offered at a time when
the Federal Reserve is following an easy money policy and interest
rates are expected to fall, since under these conditions attractive
speculative profits on the new offering are in prospect.43 In addition,
trading in rights continues after formal announcement of the offering
is made for a period of 4 or 5 days until the subscription books close.
Government security dealers play an important role in the process
of trading in rights. Dealers buy and sell rights, thus facilitating
their redistribution; moreover, as soon as the subscription books
42 The refunding of Feb. 14,1958, is a good example of a complex operation. In this case, holders of five
issues (a bill, two certificates, a note, and a bond) maturing between February and April 1958, and aggre
gating $16.8 billion (including amounts held by Treasury investment accounts and the Federal Reserve)
were offered a choice of three new issues in exchange, including a 1-year certificate, a 6-year bond, and a
32-year bond. Of the $10.9 billion of maturing securities held by the public, $4.0 billion were exchanged for
the certificate, $3.8 billion were exchanged for the short bond, $1.6 billion were exchanged for the long bond,
and $1.4 billion were redeemed for cash.
43 This was the situation at the time the 2% percent bonds of 1965 were offered in an exchange in June 1958.
In this case, there was a large volume of trading in rights prior to the announcement of terms. See “ Treas
ury-Federal Reserve Study of the Govemment-Securities Market,” pt. II (preliminary mimeographed
edition), ch. III. In this speculative episode, the market’s anticipations concerning future movements of
interest rates turned out to be wrong. This episode is discussed at some length in ch. III.
54
DEBT MANAGEMENT IN THE UNITED STATES
open (normally they remain open for 3 days) the securities begin to
trade on a “ when-issued” basis. During the subscription period,
dealers buy rights and sell when-issued securities; however, their
purchases of rights ordinarily exceed their sales of when-issued securi
ties, as they make some net purchases of the securities for their own
account. These dealer operations, which contribute to the success of
the exchange and to the proper placement of the new offering, are the
closest thing there is to systematic underwriting in connection with
refunding operations.44 One recent observer has suggested that, while
the preliminary trading in rights and when-issued securities helps
to prepare the market for exchange offerings, the amount of actual
redistribution of rights is of marginal significance. The basis for this
contention is the fact that allotments of exchange offerings to dealers—
representing their net accumulation of rights, partially offset by sales
of when-issued securities—is typically a rather small portion of total
allotments in refunding operations.45 At times when the Federal
Reserve is following an easy money policy, further underwriting sup
port may be provided by commercial banks which typically receive
large allotments of long-term exchange offerings under such conditions,
in part for their own account and in part for redistribution to other
investors. In times when credit conditions are tight, bank participa
tion in long-term exchange offerings tends to dry up, however.46
Speculative activity
While extensive speculative interest may develop in connection
with cash offerings at times,47 there are several reasons why speculators
are more likely to be attracted by exchange operations. In the first
place, quick speculative profits of the “ free riding” type—i.e., due to
underpricing of an issue and a consequent jump in its price to a
premium when trading opens— are somewhat more likely in refunding
than in cash offerings.48 The reason for this is that underwriting by
commercial banks through the use of Treasury tax and loan accounts
tends to cause cash offerings to go to a discount immediately after
issuance, as explained above, whereas exchange offerings are some
what more likely to rise to a premium.49 Another reason is that the
preliminary trading in rights which occurs in the case of refunding
operations, as discussed above, provides an opportunity for specula
tive fever to rise and for speculative commitments to become estab
lished in advance of the actual offering. Finalfy, although the Treas
ury typically requires a cash payment at the time of the subscription
for cash offerings by nonbank investors of only 5, 10, or sometimes
44 For an excellent description of these operations, see Gaines, op. cit., pp. 396-403.
45 Dealer allotments have averaged 7 percent of total allotments to investors other than Treasury invest
ment accounts and the Federal Reserve on exchange offerings during the period since Jan. 1, 1953. For
bond offerings dealer allotments have been somewhat larger, averaging about 11.5 percent of the total and
exceeding 15 percent on several occasions.
46 Gaines, op. cit., pp. 437-39. For the period since Jan. 1, 1953, allotments to commercial banks on
exchange offerings have averaged 42 percent of total allotments (excluding Treasury investment accounts
and the Federal Reserve) for certificates, 53 percent for notes, and 66 percent for bonds. Thus it is clear
that commercial banks play a major role as investors in and distributors of exchange offerings.
47 For example, there was considerable speculative interest in the cash offering of the 3j4 percent bonds
of 1978-83 in April 1953, due to the apparent underpricing of this issue and the prospect of “ free riding”
profits.
48 Free riding was a serious problem during World War II—and one that became more and more serious
as the war progressed; on this, see H. C. Murphy, “ The National Debt in War and Transition,” op. cit.,
ch. XIV. For a prewar discussion of free riding, see Sylvia Porter, “ How to Make Money in Government
Bonds” (New York, Harper & Bros., 1939), ch. III.
49 During the period 1953-57, 7 out of 14 issues sold for cash went, to a discount on first quotation, whereas
for exchange operations, such discounts made their appearance in only 4 of 35 cases. See table entitled
** Appendix TV’ in “ Investigation of the Financial Condition of the United States,” op, (it., pp. 691-692.
DEBT MANAGEMENT IN THE UNITED STATES
55
20 percent of the subscription,50 speculative positions can usually be
financed on even thinner margins in the case of exchange offerings, by
borrowing from banks or, directly or indirectly, from nonfinancial
corporations through the use of repurchase agreements.51
Attrition
The term “ attrition” is used to refer to the portion of the maturing
securities turned in for cash rather than exchanged in a refunding
operation. The amount of attrition should be related to the amount
of maturing securities held by the public—i.e., excluding those held
by Federal agencies and trust funds and the Federal Reserve System—
since these securities are ordinarily “ rolled over” into new issues with
out change. From January 1, 1953, through August 1, 1959, the
amount of maturing publicly held securities for which new securities
were offered in exchange was $173.5 billion. Holders of $155.2 billion
of these securities accepted the exchange offerings, and the remaining
$18.3 billion was turned in for cash. Thus cash turn-ins have aver
aged 10.6 percent of the amounts maturing. The percentage of cash
attrition has ranged between 1.4 percent and 32.4 percent for specific
refunding operations. In general, the attrition tends to be small
when credit conditions are easy and to increase when the money
market tightens.
The amount of attrition is commonly regarded— particularly by
the Treasury and the financial community— as an index of the success
of a refunding operation; that is, the smaller the attrition the more
successful the operation. Actually, if the Treasury were to take a
more flexible attitude toward the management of its cash balances,
attrition, within reasonable limits, would become a matter of relatively
little importance. In that case, the success of a refunding operation
could be judged, as it should be, in terms of its effects on the maturity
structure of the debt. The amount of attrition is a very poor index
of the success of a debt management operation.
It may be noted, however, that the amount of attrition has been
large enough to account for a considerable portion of the need for
cash borrowing. During the period from January 1, 1953, to August
1, 1959, the attrition of $18.3 billion on exchange offerings amounted
to nearly 35 percent of the $53.3 billion of cash sales of certificates,
notes, and bonds to the public.
CONCLUDING COMMENT
In this chapter the purpose has been to explain, with appropriate
comment and, in some cases, criticism, the techniques that are now
being employed by the Treasury in the management of the public
debt. At a later point, some possible major changes in technique,
which might produce improved results, will be considered.52
50 Commercial banks, of course, need not put up any cash, since they can pay through credit to Treasury
tax and loan accounts.
« These points are discussed further in the next chapter, where the 1958 speculative buildup and collapse
associated with the June offering of the 2% percent bonds of 1965 is taken up.
See ch. VI.
50438
60 — 5
C H A P T E R III
RECENT DEBT MANAGEMENT EXPERIENCE AND PROBLEMS
In this chapter we shall first review the highlights of Treasury debt
management since 1951 and then consider some of the more obvious
problems that emerge from this experience.
SURVEY OF RECENT DEBT OPERATIONS
Table III—1 summarizes the debt management operations of the
Treasury since 1951. Since we are interested only in the size and
composition of the publicly held portion of the debt, transactions
involving Government agencies and trust funds and the Federal
Reserve System have been eliminated. It may be noted that this
adjustment makes a considerable difference in the totals of certificates,
notes, and bonds issued, since a rather large portion, particularly of
refunding operations, is frequently accounted for by the more or less
automatic “ rollover” of maturing securities held in the portfolios of
the Federal Reserve System and Government agencies and trust
funds.1 Just as the statistics on the gross public debt exaggerate the
true size and growth of the debt, so the unadjusted data on the
issuance of securities exaggerate the true size of current debt
operations.
Table I I I - l covers approximately the period since the TreasuryFederal Reserve accord of March 1951. During 1951, no effort was
made to extend the maturity of the debt, and, as indicated in the last
column, the average maturity declined steadily during the year.
All exchange offerings during the year were in the under-l-year
category, and such cash financing as was necessary was accomplished
by means of changes in bill offerings. Even so, the Federal Reserve
continued the preaccord practice of giving direct support to the
Treasury refunding operations through the purchase of rights (ma
turing securities). During this period, the authorities were uncertain
as to how the market would react to a more flexible Federal Reserve
policy, and caution was the predominant attitude. In 1952, the
first tentative steps of the postwar period were taken to lengthen the
maturity of the debt. In March, the Treasury issued $600 million
of 2% percent 5 to 7-year bonds as an optional exchange offering,
and in July $4.1 billion of 2% percent 6-year bonds were sold to the
public for cash. However, as shown in the last column of table I I I - l ,
these cautious steps were not sufficient to prevent the average ma
turity of the debt from declining steadily during the year as a result
of the passage of time. Late in 1952, in accordance with recom
mendations submitted by an ad hoc subcommittee of the Federal
Open Market Committee, the Federal Reserve abandoned the practice
of lending direct support to Treasury refunding operations.2 Since
that time, with few exceptions, it has limited its assistance to the
Treasury to the maintenance of generally stable conditions in the
money market at times when the Treasury has been engaged in debt
operations.
1 See footnote 15 below.
2 The ad hoc subcommittee report was published in “ U.S. Monetary Policy: Recent Thinking and
Experience,” hearings before the Subcommittee on Economic Stabilization of the Joint Committee on
the Economic Report, December 1954 (Washington: Government Printing Office, 1954), pp. 257-331.
56
DEBT MANAGEMENT IN THE UNITED STATES
57
Table I I I —1.—Summary of operations affecting the publicly held debt by quarters,
19 51-59
[Dollars amounts in millions]
Certificates, notes, and bonds issued 1
Calendar year
and q u a rter
Certifi Increase Average
cates,
or de maturity
notes,
crease
of debt
and
( - ) in at end of
Average
percent bonds bills out period«
Tor
In ex maturity3 Amount4 of ma retired standing (months)
cash change (months)
turing for cash
Num
ber of Total
oper
ations
1951—1s t
2d..........
3d..........
4th.........
Total .
1952—1s t
2d..........
3d_____
4th.........
Total- —
1953—1st.........
2d..........
3d..........
4th.........
Total1954r-lst.........
2d..........
3d..........
4th........
Total- —
1955—1st-—
2d.._
3d__
4th...
Total- —
1956—1st—
2d—
3d...
4th..
Total1957—1st..
2d...
3d...
4th_.
Total--.
1958—1st.
2d._
4th..........
Total-1959—1st.
2d..
$6,298
4,112
5,778
16,188
5,590
10,580
3,042
19,212
5,033
5,192
15,373
5,110
30,708
14,252
7,276
10,092
13,893
45,513
10,174
7,230
5,571
8,578
31,553
4,282
10
Maturing issues
redeemed for
cash (attrition)
$6,298
4,112
5,778
16,188
5,590
$4,142
4,142
1,070
5,902
2,239
9,211
2,179
3,733
4,143
10,055
5,742
2,998
2,970
11,710
7,199 3,221
2,433
13,914 3,221
7,318 3,279
2,521
10,816 3,'233
4,049 2,154
24,704
10,853 1,384
13,662 4,904
9,849 3,567
104,859 01,079
39,223 10,934
10,715 3,572
2,212
6,438
3,042
15,070
5,033
14,122
9,471
2,921
21,547
14,252
5,097
6,359
9,750
35,458
10,174
1,488
2,573
5,608
19,843
4,282
9.5
11.4
10.5
19.1
$548
307
473
1,328
753
34.9
14.0
26.9
19.1
667
509
1,929
134
11.0
112.1
16.3
64.1
40.9
75.5
43.4
34.0
62.5
59.8
107.6
9.4
102.0
15.4
1.0
20.5
3,978
2,433
10.693
10.0
8.1
12.8
2,521
7,583
1,895
16,038
9,469
8,758
19.4
16.6
62.1
68.5
45.8
70.5
83.4
3,780
28,289
7,143
1,114
52.8
35.0
50.0
10.6
12.8
118
1,440
2,612
502
148
315
3,577
795
712
149
847
2,503
151
500
1,533
870
2,234
138
3,242
1,433
351
2,764
412
4, S
2,075
547
-$412
1,177
1,431
2,964
5,160
-652
-7
8.0
6.9
7.6
7.6
11.8
-12
9.4
14.3
11.3
2.5
16.7
3.6
3.9
3,501
6.6
$5,902
3.1
9.1
7.2
32.3
5.4
13.1
5,902
3,734
3,210
2.2
3.4
18.1
17.0
12.5
17.7
46.9
6.7
16.8
13.1
38.5
30.5
6,944
2,202
4,456
1,141
7,799
3,221
1,312
4,533
• 105
9387
121
11.8
22.5
32.9
80
80
78
75
73
69
15.5
8.9
11.2
(7)
(7)
(7)
3,567
5,851
-1,777
-363
-665
-1.065
-3,870
2,597
-1,860
765
-667
835
1,310
27
1,080
584
3,001
-539
-3 3
3,230
2,867
1,639
-1, 755
2,931
-427
2,388
-3,619
-2,358
2,034
5,821
1,778
3,225
-641
68
71
67
67
67
74
74
72
74
82
78
77
74
73
73
70
66
66
65
65
62
61
61
67
72
69
64
64
62
1 Excluding the exchange of $13,500,000,000 of marketable issues for 224-percent nonmarketable Treasury
bonds, investment series, in May 1951, and a further $1,000,000,000 in June 1952.
2 Excludes periodic issues of 1^-percent 5-year notes in exchange for nonmarketable 2%-percent Treasury
bonds, investment series B, 1975-80.
3 Weighted average maturity of securities issued during the quarter or year.
4 Amount of maturing securities turned in for cash by investors other than Federal Reserve banks.
« Securities turned in for cash as a percent of maturing debt held by investors other than Treasury invest
ment accounts and Federal Reserve.
• Average maturity of marketable debt excluding Federal Reserve holdings but including holdings of
Government agencies and trust funds (which amounted to $7,256,000,000 on July 31, 1959). All issues
classified to final maturity except partially tax exempt bonds, which are classified to earliest call date.
7Not available.
« Includes $417,000,000 of 3H-percent bonds of 1978-83 accepted in exchange by holders of series F and G
savings bonds maturing from May 1 through Dec. 1,1953.
e Purchases of 2$£-percent Treasury bonds of 1965 for retirement under sec. 19 of Second Liberty Bond
Act, as amended (31 U.S.C. 754a).
Includes $2,735,000,000 of special 219-day 3K-percent bill issued at a fixed price of 98.023 in October 1958.
N o t e .— Detail may not add to totals due to rounding.
Source: Treasury Department.
58
DEBT
m anagem ent
in
THE UNITED STATES
The new administration which took office at the beginning of 1953
promptly expressed its concern about the continual shortening of
maturities and announced its intention of working to lengthen them
by selling more long-term securities. The first major step in imple
menting the new policy was taken at the beginning of M ay with the
sale for cash of $1.1 billion of 3}{ percent 30-year bonds. This was
the the first offering of a long-term bond since 1946, and coming at
a time when the economy was feeling the pinch of a restrictive Federal
Reserve policy, it was widely criticized for contributing to the con
gestion in the capital market that developed at midyear. In order
to relieve the congestion, the Federal Reserve relaxed its restrictive
policy just at the time when a downturn in business activity began.
With the recession of 1953-54 underway, the Treasury desisted from
further attempts to sell long-term bonds. However, some inter
mediate-term bonds were issued in the fourth quarter, and for the
year as a whole there was only a slight decline in the average maturity
of the debt.
Although the avowed policy of the administration called for con
centrating on lengthening the debt during times of inflation in order
to absorb funds from the long-term sector and damp down private
spending, thus reinforcing the effects of a restrictive monetary policy,
the Treasury continued to struggle with the problem during the re
cession. In February 1954, it succeeded in issuing to the public
$11.2 billion of 2}£-percent bonds with a maturity of 7 years and 9
months in an exchange offering. As a result of this and other opera
tions, the average maturity of the publicly held debt was raised by
7 months during the first quarter of 1954. The issuance of several
smaller intermediate-term issues of notes and bonds during the re
mainder of 1954 permitted the Treasury to hold its own and prevent
the debt from shortening. In the first quarter of 1955, when business
recovery had developed to the point where inflation was beginning
to be a problem and the Federal Reserve was turning once again
toward a cautiously restrictive policy, another forward step in the
policy of lengthening maturities was taken. In an exchange offer
ing in February 1955, the Treasury succeeded in issuing $11.2 billion
of securities having an average maturity of approximately 9 years.
Actually, the lengthening of maturities that was accomplished in
this operation was chiefly due to the issuance of $1.9 billion of 3
percent 40-year bonds. In any case, however, the average maturity
of the publicly held debt increased by 8 months during the first
quarter.
Thus, between December 1953 and March 1955, the average matu
rity of the publicly held debt increased by 15 months— from 67 months
to 82 months. Another $800 million of 3-percent bonds was sold for
cash in July 1955, when the 40-year bond originally offered in February
was reopened. Aside from this, however, after the first quarter of
1955, the tightening of credit conditions produced by the boom itself
and reinforced by the Federal Reserve’s increasingly restrictive policy
forced— or at least persuaded— the Treasury to confine its financing
to the short-term sector. As a result, the average maturity of the
debt declined steadily from 82 months in March 1955 to 61 months in
December 1957. Relatively little effort was made to lengthen matu
rities until September 1957, when some $2.5 billion of 5-year notes
and 12-year bonds were sold for cash.
DEBT MANAGEMENT IN THE UNITED STATES
59
When credit conditions began to ease and interest rates fell with
the onset of recession in late 1957, the Treasury moved quickly to
exploit the situation. Its offerings either for cash or in exchange during
the last quarter of 1957 and the first half of 1958 included: $550 million
of 17-year bonds in November, $3.8 billion of 6-year bonds, $1.6
billion of 32-year bonds, and $1.4 billion of 8K-year bonds in February
1958, and $1.0 billion of 27-year bonds, and $7.0 billion of 6%-year
bonds in June 1958.3 These operations, particularly in the first and
second quarters of 1958, resulted in an increase in the average maturity
of the publicly held debt from 61 months in December 1957, to 72
months in June 1958.
By mid-1958, it became apparent that recovery was underway.
As a result, expectations of declining business activity and falling
interest rates quickly gave way to expectations of inflation and rising
interest rates. Long-term interest rates reacted violently to the sud
den change in expectations and rose sharply in the second half of the
year. Due to the resulting congestion in the capital market, the
Treasury confined its financing in the last two quarters of 1958 to the
short end of the market. By early 1959, the financial markets had
stabilized, and it was possible to sell small amounts of bonds for cash
on two occasions during the first half of the year, thus checking to
some extent the shortening of debt maturities which had occurred in
the last half of 1958.4
Despite the original intention of the present administration to press
measures to lengthen the debt during periods of inflation in order to
lend support to the Federal Reserve’s anti-inflationary policies, it is
clear from table III—1 that, in practice, the Treasury has been success
ful in lengthening the debt only in recession periods. Such increases
in the average maturity of the publicly held debt as have been accom
plished in the last 6 years have occurred during the period of recession
and early recovery in 1954 and the first quarter of 1955 and during
the recession of 1957-58.
The magnitude of the debt management problem has varied
greatly from year to year. The net amount of certificates, notes,
and bonds issued in both cash and refunding operations— i.e., the
total amount issued less the amount retired for cash—was $39.6
billion in 1954, $24.6 billion in 1955, $6.1 billion in 1956, $20.2 billion
in 1957, and $38.6 billion in 1958. In part, these variations reflect
changes in the budgetary situation: the Treasury had small cash
deficits in 1954 and 1955, moderate cash surpluses in 1956 and 1957,
and a rather large cash deficit in 1958.6 To some extent also, the
variations result from changes in the amount of borrowing through
the issuance of Treasury bills— for example, in 1956 and 1957 when
the money and capital market was tight, the Treasury increased the
extent of its reliance on the bill market. In addition, however, changes
from year to year in the magnitude of the debt management problem
3 The speculative tendencies that developed during this period, particularly in connection with the June
financing, are discussed later in this chapter.
4 The Treasury sold $884 million of 4-percent 21-year bonds ($834 million to the public) in January 1959,
and $619 million of 4-percent 10^-year bonds ($569 million to the public) in March. The later offering
was carried out by reopening the 12-year bond originally offered in October 1957.
6 The cash budget showed a deficit of $1.1 billion in the calendar year 1954, a deficit of $0.7 billion in 1955
a surplus of $5.5 billion in 1956, a surplus of $1.2 billion in 1957, and a deficit of $7.3 billion in 1958. Actually
cash deficits and surpluses can be related to the statistics in table III-l only in a rather loose way, since
the table does not take into account changes in the Treasury’s cash balances and since the cash budget
includes receipts and expenditures of Government agencies and Government-sponsored enterprises whose
debt operations are not included in the table. Moreover, the savings bond program, which may affect
the Treasury’s cash position, is not included.
60
DEBT MANAGEMENT IN THE UNITED STATES
are due to the unevenness with which debt matures. This is evidenced
by the fact that maturing publicly held certificates, notes, and bonds
amounted to $44.9 billion in 1954, $29.3 billion in 1955, $20.0 billion in
1956, $23.8 billion in 1957, and $33.8 billion in 1958.6 It may be
noted that the concentration of maturities in 1958 is in considerable
due to the fact that the Treasury relied heavily on short-term securi
ties in 1957, thus necessitating a large amount of reborrowing in 1958.7
The present prospect is that the debt management problem will
be less troublesome during the remainder of 1959 and through the
year 1960 than it has been in the past couple of years. In July, the
Treasury refunded $5.4 billion of publicly held certificates and notes,
issuing in exchange $3.9 billion of 4%-percent short-term notes maturing
in August 1960, and $1.5 billion of 4%-percent longer-term notes
maturing in May 1964. Between the end of June and the end of
October $10.8 billion of cash was borrowed as follows:
$4 billion in July and August by means of tax anticipation bills
due in March 1960.
$2 billion in July through sale of a special 1-year bill.
$600 million in August through an increase in regular 91- and
182-day bill issues.
$2 billion in October by means of tax anticipation bills due in
June 1960.
$2,200 million in October through sale of 5-percent 4-year and
10-month notes.8
As this is being written, the Treasury has announced that it will
offer holders of $2.6 billion (publicly held portion) of certificates and
$1.2 billion (publicly held portion) of notes maturing in November
1959, an option consisting of a 4%-percent 1-year certificate or a 4%percent 4-year note.9
The heavy cash borrowing by the Treasury since June has been
necessitated partly by a seasonal cash deficit which amounted to
about $7 billion through the end of October. In addition, however,
the Treasury has experienced a substantial cash drain in connection
with the savings bond program (cash payments for redemption ex
ceeded cash sales by nearly $800 million in July and August).10
Attrition on the August refunding amounted to about $200 million,
and due to the seasonal deficit, it was necessary, in effect, to retire
for cash $1,500 million of tax anticipation bills which matured in
September. A further $1,500 million of tax anticipation bills will
mature in December. Some further cash borrowing may be neces
sary before the end of 1959, although the amount should not be
large. Since the cash budget will probably be in balance, with per
haps a small surplus, in fiscal 1960 as a whole, most of the short-term
securities issued for cash in the second half of calendar 1959 can
presumably be retired out of excess tax revenues in the first half of
calendar 1960.
Taking account of debt operations through October 1959, and
assuming that the $2.6 billion of publicly held certificates maturing
6 These totals are obtained by adding together total securities issued in exchange operations, maturing
securities redeemed for cash, and maturing securities retired for cash.
7 Of the $33.8 billion maturing in 1958, $14.1 billion were securities that had been issued in 1957.
s This 5-percent note elicited an unusual amount of interest among individual investors. It is discussed
at length in ch. VI.
9 The Treasury has also offered to exchange the new 4£6-percent notes for the 4-percent notes of August1962, which become redeemable at the option of the holder in February 1960, on 3 months’ notice.
10 See the discussion of the savings bond program later in this chapter.
DEBT MANAGEMENT IN THE UNITED STATES
()1
in November are rolled over into an equal amount maturing a year
later, the amount of certificates, notes, and bonds that will mature
in 1960 comes to $22.6 billion. Assuming prosperous conditions con
tinue, the budgetary situation should be favorable and require no
cash borrowing except on a seasonal basis (through tax anticipation
bills) in the second half of the year. If redemptions of savings bonds
continue to exceed sales, some cash borrowing may be necessary to
cover this. However, it seems likely that the necessary amount of
financing, other than through sale of bills, will not be in excess of
$24 billion or so— about the same as in 1957, a little less than in 1959,
and about 60 percent of the volume of debt operations that were con
ducted in 1958. In addition, there are three bond issues aggregating
$8.9 billion (publicly held portion) that are subject to call which
might be refunded before the end of 1960 if conditions are favorable.11
Thus the immediate pressures of debt management should not be
as serious during the remainder of 1959 and in 1960 as they were in
1958 and the first half of 1959. However, the publicly held portions
of issues of notes and bonds already scheduled to mature in 1961
amount to $16.8 billion. In addition, the public holds a total of
about $13 billion of certificates, representing the four issues maturing
at quarterly intervals in the months of November, February, May,
and August. If the publicly held aggregate of these four issues re
mains constant as they are rolled over into 1961, this will run the total
amount of certificates, notes, and bonds maturing in that year to
approximately $30 billion. If further tightening of credit in the next
year induces the Treasury to conduct more financing in the short
term sector of the market, the total for 1961 could be run up still
further. Looking beyond 1961, maturities already scheduled for 1962
and 1963 are heavy, amounting to $13.3 billion and $13.2 billion,
respectively.
THE COMPETITIVE POSITION OF GOVERNMENT SECURITIES
In recent years, the Treasury has had great difficulty in selling
long-term bonds. During the period of nearly 7 years since the pres
ent administration came into office with the intention of extending
debt maturities, only $9.4 billion of bonds with a maturity of more
than 10 years have been sold altogether, both for cash and in exchange
offerings. Thus the average is less than $1.5 billion per year. More
over, such sales as have been made have been entirely in periods of
recession or the fairly early stages of recovery. As we saw in chapter I,
nearly all the investor groups— including savings banks, life insurance
companies, pension funds, etc.—who have traditionally shown an
interest in Treasury bonds— have either been reducing their holdings
of Government securities steadily or, at most, increasing them only
very slowly. Certainly one important aspect of debt management is
the declining popularity of Government securities, particularly of the
longer-term variety. Let us now consider some possible explanations
of the apparent deterioration of the competitive position of long-term
Treasury securities.
11 These include $4.7 billion of 2^-percent bonds of 1959-62, which reached first call on June 15, $2.7 billion
of 2^-percent bonds of 1959-62, which become callable on Dec. 15, and $1.5 billion of 2%-percent partially
tax-exempt bonds of 1960-65 which become callable on Dec. 15,1960.
62
DEBT MANAGEMENT IN THE UNITED STATES
Some common misconceptions
One explanation of the Treasury’s debt management problems that
seems to have a fairly wide acceptance is that the Federal Government
is fiscally irresponsible— that it keeps piling defict on deficit, virtually
never having a budget surplus, and that in consequence the debt
grows each year by leaps and bounds. While there is certainly plenty
of room for improvement in the fiscal policies of the Federal Govern
ment, it is the opinion of the present writer that this charge, as usually
presented, is not only unfounded but recklessly irresponsible.12 Those
who make this charge are almost invariably careless in their use of
statistics. To support their claims, they refer to the administrative
budget, changes in the gross public debt, and data relating to total
offerings of Treasury securities. As we saw in chapter I, the admin
istrative budget has been, in most years, strongly biased toward a
deficit because it does not include the transactions of the trust funds,
which have consistently shown surpluses. Similarly, the gross public
debt greatly exaggerates both the true size of the debt at any particular
time and its rate of growth over time, due to the fact that it includes a
large and, during most periods, rapidly growing portion of essentially
fictitious debt held by Government agencies and trust funds and the
Federal Reserve System. Thus, for the 13 fiscal years 1947 through
1959, the administrative budget showed a cumulative deficit of
$25.2 billion, while the cash budget, which is a much better measure
of the fiscal impact of the Government, had a cumulative surplus of
$6.3 billion. There were cash surpluses in 7 of the 13 years and cash
deficits in 6.13 During the same 13-year period, the gross debt
increased by $14.9 billion from $269.9 billion to $284.8, while the
publicly held debt (i.e., excluding securities held by Government
agencies and trust funds and the Federal Reserve) declined by $12.8
billion from $217 billion to $204.2 billion.14 Moreover, as was also
explained in chapter I, both the level of national income and product
and the amount of private debt have grown greatly in recent years,
so that, in relation to other relevant variables, the public debt has
declined even more than the above statistics suggest.
Reference to gross figures on debt operations can be equally mis
leading. For example, in the calendar year, 1958, total offerings of
certificates, notes, and bonds for cash and in exchange for maturing
securities amounted to $61.2 billion. However, when sales or ex
changes involving Government agencies and trust funds and the
Federal Reserve— which are almost entirely automatic (and fictitious)
transactions involving no problems of debt management— are elimin
ated, the total is reduced to the $39.2 billion shown in table I I I -l.
Similar large differences are present in other years.15
These exaggerated charges of fiscal irresponsibility are frequently
couched in terms which seem designed to increase the public’s fear of
inflation and to undermine public confidence in Treasury securities
on the part of the uninformed. Of course, both of these results tend
12 For a particularly flagrant example of this kind of distortion and misrepresentation, see the “ scare”
story headed “ Fiscal Crisis,” Wall Street Journal, Sept. 10, 1959, p. 1.
is See table 1-3.
« See table I -l.
w The gross offerings of certificates, notes, and bonds, including amounts taken by Government agencies
and trust funds and the Federal Reserve, in other years, for comparison with the amounts shown in tabl
III-l, are as follows: $43.8 billion in 1953, $59.5 billion in 1954, $48.4 billion in 1955, $33.2 billion in 1956, and
$54.6 billion in 1957.
DEBT MANAGEMENT IN THE UNITED STATES
63
to make the Treasury’s debt management difficulties even greater.
The exaggeration and confusion is partly the fault of the Treasury
itself, since in its own presentations of budget and debt statistics it
tends to place undue emphasis on the administrative budget and the
gross public debt. Surely the problems of fiscal policy and debt
management are sufficiently acute without exaggerating them by
using the wrong statistics.
It may be noted that there is a perfectly respectable argument that
bears a certain superficial similarity to these distortions. This is the
argument that the acuteness of the debt management problem is in
large part a byproduct of an excessive reliance on monetary as com
pared with fiscal policy as a means of controlling inflation during
prosperous times. A good case can certainly be made for greater
reliance on fiscal policy— cash budget surpluses— during inflationary
periods. This would lessen the debt management problem in two
ways: (1) by making it possible to retire more debt, and (2) by
keeping down the level of private credit demands, thus making it
unnecessary for credit to tighten and interest rates to rise as much as
would otherwise be the case. We shall return to this argument at a
later point.16
Declining attractiveness of Government securities
There can be little doubt that the Treasury’s debt management
difficulties are partly due to a number of developments in recent years
which have made Government securities— particularly longer-term
securities—less attractive to investors than they used to be relative
to other types of investments. Let us consider some of these
developments.
1.
Increased price variability.— During the Second World War, the
Federal Reserve used its powers to buy Government securities in the
open market to maintain a fixed pattern of interest rates and security
prices. While somewhat greater flexibility in short-term interest
rates was permitted beginning in 1947, the basic policy of preventing
the prices of long-term Government bonds from falling below par was
continued until the Treasury-Federal Reserve accord in March 1951.
At the time of the accord, the rigid policy of supporting bond prices
was abandoned, and as increased reliance came to be placed on
monetary policy as a means of maintaining economic stability,
interest rates and security prices began to fluctuate over a wider range.
In the preaccord period, long-term Treasury bonds were really
liquid assets, since the holder of these securities could rely upon being
able to sell them at any time at a price very close to par, with the
Federal Reserve buying them if necessary to prevent their prices from
falling. In fact, bonds were practically as liquid as Treasury bills
under these conditions, but with a yield curve sloping steeply upward
as maturities increased, the returns from bonds greatly exceeded those
from shorter-term securities.17 For this reason, particularly during
the war itself, many investors were attracted to purchase Treasury
bonds essentially due to their liquidity.18 This was even true of many
»• See ch. VI.
w During the war itself, the Federal Reserve maintained a pattern of interest rates on Government
securities running from three-eighths percent on 3-month Treasury bills up to
percent on the longestterm bonds. In the postwar period, some flexibility was gradually introduced in the short-term sector,
but short-term interest rates continued to be considerably below long-term rates.
is One of the problems that plagued the authorities during the late war and early postwar periods was
a tendency for investors to sell Treasury bills and other short-term Government securities in order to shift
their funds into long-term bonds, which were equally liquid as long as bond prices were supported but
offered a considerably better return.
64
DEBT MANAGEMENT IN THE UNITED STATES
basically long-term investors such as insurance companies. During
the war, the lack of other available outlets for funds, together with
pressures to assist the Treasury to finance the war, led these investors
to buy Treasury bonds which offered a relatively attractive rate of
return and promised to be salable at a fixed price at a later time if
more attractive investment opportunities became available.
When market forces are able to exert important effects on the
structure of interest rates, as has been increasingly the case since the
accord, the prices of long-term securities fluctuate much more than
those of short-term securities.19 In fact, in the last 4 or 5 years, as
flexible monetary policy has been used with increasing vigor, the
prices of long-term Treasury bonds have shown very substantial
fluctuations. Under these conditions, long-term bonds are not
attractive to investors desiring liquidity— these investors now hold
bills, certificates, and notes or bonds that are nearing maturity.
Moreover, even to the more stable long-term investors, such as in
surance companies and mutual savings banks, liquidity is of some
significance, and since institutions of this kind are undoubtedly
averse to risk and have to be paid for assuming it, the increased
liquidity risk means that such investors are now prepared to hold
Treasury bonds only at higher yields than formerly relative to other
investments. Of course, Government securities are still free from
risk of default of principal and interest and therefore possess an
element of superiority over corporate bonds. But the superiority of
long-term Governments has been reduced as their liquidity has
declined. This development has almost certainly tended to reduce the
differential between yields on Government securities and private
securities of various kinds and thus to make it necessary for the
Treasury to pay higher interest rates relative to other borrowers in
order to attract funds.
2.
Changing attitudes toward corporate securities.— At the end of
World War II, it seems very likely that, in their evaluation of the
risks involved in corporate bonds, investors were strongly influenced
by their experiences in the great depression of the 1930’s. There was
widespread fear that after the war ended the economy might revert
to its former state of stagnation and unemployment. Defaults of
interest and principal on corporate bonds had been fairly common in
the 1930’s, and this doubtless led investors to place relatively high risk
premiums on corporate bonds, thus making Treasury securities, which
are completely free of default risk, quite attractive and making it
possible for the Government to borrow at interest rates substantially
lower than those paid by corporate borrowers.
However, as the years have passed since the end of the war and
prosperity has been sustained with only occasional brief and relatively
mild recessions and as the conviction has spread that secular inflation
rather than secular stagnation is the problem with which we shall be
struggling for some time into the future, the attitude toward corporate
securities has undoubtedly undergone a substantial change. As a
result, the risk premiums on corporate bonds— particularly those of
relatively lower quality—have been reduced. This factor has tended
to narrow the yield differentials between corporate bonds and Treas
ury bonds and thus weaken the competitive position of the Treasury
as a borrower.
18See the discussion of the interest rate structure in ch. IV .
DEBT MANAGEMENT IN THE UNITED STATES
65
3. The rise of Government-supported mortgages.—Another develop
ment that has probably served to undercut to some extent the com
petitive position of Treasury securities is the tremendous growth
during the postwar period of amortized mortgages insured by the
Federal Housing Administration and guaranteed by the Veterans’
Administration. The amount of outstanding FHA-insured mortgages
on nonfarm one- to four-family properties rose from $4.1 billion at
the end of 1945 to $19.7 billion at the end of 1958, an increase of 380
percent, while the amount of outstanding VA-guaranteed mortgages
on the same class of properties grew from practically zero to $30.4
billion during the same period.
FHA-insured and VA-guaranteed mortgages have some of the same
investment properties as Treasury securities. While these mortgages
are not completely free from risk, they are very low-risk investments
and in this respect are very close substitutes for Government securi
ties. While the acquisition and management of these investments
involves some costs that are not present in the case of Treasury securi
ties, the interest rates on them have been above those on Government
bonds in recent years by a large enough margin to make the net returns
to the investor higher. While they are typically long-term invest
ments, having maturities in many cases of 20 to 30 years, the amorti
zation feature greatly reduces their effective maturity, and it is further
reduced by the pronounced tendency of borrowers to pay the mort
gages off in full substantially before maturity. Finally, the market
support activities of the Federal National Mortgage Association have
helped to develop an increasingly active secondary market in Govern
ment-supported mortgages, thus greatly increasing their liquidity.
There seems to be little doubt that the rapid expansion of these housing
programs has absorbed a considerable volume of funds that might
otherwise have gone into— or at least remained invested in— long
term Treasury securities.
4. Continued tax exemption of State and municipal securities.— In
1941, the interest on Treasury securities was made fully subject to
Federal taxes. While there was some discussion at the same time of
repealing the exemption applicable to interest on State and municipal
securities, such action was not taken. As a result, Treasury securities
are substantially less attractive to investors in high tax brackets
today than was the case before the war. The strength of this factor
is, of course, reinforced by the fact that tax rates are substantially
higher today. The consequence of this situation is that yields on
higher quality State and municipal securities are substnatially lower
than yields on Treasury bonds of equivalent maturity, even though
the State and municipal securities are subject to some risk of default.
If we look at developments during the postwar period, however,
some qualification of the above statement is necessary. State and
local governments have found it necessary to borrow tremendous sums
during the postwar period to finance the construction of schools, roads,
and other public facilities. As a result the net indebtedness of State
and local governments grew from $13.7 billion in 1945 to $50.9 billion
in 1958, an increase of 272 percent.20 In order to raise such large
amounts of money, it has been necessary for State and local govern
ments to tap the savings of investors in intermediate tax backets, for
20 Survey of Current Business, May 1957, p. 17; May 1959, p. 12. Net indebtedness of State and local
governments is defined as total debt less State and local government securities held by State and local
governments.
66
DEBT
m anagem ent
in
the
u n it e d
states
whom the tax exemption is considerably less valuable than it is to
investors in the very highest brackets who used to be almost the sole
investor in State and municipal securities. Thus, while States and
municipalities— at least those with high credit ratings— can still
borrow at lower interest rates than the Treasury, the differential has
narrowed somewhat in recent years.
5.
Summary.—All of the factors just discussed, to the extent that
they have been present, have presumably weakened the Treasury’s
position relative to other borrowers and increased the Treasury’s
difficulties in borrowing, particularly in the long-term market. Other
things remaining the same, they would presumably result in an in
crease in the yields on Treasury securities relative to other kinds of
debt. On this basis, one might expect to find a tendency for yields on
Treasury bonds to rise relative to yields on corporate bonds, particu
larly lower grade corporate bonds. Yields on State and municipal
bonds should be lower in relation to Treasury bonds than before the
war, but for reasons suggested above, one might expect the differential
between the two to have narrowed somewhat since the early postwar
period. In a general way, the movements of interest rates during
the postwar period do indicate these tendencies, as indicated in
chart III—1, which compares movements of yields on long-term
Treasury securities, high-grade State and local government bonds,
and intermediate grade corporate bonds. The differential between
Treasury bonds and intermediate grade corporate bonds was roughly
100 basis points in 1947, and it has been about the same recently.
However, due to the general rise in the level of yields, in relative terms
corporate yields are only about 25 percent higher than yields on
Treasury bonds at the present time, whereas in 1947 they were about
40 percent higher. Yields on high-grade State and local government
bonds have been lower than yields on Treasury bonds throughout the
postwar period, but since 1951 the differential has declined consider
ably, presumably reflecting the need to tap the savings of persons and
institutions in lower marginal income tax brackets, as suggested
above.21
While there is thus some indication that yields on Government
securities have risen relative to yields on other kinds of debt, it must
be admitted that the changes have been rather ragged and irregular
and the interpretation is not entirely clear cut. However, there is
another factor that must be taken into account. Between the end of
1947 and the end of 1958, the total amount of net corporate debt hav
ing an original maturity of over 1 year rose from $46.1 billion to $119.5
billion, an increase of 159 percent, while net State and local govern
ment debt grew from $14.4 billion to $50.9 billion, an increase of 253
percent. Total outstanding mortgage debt rose from $48.9 billion at
the end of 1947 to $171.4 billion at the end of 1958, an increase of 251
percent. During the same period, the total publicly held marketable
Federal debt having an original maturity of more than 1 year (i.e.,
notes and bonds) fell from $119.7 billion to $98.1 billion, a decline of
18 percent.22 With the volume of outstanding Treasury securities
Chart III-l also shows that yields on State and municipal securities are subjcct to unusually wide
fluctuations and seem to be especially sensitive to changes in general credit conditions—rising sharply in
periods such as early 1953 and 1955-57 when credit was tightening and falling sharply in easy credit periods
such as 1953-54 and 1957-58. Part of the explanation for this is probably that banks, which are most di
rectly affected by monetary policy changes, are heavy investors in State and municipal bonds.
« Data are taken from various issues of the Survey of Current Business and the Federal Reserve Bulletin
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1959
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MANAGEMENT
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68
DEBT
MANAGEM ENT
IN
THE
U N IT E D
STATES
declining somewhat at the same time that virtually all other kinds of
debt were registering huge increases, one might expect that the in
creased relative scarcity of Treasury securities might have produced
some decline in their yields relative to yields on other kinds of debt.
If anything, however, as we have seen, the reverse seems to have been
the case— yields on Treasury bonds appear to have risen somewhat
compared to yields on corporate bonds and have declined only a little
relative to yields on State and municipal bonds, despite the fact that
there has probably been a substantial decline in the interest saving
to State and local government units resulting from the exemption from
Federal income taxes. All of this indicates that there has indeed been
a decline in the attractiveness to investors of long-term Federal securi
ties relative to other kinds of debt. Probably the chief reasons for
this development are the reduced liquidity of Government debt under
a flexible monetary policy, the tremendous increase in the outstanding
volume of Government-backed mortgages with investment properties
somewhat similar to Federal securities and paying higher net yields,
and, to a lesser extent, the development of more optimistic views con
cerning the safety of corporate securities.23
These considerations suggest that the Treasury would have been
able to sell a substantial amount of additional long-term bonds in
recent years only if it had been willing to pay substantially higher
interest rates to overcome the decreasing attractiveness of Govern
ment securities. Moreover, to have sold bonds in boom periods
such as 1955-57 would have been particularly difficult since, in
the case of corporate securities with which the Treasury would
have been competing, yields on newly issued securities have shown
a tendency to rise sharply above those on outstanding securities.
Similarly, it seems certain that the Treasury would have found it
necessary to have priced its new issues so as to give the prospective
investor a yield substantially higher than the yields on outstanding
issues of the same maturity. Thus, an aggressive program of selling
long-term bonds would have pushed up the yield curve, especially
in the longer maturity range, and also it would have been necessary
to pay interest rates on new issues considerably above the yield curve
Suggested remedies
One hears various suggestions that are designed to restore the
Treasury’s competitive position and make it easier for the Govern
ment to borrow. One possibility might be to restore the tax exemp
tion—that is, to make the interest on Treasury securities exempt
from the Federal personal and corporate income taxes, as it was
before 1941. However, it is virtually certain that restoration of the
exemption would hurt rather than help the Treasury, since it would
almost certainty reduce tax receipts more—and probably very much
more— than it would reduce interest costs. If the amount of Federal
borrowing (together with State and local borrowing which is now tax
exempt) were so small that all of the funds could be borrowed from
investors in the very highest tax brackets, the savings in interest cost
could be expected to be just about equal to the loss of tax revenues.
23 Another factor sometimes mentioned as partly responsible for the Treasury’s difficulties is the growing
fear of secular inflation. It is true that an increase in the price level of, say, 2 percent per year means that
a 4-percent money rate of interest is in reality only a 2-percent “ real” rate of interest. For this reason,
prospective inflation may raise the money rates of interest at which given amounts of funds are forthcoming
for investment in debt contracts. To the extent that this factor is at work, however, it would affect the
cost of funds to all issuers of debt instruments and not merely to the Treasury.
DEBT
M ANAGEM ENT
IN
THE
U N IT E D
STATES
()9
This is because the yield that would have to be paid to the lender
would tend to be reduced enough to compensate for the tax loss.24
However, if, as is obviously the case, the necessary volume of bor
rowing were large enough to require the Treasury to tap the savings
of investors in tax brackets below the highest, the tax losses would
tend to exceed the reduction in interest cost. This is because the
value of the tax exemption to an investor is lower the lower his mar
ginal tax rate, while the interest rate that must be paid to all investors
will be the rate necessary to attract the marginal lender. Conse
quently, the Treasury will lose more in tax revenues than it will gain
through reduced interest cost on the securities it sells to all investors
except the marginal ones.25
Thus, it is clear that it would be foolish and costly to the Treasury
to restore the tax exemption on Federal securities; moreover, it would
tend to create a large loophole through which wealthy taxpayers could
escape taxation. In fact, a more sensible proposal which would tend
to improve the competitive position of Treasury securities would be
to remove the exemption from the Federal personal and corporate
income tax that is now applicable to State and municipal securities.
This exemption is presumably meant to be a subsidy to State and local
governments. However, it is a costly and inefficient kind of subsidy.
By the same reasoning employed above, if State and local governments
borrowed such small amounts that they could obtain the full amount
from investors in the highest Federal tax brackets, the reduction in
interest cost to States and municipalities would tend to be equal to the
loss of tax revenues to the Federal Government. However, as State
and local governments increase the scale of their borrowings, they
have to appeal to investors in lower Federal tax brackets, and the loss
in tax revenues to the Federal Government exceeds the interest savings
to States and municipalities. Thus, part of the subsidy, in effect,
goes to taxpayers in the higher tax brackets rather than to the State
and local governments, who are its intended recipients. It is quite
clear that as State and local governments have greatly increased the
scale of their borrowings in recent years, they have had to tap the
savings of investors in lower tax brackets, with the result that the
interest saving to them has been reduced while the benefits of tax ex
emption have increasingly accrued to wealthy investors.26 Although
there are some problems involved in the removal of the exemption for
State and local government borrowing, there are strong arguments for
2-» For example, if the Treasury borrowed $1 billion entirely from investors in the 90 percent tax bracket
and if the yield required to induce these investors to buy $1 billion of bonds in the absence of the tax exemp
tion was 3 percent, the required yield should fall to 0.3 percent if the interest were exempted from tax. In
the case in which the interest was taxable, the investors would receive $30 million per year in interest and
pay back $27 million in taxes on it—the after-tax income of the investors would be $3 million and so would
the net cost to the Government. If the interest were exempted from tax, the Government would pay the
investors $3 million in interest and receive no taxes on it.
25 To take a somewhat oversimplified example, suppose that, in the absence of a tax exemption, the
Treasury can sell at a 3 percent interest rate $1 billion of securities to investors in the 90 percent income
tax bracket and $1 billion more to investors in the 40 percent tax bracket. If interest is exempted from
taxes, it will be necessary to pay an interest rate of 1.8 percent to sell the $1 billion to investors in the 40
percent bracket, since this is the after-tax yield they would have received in the absence of the exemption.
By the same reasoning employed in footnote 24, the net cost per year on the $1 billion borrowed from these
investors will be $18 million whether interest is tax-exempt or not. However, in the absence of the exemp
tion, the Treasury would have had to pay $30 million in interest on the $1 billion borrowed from investors
in the 90 percent bracket but would have received in return $27 million in taxes, reducing the net cost to
$3 million. With the tax exemption, however, it would have to pay these investors $18 million and would
receive no taxes from them on this interest, so that the net cost would be $18 million. Thus the tax ex
emption would cost the Treasury $15 million.
2« It may be noted that if the tax exemption were restored to Federal securities, the result would be a
further large increase in the supply of tax-exempt securities. In order to get investors to hold these addi
tional securities, it would be necessary to reach still further down into lower income tax brackets, thus
reducing the benefits to State and local governments from tax exemption and providing substantial addi
tional gains to investors in high income tax brackets.
70
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such a step.27 If it were desired to continue subsidizing State and
local government borrowing or capital expenditures, some other more
efficient and equitable subsidy could be introduced.28
Another possible way of offsetting the attrition that appears to
have taken place in the market for Treasury securities would be to
establish a captive market for such securities by imposing requirements
on some class or classes of investors that a certain portion of their
assets must take the form of specified types of Government securities
or that they must hold such securities to the extent of a specified pro
portion of their outstanding claims. For example, commercial banks
and perhaps other financial institutions, such as savings and loan asso
ciations and mutual savings banks, could be required to hold Govern
ment securities to the extent of a certain proportion of their deposit
liabilities. Numerous proposals of this kind have been made since
World War II. Since, in addition to adding a compulsory element
to the demand for Government securities, these proposals have sig
nificance in connection with the effectiveness of credit controls, we wfll
postpone our discussion of them until a later point.29
A third possible way of increasing the attractiveness of Government
securities that has sometimes been suggested is the issuance of pur
chasing power bonds— i.e., bonds on which the periodic interest pay
ments are tied to an index of the general price level. Such bonds
might prove to be very attractive to many investors, since they would
combine complete freedom from risk of default with a guaranteed rate
of return in real terms. Thus, they would be an ideal hedge against
inflation for many types of investors. The merits of the device from
the standpoint of Treasury debt management are somewhat more
problematical. Presumably to the extent that it is the fear of inflation
that has impeded the Treasury’s success in selling bonds, the reluctance
of the public to invest in its securities could be overcome either by
simply paying a sufficiently high contractual rate of interest to com
pensate the public for the expected inflation or by the institution of a
purchasing-power guarantee. Essentially, which of these alternatives
would cost the Treasury less would depend upon whether the actual
realized rate of inflation was higher or lower than the ex ante rate of
inflation expected by investors: If the actual rate turned out to be
greater than the ex ante rate, the purchasing power guarantee would
be more expensive, while if the ex ante rate were higher than the
realized rate, the guarantee would be less expensive. However, there
is another consideration. If the Treasury’s problem arises, as we
suggested above, not chiefly as a result of the fear of inflation which
makes it necessary for all borrowers to pay higher interest rates, but
from a shift in the preferences of investors from Treasury securities
to other forms of debt instruments, a purchasing power guarantee
might help the Treasury, since it is the only economic entity which is
in a position to issue securities which behave like equities but possess
27 The problems have to do mainly with treatment of present holders of outstanding bonds and future
buyers of these bonds. For an excellent analysis of the whole problem, see L. C. Fitch, “ Taxing Munic
ipal Bond Income’' (University of California Press, 1950). See also H. E. Brazer, “ Interest on State and
Local Bonds and the Federal Income Tax,” in “ Tax Revision Compendium,” Committee on Ways and
Means, House of Representatives, (Washington: Government Printing Office, 1959), vol. I, pp. 721-728.
28 The problem of devising an appropriate form of subsidy involves many thorny questions of FederalState relations. It is probably chiefly the difficulties involved in devising an acceptable substitute that
have been responsible for the defeat of numerous efforts to remove the tax exemption.
29 See ch. VI.
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no risk of default.30 B y issuing such securities, the Treasury might be
able to take advantage of its preferred position as compared with other
borrowers to attract funds away from them at an interest saving to
itself. Moreover, to the extent that this process restrained private
spending by inducing financial institutions to buy— or at least hold
onto— Government securities rather than private debt, it would
presumably permit a relaxation of the degree of general credit restric
tion and might thereby allow the Treasury to sell further conventional
securities without a purchasing power guarantee at lower interest
rates than would otherwise be necessary.
Although a purchasing power guarantee might help the Treasury
in its debt management problems by permitting it to sell securities at
lower interest cost than would otherwise be possible, the real issues
concerning the desirability of purchasing power bonds lie entirely
outside the area of debt management. These issues are concerned
with the desirability of the Government's providing investors with
protection in the form of a hedge against inflation and what the effects
of such action would be upon expectations. The opinion appears to
be rather widespread that such a policy would be widely interpreted
as a sign that the Government had given up on the possibility of con
trolling inflation and had decided to adapt its policies to the assump
tion that inflation was inevitable.31 The present writer is inclined to
the view that it would be advantageous to experiment with escalator
provisions in savings bonds designed for small investors, but that as a
major contribution to the solution of the Treasury's debt management
problems, escalation has little to recommend it.32
Paying the necessary price
In addition to “ gimmicks” or special devices to broaden the market
for Federal bonds, such as tax exemptions, captive markets, purchasing
power bonds, etc., there is a simple, straightforward way to sell more
bonds; namely, pay a sufficiently high interest rate to induce investors
to buy them. While, as indicated, it would probably have been nec
essary to pay considerably higher interest rates, especially during
periods of tightening credit conditions, in order to have sold sig
nificantly larger amounts of long-term bonds in the last few years,
there can be little doubt that if the Treasury is in fact prepared to
pay the necessary price it can obtain— at least within reason— any
amount of long-term funds it wants. In fact, the “gimmick” approach
sometimes seems to miss the whole point about debt management.
The proper purpose of debt management is not merely to sell bonds
or any other kind of Federal securities— or even to raise money, for
that matter. The Government can always create money to finance
its expenditures, and this method of financing has the advantage that
it involves no interest cost at all. Money can be created not only to
meet a current budget deficit but to pay off maturing securities as
so Corporations are deterred from issuing equities in any ease due to the fact that interest is deductible
in computing the corporation income tax while dividends are not and also by the fact that many of the
important financial institutions have a strong aversion for risk and therefore prefer to invest in debt
instruments.
For a discussion of the alleged evil effects of escalation, see the article entitled “ Creeping Inflation,”
Federal Reserve Bank of New York Monthly Review (June 1959), pp. 86-94.
32 The introduction of escalator clauses in savings bonds is advocated in H. S. Houtthaker, “ Protection
Against Inflation,” Study Paper No. 8.
50438— 60-------6
72
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well.33 The purpose served by borrowing is therefore not the raising
of funds but the production of desirable economic effects— such as the
achievement of a more satisfactory level or pattern of private expendi
tures. Once this point is made clear, it becomes apparent that keep
ing down the interest rates that the Treasury has to pay for its borrow
ing is not necessarily a desirable objective. If interest rate variations
are an efficient means of controlling the level or the pattern of private
expenditures in pursuit of desirable economic objectives, changes in
interest rates— for example, increases in time of inflation— may be the
very thing that debt management should seek to accomplish. On the
other hand, when debt management is considered in terms of its eco
nomic effects, the use of “ gimmicks” to sell bonds is not necessarily
ruled out. However, the test applied in evaluating such devices is not
whether they save interest to the Treasury but whether they produce
desirable economic effects. For example, in time of inflation, requir
ing commercial banks to hold government securities may be a more
effective way of restraining inflation than offering high interest rates
to sell more bonds in a free market. This might be the case if, say,
private expenditures were highly inelastic to changes in interest rates,
so that offering high rates to obtain funds for the Treasury would do
little to curb private spending, while forcing bonds on the banks would
effectively reduce their ability to expand loans and contribute consid
erably to the anti-inflationary program.
Thus, the problems related to the attrition of the market for govern
ment securities, discussed above, are often regarded from the narrow
point of view of the Treasury as a “ money raiser” as the central prob
lems of debt management. However, when debt management is
viewed in the proper perspective of general economic policy, the real
issue is how to manage the debt so as to produce the most desirable
economic effects. In order to arrive at a proper answer to this ques
tion, it is necessary to consider the economic effects of changes in the
size and composition of the debt, the subject to which we shall turn
our attention in the next chapter.
OTHER RECENT
PROBLEM S
In the last couple of years particularly, the Treasury has begun to
encounter some new problems in debt management which seem to be
a byproduct of increasing sophistication on the part of the public in
anticipating what to expect from government in an environment in
which flexible monetary and fiscal policies are employed vigorously
in an effort to maintain economic stability.
Sharp changes at turning points
When the Federal Reserve reduced the discount rate in November
1957, as the first sign of a change in policy to deal with the recession,
interest rates promptly began to decline. Yields on long-term Treas
ury bonds fell from 3.73 percent in October 1957 to 3.12 percent in
April 1958, while rates on 3-month Treasury bills declined much more
sharply from 3.58 percent in October 1957 to 0.83 percent in June 1958.
Sustained heavy demands for long-term funds to refinance short-term
» Actually, this method of financing is a bit difficult to implement under our present institutional ar
rangements. However, in principle it can be achieved by having the Treasury sell its securities directly
to the Federal Reserve, with the System raising member-bank reserve requirements enough to immobilize
the excess reserves created when the Treasury uses the funds for current expenditures or the retirement of
publicly held debt.
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credits obtained during the preceding period of monetary restriction
probably accounted for the slowness with which long-term rates de
clined. In any case, short-term rates fell to very low levels, particu
larly in relation to long-term rates.
Recovery began to develop in the spring of 1958, although there
was some lag before the evidence became available that this was the
case. B y midsummer, however, recovery tendencies became generally
apparent, and a very sharp reaction of long-term rates set in. Be
tween June and September, long-term rates on Treasury bonds rose
from 3.19 percent to 3.75 percent— by the latter date, which, of course,
represented a very early stage in the recovery process, long-term rates
were higher than they had been at the peak of the period of inflation
and tight credit in 1957. Short-term rates continued to decline
after long-term rates had begun to turn up, but between June and
September they also rose rather sharply.
The sharp rise in long-term rates as soon as business activity starts
to turn up is probably something that can be expected in future recov
eries unless measures are taken to prevent it. As soon as investors
see the forces of recovery developing, they know that it will not be
long before the Federal Reserve will turn to a restrictive policy.
Moreover, they know that the recovery is likely to gain momentum
and develop into inflation and that, in consequence, a restrictive
monetary policy and rising interest rates can be expected for some
time to come. Consequently, they tend to back away from long-term
bonds whose prices are expected to fall as interest rates rise. The
result is an exaggerated and sudden rise in long-term interest rates
in anticipation of inflation and credit restriction.
Debt management problems during recovery
The Treasury encountered problems of debt management during
the period of recovery in 1958-59 which can probably be expected to
plague us again in recovery periods if fiscal policy is used aggressively
to combat recessions. These problems arise essentially from a
carryover of recession budget deficits into the recovery period. Thus,
by the spring of 1958 it was apparent that the Treasury was to have
a very large deficit during the fiscal year 1959. This was certainly
one of the factors that caused the sharp rise in interest rates between
June and September 1958, since investors saw clearly that the Treasury
would be a heavy cash borrower during the coming months.34 At the
same time, as suggested above, the onset of recovery made it apparent
that the Federal Reserve would soon shift in the direction of a restric
tive policy. This latter expectation was clearly confirmed when the
discount rate was raised in August.
The Treasury found itself faced by mid-1958 with the problem of
financing a cash deficit which, in fact, amounted to $13 billion during
the next year, at a time when interest rates were already beginning
to rise. As we saw earlier in this chapter, the Treasury’s debt manage
ment problems were further complicated by an especially heavy sched
ule of refundings during 1958, due partly to the fact that the restrictive
credit policies of 1956 and 1957 had induced it to finance heavily in
the short-term market and much of the resulting short-term debt
rolled over and came due again in 1958.
34 Speculative activities, discussed in the next section of this chapter, were also an important cause of the
sharp rise in interest rates.
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Table I I I -2 shows the cash budget surplus or deficit and the sur
plus or deficit of the Federal Government on income and product
transactions (i.e., the budget as it appears in the national income ac
counts) by quarters for 1957, 1958, and the first half of 1959. These
two sets of data are not entirely comparable because the income and
product budget surplus or deficit is expressed as an annual rate and
is seasonally adjusted, while the cash budget surplus or deficit is un
adjusted. Nevertheless, a comparison is of some interest. While
there is no single satisfactory measure of the fiscal impact of govern
ment on the economy, the budget as shown in the national income
accounts is probably the best measure available. Table I I I -2 shows
that the budget deficit in the national income accounts reached its
peak (on a seasonally adjusted basis) in the second quarter of 1958
and thereafter gradually tapered off until a small surplus appeared in
the second quarter of 1959. Making allowance for the fact that in
a normal year the cash budget shows a surplus in the first half of
the year due to heavy tax collections in March and June, it is ap
parent from the existence of small cash deficits in the first two quar
ters of 1959 that the effects of the recession were still being felt quite
strongly during this period.35 Thus, the monetary and debt manage
ment effects of the recession deficit carried over well into the recovery
period after the fiscal effects had pretty well spent themselves.36
T a b l e I I I -2 .— Comparison of surplus or deficit in cash budget and in national
income and product accounts budget, 1 957-59
[Billions of dollars]
Calendar year and
quarter
1957 I ._ ......................
1957 I I ........................
1957 I I I _ ....................
1957 IV .......................
1958 I _ ........................
Excess of
receipts from
or payments
to (—) the
public
4.8
3.3
-2.4
—4.4
4.0
Government
surplus or
deficit (—)
income and
product
transactions 1
Calendar year and
quarter
4.8 1958 I I . . .....................
2.2 1958 I I I . . ...................
3.0 1958 IV.......................
1959 I . ........................
-.6
-8 .0
1959 I I ........................
Excess of
Government
receipts from surplus or
or payments deficit (—)
to (—) the
income and
product
public
transactions 1
1.4
-5.5
-7.1
-.1
-.3
-10.9
-10.1
-7.8
-3.9
.4
1 Seasonally adjusted quarterly totals and annual rates.
Sources: Treasury Department and Department of Commerce.
Criticisms were frequently made of the heavy deficit of fiscal 1959,
and the Treasury’s debt management difficulties were attributed to
fiscal mismanagement. These criticisms seem to miss the point that
undoubtedly the heavy deficit that was initiated during the recession
was in large part responsible for the rapid pace of the recovery. If
fiscal policy is used aggressively in a recession and succeeds in pro
ducing a vigorous and prompt recovery, problems of this kind seem
to be inevitable, since the deficit is certain to persist on a cash basis
The national income and product budget adjusts to changes in national income with a much shorter
lag than the cash budget. The chief reason for this is that corporate income taxes are included in the na
tional income accounts on an accrual rather than a cash basis. For a summary of the factors accounting
for the difference between the two budgets for 1956-58, see Survey of Current Business (July 1959), p. 26,
table III-10.
sc On a calendar year basis, the national income account budget showed a deficit of $9.1 billion during
1958 and, according to present indications, will show a surplus in 1959. On the other hand, the cash budget
(including only transactions passing through the account of the Treasurer of the United States, a slightly
different concept from that shown in table III-2) showed a deficit of $7.2 billion for the period Jan. 1 through
Oct. 27,1959, as compared with a deficit of only $3.9 billion in the comparable period in 1958. Thus, it ap
pears certain that the cash deficit in 1959 will be larger than in 1958. (Calculations based on data from the
Treasury Bulletin and the Daily Treasury Statement as published in the New York Times.)
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into the period of recovery and to disappear only gradually. It
certainly would be undesirable to raise taxes or reduce expenditures
during the early stages of the recovery in order to speed the achieve
ment of budgetary balance. Actually, the debt management difficul
ties during this period probably did relatively little harm, since there
is certainly no evidence that they interfered with the Federal Reserve’s
ability to apply restrictive policies. In fact, one can question the
desirability of having the long-term rate of interest rise as rapidly
as it did during the early stages of recovery. Treasury debt man
agement operations were probably partly responsible for this, but
more flexible policies on the part of the Federal Reserve could have
mitigated it.
Speculative excesses
The occurrence of extensive speculation in connection with new
offerings of Treasury securities has aroused considerable concern
recently. Attention has centered particularly around the specula
tive debacle connected with the issuance of the 2% percent bonds of
1965 in June 1958. The chief causes and consequences of this episode
are now reasonably clear, as a result of an extensive study prepared
by the Treasury and the Federal Reserve System.37
The facts can be summarized briefly as follows: For several months
prior to the issuance of the 2% percent bond in the June refunding,
there had been considerable profitable speculation in Treasury securi
ties. After the Federal Reserve reduced the discount rate in Novem
ber 1957, indicating a shift in the direction of easy money, interest
rates fell sharply and the prices of longer term Treasury securities
rose. The Treasury put out four issues of bonds between the time
of the discount rate reduction in November and the June refunding,
and in each case the issues experienced sharp price appreciation, thus
attracting investor attention.38 Thus, investors, expecting the Treas
ury to offer a bond in the June exchange, and expecting a continuing
rise in bond prices, began to purchase the “ rights” (i.e., maturing
securities) well in advance of the June refunding.
The speculative buildup of positions in “ rights” was financed
through the availability of very abundant credit on easy terms.
Although interest rates declined substantially after the discount rate
reduction in November, a continuing heavy demand for long-term
funds (including demand by the Treasury) tended to check the decline
in long-term rates. With short-term rates falling very sharply, the
result was a situation in which the differential between long- and
short-term rates was unusually large. This situation contributed to
the speculative fever in two ways: first, by generating expectations
of further declines in long-term rates and second, by making available
an ample amount of cheap, short-term credit for the financing of
speculative positions in “ rights.” These positions were financed by
bank loans and by repurchase agreements, mainly with nonfinancial
corporations. Lenders in many cases required little or no margin.
In the June refunding, the Treasury offered holders of three matur
ing securities, a choice of two securities: a 1 }{ percent 11-month
37 “ Treasury-Federal Reserve Study of the Government Securities Market,” pts. I, II, and III. At the
time this is written, pt. I has been published by the Treasury Department and the Board of Governors of
the Federal Reserve System, but pts. II and III are available only in preliminary mimeographed form.
38 The Treasury sold $654 million of 3% percent 17-year bonds for cash in early December, $3,854 million
of 3 percent 6-year bonds and $1,727 million of ZH percent 32-year bonds in an exchange operation in early
February, and $1,484 million of 3 percent 8^-year bonds for cash in late February. An issue of $1,135
million of ZH percent 26-year bonds was also sold for cash at the time of the June refunding.
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certificate and a 2% percent 6%-year bond. The publicly held portions
of the three maturing issues aggregated $9,110 million, of which $1,725
million was exchanged for the certificate, $7,033 million was exchanged
for the bond, and $352 million was turned in for cash. The demand
for the new bond was much heavier than the Treasury had anticipated,
reflecting the speculative demand that had been built up through the
extensive trading in “rights” prior to the offering.
The difficulties that followed the issuance of the new securities
were primarily due to the fact that a sudden change in the economic
outlook and in interest rate expectations occurred at just about the
time the securities were issued. Actually, it has since become ap
parent that the low point of the 1957-58 recession occurred in April,
so that recovery was already under way at the time that the specula
tive positions in rights were being built up; however, due to the lag
in the collection and publication of statistics, this was not apparent
to most observers at the time. By mid-June when the new securities
were issued, visible signs of recovery began to appear. Expectations
that interest rates would continue to decline were suddenly replaced
by expectations of rising rates, associated with expectations of rising
business activity and a shift toward restrictive credit policy on the
part of the Federal Reserve. The expectations of rising interest rates
were accentuated by the sudden realization that the Treasury would
have a large budget deficit in the new fiscal year, which would neces
sitate heavy borrowing.
Under these circumstances, bond prices began to fall, and investors
who had bought the new 2% percent bond in anticipation of quick
speculative gains found themselves faced with losses instead. Many
small and inexperienced investors who apparently held the newly
issued bonds on thin or nonexistent margins found themselves faced
with calls for additional margin which they could not meet and were
forced to sell in a falling market.39 The resulting scramble to liquidate
set off a decline in security prices, with the result that by late Sep
tember—at a fairly early stage in the period of recovery—the yield
on long-term Treasury bonds was back at the 3%-percent level that
had prevailed at the peak of the previous period of tight credit in
1957. It may be noted that both the Treasury and the Federal
Reserve intervened on a small scale in June and July in an unsuccessful
attempt to stabilize the market.40
Too much significance probably should not be attached to the
speculative episode which occurred in 1958. The dramatic nature of
the incident is a result of the fact that it happened to occur at the
precise time that market expectations were undergoing a sudden
change. Speculative activity, if not carried to excess, can provide
useful underwriting support for Treasury financing, since speculators
buy up new Treasury issues and then sell them to other investors as
funds become available for investment. The profits of speculators
The financing of investments in “ rights” on thin or even nonexistent margins is not a particularly
reprehensible practice, since these securities, being of very short maturity, are not subject to any appreciable
price variation. However, when new longer term securities are issued in exchange for the rights, the usual
practice is to require additional margin. In the 1958 episode, however, many lenders continued to finance
positions in the 2% percent bonds, after their issuance, without requiring additional margin.
During June and July, the Treasury bought $491 million of the 2% percent bonds for retirement under
sec. 19 of the Second Liberty Bond Act, as amended, and another $100 million for the Treasury investment
accounts. At the beginning of August, a large refunding operation, involving three issues totaling $16.3
billion ($9 billion held by the public) showed signs of running into difficulties, and the Federal Reserve
bought $1.1 billion of the certificates being offered in exchange and $110 million of the rights. However,
the System shortly offset most of the monetary effects of these support operations through the sale of bills
in the market.
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may be regarded as a price the Treasury pays for underwriting
services.41 Even in the case under consideration, despite the disrup
tion caused by the sudden change in expectations, the securities had
apparently moved out into the hands of investors by the end of 1958.
There are, however, two or three disq ieting aspects to the specula
tive episode of 1958. One is that apparently the speculation tended
to be carried to excess due to the unusually large differential between
short- and long-term interest rates that was permitted to develop
in early 1958. It is not clear whether the dangers inherent in this
situation were recognized by the authorities at the time, but if they
were, the situation could probably have been corrected by a more
flexible open market policy on the part of the Federal Reserve—the
System could have sold Treasury bills and bought longer term securi
ties to correct the disparity in the rate structure. Again, after the
liquidation of speculative positions got underway in June and July
and began to drive up long-term interest rates, a more flexible System
policy might have been desirable. While the rise in long-term in
terest rates may have done no harm, there is no evidence that it was
desired by the authorities at the time. It would appear that the
System let this development occur without attempting to do any
thing about it because of a rather doctrinaire adherence to the so-called
bills-only policy.42
Finally, the loose credit practices that helped to accelerate the
speculative buildup are a matter for serious concern. They raise the
question as to whether it might be desirable to impose some kind of
legal margin requirements on trading in Treasury securities. This
question is discussed rather inconclusively in the Treasury-Federal
Reserve study of the Government securities market.43 One thing
seems clear—that if higher margins are imposed it will be necessary
to provide for special treatment of Government security dealers in
order to permit them to finance their positions in an economical
fashion. The present writer is inclined to favor waiting for further
evidence before urging that any formal action be taken. In the 1958
episode it is not clear that the speculation hurt anyone but the
speculators.
The savings bond problem
The savings bond program was begun in 1935 and grew to major
proportions during World War II. The Treasury has relied mainly
on this program as a means of attracting individual savings, especially
savings of persons of moderate means, into Government securities.
A t the present time, two types of savings bonds, the series E and
series H bonds, are being sold. The two series are similar in several
respects— they yield the same return if held to maturity, both are
redeemable on demand at specified prices, and annual purchases of
each are limited to $10,000 per year per buyer. However, the series E
is a discount-type bond which pays the entire accumulated interest at
maturity or time of redemption, while the series H bond pays interest
semiannually. Both bonds pay a return that rises with the period of
holding, so that they can be redeemed before maturity only at a
sacrifice of yield.
41 This matter is discussed further in ch. VI.
♦2 See ch. V.
43 See “ Treasury-Federal Reserve Study of the Government Securities Market.” pt.. III.
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Prior to April 1957, the Treasury also issued larger denomination
savings bonds (series F and G bonds, replaced in May 1952 by series J
and K). These had characteristics similar to the series E and H
bonds, except that they were issued in larger denominations and were
designed to appeal to wealthier individuals and institutional investors.
T a b le
III-3 . —
Operations of U.S. savings bond program, fiscal years 1947-59
[Billions of dollars]
Fiscal year
Cash pay
Sales for ments for
redemp
cash
tion i
Net cash receipts or
payments (—)
Total
Series E
and H
Accrued Increase
discount
or de Total out
on out crease (—) standing
standing in bonds at end
Other 2
bonds outstand of year
ings
1947........................
1948_______________
1949............................
1950............................
1951...........................
1952............................
1953............................
1954............................
1955............................
1956............................
1957............................
1958......... .................
1959................ ..........
7.2
6.2
7.1
5.7
5.1
3.9
4.6
5.5
6.5
5.8
4.9
4.7
4.5
5.5
5.1
5.1
5.4
6.1
5.1
5.6
6.5
7.3
7.8
9.0
8.5
7.2
1.7
1.1
2.1
.3
-1 .0
-1 .2
-1 .1
-1 .0
-.8
-2 .0
-4 .1
-3 .9
-2 .7
-0 .1
.2
.7
.5
-1 .0
-.7
(*)
.3
.7
.5
-.6
-.5
-.6
1.8
.9
1.3
-.2
(4)
-.5
-1 .1
-1 .3
- 1 .5
-2 .5
-3 .5
-3 .4
-2 .1
0.7
.8
.9
1.0
1.1
1.2
1.2
1.2
1.2
1.2
1.2
1.2
1.2
2.4
1.9
3.0
1.3
.1
(4)
.2
.2
.5
-.8
-2 .9
-2 .6
-1 .5
Total, 1947-59____
Total, 1951-59
71.8
45.5
84.4
63.2
-1 2.6
-17.7
-.6
-1 .9
-12.1
-15.9
14.4
10.9
1.8
-6 .8
49.1
51.5
53.4
56.4
57.7
57.8
58.0
58.2
58.6
57.9
55.0
52.3
50.8
1 Original sales price plus accrued discount.
2 Includes A -D , F, G, J, and K bonds.
3 “ Increase or decrease (—) in bonds outstanding” equals “ Total net cash receipts or payments (—) ”
plus “ Accrued discount on outstanding bonds.”
* Less than $60,000,000.
N ote.—Detail may not add to totals due to rounding.
Source: Treasury Department.
Table III-3 summarizes the operation of the savings bond program
for the fiscal years 1947-59. The most notable fact brought out by
this table is that the savings bond program has been a consistent cash
drain on the Treasury since 1951. During the period from mid-1950
to mid-1959, cash payments for redemption of savings bonds (includ
ing both redemptions at maturity and before maturity) amounted to
$63.2 billion, while cash receipts from sales amounted to only $45.5
billion, so that the net cash drain was $17 billion. It should be noted
that the effects of the savings bond program on the Treasury’s cash
position are appreciably understated by the statistics on bonds out
standing. During the 1951-59 period, the total amount of bonds
outstanding declined by only $6.8 billion; this amount is substantially
smaller than the cash drain because the face amount of bonds out
standing tends to be increased by interest accruals on the discounttype bonds outstanding (the series E and J bonds). The amount of
accrued discount has aggregated $10.9 billion for the 1951-59 period,
thus accounting for the difference between the cash drain on the
Treasury and the decline in the amount of bonds outstanding.
It may be noted that the bulk of the cash drain in the last few years
has been the result of redemptions of the larger denomination bonds
(mainly series J and K). These bonds, which were discontinued in
1957, as indicated above, were designed to appeal to sophisticated
investors. With the adoption of flexible monetary policy after the
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Treasury-Federal Reserve accord of March 1951, and especially as
monetary policy was applied more and more aggressively, particularly
in periods of inflation, it was discovered that these sophisticated
investors tended to redeem savings bonds and shift their funds into
higher yielding marketable Treasury (or private) securities when
interest rates rose. It was this kind of difficulty that caused the
Treasury to discontinue the sale of the larger denomination bonds in
1957.
As can be seen from table III-3, the smaller-denomination bonds
(series E and H) have also been the source of a cash drain on the
Treasury during the fiscal years 1957-59. This is doubtless mainly
due to the increases in interest rates on time deposits and savings and
loan shares which have occurred in the last few years.44 Acting under
new legislative authority, the Treasury in September 1959 raised the
interest rate on series E and H savings bonds from 3.26 to 3.75 per
cent.45 It remains to be seen whether this change will increase the
attractiveness of these securities to small investors. Other measures
which might be taken to increase the attractiveness of savings bonds
to small investors are discussed in a later chapter.46 The cash drain
resulting from redemptions of the larger-denomination savings bonds
is almost certain to continue, but it will necessarily be brought to a
halt before very long, since the amount of these bonds outstanding
had been reduced to $7.8 billion by the end of June 1959.
i ■ «
44 The yields to maturity of U.S. savings bonds, series E and H, were raised from 3 to 3.25 percent, effec
tive Feb. 1,1957. However, the yields on savings bonds rise with the period of holding and are less than
3 percent for the first 3 years; thus, low rates during the early period reduce their attractiveness relative
to time deposits and savings and loan shares. (Treasury Bulletin (May 1957), pp. A -l ff.) According to
data compiled by the U.S. Savings and Loan League for 1957, the average return on savings and loan
accounts was 3.3 percent, the average interest rate on savings deposits in mutual savings banks was 3.0
percent, and the average interest rate on time deposits in commercial banks was 1.8 percent. (Savings
and Loan Fact Book, 1958, table 34, p. 58.) However, compilations based on data contained in the ac
counting statements of all insured commercial banks indicates that the average interest rate on time and
savings deposits in commercial banks in 1957 was 2.08 percent—somewhat higher than the Savings and
Loan League estimate. (FDIO, Annual Report, 1957, p. 41.) Thus, yields on savings and loan shares
and on time deposits in mutual savings banks have been somewhat higher than the returns on U.S. savings
bonds for the first 2 or 3 years. Moreover, a number of savings and loan associations and savings banks
have recently raised their rates, in some cases as high as 4 percent.
« For a full explanation of the new terms on savings bonds, see Treasury Bulletin (October 1959), pp.
A-2 ff.
4« See ch. VI.
CHAPTER IV
ECONOMIC EFFECTS OF DEBT OPERATIONS
As indicated in an earlier chapter, we shall define debt management
to include all measures which affect the composition of the publicly
held debt.1 Specifically, debt management in this sense includes the
following kinds of decisions:
1. Decisions by the Treasury concerning the types of securities to
issue to finance deficits and to refund outstanding debt.2
2. Decisions by the Treasury concerning the types of debt to retire
with budget surpluses. In practice the Treasury retires maturing
debt—which necessarily has a zero maturity at the time it is retired
regardless of its original maturity—but in principle there is nothing
to prevent the use of excess tax revenues to buy up debt in the market
prior to maturity.
3. Decisions by the Federal Reserve concerning the kinds of secur
ities to buy and sell in the open market to effectuate monetary policy.
Also included would be “ swapping operations” in which the System
might simultaneously sell one kind of security and buy another without
affecting bank reserves or the money supply.
It should be noted that debt management as here defined does not
include actions which affect the money supply.3 Decisions concerning
the magnitude—as distinct from the composition—of Federal Reserve
open market purchases and sales fall under the heading of monetary
policy. Fiscal policy encompasses the determination of the budget
surplus or deficit. Given the surplus or deficit, the decision as to
what portion of the surplus is to be used to retire debt and what
portion is to be used to build up the Treasury's cash balances or the
decision as to what portion of the deficit is to be financed by borrowing
and what portion is to be financed by drawing down cash balances
falls under the heading of monetary policy, since changes in the
Treasury's cash balances have effects on the money supply and in
some cases bank reserves.4
In this chapter we shall assume, for the most part, that all debt is
marketable and that the extent of its marketability is unrestricted.5
Marketable debt can vary in maturity, and our discussion has to do
with the economic effects of issuing debt of different maturities and
1 See ch. I.
2 In addition to the usual kind of refunding at maturity, this takes in, of course, so-called “ advance
refunding” —i.e., the issuance of new securities in exchange for securities that have not yet matured.
3 There may be second-order effects on the money supply resulting from the fact that debt management
operations may cause shifts of bank reserves between banks having different reserve requirements. How
ever, these effects are likely to be neither important nor predictable, and we shall disregard them entirely.
* The Treasury’s decisions as to whether to carry its cash balances in Federal Reserve banks or in com
mercial banks are also regarded as part of monetary policy.
5 During World War II, the Treasury issued so-called bank restricted bonds—i.e., bonds which banks
were not permitted to hold until they were within 10 years of maturity. It might appear that by the use
of bonds that were restricted to certain classes of holders, the Treasury could reduce the interest cost of
managing the debt, since this device would permit the Treasury to act as a discriminating monopolist by
segmenting the market and, in effect, charging a higher price in submarkets having a more elastic demand.
In this case, however, it is doubtful whether such discrimination would in fact reduce interest cost, since
marketability is one of the desiderata of government debt, and placing restrictions on marketability might
reduce the attractiveness of Treasury securities to most investors.
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the considerations that might be involved in the choice of the optimum
maturity mix.
In managing the debt, the Treasury is rightly concerned about the
interest cost involved. Accordingly, we shall begin with a considera
tion of the ways in which the choice of debt management policies
affects the behavior of these costs. Then we shall look into the ways
in which alternative debt operations may affect private expenditures,
since to the extent that debt management may contribute to the
maintenance of economic stability ana growth, this contribution is a
result of its ability to affect the timing and composition of private
spending. Next we shall consider simultaneously the interest cost
effects and the expenditure effects to see how both of these considera
tions may be combined to arrive at an appropriate policy. In the
final section, we shall step slightly outside the definition of debt man
agement set forth above in order to consider certain aspects of the
management of the Treasury’s cash balances and the timing of cash
borrowing and debt retirement.
IN T E R E S T
COST TO T H E T R E A S U R Y
For purposes of the present discussion, let us suppose that the
Treasury is faced with the necessity of borrowing a given amount of
money and consider how the way in which it times its borrowings in
various maturity sectors will affect its interest cost. To begin with,
however, it will be necessary for us to consider the factors which
determine the maturity structure of interest rates.
The maturity structure of interest rates
The interest rate structure at any particular time is determined by
a combination of factors, of which the most important are the expecta
tions of borrowers and lenders concerning future interest rates. As
the economy moves from prosperity to recession and back again, the
rate structure moves in a way which is at least roughly predictable.
Generally, interest rates on debt contracts of all maturities move
up and down together.6 This is simply because demand schedules for
credit in all sectors tend to move up and down together as credit
conditions change and because both lenders and borrowers commonly
have some flexibility with respect to the maturity sector in which they
will operate, so that if rates in a particular maturity range get out of
line with other rates, corrective forces are set in motion.
Thus, in a boom period interest rates in all maturity sectors ordi
narily rise, while in recession periods they fall. However, the changes
in interest rates are ordinarily different for different maturities. In
particular, as the level of interest rates rises and falls, short-term
interest rates usually move over a considerably wider range than do
long-term interest rates. These differential movements of rates in
different maturity ranges can be explained, at least approximately,
by reference to patterns of interest rate expectations.
To illustrate how interest rate expectations influence the interest
rate structure, let us consider a situation in. which the consensus of
expectations on the part of borrowers and lenders is that interest
rates are going to rise in the near future. Before these expectations
e This is not always the case—occasionally short-term and long-term interest rates move in opposite
directions. However, this is usually a transition phenomenon which lasts only a short time. See footnote
11 below.
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developed, for whatever reason, suppose that short-term and long
term interest rates were approximately equal. As a result of the
change in expectations, lenders would have a tendency to eschew
long-term securities, because they would expect to suffer capital losses
on investments in such securities when interest rates rose and because
they would feel that it was preferable to hold back and wait until
prices of longer term securities fell before investing in them. In
vestors with this kind of expectations would tend to shift their flow
of funds toward shorter term loans and securities. In fact, some
investors might even sell out their existing holdings of long-term
securities in advance of the expected price decline and put their funds
into short-term securities. Thus, there would be a shift in the supply
of funds from the long- to the short-term market. Borrowers, on the
other hand, would tend to make a reverse shift. To the extent that
they felt that interest rates were going to rise, they would feel that the
present was an auspicious time to borrow at long-term in order to
take maximum advantage of the existing relatively low’ rates. As a
consequence of the shift of supply from the long- to the short-term
market and the shift of demand from the short- to the long-term
market, the long-term rate would tend to rise relative to the short
term rate, thus producing an upward-sloping yield curve. Under
circumstances in which interest rates were expected to fall, precisely
the opposite kinds of shifts would tend to occur. Supply would shift
from the short- to the long-term market and demand from the longto the short-term market, thus producing a rise in the short-term rate
relative to the long-term rate and a downward-sloping yield curve.
If investors or speculators are prepared to move funds between the
various maturity sectors on a carefully calculated basis, the determi
nation of the rate structure becomes somewhat more precise than the
above discussion suggests. If investors held identical expectations
with complete certainty, the long-term rate for any specified period
would become equal to the average of the expected short-term rates
over that period. That is, neglecting compounding of interest, if the
present rate for 6-month loans were 3 percent and this rate were
expected to rise continuously to 4 percent, 5 percent, and 6 percent,
respectively, for the next three 6-month periods, the current rate for a
2-year loan would be about 4.5 percent, the average of these rates.7
The reason for this is that the investor would have to be able to get
the same return for investing for 2 years as he could obtain for investing
now for 6 months and successively reinvesting in similar 6-month con
tracts over the next 2 years. If this relationship did not hold, shifts of
demand and supply similar to those discussed above would occur until
it did prevail.
When allowance is made for the fact that the expectations of in
vestors are uncertain and that expectations differ from one investor to
another, the precision of the expectational theory is destroyed.
Nevertheless, the expectational theory seems to explain, at least in
broad outline, the typical pattern of movement of the interest-rate
structure. To complete the explanation, however, it is necessary to
add one further element. It appears that, at least as regards move
i The “ expectational” theory of the interest-rate structure is expounded in J. R. Hicks, “ Value and
Capital” (2d ed.; Oxford: the Clarendon Press, 1946), ch. X I; F. A. Lutz, “ The Structure of Interest
Rates,” Quarterly Journal of Economics, LV (November 1940), 36-63, reprinted in W. Fellner and B. F.
Haley (eds.), “ Readings in the Theory of Income Distribution” (Philadelphia: Blakiston Co., 1946), pp.
499-529. See also R. A. Musgrave, “ The Theory of Public Finance” (New York: McGraw-Hill Book
Co., 1959), ch. X X IV .
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ments of interest rates associated with short-run fluctuations of busi
ness conditions, investors’ expectations are determined in relation to
some level of interest rates which they regard as “ normal” or “ con
ventional.” Thus, as interest rates rise to “ high” (at least by recent
standards) levels during a period of inflation, the expectation that
they are going to decline in the near future becomes more and more
widespread, and as a consequence, short-term rates rise relative to
long-term rates. In such circumstances, short-term rates may actu
ally rise above long-term rates. On the other hand, when interest
rates fall to “low” levels during recession periods, the expectation be
comes increasingly widespread that they are going to rise, and, accord
ingly, short-term rates fall substantially below long-term rates. At
times when rates are not expected to change or when an increase or a
decrease seems approximately equally likely, short-term and long-term
rates may be approximately equal, although this statement is subject
to an important qualification to be pointed out shortly.
It is a commonly observed phenomenon that, as interest rates and
security prices move up and down, short-term interest rates ordinarily
fluctuate over a wider range than long-term interest rates, while long
term security prices fluctuate over a wider range than short-term
security prices. This typical pattern of movement constitutes a fairly
impressive piece of indirect evidence in support of the expectational
theory as outlined above. It can be shown that if investors’ elasticities
of interest rate expectations are between zero and unity—that is, if a
rise in current interest rates causes investors to revise upward their
expectations of future interest rates over their planning horizon but
by an amount less than the rise in current interest rates—the expecta
tional theory will produce the patterns of movement in interest rates
and security prices that are typically observed.8
Lenders may have a preference for liquidity—that is, price stabil
ity—because of the possibility that an unforeseen contingency may
require them to sell securities on short notice. At the same time,
borrowers, particularly those who are borrowing for long-term pur
poses such as investment in fixed plant and equipment, clearly have a
distinct preference for long-term debt contracts, since with such con
tracts they avoid the necessity for frequent renewal of their loans
perhaps at inconvenient times. Thus, lenders have an inherent
preference for short debt and borrowers for long debt, and this tends
to bias the short-term interest rate in a downward direction compared
to the long-term rate. For this reason, even when interest rates are
not expected to change, the short-term rate is likely to be somewhat
below the long-term rate. Also, of course, there are limitations on the
s To illustrate, suppose we have two securities, a $1,000 3-percent “ bill” having a maturity of 1 year and
a $1,000 3 percent consol. Suppose the typical investor has a planning horizon of 1 year and his elasticity
of expectations is 0.5. To begin with, both securities are selling at par, to yield 3 percent. Suppose now
that, for whatever reason, the yield on consols rises to 3.1 percent so that the price of consols falls to $967.74.
With an elasticity of yield expectations of 0.5, the investor will expect that the yield on consols at the end
of his 1-year horizon will have fallen halfway back to its original level, or will be 3.05 percent so that the
price of consols will be $983.61. If he invests $967.74 in a consol and holds it for 1 year, his expected return
will be $30 interest plus a capital gain of $15.87, or a total of $45.87, giving a yield (for 1 year) of 4.74 percent.
In order to equalize the returns for holding consols and “ bills,” the interest rate on bills will have to rise
to 4.74 percent, and the price of outstanding 3-percent bills will have to fall to $983.39. Thus, the yield
on bills will rise more than the yield on consols, while the price of consols will fall more than the price of
bills. This pattern of behavior will be obtained only if the elasticity of expectations lies between zero and
unity—which is a technical translation of the idea that investors' expectations are dominated by conven
tion or the concept of a normal yield level. It may be noted that in this illustration it was assumed that
the short-term yields adjust to become consistent with current and expected long-term yields rather than
the other way around. In fact, however, the two approaches are equivalent. This extension and adapta
tion of the expectational theory is developed by Tibor Scitovsky in “ A Study of Interest and Capital,”
Economica, V II n.s. (August 1940), 304-306. See also Musgrave, op. cit., p. 596.
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mobility of funds from one maturity sector to another, and some
lenders and borrowers have conventional preferences for debt of certain
maturities, which interfere with the full realization of the rate pattern
that would be produced by the free reign of expectations.9 Neverthe
less, the actual movements of the interest rate structure seem to be
broadly consistent with the expectational theory.
Interest
Rate
Chart IV-1.
Illustrative interest-rate patterns
Chart IV -1 presents a somewhat idealized picture of the way in
which the term structure of interest rates might be expected to behave
according to the expectational theory as outlined above. Yield curve
I is the kind of pattern that would tend to prevail in recession periods
when interest rates were low and most investors expected them to
rise in the future. Curve III is the type that would prevail in boom
periods when interest rates were high and most investors expected
them to fall. Curve II is the type that would prevail in periods in
which most investors expected rates to remain unchanged for some
time in the future or when expectations of increases were about as
common as expectations of decreases.10 As business conditions
change, the rate structure would move continuously from one position
to another— for example, during a period of recovery from recession,
8 These factors are stressed in J. M . Culbertson, “ The Term Structure of Interest Rates.” Quarterly
Journal of Economics, L X X I (November 1957), 485-517. We shall also make use of them below to explain
certain peculiarities that have appeared in the rate structure recently.
io Curve II has a gentle upward slope due to the inherent preferences of lenders for short-term debt and
of borrowers for long-term debt, referred to above.
DEBT
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85
the structure would gradually change from type I to type I I I .11 Thus
interest rates would tend to rise together, but with short-term rates
moving over a considerably wider range than long-term interest rates.
For many years up until rather recently, the term structure of
interest rates in the United States was of the type I variety, with
short-term interest rates substantially lower than long-term rates.
During the depression of the 1930’s, interest rates fell to low levels,
as is characteristic of such periods, and investors, judging the rate
level by the conventional standards established in the 1920’s, felt
that rates were abnormally low and could be expected to rise. Accord
ingly, short-term rates fell to very low levels and the yield curve took
on a sharply upward-sloping shape. During World W ar II, the
Federal Reserve System, in coordination with the Treasury, decided
to peg the interest rate structure in order to assist the Treasury in
financing the war. The rate structure selected for pegging was
approximately the one then prevailing, which reflected the effects of
the prolonged depression. The Treasury bill rate was fixed at %
percent and the certificate rate at % percent, with rates rising to 2}i
percent for long-term Treasury bonds.12 Although the bill and cer
tificate rates were freed in July and August 1947, and somewhat
greater flexibility was introduced into the short-term end of the rate
structure, the fixing of the long-term rate and control over the rate
structure was maintained until the accord of March 1951. Even after
the accord, flexibility was introduced only gradually. Since the
“ bills-only” policy was put into effect in 1953 by the Federal Reserve
System, the rate structure (as distinct from the rate level) has been
determined almost entirely by market forces with very little interven
tion by the authorities other than the incidental effects caused by the
open market operations in bills.
The combined result of the depression, war finance, and the policies
of the early postwar period was to produce a situation in which the
short-term rate was below the long-term rate—and frequently very
much below it— continuously for approximately a quarter of a cen
tury. As a result of this experience, the notion came to be widely
accepted that a rate curve sloping steeply upward was the normal
thing. In accordance with the expectational theory, the existence of
this view in itself tended to inhibit movements of the rate structure
away from the upward-sloping position. Historically, however, dur
ing the period prior to 1930, short-term rates appear to have been
above long-term a good deal of the time.13 And the basic forces of
11 There may be times when short- and long-term rates move in opposite directions. For example,
during the early stages of a recovery period when interest rates begin to rise and investors expect the
rise to continue for some time as the recovery develops, lenders may hold funds back from the long
term market to wait until rates begin to stabilize, putting these funds temporarily into the short-term
market, while borrowers may anticipate their needs for long-term funds and accelerate their long-term
borrowing in order to meet their requirements before rates rise further. In these circumstances, long-term
rates may rise sharply while short-term rates are rising only slightly or perhaps even declining. In terms
of our earlier analysis, this is a circumstance in which market participants have elastic expectations rather
than the inelastic expectations which normally seem to prevail. This is likely to be a transition phenom
enon, however, which accelerates the rise in long-term interest rates to a point where inelastic expectations
again prevail and short-term rates rise sharply to produce a type III curve.
12 For a discussion of the decision to fix the rate structure, see H. C. Murphy, “ The National Debt in
War and Transition,” op. cit., pp. 92-103. The fixing of this rate structure created some problems for the
Treasury and the Federal Reserve, because the structure itself contradicted the expectations created in
the minds of investors. The upward slope of the yield curve corresponded with expectations of rising
rates, while the decision to fix rates created expectations that rates would not change. Under these cir
cumstances, it became increasingly difficult to get investors to hold short-term securities. If the rate struc
ture is to be pegged, the structure selected should be one in which short- and long-term rates [are ap
proximately equal—that is, a curve of the type II variety as shown in chart IV-1.
13 See David Durand, “ Basic Yields of Corporate Bonds, 1900-1942,” National Bureau of Economic
Research Technical Paper 3 (New York: National Bureau of Economic Research, 1942), especially charts
showing yield curves for individual years from 1900 to 1942.
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the market appear to be reasserting themselves as the implications of
a flexible interest rate policy come to be more widely understood.
Thus, we seem to be witnessing a reappearance of the classic pattern
in which the short-term rate is above the long-term rate during pros
perous times, while the opposite relation holds during recession
periods.
In one respect, however, the interest rate structure during recent
periods when monetary policy has been restrictive and the level of
interest rates has risen has departed from the pattern described above.
As interest rates have risen recently, a bulge has appeared in the yield
curve in the intermediate maturity range. This is illustrated in chart
IV-2, which shows the yield curves for Treasury securities in March
1958 and in August 1959. The March 1958 curve is a typical yield
curve for a recession period, with the short-term rate very low relative
to the long-tei*m rate. By August 1959 the forces of recovery which
increased credit demands, combined with a rather restrictive Federal
Reserve policy, had caused a considerable rise in interest rates gen
erally. Short-term rates had risen sharply from their recession lows.
However, the rate structure in August 1959 rose quite sharply from
about 3.80 percent for the shortest term securities to about 4.85 per
cent at a maturity of about
years and declined steadily thereafter
to a level of slightly over 4 percent for the longest term securities.14
It seems likely that the tendency for the shortest term interest
rates to remain below the rates on intermediate-term securities, even
when rates rise to relatively high levels, is due to the existence of
important groups of investors who are strongly interested in liquidity.
For example, nonfinancial corporations have become an important
factor in the Government securities market in recent years. Corpo
rate treasurers have become increasingly sophisticated in managing
their cash positions so as to economize on cash balances and earn
interest by investing in Treasury bills and other short-term Govern
ment securities.15 These investors seldom invest in anything but
quite short-term securities because of their aversion to price variabil
ity, since the funds invested are, in effect, transactions balances which
may be needed on short notice to make payments.16 Commercial
banks are also interested in short-term Governments, which constitute
the bulk of their secondary reserves. Foreign accounts and State
and local governments have become increasingly important investors
in Governments. Like nonfinancial corporations, these groups of
investors, being interested chiefly in liquidity, do not ordinarily spec
ulate on changes in security prices and therefore concentrate their
holdings in the short-term sector regardless of interest rate expecta
tions.17 The fact that all of these investor groups added substantially
to their holdings of Government securities between mid-1958 and
mid-1959 suggests that their activities may have served to moderate
the rise in interest rates in the shortest maturity range and thus have
14 A similar pattern made its appearance in 1956 when monetary policy became restrictive and persisted
through most of 1957 until the trend of monetary policy was reversed to counter the recession late in that
year.
is Corporations also invest their surplus funds in open market commercial paper and in repurchase agree
ments with Government security dealers. However, short-term governments are by far the most impor
tant outlet for their funds. See C. E. Silberman, “ The Big Corporate Lenders,” Fortune (August 1956).
'6 On the theoretical aspects of the management of transactions balances, see James Tobin, “ The Interest Elasticity of Transactions Demand for Cash,” Review of Economics and Statistics, X X X V III (August
1956), 241-47, and W. J. Baumol, “ The Transactions Demand for Cash: An Inventory Theoretic Ap
proach,” Quarterly Journal of Economics, L X V I (November 1952), 545-556.
17 Of course, commercial banks do shift the composition of their portfolios of Government securities in
accordance with changing interest rate expectations. But, as far as their secondary reserves are concerned,
they tend to maintain large holdings in the short-term sector under most circumstances.
C
e
n
t
-
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STATES
Chart IV-2. Term structure ot Interest rates:
March 1958 and August 1959
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been mainly responsible for the failure for short-term interest rates
to rise more than they did.18 If a restrictive monetary policy con
tinues to be applied, it may become necessary at a later time for
some of these investor groups to liquidate their holdings of short
term Governments in order to finance expenditures or to meet loan
demands (in the case of commercial banks). If and when this hap
pens, short-term rates may rise sharply, thus producing the sort of
downward-sloping yield curve which characterized prosperous periods
in earlier times.19
Debt management policy and interest costs to the Treasury
One possible objective of Treasury debt management would be the
minimization of the interest cost on the debt. To isolate this objective,
suppose the Treasury borrows enough to cover its cash deficits and
uses cash surpluses to retire debt, conducting its cash borrowing and
refunding operations entirely with a view to the minimization of
interest costs and leaving economic stabilization entirely to the
Federal Reserve. On this assumption, what can be said concerning
debt management policy?
First of all, the Treasury might attempt to minimize the current
coupon bill on Treasury securities, making no effort to look into the
future. While this would be an unrealistic and short-sighted approach
to the problem, it does bring out one important point. The Treasury
has monopolistic power in the credit market in the sense that the scale
of its borrowings in various maturity sectors has a noticeable effect
on the interest rates it has to pay. Under these conditions, borrowing
in each subsector of the market should be carried to the point at any
particular time where the marginal cost of funds is equalized in all
subsectors.20 That is, borrowing would not simply be conducted each
time in the market in which the interest rate happened to be lowest.
Presumably this would mean that borrowing would be conducted
simultaneously in most sectors of the market most of the time, with
the division of the total between subsectors depending upon the
behavior of marginal costs in the various subsectors. The behavior
of marginal costs would depend, in turn, upon the shapes of the various
supply curves of funds available from lenders and also upon the shapes
of the demand curves for funds on the part of other borrowers compet
ing with the Treasury, since the Treasury could obtain funds by
squeezing out these other borrowers. The shapes of these supply and
demand curves in various subsectors of the market and therefore the
marginal costs of funds to the Treasury would undoubtedly vary
considerably depending upon the present state of business, the future
outlook for business activity, and the interest rate expectations of
borrowers and lenders. In view of our present lack of quantitative
18 Between June 30, 1958, and June 30, 1959, nonfinancial corporations increased their holdings of Gov
ernment securities by $6.1 billion (from $13.9 billion to $20 billion). While no data on maturities are avail
able, it can be assumed that these increased holdings were heavily concentrated in short maturities. For
eign accounts increased their holdings by $3.4 billion (from $6.2 billion to $9.6 billion); most of this increase
was in bills and certificates. State and local governments added $1.3 billion to their holdings. Commercial
banks increased their investments in Government securities within 5 years of maturity by $3.4 billion
(data from Federal Reserve Bulletin).
18 This explanation of tue bulge in the rate structure in the intermediate maturity range emphasizes
compartmentalization of the market. Such factors are stressed by Culbertson, op. cit., as an important
factor in determining the rate structure generally. It may be noted that a bulge would be produced by
the expectational theory if investors expected rates to rise for a time and then fall. However, compartraentalization appears to be a more plausible explanation for this particular phenomenon.
20 To illustrate the point, suppose the Treasury could borrow 100 in a particular maturity subsector at an
interest rate of 3.10 percent, while if it tried to borrow 200 in this sector it would have to pay 3.20 percent.
Thus the interest cost of borrowing $100 would be $3.10 per year, while the cost of borrowing $200 would be
$6.40 per year. The marginal costs would be $3.10 or 3.10 percent for the first $100 and $3.30 ($6.40“ $3.tft)
or 3.30 percent for the second $100.
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knowledge of the sort necessary to permit us to predict market
reactions, the marginal cost principle is pretty much an “ empty box”
as far as providing any operational guides to the Treasury in conduct
ing debt management operations is concerned.
However, even if we knew enough about the behavior of the market
to be able to apply the marginal cost principle as outlined above, this
principle would provide a wholly inadequate guide to the Treasury as
far as minimizing interest cost is concerned. The reason is that the
minimization of interest cost is inherently a dynamic problem. To
minimize in a meaningful sense, the Treasury must try to look ahead
and foresee future interest rate developments. To illustrate, it
may at times pay the Treasury to borrow in the short-term market
even though the immediate marginal cost of funds here is higher than
in longer term sectors of the market if it expects that short-term
interest rates are going to fall sharply in the near future, thus
permitting the reborrowing of the funds at very low cost when the
short-term debts mature.
Thus, cost minimization requires the Treasury to attempt to forecast
future business conditions and Federal Reserve policy in order to
predict the future movements of interest rates as a basis for current
debt management policies. While the complexities involved in this
kind of operation make the establishment of any clear-cut rules of
action clearly impossible, it does appear that a little can be said about
what a policy of interest-cost minimization would involve.
As we have seen, the classic pattern of interest rate movements is
for interest rates on debts of all maturities to move up and down
together, with short-term rates sweeping over a wider range than
long-term rates, rising above long-term rates in prosperous periods
when the rate level is high and falling below them in recession periods
when the rate level is low. This has been the historic pattern, and
there are signs that it is becoming reestablished. In fact, the ag
gressive use of monetary policy should intensify the forces which tend
to produce this pattern of rate movements. If we assume that inter
est rates move in this way, it seems apparent that interest-cost mini
mization would require the Treasury to concentrate its long-term
borrowing in recession periods when rates tend to be low. Paradoxi
cally perhaps, this is true despite the fact that short-term rates tend to
be well below long-term rates during such periods. The explanation
is that when the Treasury borrows at long-term during recession
periods it gets the advantage of the prevailing low rates for a long
period in the future. Thus, the Treasury would concentrate its
borrowing in the short-term market during prosperous times, despite
the fact that short-term rates would be high during such periods.21
Most of this short-term debt would be rolled over at low interest
cost during recession periods when interest rates fell, thus offsetting
the high prosperity cost with a low recession cost, while some extension
of long-term borrowings would be conducted in recession periods.
This practice of shifting toward the long-term market during periods
of low interest rates and toward the short-term market during periods
of high interest rates is in line with the practices followed by many
private borrowers who are seeking to minimize interest costs—in
21 If the Treasury was prepared to buy up its outstanding debt in the market (at the prevailing market
price, of course) before maturity, it might at times pay to do this in prosperous times when interest rates
were high (and bond prices low), borrowing the necessary funds in the short-term market.
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fact, such behavior on the part of private borrowers is, as we have
seen, part of the basic explanation of the behavior of the interest rate
structure.
Obviously, this suggested pattern does not provide anything more
than a very rough guideline for the debt managers in seeking to mini
mize interest cost. The marginal cost principle continues to apply
in this expanded context, and while it is impossible to turn this prin
ciple into an operational guide to policy, the principle does at least
suggest that the Treasury should probably be raising at least part of
its funds in each sector 01 the market most of the time, while shifting
the weight of its operations toward the short-term market during
prosperous times when rates are high and toward the long-term market
during recessions when interest rates are low.
This pattern of debt management operations appears to have two
rather interesting corollaries. One is that a policy of interest-cost
minimization would tend to accentuate fluctuations in short-term
interest rates and to damp fluctuations in long-term interest rates.
This is because the Treasury would tend to concentrate its borrow
ings in the short-term sector when rates were high and in the long-term
sector when they were low.22 This effect would probably be offset to
some extent because if the Treasury behaved in this way, private
borrowers and lenders would probably do so to a lesser extent than
they would in the absence of such Treasury action. Nevertheless,
a net effect of this kind seems very likely. The second corolla^ is that
a policy of concentrating on short-term borrowing when interest rates
were high and on long-term borrowing when they were low, while mini
mizing average interest costs over time, would probably produce
strong procyclical fluctuations in Treasury interest payments. When
interest rates rose, the heavy volume of short-term borrowing wrould
drive up short-term rates and as existing short-term debt rolled over
and had to be refinanced at the higher rates, interest costs would
snowball rapidly. On the other hand, when rates declined, much of
the short-term debt would be rolled over at low rates, while part of
it would be refinanced by borrowing at long term at relatively low
rates.23
E F F E C T S ON T H E L E V E L OF P R IV A T E E X P E N D IT U R E S
It seems to be pretty generally accepted that the way in which the
Treasury conducts its debt management operations can have impor
tant effects on the level of private expenditures and consequently
that debt management can exercise either stabilizing or destabilizing
effects on the economy. The conclusions of orthodox theory in this
respect are quite clear: lengthening debt maturities is deflationary
(or anti-inflationary) and shortening maturities is inflationary (or
anti-deflationary); accordingly, the debt should be lengthened during
inflationary periods and shortened during recessions if debt manage
ment is to serve as a stabilizer. However, the clarity of the conclu
sions is not matched by an equal clarity in the underlying reasoning.
There are several possible routes by which debt operations may affect
the level of expenditures, which we shall discuss.
22 As suggested in footnote 21, the Treasury might also find it desirable to retire existing long-term debt
through market purchases financed by short-term borrowing when interest rates were high, thus still further
forcing up short-term rates and checking the rise in long-term rates.
23 This discussion refers only to cyclical movements of interest costs relative to the trend. Whether total
interest payments actually rose and fell according to this pattern would also depend upon the secular trend
in outstanding debt, together with the cyclical pattern of borrowing and debt retirement, and upon the
secular trend in interest rates.
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Interest rate efforts
Suppose the Treasury—or it could just as well be the Federal Re
serve—engages in a supposedly deflationary debt operation, borrow
ing funds in the long-term market and using the funds to retire short
term debt, thus lengthening the average maturity of the outstanding
publicly held debt.24 One way in which an operation of this kind
may affect the level of expenditures is through the effects it will have
on interest rates. In fact, this seems to be the way in which the opera
tion is viewed by the financial community—it is commonly said that
when the Treasury sells long-term bonds it “ preempts” funds from
the capital market, thus reducing the supply available for financing
private spending and exerting a restrictive effect.
The difficulty with the line of reasoning, however, is that an opera
tion of this kind, while raising the long-term rate of interest, simul
taneously lowers the short-term rate. Funds are removed from the
long-term sector and injected into the short-term sector. The rise
in the long-term rate will be deflationary and the fall in the short-term
rate will be inflationary. The net result of the operation will depend
upon which of these two effects is greater. The analysis is fairly
complicated, because it depends not only upon the sensitivity of
expenditures to changes in short-term rates compared with the sensi
tivity of expenditures to changes in long-term rates but also upon the
interest elasticities of the supplies of funds in the two sectors. More
over, the two sectors are linked together by expectations, as pointed
out earlier.
To begin with, suppose we assume that the supply of funds is com
pletely interest-inelastic in both sectors, and suppose further that we
neglect the effects of expectations. In this case, there will be no
change in total expenditures, the amount financed with short-term
funds increasing as much as the amount financed with long-term funds
declines. The long-term rate of interest will rise more or less than the
short-term rate of interest will fall depending upon whether the
elasticity of expenditure schedules in the long-term market is less or
more than the elasticity of expenditure schedules in the short-term
market.
If we make the more reasonable assumption that the supply of
funds has some interest elasticity in each sector, the direction and
magnitude of the effect on total expenditures depends upon the
elasticities of demand and supply in the two sectors. In fact, a shift
of funds from the long-term to the short-term market will have a net
restrictive effect—i.e., will reduce the level of total expenditures—if
the following condition is satisfied:
Vei^V si^
Vb s
Vss
where v e i is the absolute value of the elasticity of expenditures with
respect to the long-term interest rate, ves is the absolute value of the
24 All so-called restrictive debt operations can be subsumed under this heading. When the Treasury bor
rows cash to cover a deficit, if it borrows long-term funds, it lengthens the debt as compared with what would
have been the result if it had borrowed short-term funds. When the Treasury retires debt, it ordinarily
retires only maturing debt which is by definition short term (in fact, its maturity is zero)—except to the
extent that debt retirement takes the form of buying up existing debt for the trust funds. However, the
Treasury could buy up existing long-term debt in the market when it wanted to retire debt; if it did this, it
would shorten maturities as compared with what they would have been if it had retired short-term debt.
When the Federal Reserve sells long-term securities in order to reduce bank reserves, it lengthens the ma
turity of the publicly held debt compared with the situation that would have prevailed had it sold short
term securities instead.
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elasticity of expenditures with respect to the short-term interest
rate, rjSi is the elasticity of supply of funds with respect to the long
term rate, and r)Ss is the elasticity of supply of funds with respect to
the short-term rate.25 The restrictive effect will be larger the greater
the amount by which the left-hand side of the above inequality exceeds
the right-hand side.
Thus, the restrictive effect will be greater (a) the greater the
elasticity of expenditure schedules with respect to the long-term rate,
(b) the smaller the interest elasticity of expenditure schedules with
respect to the short-term rate, (c) the smaller the interest elasticity
of the supply of funds in the long-term market, and (d) the greater
the interest elasticity of the supply of funds in the short-term market.
Chart IV-3 shows a case in which the elasticities of supply are the
same in both markets, while the expenditure schedule is more elastic
in the long-term than in the short-term market. A shift of funds in
the amount of A E s2 ( = B E n) from the long-term to the short-term
market results in a decrease in expenditures financed with long-term
funds of E 12E 11 and an increase in expenditures financed with short
term funds of E slE s2. Total expenditures are reduced by the amount
Ei2EiiEsiEs2. In this case, the two supply elasticities are equal, and
there is a restrictive effect because the elasticity of expenditures with
respect to the long-term rate exceeds the elasticity with respect to
the short-term rate.
Chart IY-4 illustrates the case in which the two expenditure sched
ules are of equal elasticity, and a shift of funds in the amount A E s2
(— BEn ) from the long- to the short-term market produces a restric
tive effect because the elasticity of supply of funds is greater in the
short- than in the long-term market. The reduction in total expendi
tures is equal to Ei2E n—E siEs2.
Using this framework, we can make an effort to evaluate the prob
able effects of lengthening or shortening debt maturities by consider
ing, on the one hand, the probable elasticity of expenditures with
respect to the long- and short-term rates, and on the other, the corre
sponding elasticities of supply of funds.
Expenditure elasticities.—It is difficult to evaluate the effects on
private expenditures of a change in the general level of interest rates,
and obviously the effects of a change in the structure of rates is even
more difficult to judge. However, there is some theoretical basis for
such an analysis, and some empirical evidence that can be brought
to bear.
We may suppose that the kinds of real investment that are financed
by funds raised in the long-term market are, in general, of a longer
term character than those which are financed by funds raised in the
short-term market. Thus, to a considerable extent, the question we
are considering appears to be whether long-term investment projects
are more sensitive to interest rate changes than are short-term invesment projects. At first glance, it appears that there is a strong a
priori reason to believe that this is the case. If businessmen attempt
to evaluate investment projects scientifically, using a profit-maximization criterion, they may proceed by comparing the present value of
25 The supply of funds in each market means the net supply arising from saving and dishoarding. For
the derivation of this inequality, see the appendix at the end of this chapter.
DEBT
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C h a rt IV -3 .
co
rL
0
A
Es ,
Chart IV -4
E s2
DEBT
Long - term M arket
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the expected future returns from the project with the project’s cost.26
If value is greater than cost, the firm will invest ; if cost is greater than
value, it will not invest. Since a given change in the rate of discount
employed will have a much greater effect on the present value of
long- than of short-term investments, it would appear that a rise in
the long-term interest rate is more likely to push a significant amount
of investment below the margin of profitability than would a similar
rise in the short-term rate.27 According to this view, the interest
elasticity of long-term investment is likely to be substantially greater
than the interest elasticity of short-term investment.28
However, this argument requires very substantial modification, be
cause the risks connected with long-term investments are very much
greater than those associated with short-term investments. A firm
building a plant which is expected to last for 30 years must base its
calculations upon a forecast of all the factors affecting its business
over that period—including the demand for its product, the costs of
labor and materials, possible technological changes in production
methods, the possibility of the development of new products by com
petitors, etc. In making its investment decisions, it must make some
allowance for the risks involved in unexpected changes in such factors
as these, most of which are vastly more important to it than the rate
of interest. One way of allowing for risk would be to discount future
returns at an interest rate that contains a liberal allowance for risk.29
In fact, we may think of the discount rate used by a firm to evaluate
the prospective profitability of an investment as being composed of
three elements: the pure rate of interest, which represents the interest
rate on a Treasury security having the same maturity as the security
to be issued by the firm to raise funds; an allowance for lender’s risk;
and an allowance for borrower’s risk. Thus, we have
r = r p+ r z+ r b
where r is the discount rate used, rp is the pure rate of interest, r%is
allowance for lender’s risk, and r6 is allowance for borrower’s risk.
The allowance for lender’s risk (r*) is an amount of interest over and
above the pure rate that the buyer of the securities will insist on get
ting to cover the risk that the borrower will not meet the interest
and/or principal payments on the securities. The pure rate of interest
plus lender’s risk allowance is the interest rate that the borrower ac
tually has to pay in the market to obtain the funds. The allowance
for borrower’s risk (r&
) is an amount that the borrower himself adds on
to the interest rate he has to pay in the market in order to obtain the
rate he uses to discount the expected returns.
Thus, the pure rate of interest (rP) might be 3 percent and the
allowance for lender’s risk (rz) 2 percent, so that the firm had to pay
2# Another way to state this comparison is to say that they compare the interest rate they must pay for
the funds (or an imputed interest cost if they are using internal funds for financing) with the marginal
efficiency of investment. Since the present value of the investment is obtained by discounting the ex
pected future returns at the market rate of interest while the cost of the project is equal to the expected
future returns discounted at a rate equal to the marginal efficiency of investment, it follows that when the
market rate of interest is less than the marginal efficiency of investment, the present value of the project is
greater than its cost and vice versa.
27 A rise in the interest rate from 4 to 5 percent (i.e., a relative increase of 25 percent) will reduce the present
value of an investment with an expected life of 40 years by 13 percent, while the same change in the interest
rate will reduce the present value of an investment with an expected life of 1 year by only 1 percent.
28 Actually, this statement assumes that there is no difference in the underlying array of investment
projects arranged in order of declining profitability, as between the long-term and the short-term sectors.
In truth, this is a matter concerning which we have no evidence at all.
2« This discussion follows, in a general way, the analysis in G. L. S. Shackle, “ Interest Rate and the Pace
of Investment/’ Economic Journal, LV (March 1946), 1-17.
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5 percent for funds. What is a reasonable value for the borrower's
risk allowance? One study of investment decisions in England before
World War II suggests that businessmen frequently do not consider
an investment at all, regardless of the rate of interest, unless it prom
ises to pay returns in the 30- to 50-percent range.30 Even if the
borrower's risk is only 20 percent, assuming a pure interest rate of
3 percent and an allowance for lender's risk of 2 percent, the discount
rate employed would be 25 percent.
Now debt management operations (or monetary policy for that
matter) are not able to affect directly the allowances for lender's and
borrower's risk; their influence is confined to the pure rate of interest.
To illustrate the significance of this, suppose that by means of sales of
long-term securities the pure rate of interest in the above calculation
was forced up to 4 percent—a relative increase of 33 percent in the
yield on long-term Government securities. If the allowances for
lender's and borrower's risk continued to be 2 percent and 20 percent,
respectively, the discount rate employed in evaluating investments
would be raised only from 25 percent to 26 percent, a relative increase
of only 4 percent.31 A rise in the rate of discount employed in valuing
an asset from 25 to 26 percent will have only a small effect on the value
of the asset even if its expected life is long.32
The moral of this story is that the presence of uncertainty is likely
to blunt to a great extent the effect of the rate of interest even on
decisions to invest in assets with a long expected life. The above dis
cussion is probably somewhat unrealistic: Instead of discounting
expected returns at a rate of discount which contains a heavy loading
for borrower's risk, it appears that businessmen commonly use
formulas for evaluating investments which do not take account of the
current rate of interest at all. Instead they frequently use very crude
rules of thumb, such as requiring the investment to pay for itself in,
say, 2 to 5 years even though its expected life is much longer than
this.33
Turning to the empirical evidence, such as it is, we find little
indication that either short-term investment or long-term investment
possesses any great degree of sensitivity to the rate of interest. Such
surveys as have been made by means of questionnaires or interviews
relating to business investment decisions have failed to turn up
so This survey was carried out by the Oxford Economists’ Research Group in 1939. See J. E. Meade and
P. W. S. Andrews, “ Summary of Replies to Questions on Effects of Interest Rates,” and P. W. S. Andrews,
“ A Further Inquiry into the Effects of Rates of Interest,” Oxford Economic Papers, October 1938, pp. 14-31,
and March 1940, pp. 33-73, respectively. Comments on the findings by H. D. Henderson and by R. S.
Sayers were also published in the same issues of the “ Oxford Economic Papers.” A summary of the findings,
together with the original comments and some later ones, is given in T. Wilson and P. W. S. Andrews
(eds.), “ Oxford Studies in the Price Mechanism” (Oxford: The Clarendon Press, 1951), pp. 1-74. Answers
in the original survey which suggests that businessmen, in effect at least, include a very high risk premium
in their calculations concerning the desirability of investment are cited in Shackle, op. cit., pp. 6-7.
The percentage change in r is equal to rP/(rp-\-n+rb) times the percentage change in rv. Thus, in the
above example, rv increased by 25 percent, rp/(rp+n-frb) was 12 percent, and r increased by 4 percent.
32 The effect will be greatest in the case of an investment having a perpetual life. Even here a rise in the
discount rate from 25 to 26 percent will reduce the present value by something less than 4 percent.
83 For a critical discussion of such rules of thumb, see George Terborgh, “ Dynamic Equipment Policy”
(New York: McGraw-Hill Book Co., 1949), chs. X II and X III. It may be noted that if returns were dis
counted at the rate of interest the borrower had to pay (i.e., the pure rate plus allowance for lender’s risk
only), the use of a short payoff period would be a device for allowing for borrower’s risk and would, by con
verting long-term investments, in effect, into short-term investments, greatly blunt the effects of interest
rate changes on such investment.
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evidence that interest rates are an important factor.34 Numerous
econometric investigations have been conducted in recent years,
covering both aggregate investment and investment in particular
sectors. In very few of these studies have interest rates proved to be
a significant variable affecting investment.36
One might expect a priori to find a significant interest rate effect
in the case of regulated industries, such as railroads and public utili
ties and residential housing, since these sectors combine a low degree
of uncertainty with long equipment life.36 However, the evidence is
somewhat mixed. L. R. Klein in several studies of investment in
railroads and electric utilities has found indications that the long-term
interest rate exerts a significant influence.37 On the other hand, a
recent study of investment in the electric power industry suggests
that interest rates are not important.38
In the case of housing, interest rates seem to have had a very definite
effect in recent years, but the effect has worked through the supply of
funds rather than the demand. When interest rates have risen, the
fixed interest-rate ceilings on FHA-insured and VA-guaranteed mort
gages have resulted in funds being drained off into competing uses
which are free to pay higher rates. It is not clear whether housing
construction would be sensitive to interest rate variations if these
ceilings did not exist.39
Nearly all of the studies that have been made relate to long-term
investment and suggest that it is not sensitive to variations of the
rate of interest of magnitudes such as we have experienced. There
is some suggestion that possibly the effects of interest on investment
operate with a rather long lag and that failure to allow for this lag is
3* The most famous of these surveys is the Oxford survey, referred to in footnote 30, which is admittedly
very much out of date and was conducted in an economic environment entirely different from that pre
vailing in recent years. A survey of the case materials in the files of the Harvard Graduate School of Busi
ness Administration, made in the late 1930’s, also failed to turn up evidence of significant effects. See J. F.
Ebersole, “ The Influence of Interest Rates Upon Entrepreneurial Decisions in Business—A Case Study,”
Harvard Business Review, X V II (1938), 35-39. This study is subject to some of the same limitations as the
Oxford survey and some others as well. The results of the Oxford and other surveys are subjected to a
critical examination in W. H. White, “ Interest Elasticity of Investment Demand—The Case From Business
Attitude Surveys Reexamined,” American Economic Review, X L V I (September 1956), 565-587.
ss A tabulation of the results of a large number of studies of investment in the United States is presented
in J. R. Meyer and Edwin Kuh, “ The Investment Decision” (Cambridge: Harvard University Press,
1957), appendix to ch. II. This tabulation shows almost no cases, except in the railroad and public utility
industries, in which interest rates turned out to be a significant explanatory variable. Klein and Gold
berger were not able to find evidence of an interest rate effect on investment. They say, “ In using our highly
aggregative measure of investment, we find no reasonable empirical results for the effect of interest. In all
possible combinations with current nonwage income, lagged nonwage income, and long-term bond yield we
obtain estimated coefficients with signs contrary to advance expectations, large sampling errors and some
times impossibly large coefficients. To some extent these results follow from our failure to distinguish,
among inventories, construction, and equipment. In a large model we may expect to find the short-term
interest rate significant in inventory outlays, the long-term interest rate significant in construction outlays,
and unlagged income significant in either inventory or equipment outlays.” L. R. Klein and A. S. Gold
berger, “ An Econometric Model of the United States, 1929-52” (Amsterdam: North-Holland Publishing
Co., 1955), pp. 67-68.
36 Shackle (op. cit.) suggests housing as a sector in which investment is likely to be powerfully affected by
interest rates.
37 The results of the various studies by Klein are tabulated in the summary table in Meyer and Kuh,
loc. cit.
38 Avram Kisselgoff and Franco Modigliani, “ Private Investment in the Electric Power Industry and
the Acceleration Principle,” Review of Economics and Statistics, X X X I X (November 1957), 363-379.
39 See my paper, “ The Impact of Monetary Policy on Residential Construction, 1948-58,” in “ Study of
Mortgage Credit,” Committee on Banking and Currency, Subcommittee on Housing, U.S. Senate, 85th
Cong., 2d sess. (Washington: Government Printing Office, 1958), pp. 244r-264.
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partly responsible for our failure to uncover them.40 But this is not
much of a consolation for either debt management policy or monetary
policy, since the existence of lags creates serious problems in connec
tion with the timing of policy actions.
Most of the studies of the effects of interest rates on investment
have related to long-term investment. The view used to be widely
prevalent that interest rates exerted their main influence on business
inventories, and this view still seems to prevail in some quarters.41
However, while the evidence is rather inadequate, such studies as
have been made recently suggest that credit conditions do not affect
inventories strongly and that such effects as are present operate with
a troublesome lag.42 Some skepticism seems in order concerning the
effects of interest rates on inventory investment in view of the relative
unimportance of interest costs in connection with short-term loans of
the type used to carry inventories in relation to the importance of
inventories in the production process and the possibility of sub
stantial speculative inventory profits during periods of rising prices.43
Such evidence as is available suggests that the demand for consumer
credit is not very sensitive to interest rates for a variety of reasons.44
We may conclude that such evidence as there is suggests, although
by no means conclusively proves, that both long-term and short-term
investment are rather insensitive to changes in interest rates. Thus,
it seems likely that a change in the maturity structure of the debt
would be unlikely to have a very large effect on the level of expendi
tures as a result of the effects of the changes in the interest rates.
One might guess that the effects on long-term investment are likely
to be a bit more important than the effects on short-term investment,
but even this is little more than a guess. Thus, there is little reason
to think that the simultaneous sale of long-term securities and purchase
of short-term securities by the Treasury would have much effect via
the elasticity of expenditure schedules. Probably both the restrictive
effect on long-term investment and the stimulative effect on short
term investment would be quite small and the difference between the
two negligible, at least for reasonable scales of operations.
40 One recent study suggests that interest rates affect plant and equipment outlays of manufacturing
firms but that the influence operates with a 1-year lag. See Franz Gehrels and Suzanne Wiggins, “ Interest
Kates and Manufacturers’ Fixed Investment,” American Economic Review, X L V II (March 1957), pp.
79-92. In another study, based on interviews with business executives, there was evidence of a fairly long
lag between the time funds are raised and the time they are used for capital expenditures. This study did
not uncover clear evidence that either interest rates or the availability of funds are important factors in
investment decisions; however, the interviews were conducted in 1951 and 1952 before flexible monetary
policy was being vigorously applied. See Robert Eisner, “ Determinants of Capital Expenditures: An
Interview Study” (Urbana, 111.: University of Illinois, 1956), pp. 34-35 and 27-29. For an extensive dis
cussion of the lags involved in monetary policy, see Thomas Mayer, “ The Inflexibility of Monetary Policy,”
Review of Economics and Statistics, X L (November 1958), 358-374.
R. G. Hawtrey has for many years been a prominent exponent of this view. See, for example, his
“ Capital and Employment” (London: Longmans, Green, & Co., 1937). For a more recent view that, in
Britain at least, monetary restriction may have its main effects on inventory investment, see H. G. Johnson,
“ The Revival of Monetary Policy in Britain,” Three Banks Review, June 1956, pp. 3-20.
42 Gehrels and Wiggins, op. cit., find no evidence that interest rates influence manufacturers’ inventories.
Another recent study suggests that monetary controls may be able to influence inventory investment,
apparently by changing the availability of credit rather than interest rates. However, the evidence is very
tenuous, and the author expresses the view that the lags involved are a troublesome problem. See Doris M.
Eisemann, “ Manufacturers’ Inventory Cycles and Monetary Policy,” Journal of the American Statistical
Association, LIII (September 1958), 680-688.
« Moses Abramovitz, “ Inventories and Business Cycles” (New York: National Bureau of Economic
Research, Inc., 1950), pp. 125-126, 130-131. The Oxford Survey referred to earlier also indicated that in
ventory investment is not sensitive to interest rates.
44 Considerable evidence on this matter, not all pointing in the same direction, is to be found in “ Con
sumer Installment Credit” (6 vols.; Washington: Board of Governors of the Federal Reserve System,
1957). For a summary, see my article, “ Consumer Installment Credit: A Review Article,” American
Economic Review, X L V II (December 1957), pp. 966-984. See also Avram Kisselgoff, “ Factors Affecting
the Demand for Consumer Installment Sales Credit,” National Bureau of Economic Research Technical
Paper 7 (New York: National Bureau of Economic Research, 1952). This study indicates that changes
in interest rates are likely to have little effect on the demand for consumer credit but that substantial changes
in credit terms (downpayments and maturity of loans) may be of some importance.
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Supply elasticities.—The effects of shifting funds between the longand short-term markets will depend upon the elasticities of supply in
the two markets, as well as upon the elasticities of expenditures
schedules. The restrictive effect of shifting funds from the long- to
the short-term market will be greater the greater the elasticity of
supply in the short-term market and the smaller the elasticity of
supply in the long-term market. The reason for this is that, other
things equal, the interest rate will fall less in the short-term market
the more elastic is the supply and the interest rate will rise more in
the long-term market the less elastic is the supply.
Evidence regarding the elasticities of supply in the two markets
is practically nonexistent, however. One might expect that the elas
ticity of supply would be somewhat greater in the short-term market
than in the long-term market, since short-term securities are better
substitutes for money than are long-term securities. This might sug
gest that it would take smaller interest rate changes to induce people
to shift between money and short-term securities than to induce them
to shift between long-term securities and money.
Conclusions.—The above discussion suggests that lengthening of
the debt may have some restrictive effects and shortening of the debt
some stimulative effects as a result of changes in interest rates. The
elasticity of expenditure schedules may well be a little greater in the
long- than in the short-term sector, and the supply of funds more
interest-elastic in the short- than in the long-term sector. Both of
these relationships will tend to produce the indicated effects. How
ever, these relations between relative elasticities of supply and demand
are based upon very tenuous evidence, and the interest elasticities
of expenditure schedules are probably so small in both sectors that
the effects are likely to be very weak.
The above discussion assumes that the long- and short-term sectors
of the market are completely compartmentalized and, therefore, inde
pendent of one another. When induced shifts of demand and supply
between the long- and short-term sectors are allowed for the effects
of debt management are likely to be still further weakened. Thus,
when a debt-lengthening operation is carried out, the resulting decline
in short-term rates and rise in long-term rates is very likely to cause
some borrowers to shift from the long- to the short-term market and
some lenders to shift funds from the short- to the long-term market.
Thus, some long-term investment projects, instead of being abandoned
due to the rise in the cost of long-term funds, would be financed with
short-term credits, and concomitantly the increased supply of short
term funds instead of stimulating more short-term investment would,
to some extent at least, be used to finance long-term investment.
We may conclude that, in view of the uncertainties involved and
the small magnitudes of the probable reactions, interest rate effects
do not provide much of a foundation for so-called stabilizing debtmanagement operations.
Liquidity effects
Changes in the composition of the publicly held debt are sometimes
said to have an effect on the level of expenditures as a result of their
impact on the public's liquidity.45 For the sale of long-term securities
46 For a discussion of the theory of debt management constructed largely on the basis of a liquidity argu
ment, see E. R. Rolph, “ Principles of Debt Management," American Economic Review, X L V II (June
1957), 302-320.
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and use of the proceeds to retire or buy up short-term debt, the argu
ment apparently runs as follows: Those who give up money in ex
change for illiquid long-term securities are much less liquid as a result,
while those who give up relatively liquid short-term securities in
exchange for cash are made only a little more liquid. Those whose
liquidity is reduced will reduce their income-generating expenditures,
while those whose liquidity has increased will increase their expendi
tures. Since the reduction in the liquidity of the one group is larger
than the increase in the liquidity of the other, the reduction in expendi
tures by the group whose liquidity has been reduced will exceed the
increase in expenditures by the group whose liquidity has been in
creased, and the net result is restrictive or anti-inflationary.46 A
shortening of debt maturities will have the opposite effects and will
therefore be expansive or inflationary.
This argument seems to have a somewhat mystical quality to it.
Why should a person who, because of the attractive terms offered, is
induced to make a voluntary exchange of cash for long-term securities
be thereby induced to change his expenditures on goods and services?
And, similarly, why should one who voluntarily exchanges a short
term security for cash proceed to squander part of the cash on ex
penditures he did not previously deem worth making? Of course,
one explanation might be that changes in interest rates resulting from
such operations may cause revisions of expenditure plans. However,
we have already discussed the effects of interest rate changes. Dis
cussions of debt management often seem to make a great deal out of
a direct liquidity effect which is not dependent on interest rate
changes.47
Thus there seems to be a disturbing gap in the reasoning underlying
the theory of direct liquidity effects. To the extent that there is
anything to the argument, it appears to be an extension of the notion
that the level of expenditures will depend upon the size of the stock
of cash balances or other liquid assets held by households and perhaps
business firms.48 That is, according to the direct liquidity theory as
applied to debt management, the level of private expenditures depends
not only on the size of the stock of liquid claims but also on “ how
liquid” this stock is. On the basis of such empirical studies as have
been made, it is far from clear that changes in the stock of liquid assets
of the magnitude that take place in normal peacetime periods have
important effect on expenditures.49 Surely, if there is doubt as to
whether the size of the stock of claims is an important factor, it is
46 In addition to the difficulties pointed out below, the argument seems to assume that the effects are more
or less symmetrical; that is, the effects of changes in liquidity are the same (or at least not systematically
different) for the group whose liquidity is reduced as for the group whose liquidity is increased. However,
one might assume that those who give up liquidity most readily would be those who attach least importance
to it and therefore would be least influenced by it, while those who will most readily accept additions to
their liquidity would be those who attach most importance to it and would be most affected by it. If this
were the case, it would systematically weaken the liquidity effect and might conceivably reverse it.
<7 Rolph (op. cit., pp. 306-307) specifically disavows reliance on interest rate changes and rests his argu
ment on a direct liquidity effect.
48 For a discussion of various hypotheses that have been advanced concerning the relationship between
accumulated wealth and the level of expenditures—especially on the part of consumers—see Gardner Ackley,
“ The Wealth-Saving Relationship,” Journal of Political Economy, L IX (April 1951), 154-161. The most
elaborate effort to integrate wealth effects into modern monetary theory is to be found in Don Patinkin,
“ Money, Interest, and Prices” (Evanston, 111.: Row Peterson and Co., 1956).
49 Some investigators have found that liquid assets have an important effect on consumer expenditures.
See Arnold Zellner, “ The Short-Run Consumption Function,” Econometrica, X X V (October 1957),
552-567; and Klein and Goldberger, op. cit., pp. 50-66 and 89-95. However, other studies have achieved
predictive relationships that are equally satisfactory without using liquid assets. The fact is that our
knowledge of consumer behavior is quite unsatisfactory, and studies by the Survey Research Center at the
University of Michigan suggest that the influence of liquid assets is interrelated in a complex fashion with
other variables. Klein and Goldberger (ibid., pp. 50-83 and 89-92) also found that business holdings of
liquid assets influence investment, but here too there is much uncertainty.
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even more doubtful whether the composition of the stock is a matter
of appreciable significance. Certainly there is no evidence whatever
that this is the case.
To summarize, we may say that (a) the theoretical basis for direct
liquidity effects is decidedly uncertain, and (6) to the extent that these
effects may have theoretical validity they appear to represent a
second-order extension of an effect whose first-order importance has
never been clearly established. Until the theory has been clarified
and some evidence has been adduced concerning their empirical im
portance, it seems justifiable to assume that direct liquidity effects
of changing debt composition are nonexistent or at least of negligible
importance.
DEBT
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S P EC IES
OF
SELE CTIV E
CONTROL
It seems best to regard marginal changes in the composition of the
publicly held debt as a form of selective credit control which, by
changing the structure of interest rates, influences the composition
of demand for goods and services. For example, the sale of long-term
securities and use of the proceeds to retire short-term debt would
raise the long-term rate of interest and lower the short-term rate.
This might be expected to reduce expenditures on long-term invest
ment in plant and equipment and housing and increase expenditures
on inventory investment and consumer durable goods financed by
consumer credit. Admittedly our knowledge of the quantitative
magnitudes of these effects is decidedly fragmentary; nevertheless, it
is generally agreed, for instance, that to the extent that monetary
factors influence plant and equipment investment the effects are
produced mainly by changes in the long-term rate of interest.
Undoubtedly marginal changes in the composition of the publicly
held debt do have effects on the level of expenditures as well as on
their composition. For reasons indicated above, however, these
effects are of the second order of importance, and, in our present state
of knowledge, we cannot even be sure in all circumstances what the
direction of these effects is. Moreover, to the extent that changes in
debt composition do have a net effect on the public’s aggregate spend
ing, similar effects can be produced by monetary controls. It is
difficult to see what can be accomplished in the way of contracyclical
control of aggregate spending by means of debt management that
cannot be accomplished more effectively by Federal Reserve monetary
policy. Debt management, at least as presently conducted by the
Treasury, is a cumbersome instrument of stabilization policy, because
it is difficult to time in a flexible way and because the Treasury is
almost unavoidably concerned about its success in raising money.
Monetary policy is a superior instrument of economic stabilization,
because the Federal Reserve possesses a high degree of administrative
flexibility and because the maintenance of economic stability is its
major responsibility.
The superiority of the Federal Reserve as the administrator of
stabilization policy also suggests that to the extent that we rely upon
marginal changes in debt composition and interest rate structure as a
selective control for stabilization purposes, the responsibility for
producing such changes should be assigned to the Federal Reserve.
By flexible use of open market operations, the Federal Reserve is in a
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position to manage the interest rate structure. Under the so-called
bills-only policy which has been in effect since 1953, the Federal
Reserve has confined its open market operations almost entirely to
Treasury bills or equivalent short-term securities and avoided exer
cising control over the interest rate structure. The reasons underlying
the adoption of this policy and the possibility of a more flexible
approach will be discussed in the next chapter.
THE
O U TSTA N D IN G
DEBT
AS
AN
A U TO M A TIC
S TA B ILIZER
It is useful to distinguish between the debt structure at any particu
lar time and marginal changes in the debt structure. The above dis
cussion deals entirely with marginal changes and suggests that their
effects on the level of expenditures are not likely to be very great,
although their selective effects on the composition of expenditures
may be of some importance. However, the debt structure in existence
at any particular time conditions, in ways to be discussed shortly,
the manner in which the economy and particularly the financial system
react to external disturbances. Monetary policy may work more
effectively with one debt structure than with another. Consequently,
the achievement and maintenance of a desirable debt structure may
be an important objective of economic policy.
Another way to make the distinction just referred to is to distin
guish between discretionary debt policy and the debt as an automatic
stabilizer.50 This is similar to the distinction that is customarily
made between discretionary fiscal policy and automatic fiscal stabbilizers.51 Our discussion earlier in this chapter was concerned with
discretionary debt policy. Discretionary debt policy deals with the
question of how such marginal adjustments in the composition of the
debt as are possible through cash borrowing, debt retirement, and
refunding operations (together with open-market operations by the
Federal Reserve System) should be conducted under different eco
nomic conditions in order to contribute to economic stability. In dis
cussing the debt as an automatic stabilizer, we are concerned with the
way in which the composition of the outstanding debt at any particular
time conditions the way in which the economy reacts to disturbances
and the way in which monetary controls function.
We turn now to an analysis of the economic effects of alternative
debt structures or the role of the debt as an automatic stabilizer. It
has been argued that the growth of the public debt and Government
securities market, together with the growing importance of large
financial institutions, has considerably strengthened the influence of
monetary policy by providing a sensitive medium which rapidly trans
mits the influence of Federal Reserve policy to all parts of the economy.
Moreover, large institutional investors are very sensitive to small
changes in interest rates and security prices, and it is said that the
Federal Reserve can rely upon this sensitivity as a means of influenc
50 This distinction is made in Musgrave, op. cit., pp. 590,603-608.
51 Automatic fiscal stabilizers include devices, such as the personal and corporate income taxes and the
unemployment compensation system, which tend automatically to move the budget in the direction of a
deficit when economic activity slows down and in the direction of a surplus when it speeds up, thus helping
to stabilize the economy. Discretionary fiscal policy takes in changes in tax or expenditure legislation (or
administrative decisions to speed up public works expenditures, etc.) for the purpose of promoting economic
stability.
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ing the supply of funds these institutions make available to the private
sector of the economy.52
While there is undoubtedly some truth in this argument, the growth
of the public debt and the improved efficiency of the Government
securities market have also served in important ways to reduce the
influence of monetary forces in the economy and the effectiveness of
monetary policy. Transactions in Government securities provide a
means by which banks, financial institutions, and other investors can
rearrange their asset portfolios in such a way as to elude the Federal
Reserve’s attempts at control, or at least to postpone their impact for
a considerable time. This is well illustrated by reference to the 1955-57
period of credit restraint.
Between December 1954 and September 1957 bank loans expanded
by roughly $28 billion, even though the publicty held money supply
(demand deposits and currency) actually declined by about a billion
dollars.53 Table IV -l shows the factors affecting the money supply
during this period. As indicated in the table, two factors account
mainly for the fact that bank loans were able to increase so substan
tially at a time when the Federal Reserve succeeded in keeping the
money supply under tight control. The growth of time deposits
accounted for $12.4 billion. For the most part, this growth of time
deposits is related to the accumulation of saving out of the rising levels
of income associated with the prosperous business conditions of the
period.54
T a b le
I V -l. — Factors affecting money supply,l Dec. 81, 1954, to Sept. 25, 1957
[Billions of dollars; (+ ) denotes increase, (—) decrease in money supply]
Factor
A m ount
Increase in bank loans_________________________________________________ + 27. 7
Decrease in holdings of U.S. Government obligations by commercial and
savings banks_______________________________________________________ —14. 0
Increase in time deposits______________________________________________ —12.4
Other factors__________________________________________________________
—2. 4
Change in money supply________________________________________
—1. 1
i Money supply equals demand deposits adjusted plus currency outside banks.
Source: Federal Reserve Bulletin.
The other factor and the one that is important in the present context
is the reduction of $14 billion in bank holdings of Treasury securities.
Banks obtained about half of the funds they used for loan expansion
by selling such securities to nonbank investors or by redeeming them
for cash at maturity. To the extent that they did this, of course, the
money supply was not expanded because the sale of securities destroyed
money which was recreated by the lending.
Much concern is often expressed concerning the inflationary effects
of monetization of public debt by the banking system. By analgoy,
it might seem that the 1955-57 demonetization of debt—shifting it
62 R. V. Roosa, “ Interest Rates and the Central Bank,” in “ Money, Trade, and Economic Growth: In
Honor of John Henry Williams” (New York: Macmillan Co., 1951), pp. 270-295; also Roosa's “ Federal
Reserve Operations in the Money and Government Securities Markets” (New York: Federal Reserve
Bank of New York, 1956).
53 On a seasonally adjusted basis, the money supply increased by $5 billion, or 3.9 percent.
54 Part of the growth of savings deposits, especially in 1957, appears to have been induced by rising interest
rates on such deposits and to have represented shifts of funds from demand deposits. These shifts of funds
undoubtedly had some inflationary impact and represented a compensating response of the financial system
to tightening credit conditions. On this, see my article, “ Financial Intermediaries and Monetary Controls,”
Quarterly Journal of Economics, L X X III (November 1959).
50438— 60-------8
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out of the banking system—was anti-inflationary. Or, looking a
little more carefully and observing that the bank sales of Government
securities were accompanied by increases in loans, thus leaving bank
earning assets and the money supply unchanged, it might seem that
such operations were neutral in their effects. But even this view
seems to be incorrect. Taken by themselves, sales of securities by
the banking system to other investors would have restrictive effects,
since they would reduce the money supply and drive up interest rates.
Loan expansion, on the other hand, is inflationary, because it creates
money which in most cases is promptly used to finance incomegenerating expenditures. The combined operation of liquidating
securities and expanding loans will be inflationary on balance unless
the security sales reduce income-generating expenditures as much as
the loans increase them. This is possible, of course—the rise of
interest rates could induce contraction of expenditures and the use
of funds thus released to buy the securities being offered for sale by
the banks. To this extent, the active portion of the money supply
is not increased—it is reduced by the security sales and increased by
the lending—and the total amount of spending is little affected,
although its direction may be significantly changed. It does not seem
reasonable to expect such results, however. The deposits that are
extinguished by the security sales are likely to be largely idle deposits.
These deposits are then recreated through lending and promptly
inserted directly into the income stream. The net result of the opera
tion is to leave the money supply unchanged but to increase the frac
tion of the money supply that is being actively used at the expense
of the fraction that is being held idle, thus producing an increase in
the velocity of monetary circulation.55
Portfolio adjustments by nonbank financial institutions can have
similar effects to those discussed above.56 However, while these
institutions have been selling Government securities and shifting
funds into private loans and securities most of the time since World
War II, these shifts do not seem to have had a systematic cyclical
pattern.57 Commercial banks, on the other hand, have systematic
ally increased their holdings of Treasury securities during periods of
recession and low interest rates and liquidated them in order to shift
into loans during periods of tight money and rising interest rates.
This is clearly brought out in table IV-2, which shows that commercial
banks accumulated $9.7 billion of Government securities between
June 1953 and December 1954 when interest rates were low and credit
conditions relatively easy. Between December 1954 and September
1957 when credit conditions were tight and interest rates rising, they
reduced their holdings by $10.2 million.58 During the period when
55 For a further development of this argument, see my papers, “ On the Effectiveness of Monetary P olicy/’
American Economic Review, X LV I (September 1956), 588-606, and “ Monetary Policy and the Structure
of Markets,” in “ The Relationship of Prices to Economic Stability and Growth,” Compendium of Papers
Submitted by Panelists Appearing before the Joint Economic Committee (Washington: Government
Printing Office, 1958), pp. 493-511.
56 See my paper, “ On the Effectiveness of Monetary Policy,” op. cit.
w Although there are differences in the behavior of different types of institutions—such as savings and loan
associations and life insurance companies—the above statement seems to be true for all nonbank finance
institutions taken together. See my article, “ Financial Intermediaries and Monetary Controls,” op. cit.,
for an extensive discussion of this matter.
58 This amount differs from the $14 billion reduction in holdings of Government securities by the banking
system shown in table IV-1 for the same period for three reasons: (a) Table IV-1 covers commercial and
mutual savings banks, whereas the present discussion relates only to commercial banks; (6) the above
figures cover only the commercial banks included in the Treasury survey of ownership, which takes in
about 90 percent of total bank holdings; and (c) holdings are valued at book value in table IV-1, whereas
they are valued at face value in the present context.
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credit conditions became easier in connection with the 1957-58
recession—i.e., between September 1957 and June 1958—they built
up their holdings of Government securities by $6.7 billion. Since
June 1958 as credit conditions have tightened, they have liquidated
$4.0 billion of Government securities.
T a b le
IV -2. — Changes in commercial bank holdings of marketable Treasury
securities by maturity classification for specified periods
[Millions of dollars]
June 1953
to
December
1954
December
1954 to
December
1955
December
1955 to
December
1956
December December September
1954 to
1957 to
1956 to
September September June 1958
1957
1957
February
1958 to
June 1959
All maturities..
9,736
-7,121
-2,479
-613
-10,213
6,673
-3,985
Within 1 year___
1 to 5 years..........
5 to 10 years.........
Over 10 years___
-3,842
502
12,329
746
-8,005
3,157
-1,618
-655
3,902
2,525
-9,241
355
554
1,197
-1,663
-701
-3,549
6,879
-12,522
-1,021
1,242
-1,231
5,680
982
-3,386
6,810
-6,026
-1,383
N ote —D etails may not add to totals due to rounding.
Source: Federal Reserve Bulletin.
The above discussion brings out a very important point, namely,
that the existence of large quantities of liquid readily shiftable claims
introduces a considerable amount of “ play” into the financial system
and may greatly reduce the sensitivity of the economy to monetary
adjustments. This is because persons or institutions possessing such
liquid claims and desiring to sell them to finance their own current
expenditures or the expenditures of others through loans will ordi
narily have little difficulty in finding buyers for the claims among holders
of idle cash balances. Thus, it may be said that the existence of a
large stock of short-term liquid claims tends to result in a highly
elastic liquidity preference schedule. Or, to put it another way, they
lead to a situation in which credit tightening and rising interest rates
tend to induce substantial dishoarding of cash balances and a rise in
monetary velocity.
An effective debt management policy may be able to reduce the
amount of “ play” in the financial system by controlling the supply of
liquid assets, thus making the economy more responsive to changing
credit conditions and monetary policy. If there is a great quantity
of short-term securities in the hands of banks, financial institutions,
and other investors, it will be relatively easy to find buyers for these
securities and thereby obtain funds to finance direct spending and
lending activities. One reason for this is that the demand for cash
balances for transactions purposes appears to have a considerably
greater interest elasticity than we used to think. Nonfinancial cor
porations and State and local government units have become con
siderably more sophisticated in managing their cash positions in the
last few years, and when interest rates rise, they find it worthwhile
to make considerably more frequent purchases and sales of securities—
including Treasury bills, finance company paper, and repurchase
agreements with Government security dealers—in order to keep their
liquid balances invested to a maximum extent. Thus, banks, as well
as other spenders and lenders, will ordinarily find it possible to liqui
date Treasury bills or other short-term Government securities without
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having to accept much of a decline in price. In fact, with extremely
short-term securities they can realize funds at no loss at all in a rather
short time by simply turning them in for cash at maturity.
Investors holding longer term securities may have somewhat greater
difficulty in finding buyers for these securities when they want to
liquidate them and shift into loans. One reason is that these securities
are not likely to be attractive to holders of transactions balances,
because of the substantial degree of price risk involved in holding them.
Moreover, their prices normally fall substantially more than do the
prices of short-term securities when interest rates rise and, for this
reason, there may be somewhat greater reluctance to sell them due to
the capital losses involved.
Some writers in recent years have placed considerable emphasis on
this so-called locked-in effect as part of the mechanism by which
tightening credit makes itself felt. While there are some conceptual
difficulties concerning the locked-in effect,59 it does appear that in
certain situations it may be a significant factor. Suppose, for example,
that a bank holds a Government bond with 15 years to run to maturity
and a coupon rate of 3 percent. The yield on the bond to maturity is
currently 3.5 percent, and accordingly its market price is $94.20.
Suppose the bank expects interest rates to fall so that the yield on this
bond will be back at 3 percent by the end of a year. If the bank were
to sell this security and use the proceeds to make a loan to a customer,
it would have to charge an interest rate of more than 9 percent in
order to earn a return on the loan as large as the return to be expected
from holding the security for a year, taking account of the expected
price appreciation. This 9 percent rate includes no allowance for
default risk on the loan; accordingly the rate might have to be some
what higher than this to induce the shift. Thus, the locking-in effect
might be significant in the case of commercial banks, provided the
banks were faced with the prospect of liquidating longer term securities
in order to expand loans.60 Our previous discussion of bank portfolio
shifting suggests that banks have not in fact been locked in in the
last few years, but the reason may be that they have been well supplied
with short- and intermediate-term securities on which prospective
capital gains and losses are not large enough to be a major factor in
the banks' calculations.61 It may be noted that if rising interest rates
create the expectation of further rises—i.e., if interest rate expecta
See my article, “ On the Effectiveness of Monetary Policy,” op. cit., and Musgrave, op. cit., pp. 604-606.
•• M y previous criticism of the “ lacked in” effect, as well as that of Musgrave (both cited in footnote 51)
was concerned entirely with the case of a shift from a marketable Government security to a marketable
private security. In such cases, the locked-in effect is of very little significance, because the price of the
private security will ordinarily be expected to move in the same direction and to approximately the same
degree as that of the Government security. Thus, if there is a prospective capital gain to be hadfrom holding
onto the Government security, an approximatelyequal capital gain can be expected if the funds are shifted
to a private security. In the case discussed here, in which the shift is from a Government security to a
private loan (i.e., a nonmarketable security), there is no possibility of a capital gain from the loan, so any
prospect of a capital gain from holding onto the Government security must be compensated for by a higher
interest rate on the loan. This gives considerably more scope for a locked-in effect.
#< The data in table IV-2 suggest that banks have made many of the adjustments in their Government
security portfolios by buying and selling securities in the 5-to lO-ye-ir maturity range. However, this may
be partly spurious, since changes in the amount of securities in a particular maturity sector can occur due
to shifts of blocks of securities across the boundaries of that sector as a result of the passage of time, as well
as due to purchases and sales. In order to arrive at any clear conchisiDtis concerning bank portfolio practices
in this respect, it would be necessary to study the changing composition of portfolios in detail, paying atten
tion to specific Treasury issues. It would bs possible to do this, using data from the Treasury Survey of
Ownership,but the pressure of time makes it impossible in connection with the present study. The peculiar
Federal tax provisions applicable to commercial banks exert an influence over bank portfolio policies.
Capital losses are deductible from ordinary income, while capital gains are subject to the lower rates of the
capital gains tax. These provisions may encourage banks to make their portfolio adjustments through
transactions in intermediate and longer term securities. For a good discussion of these tax provisions,
see R. H. Parks, “ Income and Tax Aspects of Commercial Bank Portfolio Operations in Treasury Securi
ties,” National Tax Journal, X I (March 1958), 21-34.
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tions are elastic rather than inelastic as assumed in the above exam
ple—rising rates will strengthen rather than weaken an investor's
incentive to shift from Government securities into loans.62 However,
as suggested in connection with our earlier discussion of the interest
rate structure, there is considerable indirect evidence that inelastic
interest rate expectations predominate most of the time.
The above analysis suggests that debt management policy might
well be directed at keeping down the supply of highly shiftable liquid
assets in the economy in order to provide a financial framework within
which interest rate adjustments and monetary policy may work more
effectively to maintain economic stability. However, the implica
tions with respect to this view of debt management’s function are
somewhat different from those reflected in the orthodox theory of
stabilizing debt management policy. The time when excessive liquid
ity tends to build up, particularly in the banking system, is during
recession periods. Large buildups of short-term, highly liquid, and
readily shiftable Treasury securities in the hands of the banks does
little good in promoting recovery, and tends to create trouble during
the succeeding expansion by undermining the Federal Reserve’s abil
ity to bring the credit situation under effective control. A judicious
policy of long-term borrowing during recession periods may be able to
induce the banks to reach out for longer maturities instead of loading
up heavily with very short-term securities. Of course, if such a policy
should discourage the banks from expanding loans, it would be harm
ful. However, this does not seem likely; in fact, it may very well
have the opposite effect. If the Treasury increases the short-term
debt excessively during a recession, thus helping to keep short-term
interest rates from falling, the banks may be tempted to build up their
liquidity at the expense of their loans. On the other hand, if short
term borrowing is kept down and longer-term securities offered in
stead, the very low short-term rates may encourage the banks to press
loan expansion aggressively, since they prefer loans to long-term Gov
ernment securities. At the same time, if they can be induced to invest
in longer-term securities to the extent that the resources made avail
able to them by the decline in credit demand and by Federal Reserve
policy exceed the amount needed to satisfy such loan demand as there
is, the monetary authorities should be in a better position to exert
effective discipline during the ensuing expansion.
C O M B IN IN G IN T E R E S T C OST A N D
S T A B IL IZ A T IO N
EFFECTS
We have considered the way in which alternative debt management
policies are likely to affect the interest cost of the Treasury on the one
hand and the stability of the economy on the other. Let us now at
tempt to bring these two aspects of the problem together.
An orthodox view
Probably the nearest thing there is to a unified theory of debt man
agement along orthodox lines is that presented by Prof. Earl Rolph.63
Rolph treats debt management and open market operations as a unit,
making no concessions to the present institutional arrangements which
0* For example, in the above case, if the bank expected the yield on the Government security to continue
rising and reach 3.75 percent at the end of the year, the yield to be expected from holding the security for
a year would be only about 0.25 percent, and it would presumably be willing to make the loan at a very
low interest rate.
•* Rolph, “ Principles of Debt Management,” op. cit
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divide the responsibility between the Treasury and the Federal Re
serve. His fundamental argument is that the debt should be managed
in such a way as to minimize the interest cost of achieving a desired
level of private spending.
Chart IV-5
Rolph’s theory of debt management can be explained with the aid
of chart IV-5.64 In this chart, the C curves (of which three, OiOi,
C20 2, and CzCz, are shown) are isointerest cost curves. For simplicity
only two types of debt are allowed for—short-term debt, measured
along the vertical axis, and long-term debt, measured along the
horizontal axis. Each of the O curves represents the various combi
nations of long- and short-term debt that can be placed with investors
at a specified interest cost—for example, the Oi curve might represent
all the combinations that could be placed at a total interest cost of
$6 billion, C2 the combinations that could be placed at a cost of $7
billion, and Cz the combinations that could be placed at a cost of $8
billion. Since it is assumed that the short-term interest rate is
always below the long-term rate, the intercept of each G curve with
64This chart is adapted from fig. 3 in Rolph’s article, op. cit., p. 315.
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the vertical axis is further from the origin than is its intercept with
the horizontal axis.65 The curves are said to be concave to the origin
(as drawn in chart IV-5). This is due to the fact that when there
is, say, a great deal of long-term debt and only a little short-term debt
outstanding, the Treasury can issue more short-term debt in exchange
for long-term debt at very favorable terms, but the terms become
less ana less favorable as more and more short-term debt is issued
and more and more long-term debt is retired.
The G curves (of which two, G1 G1 and G2G2l are shown) in chart
IV-5 can be described as isoprivate-expenditure curves—that is,
each curve relates to a given level of private expenditures and takes
in all combinations of short-term and long-term debt which will
result in this level of private expenditures. For example, curves
G2G2 and G\G\ might correspond to levels of private expenditures of
$300 billion and $250 billion, respectively. In drawing these curves,
it is assumed that all other governmental measures affecting expendi
tures, such as the reserve requirements of the banks and the legisla
tion governing budgetary expenditures and taxes, are given. The
G curves are taken to be convex to the origin, as drawn in chart
IV-4. It should be noted particularly that the quantity of money
is not the same at all points on a particular expenditure curve. To
illustrate this point, suppose the authorities to issue long-term debt
and retire short-term debt in such a way as to stay on the same
expenditure curve. If they sell long-term debt and retire an equal
amount of short-term debt, the liquidity of the private sector will be
reduced and expenditures will be depressed, and in order to restore
the preexisting expenditure level, they will have to retire more short
term debt for cash.
The proper way to conduct debt management, according to Rolph/s
analysis, is as follows: First the authorities must select the desired
level of private expenditures—presumably the level consistent with
economic stability. Let us say they decide that $300 billion is the
proper level (i.e., they want to be on expenditure curve G2). Having
made this decision, they should issue the mix of short-term and long
term debt that would achieve this level of expenditures at minimum
interest cost. In order to do this, they should seek to attain the
position (point P in this case) at which the selected expenditure
curve is tangent to an isocost curve. They should, in this case,
issue OA of long-term debt and OA' of short-term debt, which will
put them on the cost curve OiOi, with an annual interest cost of $6
billion, the minimum consistent with $300 billion of private expendi
tures. If the objective chosen had been $250 billion of private
spending, the authorities should issue OB of long-term debt and OB'
of short-term debt, reaching the point Q on the curve CzCs, where
interest cost would be $8 billion a year, the minimum for that level
of spending.
This is an ingenious unified theory of debt management. Unfor
tunately, it has a number of shortcomings, some of them rather serious.
1.
The argument underlying the expenditure curves in Rolph’s
analysis rests upon direct liquidity effects. As indicated above, the
reasoning underlying direct liquidity effects is dubious, and even if
w That is, if all debt is short-term debt, more of it can be placed at a given interest cost than could be placed
at that cost if it were all long-term debt. It should be noted that the total amount of debt and the money
supply are not the same at different points on a given C curve-
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such effects are present, there is absolutely no empirical basis for
evaluating their importance. In fact there is little reason to think
that moderate changes in debt structure have much effect on private
expenditures.
2. If we accept the fundamentals of Rolph’s own argument, the
expenditure curves should be drawn concave to the origin rather
than convex.65* This does not, however, undermine his argument but
merely means that the optimum debt structure might consist entirely
of long-term or (less likely) short-term securities.
3. The analysis of interest costs is based upon a defective theory
of the interest rate structure. Rolph assumes that the short-term
rate is always below the long-term rate due to a preference for liquidity,
whereas historically this relation has not always (or even usually)
held.66
4. The theory elevates the minimization of interest cost to an
absurdly high level as a criterion of economic policy. The trouble
with this criterion is that the structure of private expenditures is
likely to be affected by changes in the composition of the publicly
held debt. Referring to chart IV-5, it might be, for example, that
the level of private spending would be $300 billion at every point on
expenditure curve G2G2. However, at point S, with a large short
term debt and a small long-term debt, it might be that inventory
investment would be considerably smaller and plant and equipment
expenditures much larger than would be the case at point P. If the
authorities felt that excessive inventory investment might lead to
instability, while plant and equipment expenditures would promote
a rapid rate of growth, they might quite properly be willing to pay
something in excess of the minimum interest cost (attainable at point
P) in order to achieve a superior pattern of expenditures.67 It is true
that we know very little about how changes in debt structure affect
the pattern of expenditures, but neither do we know how they affect
the level; indeed, it is difficult to see how we could know much about
the one without the other, in which case there would be no basis for
assuming indifference.68
5. In our present state of knowledge, the theory is completely nonoperational. Of course, even a nonoperational theory may be of some
value in providing policymakers with a framework within which to
formulate their decisions. However, the defects in Rolph’s theory
are sufficiently serious to render it of little value even for this purpose.
An alternative approach
Before attempting to develop some general principles that might
provide guides for debt management policy, it is well to take note of
several points. First, in the present state of our knowledge, it is
65a This error in Rolph’s analysis has been pointed out by two writers. See Musgrave, op. cit., pp. 602-603,
and R. M. Friedman, “ Principles of Debt Management: Comment,” American Economic Review, X L IX
(June 1959). 401-403. See also E. R. Rolph, “ Principles of Debt Management: Reply,” American Eco
nomic Review, X L IX (June 1959), 404-405, in which Rolph admits the correctness of Friedman’s criticism.
69 Rolph ad nits this himself with reference to the period before 1914 ( 4Principles of Debt Management,”
op. cit., p. 311, footnote 18). In fact, however, the long-term rate was above the short-term rate rather
frequently after 1914 up to 1930, and indications of this relation have reappeared recently, as noted earlier.
97 If the economy, including the capital markets, were perfectly competitive, it could be argued that mini
mizing interest costs would lead to a welfare-maximi ing allocation of investment. This is pointed out by
Musgrave, op. cit., p. 589. However, the presence of market imperfections renders this argument inopera
tive.
•3 It may be noted that if interest cost minimization is the appropriate criterion for debt management, it
should be applicable to other aspects of stabilization policy. Thus, if the monetary authority has the power
to raise reserve requirements, it could raise the requirements and offset the deflationary effects of this action
by purchasing debt and in this way reduce the Treasury’s interest cost. This could be continued until
reserve requirements had been raised to 100 percent; thus, Rolph’s scheme is an argument for the 100-percent
reserve plan.
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simply not possible to lay down precise rules to govern debt manage
ment. We simply do not know enough about the effects of alterna
tive debt management policies to be very specific. Second, we should
probably not take the possible stabilizing or destabilizing potentialities
of debt management too seriously. All of the effects of debt manage
ment are of the second order of importance—any debt management
operation makes some people more liquid than they were and others
less liquid, and it lowers some interest rates while raising others. In
view of the fact that there is considerable doubt about the potency of
the effects of changes in the levels of interest rates and of liquidity
on private expenditures, it is not surprising that the effects of changes
in the structure of interest rates and of liquidity are even harder to
discern. The effect of any debt management operation is the result
ant of two effects, one in one direction and one in the other. Both
are probably rather weak, their difference rather small, and commonly
we cannot even be sure of the direction of the net effect.
Even though the immediate effects of current debt operations may
not be a matter of critical importance, for the reasons just mentioned,
the composition of the existing debt stock may make some difference
to the stability of the economy and the effectiveness of monetary
policy, particularly in dealing with inflationary situations. If there
is an excessive stock of short-term, liquid, highly shiftable claims in
existence at the time when inflationary forces begin to develop, the
task of the monetary authorities may be greatly complicated.
These considerations suggest a vigorous policy of lengthening debt
maturities. By reducing the available supply of short-term, highly
shiftable, liquid claims, lengthening of debt maturities tends to tighten
up the financial system, making the economy more responsive to mone
tary controls. While a certain amount of “ slippage” in our monetary
controls is desirable, it seems pretty clear that at the present time the
amount of slippage is so great as to interfere with effective monetary
policy. Moreover, there is something to be said on several counts
for a policy of concentrating, to a certain extent, on debt lengthening
during recessions and relaxing the policy somewhat during boom
periods. The following specific points may be noted in this con
nection.
1. From the standpoint of keeping down the interest cost to the
Treasury, as pointed out earlier, it is desirable to borrow at long term
during recession periods when interest rates are low, in order to get
the maximum advantage of the low rates. An orthodox policy of
lengthening the debt during boom periods and shortening it during
recessions, to the extent that it is successful, probably tends to maxi
mize Treasury interest costs. While interest costs are certainly not
an overriding consideration, as indicated in chapter I, there is cer
tainly something to be said, from the standpoint of prudent financial
management, for keeping them low unless some important objective
is achieved by increasing them.
2. If the Treasury sells longer term securities during recessions
while, if possible, reducing the short-term debt, there will be some
advantages from the standpoint of economic stability.69 The reduc
tion in the supply of short-term securities will accentuate the tendency
for short-term rates to fall. This will make such securities less at
69 There is a problem connected with the financing of cash deficits which will occur during recessions, as
suming that a stabilizing fiscal policy is followed. This is discussed in the next section.
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tractive to the banks, thus increasing their incentive to follow an
aggressive loan policy, which, of course, is precisely what is needed
from the standpoint of promoting recovery. At the same time, the
sale of intermediate and longer term securities will tend to keep rates
up in these sectors and attract banks to invest in these securities to
the extent that they cannot find outlets for their funds in loans. Since
these securities will probably be somewhat less easily shiftable during
the ensuing recovery period, the banks will find it somewhat more
difficult to elude the effects of restrictive monetary policy than would
have been the case had they become loaded down with very short-term
securities during the recession. Thus, monetary controls will prob
ably take hold somewhat more quickly and smoothly than would
otherwise have been the case.
3. During periods of expansion as economic activity quickened and
the level of interest rates rose as a result of an increasingly restrictive
Federal Reserve policy, the Treasury would gradually diminish its
efforts to sell long-term securities, shifting more and more to the short
term market. This would probably also have some beneficial effects
from a stabilization point of view. To the extent that the banking
system had accumulated short-term securities during the preceding
recession—which would certainly occur to some extent—the rise in
short-term rates would discourage their sale, or at least lead the banks
to mark up loan rates more rapidly. This might serve to make
monetary controls take hold more effectively, particularly in the
short-term sectors. It might have some tendency to discourage an
excessively rapid buildup of inventories, thus weakening the effect
of the destabilizing inventory accelerator, although too much should
not be expected here. However, these forces would probably strength
en the availability effects of monetary policy, which have been so
much stressed in the last few years.70
4. Perhaps the greatest advantage of this policy would be that it
would tend to minimize the extent to which the Treasury’s debt
management problems would interfere with the freedom of the
Federal Reserve during periods of inflation. A well-managed program
of extending maturities during recession periods would reduce the
frequency with which the Treasury had to come to the market. More
important, however, during tight credit periods, the Treasury would
shift to the short-term market, where it would be out of the Federal
Reserve’s way. Short-term borrowing causes few difficulties for the
Federal Reserve, whereas long-term borrowing at inopportune times
during inflationary periods has frequently forced the Federal Reserve
to ease up on policies of monetary restriction.
5. This kind of debt policy would probably accentuate the cyclical
swings in Treasury interest payments and particularly cause them to
rise very rapidly during periods of expansion, since short-term rates
would be forced up sharply, and short-term debt rolls over rapidly
tending to make rising interest costs snowball. This effect would be
destabilizing, since rising interest payments, being a species of transfer
payment, have an income effect. Thus, rising interest payments
would have an inflationary effect unless offset by a somewhat tighter
monetary or fiscal policy than would otherwise have been followed.
However, this effect is not likely to be important, since, as pointed
70 On the availability doctrine, seeH. S. Ellis, “ The Rediscovery of Money,” and R. V. Roosa, “ Interest
Rates and the Central Bank,” both in “ Money, Trade, and Economic Growth: In Honor of John Henry
Williams,” op. cit., pp. 253-269 and 270-295, respectively.
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out in an earlier chapter, the multiplier applicable to Treasury interest
payments is probably rather small.71
6. In an economy as buoyant as the American economy has been
in recent years and with an active full-employment policy, recessions
are likely to be shorter in duration than booms. For this reason, it
may be difficult to sell enough long-term securities during recessions
to prevent the debt from shortening gradually. Accordingly, in order
to prevent the slow accumulation of an undue amount of liquid short
term debt, it would be desirable to make some—albeit diminishing—
effort to sell long-term securities during periods of expansion, especially
if such offerings can be handled and timed in such a way as not to
interfere with the Federal Reserve’s freedom to control credit. Some
possible changes in debt management techniques which might facili
tate such operations—as well as have other advantages—are discussed
in a later chapter.72
7. Finally, but very important, a bold policy of the kind here
advocated would require as an accompaniment a flexible policy on
the part of the Federal Reserve. For example, the debt managers
might overshoot the mark in their attempts to raise long-term funds
during a recession, with the result that recovery would be impeded
unless some compensating action were taken. If such a situation
should arise, the Federal Reserve should be able to perceive it and
should be prepared to act promptly and effectively to offset it by
putting funds directly into the long-term market through open
market purchases of long-term securities. Thus it would be desirable
to abandon the present “ bills only” policy and be prepared to deal
in all sectors of the market if necessary. The feasibility of such a
change is examined at some length in the next chapter.
In conclusion, a word of caution is in order. The importance of
debt management as a means of keeping down the supply of liquid
assets should not be exaggerated. The shiftabilit}^ effects of debt
management policy, like the interest rate effects and direct liquidity
effects, are of the second order of importance. Short-term Govern
ment securities are more liquid than longer term securities, but the
latter also possess a considerable degree of liquidity. Funds can be
activated by means of transactions in intermediate- or long-term
securities, as well as by means of transactions in short-term securities.
A policy of lengthening debt maturities may help to tighten up our
system of monetary controls, but it is no panacea and too much should
not be expected from it.
THE
H A N D L IN G
OF B U D G E T D E F IC IT S A N D
SU R P L U S E S
A budget deficit has an inflationary (or antideflationary) income
effect on the economy, whether it is produced by an increase in
expenditures or a reduction in taxes. Similarly, a budget surplus
has a deflationary (or anti-inflationary) income effect.73 On the other
hand, borrowing to finance a deficit has a deflationary (or antiinflationary) effect, while the use of a surplus to retire debt has an
inflationary (or antideflationary) effect. The inflationar}- effect of
w See ch. I.
72 See ch. VI.
73 The income effects are reinforced by asset effects, since a deficit will increase the nominal value of the net
claims held by the public, while a surplus will decrease net claims. These effects on the size of the stock of
net claims are independent of the way in which the deficit is financed or the use to which the surplus funds
are put; however, it is doubtful whether they are of much importance.
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a budget deficit is almost certain to be more important than the
deflationary effect of an equal amount of borrowing, so that the net
effect of a deficit financed by borrowing is inflationary. Similarly,
the net effect of a surplus and an equal amount of debt retirement is,
under most circumstances, strongly deflationary. Nevertheless, it is
desirable to distinguish between the effects of deficits and surpluses,
on the one hand, and borrowing and debt retirement, on the other.
This distinction is not always made. For example, emphasis is fre
quently placed on the desirability of paying off some of the debt
out of budget surpluses in good times as part of an anti-inflationary
program.74
The deflationary effects of borrowing to finance a deficit during a
recession do not ordinarily cause serious problems, because the
Federal Reserve can easily offset these effects by means of appropri
ately easier monetary policy. However, the effects of debt retire
ment dining inflationary periods cannot be so easily dismissed. The
reason is that the Treasury is likely to be absorbing securities through
debt retirement at the very time when commercial banks and other
investors, who are hard pressed as a result of a restrictive Federal
Reserve policy, are trying to sell such securities in order to finance
private spending. Thus, the debt retirement may complicate the
problems of the Federal Reserve considerably—or, to put it another
way, the Federal Reserve’s job would be considerably easier if the
Treasury were not retiring so much debt.
T a b le
IV -3.— Changes in holdings of Government securities by various investor
groups, Dec. 81, 1955, to June 30, 1957
[Billions of dollars]
Change,
Holdings,
Holdings,
Dec. 31,1955,
to
Dec. 31,1955 June 31,1957
June 31,1957
Total debt held outside Government agencies and trust
funds________________________ _____ _______ _______
229.1
215.1
-1 4.0
Federal Reserve__________________________________________
Commercial banks_______________________________________
Mutual savings banks____________________________________
Insurance companies_____________________________________
Other corporations_______________________________________
State and local governments_______________________________
Individuals______________________________________________
Miscellaneous investors 1__________________________________
24.8
62.0
8.5
14.3
23.5
15.1
65.3
15.6
23.0
55.8
7.9
12.3
16.1
16.9
67.1
16.0
—1.8
-6 .2
-.6
-2 .0
-7 .4
1.8
1.8
.4
i Includes savings and loan associations, dealers and brokers, foreign accounts, corporate pension funds,
and nonprofit institutions.
Source: Federal Reserve Bulletin.
This problem is dramatically illustrated during the period from
December 1955 to June 1957. During this period, the Federal
Reserve was applying an increasingly restrictive monetary policy for
the purpose of keeping down inflationary pressures. As shown in
table IV-4, substantial amounts of Government securities were
liquidated by commercial banks ($6.2 billion), nonfinancial corpora
tions ($7.4 billion), insurance companies ($2 billion), and mutual
savings banks ($0.6 billion). These investor groups sold governments
m In this vein, the Cabinet Committee on Price Stability for Economic Growth said in a recent report,
“ Not only is it imperative that the budget be balanced in the fiscal year starting next month, but it is im
portant that the national debt be reduced” (New York Times, June 29, 1959, p. 16).
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either to finance their own spending—as in the case of nonfinancial
corporations—or to increase their loans to finance the spending of
others, and there can be little doubt that the liquidations blunted the
effects of the Federal Reserve's restrictive policy. The Federal
Reserve itself sold $1.8 billion of Government securities in the process
of implementing its restrictive policy. Part of the $18 billion of
Government securities sold by all of these groups combined was
absorbed by other classes of investors who increased their holdings.
Net purchases were made by State and local governments ($1.8
billion), individuals ($1.8 billion), and miscellaneous investors ($0.4
billion). However, these absorptions totaled only $4 billion. The
remaining $14 billion was absorbed by the Treasury itself through
outright debt retirement or purchase by Government agencies and
trust funds. Thus, while the Treasury's cash surplus of $13.6 billion
during this period undoubtedly was an important anti-inflationary
influence, the use of this surplus to carry out a large program of debt
retirement unquestionably reduced the effectiveness of restrictive
monetary policy.
Actually, in order to get the maximum anti-inflationary mileage
out of a budget surplus, the Treasury should impound the funds in the
form of deposits in the banks rather than retire debt. These accumu
lated deposits could then be used to finance deficits and/or retire debt
during recession periods, since debt retirement is appropriate in
recessions and inappropriate in times of inflation. If cash balances
are built up by the Treasury, the effect is most deflationary if the
funds are held in the Treasury's accounts at Federal Reserve banks,
since this reduces bank reserves and, unless offset by Federal Reserve
action or accidental factors, forces the banks to carry through a
secondary contraction of loans and investments and the money
supply. Holding the budget surplus in the form of deposits in the
commercial banks reduces the publicly held money supply but does
not force the banks into a secondary contraction of credit. In lieu
of holding the funds in the form of increased balances in the Federal
Reserve banks, the Treasury could use them to retire Federal-Reserveheld debt, but since the Federal Reserve returns most of its interest
earnings to the Treasury at the end of each year, such debt retirement
is mostly fictitious.
When the Treasury has a budget surplus, considerations of prudent
financial management make it appear desirable to retire debt in order
to reduce interest costs. However, the considerations referred to
above suggest that if an arrangement could be negotiated with the
commercial banks to pay interest on Treasury deposits which exceed
some specified levels and are left in the banks for some specified mini
mum period of time, so that the Treasury would be partially com
pensated for forgoing the saving of interest to be obtained from
retiring debt, it might be desirable at times to let surpluses build up
in the form of deposits in commercial banks in prosperous periods
and then draw them down to finance deficits in recession periods.
Perhaps the surplus funds could be shifted to time deposit accounts.
It might not be desirable to impound the full amount of a budget
surplus in this way, but an arrangement such as this would consider
ably increase the Treasury's financial flexibility and might at times
make a useful contribution to effective stabilization policy.
116
DEBT
M ANAGEMENT
IN
THE
U N IT E D
A p p en d ix t o C h a p te r
STATES
IV
The discussion of the interest rate effects of debt management operations in the
text is based on the following simple model:
E = E 8-\~E i
S 8= S 8(r8) + G8
Si=Si(ri) + Gi
S8= E 8
Si—Ei
Here E — total expenditures, E s= expenditures affected by the short-term interest
rate, E i—expenditures affected by the long-term interest rate, $ «= th e total sup
ply of short-term funds, 6rs= th e exogenous portion of the supply of short-term
funds, Si—the total supply of long-term funds, (rj=the exogenous portion of the
supply of long-term funds, r8= th e short-term interest rate, and r*=the long-term
interest rate. The supplies of funds in both markets include saving and dis
hoarding of existing cash balances. The two markets are assumed to be entirely
independent. The model takes account only of direct effects; no income effects
via the multiplier are allowed for.
We wish to consider the effects of a shift of funds from one market to another—
say, from the long-term to the short-term market. Thus, we consider the effects
of an increase in Gs, together with an equal and simultaneous reduction in Gi.
The model can be simplified to the following:
Differentiating with respect to Ga, we obtain
dE
dFI- dr-dTVi dri
(i)
w r
dJEJ8 dr8
dr8 dG8
(2)
dSi dri j d G i _dEi dri
(3)
dS$ drg _i I
dra dG8
177
cl * dG8
ria 7/^
dn a
dGs
dri7 dGs
Since the increase in Gs is assumed to be matched by an equal decrease in Gi, we
Making use of this, we can solve equation (3) for
dn
8
as follows:
d ri ______1
dG8 dSi dEi
dri dri
Similarly, we can solve equation (2) for
dr8
dGs
Substituting these last two results for
dr
as follows:
______1
#
dS8 dEs
dr8 drs
dr
dri
and -jpt
equation (1), we have
DEBT MANAGEM ENT IN TH E UNITED STATES
117
W e shall assume that
fk o ,
drt
^ > 0 , and f - ’ > 0
’ drs
’ dri
dr8
If the shift of funds from the long- to the short-term market is to have a restrictive
effect, we must have
^<0
dO, ^ U’
which will be the case if
dEi
dEs
____ dr8
dri
dSi dEi dS8_dE,
dri dri
drs dr8
dEi
dri
^
dSi_dEi
dri dri
dEs
dr8
dS8__dEs
dr8 drg
or
dEi dSs_dEi dEs A E s dSi
dri drs dri drs dr8 dri
dEs dEi
dr8 dri
or
dEi dS8 A E SdSi
dri drs dr8 dri
or
dEi dEs
dri . dr8
dSi dS8
dr
dr8
If we interpret the supplies in the two markets to mean the total supplies including
the exogenous portions, this expression can be converted to elasticity form, as
follows:
r,Et r,Ea
VSi
yS8
rjEi= elasticity of expenditures with respect to the long-term interest rate, rjEs —
elasticity of expenditures with respect to the short-term interest rate, rjSi=
elasticity of supply of long-term funds, and rjS8—elasticity of supply of short-term
funds. If we change the signs of tjez and r}Er, both of which are negative, we must
reverse the inequality, thus
rjEi^ rjEs
vSi
t)S8
where yEi and rjE8 are the numerical values of the elasticities of the two expendi
ture schedules. If this inequality is satisfied, a shift of funds from the long- to
the short-term market will reduce the level of total expenditures.
C H A P T E R
V
FEDERAL RESERVE OPEN M ARKET OPERATIONS
Under the definition adopted in this study, debt management in
cludes all operations which affect the composition of the publicly held
debt. Accordingly, it takes in some aspects of Federal Reserve oper
ations; in particular, decisions concerning the maturity sectors in
which the system shall conduct its operations fall within the scope of
our study.
In the spring of 1953, the Federal Open Market Committee adopted
a new code of rules governing the conduct of open market operations.
The rules adopted followed the recommendations of an ad hoc sub
committee of the Federal Open Market Committee, which made an
extensive study of the Government securities market in 1952.1 The
rules were as follows:
1. Open market operations were to be confined, under normal cir
cumstances, to the short end of the market—i.e., to Treasury bills or
equivalent short-term securities.
2. System intervention for the purpose of influencing the behavior
of the Government securities market—as distinct from actions de
signed to implement monetary policy—was to be confined to the cor
rection of “ disorderly situations” in the market. In effectuating this
aspect of open market policy, transactions in whatever maturit}^ sector
seemed most appropriate were to be permissible.
3. The System was to discontinue the practice prevalent up to that
time of providing direct support to the market during periods of
Treasury financing through purchases of maturing issues, new issues
being offered, or other comparable issues.
These rules have been adhered to with little deviation since their
adoption,2 but the “ bills-only” policy, as it has come to be called, has
excited a good deal of controversy both within the Federal Reserve
System and outside.3
1 The full text of the report of the ad hoc subcommittee is included in “ U.S. Monetary Policy: Recent
Thinking and Experience,” hearings before the Subcommittee on Economic Stabilization of the Joint Com
mittee on the Economic Report (Washington: Government Printing Office, 1954), pp. 257-307. This docu
ment will be referred to hereafter as the “ Flanders Hearings.”
2 The Federal Open Market Committee has deviated from the 1953 rules on only one occasion. In late
November 1955, the Committee authorized the manager of the System account to purchase, on a whenissued basis, up to $400 million of 2% percent certificates dated Dec. 1, 1955, and maturing Dec. 1, 1956.
Actual purchases under this authorization amounted to $167 million. This exception was authorized in
response to an appeal from the Secretary of the Treasury for assistance in preventing undue cash redemp
tions in connection with a large refimding operation. (See Board of Governors of the Federal Reserve
System, Annual Report, 1955, pp. 8,109-110.) In July 1958 the Committee authorized for the first time
action under the second clause of the 1953 rules to “ correct a disorderly situation in the market.” This action
was an aftermath of the disruption of the market related to the speculative activity in the 2% percent bonds
issued in June 1958 (see ch. III). In connection with a Treasury refunding operation, the System pur
chased $1.1 billion of 1% percent certificates dated Aug. 1,1958, and maturing Aug. 1,1959. In addition, it
purchased $0.1 billion of “rights” and a small amount of other securities, exclusive of Treasury bills. By
early August, it had offset the effects of t.hece transactions on member bank reserve* by means of sales of
Treasury bills. (See Board of Governors of the Federal Reserve System, Annual Report, 1958, pp. 7-8,
31,53-55*; also “ Treasury-Federal Reserve Study of the Government Securities Market,” pt. II (preliminary
mimeographed edition, 1959), pp. 93-98.)
3 The controversy within the Federal Reserve System has erupted into public view on several occasions.
See the reply submitted by Chairman Martin to the questions submitted by the Subcommittee on Eco
nomic Stabilization (especially pp. 15-26), the comments of Allan Sproul, then President of the Federal
Reserve Bank of New York (pp. 223-227), and the comments of the Federal Reserve Bank of New York on
the ad hoc subcommittee report (pp. 307-331) in the Flanders hearings. See also the Record of Policy
Actions of the Federal Open Market Committee for the year 1953 in Board of Governors of the Federal
Reserve System, Annual Report, 1953, pp. 86-105.
118
DEBT MANAGEM ENT IN TH E UNITED STATES
110
Whatever the objectives of debt management policy may be, the
question necessarily arises as to how the responsibility in this field
shall be divided between the Treasury and the Federal Reserve. In
principle at least, the Federal Reserve can do anything that the Treas
ury can do. There may be practical limitations arising from “ lack
of appropriate ammunition” on the part of the Federal Reserve—i.e.,
the System may not have in its possession at any particular tune secu
rities of the maturities needed to conduct the desired type of opera
tions. However, there are various ways in which this limitation
might be circumvented, such as an arrangement under which the
System could exchange securities with the Treasuiy at any time in
order to obtain the maturities it needed.4
It was suggested in the last chapter that marginal changes in the
composition of the publicly held debt are best regarded as a species
of selective credit controls which affect the interest rate structure.
To the extent that such marginal changes in debt composition and in
the interest rate structure are to be used to achieve the objectives
of economic policy, there is much to be said for assigning the responsi
bility to the Federal Reserve rather than the Treasury. The System
has important advantages over the Treasury as an agent for carrying
out carefully timed marginal adjustments in debt composition. For
one thing, the Treasury, being responsible for paying the Nation's
bills, is necessarily concerned, as a practical matter, with raising money
above all else. The Federal Reserve is free from this particular re
sponsibility and can concentrate wholeheartedly on the economic
effects of its operations. Moreover, the Treasury's flexibility is
bound to be inhibited to a considerable extent by the fact that its
outstanding debt matures in large chunks at predetermined times.
While, in principle, the timing and magnitude of borrowing operations
need not be narrowly determined by the time pattern of maturing
debt and the need to raise new money, in practice these considerations
are bound to be the major determining factors. Within reasonable
limits, on the other hand, the Federal Reserve can adjust the timing
and magnitude of its operations to the requirements of economic
stability and growth—in fact, this administrative flexibility is
commonly cited as the great strength of Federal Reserve monetary
policy.
This suggests a rough division of labor with respect to debt manage
ment, under which the Treasury would concern itself with achieving
and maintaining a debt structure which would minimize the economy's
resistance to destabilizing external disturbances, with due regard for
keeping down the interest cost of the debt, as outlined in the last
chapter. The Federal Reserve would take responsibility for such
carefully timed marginal changes in the debt structure as might be
desirable for the purpose of regulating the interest rate structure in
the interest of economic growth and stability.
Under the bills-only policy, the Federal Reserve has allowed the
interest rate structure to be determined by market forces, as condi
* It is interesting to note that the System has shortened the maturities of the securities in its portfolio
considerably in the la^t decade. On Dec. 31, 1948, the System’s total holdings of Government securities
amounted to $23.3 billion. Of this amount $12.4 billion were due to mature within 1 year, $3.3 billion in
1 to 5 years4 $0. billion in 5 to 10 years, and $7.2 billion in more than 10 years. On Dec. 31,1958, total hold
ings amounted to $26.3 billion, of which $21.0 billion were scheduled to mature within 1 year. $3.9 billion in
1 to 5 years, $0.2 billion in 5 to 10 years, and $1.3 billion in more than 10 years. By permitting its portfolio
to shorten in this way the System has deliberately allowed its ability to intervene in various sectors of the
market to become greatly weakened.
50438— 60----9
120
DEBT MANAGEM ENT IN TH E UNITED STATES
tioned by the impact of Treasury debt management operations. It
is appropriate for us to consider at this point the reasons underlying
the adoption of the bills-only policy, the extent to which it has been
successful in achieving its avowed objectives, and the desirability of
this policy in comparison with an alternative policy under which the
Federal Reserve would take some responsibility for regulating the in
terest rate structure.
AN EVALUATION OP THE BILLS-ONLY POLICY
There appear to be several reasons for the adoption of the bills-only
policy by the Federal Reserve System. Some of these reasons are
matters of economic philosophy, others relate to the technical opera
tion of the Government securities market, and still others are con
nected with the administrative procedures of the System.
Neutrality and minimum intervention
It seems quite clear that the preference of the Board of Governors
and the Federal Open Market Committee for the bills-only policy is
a manifestation of the preference for primary reliance on “ free markets” that has been so frequently expounded by Chairman Martin.5
According to this view, the System should confine itself to controlling
the total supply of money and bank credit and leave the allocation of
credit to the operation of the “ free market.” This means that all
forms of selective controls should be sedulously avoided, and policy
should seek in every way possible to stay “ neutral” as far as the allo
cation of credit is concerned. Since the structure of interest rates is
related primarily to the allocation of credit, the market should be
permitted to determine the structure.6
From a strictly theoretical standpoint, the ideal way to implement
a monetary policy that was completely neutral as far as the interest
rate structure is concerned would be to rely upon changes in reserve
requirements as a credit control weapon. However, System officials
are convinced that variable reserve requirements are a clumsy and
ineffectual means of conducting the day-to-day adjustments required
to adapt monetary policy to constantly changing circumstances.7
The superior administrative flexibility of open market operations
means that they are necessarily the principal weapon of monetary
•In explaining the changes in open market techniques that were made in 1953, the Board of Governors
referred to these measures as steps toward “ freer, more self-reliant financial markets.” It observed that in
such markets, “ the Federal Reserve would seek to have the impact of its actions as broad, general, and
impersonal as possible. It would neither establish prices of particular securities or classes of securities
directly, nor set up or maintain particular relationships in rate levels as between different sectors of the
credit market, such as might impair the efficiency of the market in performing its allocative function.”
Board of Governors of the Federal Reserve System, Annual Report, 1953, pp. 6-7.
• The proponents of neutrality and minimum intervention on the part of the Federal Reserve System
are sometimes guilty of an inconsistency. Such persons often argue that Treasury debt management
operations should be conducted with a view to their effects on the stability of the economy. This obvi
ously means that the Treasury should vary its debt offerings as between different maturity sectors of the
market in such a way as to contribute to stability. Thus, debt policy would interfere with the forces of
the free market in the determination of the interest rate structure. It is quite clear that if intervention of
this kind is an improper activity for the Federal Reserve, it is equally improper for the Treasury. In fact,
it would appear that the only approach to Treasury debt management which would be consistent witn
minimum intervention would be one of minimizing interest costs without regard to the effects on the
economy.
i Re-erve requirements have not been increased since 1951 and since that time have been reduced several
times—in the recessions of 1953-54 and 1957-58. It is apparent that the System has given up on reserve
requirements as a cyclical weapon—at least under normal circumstances—and it is in the process of adjust
ing them to the level it feels is proper from a secular standpoint. While some economists feel that there is
no fundamental reason why reserve requirement changes cannot be used to a greater extent, the present
writer is inclined to agree with the apparent System view that they are inherently clumsy and ill-suited
to the making of frequent small changes in credit conditions. The secular downward adjustment of reserve
requirements in preference to open market purchases of securities as a means of providing reserves to support
economic growth does, however, have some debt management implications which are discussed in ch. VI.
DEBT MANAGEMENT IN TH E UNITED STATES
121
control. And it can be argued that a policy of dealing only in the
shortest term securities is the closest practicable approach to a neutral
open market policy, since under such a policy the System is controlling
member bank reserves and thereby the aggregate supply of money
and credit by dealing in the type of debt that is “ nearest to money.” 8
What one thinks of this “ neutrality” or “ minimum intervention”
argument depends partly upon one’s economic (and perhaps political)
philosophy.® However, when proponents of this view go on to claim,
as they often do, that the objectives of economic stability and growth
can be achieved just as effectively by means of a policy which aims to
control only the total suppty of money and credit as by a policy which
is more flexible and attempts to influence the interest rate structure
and the allocation of credit, the question becomes debatable on
economic grounds. As a result of institutional factors and market
imperfections, the incidence of general monetary controls which
change the total supply of money and bank credit is uneven, some
sectors of the economy being affected strongly and others being left
almost untouched.10 Thus, the distinction between “ general” and
“ selective” credit controls is largely an illusion, since so-called general
controls have selective effects. Moreover, recent analysis of the
structure of the economy suggests that, at least in dealing with infla
tion, policies need to be selective in an intelligent way. When the
inflation is concentrated in certain sectors of the economy, policies
which strike other parts of the economy where prices are rigid in a
downward direction due to the existence of market power may create
unemployment in those sectors but do little to check the rise in prices.11
This suggests that if intelligent selectivity can be achieved by manip
ulating the structure of interest rates, such manipulation is a perfectly
proper activity for the central bank to engage in, just as it suggests in
general that selective controls are a proper—indeed essential and
unavoidable—ingredient of effective stabilization policy. It may be
noted that the System’s emphasis on neutrality is quite out of tune
with the attitudes that prevail among central bankers in many foreign
countries, where there has been a notable development of selective
control devices in recent years.12
Strengthening the Government securities market
In recommending that the Federal Reserve System confine its open
market operations to short-term securities, the ad hoc subcommittee
s As a matter of fact, though, it is hard to see why the neutrality argument could not be used to justify a
policy of “ bonds only” about as well as one of bills only. That is, it is the “ only” rather than the “ bills”
that makes the policy more or less neutral. If one wants to split hairs, a fully neutral open market policy
would call for dealings in all maturities according to some complicated formula which would be neutral in
its effects on the interest rate structure.
9 It should also be noted that “ minimum intervention” as the term is sometimes used to characterize the
bills-only policy clearly does not mean minimum volume of Federal Reserve operations. There can be no
doubt that at times the Federal Reserve could accomplish its objectives with a smaller volume of open
market purchases or sales if it were prepared to deal in the maturity most appropriate to the particular
situation. This has been pointed out by Allan Sproul (Flanders hearings, pp. 226-227). Thus, minimum
intervention means something considerably broader and less specific; namely, minimum interference with
the working of market forces.
10 See “ Staff Report on Employment, Growth, and Price Levels,” prepared for consideration by the
Joint Economic Committee, 86th Cong., 1st sess. (Washington: Government Printing Office, 1959), pp.
362-394.
» See Charles L. Schulte, “ Recent Inflation in the United States,” Study Paper No. 1.
I2 An alternative view of central banking which appears to typify the attitudes prevalent in many other
countries has been expressed by the British monetary expert, R. S. Sayers, in the following words: “ The
business of a central bank is to influence the behavior of the country’s financial institutions in the interest
of the broad economic policy of the government. The most appropriate way for it to function depends
upon the nature of the financial institutions it is called upon to influence, and the economic policy whose
furtherance is its ultimate purpose * * *. The central bank should be quick to adapt itself to changes in
the economy, and should be ready to use any device it can find to control the behavior of the financial
system in the interest of the ‘ employment policy’ adopted by the government.” Sayers, “ Central Bank
ing after Bagehot” (Oxford: Clarendon Press, 1957), pp. 47, 33.
122
DEBT M ANAGEM ENT IN TH E UNITED
STATES
based its recommendation on the desirability of developing a stronger
Government securities market—a market characterized, to use the
subcommittee’s phrase, by “ depth, breadth, and resiliency.” 13 The
subcommittee contended that dealers would not be prepared to take
positions and make markets in longer-term Treasury securities as long
as a serious possibility existed that the Federal Reserve would conduct
open market operations in these maturities for the purpose of effectuat
ing monetary policy. Dealers were said to feel incapable of predicting
what actions the System might take, and the risk of price variation in
longer term securities is so great that they might suffer severe losses if
the Federal Reserve should unexpectedly decide to sell from its port
folio at a time when dealers were holding substantial positions in long
term bonds. Thus, as long as the possibility of open market opera
tions in long-term securities existed, there was a strong likelihood that
dealers would cease taking positions in such securities, thus becoming
merely brokers rather than true dealers.
In the short-term market, the heavier volume of trading and the
inherently greater stability of prices would make it possible for the
dealers to continue to make markets and take positions despite the
existence of open-market trading by the Federal Reserve. Openmarket operations in the short-term market would transmit their
effects to the long-term market anyhow through the process of market
arbitrage which links the various sectors of the market together.
The dealers would be able to take positions and make markets in
longer-term securities in the face of these indirect effects, because
these effects are produced by the actions of private traders seeking
(presumably) to maximize returns, and dealers in Government securi
ties are highly expert at understanding and even anticipating the
actions of such traders. Thus, a policy of bills only would increase
dealer participation and thereby strengthen the market.14
The question that naturally arises, in light of the subcommittee’s
recommendation, is whether or not the bills-only policy has actually
resulted in a stronger Government securities market. It is extremely
difficult to arrive at a definite conclusion concerning this question.
One reason for the difficulty is that the Federal Reserve System has
followed a much more aggressively flexible monetary policy since the
adoption of the bills-only policy tnan it did prior to that time. Thus,
even with the best of data, it wouM be difficult to judge how the
market would have performed in the face of an equally aggressive
policy under some other kind of open-market technique. Nevertheless,
some useful judgments can be arrived at on the basis of a study of the
performance of the Government securities market since 1953. Such a
study suggests the following generalizations concerning the behavior
of the Government securities market.15
13 The subcommittee uses this phrase repeatedly in its report. The meaning attached to it is described
in the following words: “ In strictly market terms, the inside market, i.e., the market that is reflected on
the order books of specialists and dealers, possesses depth when there are orders, either actual orders or
orders that can be readily uncovered, both above and t elow the market. The market has breadth when
there orders are in volume and come from widely divergent investor groups. It is resilient when new orders
pour promptly into the market to take advantage of sharp and unexpected fluctuations in prices.” Flanders
hearings, p. 265.
14 Ibid., pp. 264-268. This is the essence of the subcommittee recommendation. It was qualified by
recognition of a possible need to intervene in sectors other than short term in order to correct disorderly
situations, and there was considerable discussion of facilities for financing dealers, the administration of
System open-market operations, and so on.
18 The following interpretations are bared upon a study of materials made available to the author by the
Board of Governors of the Federal Reserve System.
DEBT MANAGEM ENT IN TH E UNITED STATES
123
1. Dealer positions are influenced chiefly by expectations concerning
interest rate movements, although Treasury financing activity also
has important effects.
2. Dealer positions appear to fluctuate principally in response to
broad interest rate movements and expectations related thereto.
Positions in longer-term obligations rise sharply when a trend toward
lower interest rates is clearly indicated and there are strong signs that
this direction will continue for some time, and they are reduced as
quickly as possible when this trend is reversed. Positions in Treasury
bills and other short maturities are less affected since the possibility
of profit or loss on these obligations resulting from sustained interest
rate movements is not so great.
3. Short-term fluctuations in interest rates—i.e., temporary upward
movements during a period when the trend is downward or temporary
downward movements when the trend is upward—do not appear to
have appreciable effects on dealer positions.
4. The only quantitative information available on changes in the
willingness of dealers to make markets for various classes of securities
is in the spreads between their quoted bid and asked prices. Such
spreads were generally larger on all types of interest-bearing securities
in late 1956 and the first half of 1957 when price fluctuations were large
and the risk of loss great, than at any earlier time since the end of
World War II. Dealers' comments in 1956 and 1957 also suggested
that the market outside the short-term sector was thin, narrow, etc.,
but it would be dangerous to place much emphasis on these qualitative
statements.
These observations suggest—as a priori reasoning would lead one
to expect— that the market for longer term securities is inherently a
thin market. No dealer can afford to resist market trends—any
dealer who tried to do so would soon be bankrupt. In fact, dealers
tend to accentuate major market movements. When a sustained up
ward movement of bond prices appears to be getting underway, deal
ers buy long-term securities, planning to sell out later on at higher
prices. On the other hand, when a downward movement of bond
prices gets underway, dealers liquidate their positions in order to
avoid losses and may even assume short positions. Clearly, such
actions by dealers, far from stabilizing the market and giving it
“ depth, breadth, and resiliency," tend to accelerate major movements
of interest rates and to make the market thin.
These points are rather dramatically illustrated by the changes in
dealer positions in securities of over 10 years' maturity that took
place during 1955, 1956, and 1957. In 1955, dealer positions were
relatively large—averaging three to four times their average level for
the period 1951-57 during most of the first half of the year. Late in
the year, as interest rates rose, dealer positions began to decline and
by February of 1956 were only a fraction of their 1955 levels. Positions
remained small during 1956, with some rise near the end of the year
and carrying over into 1957. A further decline set in. In April, and
from the beginning of June to the middle of September, dealers occu
pied a net short position. However, in mid-September, amid signs
of a recession which created expectations of a turn-about in monetary
policy, the situation reversed itself dramatically and dealers built up
their positions to levels comparable with those which prevailed in
50438— 60-------10
124
DEBT MANAGEM ENT IN TH E UNITED STATES
1955. Positions in securities of 5 to 10 years’ maturity followed a
rather similar, although by no means identical, pattern.
In February 1958, dealers increased their positions in bonds, both
in the 5-to-10-year and the over-10-vear categories, as a result of
heavy subscriptions to three Treasury bond offerings during that
month.16 On February 5, 1958, total dealer positions amounted to
$290 million in bonds of 5 to 10 years’ maturity and $266 million in
bonds of over 10 years’ maturity.17 Dealer positions in bonds re
mained high until July; then with interest rates rising and the outlook
suggesting the beginning of an upward trend in interest rates, posi
tions were pared down sharply, particularly in the over-10-year
maturity range.18
It is possible that dealers sometimes resist movements of bond
prices which they regard as temporary— e.g., that when some develop
ment that they interpret as self-correcting causes bond prices to rise,
they may sell bonds out of their position, hoping to rebuild their
position on favorable terms when the temporary price rise is reversed.
However, it is difficult to obtain clear evidence of this. In any case,
it is perfectly clear that, as far as major price movements are con
cerned, dealers ride with them and even accentuate them.
In fact, it seems quite obvious that, as long as an aggressively
flexible monetary policy is followed, the long-term bond market is
bound to be thin and subject to rather large and cumulative price
fluctuations, regardless of the kind of open market policy followed
by the Federal Reserve. Although the evidence is not entirely
satisfactory and there are many gaps in our knowledge of the behavior
of the Government securities market, it is very doubtful whether the
bills-only has significantly encouraged dealers to take positions and
make markets in long-term securities, particularly at times when
interest rates are moving sharply upward.
The fact of the matter is that it is doubtful whether it would be
desirable from the standpoint of flexible monetary policy to maximize
the depth, breadth, and resiliency of the Government securities
market. To some extent at least, flexible monetary policy relies on
fluctuations of interest rates as the medium through which it exerts
its effects on the economy. At times the ad hoc subcommittee seems
to be saying that it would be desirable to have a Government securi
ties market in which the Federal Open Market Committee could
conduct the maximum possible volume of open market purchases and
sales with the minimun effect on interest rates and security prices.19
In reality it is extremely difficult to specify with any precision the
properties that would be most desirable to inculcate in the Government
securities market in order to make this market best serve the ends of
effective monetary policy. However, it seems perfectly clear that
“ minimum price reaction to a given volume of operations” would not
be the ideal market characteristic. Thus, it is not even clear that
if the bills-only policy accomplished the objective set out in the ad
16 In February 1958, the Treasury sold $1.4 billion of 8^-year bonds for cash and $3.8 billion of 6-year bonds
and $1.6 billion of 32-year bonds in an exchange operation.
w These data are taken from the “ Treasury-Federal Reserve Study of the Government Securities Market,’ ’
pt. II (preliminary mimeographed edition, 1959), app. C, table 1.
is Dealers received large allotments of the speculation-ridden 2^-percent bond of 1965 which was issued in
June 1958. As a result of this, dealer positions in the 5- to 10-year maturity range rose sharply in June and
declined beginning in July.
This point (together with a number of other telling criticisms of the ad hoc subcommittee report) is made
in “ Comments of the Federal Reserve Bank of New York on Report of the A d Hoc Subcommittee on the
Government Securities Market,” Flanders hearings, pp. 307-331.
DEBT MANAGEM ENT IN TH E UNITED STATES
125
hoc subcommittee report, this result would be in the best interest of
effective monetary policy.
For the reasons just outlined, the case for the bills-only policy
presented in the ad hoc subcommittee report appears to be rather
weak, because (1) the change in market behavior foreseen in that
report does not appear to have been realized, and (2) it is by no means
clear that this kind of market behavior, if it were to be achieved, would
best serve the interest of flexible monetary policy.
Arbitrage between short- and long-term interest rates
Another argument that has been advanced in support of the billsonly policy is that the effects produced on short-term interest rates
are rapidly and effectively transmitted to the long-term market by a
process of arbitrage. That is, it is said that the long-term rate is
influenced just about as effectively by trading in the short-term
market as it would be by dealing directly in long-term securities.20
Partly the sensitivity of long-term rates of interest to operations
initiated in the short end of the market is due to the presence of
market professionals who engage in carefully timed operations when
yields on different maturities get out of line with one another and with
market expectations. Perhaps more important are the activities of
various classes of borrowers and lenders who are prepared to enter
various sectors of the market and who thereby provide links between
sectors.21 There can be little doubt about the existence of these
links, as well as the presence of systematic arbitrage. In fact, in our
earlier discussion, we placed considerable emphasis on these factors as
the determinants of the term structure of interest rates.22 The ques
tion in the present context, however, is whether these links between
the short- and long-term markets are sufficiently tight to permit
precise and effective control of long-term interest rates by means of
operations confined to the short-term market.
Direct versus indirect effects of open market operations.— One argu
ment that has been advanced in support of the bills-only policy is
that open market operations exert their effects on interest rates partly
by changing the supply of securities directly and partly indirectly
through their effects on the supply of bank reserves and that the sec
ond, indirect effect, which is independent of the sector in which the
operations take place, is much more important than the direct effect.23
The reason for this is that the indirect effect through bank reserves
is magnified by the power of the banking system to engage in multiple
credit expansion. Thus, it is said that, with reserve requirements
averaging around 14 percent for demand deposits, so that the credit
expansion multiplier is approximately 7, about one-eighth of the effect
of open market operations on interest rates comes through the direct
effect and about seven-eighths of the effect comes about through the
expansion or contraction of bank credit resulting from the change in
bank reserves. Since the direction of the indirect seven-eighths will
presumably be largely independent of the sector in which the opera20it may be noted that if this argument Is correct, it reduces considerably whatever merit there might
otherwise be in the minimum intervention or neutrality argument. If interest rates move in more or less
the same way regardless of the sector in which open market operations are conducted, it becomes rather
difficult to argue that, as a matter of principle, it is important to confine operations to the short-term market.
21 These links are stressed in W. W. Riefler, “ Open Market Operations in Long-Term Securities,” Federal
Reserve Bulletin, November 1958,1260-1274.
22 See ch. IV.
23Riefler, op. cit.
126
DEBT MANAGEM ENT IN TH E UNITED STATES
tions are conducted, it makes relatively little difference whether the
Federal Reserve deals in bills or in longer term securities.24
A study of changes in the System’s portfolio of Government securi
ties, corrected for changes in member bank reserve requirements so
as to show the amount of bank reserves injected into or withdrawn
from the banking system by Federal Reserve action, indicates that the
relation between such actions and changes in the aggregate supply of
bank credit is a very loose one indeed in the short run. On a weekto-week basis, the change in the supply of bank credit frequently moves
in the opposite direction from that indicated by the System’s action,
and even when the movements are in the same direction, the ratio of
the change in loans and investments to the change in reserves attribut
able to Federal Reserve operations varies in a highly erratic and un
predictable way.25 There are, of course, many reasons for the erratic
relation between System actions affecting reserves and changes in
loans and investments. One is that there are many factors other than
Federal Reserve open market operations and changes in reserve
requirements that affect member bank reserves—including changes in
float, currency in circulation, gold stock, and so on. In fact, a con
siderable part of Federal Reserve open market operations are designed
to offset, in whole or in part, the effects of these other factors, rather
than to change the net amount of reserves available.26 In addition,
shifts of deposits among different classes of member banks and be
tween member and nonmember banks affect the credit expansion power
of the banking system, due to the fact that the different classes of
member and nonmember banks are subject to different reserve
requirements.
The relationships referred to above suggest that the primary effects
of Federal Reserve open market operations may at times be of con
siderable importance, and whether the System buys in one maturity
sector or another may have a major influence on the structure of
interest rates. Furthermore, the System’s influence on the rate
structure is seen to be potentially even more important when it is
recognized that it is quite possible to buy securities in one maturity
sector and simultaneously sell in another sector without changing the
aggregate volume of member bank reserves at all. The System is
obviously in a position to exercise a major influence on the rate
structure if it so desires.
Bank reserves and the Treasury bill rate.—Under the bills-only
policy, the ability of the Federal Reserve to control long-term interest
rates through open market operations depends upon (1) its ability to
control interest rates on Treasury bills, and (2) the existence of a
stable, predictable relationship between changes in short-term and
long-term interest rates. With respect to control of the Treasury bill
rate, there can be little doubt that the System could regulate this rate
with great precision by means of dealings in Treasury bills if it were
to make such regulation the purpose of open market policy. How
ever, at the present time open market operations in Treasury bills
are conducted with a view to maintaining stable conditions in the
24 Allowance for cash drain might reduce the credit expansion multiplier somewhat, but since changes in
currency in circulation do not follow changes in demand deposits closely in the short run, we shall disregard
this refinement. Ibid., p. 1269, footnote 2.
25 Accurate comparisons of the kind referred to are impossible to make because of various inadequacies in
the data, but judging from such information as is available the above statement seems justified.
so See R. V. Roosa, “ Federal Reserve Operations in the Money and Government Securities Markets”
(Federal Reserve Bank of New York, 1956).
DEBT MANAGEMENT IN THE UNITED STATES
127
money market as a whole and for the purpose of achieving an approxi
mate target level of “ free reserves.” 27 Chart V -l shows the relation
between week-to-week changes in free reserves, plotted on the horiChange in
free reserves, Jan. I, 1958, to May 13,1959
zontal axis, and week-to-week changes in the new-issue rate on
Treasury bills, plotted on the vertical axis. Although reduced levels
of free reserves are strongly associated with higher levels of short-term
27 “ Free reserves'' is the difference between aggregate member bank excess reserves and aggregate member
bank borrowings from the Federal Reserve (discounts and advances). When member bank borrowings
exceed excess reserves, it is said that there are “ negative free reserves" or “ net borrowed reserves.”
128
DEBT MANAGEMENT IN TH E UNITED STATES
interest rates over longer periods of time, it is clear from chart V -l
that there is not a very close relation between week-to-week changes
in the Treasury bill rate and w~eek-to-week changes in free reserves.28
There are many factors that affect the Treasury bill rate other than
the reserve position of the banking system, particularly in the short
run.
The point of this analysis is that System operations in Treasury
bills, as now conducted, are not designed to control the Treasury bill
Change in
Yieldon
Long-Term
Chart 3 Z - 2
Relation
between
in Treasury bill rate and
weekly changes
weekly changes in
yield on l o n g - t e r m treasury bonds, Ja n. 4 ,
1 9 5 8 , to May 3 0 ,1 9 5 9 .
rate but to regulate the volume of free reserves and that the relation
between free reserves and the Treasury bill rate is so loose that these
operations do not effectively regulate the bill rate in the short run,
even indirectly. Thus, the fulcrum by which the System affects
long-term interest rates is a very unsteady one. For that reason,
even if there were a stable and predictable relation between shortand long-term interest rates as a result of arbitrage, control over the
long-term interest rate would be very imprecise with present tech
niques.
28
The coefficient of correlation, r, for the data presented in chart V-l is only —.285, and r2 is .0812. That
is, only about 8 percent of the variance in wee\-to-week changes in the Treasury bill rate is explained by its
relation to free reserves. The two regression lines representing the regression of free reserves on the bill rate
and of the bill rate on free reserves are shown on the chart.
DEBT MANAGEMENT IN THE UNITED STATES
129
Arbitrage between short-term and long-term markets.— A s in d ic a te d
earlier, th ere is a r e a s o n a b ly p r e d ic ta b le r e la tio n sh ip b e tw e e n m o v e
m e n t s in s h o r t -t e r m in te re st ra te s a n d m o v e m e n t s in lo n g -te r m
in te re s t r a te s o v e r th e b u sin e ss c y c le , a n d th is re la tio n se e m s to b e
e x p la in a b le in te r m s o f e x p e c ta tio n s.
H o w e v e r , th e re la tio n sh ip is
n o t v e r y p recise fo r sh o r t p e rio d s o f tim e .
C h a r t V - 2 sh o w s w e e k -t o w e e k c h a n g e s in th e T r e a s u r y b ill r a te o n th e h o r iz o n ta l a x is a n d
w e e k -t o -w e e k c h a n g e s in th e y ie ld on lo n g -te r m T r e a s u r y b o n d s o n th e
h o r ix o n ta l a x is.
W h i le th ere is so m e r e la tio n b e tw e e n m o v e m e n t s o f
th e tw o in te re s t r a te s , th e r e la tio n is n o t v e r y e x a c t o r p r e d ic ta b le .29
T h e r e a so n is t h a t s h o r t -t e r m r a te s are c o n n e c te d to lo n g -t e r m r a te s
b y a fle x ib le lin k t h a t is v e r y se n sitiv e to c h a n g e s in b u sin e ss s e n tim e n t
a n d to ch a n g e s in th e o u t lo o k fo r m o n e ta r y p o lic y a n d in te r e st r a te s.
T h u s , e v e n if o p e n m a r k e t o p e r a tio n s in T r e a s u r y b ills w e re su c c e ssfu l
in c o n tr o llin g th e T r e a s u r y b ill r a te w ith a h ig h d e gree o f p r e c isio n , it
is q u ite c le a r t h a t c o n tr o l o v e r lo n g -te r m r a te s w o u ld n o t b e e q u a lly
e x a c t.
I f c o n tr o l o v e r lo n g -t e r m in te re st r a te s is to b e r e a s o n a b ly
p recise, i t c a n b e a c c o m p lish e d o n ly b y d ir e c t d e a lin g s in lo n g -te r m
secu rities.
Bills-only and the administration of open market operations
I n a d d itio n to th e p h ilo so p h ic a l desire to a c h ie v e n e u t r a lit y , th e
c o n te n tio n t h a t th e p e r fo r m a n c e o f th e G o v e r n m e n t sec u rities m a r k e t
w o u ld b e im p r o v e d , a n d th e a r g u m e n t t h a t d e a lin g s in b ills w o u ld
e ffe c tiv e ly in flu e n c e in te re st r a te s in a ll m a t u r it y se c to r s o f th e
m a r k e t, i t a p p e a r s t h a t th e r e w a s a n o th e r re a so n fo r th e a d o p tio n o f
th e b ills -o n ly p o lic y .
T h i s is th e d esire to a c h ie v e s im p lic ity in
m o n e ta r y p o lic y in o rd er to m in im iz e th e p r o b le m s o f a d m in is tr a tio n .
T h e p r e se n t a rr a n g e m e n ts fo r th e a d m in is tr a tio n o f o p e n m a r k e t
o p e r a tio n s are e x c e p tio n a lly c u m b e r s o m e .
T h e F ederal O pen M a rk e t
C o m m it t e e c o n sists o f 12 m e m b e r s , in c lu d in g th e 7 m e m b e r s o f th e
B o a r d o f G o v e r n o r s a n d 5 o f th e p r e sid e n ts o f F e d e r a l R e s e r v e b a n k s .
T h e p r e s id e n t o f th e N e w Y o r k R e s e r v e B a n k is a lw a y s a m e m b e r o f
th e C o m m i t t e e , d u e to th e sp e c ia l ro le o f th e N e w Y o r k b a n k in th e
a d m in is tr a tio n o f o p e n m a r k e t o p e r a tio n s, w h ile th e o th e r 11 b a n k s
are r e p r e s e n te d o n a r o t a t in g b a s is .30 T h e p r e sid e n ts o f th e se v e n
R e s e r v e b a n k s t h a t are n o t c u r r e n tly r e p r e se n te d o n th e C o m m i t t e e
o ft e n c o m e to th e m e e tin g s in o rd er to k e e p in t o u c h w ith c u rre n t
c o n d itio n s a n d to m a k e th e ir a d v ic e a v a ila b le .
M o re o v e r, n u m erou s
m e m b e r s o f th e s ta ffs o f th e B o a r d o f G o v e r n o r s a n d o f th e in d iv id u a l
R e s e r v e b a n k s a re o r d in a rily p r e se n t.
T h u s , th e b o d y re sp o n sib le
fo r th e c o n d u c t o f o p e n m a r k e t o p e r a tio n s fr e q u e n t ly c o n sists, in
effe c t, o f 3 0 to 4 0 p e o p le .
E v e n a b o d y o f 12 is a c lu m s y a d m in is
tr a tiv e o r g a n , a n d th e p rese n c e o f n u m e r o u s n o n v o t in g p a r tic ip a n ts
m a k e s th e p r o b le m w o rse .
T h e n e e d to a rr iv e a t a re a so n a b le c o n
se n su s a m o n g su c h a la rg e n u m b e r o f p e rso n s m a k e s i t e x tr e m e ly
d iffic u lt to c o n d u c t a n y t h in g b u t a v e r y s im p le p o lic y w it h a m in im u m
n u m b e r o f d im e n sio n s.
B i lls -o n ly m e e ts th e n e e d fo r s im p lic ity
a d m ir a b ly , a n d th is is u n d o u b t e d ly o n e o f th e re a so n s fo r its a d o p tio n .
The coefficient of correlation for the data presented in chart V-2 is —.352, and r* is .1236, indicating that
only about 12 percent of the variance in week-to-week changes in bond yields is explained by the relation
with the Treasury bill rate.
30 One member of the Open Market Committee is elected by the Federal Reserve Banks of Boston, Phila
delphia, and Richmond; one by the Federal Reserve Banks of Cleveland and Chicago; one by the Federal
Reserve Banks of Atlanta, St. Louis, and Dallas; and one by the Federal Reserve Banks of Minneapolis,
Kansas City, and San Francisco. In each of these groups, the practice is to allow membership to rotate on
a year-to-year basis among the presidents of the constituent Reserve banks.
130
DEBT MANAGEMENT IN THE UNITED STATES
A D VAN TAG ES OF A MORE F LEXIBLE OPEN M ARKET POLICY
A s w e h a v e se e n , th e n e u t r a lit y o r m in im u m in te r v e n tio n a rg u m e n t
in s u p p o r t o f b ills o n ly is o p e n to q u e stio n o n th e g ro u n d s t h a t all
p o lic ie s are s e le c tiv e in th e ir im p a c t s o n d iffe re n t se c to r s o f th e
e c o n o m y a n d t h a t in te llig e n t s e le c t iv ity is a n e c e ssa r y a tt r ib u te o f
e ffe c tiv e s ta b iliz a t io n p o lic y u n d e r p r e s e n t-d a y c o n d itio n s.
M ore
o v e r , th ere is lit tle e v id e n c e t h a t b ills o n ly h a s r e su lte d in im p r o v e d
p e r fo r m a n c e o f th e G o v e r n m e n t secu rities m a r k e t, a n d th ere d o e s n o t
s e e m t o b e m u c h b a sis fo r th e v ie w t h a t e ffe c tiv e c o n tr o l o v e r lo n g
t e r m in te re s t r a te s ca n b e a c h ie v e d b y d e a lin g o n ly in b ills.
W h i le
t h e a d m in is tr a tiv e d ifficu lties o f c o n d u c tin g a m o r e c o m p le x p o lic y
s h o u ld n o t b e u n d e r r a te d , it is a lw a y s p o ssib le to ch a n g e a d m in is tr a
t iv e a r r a n g e m e n ts.
T h u s , n o n e o f th e p o s itiv e a r g u m e n ts t h a t h a v e b e e n a d v a n c e d in
s u p p o r t o f b ills o n ly se e m to h a v e v e r y m u c h v a li d it y .
W e tu rn n o w
t o a c o n sid e r a tio n o f s o m e o f th e a d v a n ta g e s t h a t m ig h t b e a c h ie v e d
th r o u g h a lim ite d d e p a rtu r e fr o m th is p o lic y .
I t is p o ssib le to d is
tin g u is h th re e d iffe re n t p u r p o se s fo r w h ic h o p e n m a r k e t o p e r a tio n s
in lo n g e r te r m sec u rities m ig h t b e e m p lo y e d : (1 ) p r e v e n tio n o f t e m
p o r a r y d is to r tio n s in th e in te r e st r a te s tr u c tu r e , (2 ) p r e v e n tio n o f
m e a n in g le s s s h o r tru n flu c tu a tio n s in th e p rices o f T r e a s u r y se c u r itie s,
a n d (3 ) m a n ip u la tio n o f th e in te r e st r a te s tr u c tu r e as a s e le c tiv e c o n
tr o l in th e in te r e st o f e c o n o m ic s t a b ilit y .
L e t u s c o n sid e r each o f th e se
in t u r n .
Prevention of temporary distortions in the interest rate structure
A n ex c e lle n t e x a m p le o f a s itu a tio n in w h ic h a tr o u b le s o m e d is to r
tio n in th e in te r e st r a te str u c tu r e d e v e lo p e d is t h e ea rly m o n t h s o f
1958.
W h e n m o n e t a r y p o lic y tu r n e d fr o m tig h tn e s s t o ease in th e
la t t e r p a r t o f 1 9 5 7 as p a r t o f th e p o lic y fo r d e a lin g w ith d e v e lo p in g
re c e ssio n , s h o r t -t e r m in te r e st r a te s fe ll v e r y s h a r p ly .
W h i le lo n g
te r m in te r e s t r a te s also d e c lin e d , th e d e c lin e w a s q u ite m o d e r a t e ,
d u e in g o o d p a r t to th e fa c t t h a t th e d e m a n d fo r lo n g -te r m fu n d s
r e m a in e d h e a v y .
B o n d issu es t h a t h a d b e e n p o s tp o n e d b y c o r p o r a
tio n s a n d b y S t a te a n d lo c a l g o v e r n m e n ts w ere p u t o n th e m a r k e t as
s o o n as c re d it c o n d itio n s e a se d , w ith th e p r o ce e d s b e in g u se d in p a r t
to r e p a y b a n k lo a n s t h a t h a d b e e n in c u rre d d u r in g th e p e rio d o f t ig h t
c r e d it in o rd er to fin a n ce in v e s tm e n t p r o je c ts te m p o r a r ily u n til su c h
tim e as c o n d itio n s in th e c a p ita l m a r k e t b e c a m e m o r e fa v o r a b le fo r
r a is in g lo n g -te r m fu n d s.
T h u s , in e a r ly 1 9 5 8 a n u n u s u a lly w id e d iffe re n tia l e x iste d b e tw e e n
s h o r t - a n d lo n g -te r m in te r e st r a te s .
A s lo n g as th e e x p e c ta tio n p r e
v a ile d t h a t th e rec essio n w o u ld c o n tin u e , in v e s to r s e x p e c te d a fu r th e r
d e c lin e in lo n g -t e r m in te r e st r a te s w ith a c o n s e q u e n t rise in b o n d
p ric e s.
A t th e s a m e t im e , th e u n u s u a lly lo w s h o r t -t e r m in te r e s t r a te s
r e fle c te d th e a v a ila b ility o f c h ea p a n d a m p le s h o r t -t e r m c r e d it a c c o m
m o d a t io n s .
A s th e T r e a s u r y -F e d e r a l R e s e r v e s t u d y o f th e G o v e r n
m e n t s e c u r ity m a r k e t h a s in d ic a te d , th is p a r tic u la r c o m b in a t io n o f
c irc u m s ta n c e s w a s v e r y c o n d u c iv e to th e d e v e lo p m e n t o f s p e c u la tio n
in T r e a s u r y s e c u r itie s, sin c e it w a s p o ssib le to b o r r o w s h o r t -t e r m fu n d s
a t lo w c o s t a n d o n th in (o r n o n e x is te n t) m a r g in s a n d u se th e fu n d s to
b u y n e w ly is s u e d lo n g e r te r m T r e a s u r y issu es w h ic h a p p e a r e d a lm o s t
c e r ta in to rise in p r ic e , th u s r e su ltin g in v e r y lu c r a tiv e c a p ita l g a in s.
T h i s d is to r tio n in th e in te r e s t r a te s tr u c tu r e w a s c e r ta in ly o n e o f th e
DEBT MANAGEMENT IN THE UNITED STATES
131
ca u se s o f th e ex c e ssiv e sp e c u la tio n w h ic h d e v e lo p e d in c o n n e c tio n w it h
th e r e fu n d in g o f J u n e 1 9 5 8 , a n d d e m o r a liz e d th e G o v e r n m e n t sec u ri
tie s m a r k e t fo r th e r e m a in d e r o f th e y e a r .31
I n th is case , it is q u ite clear t h a t th e F e d e r a l R e s e r v e sh o u ld h a v e
r e c o g n ize d th e d a n g e rs in h e r e n t in th e situ a tio n a n d ta k e n ste p s to
co rrec t th e d isto r tio n in th e r a te s tru c tu re .
T h is c o u ld h a v e b e e n
d o n e b y th e p u rc h a se o f a lim ite d q u a n t it y o f lo n g -t e r m sec u rities
in th e o p e n m a r k e t eith er in lieu o f o r in a d d itio n to th e p u rc h a se s
o f s h o r t -t e r m secu rities t h a t w ere m a d e .
I n a d d itio n to r e d u c in g th e
d a n g e r o f s p e c u la tiv e ex cesses, in th is p a r tic u la r case , th e d e c lin e in
lo n g -t e r m in te re st r a te s w o u ld c e r ta in ly h a v e d o n e n o h a r m a n d
c o n c e iv a b ly m ig h t h a v e h e lp e d a lit tle to s tim u la te a r e c o v e r y o f
p la n t a n d e q u ip m e n t sp e n d in g b y b u sin e ss.
Smoothing fluctuations in bond prices
I t w a s p o in te d o u t earlier t h a t o n e o f th e rea so n s fo r th e fa c t t h a t
T r e a s u r y secu rities h a v e b e c o m e less a t t r a c tiv e to in v e s to r s is th e
g r e a t ly in cre ase d in s ta b ilit y in th eir p rices in re c e n t y e a r s .32 T o
s o m e e x te n t th e v a r ia b ility in prices o f G o v e r n m e n t sec u rities is a n
in e v ita b le a c c o m p a n im e n t o f a flex ib le m o n e ta r y p o lic y w h ic h relies
u p o n in te r e s t r a te s as a n e c o n o m ic re g u la to r .
H o w e v e r , s o m e o f th e
flu c tu a tio n s in b o n d p rices are d u e to sp e c u la tiv e fa c to r s in th e m a r k e t
w h ic h n o t o n ly d o n o t c o n tr ib u te to e ffe c tiv e m o n e t a r y p o lic y b u t
m a y e v e n in te rfe re w ith it.
A n e x a m p le o f th is is th e c o lla p se o f th e
b o n d m a r k e t w h ic h o ccu rre d in th e m o n t h s fo llo w in g th e issu a n c e o f
th e 2% p e rc e n t b o n d s o f 1 9 6 5 in J u n e 1 9 5 8 .33 W h e n b o n d p rices
b e g a n to fa ll, th e fo r c e d liq u id a tio n o f th in ly m a r g in e d sp e c u la tiv e
p o sitio n s in th e se b o n d s a c c e le r a te d th e d e clin e, w h ic h q u ic k ly sp rea d
to o th e r issu es o f G o v e r n m e n t secu rities.
T h e T reasu ry b ou gh t b ack
a s m a ll a m o u n t o f th e 2% p e rc e n t b o n d s in J u ly , a n d th e F e d e r a l
R e s e r v e g a v e s o m e su p p o r t to a T r e a s u r y r e fu n d in g o p e r a tio n in
A u g u s t , b u t th e t o t a l a m o u n t o f s u p p o r t g iv e n to th e m a r k e t in
th ese tw o o p e r a tio n s w a s q u ite s m a ll a n d en tire ly in su fficien t to restore
s t a b ility .
T h e F e d e r a l R e s e r v e w a s u n d e r s ta n d a b ly r e lu c ta n t to b a il o u t th e
s p e c u la to r s w h o h a d su b sc r ib e d to th e 2% p e rc e n t b o n d s in o rd er to
earn a q u ic k p r o fit.
H o w e v e r , o n b a la n c e , m o r e e x te n siv e su p p o r t
to th e m a r k e t w o u ld a lm o s t su r e ly h a v e b e e n d e sira b le , sin ce i t
w o u ld h a v e m o d e r a t e d th e sh a rp rise in in te re st r a te s w h ic h o cc u rre d
in th e la s t h a lf o f 1 9 5 8 w h ile th e e c o n o m y w a s ju s t b e g in n in g to
r e c o v e r fr o m th e recessio n a n d w o u ld h a v e d a m p e d th e g y r a tio n s o f
G o v e r n m e n t s e c u r ity p rices, w h ic h m a y w e ll h a v e s e r v e d to re d u c e
th e a ttr a c tiv e n e s s o f su c h sec u rities to in v e sto r s.
J u s t as a n e x c h a n g e s ta b iliz a tio n fu n d m a y serv e a u se fu l p u rp o se
u n d e r a re g im e o f flex ib le fo r e ig n ex c h a n g e r a te s b y m o d e r a tin g ex
c essiv e flu c tu a tio n s o f e x c h a n g e r a te s t h a t m e r e ly r ep rese n t tr a n sito r y
fa c to r s , a s k illfu lly c o n d u c te d p r o g r a m o f o p e n m a r k e t o p e r a tio n s in
lo n g e r -te r m sec u rities c a n o ffse t tr a n s ito r y r a n d o m flu c tu a tio n s in
s e c u r ity p rices w it h o u t in te rfe r in g w ith in te re st r a te m o v e m e n t s t h a t
rep rese n t b a s ic a d ju s t m e n ts to c h a n g in g e c o n o m ic c o n d itio n s.
R ecent
ex p erien ce su g g e sts t h a t G o v e r n m e n t s e c u r ity d e a lers c a n n o t b e relied
u p o n to a c t in su c h a w a y as to o ffse t e v e n te m p o r a r y flu c tu a tio n s in
31 For a more extensive discussion of this episode, see ch. Ill above.
32 See ch. III.
33 For a more detailed discussion, see ch. III.
132
DEBT MANAGEMENT IN THE UNITED STATES
s e c u r ity p rices.
I f ex c e ssiv e a n d m e a n in g le ss short-run flu c tu a tio n s
are to b e m o d e r a t e d o r p r e v e n te d in th e in te r e st o f o rd e r ly m a r k e ts ,
th e in itia tiv e in th is r e sp e c t m u s t b e ta k e n b v th e F e d e r a l R e s e r v e
S y stem .
Interest rate structure and economic stabilization
A s in d ic a te d a b o v e , i t se e m s b e s t to v ie w c h a n g e s in th e stru c tu re
o f in te re s t r a te s p r o d u c e d b y m a r g in a l a d ju s t m e n ts in th e c o m p o sitio n
o f th e p u b lic ly h e ld d e b t as a fo r m o f se le c tiv e c re d it c o n tr o l.
W h i le
c h a n g e s in th e in te re st r a te s tru c tu re d o h a v e se le c tiv e effe c ts, o ur
g e n e r a l k n o w le d g e co n c e rn in g th e n a tu r e o f th e se effe c ts is a t p r e se n t
v e r y u n s a tis fa c to r y .
H o w e v e r , i t is r e a s o n a b ly clear t h a t , to th e
e x te n t t h a t m o n e t a r y p o lic y w o r k in g th ro u g h in te r e st r a te a d ju s t
m e n t s d o es h a v e a n im p a c t o n b u sin e ss in v e s tm e n t in fix ed c a p ita l,
th is effect d e p e n d s p r im a r ily u p o n c h a n g e s in lo n g -te r m in te re st r a te s ,
a lth o u g h , as w a s in d ic a te d in o u r d isc u ssio n in th e la s t c h a p te r , it
a p p e a r s t h a t e v e n th e lo n g -te r m r a te is n o t a m a jo r in flu e n ce o n su c h
in v e s tm e n t .
P e rio d ic b o o m s in p la n t a n d e q u ip m e n t e x p e n d itu r e s, su c h as
o c c u r re d in 1 9 5 5 - 5 7 , are o n e o f th e m a jo r so u rces o f in s ta b ilit y in th e
e c o n o m y , a n d if m o n e t a r y -d e b t p o lic y c o u ld se r v e as a r e g u la to r o f
s u c h ex p e n d itu r e s, its c o n tr ib u tio n to e c o n o m ic s t a b ilit y m i g h t b e
g r e a t ly en la rg e d .
I n p a r t, th e in te r e st in s e n s itiv ity o f in v e s tm e n t
is d u e to in s titu tio n a l fa c to r s , su c h as th e s tro n g p r o p e n s ity o f b u sin e ss
to fin a n ce in v e s tm e n t fr o m fu n d s g e n e r a te d in te r n a lly th r o u g h d e p r e
c ia tio n a llo w a n ce s a n d r e ta in e d ea rn in g s a n d th e h ig h m a r g in a l r a te o f
ta x a t io n o f 5 2 p e r c e n t u n d e r th e c o r p o r a te in c o m e t a x , w h ic h c u ts
e ffe c tiv e in te re st c o sts in h a lf.34 I t is p o ssib le t h a t th e in te re st se n si
t i v i t y o f in v e s tm e n t c o u ld b e in c re a se d b y su c h m e a su re s as a n
u n d is tr ib u te d p r o fits t a x , w h ic h w o u ld e n c o u ra g e g re a te r d iv id e n d
d is tr ib u tio n s a n d c o r r e sp o n d in g ly h e a v ie r relia n ce o n ex te r n a l so u rc es
o f fu n d s to fin a n ce in v e s tm e n t , a n d r e p e a l, in w h o le o r in p a r t, o f th e
d e d u c t ib ilit y o f in te r e st as a n e x p e n se u n d e r th e c o r p o r a te in c o m e
t a x .35 I f su c h a n effo rt is m a d e to in cre a se th e in te r e st s e n s it iv ity o f
in v e s tm e n t a n d t h e r e b y str e n g th e n th e in flu e n ce o f m o n e ta r y p o lic y ,
i t s h o u ld c e r ta in ly b e a c c o m p a n ie d b y a v ig o r o u s p r o g r a m o f o p e n
m a r k e t o p e r a tio n s in lo n g -t e r m se c u rities fo r th e p u r p o se o f e x erc isin g
m o r e e ffe c tiv e c o n tr o l o v e r lo n g -te r m in te re st r a te s.
W h i le th e p o s s ib ility o f e x e r tin g m o r e in flu e n ce o v e r fix e d in v e s t
m e n t b y m e a n s o f th e lo n g -te r m r a te o f in te r e s t is wro r t h y o f c a r e fu l
s t u d y , it is n o t clear t h a t , e v e n u n d e r th e m o s t fa v o r a b le c ir c u m sta n c e s,
th e in te r e s t r a te is a su ffic ie n tly p o t e n t in s tr u m e n t to e x e rt e ffe c tiv e
c o n tr o l.
I n a d d itio n , th ere is th e d a n g e r t h a t if m e a su re s c o u ld b e
d e s ig n e d w h ic h w o u ld h o ld in v e s tm e n t b o o m s in e ffe c tiv e c h e c k , th e
r e s u lt m ig h t b e a g e n e r a lly lo w e r le v e l o f in v e s tm e n t , w h ic h w o u ld
te n d to s lo w d o w n th e r a te o f e c o n o m ic g r o w t h .36
E v e n u n d e r p r e se n t c irc u m sta n c e s, c h a n g es in lo n g -t e r m in te r e st
r a te s e x e rt a p o t e n t in flu e n ce o v e r r e sid e n tia l c o n s tr u c tio n .
T h is
in flu e n c e is la r g e ly d u e t o th e ex iste n ce o f le g a l c eilin g s o n th e in te r e s t
3* On the basis of rational calculations, the existence of high taxes should not influence the interest sen
sitivity of investment very much, since the tax reduces the prospective returns from investment in the
same proportion as it reduces the interest cost of funds. Nevertheless, it is widely alleged that the tax
does weaken the influence of interest rates.
36 For an argument in support of a reduction in the extent of deductibility of interest under the corporate
income tax, see H. S. Houthakker, “ Protection Against Inflation,” Study Paper No. 8, pp. 131-133.
38 For a more extensive discussion of the possibilities and difficulties of exerting more effective contro
over fixed investment, see “ Staff Report on Employment, Growth, and Price Levels,” op. cit., pp. 396-398
DEBT MANAGEMENT IN THE UNITED STATES
133
r a te s o n F H A -i n s u r e d a n d V A -g u a r a n t e e d m o r tg a g e s . W h e n in te r e s t
r a te s o n c o m p e t it iv e in v e s tm e n ts , su c h as c o rp o ra te a n d T r e a s u r y
sec u rities, rise a b o v e th e se ceilin g s, th e s u p p ly o f fu n d s is a t t r a c t e d
a w a y fr o m r e s id e n tia l c o n str u c tio n , a n d w h e n in te re st r a te s o n c o m
p e tit iv e in v e s tm e n t s d e c lin e, th e s u p p ly o f fu n d s flo w s b a c k in to th e
m o r tg a g e m a r k e t, th u s stim u la tin g r e sid e n tia l c o n str u c tio n .
I t is
q u ite clear t h a t , d u e m a in ly to th e ex iste n ce o f th e ceilin g s, m o n e t a r y
p o lic y h a s h a d a g re a te r effe c t o n r e sid e n tia l c o n str u c tio n th a n o n a n y
o th e r s e c to r o f th e e c o n o m y .37
A lt h o u g h th e effe c ts are n o t as g re a t as in th e ca se o f r e sid e n tia l
c o n s tr u c tio n , it se e m s r e a s o n a b ly clear t h a t m o n e ta r y p o lic y h a s h a d a
s ig n ific a n t im p a c t o n e x p e n d itu r e s b y S t a t e a n d lo c a l g o v e r n m e n ts o n
s c h o o ls , h ig h w a y s , a n d o th e r p u b lic p r o je c ts , w h ic h are fin a n c e d b y
lo n g -t e r m b o r r o w in g .38 W h i le th e se effe c ts m a y a t tim e s c o n tr ib u te
to e c o n o m ic s t a b ilit y , t h e y m a y also r e su lt in u n d e sir a b le c u r ta ilm e n t
o f p r o je c ts h a v in g a h ig h so cia l p r io r ity .
E v e n i f n o e ffo r t is m a d e to d e v e lo p th e lo n g -te r m r a t e o f in te r e st
in to a m o r e e ffe c tiv e r e g u la to r o f lo n g -te r m in v e s tm e n t , i t is fr e q u e n t ly
im p o r t a n t to b e a b le to ex ert e ffe c tiv e c o n tr o l o v e r th e lo n g -te r m
in te r e s t r a te b y m e a n s o f o p e n m a r k e t o p e r a tio n s in lo n g -t e r m secu ri
tie s .
F o r e x a m p le , th ere m a y b e tim e s w h e n it w o u ld b e d e sira b le to
fo llo w a r e s tr ic tiv e c r e d it p o lic y w it h o u t e x e r tin g a n u n d u e effe c t o n
S t a te a n d lo c a l g o v e r n m e n t ex p e n d itu r e s o r o n r e sid e n tia l c o n s tr u c tio n .
U n d e r th e se c irc u m sta n c e s, m e a su re s to p r e v e n t lo n g -t e r m in te re st
r a te s fr o m r is in g u n d u ly — t h a t is, o p e n m a r k e t p u r c h a se s o f lo n g -t e r m
secu rities— m ig h t a c c o m p a n y a g e n e r a lly r e str ic tiv e p o lic y .
I n g e n e r a l, w e m a y c o n c lu d e t h a t w h e th e r w e m o v e in t h e d ir e c tio n
o f tr y in g to in c re a se th e in flu e n c e o f in te r e s t r a te s a n d th u s r e ly o n
in te r e s t r a t e flu c tu a tio n s to m a k e m o n e t a r y p o lic y e ffe c tiv e o r m o v e
in th e o th e r d ire c tio n o f p la c in g g re a te r relia n ce o n se le c tiv e c red it
c o n tr o ls w h ic h d o n o t w o r k th r o u g h in te r e st r a te s , th e re w ill b e tim e s
w h e n o p e n m a r k e t o p e r a tio n s in lo n g e r -t e r m secu rities w ill c o n tr ib u te
s ig n ific a n tly to th e effe c tiv e n e ss o f m o n e ta r y p o lic y in m a in ta in in g
e c o n o m ic s t a b ilit y .
F o r th is r e a so n , i t is i m p o r t a n t t h a t th e F e d e r a l
R e s e r v e S y s t e m a b a n d o n th e p r e se n t p r a c tic e o f a r b itr a r ily c o n fin in g
its o p e n m a r k e t o p e r a tio n s to T r e a s u r y b ills o r e q u iv a le n t s h o r t -t e r m
sec u rities a n d b e p re p a re d to d e a l in w h a te v e r m a tu r itie s w ill c o n
tr ib u te m o s t effectively" to th e m a in te n a n c e o f g r o w th a n d s t a b ilit y .
C O N C L U S IO N
I t is q u ite clear t h a t o p e n m a r k e t o p e r a tio n s in lo n g -t e r m sec u ritie s
are u s e fu l a t tim e s as a m e a n s o f p r e v e n tin g o r e lim in a tin g d isto r tio n s
in th e in te re s t r a te stru c tu re as w e ll as to p r e v e n t flu c tu a tio n s in b o n d
p rices w h ic h are th e r e su lt o f sp e c u la tiv e in flu e n c es a n d w h ic h se r v e
n o u se fu l e c o n o m ic fu n c tio n .
M o r e o v e r , fr o m th e s t a n d p o in t o f
c r e d it c o n tr o l fo r th e p u r p o se o f e c o n o m ic s ta b iliz a tio n , th ere are
c le a r ly tim e s w h e n o p e n m a r k e t o p e r a tio n s in lo n g e r m a tu r itie s m a y
s e r v e a u se fu l p u r p o se , w h e th e r m o n e ta r y p o lic y d e p e n d s la r g e ly u p o n
in te re s t r a te flu c tu a tio n s to a c h ie v e its o b je c tiv e s o r relies e x te n s iv e ly
37 For a more extensive discussion, see my paper, “The Impact of Monetary Policy on Residential Con
struction, 1948-58,” in “ Study of Mortgage Credit,” Subcommittee on Housing, Committee on Banking
and Currency, U.S. Senate, 85th Cong., 2d sess. (Washington: Government Printing Office, 1958), pp.
244-264; also “ Staff Report on Employment, Growth, and Price Levels,” op. cit., pp. 363-368.
38 See “ Staff Report on Employment, Growth, and Price Levels,” op. cit., pp. 381-385.
134
debt management in the united states
u p o n s e le c tiv e c o n tr o ls.
I n v ie w o f th e fa c t t h a t th e b ills -o n ly p o lic y
d o e s n o t a p p e a r to h a v e s tre n g th e n e d th e G o v e r n m e n t secu rities
m a r k e t in th e w a y it s p r o p o n e n ts e x p e c te d it t o , i t w o u ld se e m to b e
d e sira b le to a b a n d o n th e p o lic y in its p r e se n t r a th e r rig id a n d d o c
trin a ire fo r m .
A t th e s a m e tim e , it sh o u ld b e r e c o g n iz e d t h a t to a
c o n sid e r a b le e x t e n t th e fu n c tio n o f o p e n m a r k e t o p e r a tio n s is to k e e p
th e m o n e y m a r k e t o n a n e v e n k e e l b y o ffse ttin g u n d e sir a b le effe c ts o n
m e m b e r b a n k reserv es r e su ltin g fr o m c h a n g es in th e flo a t o f u n c o lle c te d
c h e c k s , c u rr e n c y in c irc u la tio n , g o ld s to c k , a n d o th e r fa c to r s w h ic h are
la r g e ly o u ts id e t h e c o n tr o l o f th e F e d e r a l R e s e r v e a u th o r itie s.
The
fr e q u e n t r eserv e a d ju s t m e n ts t h a t are n e c e ssa r y fo r su c h sh o r tru n
s ta b iliz in g p u r p o se s sh o u ld , u n d e r o r d in a r y c irc u m sta n c e s, b e a c
c o m p lis h e d t h r o u g h p u rc h a se s o f T r e a s u r y b ills o r e q u iv a le n t s h o r t
te r m secu rities.
T h u s , it is lik e ly t h a t e v e n w it h a fle x ib le o p e n m a r k e t
p o lic y u n d e r w h ic h th e S y s t e m w a s p r e p a r e d to e n te r a n y m a t u r it y
s e c to r w h e n su c h in te r v e n tio n w a s c a lle d fo r , th e g r e a t b u lk o f o p e n
m a r k e t o p e r a tio n s m o s t o f th e t im e w o u ld b e in th e s h o r t -t e r m se c to r .
CHAPTER VI
SOM E
S U G G E S T IO N S
C O N C E R N IN G
DEBT
M ANAGEM ENT
P O L IC Y
I n th is c o n c lu d in g c h a p te r , w e sh a ll su m m a r iz e th e a p p r o a c h to
d e b t m a n a g e m e n t t h a t em e rg e s fr o m th e a n a ly sis in earlier c h a p te r s ,
p a r tic u la r ly c h a p te r I V . W e sh a ll th e n c o n sid e r th e r e la tio n o f d e b t
m a n a g e m e n t t o m o n e t a r y a n d fiscal p o lic ie s, c o n sid e rin g p a r tic u la r ly
th e w a y in w h ic h r e fo r m s in p r e se n t m o n e t a r y a n d fiscal p o lic ie s w h ic h
a p p e a r to b e d e sira b le o n o th e r g ro u n d s m ig h t s im p lify o u r d e b t m a n
a g e m e n t p r o b le m s .
F in a lly , w e sh a ll c o n sid e r s o m e c h a n g e s o f a
te c h n ic a l n a tu r e w h ic h m ig h t red u ce in te re st c o st a n d a d d to th e
fle x ib ility o f d e b t m a n a g e m e n t.
A SUGGESTED APPROACH TO DEBT M AN A G E M EN T
T h e a n a ly s is p r e se n te d in earlier c h a p te r s su g g e sts a n a p p r o a c h to
d e b t m a n a g e m e n t a lo n g th e fo llo w in g li n e s :
1. I n m a n a g in g its ca sh b o r r o w in g , d e b t r e tir e m e n t, a n d r e fu n d in g
o p e r a tio n s , th e T r e a s u r y sh o u ld c o n ce rn its e lf w ith th e a c h ie v e m e n t
a n d m a in te n a n c e o f a s a tis fa c to r y d e b t stru c tu re . I t s h o u ld n o t b e
g r e a t ly c o n c e rn e d w it h th e im m e d ia te e c o n o m ic im p a c t o f its c u rren t
d e b t o p e r a tio n s, sin ce th e a g g re g a te effe c ts o f th e se o p e r a tio n s are o f
th e sec o n d o rd er o f im p o r ta n c e a n d sin ce it sh o u ld b e th e re sp o n si
b ilit y o f th e F e d e r a l R e s e r v e to o ffse t th e se effe c ts i f t h e y a re u n d e sir
a b le .
W h ile it is n o t p o ssib le in th e p r e se n t sta te o f o u r k n o w le d g e
to s p e c ify a n o p t im u m d e b t stru c tu re fr o m th e s ta n d p o in t o f e c o n o m ic
s t a b ility a n d g r o w th , it is q u ite cle ar t h a t a t th e p r e se n t tim e th e
d e b t s h o u ld b e le n g th e n e d in o rd er to red u c e its s h ift a b ilit y , in crease
th e re sista n c e o f th e e c o n o m y t o e x te r n a l d is tu r b a n c e s , a n d tig h te n
u p m o n e t a r y c o n tr o ls .
T h u s , fo r th e p r e se n t, th e T r e a s u r y sh o u ld
c o n c e n tr a te o n le n g th e n in g d e b t m a tu r itie s .
2 . T h e in te re st c o s t o f m a n a g in g th e d e b t is a m a t t e r o f so m e
im p o r ta n c e , a n d th e T r e a s u r y sh o u ld p la n its d e b t o p e r a tio n s a t le a st
p a r tia lly w it h a v ie w to k e e p in g d o w n th e in te re st c o s t .
T h i s su g
g e s ts v ig o r o u s effo rts to e x te n d d e b t m a tu r itie s d u r in g recessio n
p e rio d s w h e n in te re st r a te s a re r e la tiv e ly lo w .
S in c e th e im m e d ia te
e ffe cts o f d e b t m a n a g e m e n t d o n o t see m t o b e v e r y im p o r t a n t , as
e x p la in e d earlier, d e b t le n g th e n in g d u r in g r ec essio n s is n o t lik e ly to
b e h a r m fu l, a n d it w ill h a v e th e a d v a n ta g e o f h e lp in g to p r e v e n t th e
e x c essiv e b u ild u p s o f liq u id ity d u rin g r ec essio n s w h ic h te n d to u n d e r
m in e th e e ffe c tiv e n e ss o f m o n e t a r y p o lic y d u r in g e n su in g b o o m p e rio d s.
D u r in g p e rio d s o f in fla tio n , th e T r e a s u r y s h o u ld n o t d isc o n tin u e e n
tir e ly its e ffo r ts to sell lo n g -te r m secu rities, b u t it sh o u ld sh ift th e
e m p h a s is in th e d ir e c tio n o f s h o r t -t e r m b o r r o w in g .
T h is w ill k e ep
d o w n in te re st c o s ts in th e lo n g ru n a n d w ill a lso m in im iz e th e e x te n t
t o w h ic h th e T r e a s u r y in te rferes w it h th e fr e e d o m o f th e F e d e r a l
R e s e r v e in a p p ly in g a r e str ic tiv e m o n e t a r y p o lic y .
135
136
DEBT
management in the united states
3.
M a r g in a l a d ju s t m e n t s in d e b t c o m p o s itio n a n d in te re st r a te
s tr u c tu r e s h o u ld b e v ie w e d as a sp ecies o f s e le c tiv e c o n tr o ls , a n d th e
F e d e r a l E e s e r v e sh o u ld b e a ssig n ed th e r e s p o n s ib ility fo r m a k in g su c h
a d ju s t m e n ts o f th is k in d a s a p p e a r to b e c a lle d fo r in o rd e r t o a c h ie v e
e c o n o m ic g r o w t h a n d s t a b ilit y .
T h i s s u g g e sts th e a b a n d o n m e n t o f
t h e b ills -o n ly p o lic y a n d th e a d o p tio n o f a m o r e fle x ib le p o lic y w ith
r e s p e c t t o o p e n -m a r k e t o p e r a tio n s in o rd er (1 ) t o p r e v e n t d is to r tio n s
in th e in te r e s t r a t e str u c tu r e , (2 ) t o p r e v e n t u n n e c e ssa r y tr a n s ito r y
a n d r a n d o m flu c tu a tio n s in s e c u r ity p rices w h ic h h a v e n o im p o r t a n t
e c o n o m ic fu n c t io n , a n d (3 ) to c o n tr o l th e r a te s tr u c tu r e in t h e in te r e st
o f g r o w th a n d s t a b ilit y .
I t w ill b e n o te d t h a t th is p r e sc r ip tio n c o m e s r a th e r c lo se to s a y in g
t h a t th e T r e a s u r y sh o u ld m a n a g e th e d e b t e n tir e ly w it h a v ie w to
m in im iz in g in te r e st c o sts, w h ile th e F e d e r a l R e s e r v e sh o u ld b e a s
s ig n e d th e en tire r e s p o n s ib ility fo r e c o n o m ic s t a b iliz a t io n .1 I n v ie w
o f o u r la c k o f e x a c t k n o w le d g e o f th e r e la tio n sh ip s in v o lv e d , h o w e v e r ,
i t s e e m s b e t te r n o t to s t a t e th e p r e sc r ip tio n in su c h p rec ise la n g u a g e .
I n fa c t , th e a b o v e g e n e r a liz a tio n s c a n c o n s titu te o n ly a s e t o f r o u g h
g u id e lin e s fo r d e b t p o lic y r a th e r th a n a n e x a c t p r e sc r ip tio n o r r u le .
S o m e s tu d e n t s o f d e b t m a n a g e m e n t h a v e s u g g e s te d t h a t , sin ce
T r e a s u r y d e b t m a n a g e m e n t a n d F e d e r a l R e s e r v e o p e n -m a r k e t o p e r a
tio n s are v e r y s im ila r fr o m a fu n c tio n a l e c o n o m ic s t a n d p o in t , th e tw o
b e c o m p le t e ly u n ified .
T h is c o u ld b e a c c o m p lish e d b y tu rn in g o v e r
th e en tire ta s k o f d e b t m a n a g e m e n t to th e F e d e r a l R e s e r v e .2 T h e
T r e a s u r y m ig h t , fo r e x a m p le , raise w h a te v e r fu n d s i t n e e d e d in ex c ess
o f t a x re c e ip ts b y b o r r o w in g d ir e c tly fr o m th e F e d e r a l R e s e r v e , w h ic h
w o u ld t a k e r e s p o n s ib ility fo r sellin g th e a p p r o p r ia te secu rities t o th e
p u b lic .
I n p rin c ip le , th is a p p r o a c h h a s m u c h to r e c o m m e n d i t .
H o w e v e r , as a p r a c tic a l m a t t e r , in v ie w o f th e u n s a tis fa c to r y s t a t e o f
k n o w le d g e c o n c e rn in g th e effe c ts o f d e b t m a n a g e m e n t, su c h a r e fo r m
w o u ld p r o b a b ly b e u n w ise .
T h e r e is a d a n g e r t h a t th e en erg ies o f
t h e F e d e r a l R e s e r v e w o u ld b e u n d u ly a b s o r b e d b y th e p r o b le m s o f
r a is in g fu n d s w h ic h a re n o w th e co n c e rn o f th e T r e a s u r y a n d t h a t th e
c o n d u c t o f s ta b iliz in g m o n e t a r y p o lic y w o u ld su ffer a c c o r d in g ly .
It
s e e m s b e t te r t o le a v e th e r e s p o n s ib ility fo r th e m a in te n a n c e o f a
p r o p e r d e b t stru c tu re a n d o f a v o id in g u n d u ly h ig h in te re st c o s ts in
t h e h a n d s o f th e T r e a s u r y , w it h th e F e d e r a l R e s e r v e t a k in g r e sp o n
s ib ilit y fo r p r o d u c in g su c h c a r e fu lly tim e d m a r g in a l ch a n g e s in d e b t
c o m p o s itio n as are n e c e ssa r y to r e g u la te th e in te re st r a te str u c tu r e
to p r o d u c e se le c tiv e effe c ts w h ic h m a y c o n tr ib u te to e c o n o m ic g r o w th
a n d s t a b ilit y .
A n o t h e r p o ssib le a p p r o a c h to d e b t m a n a g e m e n t t h a t h a s b e e n
s u g g e s te d r e c e n tly is t h a t th e T r e a s u r y ta k e in itia l s te p s to a tt a in a
v ia b le d e b t s tru c tu re a n d th e n p r o g r a m a s ta n d a r d s e t o f d e b t o p e r
a tio n s su c h a s to m a in ta in th is d e b t stru c tu re a n d c a r r y o u t su c h a
s e t o f o p e r a tio n s e a c h y e a r , reg a rd le ss o f e c o n o m ic c o n d itio n s .
The
o b je c t iv e o f th is p r o p o sa l w o u ld b e to a tt a in a p o s itio n o f n e u t r a lit y
1It may be noted that, strictly speaking, a policy of minimizing interest costs would require the Treasury
to anticipate the actions of the Federal Reserve, since to the extent that securities are absorbed into the
Federal Reserve portfolio, the net interest cost to the Treasury is reduced due to the fact that most of the
interest earned by the Federal Reserve is returned to the Treasury at the end of the year. However, it
seems proper to overlook this refinement on the grounds that it would complicate the formulation of debt
management policy considerably. Moreover, it could be argued that the Federal Reserve differs from other
investors merely because it happens to be subject, in effect, to a particularly high marginal rate of taxation.
Since it would be wholly impracticable for the Treasury to take account of different marginal rates of tax
applicable to other investors, it is legitimate to disregard tax rates in the case of the Federal Reserve also.
2 This is proposed in R. L. Bunting, “A Debt Management Proposal,” Southern Economic Journal,
X X V (January 1959), 338-342.
DEBT MANAGEMENT IN THE UNITED STATES
137
in d e b t m a n a g e m e n t.3 A n a lte r n a tiv e a p p r o a c h w o u ld b e to e sta b lish
a b e n c h m a r k p a tte r n o f d e b t o fferin g s to b e m a d e in a n o r m a l y e a r
w h e n th ere w a s n o re a so n fo r d e b t m a n a g e m e n t to b e eith er r e s tr ic tiv e
o r e x p a n s iv e .
S t a r t in g fr o m th is p o sitio n , th e v o lu m e o f lo n g e r te r m
o ffe rin g s c o u ld b e sp e e d e d u p d u rin g in fla tio n a r y p e rio d s a n d s lo w e d
d o w n a n d r e p la c e d b y sh o rte r te r m o ffe rin g s in p e rio d s o f re c e ssio n .4
I n p r a c tic e i t m ig h t p r o v e v e r y c o s t ly to p u t su c h sc h e m e s in to e ffe c t,
a n d i t is n o t cle ar t h a t th e im p o r ta n c e o f d e b t m a n a g e m e n t is g r e a t
en o u g h to ju s t i fy th e c o s t ; m o r e o v e r , i t m ig h t s im p ly p r o v e v e r y d iffi
c u lt a t tim e s to sell th e req u ire d a m o u n t o f lo n g -te r m sec u rities.
And
it is n o t c ertain t h a t th e a d v a n c e p r o g r a m in g o f fin a n c in g w o u ld n o t
b e p la y in g in to th e h a n d s o f th e m a r k e t.
W i t h r e sp e c t to th e se c o n d
p r o p o s a l, it w o u ld se e m t h a t to th e e x te n t t h a t s t a b iliz a t io n p o lic y
relies u p o n ch a n g e s in th e in te r e st r a te s tru c tu re , th e F e d e r a l R e s e r v e ,
w ith its g re a te r fle x ib ility o f m a n e u v e r a n d m o r e u n d iv id e d r e sp o n si
b ilit y fo r e c o n o m ic sta b iliz a tio n , w o u ld b e th e a p p r o p r ia te a g e n c y to
ta k e th e r e s p o n sib ility .
R E L A T IO N O F D E B T M A N A G E M E N T T O O T H E R P O L IC IE S
T h e m a g n itu d e o f th e T r e a s u r y ’s d e b t m a n a g e m e n t p r o b le m s a n d
th e in te r e s t c o s t to th e T r e a s u r y d e p e n d p a r tly u p o n th e k in d s o f
m o n e ta r y a n d fisca l p o lic ie s t h a t are b e in g fo llo w e d .
Debt management and the “ mix” of monetary and fiscal policies
A g iv e n le v e l o f a g g re g a te d e m a n d c a n b e a c h ie v e d b y v a r io u s c o m
b in a tio n s o f m o n e ta r y a n d fisca l p o lic ie s.
W i t h in lim its , a d ju s t m e n ts
in G o v e r n m e n t e x p e n d itu r e s, a d ju s t m e n t s in ta x e s, a n d a d ju s t m e n ts
in in te re s t r a te s a n d c red it a v a ila b ility a re s u b s titu te s fo r o n e a n o th e r
in r e g u la tin g a g g re g a te d e m a n d .
T h e ch oices w e m a k e a m o n g th ese
v a r io u s t y p e s o f a d ju s t m e n ts a ffe c t th e c o m p o s itio n o f d e m a n d a n d
h e n c e th e w a y in w h ic h reso u rces are a llo c a te d a m o n g cu rren t c o n
s u m p tio n , p r iv a te in v e s tm e n t , a n d th e p r o d u c tio n o f G o v e r n m e n t
serv ice s.
W e c a n tig h te n u p o n fisca l p o lic y b y , fo r e x a m p le , r a isin g
ta x e s , a n d c o m p e n s a te fo r th e effe c ts o n a g g re g a te d e m a n d b y ea sin g
c re d it a n d lo w e rin g in te re st r a te s.
O v e r a p e rio d o f y e a r s th e m ix o f m o n e ta r y a n d fisc a l p o lic ies m a y
h a v e a sig n ific a n t e ffe c t o n th e r a te o f e c o n o m ic g r o w th .
F o r e x a m p le ,
b y ra isin g p e rso n a l in c o m e ta x e s to r ed u c e th e le v e l o f c o n s u m p tio n
a n d lo w e rin g th e r a te o f in te r e s t to en c o u ra g e in v e s tm e n t , w e c a n , a t
le a s t to s o m e e x te n t, in cre a se th e r a te o f g r o w th , sin c e in v e s t m e n t
a d d s to p r o d u c tiv e c a p a c it y a n d th u s p e r m its in c o m e a n d p r o d u c tio n
to g r o w m o r e r a p id ly in fu tu r e y e a r s .5 T h u s , a h ig h -t a x -lo w -in t e r e s t r a te p o lic y w o u ld te n d to p r o d u c e a h ig h e r r a te o f g r o w th t h a n a l o w ta x -h ig h -in te r e s t-r a t e p o lic y .
A g e n e r a lly ea sier m o n e t a r y p o lic y , c o m p e n s a te d b y a tig h te r fisca l
p o lic y , w o u ld in a d d itio n to p r o m o tin g a m o r e r a p id r a te o f g r o w th ,
3 T. C. Gaines, “ Techniques of Treasury Debt Management” (unpublished Ph, D. dissertation, Colum
bia University, 1959), ch. XII.
4J. M. Culbertson, “A Positive Debt Management Program/’ Review of Economics and Statistics,
XLI (May 1959), 89-98.
8 For a discussion of the effects of changes in the mix of expenditure, tax, and monetary policies on the rate
of growth and on the further problem of maintaining a balance between the growth of productive capacity
and the growth of demand, see my article, “ Monetary-Fiscal Policy and Economic Growth,” Quarterly
Journal of Economics, L X X I (February 1957), 36-55. It may be noted that many types of Government
expenditures add to capacity, and the rate of growth may be increased by raising the level of such capacity
creating Government expenditures while making other adjustments in taxes or in monetary policy to control
the aggregate level of demand. On this see R. A. Musgrave, “ The Theory of Public Finance” (New York:
McGraw-Hill Book Co., 1959), ch. 20.
138
DEBT MANAGEMENT IN THE UNITED STATES
s im p lify th e p r o b le m s o f d e b t m a n a g e m e n t a n d red u c e th e in te r e st
c o s t to th e T r e a s u r y in tw o w a y s : (1 ) la rg e r su rp lu se s a n d /o r sm a lle r
d e fic its in th e cash b u d g e t w o u ld re su lt in a lo w e r r a te o f g r o w th (or
p e rh a p s a d e c lin e ) in th e size o f th e p u b lic ly h e ld d e b t , a n d (2 ) lo w e r
in te r e s t ra tes r e su ltin g fr o m easier m o n e ta r y p o lic ies w o u ld s a v e in
te r e s t c o sts to th e T r e a s u r y a n d w o u ld m a k e e ffe c tiv e d e b t m a n a g e
m e n t easier to a c h ie v e .
T h e r e is s o m e re a so n to b e lie v e t h a t e v e n r e la tiv e ly s lig h t c h a n g e s
in th e p o lic y m ix b e tw e e n m o n e ta r y a n d fisca l p o lic ies c o u ld h a v e a
s u b s ta n tia l e ffe ct o n th e in te re st c o st o f m a n a g in g th e p u b lic d e b t .
T h e rea son fo r th is is t h a t su c h e v id e n c e as th ere is su g g e sts t h a t m o s t
t y p e s o f ex p e n d itu r e s are n o t v e r y s e n sitiv e to in te r e st ra te s so t h a t ,
fo r e x a m p le , e v e n a r e la tiv e ly s m a ll in cre ase in ta x e s w h ic h r e d u c e d
t h e le v e l o f c o n s u m p tio n w o u ld req u ire a r a th e r sh a rp d e c lin e in
in te r e s t ra tes in o rd e r to s t im u la t e en o u g h a d d itio n a l in v e s tm e n t
s p e n d in g to m a in t a in a n u n c h a n g e d le v e l o f a g g r e g a te d e m a n d .
T h e r e h a s r e c e n tly b e e n m u c h co n c e rn a b o u t th e r e la tiv e ly slo w
r a te o f e c o n o m ic g r o w th t h a t h a s c h a r a c te r iz e d th e A m e r ic a n e c o n o m y
in th e la s t fe w y e a r s .
M u c t o f th is con c e rn arises o u t o f th e ex iste n ce
o f th e e c o n o m ic s tr u g g le b e tw e e n th e U n it e d S t a te s a n d th e S o v ie t
U n io n a n d th e fa c t t h a t th e S o v ie t e c o n o m y h a s b e e n g ro w in g m u c h
m o r e r a p id ly th a n th e A m e r ic a n e c o n o m y .
T h u s , th e r e is m u c h t o b e
s a id fo r a less r e s tr ic tiv e m o n e ta r y p o lic y , t o g e th e r w ith a m o r e
r e s tr ic tiv e fisca l p o lic y as a m e a n s o f e n c o u ra g in g g r o w th .
An
in c id e n ta l a d v a n ta g e o f su c h a s h ift in th e p o lic y m ix is t h a t it w o u ld
s im p lif y th e T r e a s u r y 's d e b t m a n a g e m e n t p r o b le m s .
General versus selective monetary controls
I n th e la s t fe w y e a r s , th e F e d e r a l R e s e r v e h a s relie d a lm o s t e n tir e ly
o n s o -c a lle d g en era l c r e d it c o n tr o ls, im p le m e n te d b y m e a n s o f o p e n
m a r k e t o p e r a tio n s, ch a n g e s in d is c o u n t ra te s, a n d c h a n g es in m e m b e r
b a n k re se rv e r e q u ir e m e n ts.
M e a s u r e s o f th is k in d ex ert th e ir in flu e n ce
b y c h a n g in g th e t o t a l s u p p ly o f b a n k cred it a v a ila b le a n d te n d to b e
r e fle c te d in s u b s ta n tia l c h a n g es in in te re st r a te s.
T h e e ffe cts o f re
s t r ic t iv e c re d it p o lic ie s a p p lie d d u r in g p e rio d s o f in fla tio n a r y p ressu re
in e a r ly 1 9 5 3 , 1 9 5 5 - 5 7 , a n d 1 9 5 8 - 5 9 h a v e s u b s ta n tia lly o u tw e ig h e d th e
e ffe c ts o f t h e e a sy m o n e y p o lic ies w h ic h p r e v a ile d in th e recessio n s o f
1 9 5 3 - 5 4 a n d 1 9 5 7 - 5 8 , w it h th e re su lt t h a t th ere h a s b e e n a v e r y s u b
s t a n t ia l rise in in te re st r a te s, e sp e c ia lly sin ce 1 9 5 2 .
T h e F e d e r a l R e s e r v e h a s, in th e la s t fe w y e a r s , b e e n o p p o s e d to th e
u s e o f s e le c tiv e c re d it c o n tr o ls, su c h as th e c o n tr o l o f c o n su m e r
in s ta llm e n t c re d it th r o u g h th e s e t t in g o f m in im u m d o w n p a y m e n ts
a n d m a x im u m m a tu r itie s , as w a s d o n e u n d e r r e g u la tio n W o f th e
B o a r d o f G o v e r n o r s d u r in g W o r l d W a r I I a n d th e K o r e a n w a r .6
T h e r e is c e r ta in ly s o m e th in g to b e sa id fo r in c re a se d relia n ce o n selec
t iv e c r e d it c o n tr o ls d ir e c te d a t s o m e o f th e se c to r s o f th e e c o n o m y
w h ic h h a v e e x h ib ite d ex c e ssiv e in s ta b ilit y .
F o r e x a m p le , seriou s
c o n s id e r a tio n m ig h t b e g iv e n to se le c tiv e c o n tr o ls in th e area o f c o n
s u m e r c r e d it, in c lu d in g h o u sin g , a n d p e rh a p s m o r e e ffe c tiv e c o n tr o l
o v e r b a n k le n d in g to red u c e th e m a g n itu d e o f in v e n to r y flu c tu a tio n s .7
I n th e p r e se n t c o n t e x t, it is im p o r t a n t to n o te t h a t in c re a se d
relia n ce o n se le c tiv e c r e d it c o n tr o ls w o u ld h a v e s o m e a d v a n ta g e s fr o m
« At the present time, the only selective control being used by the Federal Reserve is the control of margin
requirements for loans to finance the purchasing and carrying of securities.
7 See “ Staff Report on Employment, Growth, and Price Levels,” prepared for consideration by the
Joint Economic Committee, 86th Cong., 1st sess. (Washington: Government Printing Office, 1959), ch. 9.
DEBT MANAGEMENT IN THE UNITED STATES
139
th e s t a n d p o in t o f d e b t m a n a g e m e n t, sin ce m o s t t y p e s o f se le c tiv e
c o n tr o ls ex e rt th e ir im p a c t b y r e d u c in g th e d e m a n d fo r c r e d it d ir e c tly
ra th e r th a n b y r e ly in g u p o n risin g in te re st r a te s to a c c o m p lish th e
p u r p o se .
I n fa c t, r e stric tin g c r e d it th ro u g h th e u se o f s e le c tiv e c o n
tro ls, ta k e n b y itse lf, w ill te n d , if a n y th in g , to re d u c e in te r e st r a te s.
T h u s , a m o n e ta r y p o lic y r e ly in g m o r e o n se le c tiv e c re d it c o n tr o ls
w o u ld p r e s u m a b ly req u ire sm a lle r in creases in in te re st r a te s to a c h ie v e
a g iv e n re s tric tiv e e ffe ct th a n w o u ld a p o lic y re ly in g e n tire ly o n g en era l
c o n tr o ls .
T h is b e in g th e case, in c re a se d relian ce o n s e le c tiv e c re d it
c o n tr o ls w o u ld h a v e th e in c id e n ta l a d v a n ta g e o f r e d u c in g th e in te re st
c o s t o f m a n a g in g th e p u b lic d e b t .
Criteria for choosing the policy “ mix”
A s in d ic a te d a b o v e , a s o m e w h a t tig h te r fiscal p o lic y a c c o m p a n ie d
b y a n easier m o n e ta r y p o lic y w o u ld te n d to red u c e th e T r e a s u r y ’ s
in te re s t c o s t a n d s im p lify th e p r o b le m s o f d e b t m a n a g e m e n t.
G r e a te r
relia n ce o n s e le c tiv e as c o n tr a s te d w it h g en era l c re d it c o n tr o ls in th e
area o f m o n e t a r y p o lic y w o u ld h a v e a sim ila r e ffe c t.
I t happens
th a t , u n d e r p r e se n t c irc u m sta n c e s, th ere is m u c h to b e sa id fo r ea ch
o f th ese ch a n g e s in p o lic y e m p h a sis o n g ro u n d s o th e r th a n d e b t
m a n a g e m e n t — th e first b e c a u se it w o u ld te n d to in cre a se th e r a te o f
e c o n o m ic g r o w th a n d th e se c o n d b e c a u se i t m ig h t r e s u lt in m o r e
e ffe c tiv e e c o n o m ic s ta b iliz a tio n .
I t is im p o r t a n t to e m p h a siz e , h o w e v e r , t h a t d e b t m a n a g e m e n t
sh o u ld n o t b e m o r e th a n a v e r y m a r g in a l c o n sid e ra tio n in a rr iv in g a t
d e cisio n s c o n c e rn in g th e p r o p e r p o lic y m ix .
W e sh o u ld se le c t th e
p ro p er c o m b in a tio n o f fisca l a n d m o n e t a r y p o lic ies, o n th e o n e h a n d ,
a n d th e p r o p e r m ix o f s e le c tiv e a n d g en era l m o n e ta r y c o n tr o ls o n th e
o th e r , o n th e b a sis o f th e im p a c t th e se p o licies h a v e u p o n th e e c o n
om y.
D e b t m a n a g e m e n t, w h ile a m a t t e r o f s o m e im p o r ta n c e , is
d is tin c tly s u b s id ia r y to th e se le c tio n o f p ro p er m o n e t a r y a n d fiscal
po licies fr o m th e s ta n d p o in t o f e c o n o m ic g r o w th a n d s t a b ility .
Open market operations versus reserve requirement changes
I n th e c o n d u c t o f its g en era l m o n e ta r y p o lic y d ir e c te d a t c o n tr o l o f
th e s u p p ly o f m o n e y a n d b a n k c re d it, th e F e d e r a l R e s e r v e h a s a ch oice
b e tw e e n th e u se o f o p e n m a r k e t o p e r a tio n s a n d c h a n g e s in m e m b e r
b a n k r eserv e re q u ir e m e n ts.
I n r e c e n t y e a r s, th e S y s t e m h a s relied
o n o p e n m a r k e t o p e r a tio n s fo r sh o r t-r u n s ta b iliz a tio n o f th e e c o n o m y ,
b u t a p p e a r s to b e e n g a g e d in a p r o g r a m o f sec u la r r e d u c tio n o f m e m
b e r b a n k reserv e r e q u ir e m e n ts.
R e s e r v e r e q u ir e m e n ts h a v e b e e n
lo w e re d s e v e r a l tim e s d u r in g th e recessio n s o f 1 9 5 3 - 5 4 a n d 1 9 5 7 - 5 8 ,
w h ile t h e y h a v e n o t b e e n in c re a se d sin ce 1 9 5 1 .
T h u s , re se rv e req u ire
m e n t s h a v e b e e n a d ju s t e d d o w n w a r d p a r tic u la r ly d u r in g recessio n
p e rio d s, a p p a r e n tly fo r th e p u r p o se o f s u p p ly in g th e reserv es n ee d ed
to s u p p o r t e c o n o m ic g r o w th .
T h e u se o f o p e n m a r k e t p u rc h a se s o f G o v e r n m e n t secu rities to
s u p p ly reserv es to th e b a n k in g s y s te m h a s an a d v a n ta g e , fr o m th e
s ta n d p o in t o f d e b t m a n a g e m e n t, o v e r re d u c tio n s in reserv e req u ire
m e n t s , sin ce o p e n m a r k e t p u rc h a se s te n d to re d u c e th e in te r e st c o st
to th e T r e a s u r y in tw o w a y s :
1.
I f reserv es are p r o v id e d b y b u y in g secu rities, th e in te re st r a te
d iffe re n tials b e tw e e n G o v e r n m e n t a n d p r iv a te sec u rities sh o u ld b e a
lit tle g re a te r th a n w o u ld b e th e case if r eserv e r e q u ir e m e n ts w ere
lo w e re d .
I f w e m a k e th e r e a so n a b le a s s u m p tio n t h a t th e m o n e t a r y
50438—60-----11
140
debt management in the united states
a u th o ritie s h a v e a “ t a r g e t ” le v e l o f c r e d it r e stric tio n w h ic h t h e y
wall a c h ie v e u n d e r eith er a rr a n g e m e n t a n d t h a t th is ta r g e t le v e l o f
c re d it r e stric tio n d e te rm in e s th e le v e l o f in te re st r a te s o n p r iv a te
d e b t , w e m a y su p p o se t h a t th ese p r iv a te in te re st r a te s w ill b e a p p r o x i
m a t e ly th e s a m e in eith er case.
H e n c e , in te re st r a te s o n G o v e r n m e n t
d e b t s h o u ld b e a lit tle lo w e r u n d e r a p o lic y o f b u y in g sec u rities.
2.
T h e r e w o u ld b e a fu r th e r in te re st s a v in g to th e T r e a s u r y fr o m
a p o lic y o f b u y in g sec u rities d u e to th e fa c t t h a t n e a r ly all (9 0 p e r c e n t,
to b e ex a c t) o f th e a d d e d in te r e st p a id o n secu rities h e ld b y th e F e d e r a l
R e s e r v e w o u ld b e r e tu rn e d to th e T r e a s u r y a t th e en d o f th e y e a r .
T h a t is to s a y , th e m a r g in a l t a x r a te a p p lic a b le to in te re st p a y m e n ts
re c e iv e d b y th e F e d e r a l R e s e r v e is h ig h e r th a n t h a t a p p lic a b le to
o th e r h o ld ers o f T r e a s u r y secu rities.
T o illu s tr a te th e p o ssib le m a g n itu d e s in v o lv e d , w e m ig h t c o n sid e r
th e s itu a tio n p r e v a ilin g in O c to b e r 1 9 5 9 .
I n t h a t m o n t h th e d a ily
a v e r a g e a m o u n t o f re q u ir e d r eserv es o f m e m b e r b a n k s a t th e p r e v a il
in g re se rv e r e q u ir e m e n ts (1 8 p e r c e n t, 1 6 ){ p e r c e n t, a n d 11 p e r c e n t fo r
d e m a n d d e p o sits a t c e n tra l R e s e r v e c it y , R e s e r v e c it y , a n d c o u n t r y
b a n k s , r e s p e c tiv e ly , a n d 5 p e rc e n t fo r t im e d e p o sits) w a s $ 1 8 .2 b illio n .
I f th e reserv e r e q u ir e m e n ts h a d b e e n a t th e m a x im u m p e r m it te d b y
p r e s e n t la w (2 2 p e r c e n t, 2 2 p e rc e n t, a n d 14 p e r c e n t fo r d e m a n d d e
p o s its , a t th e th re e c la sses o f b a n k s a n d 6 p e rc e n t fo r tim e d e p o s it s ),
re q u ir e d re se rv e s w o u ld h a v e b e e n $ 2 3 .1 b illio n .
I n th is s itu a tio n , if
re se r v e r e q u ir e m e n ts w ere ra ised to th eir m a x im u m le v e ls , th e F e d e r a l
R e s e r v e w o u ld h a v e t o b u y a p p r o x im a t e ly $ 5 .1 b illio n o f G o v e r n m e n t
s ec u rities i f its o b je c tiv e w a s t o k e e p th e s u p p ly o f m o n e y c o n s t a n t .8
T h e in te re s t o n th is a m o u n t o f d e b t , a t th e p r e se n t le v e l o f in te r e st
r a te s o f a b o u t 4 p e r c e n t, w o u ld b e a p p r o x im a t e ly $ 2 0 0 m illio n p e r
year.
A s s u m in g t h a t th e a v e r a g e t a x r a te a p p lic a b le to th is in te r e st
w a s 3 0 p e r c e n t, th ere w o u ld b e a s a v in g o f r o u g h ly $ 1 2 0 m illio n a y e a r
t o th e T r e a s u r y as a r e su lt o f sh iftin g th e se sec u rities in to th e h a n d s
o f th e F e d e r a l R e s e r v e , w h ic h is, in e ffe c t, s u b je c t t o a m a r g in a l t a x
r a te o f 9 0 p e rc e n t.
T h i s w o u ld b e th e s a v in g fr o m th e se c o n d o f th e
so u r c e s referre d to a b o v e .
T h e t o t a l m a r k e ta b le d e b t h e ld o u tsid e
th e T r e a s u r y in v e s tm e n t a c c o u n ts a n d th e F e d e r a l R e s e r v e a m o u n te d
t o $ 1 4 9 .5 b illio n a t th e e n d o f S e p te m b e r 1 9 5 9 .
T h u s , th e F e d e r a l
R e s e r v e p u r c h a se s o f $ 5 .1 b illio n n e e d e d to im p le m e n t th e sc h e m e
w o u ld h a v e a m o u n te d t o 3 .3 p e rc e n t o f th e m a r k e ta b le d e b t o u t s t a n d
in g .
I t s e e m s v e r y d o u b tfu l w h e th e r p u r c h a se s o f th is m a g n itu d e
w o u ld h a v e m u c h effe c t o n th e y ie ld d iffe re n tia ls b e tw e e n G o v e r n m e n t
a n d p r iv a t e s e c u r itie s; c o n s e q u e n tly , th e in te re st s a v in g fr o m th e first
so u rc e referre d to a b o v e w o u ld p r o b a b ly b e n e g lig ib le .
T h u s , th e
t o t a l s a v in g t o th e T r e a s u r y th e first y e a r w o u ld p r o b a b ly b e a b o u t
$ 1 2 0 m illio n .
I t sh o u ld b e n o te d t h a t th is s a v in g w o u ld b e re p e a te d
in e a c h fu tu r e y e a r , a n d th e r e w o u ld b e fu r th e r s a v in g s r e s u ltin g fr o m
t h e fa c t t h a t w it h th e h ig h e r reserv e r e q u ir e m e n ts it w o u ld b e n e c e s
s a r y t o b u y m o r e sec u rities th a n w o u ld o th e r w ise h a v e b e e n t h e c a se
in o rd er t o p r o v id e fo r fu tu r e g r o w th o f th e m o n e y s u p p ly .
T h e a b o v e e s tim a te re la te s to th e m a x im u m p o ssib le s a v in g a s s u m
in g t h a t th e F e d e r a l R e s e r v e r a ised re se rv e r e q u ir e m e n ts to th e m a x i
m u m le v e l p e rm issib le u n d e r p r e se n t la w a n d k e p t t h e m th e r e .
Such
8 Slightly larger purchases might be necessary to offset the loss of liquid assets by the public if the level of
income flow was to be held constant. In fact, an alternative objective instead of holding the money supply
constant might be to maintain a constant supply of bank credit; this would require soemwhat larger pur
chases. This matter is considered below.
DEBT MANAGEMENT IN THE UNITED STATES
141
a p o lic y h a s n o t b e e n p r o p o se d , b u t it h a s b e e n s u g g e ste d t h a t th e
F e d e r a l R e s e r v e sh o u ld d e sist fr o m fu r th e r r e d u c tio n s in reserv e r e
q u ir e m e n ts a n d , fr o m n o w o n , s u p p ly rese rv e s n ee d ed fo r g r o w th b y
p u r c h a s in g se c u r itie s.9 A s s u m in g th a t the m o n e y s u p p ly is p e r m itte d
to g ro w a t a ra te o f 3 p e r c e n t per a n n u m a n d t h a t a n average' in te re st
r a te o f 2 .8 p e rc e n t p r e v a ils , th e s a v in g to th e T r e a s u r y th a t w o u ld
resu lt fr o m th is p o lic y as c o m p a r e d w ith a p o lic y o f s u p p ly in g th e
n e c e s s a r y re se rv e s b y r e d u c in g re se r v e r e q u ir e m e n ts h a s b een e s ti
m a t e d a t a n a v e r a g e o f $ 4 5 m illio n p e r y e a r fo r th e n e x t 10 y e a r s .10
I t s e e m s clear t h a t th e s a v in g s to th e T r e a s u r y t h a t m ig h t r e su lt
fr o m in c re a se d relia n ce o n o p e n m a r k e t p u rc h a se s in s u p p ly in g r eserv es
to s u p p o r t g r o w th o f th e m o n e y s u p p ly , w h ile p e rh a p s n o t a m a t t e r
o f m a jo r im p o r ta n c e , are b y n o m e a n s n eg lig ib le .
H o w e v e r , in o rd er
to a ssess th e d e sir a b ility o f p la c in g g re a te r relia n ce o n o p e n m a r k e t
p u rc h a se s a s a m e a n s o f s u p p ly in g m e m b e r b a n k r e se r v e s, it is n e c e s
sa r y to c o n sid e r th e o th e r d iffe re n ce s in th e e ffe cts o f su c h p u rc h a se s
as c o m p a r e d w ith r eserv e r e q u ir e m e n t r e d u c tio n s.
T h e r e a re tw o
su ch effe c ts to b e c o n sid e r e d .
F ir s t, r eserv e r e q u ir e m e n t r e d u c tio n s
te n d to r e s u lt in h ig h e r p r o fits fo r c o m m e r c ia l b a n k s th a n are p r o d u c e d
b y o p e n m a r k e t p u r c h a s e s ; se c o n d , r eserv e r e q u ir e m e n t r e d u c tio n s
in crease th e “ le v e r a g e ” o f m o n e t a r y c o n tr o ls w h e re a s o p e n m a r k e t
p u rc h a se s d o n o t a ffe c t th e “ le v e r a g e .”
L e t u s c o n sid e r e a c h o f th ese
effe cts b rie fly .
1.
I t se e m s lik e ly t h a t re se rv e r e q u ir e m e n t r e d u c tio n s d o h a v e a
m o r e fa v o r a b le e ffe c t o n b a n k ea rn in g s th a n d o o p e n m a r k e t p u r c h a se s.
T h is is s im p ly d u e to th e fa c t t h a t w it h lo w e r r e se r v e r e q u ir e m e n ts ,
th e ra tio o f ea rn in g a ssets to t o t a l b a n k a sse ts w ill b e h ig h e r.
H ow
e v e r , th e q u a n t it a tiv e effe c ts a re n o t e a s y to e s tim a te .
O n e stu d y
w h ic h a s s u m e s t h a t th e m o n e y s u p p ly g ro w s a t a r a te o f 3 p e rc e n t per
a n n u m e s tim a te s t h a t m e m b e r b a n k n e t p ro fits w o u ld a v e r a g e a b o u t
$ 4 0 m illio n p e r y e a r h ig h e r o v e r a 1 0 -y e a r p e rio d if r e se r v e s are s u p
p lie d b y r e d u c in g reserv e r e q u ir e m e n ts th a n if t h e y are su p p lie d b y
o p e n m a r k e t p u r c h a s e s .11 I t m a y b e n o t e d , h o w e v e r , t h a t th ere is a
q u e s tio n w h e th e r th e m o n e y s u p p ly sh o u ld b e a s s u m e d to g r o w a t th e
s a m e r a te w h e th e r rese rv e s a re su p p lie d o n e w a y o r th e o th e r .
An
a lte r n a tiv e a s s u m p tio n , w h ic h is p e rh a p s ju s t as r e a s o n a b le a n d w o u ld
le a d to r a th e r d iffe re n t c o n c lu sio n s, is t h a t th e v o lu m e o f b a n k c red it
(i.e ., lo a n s a n d in v e s tm e n t s ) w o u ld b e th e q u a n t it y w h o se g r o w th w o u ld
b e k e p t th e s a m e u n d e r eith er p o lic y .
I f th is w e re th e case , b a n k
p r o fits s h o u ld b e a t le a s t a p p r o x im a t e ly th e s a m e u n d e r eith er p o li c y .12
I t s e e m s p r o b a b le t h a t th e b a n k s w o u ld b e m a d e w o r se o ff b y h ig h e r
re s e r v e r e q u ir e m e n ts , b u t it is e x tr e m e ly d iffic u lt to m a k e a r e a listic
e s tim a te o f th e m a g n itu d e o f th e e ffe c t.
9 This was the purpose of the proposed “sense of Congress” amendment to the legislation to raise the
interest-rate ceiling of 4H percent applicable to Government securities having a maturity of more than 5
years, which was consdered but not acted upon during the 1st sess. of the 86th Cong. See the state
ment and testimony by Rep resentative Henry S. Reuss in “ Public Debt Ceiling and Interest Rate Ceiling
on Bonds/’ hearings before the Committee on Ways and Means, House of Representatives, June 10, 11,
and 12, 1959 (Washington: Government Printing Office, 1959), pp. 253-261.
This estimate is taken from an unpublished study by Prof. John H. Kareken.
11This estimate is based on an unpublished study by Prof. John H. Kareken.
12 If the objective was the maintenance of a constant income flow, it would appear that the resulting policy
would lead to a result lying somewhere between one which would produce the same growth in the money
supply under either policy and one which would lead to the same growth of bank earning assets. It may
be noted also that it is not safe to assume that the average net return on additional earning assets will be the
same whether reserves for growth are supplied by open market purchases or by reserve requirement reduc
tions. Since reserve balances are riskless assets, when the banks hold larger reserves, they may feel justified
in assuming somewhat greater risks on the remainder of their assets and thus be able to earn higher returns
per dollar of earning assets.
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DEBT MANAGEMENT IN THE UNITED STATES
2.
T h e d iffe re n tia l effe cts o f th e tw o p o lic ies o n th e le v e ra g e o f
m o n e t a r y c o n tr o ls sh o u ld n o t b e d ism isse d lig h tly .
A c c o r d in g to th e
s t u d y re fe rre d to a b o v e , if reserv es w e re su p p lie d to s u p p o r t a 3 p e r
c e n t p e r a n n u m g ro w th o f th e m o n e y s u p p ly b y r e d u c in g reserv e r e
q u ir e m e n ts , a v e r a g e m e m b e r b a n k r eserv e r e q u ir e m e n ts w o u ld b e
r e d u c e d fr o m th e p r e se n t le v e l o f a p p r o x im a t e ly 15 p e r c e n t to a b o u t
11 p e rc e n t a t th e e n d o f th e d e c a d e .
A llo w in g fo r a c a sh d ra in o f 10
p e rc e n t o f d e m a n d d e p o sits, w h ic h is a p p r o x im a t e ly th e m a r g in a l r a tio
o f th e e x p a n sio n o f c u rr e n c y o u tsid e b a n k s to th e e x p a n sio n o f d e m a n d
d e p o s its a d ju s t e d fo r th e d e c a d e 1 9 4 8 - 5 8 , th e c o e fficie n t o f c o m m e r
c ia l b a n k c red it ex p a n sio n is a b o u t 4 .4 fo r a re se rv e r e q u ir e m e n t o f 15
p e rc e n t a n d a b o u t 5 .2 fo r a re se rv e r e q u ir e m e n t o f 11 p e r c e n t.13
T h u s , a p o lic y o f r e d u c in g r eserv e r e q u ir e m e n ts w o u ld , o v e r th e 1 0 y e a r p e rio d , r e su lt in a n in crease o f a p p r o x im a t e ly 18 p e rc e n t in th e
c o e fficie n t o f b a n k c re d it ex p a n sio n .
T h is w o u ld m e a n t h a t b y th e
e n d o f th e p e rio d a c h a n g e o f $ 8 2 in excess re se rv e s w o u ld h a v e a p
p r o x im a t e ly th e s a m e effe c t on th e s u p p ly o f m o n e y a n d c re d it a s a
change o f $ 1 0 0 n ow h as.
S in c e th e slo w n e ss w it h w h ic h m o n e t a r y
p o lic y m a k e s its effe c ts fe lt o n th e e c o n o m y se e m s to b e p a r t ly d u e to
th e n e e d to c a r r y o u t a la rg e v o lu m e o f o p e r a tio n s to a c c o m p lis h a
g iv e n r e s u lt, s u c h a n in cre ase in th e coefficien t o f ex p a n sio n m ig h t b e
q u it e h e lp fu l.
I t m a y b e n o t e d in th is c o n n e c tio n t h a t th e fle x ib ility
o f o p e n m a r k e t o p e r a tio n s m a k e s su ch o p e r a tio n s th e b e s t in s tr u m e n t
t o u se fo r c y c lic a l a n d sh o r t-r u n m o n e t a r y a d ju s t m e n ts , a n d a n in
crea se in th e le v e ra g e r e d u c e s th e v o lu m e o f su c h o p e r a tio n s n e e d e d
to p r o d u c e a g iv e n e ffe c t.
E v a lu a t io n o f th e d e sir a b ility o f o p e n m a r k e t o p e r a tio n s a s c o m
p a r e d w it h re se r v e r e q u ir e m e n t re d u c tio n s a s a m e a n s o f s u p p ly in g
r e s e r v e s see m s to in v o lv e a d e cisio n a s to w h e th e r th e in c re a se d le v e r
a g e o f m o n e ta r y p o lic y r e su ltin g fr o m lo w e r re se rv e r e q u ir e m e n ts is
w o r th th e c o s t in te r m s o f a d d itio n a l in te re st p a y m e n ts b y th e T r e a s
u ry.
T h e q u e stio n o f b a n k p ro fits a lso en ters in , b u t a p r o p e r e v a lu
a tio n o f th is q u e s tio n w o u ld re q u ire m o r e a c c u r a te e stim a te s th a n a re
n o w a v a ila b le c o n c e rn in g th e effects o f a lte r n a t iv e p o licies o n su c h
p r o fits , to g e th e r w ith s o m e k in d o f ju d g m e n t as to w h e th e r p ro fits a re
a d e q u a t e a t th e p r e se n t t im e .
I t w o u ld se e m a p p r o p r ia te fo r th e
F e d e r a l R e s e r v e S y s t e m to in d ic a te w h a t a s s u m p tio n s a n d ju d g m e n t s
c o n c e rn in g a ll o f th ese m a t t e r s (a n d p e rh a p s o th e r c o n sid e r a tio n s it
fe e ls are in v o lv e d ) it h a s b e e n u sin g a s a b a sis fo r th e p r o g r a m o f
se c u la r r e d u c tio n in re se rv e re q u ir e m e n ts it a p p e a rs to h a v e b e e n en
g a g e d in .
POSSIBLE IN N O VA TIO N S IN DEBT M AN A G E M EN T TECH N IQ U E
G iv e n (1) th e m ix b e tw e e n m o n e t a r y a n d fisca l p o lic y , (2 ) th e m ix
b e tw e e n g en era l a n d se le c tiv e m o n e t a r y c o n tr o ls, (3 ) th e m ix b e tw e e n
o p e n m a r k e t o p e r a tio n s a n d r e se r v e r e q u ir e m e n t a d ju s t m e n t s in th e
c o n d u c t o f g e n e r a l m o n e t a r y p o lic y , a n d (4 ) th e s tr u c tu r e o f th e d e b t
c u r r e n tly o u t s t a n d in g , th e a p p r o x im a te sc o p e o f th e T r e a s u r y 's d e b t
m a n a g e m e n t p r o b le m s is d e te r m in e d .
I t w a s su g g e s te d a b o v e t h a t
th e T r e a s u r y sh o u ld m a n a g e th e d e b t w ith a v ie w to le n g th e n in g m a
tu r itie s — a t le a s t u n d e r p r e se n t c ir c u m sta n c e s— in o rd er to tig h te n u p
13 With a cash drain, the coefficient of expansion is equal to (l+c)/(r+c), where c is the marginal ratio of
currency to demand deposits and r is the reserve requirement for demand deposits.
DEBT MANAGEMENT IN THE UNITED STATES
143
th e fin a n cia l s y s te m and p r o v id e a n e n v ir o n m e n t in w h ic h m o n e t a r y
co n tr o ls m a y w o r k m o r e e ffe c tiv e ly , w h ile a t th e s a m e t im e g iv in g
d u e c o n sid e ra tio n to k e e p in g d o w n th e in te re st c o s t.
W e tu r n o u r
a tt e n t io n n o w to th e q u e stio n o f th e tec h n iq u e s to b e e m p lo y e d in
h a n d lin g d e b t o p e r a tio n s .
I t is q u ite cle ar t h a t th e te c h n iq u e s e m
p lo y e d s h o u ld , in so fa r a s p o ssib le , b e th e o n e s w h ic h p e r m it th e
T r e a s u r y to sell th e d esired secu rities a t m in im u m c o s t u n d e r a n y
g iv e n c irc u m s ta n c e s.
S e v e r a l c h a n g es in te c h n iq u e w h ic h are w o r t h y
o f c o n sid e r a tio n can b e su g g e ste d .
Auctioning oj longer term securities
T h e a u c tio n m e t h o d o f sellin g n e w secu rities h as p r o v e d to b e h ig h ly
s u c c e ssfu l in c o n n e c tio n w ith th e m a r k e tin g o f T r e a s u r y b ills .14 T h e r e
m ig h t b e s o m e a d v a n ta g e s in u sin g th is s a m e m e t h o d in se llin g n e w
issu es o f in te r m e d ia te a n d lo n g e r te r m se c u r itie s.15 U n d e r th is a r
r a n g e m e n t, th e T r e a s u r y w o u ld se t th e c o u p o n r a te o n n e w n o te s o r
b o n d s a n d call fo r b id s b y in v e sto rs w h o w o u ld s p e c ify th e a m o u n ts
th e y w o u ld ta k e a n d th e prices t h e y w o u ld p a y .16 T h e T r e a s u r y
w o u ld a c c e p t b id s, s ta r tin g w ith th e h ig h e st a n d g o in g d o w n th e list
as fa r as n e c e ssa ry to raise th e a m o u n t o f fu n d s n e e d e d .
O n e o f th e p o ssib le a d v a n ta g e s o f th e a u c tio n te c h n iq u e is th a t it
m ig h t re d u c e th e in te re st c o sts o f th e T r e a s u r y .
O n e p o t e n tia l so u rce
o f in te re s t s a v in g w o u ld b e th e p o s s ib ility o f c o lle c tin g s o m e c o n s u m
ers’ su r p lu s — i.e ., ea c h b lo c k o f secu rities w o u ld b e s o ld a t th e h ig h e st
p rice th e in v e s to r w o u ld b e w illin g to p a y , w h e re a s u n d e r th e p r e se n t
a rr a n g e m e n t e v e r y o n e is, in e ffe c t, p a id th e p rice n e c e ssa r y to a tt r a c t
th e le a s t w illin g b u y e r .
I n a d d itio n , th e T r e a s u r y a t p r e se n t feels th e
n e e d to s e t th e c o u p o n r a te a lit tle o n th e h ig h sid e— i.e ., to sw e eten
th e o fferin g a lit tle — to in su re th e su c c ess o f th e o p e r a tio n .
T h is
fr e q u e n tly re s u lts in th e secu rities r isin g a lit tle in p rice s h o r t ly a fte r
issu a n c e, g iv in g s p e c u la tiv e p ro fits to free rid ers.
T h is te n d e n c y
w o u ld b e e lim in a te d if th e a u c tio n te c h n iq u e c o u ld b e su c c e ssfu lly
a p p lie d .
I t s h o u ld b e n o t e d , o n th e o th e r h a n d , t h a t a u c tio n in g w o u ld
im p o s e a s o m e w h a t g re a te r risk o n th e in v e s to r ; c o n s e q u e n tly it is n o t
a b s o lu te ly c e rta in t h a t it w o u ld lo w e r in te re st c o sts to th e T r e a s u r y .
O n b a la n c e , h o w e v e r , it d o es se e m p o ssib le t h a t s o m e s a v in g in in te re st
c o s ts w o u ld re s u lt fr o m th e su c c e ssfu l a d o p tio n o f a u c tio n in g .
T h e p r e se n t b ill a u c tio n s in te rfe re s c a r c e ly a t a ll w it h th e F e d e r a l
R e s e r v e ’s fr e e d o m o f a c tio n in a p p ly in g a r e s tr ic tiv e p o lic y in tim e s o f
in fla tio n , w h e re a s w ith th e te c h n iq u e s p r e s e n tly in u se, o fferin g s o f
lo n g e r te r m sec u rities fr e q u e n tly n e c e ssita te a r e la x a tio n o f a p o lic y o f
a c tiv e r e stric tio n d u r in g th e o ffe rin g p e rio d .
A u c tio n in g o f lo n g e r
See ch. II.
« The auction method as a device for selling new Treasury securities should not be confused with the
possible organization of the market for existing securities as an auction or exchange market. The question
whether the market for existing securities should continue to be organized, as it is at present, as a negotiated
or over-the-counter market or should be reorganized as an auction or exchange market is discussed in “Treassury-Federal Reserve Study of the Government Securities Market” (1959), pt. I, pp. 71-108. The conclusion
reached there is that the present organization is probably preferable, chiefly because the large size of many
transactions in Government securities would create difficulties in an auction market. Auctioning of new
Treasury securities is also different from competitive bidding in connection with the sale of new corporate
and municipal bonds. Here underwriting syndicates are formed among investment banking firms which
submit bids for the issue. The entire issue is sold to the lowest bidder who then redistributes the securities
to ultimate investors, normally at a price a little higher than that paid to the issuing corporation or munici
pality. Auctions of Treasury securities would invite the participation of all investors and would not involve
the formation of underwriting syndicates to buy up an entire issue.
is In the case of Treasury bills, it is not necessary to set a coupon rate since they are sold on a straight
discount basis—i.e., for a 91-day bill the investor bids something less than the maturity value of $1,000, his
bid determining the yield he is willing to accept. The $1,000 he receives at the end of 91 days represents the
return of his principal plus his interest return. In the case of longer term securities, it would be necessary to
set a coupon rate to determine the size of the periodic payment of interest to be made to the holder.
144
DEBT MANAGEMENT IN THE UNITED STATES
t e r m s ec u rities m ig h t r e d u c e th e e x te n t to w h ic h T r e a s u r y fin a n cin g
in te rfe r e s w it h th e fr e e d o m o f th e F e d e r a l R e s e r v e .
H o w e v e r , it m a y
w e ll b e t h a t o ffe rin g s o f lo n g e r te r m secu rities are b o u n d to im p in g e
s o m e w h a t o n th e F e d e r a l R e s e r v e 's fr e e d o m o f a c tio n a n d t h a t th e
a u c tio n te c h n iq u e w o u ld d o little to r e so lv e th e p r o b le m .17
T h e c h ief d is a d v a n ta g e o f a u c tio n in g , a c c o rd in g to th e T r e a s u r y ,
is t h a t s o m e s m a ll in v e sto r s w h o n o w b u y n e w issu es o f T r e a s u r y
b o n d s w o u ld n o t p a r tic ip a te in a u c tio n s b e c a u se t h e y w o u ld n o t feel
c o n fid e n t o f th e ir a b ilit y to ju d g e m a r k e t tre n d s to th e d e g ree n e c e s
s a r y to m a k e in te llig e n t b i d s .18 P r o b a b ly th e seriou sn ess o f th is d if
fic u lt y is c o n s id e r a b ly e x a g g e r a te d , sin ce it se e m s d o u b tfu l w h e th e r
th e q u a n t it a tiv e im p o r ta n c e o f sa les to s m a ll in v e s to r s o f th e t y p e
referred to is v e r y g r e a t.
A m o r e seriou s p r o b le m a n d o n e w h ic h sh o u ld b e e x p lo r e d c a r e fu lly
in c o n n e c tio n w ith a n e x te n sio n o f th e a u c tio n d e v ic e , is th e p o s s ib ility
t h a t th e b id d in g w o u ld b e d o m in a te d b y a s m a ll g ro u p o f m a r k e t p r o
fe s s io n a ls , w ith an a t t e n d a n t d a n g e r o f c o llu sio n , o u t r ig h t o r t a c it.
T h e e x te n t o f th is d a n g e r w o u ld d e p e n d u p o n th e n u m b e r o f b id s t h a t
c o u ld b e e x p e c te d a n d th e e x te n t to w h ic h a s m a ll n u m b e r o f b id s b y
la rg e in s titu tio n a l in v e s to r s a n d p r o fe ssio n a l dealers a n d tra d e rs m ig h t
d o m in a t e th e m a r k e t.
I n th e b ill a u c tio n s , se v e r a l h u n d r e d b id s a re
a p p a r e n tly t y p ic a lly r e c e iv e d .
H o w e v e r , in th e case o f lo n g e r t e r m
se c u r itie s, th e n u m b e r o f b id s w o u ld d o u b tle ss b e sm a lle r , a n d it w o u ld
a p p e a r t h a t c o llu siv e b id d in g m ig h t b e a seriou s p o s s ib ility .
I f a u c tio n in g w ere to b e a p p lie d to r e fu n d in g o p e r a tio n s, it w o u ld
b e n e c e s s a r y to sell th e n e w secu rities fo r c a sh w h ic h w o u ld t h e n b e
u s e d to retire th e m a t u r in g sec u rities.
I t is p o ssib le t h a t s o m e sa le s
m i g h t b e lo s t, sin ce s o m e in v e sto r s w h o w o u ld tu r n th e o ld s e c u r ity
in fo r th e n e w o n e u n d e r a n e x c h a n g e p ro ce d u re m ig h t n o t p a r tic ip a te
in th e a u c t io n in g .19 H o w e v e r , w h e n a se c u r ity rea ch e s m a t u r it y it
is a liq u id s h o r t -t e r m in v e s tm e n t a n d is lik e ly to b e in th e h a n d s o f
a n in v e s to r w h o is in te re ste d in su ch a n in s tr u m e n t.
N e w lo n g -t e r m
se c u r itie s, o n th e o th e r h a n d , a p p e a l to a d iffe re n t t y p e o f in v e s to r ,
o n e w h o h a s s a v in g s to in v e s t o n a p e r m a n e n t b a sis or w h o b u y s to
re se ll fo r s h o r t-r u n s p e c u la tiv e p r o fit.
C o n s e q u e n tly , u n d e r p r e se n t
a r r a n g e m e n ts th ere is a c o n sid e r a b le a m o u n t o f tr a d in g in th e m a r k e t
p r io r to a n e w e x c h a n g e o ffe rin g , as h o ld e r s o f r ig h ts (t h a t is, th e
m a t u r in g secu rities) w h o d o n o t w a n t th e n e w s e c u r ity sell s u c h r ig h ts
t o o th e r in v e s to r s w h o d o w a n t it .
A t t im e s , th is la rg e v o lu m e o f
m a r k e t a c t i v i t y ca u se s d ifficu ltie s, a n d it m ig h t b e a n a d v a n t a g e o f
th e a u c t io n te c h n iq u e t h a t it w o u ld e lim in a te th e n e e d fo r su c h
a c tiv ity .
A n o t h e r p o ssib le a d v a n ta g e o f th e a u c tio n te c h n iq u e is t h a t it w o u ld
e lim in a te th e n e e d fo r th e T r e a s u r y to c o n su lt w it h in s tit u tio n a l in
v e s to r s a n d m a r k e t p r o fe ssio n a ls in th e p ro cess o f d e te r m in in g w h a t
p ric e to p u t o n its issu es.
H o w e v e r , it w o u ld s t ill b e n e c e ssa r y to
c o n s u lt m a r k e t e x p e rts o r to r e ly u p o n in fo r m a tio n c o lle c te d in o th e r
17 The Treasury itself has expressed the view that extended use of auctioning would not lessen the extent
to which debt management interferes with the freedom of monetary policy. See “ Employment, Growth,
and Price Levels,” hearings before the Joint Economic Committee, 86th Cong., 1st sess., pt. 6C-, pp. 17391740.
is Ibid., p. 1736.
is One student of debt management has suggested that the Treasury handle refunding operations by
offering a new security in exchange at a fixed price and at the same time offering an unspecified amount of
the same security at competitive auction for cash. The size of the cash offering would then be set at the
amount needed to cover attrition on the exchange. See T. C. Gaines, “ Techniques of Treasury Debt
Management” (unpublished Ph. D. dissertation, Columbia University, 1959), pp. 547, 555, and 563.
DEBT MANAGEMENT IN THE UNITED STATES
145
w a y s in o rd er to d e c id e u p o n th e t im in g a n d m a t u r it y s e c to r o f p r o s
p e c tiv e lo n g e r te r m issu es.
A fin a l a d v a n ta g e o f th e a u c tio n m e t h o d is t h a t it w o u ld e fim in a te
th e c o n fu s io n a n d u n c e r ta in ty t h a t n o w ex ists c o n c e rn in g a llo tm e n t s
o f ca sh o ffe rin g s.
U n d e r p r e se n t a r r a n g e m e n ts, w h e n a n o ffe r in g is
o v e r s u b s c r ib e d , as is o rd in a rilly th e case , a n in v e s to r c a n n o t te ll w ith
a n y a c c u r a c y w h a t p r o p o r tio n o f h is s u b sc r ip tio n w ill b e a llo te d to
h im .
I n o th e r w o r d s, th e T rea su ry ' m u s t esta b lish s o m e k in d o f a rb i
t r a r y ru les to r a tio n th e secu rities.
I n s t it u t io n a l in v e s to r s , su c h as
life in su ra n c e c o m p a n ie s a n d sa v in g s b a n k s , h a v e in d ic a te d t h a t th e
u n c e r ta in ty a b o u t a llo tm e n ts is a sig n ific a n t d e te rr e n t to th e ir p a r
tic ip a tio n in n e w o ffe rin g s.
U n d e r th e a u c tio n m e t h o d , th is p r o b le m
w o u ld b e s o lv e d , sin ce a n in v e s to r c o u ld r e ly u p o n g e t tin g th e fu ll
a m o u n t o f secu rities fo r w h ic h h e p la c e d b id s , p r o v id e d h is b id s w ere
h ig h e n o u g h to b e a m o n g th o se a c c e p te d b y th e T r e a s u r y .20
T h e T r e a s u r y its e lf h a s ex p resse d its o p p o s itio n to th e a u c tio n
m e t h o d as a p p lie d to lo n g e r te r m secu rities a n d h a s in d ic a te d a n u m b e r
o f re a so n s w h y i t d o es n o t b e lie v e th e m e t h o d w o u ld w o r k w e ll.21
M o s t o f th e se rea so n s a p p e a r to th e p r e se n t w riter to b e m e r e ly
su rm ise s, th e v a lid it y o f w h ic h c a n o n ly b e te ste d b y g iv in g th e
m e t h o d a seriou s tria l.
O n e o b je c tio n , r a ised b y th e T r e a s u r y a n d
also b y s e v e r a l dealers in G o v e r n m e n t sec u rities, m o s t o f w h o m o p p o se
a u c tio n in g , is t h a t th e in te r e st c o st to th e T r e a s u r y w o u ld b e in
c reased a t tim e s w h e n c red it is t ig h t a n d in te r e st r a te s r isin g .22 W h i le
th is m ig h t w e ll tu rn o u t to b e th e case , th o se w h o t a k e th is p o s itio n
d o n o t a d v a n c e a n y v e r y c o n v in c in g a r g u m e n ts .
T h e r e are te c h n ic a l
d ifficu lties r e la te d to th e h a n d lin g o f d isc o u n ts o n th e sa le o f b o n d s
u n d e r p r e se n t t a x r e g u la tio n s, b u t th ere is n o re a so n w h y th e se diffi
cu ltie s c o u ld n o t b e iro n ed o u t b y a p p r o p r ia te c h a n g es in th e r e g u
la tio n s .23
W e m a y c o n c lu d e t h a t th e p o ssib le a d v a n ta g e s to th e T r e a s u r y fr o m
u se o f th e a u c tio n m e th o d in m a r k e tin g lo n g e r te r m sec u rities cer
t a in ly a p p e a r s u ffic ie n tly p r o m isin g to ju s t i f y s o m e e x p e r im e n ta tio n
w ith th e te c h n iq u e .
Smaller and more frequent offerings
I t is p o s s ib le t h a t s m a ll o ffe rin g s o f lo n g e r te r m sec u rities m a d e a t
fr e q u e n t in te r v a ls w o u ld h e lp th e T r e a s u r y to secu re a la rg er sh a re o f
t h e c u rre n t flo w o f s a v in g .
S a le o f la rg e b lo c k s o f lo n g -te r m sec u rities
m a y r e q u ir e eith er e x te n siv e resh u fflin g o f p o r tfo lio s a s in v e sto rs sell
e x is tin g sec u rities to m a k e r o o m fo r th e n e w o ffe rin g o r s u b s ta n tia l p u r
c h a se s o f a n u n d e rw ritin g n a tu r e b y , s a y , c o m m e r c ia l b a n k s a n d
G o v e r n m e n t s e c u r ity d e a lers, w h o th e n fe e d th e sec u rities in to th e
20 One of the objections of the Treasury itself to the auction method for selling longer term securities is
that under this method it is difficult to control the amount of securities issued to “ any single investor or
investor class.” In particular, it seems to be concerned that it would be difficult to limit commercial bank
subscriptions and allotments. (“ Employment, Growth, and Price Levels,” hearings, pt. 6C, op. cit., pp.
1736-1737.) The Treasury seems obsessed with the idea that commercial bank subscriptions are bad,
apparently on the ground that during inflationary periods they result in an increase in the money supply.
However, this objection has little if any validity under a regime of flexible monetary policy in which the
Federal Reserve exerts effective control over the credit base. Under these conditions, if the Treasury pre
empts part of the supply of bank credit, there is no net increase in the money supply but merely a corre
sponding reduction in the amount of money that can be created by loans to the private sector. In fact,
commercial bank underwriting of shorter term issues through the use of tax and loan account credits has
been very helpful to the Treasury, and, as indicated in ch. II, the Treasury has weakened its position un
necessarily by discouraging bank subscriptions to longer term securities and discriminating against banks
in determining allotments.
21 “ Employment, Growth, and Price Levels,” hearings, pt. 60. op. cit., pp. 1736-1739,
22Ibid., pp. 1737, 1887-1902.
23Ibid., pp. 1738-1739,
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DEBT MANAGEMENT IN THE UNITED STATES
m a r k e t o v e r a p e rio d o f tim e a s cu rren t sa y in g s b e c o m e a v a ila b le fo r
in v e s tm e n t .
S m a ll o ffe rin g s w h ich ta p c u rre n t flo w s o f s a v in g a s t h e y
b e c o m e a v a ila b le m ig h t b e m o r e efficient.
O n e d iffic u lty w it h sm a ll o fferin g s w h ic h w ere m a d e fr e q u e n t ly is
t h a t s u c h a te c h n iq u e w o u ld p r o b a b ly r eq u ire th e r e p e a te d r e o p e n in g
o f e x istin g is s u e s ; o th e r w ise th e n u m b e r o f s e p a r a te issu es w o u ld b e
c o m e u n d u ly la rg e .
T h e fr e q u e n t r e o p e n in g o f e x istin g issu es m ig h t
t e n d to u n d e rm in e th e w o r k in g o f th e s e c o n d a r y m a r k e t in th e se issu es,
sin c e in v e s to rs m ig h t c o m e t o a n tic ip a te p e rio d ic d e c lin es in th e p rices
o f th e issu es a t th e t im e o f r e o p e n in g s a s th e m a r k e t w a s c a lle d u p o n
t o a b s o r b a d d itio n a l a m o u n ts o f sec u rities.
U n d e r th e se c o n d itio n s ,
in v e s to r s m ig h t h e s ita te t o b u y th e se secu rities in th e m a r k e t b e tw e e n
s u c c e ssiv e T r e a s u r y o ffe rin g s, w it h th e r e su lt t h a t tr a d in g w o u ld d r y
u p a n d th e issu es b e c o m e u n a ttr a c tiv e .
D u r in g th e p e rio d M a y - A u g u s t 1 9 3 5 , th e T r e a s u r y e x p e r im e n te d
w it h fr e q u e n t s m a ll o ffe rin g s so ld a t c o m p e t it iv e b id d in g t h r o u g h th e
r e o p e n in g o f e x istin g issu es.
I n t h a t case , th e r e su lts w e re a s in d ic a te d
above.
T h e p rices o f th e secu rities in v o lv e d d e c lin ed r a th e r s t e a d ily ,
th e v o lu m e o f b id s r e c e iv e d fe ll o ff, a n d in v e s to r in te re st d ried u p , so
t h a t th e s c h e m e w a s a b a n d o n e d .24 T h is e p iso d e is s o m e tim e s c ite d a s
e v id e n c e t h a t th e a u c tio n te c h n iq u e d o es n o t w o r k w e ll in th e sa le o f
lo n g e r te r m se c u r itie s, b u t th e ex p erien ce se e m s m o r e p r o p e r ly a t t r i b
u t a b le to th e fa c t t h a t th e o fferin g s w ere r e la tiv e ly s m a ll a n d in v o lv e d
th e r e o p e n in g o f e x istin g issu es t h a n to th e fa c t t h a t th e a u c t io n
m e t h o d w a s e m p lo y e d .25
I t sh o u ld b e p o ssib le to d e v ise w a y s to g e t a ro u n d th is d iffic u lty .
F o r e x a m p le , th e T r e a s u r y c o u ld e m p lo y a m e t h o d o f r a n d o m
s e le c tio n (e .g ., b y d r a w in g lo ts ) to d e te rm in e w h ic h o f a n u m b e r
o f issu es sp rea d o v e r a c o n sid e ra b le m a t u r it y r a n g e w a s to b e r e
o p e n e d ea ch tim e .
T h u s , th e lik e lih o o d o f a n y p a r tic u la r issu e
b e in g r e o p e n e d w o u ld b e r e la tiv e ly s m a ll so t h a t th e t e n d e n c y fo r
th e s e c o n d a r y m a r k e t to d r y u p w o u ld b e a v o id e d .26
I t m ig h t a p p e a r t h a t a n in crease in th e fr e q u e n c y o f o ffe rin g s
w o u ld m e a n a n in crease in th e e x te n t to w h ic h d e b t m a n a g e m e n t
w o u ld in te rfere w ith th e F e d e r a l R e s e r v e ’s fr e e d o m o f a c tio n in
c o n d u c tin g m o n e ta r y p o lic y , e sp e c ia lly w h e n a r e str ic tiv e p o lic y w a s
c a lle d fo r .
H o w e v e r , th e o p p o site m ig h t w e ll b e t r u e — t h a t th e
sm a lln e s s o f th e o ffe rin g s w o u ld re su lt in a m in im u m o f in te rferen c e.
I n th is c o n n e c tio n , r e g u la r ity m ig h t b e im p o r t a n t .
I f th e T r e a s u r y
w ere to m a k e a s m a ll o ffe r in g o f b o n d s , p e rh a p s u sin g th e a u c tio n
m e t h o d e a c h m o n t h , in v e s to r s w o u ld b e a b le to p la n o n th e b a sis o f
th e se o ffe rin g s a n d m ig h t d e v e lo p th e p r a c tic e o f s e t t in g a sid e a
c e r ta in p o r tio n o f th eir c u rren t in flo w s o f fu n d s fo r in v e s tm e n t in
th e s e sec u rities, a n d th e o ffe rin g s w o u ld p r o b a b ly c o m e to b e a r o u tin e
24In May 1935, the Treasury reopened a 3-percent bond of 1946-48 which had originally been sold in June
1934. Tenders were received for $270.1 million, of which $98.8 million were accepted at an average price
of 103^2. The same issue was again reopened in June tenders amounting to $461.3 million, of which $112.7
million were accepted at an average price of 1031^ 2. In July 1935, an issue of 2^-percent bonds, originally
sold in March 1935, was reopened. Tenders of $511.0 million were received, of which $102.0 million were
accepted at an average price of 1011*^2. This issue was again reopened later in July, tenders dropping to
$231.0 million, of which the Treasury accepted $106.5 million at an average orice of 101*$$2. When the same
issue was reopened for a third time in August, tenders fell to $147.3 million, of which $98.5 million were
accepted at an average price of 1002H 2.
2« One more effort was made to use the auction method in August 1935. This was in connection with an
offering of $100 million of lK-percent Federal Farm Mortgage Corporation 4-year notes. This offering was
a failure in the sense that tenders amounted to only $85.6 million, of which $85.3 million were accepted at
an average price of 99. The auction method has not been used to sell any security other than Treasury
bills since that time.
261 am indebted to Prof, John Lintner for this suggestion,
DEBT MANAGEMENT IN THE UNITED STATES
147
m a t t e r w h ich w o u ld in te rfere v e r y little w ith th e fr e e d o m o f m o n e t a r y
p o lic y .27 H o w e v e r , th e d iffic u lty w ith reg u la rizin g o ffe rin g s in th is
w a y is t h a t it w o u ld p u t th e T r e a s u r y a t th e m e r c y o f th e m a r k e t a n d
a t tim e s w o u ld a lm o s t c e r ta in ly req u ire th e p a y m e n t o f e x tr e m e ly
h ig h in te re st c o sts.
I n th e o p in io n o f th e p rese n t w riter, th is d is
a d v a n ta g e w o u ld p r o b a b ly b e seriou s e n o u g h to m a k e su c h re g u la r iz a
tio n u n d e sir a b le o n b a la n c e .
N e v e r th e le s s , it is a p r a ctic e t h a t is
su ffic ie n tly p r o m isin g to m erit, e x p e rim e n ta tio n o n a s m a ll scale.
More effective underwriting
O n e o f th e T r e a s u r y ’ s d ifficu lties h a s b e e n t h a t it h a s h a d in a d e q u a te
u n d e rw ritin g s u p p o r t, m u c h less th a n is u se d in p r iv a te fin a n cin g .
S u c h u n d e rw ritin g o f T r e a s u r y issues as th ere is d e riv es fr o m (1 ) c o m
m e r c ia l b a n k s , e sp e c ia lly th ro u g h th e u se o f t a x a n d lo a n a c c o u n t
c red its in c o n n e c tio n w ith s h o r t -t e r m ca sh o ffe r in g s; (2 ) d e a lers w h o
b u y fo r resa le a n d w h o p r o v id e s u p p o r t fo r r e fu n d in g o p e r a tio n s b y
tr a d in g in “ r ig h t s ” a n d “ w h e n -issu e d se c u r itie s” ; a n d (3 ) sp e c u la to r s,
w h o h a v e a t tim e s b o u g h t n e w ly issu ed secu rities in th e h o p e o f r e
s e llin g a t a p ro fit w ith in a sh o r t p e rio d o f tim e .
T h e T rea su ry has
d e n ie d its e lf th e fu ll s u p p o r t o f th e c o m m e r c ia l b a n k s in d is tr ib u tin g
lo n g e r te r m cash o ffe rin g s b y tr y in g to d isc o u ra g e b a n k su b sc r ip tio n s
a n d b y d isc r im in a tin g a g a in st b a n k s in a llo ttin g secu rities.
A s lo n g
a s th e F e d e r a l R e s e r v e is in a p o sitio n to ex ert e ffe c tiv e c o n tr o l o v e r
th e re se rv e b a se o f th e b a n k in g s y s t e m , th ere se e m s to b e lit tle
ju s tific a tio n fo r th ese p ra ctic e s.
S erio u s c o n sid e r a tio n sh o u ld b e g iv e n t o th e p r o v isio n o f so m e
u n d e rw ritin g s u p p o r t th ro u g h th e F e d e r a l R e s e r v e S y s t e m .
The
F e d e r a l R e s e r v e b a n k s c o u ld b u y p a r t o f a n e w T r e a s u r y c a sh offerin g
o f lo n g e r te r m secu rities a n d th e n resell (i.e ., d istr ib u te ) th e se secu rities
t o th e p u b lic o v e r a p e rio d o f tim e .
A p ro ce d u re o f th is k in d h a s b e e n
u s e d s u c c e s s fu lly in E n g la n d .28 U n d e r th e B r it is h s y s t e m , w h e n a
n e w se c u r ity is so ld fo r c a sh , th e a m o u n t n o t su b sc r ib e d b y th e p u b lic
is su b s c r ib e d b y th e Is s u e D e p a r t m e n t o f th e B a n k o f E n g la n d , w h ic h
is in effe ct th e u nderw T iter fo r th e G o v e r n m e n t .29 T h e Is s u e D e p a r t
m e n t th e n g r a d u a lly d isp o ses o f th e secu rities to th e p u b lic .
In
r e c e n t y e a r s , th e a u th o r itie s h a v e so u g h t to h a v e a v a ila b le in th e
I s s u e D e p a r t m e n t a t a ll tim e s a t le a st o n e m e d iu m -te r m a n d o n e lo n g
t e r m issu e fo r sa le to th e p u b lic .
T h e s e secu rities are s o ld o n a “ t a p ”
b a s is a t p rices w h ic h a re d e te r m in e d b y t h e a u th o r itie s.
A t th e s a m e t im e t h a t it is se llin g lo n g e r -te r m sec u ritie s o n a “ t a p ”
b a s is , th e Is s u e D e p a r t m e n t h a b it u a lly b u y s u p in th e m a r k e t p o r tio n s
o f th e lo n g e r te r m issu e t h a t is n e x t m a t u r in g .
T h u s , b y th e t im e th e
s e c u r ity m a tu r e s , th e a m o u n t h e ld b y th e p u b lic h a s b e e n r e d u c e d ,
th e r e b y fa c ilita tin g r e fu n d in g .
D u r in g a n y p e rio d , t h e I s s u e D e p a r t
m e n t m a y b e a n e t b o r r o w e r fr o m or n e t le n d e r to th e m a r k e t, d e p e n d
in g u p o n w h e th e r its sa les o f “ t a p ” issu es ex cee d or fa ll sh o r t o f its
p u rc h a se s o f o th e r sec u rities.
W h ic h o f th e se c o n d itio n s p r e v a ils
d e p e n d s u p o n w h e th e r th e T r e a s u r y n ee d s fu n d s fr o m th is so u rc e to
27 The use of frequent and regular small offerings sold by the auction method is advocated in Culbertson,
op. cit.
28 See “ Report of the Committee on the Working of the Monetary System” (the so-called Radcliffe Re
port) (London: Her Majesty's Stationery Office, 1959), pp. 36-38.
29 Under the Bank Charter Act of 1844, the Bank of England was divided into an Issue Department and
a Banking Department. Although the division is now merely a matter of accounting which has no policy
significance, the Issue Department is formally responsible for the issuance of bank notes and holds gold and
Government securities as “cover” for the note issue. See R. S. Sayers, “Modern Banking” (4th ed.; Lon
don: Oxford University Press, 1958), pp. 80-82.
148
DEBT MANAGEMENT IN THE UNITED STATES
fin a n ce a b u d g e t d e ficit or lias fu n d s a v a ila b le fr o m a b u d g e t su rp lu s
fo r d e b t r e tir e m e n t.
T h e s e p ro ce d u res te n d to sp re a d o u t th e im p a c t o f d e b t o p e r a tio n s
o v e r t im e a n d m in im iz e th eir d istu rb in g effe cts o n th e c a p ita l m a r k e t.
T h e r e is n o re a so n w h y sim ila r te c h n iq u e s c o u ld n o t b e a p p lie d in th is
c o u n t r y b y th e T r e a s u r y a n d th e F e d e r a l R e s e r v e .
O r if it is fe lt t h a t
th e F e d e r a l R e s e r v e sh o u ld con fin e its o p e r a tio n s to e c o n o m ic s ta b ili
z a tio n , it s h o u ld b e p o ssib le to d e v ise so m e o th e r in s titu tio n a l a rr a n g e
m e n t — su c h as a k in d o f “ sta b iliz a tio n f u n d ” — w h ich w o u ld p e r fo r m a
s im ila r fu n c tio n .
I n th is c o n n e c tio n , h o w e v e r , it sh o u ld b e n o t e d t h a t
th e B r itis h a u th o r itie s d e lib e r a te ly u tiliz e th e u n d e rw ritin g o p e r a tio n s
o f th e Is s u e D e p a r t m e n t as a m e a n s o f ex ertin g a m a r g in a l in flu e n ce
o v e r th e in te re st r a te s tru c tu re , th u s in te g r a tin g th e se o p e r a tio n s in to
th e fr a m e w o r k o f s ta b iliz a tio n p o lic y .
Advance refunding
A d v a n c e r e fu n d in g m e a n s o ffe rin g to h o ld ers o f a n e x istin g s e c u r ity
th e o p tio n o f tu rn in g it in fo r a n e w ly issu ed s e c u r ity b e fo r e m a t u r it y .
A s lo n g e r -te r m sec u rities a p p r o a c h m a t u r it y , t h e y fr e q u e n t ly fa ll
in to th e h a n d s o f in v e s to r s w h o are in te re ste d in th e m as liq u id it y
in s tr u m e n ts , a n d w h e n t h e y m a tu r e , it is d iffic u lt to in te re st su c h
in v e s to r s in e x c h a n g in g t h e m fo r n e w lo n g -te r m sec u rities.
J u d ic io u s
a d v a n c e r e fu n d in g w o u ld c a tc h th ese secu rities b e fo r e t h e y le a v e th e
h a n d s o f th o s e w h o a re h o ld in g th e m as in v e s tm e n t s a n d o ffe r a n e w
lo n g e r te r m s e c u r ity in e x c h a n g e a t t h a t p o in t.
A d v a n c e r e fu n d in g c a n b e u se d a s a m e a n s o f b rin g in g a b o u t a
la rg e o n c e -a n d -fo r -a ll r e a d ju s t m e n t o f th e d e b t s tr u c tu r e in o rd er to
a c h ie v e a stru c tu re t h a t is a m e n a b le to e ffe c tiv e m a n a g e m e n t.
An
e x a m p le o f th is is th e la rg e -sc a le c o n v e r sio n o p e r a tio n w h ic h w a s
c a rried o u t in C a n a d a in 1 9 5 8 .
I n J u ly o f t h a t y e a r , th e C a n a d ia n
G o v e r n m e n t m a d e p u b lic a p la n to r e fu n d u p to $ 6 .4 b illio n o f o u t
s t a n d in g V i c t o r y b o n d s in a d v a n c e o f th eir d u e d a te s .
T h e V ic to r y
b o n d s c o n s is te d o f fiv e issu es o f m a r k e ta b le d e b t w ith m a t u r it y d a te s
r a n g in g fr o m J a n u a r y 1 9 5 9 to S e p te m b e r 1 9 6 6 a n d a c o u p o n r a t e o f
3 p e r c e n t.
T w o o f th e issu es w ere n ea r m a t u r it y d a te s a n d th e
o th e r s w e re d u e to b e c o m e c a lla b le in a fe w y e a r s.
T h ese bon d s,
w h ic h w e re issu e d d u r in g th e fin a n cin g o f W o r ld W a r I I , a m o u n te d
to a b o u t 4 3 p e rc e n t o f th e C a n a d ia n n a t io n a l d e b t a n d 61 p e r c e n t o f
its o u t s t a n d in g m a r k e ta b le G o v e r n m e n t secu rities.
I n e x c h a n g e fo r th e se secu rities, h o ld e rs o f th e V i c t o r y b o n d s w e re
o ffe red th e ir c h o ic e o f fo u r n o n c a lla b le , m a r k e ta b le i s s u e s : a 3 p e r c e n t
b o n d d u e in 1 9 6 1 , a 3% p e rc e n t b o n d d u e in 1 9 6 5 , a 4 } { p e r c e n t b o n d
d u e in 1 9 7 2 , o r a 4% p e rc e n t b o n d d u e in 1 9 8 3 .
H o ld e r s o f V i c t o r y
b o n d s m a t u r in g in 1 9 6 2 w e re n o t elig ib le fo r th e n e w 1 9 6 1 issu e , a n d
h o ld ers o f V i c t o r y b o n d s w ith la te r d u e d a te s w ere n o t elig ib le fo r th e
issu es m a t u r in g in 1 9 6 1 o r 1 9 6 5 .
T h o s e w h o c o n v e r te d w e re e n title d
to a n im m e d ia te c a sh p a y m e n t o f fr o m $ 1 2 .5 0 to $ 2 5 p e r $ 1 ,0 0 0 o f
b o n d s c o n v e r te d w it h th e h ig h e r p r e m iu m s g o in g to th o se w h o se le c te d
th e lo n g e r te r m issu es.
T h e 9 -w e e k r e fu n d in g p e rio d w a s b e g u n b y a sa les a p p e a l b y th e
F in a n c e M in is t e r a n d th e G o v e r n o r o f th e B a n k o f C a n a d a , to an
e s tim a te d 1 0 ,0 0 0 b a n k e r s a n d b o n d d e alers th r o u g h o u t C a n a d a o v e r
a c lo s e d -c irc u it t r a n s c o n tin e n ta l te le v isio n h o o k u p .
A n a t io n a l a p
p e a l to c o n v e r t w a s m a d e b y th e G o v e r n m e n t o v e r r a d io a n d te le v isio n .
DEBT MANAGEMENT IN THE UNITED STATES
149
A ii e x te n s iv e n e w sp a p e r a d v e r tisin g p r o g r a m w a s carried o n b y th e
b a n k s in a n a t t e m p t to a p p e a l to s m a ll in v e sto rs w h o h e ld a n e sti
m a t e d o n e -t h ir d o f th e d e b t .
T h e im m e d ia te ca sh p a y m e n t s w ere
e m p h a s iz e d as a n in d u c e m e n t to s m a ll in v e sto r s.
T h e r e fu n d in g o p e r a tio n w a s su c c e ssfu l.
A b o u t 9 0 p e rc e n t ($ 5 .8
b illio n ) o f th e V i c t o r y b o n d s w ere c o n v e r te d in to th e n e w issu es
in c lu d in g $ 3 .5 b illio n o f th e tw o lo n g e st issu e s.
T h e a v e r a g e m a t u r it y
o f th e t o t a l m a r k e ta b le d e b t in cre ase d fr o m 6 .3 y e a r s to 1 0 .5 y e a r s
as a re su lt o f th e o p e r a tio n .
D u r in g th e p e rio d o f th e r e fu n d in g a n d fo r a sh o r t t im e th e r e a fte r
th e B a n k o f C a n a d a su p p o r te d th e m a r k e ts fo r th e V i c t o r y b o n d s a n d
th e n e w issu es a t o r n e a r p a r ; as a r e su lt, it a cq u ire d o v e r $1 b illio n
o f th e lo n g e r te r m b o n d s .
T h e e x p a n sio n a r y effe c t o f th e se p u rc h a se s
w a s p a r tia lly o ffse t b y th e sa le o f tre a su r y b ills a n d s h o r t -t e r m b o n d s .
O v e r th e p e rio d o f fin a n cin g , th e B a n k o f C a n a d a e x p a n d e d its
h o ld in g s o f b o n d s m a tu r in g in m o r e th a n 10 y e a r s fr o m 10 p e rc e n t to
5 0 p e rc e n t o f its G o v e r n m e n t s e c u r ity p o r tfo lio , w h ile its h o ld in g s o f
b ills a n d s h o r t -t e r m b o n d s fe ll fr o m a b o u t 6 0 p e rc e n t to le ss th a n 12
p e rc e n t o f its p o r tfo lio .
A s a re s u lt o f th is a n d also as a re su lt o f relia n ce o n th e b a n k in g
s y s te m fo r earlier d e b t fin a n cin g d u r in g th e y e a r , th e m o n e y s u p p ly
in 1 9 5 8 rose b y 16 p e rc e n t fr o m J a n u a r y to O c to b e r , c o m p a r e d w ith
an in crease o f o n ly a b o u t 6 p e rc e n t d u r in g 1 9 5 6 a n d 1 9 5 7 . A c c o r d in g
to th e G o v e r n o r o f th e B a n k o f C a n a d a —
T h e C a n a d a c o n v e r s i o n l o a n o f 1958 m a d e p o s s i b l e a r e t u r n t h e r e a f t e r t o n o n b a n k f in a n c in g o f G o v e r n m e n t b o n d is s u e s a n d a h a lt in g a f t e r e a r ly O c t o b e r o f
th e m o n e ta r y e x p a n s io n w h ic h h a d b e e n n e c e s s a r y u p t o t h a t t im e . T h e d e g re e
o f m o n e ta r y e x p a n s io n e x p e r ie n c e d p r io r t o th is d a te w a s s u b s t a n t ia lly g r e a te r
th a n w o u ld h a v e b e e n n e c e s s a r y o r d e s ir a b le fo r m o n e t a r y a n d e c o n o m ic r e a s o n s
a lo n e , b u t w a s , I b e lie v e , ju s t if ie d a n d u n a v o i d a b l e in o r d e r t h a t a s t r e n u o u s a n d
s u c c e s s fu l e ffo r t m ig h t b e m a d e t o d e a l w it h s e r io u s p r o b le m s a ffe c t in g t h e
G o v e r n m e n t / s c a s h d e f i c i t a n d t h e c o n d i t i o n o f t h e p u b l i c d e b t .30
T h e a d d itio n a l c o st o f c a r r y in g th e d e b t w a s e s t im a t e d a t a b o u t
$ 1 3 0 m illio n fo r 1 9 5 8 , a n in cre ase o f a b o u t 2 5 p e rc e n t o v e r th e d e b t
ch arge s o f th e p r e v io u s fiscal y e a r .
A b o u t h a lf o f th is in cre ase w a s
co n sid e red to b e th e c o st o f th e a c tu a l o p e r a tio n , w h ile th e r e m a in d e r
re p re se n te d a d d itio n a l in te r e st c h arge s.
T h e c o u p o n r a te s o n th e
lo n g e r issu es w ere th r e e -e ig h ts p e rc e n t a b o v e th o se o n c o m p a r a b le
se c u rities issu ed a sh o r t t im e b e fo r e th e c o n v e r sio n o p e r a tio n .
T h e U .S . T r e a s u r y h a s in d ic a te d str o n g in te r e st in a d v a n c e r e fu n d
in g as a m e a n s o f a c h ie v in g a b e tte r b a la n c e d d e b t s tr u c tu r e .31 L e g is
la tio n p a sse d in th e la s t sessio n o f C o n g r e ss e lim in a te d te c h n ic a l
o b s ta c le s b y c h a n g in g th e t a x t r e a tm e n t o f lo sses in cu rred in c o n n e c
tion w ith a d v a n c e r e fu n d in g o p e r a tio n s a n d th u s p a v e d th e w a y fo r
use o f th e d e v ic e .32 A d v a n c e r e fu n d in g c o u ld b e u sed as a m e a n s o f
r e d u c in g th e la rg e v o lu m e o f d e b t sc h ed u led to m a tu r e in 1 to 5 y e a r s .
A t th e en d o f S e p te m b e r 1 9 5 9 , th e a m o u n t o f p u b lic ly h e ld m a r k e ta b le
d e b t in th is m a t u r it y se c to r c a m e to $ 5 2 .9 b illio n .
R e p la c e m e n t o f
s o m e o f th is d e b t w ith lo n g e r te r m sec u rities c o u ld re su lt in a b e tte r
b a la n c e o f m a tu r itie s a n d also c o n tr ib u te to th e b a sic o b je c tiv e o f
d e b t le n g th e n in g . A d v a n c e r e fu n d in g c o u ld also b e u se d as a m e a n s
so Bank of Canada, “Annual Report of the Governor to the Minister of Finance, 1958,” pp. 3-4.
31 See report of a speech by Julian B. Baird, Under Secretary of the Treasury for Monetary Affairs, to the
stockholders of the Federal Reserve Bank of Boston, New York Times, Oct. 16, 1959.
32 For a discussion of the tax problems connected with advance refunding and of the legislation designed
to deal with these problems, see “Public Debt Ceiling and Interest Rate Ceiling on Bonds,” op. cit., pp.
30-31, 84-87.
150
DEfeT MANAGEMENT IN THE UNITED STATES
o f d e a lin g w ith s o m e $ 2 4 b illio n (p u b lic ly h e ld p o r tio n ) o f 2 }{ p e rc e n t
b o n d s is s u e d d u r in g W o r ld W a r I I a n d h a v in g first c a ll d a te s ra n g in g
fr o m 1 9 6 2 to 1 9 6 7 a n d m a t u r it y d a te s r a n g in g fr o m 1 9 6 7 to 1 9 7 2 .
A t th e p r e s e n t t im e , h o w e v e r , th e im p le m e n ta t io n o f su c h a p r o g r a m
o f a d v a n c e r e fu n d in g is im p o ssib le d u e to th e fa c t t h a t it w o u ld req u ire
th e p a y m e n t o f in te r e st r a te s in ex cess o f th e 4}i p e rc e n t le g a l c eilin g
a p p lic a b le to T r e a s u r y sec u rities w ith m a tu r itie s b e y o n d 5 y e a r s .33
U s e d c a r e fu lly a n d in m o d e r a tio n u n d e r p ro p e r c o n d itio n s, a d v a n c e
r e fu n d in g can b e a u se fu l w a y o f a tt a in in g a m o r e v ia b le d e b t s tr u c tu r e .
H o w e v e r , a m a s s iv e co n v e rsio n o p e r a tio n su c h a s w a s u n d e r ta k e n
in C a n a d a w o u ld a p p e a r to b e u n w ise .
A series o f c a u tio u s a n d p ie c e
m e a l o p e r a tio n s c a n a c c o m p lis h th e sa m e r e su lts w ith o u t e n ta ilin g
su c h h e a v y in te re st c o sts as th e C a n a d ia n G o v e r n m e n t w a s fo r c e d
to p a y .
I n fa c t , th e U .S . T r e a s u r y a p p e a r s to h a v e in m in d a m o r e
c a u tio u s a n d e x p e rim e n ta l a p p r o a c h .34
Use of call provisions
T h e p rese n ce o f a call fe a tu r e in a T r e a s u r y s e c u r ity g iv e s th e
T r e a s u r y g re a ter p o ssib ilitie s o f b e in g a b le to t a k e a d v a n ta g e o f
fa v o r a b le m o v e m e n t s o f in te re st r a te s in fu tu r e y e a r s .
T h e T reasu ry
h a s issu e d n o n c a lla b le sec u rities in th e la s t fe w y e a r s .35 C a ll fe a tu r e s
a re c o m m o n ly in c lu d e d in c o r p o r a te secu rities, a n d se v e ra l F e d e r a l
a n d S t a t e r e g u la to r y a g e n c ie s fo llo w a firm p o lic y o f r e q u irin g a p r o
v is io n fo r im m e d ia te c a lla b ility or a sh o r t d e fe r m e n t p e rio d , to g e th e r
w ith a lo w call p r e m iu m , in sec u rities issu ed b y c o m p a n ie s u n d e r th eir
ju r is d ic tio n .
R e c e n t stu d ie s su g g e st t h a t th e p rese n ce o f a ca ll
p r iv ile g e in c o r p o r a te b o n d s is n o t reflec ted to a n y v e r y sig n ific a n t
e x te n t in a n in cre ase in th e in te re st r a te o n th e b o n d s .36 I t se e m s lik e ly
t h a t th e in clu sio n o f call fe a tu r e s in T r e a s u r y secu rities w o u ld c o m m o n ly
b e w e ll w o r th th e e x tra im m e d ia te c o st in v o lv e d .
Establishment of captive markets for Treasury securities
F r o m t im e to tim e , it h a s b e e n su g g e ste d t h a t c erta in t y p e s o f
fin a n cia l in s titu tio n s , m o s t c o m m o n ly c o m m e r c ia l b a n k s , sh o u ld b e
r e q u ir e d t o h o ld G o v e r n m e n t secu rities to th e e x te n t o f a c ertain
p o r tio n o f th eir a sse ts or lia b ilitie s .37 S u c h p r o v isio n s w o u ld h a v e a
n u m b e r o f e ffe cts, o n e o f w h ic h w o u ld b e to e sta b lish c a p tiv e m a r k e ts
fo r T r e a s u r y secu rities, p r e s u m a b ly r e d u c in g to s o m e e x te n t th e c o st
a n d t r o u b le in v o lv e d in m a n a g in g th e d e b t.
T h o s e w h o h a v e a d v o c a t e d p r o v isio n s o f th is k in d in th e la s t fe w
y e a r s h a v e o rd in a rily d o n e so o n th e g r o u n d s t h a t t h e y w o u ld c o n tr i
b u te to th e e ffe c tiv e n e ss o f m o n e t a r y c o n tr o ls r a th e r t h a n b e c a u se
t h e y w o u ld re d u c e th e c o sts o f d e b t m a n a g e m e n t .38 F o r e x a m p le , it
33In November 1959, the Treasury engaged in a minor bit of advance refunding. In September 1957, it
issued $2 billion of 4-percent notes due Aug. 15,1962, which could be redeemed in February 1960, at the option
of the holder on 3 months’ notice. In the November financing, holders of these notes were given an oppor
tunity to exchange their securities for 4^-percent notes of November 1963; $1,684 million of the original
notes were exchanged, $157 million were redeemed for cash, and the remaining $160 million were held for
redemption in 1962. (Treasury Bulletin, December 1959, pp. A -l ff.)
34 See report of speech by Mr. Baird in New York Times, Oct. 16,1959.
35In the case of two issues of notes which were sold in 1957, the Treasury actually provided for redemption
at the option of the holder after a specified period of time on 3 months’ advance notice.
36 See W. J. Winn and A. Hess, Jr., “The Value of the Call Privilege,” and the accompanying discussion
by J. A. Pines in Journal of Finance, XIV (May 1959), pp. 182-195 and 218-227.
37 For a recent discussion of such provisions as applied to commercial banks, see Joseph Aschheim, “Sup
plementary Security-Reserve Requirements Reconsidered,” Journal of Finance, XIII (December 1958),
473-487.
38 In the period right after World War II when the Federal Reserve was supporting the prices of Govern
ment bonds, on the other hand, there was considerable support for a secondary reserve requirement for
commercial banks in the form of Government securities as a means of permitting the Federal Reserve to
restrict credit and push up interest rates on private debt without depressing the prices and raising the yields
of Government securities.
DEBT MANAGEMENT IN THE UNITED STATES
151
h a s b e e n a rg u e d t h a t a s e c o n d a r y r eserv e r e q u ir e m e n t in th e fo r m o f
G o v e r n m e n t sec u rities a p p lie d to c o m m e r c ia l b a n k s m ig h t b e h e lp fu l,
b e c a u s e it w o u ld m a k e it m o r e d ifficu lt fo r b a n k s to sh ift th e c o m p o s i
tio n o f th eir p o r tfo lio s fr o m G o v e r n m e n t secu rities to lo a n s d u r in g
p e rio d s w h e n th e F e d e r a l R e s e r v e is tr y in g to r e stric t c r e d it.39 I n th e
o p in io n o f th e p r e se n t w rite r, th ere is a p r e su m p tio n a g a in s t th e
e s ta b lis h m e n t o f le g a l re q u ir e m e n ts c o n c e rn in g th e h o ld in g o f G o v e r n
m e n t sec u rities b y fin a n cia l in s titu tio n s m e r e ly fo r th e p u r p o se o f r e
d u c in g th e T r e a s u r y 's in te re st c o sts. I f su c h r e q u ir e m e n ts are to b e
p u t in to e ffe c t, it sh o u ld b e d o n e fo r th e r e a so n t h a t t h e y m a k e th e
fin a n cia l m e c h a n is m p e r fo r m m o r e sa tis fa c to r ily — b y in c re a sin g th e
effe c tiv e n e s s o f o v e r a ll m o n e t a r y c o n tr o ls, im p r o v in g th e a llo c a tio n
o f c r e d it, o r m a k in g c o n tr o ls m o r e e ffe c tiv e in d e a lin g w ith a se c to r
o f th e e c o n o m y w h ic h is a so u rce o f in s t a b ilit y .40
Improved marketing techniques
T h e T r e a s u r y relies r a th e r h e a v ily o n th e a d v ic e it r e c e iv e s in c o n
s u lta tio n s w ith p r o fe ssio n a l in v e s to r g r o u p s in d e c id in g o n th e
m a t u r it y ra n g e s in w h ic h to issu e sec u rities, as w e ll as o n th e in te re st
ra te s a n d o th e r p r o v isio n s to b e in c o r p o ra te d in its issu es.
W h ile
th e in fo r m a tio n o b ta in e d as a r e su lt o f c o n s u lta tio n s w ith in v e s to r
g ro u p s is u n q u e s tio n a b ly u se fu l to th e T r e a s u r y , th ere is m u c h to b e
sa id fo r th e d e v e lo p m e n t o f m o r e e x te n siv e fa c ilitie s o n th e p a r t o f th e
T r e a s u r y its e lf fo r a ssessin g th e m a r k e t fo r G o v e r n m e n t sec u rities o n
a c o n tin u in g b a sis a n d fo r e n g a g in g in a v ig o r o u s p r o g r a m o f sa les
p r o m o tio n .
I t m ig h t b e p o ssib le to m a k e use o f th e d is tr ic t F e d e r a l
R e s e r v e b a n k s a n d th eir b r a n c h e s as o n e c h a n n e l fo r d e v e lo p in g m o r e
e x te n s iv e c o n t a c t s w ith in v e s to r s .
I t se e m s p o ssib le t h a t a v ig o r o u s
e d u c a tio n a l a n d sa les p r o m o tio n p r o g r a m c o u ld s u b s ta n tia lly b ro a d e n
th e m a r k e t fo r T r e a s u r y sec u rities b y in c re a sin g th e p a r tic ip a tio n o f
in d iv id u a l in v e s to r s , as w e ll as s m a lle r fin a n cia l in s titu tio n s lo c a te d
in p la c es r e m o t e fr o m th e c en ters o f fin a n ce .
A s a m a t t e r o f fa c t, r e c e n t d e v e lo p m e n t s in d e b t m a n a g e m e n t in
d ic a te a n in c re a sin g in te re st in T r e a s u r y secu rities o n th e p a r t o f
in d iv id u a l in v e s to r s , a p p a r e n tly as a r e su lt o f in c re a sin g y ie ld s . T h e
m o s t s tr ik in g e v id e n c e o f th is is to b e fo u n d in th e r e c e p tio n a c c o rd e d
th e s o -c a lle d “ m a g ic 5 's ” — an issu e o f 4 -y e a r , 1 0 -m o n t h m a r k e ta b le
5 -p e r c e n t n o t e s issu ed in O c t o b e r 1 9 5 9 — w h ic h t o o k th e m a r k e t b y
d is tin c t su rp rise a n d a ro u se d n a tio n w id e a tt e n t io n .
O n O c t o b e r 1, 1 9 5 9 , th e T r e a s u r y a n n o u n c e d a p la n to raise a b o u t
$ 4 b illio n in a c a sh o ffe rin g .
T h e o ffe rin g c o n siste d o f $ 2 b illion o f
2 4 5 - d a v t a x a n tic ip a tio n b ills to b e so ld o n a n a u c tio n b a sis a n d $2
b illio n o f th e a fo r e m e n tio n e d 5 -p e r c e n t n o te s .
T h e n o te issu e w a s
d e sig n e d sp e c ific a lly to a p p e a l to s m a ll in v e s to r s .
T h e T reasu ry
p r o m is e d t h a t all su b sc r ip tio n s u p to $ 2 5 ,0 0 0 w o u ld b e h o n o r e d in
fu ll if a c c o m p a n ie d b y c a sh p a y m e n t .
I n a d d itio n , h o ld ers w ere
g iv e n th e o p tio n o f re g iste rin g th eir secu rities as a p r o te c tio n a g a in st
lo s s or t h e ft a n d as a m e a n s o f o b ta in in g in te r e st p a y m e n ts d ir e c tly
w it h o u t g o in g th r o u g h th e s ta n d a r d c o u p o n -c lip p in g p ro ce d u re.
T h e 5 -p e r c e n t r a te , th e h ig h e st p a id b y th e T r e a s u r y in o v e r 3 0 y e a r s ,
39 For example, see my paper, “ On the Effectiveness of Monetary Policy,” American Economic Review,
XLVI (September 1956), 588-806.
40Some suggestions for selective controls along these lines are made in “ Staff Report on Employment
Growth, and Price Levels,” op. cit., ch. 9.
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DEBT MANAGEMENT IN THE UNITED STATES
re c e iv e d fr o n t-p a g e a tt e n t io n in m a n y n e w sp a p e r s a n d w a s rev ie w e d
e x te n s iv e ly o v e r ra d io a n d te le v isio n n ew s b r o a d c a s ts — a n u n u su a l
p h e n o m e n o n fo r a T r e a s u r y fin a n cin g o p e r a tio n .
S u b s c r ip tio n s to th e n o te issu e to ta lin g o v e r $ 1 1 .1 b illio n w ere
re c e iv e d fr o m a n e s tim a te d 1 3 0 ,0 0 0 su b scrib ers in c lu d in g a b o u t
1 1 0 ,0 0 0 s m a ll in v e sto r s.
T h e a llo tm e n t ex cee d ed $ 2 .3 b illio n in c lu d in g
$ 1 0 0 m illio n to th e T r e a s u r y in v e s tm e n t a cc o u n ts.
T h e fu lly p a id
su b s c r ip tio n s o f $ 2 5 ,0 0 0 or le ss, w h ic h w ere a llo tte d in fu ll, t o t a le d
$ 9 4 1 m illio n .
S a v in g s t y p e in v e sto r s w ere a llo tte d 4 5 p e rc e n t o f
th e ir $ 1 ,3 6 1 m illio n o f su b sc r ip tio n s, c o m m e r c ia l b a n k s w ere a llo tte d
o n ly 8 p e rc e n t o f th e ir $ 6 ,3 9 0 m illio n o f su b sc r ip tio n s, a n d all o th e r
in v e s to r s o b ta in e d 5 p e rc e n t o f $ 2 ,4 3 3 m illio n in s u b sc r ip tio n s, w ith
a ll su b scrib ers r e c e iv in g a t le a s t $ 1 ,0 0 0 o f th e n o t e s .41
I t see m s lik e ly t h a t to so m e e x te n t in v e sto rs r e d e e m e d sa v in g s
b o n d s in ord er to b u y th e 5 -p e rc e n t n o te s.
T o th e e x te n t t h a t th is
o cc u rre d , th e T r e a s u r y exp e rie n ce d an in crease in in terest c o sts
w it h o u t a n y n e t g a in in fu n d s a v a ila b le .
F u n d s w ere also u n
d o u b te d ly w ith d r a w n fr o m o th e r sa v in g s m e d ia — su c h as sa v in g s
d e p o s its a n d sa v in g s a n d lo a n sh ares— fo r in v e s tm e n t in th e n o te s.
A s a re su lt o f th e ep iso d e o f th e 5 -p e r c e n t n o te s , th ere w a s c o n sid e r
a b le a p p reh e n sio n o n th e p a r t o f sa v in g s in s titu tio n s c o n c e rn in g th e
im p a c t o f fu tu r e T r e a s u r y d e b t m a n a g e m e n t a ctio n s.
T h e ex p erience w ith th e “ m a g ic 5 ’ s ” su g g e sts t h a t b y o ffe rin g
s u ffic ie n tly a tt r a c tiv e in terest ra te s th e T r e a s u r y m a y b e a b le to ta p
th e flo w o f in d iv id u a l s a v in g d ir e c tly .
I n th e p a st it h as secu red a
p o r tio n o f th is flo w th r o u g h th e sa v in g s b o n d p r o g r a m a n d th r o u g h
th e sa le o f m a r k e ta b le secu rities to sa v in g s in s titu tio n s w h ic h in tu rn
o b ta in e d their fu n d s b y sellin g th eir c la im s to in v e sto r s.
H ow ever,
m a r k e ta b le secu rities m a y b e m o r e a tt r a c tiv e — e sp ec ia lly w h e n
in te re st ra te s are r e la tiv e ly h ig h — to m a n y in v e s to r s th an s a v in g s
b o n d s , a n d s a v in g s in s titu tio n s h a v e g e n e r a lly b e e n c h a n n e lin g th e ir
fu n d s in to p r iv a te in v e s tm e n t ra th e r th a n in to G o v e r n m e n t se c u r itie s.
I t s e e m s lik e ly th a t th e m a r k e t fo r T r e a s u r y secu rities a m o n g in d i
v id u a l in v e s to r s c o u ld b e s u b s ta n tia lly e x p a n d e d b y a v ig o r o u s
e d u c a tio n a l a n d sales p r o m o tio n effo rt.
The savings bond program
I n S e p te m b e r 1 9 5 9 , th e C o n g r e ss raised th e m a x im u m p e rm issib le
in te re s t r a te o n series E a n d H sa v in g s b o n d s (th e o n ly series n o w b e in g
s o ld ) to 4 K p e rc e n t, th e sa m e as th e m a x im u m r a te fo r m a r k e ta b le
sec u rities h a v in g m a tu r itie s in ex cess o f 5 y e a r s .
T a k i n g im m e d ia te
a d v a n ta g e o f th e le g isla tiv e a u th o r iz a tio n , th e T r e a s u r y r a ised th e
y ie ld to m a t u r it y o n th ese b o n d s fr o m 3
pe r c e nt to 3% p e r c e n t.42
D e s p it e earlier im p r o v e m e n t s in th e y ie ld s a n d o th e r te r m s o f s a v in g s
b o n d s in M a y 1 9 5 2 a n d A p r il 1 9 5 7 ,43 th e in creases in o th e r in te re st
r a te s h a d r e d u c e d th e a ttr a c tiv e n e s s o f th e b o n d s , w ith th e re su lt
t h a t th e s a v in g s b o n d p r o g r a m h a d b een a seriou s c a sh d ra in o n th e
T r e a s u r y fo r se v e ra l y e a r s, as in d ic a te d ea rlier.44 U n lik e earlier
im p r o v e m e n t s in te r m s, th o se t h a t w ere p u t in to effe c t in S e p te m b e r
1 9 5 9 , a p p lie d to a lim ite d e x te n t to b o n d s a lre a d y o u t s t a n d in g as w e ll
41 Treasury Bulletin. October 1959, p. A-l.
42 For details, see Treasury Bulletin, October 1959, r>p. A-2 ff.
43 See Treasury Bulletin, May 1952, pp. A -l ff., a id May 1957, pp. A-l ff.
44 See ch. IIT.
DEBT MANAGEMENT IN THE UNITED STATES
153
as to b o n d s issu ed s u b s e q u e n t ly .45 I n N o v e m b e r 1 9 5 9 , th e T r e a s u r y
a n n o u n c e d a p la n , e ffe c tiv e J a n u a r y 1, 1 9 6 0 , w h ic h w o u ld p e r m it
in v e s to r s w h o s w itc h fr o m series E , F , or J b o n d s (w h ic h p a y in te re st
a t m a t u r it y or w h e n t h e y are r e d e e m e d ) to series H b o n d s (w h ich
p a y in te re st e v e r y 6 m o n t h s ) to d e fe r th e p a y m e n t o f in c o m e t a x o n
th e a cc ru ed in te re st o n th e E , F , o r J b o n d s u n til th e H b o n d s m a t u r e
o r are re d e e m e d prior to m a t u r it y .46
I t r e m a in s to b e seen w h e th e r th e in crease in y ie ld s o n sa v in g s b o n d s
w ill m a k e th e m su ffic ie n tly a tt r a c tiv e to in v e sto rs to e lim in a te o r
red u c e s u b s ta n tia lly th e cash d ra in t h a t th e p r o g r a m h a s im p o s e d o n
th e T r e a s u r y .
I n a d d itio n to a fu r th e r in crease in in te r e st r a te s ,
a n o th e r d e v ic e th a t m ig h t b e reso rted to w o u ld b e th e issu a n c e o f
b o n d s w h o se r e d e m p tio n v a lu e (a n d in te re st p a y m e n ts , if a n y ) are tie d
to th e C o n s u m e r P rice In d e x .
A sc h em e o f th is k in d c o u ld , o f cou rse,
be a p p lie d to m a r k e ta b le secu rities a lso, b u t th e s a v in g s b o n d s se e m
to b e th e m o s t eligib le c a n d id a te .
T h e c h ief d a n g e r w it h th e in tr o
d u c tio n o f s o -c a lle d p u r c h a sin g p o w e r b o n d s w o u ld b e t h a t it m ig h t
b e in te rp re te d as a sign t h a t th e a u th o ritie s h a d b e c o m e c o n v in c e d
t h a t a n u p w a r d d r ift o f th e p rice le v e l w a s in e v ita b le .
I t is n o t clear,
h o w e v e r , h o w seriou s th is d a n g e r w o u ld b e, a n d o n b a la n c e th ere is
m u c h to b e sa id fo r th e v ie w t h a t it is a p ro p er fu n c tio n o f th e G o v e r n
m e n t to p r o v id e th e sm a ll, u n so p h istic a te d in v e s to r w ith a fo r m o f
in v e s tm e n t w h ic h co n ta in s p r o te c tio n a g a in st th e ero sio n o f h is w e a lth
th ro u g h in fla tio n .47
THE IN TE RE ST RATE CEILING
T h e in te r e s t r a te c eilin g o f 4}i p e rc e n t a p p lic a b le to T r e a s u r y
secu rities h a v in g m a tu r itie s in ex cess o f 5 y e a r s (i.e ., all T r e a s u r y
b o n d s ) h a s b e e n in effe ct sin ce W o r ld W a r I . 48 U n t i l r e c e n tly th e
in te re s t r a te ceilin g w a s o f n o m o r e th a n a c a d e m ic in te r e st, sin ce
in te re st r a te s w e re fo r m a n y y e a r s b e lo w th e le v e ls w h e re th e ceilin g
c o n s titu te d a m e a n in g fu l re stric tio n o n th e T r e a s u r y ’s fr e e d o m o f
a c tio n .
B u t in te re st r a te s h a v e b e e n m o v in g u p w a r d , e x c e p t fo r
r e la tiv e ly b r ie f p e rio d s o f recessio n in 1 9 4 9 , 1 9 5 3 - 5 4 , a n d 1 9 5 7 - 5 8 ,
d u r in g th e en tire p o s tw a r p e rio d , a n d p a r tic u la r ly sin c e th e v ig o r o u s
r e v iv a l o f flex ib le m o n e t a r y p o lic y b e g in n in g in 1 9 5 3 .
B y m id -1 9 4 9 ,
in te r e s t r a te s h a d risen to su c h a h ig h le v e l t h a t it h a d b e c o m e i m
p o s s ib le fo r th e T r e a s u r y to b o r r o w lo n g e r te r m fu n d s a t r a te s b e lo w
th e c e ilin g .49
T h e in te re s t r a te ceilin g is a n a r b itr a r y lim ita tio n w ith n o a n a ly tic a l
ju s tific a tio n , a n d it sh o u ld a c c o r d in g ly b e re p e a le d .
H o w e v e r , th e
c eilin g h a s b e c o m e a m a jo r p o litic a l a n d e c o n o m ic issu e, b e c a u se it
45A summary of the changes in the terms of existing bonds is given in Treasury Bulletin, December 1959,
pp. A-4 ff.
46 For the details, see Treasury Bulletin, December 1959, pp. A-3 ff.
47 For an argument in support of purchasing-power bonds, see H. S. Houthakker, “Protection against
Inflation,” Study Paper No. 8.
48The 4 -percent ceiling was first applied to both notes (i.e., securities with maturities of 1 to 5 years)
and bonds in the Third Liberty Bond Act of April 1919. Subsequently, in March 1918, in response to a
request by Secretary of the Treasury Carter Glass for complete removal of the ceiling, the Congress in the
Victory-Liberty Loan Act eliminated the ceiling as applied to notes but kept it for bonds. See “ Public
Debt Ceiling and Interest Rate Ceiling on Bonds,” op. cit., pp. 14-16.
49 The Treasury has the right to sell securities at a discount, and it would accordingly be possible to cir
cumvent the ceiling by selling bonds with a coupon of 4U percent (or less) at a price sufficiently below par
to provide a yield which would make them attractive to investors. However, the Secretary of the Treasury
has taken the position that it is not proper to circumvent the ceiling in this way. See “ Public Debt Ceiling
and Interest Rate Ceiling on Bonds,” op. cit., p. 18.
154
DEBT MANAGEMENT IN THE UNITED STATES
s y m b o liz e s a n im p o r t a n t c o n tr o v e r s y c o n c e rn in g e c o n o m ic p o lic y .
T h e a d m in is tr a tio n a n d th e F e d e r a l R e s e r v e in a d v o c a t in g r e p e a l o f
th e in te r e s t r a te ceilin g h a v e c o n te n d e d t h a t th e p r e se n t h ig h le v e l
o f in te re s t r a te s is th e re su lt o f th e w o r k in g o f in e x o r a b le e c o n o m ic
la w s u n d e r c o n d itio n s in w h ic h th e d e m a n d fo r g o o d s a n d se rv ic e s is
p ressin g o n th e c a p a c it y o f th e e c o n o m y a n d in fla tio n is th r e a te n in g ,
a n d t h a t w e are fa c e d w ith a sim p le ch oice o f le tt in g in te re st r a te s
c o n tin u e to rise a n d a d ju s t in g th e T r e a s u r y 's b o r r o w in g c o sts u p w a r d
a c c o r d in g ly , o r else o f in te rfe rin g w ith th e w o r k in g o f fu n d a m e n t a l
e c o n o m ic fo rc es, th u s p r o d u c in g c a ta s tr o p h ic in fla tio n .
L i t t le r e c o g
n itio n is g iv e n to th e fa c t t h a t th ere are o th e r w a y s o f d e a lin g w it h
in fla tio n b esid e s th e sim p le a p p lic a tio n o f r e stric tiv e g en era l m o n e t a r y
p o lic y .
W e c o u ld , fo r e x a m p le , p la c e m o r e relia n ce o n fisca l p o lic y
a n d s e le c tiv e c red it c o n tr o ls a n d le ss relia n ce u p o n r e stric tin g th e
g r o w th o f th e t o t a l s u p p ly o f m o n e y a n d c r e d it ; u n d e r su c h a p o lic y
in te r e s t r a te s w o u ld b e lo w e r th a n u n d e r a p o lic y w h ic h p la c e d g re a te r
e m p h a s is o n g en era l c re d it restric tio n .
N o r is a n y seriou s a tt e n t io n
a p p a r e n tly p a id b y th e a d v o c a t e s o f g en era l m o n e t a r y p o lic y to t h e
c o n te n tio n t h a t th e se c o n tr o ls h a v e a n u n e v e n im p a c t o n th e e c o n o m y
a n d t h a t in th e p r e se n t e c o n o m ic e n v ir o n m e n t t h e y m a y serv e to k e e p
d o w n th e le v e l o f e m p lo y m e n t a n d th e r a te o f e c o n o m ic g r o w th
w it h o u t c o m in g to g rip s w ith th e p r o b le m o f in fla tio n in a n e ffe c tiv e
w a y .50
T h e ex iste n ce o f th e in te re st r a te c eilin g h a s p r o b a b ly d o n e lit t le
d a m a g e th u s fa r , sin ce th e T r e a s u r y w o u ld p r o b a b ly h a v e d o n e v e r y
lit t le b o r r o w in g in m a t u r it y r a n g e s b e y o n d 5 y e a r s in r e c e n t m o n t h s
in a n y c a se .
N e v e r th e le s s , as in d ic a te d earlier in th is s t u d y , le n g t h e n
in g o f th e d e b t is a n o b je c tiv e o f so m e im p o r ta n c e , a n d it w o u ld b e
d e s ira b le fo r th e T r e a s u r y to b e fre e to a c h ie v e w h a t it c a n in th is
r e s p e c t a t a ll t im e s .
R e m o v a l o f th e in te re st r a te ceilin g w o u ld
th e re fo re b e d e sira b le, b u t a fu n d a m e n t a l r e e x a m in a tio n o f o u r
p r e s e n t s ta b iliz a tio n p o lic ies is e v e n m o r e im p o r t a n t .
soThese arguments concerning the effects of general monetary controls are spelled out in “ Staff Report on
Employment, Growth, and Price Levels,” op. cit., ch. 9.
O
@FedFRASER