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'J

A Prelude to
the Annual Report for 1970




REFERENCE"
v t ^ o
C ~Cj

Contents
The U.S. Economy in
3

Transition

INTRODUCTION

7
7
11
13
16
17
20
24

M O N E T A R Y P O L I C Y A N D T H E E C O N O M Y I N 1970
Demands for goods and services
Federal budget
Resource utilization and prices
Balance of payments
Instruments of monetary policy
Monetary aggregates
Interest rates and credit flows

28

WAGES, P R O D U C T I V I T Y , A N D PRICES

34

CONSUMER ATTITUDES A N D BEHAVIOR

38
38
40

RESPONSIVENESS OF H O U S I N G A N D STATE A N D
LOCAL GOVERNMENTS
Housing
State and local governments

42
42
44

EASING I N CREDIT A V A I L A B I L I T Y A T BANKS
Sources of funds
Bank credit

47
48
49
50
52

A D J U S T M E N T S I N T H E BUSINESS SECTOR
Business investment
Internal funds
External financing
Corporate liquidity

53
53
55
56

U.S. B A L A N C E OF P A Y M E N T S
Merchandise trade
Capital flows
Over-all balance

I-VII

Principal




Federal

Reserve

Policy

Actions,

1970:

Digest




The

Economy inTransition







Introduction
Economic and financial conditions in the United States during 1970
were in a difficult transitional stage. Real output was stagnant and
unemployment was rising, and at the same time prices continued upward under continued cost pressures. Meanwhile, the balance of payments was affected by adverse shifts in capital flows, as a sharp drop
in short-term interest rates in this country led to a reversal of the
very large inflow of short-term capital that had contributed to surpluses in the U.S. official settlements balance in the previous 2 years.
Substantial progress was made during 1970, however, in re-establishing the basis for sustainable economic expansion. Although wage
increases—particularly under collective bargaining agreements—continued to be large, resumption of growth in productivity after the
first quarter served to moderate the rate of increase in unit labor
costs. The gains in efficiency that were effected in the business sector
also worked toward an improvement in the international competitive
position of the United States.
The financial positions of key spending sectors also improved in
1970. The position of corporations generally was bolstered by further heavy long-term borrowing and some restructuring of balance
sheets in the direction of greater liquidity. As to consumers, their
savings in liquid forms were considerably enlarged, to some extent as
a result of their cautious spending behavior throughout the year; and
financial positions were also favorably affected later in the year as
the recovery in the stock market in the second half offset a large
part of the earlier price declines.
Financial markets too moved into a position more compatible with
sustainable, long-term economic growth. By early 1971 conditions in
these markets had eased substantially. Interest rates were considerably lower, banks and other financial institutions were more liquid,
and the volume of funds available to borrowers was much improved
as compared with the situation a year earlier. Part of this easing in
financial conditions reflected a moderation in private borrowing
needs stemming from slower growth in current-dollar gross national
product and a leveling off in the capital expenditures of business,
which earlier had been running far ahead of internally generated
funds.




3

But more important was the resumption in 1970 of growth at
moderately high rates in such monetary aggregates as the money
stock and bank credit—an expansion that became feasible and desirable because excess demand had been eliminated. Broader measures
of liquidity showed relatively more rapid growth than the narrowly
defined money stock (currency plus demand deposits other than interbank and U.S. Government). With yields on market securities declining, interest rates paid on time and savings deposits became progressively more attractive, and such deposits expanded sharply at
both commercial banks and at other savings institutions. For commercial banks, time deposit expansion was particularly rapid following the suspension at midyear of interest rate ceilings on large negotiable certificates of deposit (CD's) in the 30- to 89-day maturity
range. In total, the greater inflow of time and savings deposits considerably increased the availability of funds seeking investment in
mortgages, State and local government securities, and short-term
business and consumer loans.
Federal fiscal policy also turned more stimulative in 1970: (1)
The 10 per cent surcharge on income taxes was terminated in two
stages; (2) the first of the reductions contained in the Tax Reform
Act of 1969 became effective; and (3) a sharp increase occurred in
Federal expenditures—mainly through enlargement of grants-in-aid
to local governments and transfer payments to individuals. Even
though Federal purchases of goods and services declined slightly in
dollar terms as a result of an appreciable reduction in the defense
budget, the effect of fiscal policy was to increase consumer disposable income and to buttress State and local government expenditures.
Despite these measures, aggregate economic activity lagged
throughout 1970 and output fell increasingly below the Nation's expanding output potential. At the year-end the unemployment rate
was up to 6.2 per cent, as against 3.5 per cent a year earlier, and
manufacturing facilities generally were being operated at well under
preferred rates. In terms of real GNP, the shortfall in output of
goods and services below full employment levels at the year-end exceeded 5 per cent. A t current prices, this represented a shortfall of
more than $50 billion at an annual rate.
I n view of the gap that has developed in the economy's performance relative to potential, and of the accompanying unemployment
and under-utilization of the Nation's human resources, the emphasis

4




in public policy continues to be on the restimulation of economic activity. A t the beginning of 1971, depreciation schedules on purchases
of business equipment were liberalized for tax purposes in order to
enhance the prospective return on, and thereby stimulate, such investment. The Federal budget proposed for fiscal year 1972 calls for
an increase in total expenditures of $16.2 billion—about the same as
is projected for the fiscal year 1971—and although balanced in
terms of the revenues that would be produced at full employment, it
will involve a substantial, realized deficit.
Monetary policy is also on an expansive course, as reflected not
only in the substantial growth in money, bank credit, and financial
flows, but also in marked declines in interest rates. In designing policies to help revitalize the economy, of course, care must be taken not
only to avoid encouraging a rebound that is so swift as to regenerate
inflationary pressures and expectations, jeopardizing the hard-won
progress that has been achieved in this area, but also to avoid weakening further the U.S. competitiveness in world markets.
It seems likely that an increasing number of sectors in our economy will contribute to economic expansion over the months ahead.
Residential construction has already achieved near-record levels, reflecting both large pent-up demands for housing and the marked improvement during 1970 in the availability of funds for mortgage lending. A n d a large and increasing volume of bond financing by State
and local governments points to a growing trend of expenditures for
public facilities.
The outlook for spending by businesses in the coming year is still
somewhat uncertain. Capital outlays are being adjusted downward in
many industries, following a long period of very heavy investment
spending. However, investment programs in some other industries—
notably the utilities—continue to indicate sharp growth in capital
outlays. Hence, the total dollar volume of capital spending, even
though it has leveled off, may well remain close to the peak rates
reached in 1970. Many businesses also worked during 1970 to trim
and balance their inventory positions. But the degree of inventory
adjustment was quite small by the standards of many other periods
of sluggish economic activity.
The key to the speed and extent of economic recovery in 1971
may well prove to be in the hand of the consumer. Total income
available for spending rose strongly during 1970—reflecting tax cuts,




5

higher social security and other Federal transfer payments, and further growth in aggregate wages and salaries. But spending was sluggish. I t rose less in current dollars than in other recent years—and
little at all after adjustment for higher prices. Consumers were in a
cautious mood—responding to rising prices, increasing unemployment, extended strikes, reduced overtime pay, an uncertain and at
times sharply lower stock market, political and military tensions
abroad, and social disorders at home. As a result, they restrained
their buying and instead strengthened their financial positions
through accumulation of liquid financial assets and repayment of
debt.
A n improvement in consumer sentiment now would serve to spur
consumer spending, just as the deterioration in confidence earlier
tended to restrict it. And stronger consumer markets would communicate strength to the business sector, would generate jobs and additional income, and would enlarge the tax revenues of governmental
units hard pressed by sharp increases in operating costs.
On balance, prospects seem good for a resumption of growth in
aggregate economic activity in 1971. Indeed, the recovery could
prove to be relatively vigorous if consumers become more confident
of future prospects and increase their propensity to spend accordingly. The prospects for sustaining economic expansion should be enhanced to the extent that such expansion is accompanied by increased efficiency in our economic processes through tighter
management. Continued moderation in inflation is also an important
pre-condition to lasting prosperity, and its achievement will require a
gradual subsidence in the cost pressures that lead to higher prices of
products and services.
The next section of this report describes monetary policy during
1970 in relation to broad financial and nonfinancial developments in
the economy. In order to help evaluate the positions of key areas in
early 1971, ensuing sections discuss recent trends in particular sectors or markets in terms of the types of adjustments made during the
year to, among other things, the abatement of aggregate demands
and the easing of monetary policy. A digest of the principal Federal
Reserve policy actions in 1970 appears on pages I - V I I , following
page 28.
•

6



Monetary Policy and the
Economy in 1970
To help stimulate economic activity while at the same time guarding
against fueling inflation, monetary policy during 1970 shifted from
the posture of restraint that had prevailed during much of 1969 to a
posture designed to assure adequate expansion in monetary and
credit aggregates and an easing in over-all credit conditions. From
December 1969 to December 1970, the money stock grew at an annual rate of 5.4 per cent and bank credit (adjusted for loan sales to
affiliates) at a rate of 7.4 per cent, up 2.3 and 3.4 percentage points,
respectively, from the year before. Except for a brief period in the
second quarter, short-term interest rates declined sharply during
1970. On the other hand, long-term interest rates did not show significant net declines until the latter part of the year, because credit
demands in bond markets remained strong and it took time for the
inflationary expectations of investors and borrowers to begin abating.
Once the decline in long-term rates got under way, however, it proceeded with a speed unprecedented in recent financial history.
D E M A N D S FOR GOODS A N D SERVICES
The weakening of demands in 1970 was reflected in production cutbacks in many industries. Output of goods and services (GNP) rose
about 5 per cent from 1969 to 1970 in terms of current dollars. But
all of the increase reflected a rise in the average level of prices, and
in constant dollars GNP declined slightly. In goods-producing sectors, output dropped by 3 per cent from 1969 to 1970. The declines
in industrial production were concentrated in defense products, off
19 per cent; in consumer durable goods, down 7 per cent; and in
business equipment, off 4 per cent.
The weakness in the economy was exacerbated by the extended
strike at a major automobile manufacturer, which lasted from September 14 to November 23. This strike contributed to the greater
than 3 per cent decline (annual rate) in real economic activity in the
fourth quarter. Apart from the effects of this strike, real GNP would
probably have shown a further small increase in the last quarter of




7

1. C H A N G E I N GNP

Dept.

of

Commerce

d a t a . Q u a r t e r l y t o t a l s are at seasonally a d j u s t e d a n n u a l rates.

the year. Real GNP had shown small increases in the second and
third quarters, following a decline of almost 3 per cent at an annual
rate in the first quarter as businesses cut back substantially on their
inventory investment.
Inventory policies of business were not a significant drag on the
economy after the first quarter, however. Following the first-quarter
decline in the rate of such investment, and a similar drop in the
fourth quarter of 1969, inventory accumulation picked up somewhat,
although the rate was still lower than at any other time since 1961.
Altogether, the over-all adjustment of inventories was mild.
Tn the first half of 1970 consumer spending was bolstered by additions to disposable income resulting from a Federal pay raise, increases in social security benefits, and the first-stage reduction in the
income tax surcharge. Nevertheless, the increase in such spending
did not keep pace with the rise in income—as consumers resisted
high and rising prices and as uncertain economic prospects also appeared to contribute to an increase in the propensity to save. The
personal saving rate rose to 7.5 per cent by spring and changed little
from this advanced rate in the second half of the year.
Growth in consumption outlays slowed further in the second half
of the year, reflecting a much reduced increase in disposable personal




income—despite elimination of the surtax at midyear—as employment showed only minor gains and the workweek was cut further in
the third quarter. The smaller increase in spending resulted mainly
from an actual drop in outlays on consumer durable goods. This
drop became evident in the third quarter prior to the strike in the
auto industry, and it was accentuated in the fourth quarter when expenditures for autos were cut sharply. Strike effects also contributed
to a reduced rise in disposable personal income in the second half of
the year, especially in the fourth quarter when such income grew at
less than one-half of the third-quarter pace and at about one-fourth
of the average rate for the first half.
In the business sector the principal development in 1970 was the
ending of the long fixed investment boom, which had persisted with
only minor interruptions since the early 1960's. Business spending on
new fixed capital rose by only about 3 per cent from 1969 to 1970

TABLE

1:

GROSS N A T I O N A L

PRODUCT

C h a n g e f r o m preceding p e r i o d , i n b i l l i o n s o f d o l l a r s

19 70
1968

Item

1969

1970
I

II

Gross national product

71 .1

66.4

45 1

7 8

Personal c o n s u m p t i o n e x p e n d i tures
Durable goods
Nondurable goods
Services

43.7
10.9
15.2
17.6

41.7
6.0
15.6
20.0

39 2
— 6
18 9
21 0

10.5
-1 7
6 8
5 4

6.8

6.0

7 3

10.5
5.2
5.4

12.5
1 .7
10.6

Addendum:
cent)

Saving rate

11. 6

14,4

11.
2.
3.
4.

i
8
8
7

IV

7 7
7
3 2
5 2

_

4 4
4
-5
5
5

9
9
7
1

(per

Fixed investment
R e s i d e n t i a l structures
Nonresidential
I n v e n t o r y change

-

N e t e x p o r t s o f g o o d s a n d services.
Exports
Imports
G o v t , purchases o f g o o d s
services
Federal
Defense
Other
State a n d l o c a l

III

-1
-1

4
3
0

0

-5

7. 5

_

7 6

7 4

4
7
2

1 5
8
8

8
3 0
- 2 3

6

1 5

2 4

-1

9

.6
4.9
5.5

I 7
6 7
5 0

9
2 3
1 4

6
1 7
1 1

1
0
1

-1

6
8
7

12.0
1.8
.8
1.1
10.1

8 3
-1 6
- 2 2
5
10

3 3
2
5
— 3
3 2

.6

-2.7
4.4
7.1

6 7

9
-2 3
3 3

.9
-

-5

-

—

and
20. 1
8.8
5.6
3.1
11.3

1

-1
- 2
-2

2
6
5

1
1.3

—

2 6
-1 1
-1 0
0
3 7

2 2
4
2
6
2 6

—

-1

NOTE.—Based o n d a t a f r o m D e p t . o f C o m m e r c e .




9

in current-dollar terms and actually declined after allowing for price
increases.
The leveling off of expenditures for plant and equipment appeared
to be in large part the product of developments cumulating over a
long period. The sharp expansion in plant and equipment outlays in
the second half of the 1960's ultimately gave rise to a drop in the
rate of plant capacity utilization in manufacturing, which by the end
of 1969 had declined to 83.7 per cent. I n 1970, as defense production was reduced and consumer propensities to spend declined, capacity utilization rates dropped further—to 72 per cent by the end of
the year. With wage costs and the costs of external funds rising
sharply, business profits too came under pressure, and investment incentives were reduced. The weakening of investment incentives, however, was counterbalanced in part by the sharp drop in the cost of
capital—as represented by long-term interest rates—in late 1970 and
early 1971.
Other types of capital outlays were particularly responsive to
emerging tightness or ease in credit markets. Residential construction
expenditures, which had begun to decline in the second half of 1969,
continued to drop in the first half of 1970 in lagged response to the
reduced availability and higher cost of funds from private lenders.
The decline from mid-1969 to mid-1970 was less sharp than that
during the 1966-67 period of mortgage market tightness, however.
The fact that it was smaller reflected in part the expansion of Federal
support programs to provide more insulation of the housing market
from the effects of monetary tightness and in part a response to nonmonetary factors that sustained the demand for homes.
With the turn toward monetary ease in early 1970, availability of
funds in the mortgage market began to improve. The ensuing decline
in short-term market interest rates was accompanied by a sharp increase in the net inflow of funds to savings institutions as the public
diverted savings from market instruments to interest-bearing deposits.
Although mortgage interest rates showed little net decline until late
in the year, when they began to drop significantly, the increased
availability of funds led to a rise in housing starts from a seasonally
adjusted annual rate of 1.25 million units in the first quarter to an
average of 1.75 million units in the fourth quarter. A n d outlays for

10




residential construction turned up in the second half of the year. The
dollar rise in the fourth quarter was the largest in 3 years.
Purchases of State and local governments rose by only about the
same amount from 1969 to 1970 as they had the year before, despite a 20 per cent increase in Federal grants-in-aid from 1969 to
1970. Normally, increases in such purchases have tended to accelerate from year to year as the demand for public facilities and services
has expanded. But spending was held back in 1970 as a result of the
financing difficulties that many governments encountered in late 1969
and early 1970. Debt issues were difficult to place in view of the
tight position of commercial banks, which are principal buyers of
such issues; and in some cases governments were unable to issue
bonds because of restrictive interest rate ceilings imposed by State
regulations or public referenda. As 1970 progressed, however, the
easing in the availability of funds at banks helped to facilitate marketing of a larger volume of issues. Since there is a substantial lag
between financing and actual spending, State and local government
capital outlays by year-end had not yet risen appreciably.
FEDERAL BUDGET
Demands by the Federal Government for goods and services moderated in 1970. In fact, the total of such purchases, as measured in the
national income accounts, declined for the first time in 10 years. The
$2 billion year-over-year decline in defense spending reflected substantial reductions in real terms, including a reduction of 318,000
in the size of the Armed Forces and sizable cutbacks in orders and
deliveries of defense products. The budgetary reductions in defense
spending occurred despite a sizable increase in U.S. Government
compensation for military and civilian employees. Increases in purchases of nondefense goods and services were minor. On the other
hand, Federal expenditures other than purchases rose by about $16.5
billion from 1969 to 1970, a record increase. In addition to the
larger grants-in-aid to State and local governments already noted, social security payments rose—a 15 per cent increase in benefits was
enacted in A p r i l retroactive to the first of the year—and medicare
programs and unemployment compensation also entailed larger disbursements.




11

Total Federal receipts, as measured in the national income accounts, dropped by about $5 billion in 1970, reflecting principally
the effects of the elimination of the 10 per cent tax surcharge. In addition, however, growth in taxable income of businesses and consumers was considerably below normal.
With receipts dropping and total expenditures continuing to rise,
the Federal sector of the national income accounts showed a deficit
of $11 billion in 1970, following a $9 billion surplus in 1969. The
unified budget also shifted into sizable deficit during the year, and
the Federal Government once again became a large net borrower in
credit markets.
The extent of the swing from budgetary surplus in 1969 to deficit
in 1970 was, as noted above, strongly influenced by the sluggish
pace of economic activity. To that extent it was not reflective of a
more active fiscal policy. But in addition, certain discretionary
changes—such as the reduction in tax rates—were undertaken that
moved fiscal policy in a somewhat more expansive direction.
TABLE 2 :

FEDERAL

GOVERNMENT

RECEIPTS

AND

EXPENDITURES

In billions o f dollars

C a l e n d a r year

1970

Item
1968

1969

1970

I

II

III

IV

F e d e r a l Sector N I A basis
( A n n u a l totals, or quarterly totals
at seasonally a d j u s t e d a n n u a l rates)
Receipts
Expenditures
Purchases o f goods a n d services
Other
S u r p l u s o r deficit

175.4
181.6
99.5
82. 1
-6.2

200.6
191.3
101.3
90.0
9.3

P 195.2
P 206.3
P 99.7
p 106.6
5-11.1

195.9
197.7
102.3
95.4
-1.7

196.7
210.9
99.7
111.2
- 14.2

194.9
206.7
98.6
108. 1
-11.8

•193.3
P209.9
5 98.2
"111.7
e
— 16.6

U n i f i e d budget
( A n n u a l t o t a l s , o r q u a r t e r l y t o t a l s n o t seasonally a d j u s t e d )

Receipts
Outlays
Budget surplus, or deficit
N e t cash b o r r o w i n g

169.4
185.5
-16. 1
15.3

195.7
190.3
5.4
-2.6

190.5
201.9
-11.4
11.8

44.4
47.8
-3.5
2.0

58.6
49.8
8.7
-6.4

46.5
54.3
-7.8
7.4

41. 1
49.9
-8.9
8.9

e
Estimate.
p Preliminary.
N O T E . — T h e F e d e r a l sector i n t h e n a t i o n a l i n c o m e a c c o u n t s measures F e d e r a l receipts a n d expend i t u r e s as t h e y d i r e c t l y affect p r i v a t e i n c o m e s i n the n a t i o n a l a c c o u n t s . T h u s it excludes all F e d e r a l l e n d ing, w h i c h affects p r i v a t e d e b t b u t n o t incomes. A l s o the t i m i n g i n some t r a n s a c t i o n s is o n a n a c c r u a l
basis; i n o t h e r s , o n a d e l i v e r y basis. G e n e r a l l y s p e a k i n g , t h e u n i f i e d b u d g e t includes l e n d i n g by f e d e r a l l y
o w n e d agencies ( b u t n o t t h a t o f f e d e r a l l y s p o n s o r e d c o r p o r a t i o n s ) , a n d it r e c o r d s F e d e r a l t r a n s a c t i o n s
o n a cash basis.

12



A measure of the extent of the change in fiscal policy is provided
by the "full employment" budget. There are a number of different
ways of measuring expenditures and receipts under the full employment concept, but all show a decline in the full employment surplus
from 1969 to 1970. According to the measure calculated by the
Council of Economic Advisers, the drop in the full employment surplus was about $5 billion, but there was still a moderate surplus for
the calendar year 1970.
RESOURCE U T I L I Z A T I O N A N D PRICES
The weakening of aggregate demands for goods and services in 1970
was reflected, in turn, in reduced demands for labor. While reflecting
in part the effects of the auto strike, total civilian employment
showed practically no net change from the fourth quarter of 1969 to
the fourth quarter of 1970. Although growth was considerably less
than in 1969, the total labor force continued to expand substantially.
Growth in the civilian labor force was further raised by the reduction
in the size of the Armed Forces. The rate of unemployment rose
from an average of 3.6 per cent in the fourth quarter of 1969 to 5.9
per cent in the last quarter of 1970. For the year as a whole, it averaged 4.9 per cent.
In manufacturing industries, employment by the end of 1970 was
down sharply—by about 1.3 million workers—from a year earlier.
During the year employment demands diminished over a broad spectrum of manufacturing, including both defense activities and civilian
industries. Layoffs affected production workers for the most part.




2. U N E M P L O Y M E N T R A T E
PER CENT

1968

1969

B u r e a u o f L a b o r Statistics d a t a .

13

However, in view of the pressures on profit margins, businesses were
very sensitive to the need for reducing costs, and as a result employment of nonproduction workers too was cut substantially, especially
in the defense-products industry.
T A B L E 3 : LABOR M A R K E T

INDICATORS

C h a n g e ( i n t h o u s a n d s o f persons)
d u r i n g year e n d i n g Q 4 :
Item
1968

1969

1970

T o t a l l a b o r force
A r m e d Forces

1 .031
73

2,339
-53

1 .331
-444

C i v i l i a n l a b o r force
Employed
Unemployed

958
1.312
-353

2,392
2,167
224

1 .774
- 1
1,775

N o n f a r m e m p l o y m e n t (based o n
payroll data):
Manufacturing
Production workers
Other
Private n o n m a n u f a c t u r i n g . . . .
Government
Federal
State a n d l o c a l

439
315
124
1 .440
425
-23
448

184
55
129
1 .502
341
5
336

- 1 .455
-1.265
-190
364
453
-66
518

Despite a weakening in demand for labor, upward wage pressures
continued strong, reflecting both the large number of union wage
contracts that came up for renewal and the attempts of both union
and nonunion workers to make up for previous—or to anticipate future—cost-of-living increases. Compensation per manhour in the private nonfarm sector of the economy increased by about 7 per cent
on the average in 1970, very little different from the increase in
1969, even though there was a reduction in overtime work.
In spite of the sizable further rise in compensation in 1970, unit
labor costs in the private nonfarm economy rose less than in 1969.
Output per manhour, after failing to show any improvement since
the first quarter of 1969, began to rise in the second quarter of
1970; the rise appears to have been interrupted in the fourth quarter, but this was apparently the result of a sharp drop in production
related to the auto strike. The moderate rebound in productivity and
the slowing of growth in unit labor costs tended to ease, to some degree, the pressures on profits resulting from the slackness in demands

14



for industrial output and for services; still, the general pressures on
profit margins caused businesses to raise prices further.
Progress toward containing the rate of inflation was slow. The rate
of increase in wholesale prices of industrial commodities diminished
somewhat, from an average annual rate of 3.8 per cent in the first
half of the year to 3.4 per cent in the second half. However, prices of
finished goods rose sharply in the fourth quarter in reflection of upward adjustments in passenger car prices. But nonfood crude materials, excluding fuels, declined in price during the last three quarters
of the year. The consumer price index rose somewhat more moderately in the second half of the year than it had in the first half,
largely as a result of an increase in food supplies, mainly meat.
Although the increase in average consumer prices moderated somewhat, there were a number of areas—such as construction costs—
in which price increases, reflecting the upward momentum gathered
over the past several years, continued to be very strong. Nevertheless,
as measured by the private GNP implicit deflator, the rate of price
increase over-all seems to have leveled off during the year, if rough
allowance is made for the technical effects of the auto strike on the
composition of fourth-quarter output and hence on the computation
of the deflator.
TABLE 4 :

PRICE

CHANGES

I n per cent
1970 a n n u a l r a t e 1

Year
Category
1967

W h o l e s a l e prices, t o t a l
Industrial commodities
Crude materials 2
Finished goods
Farm
products,
processed
f o o d s , a n d feeds

.9
1 .9
1.0
2.4

1968

1969

1970

Dec.Mar.

Mar.June

JuneSept.

SeptDec.

4.0
3.1
9.5
2.8

1.1
4.5
-2.6
2.8

3.9
2.9
-7.3
2.8

.4
3.8
-3.8
8.8

2.8
2.6
-1.3
2.4

4.7
3.9
7.3
3.4

2.3
3.6
-1.2
4.3

-1.8

3.5

7.3

-1.2

6.8

-9.9

8.9

-9.2

Consumer p r i c e s , t o t a l
Food
O t h e r c o m m o d i t i e s (less f o o d ) .
Services

3.0
1.2
3.2
3.9

4.7
4.3
3.7
6.1

6.1
7.2
4.4
7.4

5.5
2.2
4.8
8.2

6.3
5.4
2.9
11.2

5.8
1.3
6.4
7.3

4.2
1.4
3.7
7.2

5.7
.9
6.4
7.0

G N P , private implicit deflator. .

3.0

3.8

4.7

5.0

5.3

4.1

4.7

5.8

1

Compounded.
E x c l u d e s f o o d s , feeds, a n d fuels.
N O T E . — A l l d a t a are seasonally a d j u s t e d except f o r c r u d e m a t e r i a l s a n d finished g o o d s i n wholesale
prices a n d services i n c o n s u m e r prices. A n n u a l changes c a l c u l a t e d D e c e m b e r t o D e c e m b e r , except f o r
d e f l a t o r f o r w h i c h q u a r t e r l y d a t a are used t h r o u g h o u t .
2




15

B A L A N C E OF PAYMENTS
There were divergent trends in the current and capital accounts of
the U.S. balance of payments during 1970. In the first half of the
year the trade balance strengthened considerably, under the influence
of lessened demand pressures here and a high level of activity in
most industrial countries. However, the trade surplus declined after
midyear as imports rose further despite the growing slack in the U.S.
economy, while exports fell off somewhat in response to an easing of
the rate of expansion abroad. On the other hand, net outflows of
long-term capital were very large in the first half, as U.S. direct
investors placed large amounts abroad while foreign investors were
net sellers of U.S. corporate stocks. Foreign purchases of equity securities were resumed on a substantial scale in June, and the outflow
of funds from U.S. corporations for direct investment abroad appeared to be much less in the second half of the year.
I n total, the liquidity measure of the U.S. balance of payments
showed a small improvement in 1970—registering a deficit of about
$5 billion, or $1 billion less than in 1969 (balances adjusted to exclude special transactions and, in 1970, the allocation of SDR's).
Gains in the liquidity balance reflected primarily an improvement in

TABLE 5 : U . S . INTERNATIONAL

TRANSACTIONS

I n b i l l i o n s o f d o l l a r s , seasonally a d j u s t e d

1970
1970'

G o o d s a n d services, net
Exports
Imports
T r a d e balance
Services, net
A l l other transactions corresponding
l i q u i d i t y basis 1

I.I

3.6
42.0
-39.8
2.2
1.4

10.2
-9.7
.5
.3

10.7
-9.9

10.7
-10.0
.7
.3

-7.9

-8.5

-2.1

-3.2

-1.7

-6.0

-4.9

-1.3

-2. I

9.2
-.5

-6.5
.3

-1.9

to

L i q u i d i t y balance a d j u s t e d 1 , 2
L i q u i d liabilities t o :
Foreign commercial banks
Other private foreigners3
O f f i c i a l settlements balance a d j u s t e d 1 , 2 . .

2.8

11.0

-3.2

' Estimated.
1
E x c l u d e s special transactions.
Excludes S D R allocation.
Includes international organizations.
NOTE.—Details m a y n o t a d d t o t o t a l s because o f r o u n d i n g .
SOURCE.—Survey of Current Business a n d Federal Reserve estimates.
2

16




1.0

I .9
36.5
-35.8
.6
1.3

-.7

— 1.4
- .I
-2.1

the trade balance from a slim $0.6 billion surplus in 1969 to a surplus of about $2.2 billion in 1970, plus somewhat larger net receipts
of investment income.
A major feature of the U.S. accounts in 1970 was a net reduction
of more than $6 billion in liabilities of U.S. banks to foreign commercial banks through their branches. These borrowings had been
built up mainly in 1969 when monetary restraint and the low level
of Regulation Q ceiling rates relative to domestic market rates had
limited the growth of bank liabilities to domestic holders. As funds
borrowed from abroad were returned to the Euro-dollar market, the
dollar holdings of foreign monetary authorities grew rapidly. Consequently, the balance on the official reserve transactions basis (excluding special transactions and the allocation of SDR's) registered a
deficit of $11 billion, reversing the $2.8 billion surplus of 1969.

I N S T R U M E N T S OF M O N E T A R Y P O L I C Y
During 1970, as usual, the Federal Reserve relied mainly on open
market operations in encouraging growth in the monetary aggregates
and easier credit market conditions. But it also used other monetary
policy instruments as the stance of policy was adapted during the
year to emerging sectoral, liquidity, and balance of payments problems.
Early in the year the Board of Governors announced an acrossthe-board increase in the maximum interest rates payable by member
banks on time and savings deposits. The realignment was part of a
coordinated move on the part of the Board, the Federal Deposit Insurance Corporation, and the Federal Home Loan Bank Board that
involved general increases in ceiling rates on deposits at both banks
and nonbank thrift institutions. In addition to an upward scaling
of ceilings by maturity on both large time CD's and—for the first
time—consumer-type time certificates, maximum rates payable on
savings deposits at commercial banks were raised for the first time in
several years. This latter change reflected efforts to introduce greater
equity into rates payable for smaller savings balances.
More broadly, these actions were designed to bring rates payable
by banks and other savings institutions for deposits more into line
with rates prevailing at the time on competing market securities. It
was expected that the realignment of deposit rates with market rates




17

would help to generate the deposit funds needed to finance a moderate pick-up in the growth of credit flows through financial institutions.
I n May and June, Federal Reserve authorities took several actions
to assure that the System would fulfill effectively the oldest and most
traditional central banking function—that of serving as lender of
last resort and of alleviating liquidity squeezes. In that period U.S.
money and capital markets were experiencing unusual strains.
Among the causes of these tensions were heavy corporate demands
for long-term credit, expectations of a large volume of borrowing by
the U.S. Treasury in the latter half of the year, concern that some
prominent firms were financially over-extended and might not be
able to refinance their short-term obligations, a sharp drop in stock
market prices, and unsettlement arising from the unexpected U.S. involvement in Cambodia. While anxieties in financial circles that a
general liquidity squeeze was emerging proved to be clearly exaggerated, it is true nonetheless that their net effect was to cause a sharp
increase in over-all demand for liquidity. In view of these market
uncertainties and liquidity strains, open market policy gave first priority in this period to moderating pressures on financial markets.
And in May the Board of Governors reduced margin requirements
on equities from 80 to 65 per cent, and on convertible bonds from
60 to 50 per cent.
I n recognition that pressures might pyramid in the commercial
paper market after a major railroad filed for reorganization in midJune, the authorities supplemented their efforts to ameliorate market
strains through open market policy with other policy measures. It
was made clear that the Federal Reserve discount window would be
available to assist banks in meeting the needs of businesses unable
to roll over their maturing commercial paper. Also the Board of
Governors moved promptly to suspend maximum rate ceilings on
large-denomination CD's with maturities of 30 to 89 days.
This action enabled banks to obtain funds that investors had become reluctant to place in other markets and to rechannel these
funds to borrowers previously dependent on the issuance of commercial paper. Aided by these Board actions, banks responded effectively to the midyear shifts in demands for funds, and the widespread
concern that a lessening of investor participation in the commercial
paper market might trigger a series of business bankruptcies subsided.

18




In mid-August, after conditions in the commercial paper market
had calmed, the Board announced the application of a 5 per cent reserve requirement against funds obtained by member banks through
the issuance of commercial paper by their affiliates. This action was
designed to put bank-related commercial paper, which is typically issued in denominations of $100,000 or more, on a substantially equal
footing—in terms of reserve requirements—with large negotiable
time CD's. A somewhat similar proposal, with a higher reserve requirement, had been published for comment in January, but given
the interim course of economic and financial developments, circumstances were not appropriate for its adoption.
The extension of reserve requirements to bank-related commercial
paper was accompanied by a reduction from 6 to 5 per cent in the
reserves that member banks must hold against time deposits in excess of $5 million. These two actions, in combination, resulted in a
net reduction in required reserves of about $400 million for the
banking system as a whole. Most of the reduction in reserves affected banks that might be expected to be relatively active lenders in
markets for mortgages and State and local government securities.
A n additional reserve requirement action, announced at the end of
November, was designed to have an effect on the balance of payments. In the closing months of the year further declines in U.S.
short-term interest rates were sharply increasing the relative costs for
major U.S. banks of borrowing Euro-dollars in lieu of domestic
short-term funds. This widening of rate spreads threatened to cause
large U.S. bank repayments of Euro-dollar borrowings, and a consequent deepening of the very large official settlements deficit in the
U.S. balance of payments.
Therefore, to temper Euro-dollar reflows, the Board of Governors amended Regulations D and M to increase—from 10 to 20
per cent—the reserve ratio required on Euro-dollar borrowings exceeding the average level that is reserve-free. This reserve-free base
declines as the average level of Euro-dollar borrowings is reduced
below a line established for the individual bank. The doubling of the
reserve ratio was expected to moderate further outflows of bank-held
Euro-dollars by enhancing the prospective value of existing reservefree bases.
After A p r i l 1969 market interest rates had moved well above the
discount rate, but by October 1970 declines in such rates had again




19

brought the discount rate about in line with the market. When
short-term market rates then dropped below the discount rate during
November, the Federal Reserve lowered the discount rate to bring it
into closer alignment with market rates. Effective November 1 1 and
December 1, the rate was reduced from 6 to 5V2 per cent. These
were the first changes in the discount rate since April 1969, and the
first cuts since a Va percentage point reduction in mid-August 1968,
and before that a Vi percentage point reduction in early A p r i l 1967.
Two further reductions of V \ percentage point in the discount rate
<
were made in early 1971, as short-term market rates dropped further, and at the end of January 1971 the discount rate was 5 per
cent.
MONETARY

AGGREGATES

In the latter half of 1969 growth of the narrowly defined money
stock had slowed to a virtual halt, and bank credit—as measured by
the adjusted bank credit proxy—had contracted slightly. In moving
from a restrictive to a more expansionary monetary policy in early
1970, the Federal Open Market Committee sought to achieve moderate growth in money and bank credit. To implement its policy of
encouraging more rapid growth in such aggregates, the Committee
placed somewhat greater emphasis on the monetary aggregates in the
operating instructions given to the System Account Manager for
guidance in the day-to-day conduct of open market operations. The
Committee did not decide to pursue fixed target rates of growth of
the monetary aggregates in any exclusive sense, however, and it continued to adjust its stance as required to meet other policy objectives—for example, the need already noted to cope temporarily with
liquidity strains and undue pressures in security markets.
Reflecting the diversity of operating targets, the large variations
often found in month-to-month deposit data, and what seemed to be
temporary but sharp shifts in the public's willingness to hold cash,
the growth rate of the narrowly defined money stock in 1970 sometimes fluctuated fairly widely. Over the year as a whole, however, the
money stock expanded by 5.4 per cent. During each of the first three
quarters of the year the annual rate of growth averaged close to 6 per
cent. Although the growth rate then dropped to about 2 per cent on
the average in October and November, when demands for money

20



TABLE 6 :

CHANGES

IN

SELECTED

MONETARY

AGGREGATES

1969
Item

1968

1969

1970

1970
1st H

2nd H

1st H

2nd H

I n per c e n t ; q u a r t e r l y figures, at seasonally adjusted a n n u a l rates
7.8

— 1.6

6.4

. 7

— 3.9

7.8

3. 1

5.4

5. 1

1.2

-

.2

13.0

5.9

4.8

Concepts of m o n e y :
M i ( C u r r e n c y plus d e m a n d
M i ( M i plus t i m e d e p o s i t s at
commercial
banks
other
9.4
M 3 ( M 2 plus deposits at n o n bank thrift i n s t i t u t i o n s ) . . . .
Bank credit:
Bank credit proxy adjusted2. .
Loans and investments
of

2.4

8.2

5. 1

.4

5.9

10.2

8.4

2.8

7.9

5.1

.4

5.3

10.2

9.8

.2

8.3

1.6

-1.2

3.5

12.9

4.0

7.4

5. 1

2.9

4.5

10. 1

2.0
1.9

12.8
-4. 1

2.6

-5.0

11.0

-

I n billions o f dollars
M e m o items on s h o r t - t e r m
market paper:
L a r g e t i m e C D ' s at b a n k s . . . .

2.9
2.6

-12.8
6.8

14.8
-6.0

-8.2
4. 8

-4.6
2.0

« 5.9

-2.4

' 2.8

3.1

-

B a n k - r e l a t e d c o m m e r c i a l paper a n d o t h e r n o n d e p o s i t

e

Estimated.
C u r r e n c y held outside the T r e a s u r y , F . R . Banks, a n d the vaults o f a l l c o m m e r c i a l banks, plus
d e m a n d deposits o t h e r t h a n i n t e r b a n k a n d U . S . G o v e r n m e n t .
2
T o t a l m e m b e r b a n k deposits subject t o reserve r e q u i r e m e n t s , plus E u r o - d o l l a r b o r r o w i n g s , b a n k related c o m m e r c i a l p a p e r , a n d c e r t a i n o t h e r n o n d e p o s i t items. T h i s series f o r deposits is referred t o as
" t h e adjusted b a n k c r e d i t p r o x y . "
3
Based o n m o n t h - e n d figures. Includes loans sold o u t r i g h t t o affiliates a n d branches.
1

were temporarily affected by the dampening effect of the auto strike
on economic activity, in December it again moved up to 6.2 per
cent.
Broader measures of the money stock—which encompass various
types of time and savings deposits as well as private demand deposits
and currency, such as the M 2 and M 3 concepts listed in the accompanying table—showed substantially more rapid growth in 1970 than
M i (narrowly defined money stock). Moreover, the growth in these
aggregates accelerated in the second half of 1970. As already noted,
the stage had been set for expansion in these other measures when
ceiling rates of interest were increased in January for time and savings deposits at all types of thrift institutions.
As market interest rates moved down toward, and below, these




21

higher ceilings, savings inflows accelerated at both bank and nonbank thrift institutions. Although this pick-up began as early as February, the inflow gained momentum during the second quarter and
was most pronounced after midyear. The late June suspension of
ceiling rates on large short-maturity bank CD's triggered an abrupt
increase in such instruments during the third quarter. A n d for the
year as a whole the total growth in CD's more than offset the sharp
contraction that had occurred in 1969.
The expansion was not limited to CD's, however. Consumer-type
time and savings accounts at banks grew nearly as much as CD's in
the third quarter, and for the year as a whole their expansion was
substantially larger than that of CD's. A somewhat similar growth
pattern was evident at savings and loan associations and, with some
lag, at savings banks as well. Apparently consumers were encouraged
to add to liquidity in these forms by several factors: the dramatic
improvement of yields on such accounts relative to market rates; a
desire to maintain their financial asset holdings in risk-free form; and
a more conservative attitude on their part toward spending, as overtime hours of work dropped and unemployment widened.
To a considerable extent the rapid growth of large CD's indicated
that banks were using this less costly and more convenient means of
obtaining funds instead of borrowing through the Euro-dollar market
or issuing bank-related commercial paper. After the Board announced the extension of reserve requirements to bank-related commercial paper, the volume of such paper outstanding declined by
$5.2 billion through December. And over the full year, as domestic
markets for short-term funds became relatively more attractive, major
banks reduced their Euro-dollar borrowing by more than $6 billion.
Nevertheless, when bank funds from these sources are added to deposits, as in the adjusted bank credit proxy, the growth in this comprehensive measure was still sizable—more than 8 per cent for the
year, as compared with less than one-half of 1 per cent for 1969.
Moreover, growth in bank credit—like that in the broader measures
of money and liquidity—accelerated in the second half of 1970.
The total reserves that support aggregate member bank deposits
grew by 6.4 per cent in 1970; expansion was especially rapid in the
second half of the year. Nonborrowed reserves provided to banks
through open market operations rose more rapidly than the total, as
member banks reduced their borrowings at Federal Reserve Bank

22



discount windows from around $1 billion early in 1970 to a range of
$200 million to $300 million at the year-end. Over the same period
net borrowed reserves (excess reserves less borrowings) dropped
from around $800 million to virtually zero, with excess reserves rising modestly over the year as short-term interest rates—representing
the cost of holding excess reserves—declined sharply.
Part of the rapid expansion in bank credit in 1970 represented a
channeling of funds through the banking system, whereas in 1969
funds had been going directly into market securities. Perhaps the
most dramatic illustration of this rechanneling process occurred during the squeeze on the commercial paper market in late June and
July when outstanding nonbank commercial paper declined by more
than $2 billion in the course of a few weeks, while bank CD's and
loans to businesses and to finance companies showed a marked expansion.
Although movement of funds back into banks and into nonbank
savings institutions was an important aspect of credit flows in 1970,
there was also an increase in the over-all availability of credit and in
the actual amount of funds raised, as both institutions and direct
market participants became more willing lenders. Total funds raised
by nonfinancial sectors rose by about $14 billion (annual rate)—or
16 per cent—from the second half of 1969 to the second half of 1970,
TABLE 7 : FUNDS

RAISED BY N O N F I N A N C I A L

SECTORS

I n b i l l i o n s o f d o l l a r s ; h a l f - y e a r figures, at seasonally a d j u s t e d a n n u a l rates

1969
Sector

1968

1969

1970

1970
1st H

Total

97 4

U.S. G o v e r n m e n t

13 4

T o t a l , other nonfinan. sectors1..
State a n d l o c a l g o v t , issues
N o n f i n a n c i a l c o r p o r a t e business:
Bonds a n d stocks
Mortgages
C o m m e r c i a l paper
Consumers:
Consumer instalment debt. . . .
Mortgages

88 2

96 1

6

I 19

84 1
10 2

91 9
8 9

12 1
5 8
6
9 6

16
4
2
10

9 0
16 0

1

2nd H

1st H

2nd H

88 8

101 .5

87 8

89 1

3

2 0

8 7

13.6

84 2
12 6

98 1
10 0

85 8
6 9

80 4
10 1

87.9
15. 1

4
3
7
9

27 9
5 0
2 8

14
4
3
13

17
4
1
8

24
4
3
3

6
5
1
9

31.2
5.5
2.4
-3 9

8 3
17 4

3 0
13 0

8 9
18 0

4 3
13 5

1 .7
14.6

-3

-9

8
6
8
4

9
0
5
3

7 9
16 7

1
Includes b o r r o w i n g o t h e r t h a n the types s h o w n below.
NOTE.— F l o w o f f u n d s data.




23

over a period when interest rates were showing substantial declines.
The increase in funds raised reflected larger borrowings by the U.S.
Government, while funds raised by other sectors were little changed
between the two periods.
I N T E R E S T R A T E S A N D C R E D I T FLOWS
Declines in U.S. short-term market rates of interest in 1970 were the
most dramatic in absolute terms for any year in the postwar period.
The reductions ranged from about 3 to 4 percentage points, or from
about one-third to nearly one-half of their levels prevailing in December 1969. Declines in long-term market rates, while also large,
ranged only from about one-tenth to nearly one-fourth of their December 1969 levels, although this amounted to 1 to 1 Vi percentage
points in yield. As a result of their much wider swing, short-term
rates generally moved from a position of historically wide spreads
above, to one of wide spreads below, long-term rates.
TABI.E

8:

CHANGES

IN

SELECTED I N T E R E S T

RATES,

1970

I n basis p o i n t s

Total,
Dec.'69
to
Dec.'70

Dec.'69
to
Mar.'70

Mar.'70
to
spring
high

Short-term:
Federal funds
T r e a s u r y bills
C o m m e r c i a l paper
Euro-dollars

-407
-295
-311
-384

-121
-119
i -78
-221

+ 34
+ 20
i +23
+ 51

Long-term:
Corporate Aaa
U.S. G o v t
State a n d local g o v t

-95
- 126
-136

-15
-58
-79

+ 51
+ 84
+ 97

Series

Oct.'70
to
Dec.'70

- 130
-104
- 1 12
-69
— 83
-94
-93

1
Periods used are December t o A p r i l a n d A p r i l t o the s p r i n g h i g h ,
since changes i n this series lagged b e h i n d the changes i n other shortt e r m rates.
NOTE.—Changes are calculated f r o m m o n t h l y averages. T r e a s u r y
bills, 3 - m o n t h m a r k e t y i e l d ; c o m m e r c i a l p a p e r , 4-6 m o n t h s ; E u r o d o l l a r s , 3 - m o n t h ; c o r p o r a t e A a a , new issues, F R B series; U . S .
G o v t . , 10-year c o n s t a n t m a t u r i t y ; State a n d l o c a l g o v t . , f r o m the
B o n d Buyer.

The pattern of change within the year was also somewhat different
for short- as compared with long-term rates, although rate declines
in both maturity sectors during the first quarter were generally typical of what might be expected at a cyclical downturn in rates. In the

24



second quarter, even though interest rates rose in both short- and
long-term markets, the size of the increase was much larger in longterm markets, where yields rose to new highs. By midsummer shortterm rates had generally dropped through the lows reached in the
first quarter, while long-term rates had declined considerably less. Indeed, most of the total decline in long-term market rates in 1970 occurred during the last 2 months of the year. In early 1971 both
short- and long-term rates declined considerably further.
This varied pattern of interest rate behavior in 1970 reflected the
interaction of shifting market expectations and actual credit flows.
During the first quarter, for example, as it became evident that real
GNP was declining and the Federal Reserve was promoting some
easing in credit market conditions, financial market sentiment
strengthened dramatically, particularly after banks lowered their
prime rate by V2 percentage point. But as often happens in financial
markets, evidence that emerged in the second quarter did not seem
to support the expectations that had helped to bring about the firstquarter rate declines. News concerning the economy seemed to indicate that the downturn in real GNP was about over. With progress
in controlling inflation also disappointing and the Cambodian incursion creating general unsettlement, question was raised whether further easing of monetary policy could be expected.
As short-term market rates rose, banks' access to funds through
CD's was again curtailed. In these circumstances the heavy forward
calendar of corporate and municipal borrowing, the large prospective
volume of U.S. deficit financing in the second half of the year, and
the growing concern that some major firms were financially overextended, all contributed to an abrupt weakening of market psychology. In the face of this sharply changed outlook, borrowers actually
coming to market had to pay substantially higher rates.
Accompanying the strains in security markets in the second quarter, depositary institutions generally experienced a noticeable improvement of deposit flows as consumers placed a greater premium
on risk-free financial assets. These flows permitted the commercial
banking system to add significantly to liquid asset positions. After
midyear, with the suspension of rate ceilings on short-maturity time
CD's and the relaxation of tensions in the commercial paper market,




25

3. SHORT - A N D L O N G -TERM INTEREST RATES
PER CENT

1968

1969

1970

1968

1969

1970

market interest rates turned down again, and deposit flows to banks
became much larger, as noted earlier. In addition to financing the
large volume of business and finance company borrowing transferred
from the commercial paper market to the banks, these enlarged deposit flows permitted a substantial further expansion in bank holdings of U.S. Government and of State and local government securities. In this way the heavy increases in borrowing by these two levels
of government during the second half of 1970 were financed at
generally declining rates.
During the summer months—perhaps because of the large amount
of refinancing by borrowers who were transferring out of the commercial paper market—banks generally presumed that underlying de-

26



mands for business loans were still strong. Hence, there was no significant relaxation of loan terms, even though bank liquidity
increased greatly. But by mid-September, when corporate tax payments became due, it became apparent that business borrowing at
banks had dropped off sharply, and shortly after that, banks cut the
prime rate by another V2 percentage point to IV2 per cent. Nevertheless, there was still considerable uncertainty about the underlying
strength of business loan demand, for the trend in such lending was
being obscured by the effects of the auto strike and also by the large
repayments of loans arising from the heavy volume of corporate
financing then under way in capital markets. In the expectation that
these two temporary drags on loan growth would soon end, bankers
tended to hold off on further reductions in the prime rate.
In November and December, however, with no sign of any significant pick-up in demand for loans and with plenty of liquidity, banks
reduced the prime rate further, in a series of
percentage point
changes, from IV2 to 6% per cent by the year-end. The Federal
Reserve discount rate was also reduced in this period. And there
were further general declines in both short- and long-term market
rates, even though the volume of new corporate and municipal bond
offerings remained very large. Moreover, earlier accumulations of
savings flows, liquidity, and commitments at nonbank thrift institutions were finally reflected in widespread reductions in interest rates
on mortgages—including a cut, from 8V2 per cent to 8 per cent, in
the ceiling rate on federally underwritten mortgages.
These declines continued into 1971. The bank prime rate was cut
successively from 6% to 6 per cent; the Federal Reserve discount
rate was reduced further in two steps from 5!/2 to 5 per cent; and
the F H A - V A mortgage rate ceiling was reduced in mid-January from
8 to IV2 per cent.
•




27

IVages, Productivity,
and Prices
In view of the sluggishness of the economy, the main thrust of monetary policy during 1970 was directed toward achieving financial conditions that would stimulate demands for goods and services. A t the
same time, however, persisting inflationary pressures, generated
mainly from the cost side, remained a very serious problem for the
economy and a threat to the efficiency of its future performance.
Thus, the interrelationships among wages, productivity, and prices
that appear to be developing are critical factors in appraising the
progress being made toward setting the stage for sustainable, noninflationary economic growth.
In the latter half of the 1960's, excess demand persisted for an exceptionally long period, with the unemployment rate dropping and
remaining below 4 per cent. Strong demands for goods and services
exerted upward pressures on prices, and the associated competition
for labor resulted in sizable wage increases, which on the average exceeded gains in productivity. Price and wage increases became mutually reinforcing in an upward spiral.
During the latter half of 1969 and early 1970, the demand-pull
component of the inflationary spiral was broken. Total real output of
goods and services rose only moderately in 1969, and indeed had declined in the fourth quarter. In 1970 demands for goods and services
continued weak while productive capacity continued to expand; there
was a marked further reduction in the rate of capacity use in manufacturing and a considerable easing in labor markets. Under these
circumstances, the persistent increase in 1970 in the principal indexes of prices resulted, for the most part, from continued pressures
associated with costs. The dominating role of costs in the further
price increase is indicated by the sharp decline in the ratio of prices
to unit labor costs in manufacturing. This ratio, which had reached
a high of 105 (with 1957-59 as 100) in the strong demand-pull
inflation of 1965-66, had dropped to 97 by the end of 1969, and
then declined further to 95 by the end of 1970. Concurrently with
the decline in this ratio, after-tax profits per dollar of sales in

28



s

Principal



Federal

Reserve Policy Actions, 1970: Digest

Principal
Period, or
announcement date
January

January 20




Federal

Reserve

Policy

Actions,

1970: D i g e s t — C o n t i n u e d

Action

Purpose

Directed that System open market operations be
conducted with a view to maintaining firm conditions
in the money market, while taking account of the desire of the Federal Open Market Committee to see
a modest growth in money and bank credit, with a
provision for modification of operations depending
on the course of money and bank credit developments.

To foster financial conditions conducive to the orderly reduction of inflationary pressures, with a view to
encouraging sustainable economic
growth and attaining reasonable
equilibrium in the country's balance
of payments.

Increased maximum interest rates payable by
member banks on time and savings deposits, effective January 21. This action, in combination with a
minor further amendment on February 26 (retroactive to January 21) bringing rates on multiplematurity deposits in line with those on single maturities, set the following maximum rates:
(1) Passbook savings, raised from 4 to 4.5 per
cent.
(2) Other types of consumer-type deposits—those
of less than $100,000—raised as follows:

To readjust the structure of maximum interest rates payable by member banks for deposits to bring it
somewhat more in line with going
yields on market securities and to
set the stage for renewed expansion of bank credit; to bring about
greater equity in the rates payable
on smaller savings balances, and
to encourage longer-term savings
within the framework of continued
over-all credit restraint.




Rate ( % )
Previous
New
Maturity
Multiple-maturity:
4.00
4.50
30-89 days
5.00
5.00
90 days to 1 year
Single-maturity:
5.00
5.00
30 days-1 year
Single- and multiple-maturity:
5.00
5.50
1 to 2 years
5.00
5.75
2 years or more
(3) Time deposits of $100,000 or more, raised as
follows:
Rate ( % )
Previous
New
Maturity
5.50
6.25
30-59 days
5.75
6.50
60-89 days
6.00
6.75
90-179 days
6.25
7.00
180 days to 1 year. . .
6.25
. . 7.50
1 year or more
Directed that System open market operations be
conducted with a view to moving gradually toward
somewhat less firm conditions in the money market,
taking account of the Committee's desire to see moderate growth in money and bank credit over the
months ahead, with a provision for modification
of operations depending on the course of money and
bank credit developments.

To foster financial conditions conducive to the orderly reduction of inflationary pressures, with a view to
encouraging sustainable economic
growth and attaining reasonable
equilibrium in the country's balance
of payments.

Principal

Federal

Reserve

Period, or
announcement date

Policy

Actions,

1970:

Digest—Continued

Action

Purpose

March through late
May

Directed that System open market operations be
conducted with a view to maintaining money market
conditions consistent with the objective of moderate
growth in money and bank credit over the months
ahead, with a provision in effect during much of May
for modification of operations as needed to moderate
excessive pressures on financial markets, should they
develop.

To foster financial conditions conducive to orderly reduction in the
rate of inflation, while encouraging
the resumption of sustainable economic growth and the attainment of
reasonable equilibrium in the country's balance of payments.

May 6

Reduced the
banks, brokers
the purpose of
equity securities

To be less restrictive in view of
the sharp reduction in the use of
credit for stock purchases.

margin requirements on loans by
and dealers, and other lenders for
purchasing or carrying registered
from 80 to 65 per cent.

Reduced the margin requirements on such loans
by these lenders against securities convertible into
registered equity securities from 60 to 50 per cent.
Late May through
late July




Directed that System open market operations be
conducted with a view to moderating pressures on
financial markets while, to the extent compatible
therewith, maintaining bank reserves and money
market conditions consistent with the longer-run ob-

To foster financial conditions conducive to orderly reduction in the
rate of inflation, while encouraging
the resumption of sustainable economic growth and the attainment of

jective of moderate growth in money and bank credit,
with allowance after late June for a possible shift of
credit flows from market to banking channels.

reasonable equilibrium in the country's balance of payments.

Suspended limitations on the maximum rate of interest member banks may pay on single-maturity deposits of $100,000 or more that mature 30 days or
more but less than 90 days after date of deposit.

To facilitate meeting any unusual
demands upon commercial banks
for short-term credit accommodation that might occur as a consequence of serious current uncertainties in financial markets.

Late July through
mid-August

Directed that System open market operations be
conducted with a view to maintaining bank reserves
and money market conditions consistent with the objective of moderate growth in money and bank credit
over the months ahead, allowing for a possible continued shift of credit flows from market to banking
channels, with a provision for modification of operations as needed to counter excessive pressures on
financial markets, should they develop.

To foster financial conditions conducive to orderly reduction in the
rate of inflation, while encouraging
the resumption of sustainable economic growth and the attainment of
reasonable equilibrium in the country's balance of payments.

August 17

Reduced reserve requirements against time deposits in excess of $5 million at each member bank
from 6 to 5 per cent and applied a 5 per cent reserve
requirement on funds obtained by member banks
through the issuance of commercial paper by their
affiliates, both actions to become effective in the
reserve computation period beginning October 1 and
be applicable to such deposits and commercial paper
outstanding in the week beginning September 17.

To maintain the effectiveness of
the reserve requirements of Regulation D by applying those requirements to funds received by a member bank as the result of issuance of
obligations (commonly described as
commercial paper) by an affiliate,
and to provide a net release of reserves to the banking system.




Principal
Period, or
announcement date

Federal

Reserve

Policy

Actions,

1970:

Digest—Continued

Action

Purpose

Mid-August
through
mid-September

Directed that System open market operations be
conducted with a view to maintaining bank reserves
and money market conditions consistent with the objectives of some easing of conditions in credit markets and of somewhat greater growth in money over
the months ahead than had occurred in the second
quarter, taking account of possible liquidity problems
and allowing bank credit growth to reflect any continued shift of credit flows from market to banking
channels.

To foster financial conditions conducive to orderly reduction in the
rate of inflation, while encouraging
the resumption of sustainable economic growth and the attainment of
reasonable equilibrium in the country's balance of payments.

Mid-September
through
mid-December

Directed that System open market operations be
conducted with a view to maintaining bank reserves
and money market conditions consistent with the
objectives of some easing of conditions in credit markets and of moderate growth in money and attendant
bank credit expansion over the months ahead, with
allowance in the latter part of the period for temporary shifts in money and credit demands related to
the auto strike.

To foster financial conditions conducive to orderly reduction in the
rate of inflation, while encouraging
the resumption of sustainable economic growth and the attainment of
reasonable equilibrium in the country's balance of payments.

November 10

Reduced discount rates from 6 to 53A per cent
at 6 Reserve Banks, effective November 11. (By No-

To bring the discount rate into
better alignment with short-term in-




vember 16, the 53A per cent rate was in effect at all
Reserve Banks).
November 30

Amended rules governing member bank reserves
(Regulation D) and foreign branches of member
banks (Regulation M ) , effective January 7, 1971, to
(1) raise from 10 to 20 per cent the reserve ratio
applicable to a member bank's Euro-dollar borrowings to the extent that they exceed a specified reservefree base and (2) apply an automatic downward adjustment feature to the minimum reserve-free bases
applicable to Euro-dollar borrowings.
Reduced discount rates from 53A to 5V2 per cent
at 5 Reserve Banks, effective December 1. (By December 11, the 5 Vz per cent rate was in effect at all
Reserve Banks.)

Mid-December
through year-end

<




Directed that System open market operations be
conducted with a view to maintaining the money
market conditions recently attained, provided that
the expected rates of growth in money and bank
credit were at least being achieved.

terest rates, in which reductions had
recently taken place.
To give banks an added inducement to retain Euro-dollar borrowings in order to preserve reserve-free
bases.

To re-establish better alignment
between the discount rate and shortterm interest rates, in recognition of
further downward movements that
had recently taken place in the
latter.
To foster financial conditions conducive to orderly reduction in the
rate of inflation, while encouraging
the resumption of sustainable economic growth and the attainment of
reasonable equilibrium in the country's balance of payments.




manufacturing declined in 1970 to levels near the lows reached in
the recessions of 1957-58 and 1960-61.
Nevertheless, some progress was made in 1970 toward moderating
cost pressures. For the private economy as a whole, the rise in overall unit labor costs was smaller from the third quarter of 1969 to the
third quarter of 1970 than over the preceding year—5.5 per cent as
compared with 7 per cent. To avoid the distorting influence of the
strike in the auto industry, Chart 4 shows changes between the third
quarters of 1969 and 1970, rather than between fourth quarters as
in preceding years. In the manufacturing sector, however, unit labor
costs apparently increased more in 1970 than in 1969.
4. OUTPUT PER M A N H O U R A N D R E L A T E D D A T A
PERCENTAGE CHANGE

OUTPUT

COMPENSATION

LABOR COSTS

B u r e a u of L a b o r Statistics data f o r the t o t a l private e c o n o m y . Changes are f r o m
quarter to f o u r t h quarter—except f o r 1970, w h i c h is f r o m t h i r d to t h i r d .

fourth

The deceleration of the rise in unit labor costs in the private economy as a whole in 1970 was attributable to a resumption of productivity gains. After having shown little net change over 1969, output
per manhour—accompanying gains in real output—rose appreciably
in the second and third quarters of 1970; the annual rate of gain in




29

these two periods averaged about 4 per cent. Productivity in manufacturing also improved in that period, although the gain in output
per manhour was a little less for that sector of the economy. I t is
difficult to evaluate the extent to which progress may have continued
in the fourth quarter because sharp cutbacks in output resulting
from the auto strike distorted the aggregate productivity figures at
that time.
The increase in productivity during the middle quarters of 1970 is
somewhat atypical since the largest gains in output per manhour are
usually achieved during periods of rapid growth in output. However,
the increase in real GNP was quite small in the second and third
quarters, and manufacturing output was declining. Nevertheless, productivity gains were achieved as the sluggishness of demands, coupled with continued advances in costs, induced management to adopt
unusually stringent economy measures. These measures included a
careful scrutiny of overhead costs and a paring of conventional management perquisites, in addition to an intensive review of labor force
needs.
There was, as part of such a review, a sizable reduction in the
number of salaried (nonproduction) workers in manufacturing—especially in defense-related industries—as well as a cyclical decline in
demands for production workers. In trade, finance, and services a
similar review seems to have been going on, since the increase in
employment in these industries in 1970 was substantially smaller
than in prior years. The efforts to keep costs under control seem
likely to persist; in any event, productivity typically increases faster
in periods of cyclical upswing than during periods of recession or of
sluggish aggregate demands.
While productivity has shown indications of a faster rate of gain,
strong cost pressures are still persisting as hourly labor compensation
(which includes wages, salaries, and fringe benefits) has continued
to increase rapidly for the private economy as a whole. But while the
increase in hourly compensation from the third quarter of 1969 to
the third quarter of 1970 was not much different from that over the
preceding year, it was smaller than during 1968. I n the manufacturing sector, however, the aggregate increase in hourly compensation
during 1970 was larger than over the preceding year, even though
the rise was held down by reduced overtime pay resulting from a

30



shorter workweek and also by a shift away from the relatively highpay durable goods industries.
Large and widely distributed increases in wage rates in 1970 in
the face of declining employment and sharply rising unemployment
reflect in part a lagged response to past increases in consumer prices
and in part expectations of substantial future price increases—
expectations that have become well entrenched after the experience of the past several years. In recent years average advances
in compensation per manhour in the private economy—and in the
manufacturing sector—have been only a little in excess of increases
in consumer prices.
Despite the behavior of the averages cited above, wages in some
sectors have shown some response to slack demands and soft labor
markets. Thus, it appears that the average wage gain of nonunion
workers slowed in 1970. For such employees, wage adjustments are
commonly made each year rather than in the multiyear negotiations
that are typical of contracts involving unionized workers. In part because of this, wages in the nonunion sector appear to respond more
quickly to cyclical changes in the demand for labor.
Nonunion workers are heavily concentrated in retail trade, finance,
and other services. There was a marked slowing in 1970 in the advance of average hourly earnings in trade. On the other hand, the
rise in average hourly earnings of construction workers remained exceptionally large—with year-over-year increases averaging 9 per cent
in both 1969 and 1970. The substantial increase in earnings of this
group reflects mainly the extraordinarily large increases for union
workers. In manufacturing too, union workers received larger increases on the average in 1970 than did nonunion workers; furthermore, relatively more union than nonunion workers received wage
increases—two-thirds as compared with only about one-third.
There has been a substantial escalation since 1968 in the size of
wage increases negotiated in collective bargaining settlements—not
only for first-year wage increases but also for the life of the contract.
The increases provided in 1970 to cover the second and third contract years were well above the long-term trend of growth in productivity. Moreover, there has been some shift—after a lapse of many
years—toward the incorporation in long-term contracts of escalator
provisions based on the consumer price index and an insistence, as in




31

5. A V E R A G E H O U R L Y E A R N I N G S

C h a n g e f r o m c o r r e s p o n d i n g q u a r t e r a year
Statistics d a t a , w i t h o u t seasonal a d j u s t m e n t .

earlier,

calculated

from

Bureau

of

Labor

recent contracts in the automobile industry, on an unlimited escalator. Since the amounts involved in such increases are, of course, unknown, they are not reflected in the data on the size of settlements
negotiated. Relatively few workers are covered by escalator clauses;
at the beginning of 1971 only about 3 million workers were covered
by cost-of-living clauses providing for adjustments in wage rates tied
to increases in the consumer price index.
I n 1971 new wage agreements will be negotiated for nearly 5 million workers under major contracts in private nonfarm industries;
this will make 1971 the second successive year of heavy collective
bargaining activity. In the 1960's the largest number of workers covered by major contract settlements had been 4.6 million—in 1968.
Moreover, in 1971 another 5.3 million workers already covered by
multiyear contracts will receive deferred wage increases averaging
7.8 per cent—exclusive of cost-of-living increases—compared with
an average deferred wage increase of 5.6 per cent in 1970.
The persistence of strong upward wage pressures raises questions
concerning the extent to which market forces will moderate cost in-

32



TABLE

9:

WAGE

COLLECTIVE

RATE

ADJUSTMENTS

BARGAINING

IN

MAJOR

SETTLEMENTS

M e a n percentage increases

Item

1968

1969

1970

A l l private n o n f a r m industries:
Over life o f contract
First year
2 n d a n d 3 r d year a v e r a g e . . .

5 9
7 4
5 2

7 6
9 2
6 8

8 9
11 9
7 4

Manufacturing:
Over life o f contract
F i r s t year
2 n d a n d 3 r d year a v e r a g e . . .

5 2
7 0
4 3

6 0
7 9
5

6 0
8
5 0

Construction:
O v e r life o f c o n t r a c t
F i r s t year
2 n d a n d 3 r d year a v e r a g e . . .

8 6
8 7
8 5

13 1
13 1
13 1

14 7
18 3
12 9

NOTE.—BLS data.
workers or more.

Major

settlements

1

1

are t h o s e

affecting

1.000

creases as economic recovery proceeds in 1971. It seems likely that
some cost abatement will develop, in part as a result of the business
economies already undertaken and in part because the widely anticipated upturn in aggregate output may be associated with gains in
productivity that are more rapid than those in recent years. But the
underlying strength of wage demands, if they persist well in excess of
likely gains in productivity, would pose a major threat to the containment of price inflation, not only for 1971 but also over the
longer run.
•




33

Consumer Attitudes
and Behavior
Consumers in 1970 slowed their rate of spending relative to income
and shifted their savings toward more liquid forms, particularly deposits with banks and nonbank savings institutions. While declining
yields on market securities were a major factor in the shift in the
form of consumer financial saving, the emphasis on liquidity and
risk-free assets was probably also an aspect of the development of
more cautious attitudes on the part of consumers over the course of
the year.
The bearishness of consumer sentiment in 1970 was indicated
both by actual behavior and by various attitudinal surveys taken during the year. Two factors in particular—high and rising prices and
job uncertainties—led to conservative spending behavior. In consequence, consumer spending increased less rapidly in 1970 than in the
previous year, even though gains in disposable personal income had
been relatively larger until the fourth quarter, when strike effects
6. CONSUMER I N C O M E A N D EXPENDITURES
PERCENTAGE CHANGE

Change f r o m f o u r t h quarter to f o u r t h quarter—except
t h i r d — b a s e d o n D e p t . o f C o m m e r c e data.

34



for

1970, w h i c h is f r o m t h i r d

to

7. S A V I N G R A T E
PER CENT

1966

1968

1970

Dept. of Commerce data.

held down the income flow. In Chart 6, which shows changes in disposable income and consumer outlays, the changes for 1970 are
measured from the third quarter of 1969 to the third quarter of
1970 in order to avoid the effects of the auto strike.
In current-dollar terms the percentage increase was less for consumer outlays than for income in 1970—in contrast to the previous
2 years. The slowed pace of consumer spending was even more
marked in constant-dollar terms, as prices continued to rise rapidly.
As the advance in spending was curtailed, the rate of personal
saving rose. For the year 1970 as a whole, the saving rate averaged
7.3 per cent, as compared with 6 per cent in 1969. The rate for
1970 was high in terms of experience in most years since World War
I I . In the past decade, that rate had been exceeded in only one calendar year—1967.
A number of influences contributed to the sharp increase in the
saving rate in 1970. The sharpest jump occurred in the second quarter when the rise in disposable income was exceptionally large because of retroactive social security benefits and a retroactive Federal
pay increase. A lag in adjusting spending to such a large and concentrated rise is to be expected, but other developments probably
also contributed to the rise. Prices of common stocks broke sharply
further in the early months of 1970, with the low reached in May.
Both market participants who had suffered substantial losses and
others who were concerned about what the break might mean for the
economy probably curtailed their spending on this account.




35

Adding to these uncertainties in the spring were the widely publicized difficulties of some well-known corporations. Social tensions
and crises abroad also were prevalent in the spring. Then as the year
progressed, there were growing uncertainties associated with weakness in the labor market—an increasing number of layoffs, shorter
workweeks, and a rise in unemployment. These, together with the
anxieties that they generated in many who were not directly affected,
may have served to keep the saving rate close to its spring peak. Finally, in the fourth quarter, shortages of new cars resulting from the
auto strike may have kept the over-all saving rate up despite slower
growth in disposable income.
A counterpart in 1970 of the high personal saving rate and the
large dollar volume of personal saving was a very sharp increase in
net financial investment by the consumer sector, as may be seen in
the table. A similar spurt had occurred in 1967, when the saving
rate also was relatively high.
The sharp increase in net financial investment in 1970—about
double the 1969 pace—took the form partly of a larger flow of
funds into financial assets, particularly interest-bearing deposit accounts. Much of the higher saving was also reflected in a lower rate
of borrowing, the lowest in the past 5 years. Thus, the increase in
outstanding consumer instalment credit was the smallest since 1961,
and home mortgage debt, constrained by the high cost and earlier restricted availability of such funds, increased at a somewhat slower
rate than in 1969.
TABLE 10: CONSUMER

FINANCIAL

INVESTMENT

In billions o f dollars

Type

1966

1967

1968

1969

19701

N e t financial investment

25.6

37 0

24 2

20.3

44.4

N e t a c q u i s i t i o n o f f i n a n c i a l assets
D e m a n d deposits a n d c u r r e n c y
T i m e deposits
M a r k e t instruments

49.3
3. 1
19.1
11.9

60
11
32
-1

7
4
5
3

58
6
27
5

9
9
7
4

50
3
11
18

3
4
3
8

66.7
4.7
31.4
12.2

N e t increase i n l i a b i l i t i e s
Consumer instalment credit
M o r t g a g e debt
Other

23.6
6.2
13.6
3.8

23
3
11
8

7
4
7
6

34
9
16
9

6
0
0
6

30
8
17
4

0
3
4
3

20.0
3.0
13.0
4.0

1 Preliminary.
N O T E . — F l o w o f f u n d s d a t a f o r h o u s e h o l d s , p e r s o n a l trusts, a n d n o n p r o f i t o r g a n i z a t i o n s .

36



The extent to which consumer spending will rebound in 1971 is a
critical question in appraising the likely speed of economic recovery.
This will depend not only on the extent of future increases in personal disposable income, but also on the confidence with which consumers view the future. Certainly the improvement in financial positions, taking into account the sharp recovery in stock prices over
recent months, should tend to make consumers more willing to increase spending and to reduce their rate of saving. Really vigorous
support for the economy from consumption, however, probably must
await progress in dampening fears that family budgets will continue
to be pressed by rapidly rising prices for the goods and services that
people must buy.
•




37

Responsiveness of Housing
and State and Local
Governments
The more expansive monetary policy followed during 1970 led to a
significant increase in flows of credit into markets for mortgages and
for State and local government securities. Outlays for residential construction began to expand after midyear, and by the final quarter private housing starts had risen to the highest annual rate in 20 years.
I n contrast, construction expenditures by State and local government
units had not increased appreciably by the close of 1970. Easier
credit conditions, however, have led to heavy volumes of financing
by such units. Under these circumstances construction contracts and
actual outlays in this area are likely to increase in the months to
come.
HOUSING
As noted earlier, deposit inflows to savings and loan associations and
mutual savings banks increased sharply in 1970. By the fourth quarter these inflows had reached the highest rate since 1967 and were
permitting the thrift institutions to rebuild their depleted liquidity positions and to increase their lending on both new and existing residential properties.
A t the year-end the thrift institutions had accumulated a substantial backlog of mortgage commitments. Such a backlog pointed
toward a continued, if not enlarged, flow of credit to the housing
market. Other lenders—including commercial banks—also appeared
to be showing more interest in residential mortgages, as yields on
such loans were declining less sharply than returns on other types of
capital market instruments, and hence were becoming relatively more
attractive. In addition, weaknesses in business loan demands made
more funds available to commercial banks for investment in mortgages.

38



8. T H R I F T - I N S T I T U T I O N A C T I V I T Y ;
HOUSING STARTS
BILLIONS OF DOLLARS

RATIO SCALES

M I L L I O N S OF UNITS

30

20

10
2.0

1.5

1.0

1966

1968

1970

Q u a r t e r l y averages o f m o n t h l y data at seasonally a d j u s t e d a n n u a l rates. T h r i f t i n s t i t u t i o n s i n c l u d e savings and l o a n associations a n d m u t u a l savings b a n k s ( N e w Y o r k State
b a n k s o n l y f o r mortgages c l o s e d ) .
Sources: S&Ls, F e d e r a l H o m e L o a n B a n k B o a r d ; savings b a n k s . N a t i o n a l A s s o c i a t i o n o f
M u t u a l Savings Banks a n d Savings Banks A s s o c i a t i o n o f the State o f N e w Y o r k ; p r i v a t e
f a r m a n d n o n f a r m h o u s i n g starts. B u r e a u o f t h e Census.

As the availability of private credit expanded, market support
from the Federal National Mortgage Association and the Federal
home loan banks slackened in the latter months of 1970. Support
provided by these institutions had been an important factor limiting
the decline in housing starts in 1969 relative to 1966, even though
deposit growth at the thrift institutions—the dominant group that
lends on residential mortgages—dropped sharply in each of these
years. To finance this support, the two housing-related agencies together had borrowed a net of more than $7 billion in 1969. I n 1970
they borrowed a similar amount. During 1971, however, these institutions are more likely to be net repayers of debt, in view of the expectation of some net repayment to the home loan banks of outstanding advances made to member savings and loan associations and
of a reduced volume of F N M A purchases in the secondary market.
In early 1971 the low rate of housing vacancies, the accelerated
pace of inflows of funds to thrift institutions, the high level of out-




39

standing mortgage commitments, and the increased momentum in
builder planning and activity all suggested that the pace of housing
starts would continue at advanced levels. The demand for housing in
1971, however, will be tested critically by consumer concern about
unemployment and by record levels of housing costs, prices, and
rents. Mortgage interest rates, though somewhat reduced, also continue at levels that are high by historical comparison. During 1970,
new home buyers were already tending to focus on smaller units that
carry lower average prices, and it also became more difficult for
owners of new apartments in the highest rent brackets to lease such
units. A sharply increased portion of the market for lower-priced or
lower-rent dwellings was aided in 1970 by Federal subsidies—a type
of support that appears likely to expand further in 1971.
STATE A N D L O C A L GOVERNMENTS
By the final months of 1970, gross long-term borrowing by State and
local governments had risen to new highs. The increased volume of
9. S T A T E A N D L O C A L G O V E R N M E N T S
BILLIONS OF DOLLARS

All
figures
f o r 1970 are p r e l i m i n a r y . B o r r o w i n g s : f r o m I n v e s t m e n t B a n k e r s A s s o c i a t i o n ; q u a r t e r l y d a t a , at a n n u a l rates n o t seasonally adjusted. C o n s t r u c t i o n o u t l a y s : B u r e a u
o f the Census e s t i m a t e s ; s e m i a n n u a l data, at a n n u a l rates seasonally adjusted.

40



such borrowing and the strong pace expected in 1971 reflect several
factors.
In 1970 many State and local governments took advantage of declining interest rates—and record purchases of tax-exempt bonds by
commercial banks—to market issues that had been postponed the
previous year. In 1969, according to Federal Reserve surveys, the
rapid increase of market interest rates had contributed directly and
indirectly to the first year-to-year declines in gross long-term borrowing by State and local governments since 1960. I n addition, many
units had resorted to short-term financing to cover their most urgent
needs in 1969 and early 1970 and were under pressure to issue
long-term bonds as market interest rates declined in the second half
of 1970. Moreover, the ability of State and local units to borrow had
been improved since the fall of 1969, as the ceiling rates that many
units could pay on their securities had been increased or temporarily
suspended. Thus, by the end of 1970 many States and their subdivisions had a greater amount of flexibility to market new long-term
bond issues, particularly in view of the fact that interest rates on
such issues had declined substantially below their earlier peaks.
Construction outlays by State and local governments, which are
financed in large part by borrowing, had increased at an average annual rate of more than 9 per cent from 1962 to 1968. The shortfall
in their borrowing in 1969 restrained such expenditures, however,
and these outlays rose little further even in current dollars. Despite
the increased pace of borrowing in 1970, total outlays showed no
significant change—and actually declined in real terms—because of
the long lags between fund availability and expenditures. I n view of
the increased borrowing undertaken since mid-1970, however, it appears likely that construction outlays in 1971 will move back toward
their earlier pattern of growth. Indeed, a period of unusual expansion in such outlays could well develop as shortfalls from previous
capital budget plans are made up.
•




41

Easing in Credit
at Banks

Availability

Deposit inflows to, and the availability of credit from, commercial
banks improved progressively during 1970 as a result of the cumulative effects of the general easing in monetary policy, of bank regulatory changes, and of the broad decline in market rates of interest.
Because inflows of deposit funds were strong and loan demands were
relatively weak, banks reduced sharply their reliance on nondeposit
sources of funds after midyear and restored severely depleted liquidity positions. In light of these developments, banks by the end of
1970 were in a considerably better position to meet the credit needs
of an expanding economy.
SOURCES OF F U N D S
Total deposits at banks rose sharply in 1970, in contrast to the decline during 1969 when monetary policy was quite restrictive. While
demand deposits resumed their growth as market rates of interest declined and the public sought increased liquidity, the bulk of the increase in inflows at banks was attributable to the sharp rise in time
and savings deposits.
Time and savings deposits other than large-denomination CD's—
principally consumer-type time and savings deposits—grew rapidly
after the first quarter of 1970. Banks generally raised the interest
rates offered on these deposits shortly after the Board acted in January to liberalize ceiling rates under Regulation Q. Other authorities
raised interest rate ceilings for savings and loan associations and mutual savings banks at the same time, and all three types of depositary
institutions subsequently experienced increased rates of deposit inflow.
Growth in total time deposits surged after midyear when banks
became able to compete aggressively for large CD's. Even though
ceiling rates on large CD's had been raised in January, along with
rates on other time and savings deposits, banks could sell only limited volumes of CD's because interest rates on competing money

42



10. I N T E R E S T - B E A R I N G SOURCES OF
B A N K FUNDS
B I L L I O N S OF DOLLARS

Seasonally adjusted m o n t h l y averages o f d a i l y figures f o r a l l c o m m e r c i a l b a n k s . T i m e a n d
savings deposits other t h a n C D ' s exclude b o t h those due to d o m e s t i c c o m m e r c i a l b a n k s a n d
the U . S . G o v t , and balances a c c u m u l a t e d f o r r e p a y m e n t o f p e r s o n a l loans. N o n d e p o s i t
sources i n c l u d e b o r r o w i n g s f r o m f o r e i g n branches a n d * b e g i n n i n g J u n e 1969, b a n k - r e l a t e d
c o m m e r c i a l p a p e r , l o a n repurchase agreements, a n d b o r r o w i n g s f r o m f o r e i g n b a n k s a n d
branches i n U . S . territories a n d possessions.

market instruments remained significantly above the rates that banks
were permitted to offer. Following the suspension of the Regulation
Q ceilings on large 30- to 89-day CD's in late June, banks quickly
raised their offering rates on short-term CD's to competitive levels.
As a result banks were able to increase their outstanding CD's by
$4.9 billion during the month of July alone. There are indications
that part of these CD's were acquired by investors who did not want
to roll over their commercial paper in the wake of the substantial deterioration of confidence in such paper following the announced insolvency of a major railroad. In addition to CD inflows, banks during the summer used the Federal Reserve discount facility to meet
unusual loan demands from customers who were unable to refund
maturing issues in the commercial paper market.
But even after the pressures associated with the commercial paper
crisis subsided, banks continued to issue large CD's in volume. They
used a sizable portion of these inflows to restructure their liabilities,
with particular emphasis on repaying higher-cost Euro-dollar borrowings and bank-related commercial paper. Many banks had relied




43

heavily on such funds during 1969 and early 1970 to supplement the
funds they acquired through normal deposit channels. Repayments of
borrowings from nondeposit sources were accelerated in September,
when bank-related commercial paper was made subject to reserve requirements.
Total deposit inflows continued strong in late 1970. In view of the
continuing weakness in demands for loans and the substantial readjustment of portfolios already accomplished, banks made sharp reductions near the year-end in rates paid on large CD's to moderate
inflows of such deposits. By the year-end they had more than replaced the volume of CD's that had run off in 1969 and early 1970,
and outstanding CD's were at a seasonally adjusted monthly average
of $26.0 billion in December—a new peak.
BANK CREDIT
Bank credit developments in 1970 and early 1971 have reflected
principally the marked increase in fund availability and the lessening
of loan demands. Total loans and investments at all commercial
banks, including loans sold to bank affiliates or subsidiaries, increased by $30 billion in 1970, or nearly twice the increase over the
preceding year. A substantial portion of this growth represented
bank acquisitions of securities, which had registered a considerable
decline in 1969.
Participating heavily in U.S. Treasury financing operations, banks
acquired a net of more than $7 billion, seasonally adjusted, of U.S.
Government securities during the middle two quarters of 1970. And
throughout the year they increased sharply the rate of acquisition of
other securities—principally State and local government obligations
—after having maintained their holdings of such securities virtually
unchanged in 1969. I n large measure, banks concentrated on acquiring shorter-term investments so as to restore their depleted liquidity
positions. The large rise in liquid assets along with concerted efforts
to reduce reliance on borrowed funds resulted in an appreciable improvement in over-all bank liquidity and contributed significantly to
banks' willingness to extend a larger volume of loans.
Although the substantial rebuilding of liquidity was in large part
desired, it also reflected the general weakness in demand for loans.
Total loans at all commercial banks, including loans held by affiliates

44



11. B A N K CREDIT, 1969-70
CHANGE, BILLIONS OF DOLLARS

16
TOTAL
1 2 -

Seasonally adjusted data f o r all c o m m e r c i a l banks. B e g i n n i n g June 1969, l o a n items
have been adjusted to include loans sold to bank affiliates, subsidiaries, h o l d i n g companies,
and f o r e i g n branches.

and subsidiaries, grew slowly in the first half of 1970, then rose by
$7 billion in the third quarter. During the latter period banks extended a large volume of credit to securities dealers as well as to
finance companies and other borrowers experiencing difficulty in the
commerical paper market. But in the fourth quarter loans at commercial banks declined on a seasonally adjusted basis.
The reduction in loans at banks in the fall reflected the general
weakness in economic activity and the associated decline in credit requirements, together with the effects of the auto strike in the fourth
quarter. In addition, banks have experienced substantial business
loan repayments out of the proceeds of capital market financings as
corporations placed considerable emphasis on lengthening their debt
structure and improving liquidity positions.




45

12. L I Q U I D I T Y R A T I O
Weekly reporting banks
PER CENT

M o n t h l y averages o f W e d n e s d a y figures f o r a l l w e e k l y r e p o r t i n g b a n k s . R a t i o o f l i q u i d
assets t o t o t a l l i a b i l i t i e s less c a p i t a l accounts a n d v a l u a t i o n reserves. L i q u i d assets i n c l u d e
F e d e r a l f u n d s , T r e a s u r y b i l l s , T r e a s u r y certificates, T r e a s u r y notes a n d b o n d s m a t u r i n g w i t h i n
1 y e a r , l o a n s t o b r o k e r s a n d dealers, loans t o d o m e s t i c c o m m e r c i a l b a n k s , balances w i t h
d o m e s t i c b a n k s , b a n k e r s acceptances, a n d t a x w a r r a n t s a n d b o n d a n t i c i p a t i o n notes.

Other loan categories have also shown limited growth, particularly
consumer and mortgage loans. Demand for consumer credit was restrained by the weakness in sales of durable goods and in the fourth
quarter by the additional effects of the auto strike. Whereas banks
had sharply curtailed their extension of mortgage credit in 1969 and
early 1970, when their fund inflows were constrained, since the autumn they have indicated an increased willingness to extend mortgage credit. The increase in mortgage loan portfolios did not pick up
appreciably until late in the year, but this appears to reflect the long
lags between mortgage commitments and the actual takedown of
funds.
These changes in bank asset positions were an important factor in
the decline in the prime rate of interest from 8V2 per cent in early
1970 to 6 per cent in January 1971. Other loan terms and conditions also have been eased, and banks are now more willing to undertake loan commitments that they would not have made earlier, including extensions of term loans to business. However, with concern
over the quality of loan portfolios heightened by the well-publicized
difficulties of several major firms, banks reportedly are continuing to
emphasize quality standards.
•

46



Adjustments in the
Business Sector
In the business area, financing problems had become much less acute
by early 1971. The increased availability and declining cost of
short-term credit, especially in the latter half of 1970, has made it
easier for businesses to finance the current level of activity and
should facilitate the return to a more normal rate of sales growth. I n
addition, the flow of internal funds, after having remained stable for
several years, seems likely to increase in 1971, and this, together
with the anticipated leveling off in fixed investment expenditures and
the improved access to short-term credit, should moderate corporate
needs for capital market funds.
During 1970, in contrast, corporate financing operations in money
and capital markets were characterized by a large increase in new issues of long-term securities and by greatly reduced financing in
shorter-term markets. This pattern reflected several factors: the continued sharp rise in spending for plant and equipment by certain industries, the slow growth in current sales, and the funding of a portion of the large volume of short-term debt incurred in 1969.
In the closing months of 1970 business corporations floated a
record volume of long-term securities while apparently repaying
short-term debt on balance. Much of the year-end weakness in business demand for short-term credit, however, was attributable to the
continued influence of the auto strike. But by early 1971 the situation had changed considerably: The auto strike was over; plant and
equipment expenditures were expected to show little or no further
rise, but it seemed likely that inventory accumulation would resume;
and there would probably be some improvement in the flow of internal funds, in part because of the revised depreciation schedules that
became effective in early 1971.
Hence there should be increased needs for—and greater availability of—short-term credit and some reduction in corporate demands
on long-term capital markets in 1971. Some corporations may still
wish to lengthen the maturity of their debt or otherwise improve
their liquidity positions. But pressures to do so have subsided since




47

13. CORPORATE E X T E R N A L F I N A N C I N G
BILLIONS OF DOLLARS

20

0
20

+
0

F l o w o f f u n d s d a t a f o r n o n f i n a n c i a l c o r p o r a t i o n s . Q u a r t e r l y d a t a seasonally a d j u s t e d at
a n n u a l rates. " O t h e r b o r r o w i n g " comprises b a n k loans n.e.c., o p e n m a r k e t p a p e r , a n d o t h e r
loans. Q 4 1970 p r e l i m i n a r y .

the easing of monetary policy has made renewal of maturing shortterm debt more manageable and additional liquidity more readily
available.
BUSINESS I N V E S T M E N T
As of early 1971 business firms in the aggregate were planning almost no increase in spending for fixed assets during the year. This
weakness reflects mainly developments in manufacturing. With their
margin of unused capacity at the highest average level since early
1958, and with their profits greatly reduced, manufacturers were
planning reductions in capital outlays in 1971 for the second consecutive year. I n the public utility and communications sectors, on the
other hand, present capacity is inadequate to meet demands
efficiently, and as in 1970 a further substantial increase in capital expenditures is scheduled for 1971. Since public utility and communications companies finance a large part of their capital outlays with
the proceeds of new bond and stock issues, the increased expenditures they have planned for 1971 are likely to be reflected in heavier
corporate demands on long-term securities markets than would otherwise be suggested by the expected minimal growth in over-all business fixed investment.

48



Inventory accumulation (GNP basis) by nonfarm businesses declined in 1970 to the lowest rate since 1961. Weakness in the growth
of final sales appears to have been a primary factor in the cutback,
but other influences also contributed to the reduced rate. These included the depletion of auto stocks in the fall as a result of the strike,
reluctance to incur additional short-term debt, the desire to conserve
available funds for more pressing needs and, as the year progressed,
some waning of inflationary expectations. Nevertheless, reflecting to
a considerable extent the sluggishness in sales, inventory/sales ratios
remained high by historical standards.
I N T E R N A L FUNDS
Although corporate profits declined less in 1970 than in most earlier
periods of economic slowdown, the over-all profits picture—especially with respect to undistributed profits—has been exceptionally
weak for some time. The profits share of income originating in nonfinancial corporate business has declined almost steadily in recent
years, from 20 per cent or more in 1965 and 1966 to 14 per cent in
1970. Profits retained after payment of taxes and dividends have declined more than 50 per cent since 1966. Offsetting this decline has
been a continued growth in capital consumption allowances. As a result, the total volume of internal funds has been static for several
years.
Weakness in profits has been evident particularly in the manufacturing sector where both the ratio of profits to sales and the rate of
return on net worth have declined to levels near the lowest since
World War II. The erosion in profit margins has paralleled the decline in the capacity utilization rate, and if one judges from past experience, profit margins are not likely to rise to any significant extent
until the utilization rate also rises sharply.
Nevertheless, trends within 1970 suggest a strengthening in profits
and internal funds that should carry over into 1971. Abstracting the
adverse developments in the fourth quarter because of the auto
strike, the decline in profit margins slowed as the year progressed,
reflecting efforts to reduce expenses and the faster growth in productivity; the share of profits in income, as well as total corporate profits
before taxes (and before inventory profits), changed little after the
first quarter; and total internal funds rose throughout the year from
their first-quarter low. With somewhat faster growth in sales volume,




49

14. C O R P O R A T E PROFITS

Q u a r t e r l y except 1962-68 r e t u r n o n net w o r t h , w h i c h is s e m i a n n u a l . Share o f i n c o m e :
r a t i o o f p r o f i t s ( b e f o r e t a x ) a n d i n v e n t o r y v a l u a t i o n adjustment t o i n c o m e o r i g i n a t i n g i n
n o n f i n a n c i a l c o r p o r a t e business, w h i c h is sum o f p r o f i t s , c o m p e n s a t i o n o f employees, a n d
net i n t e r e s t p a i d ; based o n D e p t . o f C o m m e r c e seasonally a d j u s t e d d a t a . R e t u r n o n net
w o r t h : r a t i o o f p r o f i t s a f t e r t a x , at a n n u a l rate, to s t o c k h o l d e r s ' e q u i t y ; n o t seasonally
a d j u s t e d ; source, F T C - S E C Q u a r t e r l y F i n a n c i a l R e p o r t f o r M a n u f a c t u r i n g C o r p o r a t i o n s .

and especially with the recent liberalization in depreciation schedules for tax purposes, the flow of internal funds to nonfinancial corporations in 1971 may show the first significant increase since 1966.
EXTERNAL

FINANCING

The failure of internal funds to grow in the face of a continued rise
in spending for additions to fixed and working assets during recent
years has required increased reliance by nonfinancial corporations on
external sources of funds. In 1970 these businesses financed about
35 per cent of their total spending with funds raised in money and
capital markets. This was the same as the record proportion in 1969,
but the composition was quite different. Long-term financing in capital markets was three-fifths again as large as in 1969, whereas borrowing in short-term forms was the least since 1964.
The sharply reduced volume of borrowing by corporations from
banks and other short-term lenders in 1970 reflected only in part the
lower rate of inventory accumulation and the direct and indirect effects of the auto strike in the fourth quarter. A n equally important

50



15. C A P I T A L O U T L A Y S A N D I N T E R N A L
FUNDS
B I L L I O N S OF D O L L A R S

1966

1968

1970

F l o w o f funds data f o r n o n f i n a n c i a l c o r p o r a t i o n s , seasonally a d j u s t e d at a n n u a l rates.
" O u t l a y s " c o m p r i s e plant a n d e q u i p m e n t e x p e n d i t u r e s a n d change i n i n v e n t o r i e s . " F u n d s "
are s u m o f c a p i t a l c o n s u m p t i o n allowances a n d u n d i s t r i b u t e d p r o f i t s , w h i c h are a f t e r i n v e n t o r y v a l u a t i o n adjustment a n d i n c l u s i o n o f f o r e i g n b r a n c h p r o f i t s . Q 4 1970 p r e l i m i n a r y .

factor was the desire to limit further expansion of short-term debt,
following the exceptionally large growth in such debt in 1969, and to
lighten the pressure of frequent maturities by repaying short-term
debt to the extent feasible.
Business demand for short-term credit remained weak through
1970. But the increased supply of such funds at declining cost, together with the return of confidence in financial markets, should result in a strengthening of credit demands in this area as sales prospects improve and inventory policies become more expansive.
Demands for long-term external funds, on the other hand, seem
likely to moderate somewhat although remaining large by historical
standards. A large share of the increase in long-term financing by
corporations in 1970 reflected the expanded needs of public utility
and communications companies, which rely heavily on such funds to
finance plant and equipment outlays, and which will need to sell a
substantial volume of security issues in 1971 too. But offerings by
manufacturing corporations may be below the unusually large 1970
volume. Real estate investment trusts, whose offerings helped to
swell the volume of new stock issues in 1970 to the largest total in




51

many years, may also do less financing in 1971 in view of the increasing availability of conventional mortgage financing. On the
other hand, financial corporations, which did little long-term financing in 1970, may step up their offerings in 1971.
CORPORATE LIQUIDITY
Corporations added moderately to their holdings of liquid assets in
1970, largely in the form of time deposits at commercial banks. The
ratio of liquid assets to total current liabilities rose somewhat in the
fourth quarter, but not enough to offset the declines that had occurred earlier in the year. Thus, despite the switch from short- to
long-term market financing, the over-all corporate liquidity ratio
reached a new end-of-year low in 1970, though the deterioration was
much less than in 1969. The ratio of total current assets to total current liabilities also declined to a new low, primarily because the
slowdown in economic activity resulted in an even slower growth in
accounts receivable than in total current liabilities.
•

52



U.S. Balance of Payments
Developments in U.S. transactions with the rest of the world in 1970
illustrated the tenacity and complexity of problems involved in
achieving a satisfactory over-all balance of payments position. There
was indeed some strengthening of the merchandise trade surplus and
of net receipts on international investments, but the cyclical situation,
both here and abroad, that led to such gains also resulted in adverse
shifts in capital flows. Meanwhile, other elements in the U.S. international accounts—notably military expenditures and U.S. Government
aid and private transfers to foreign countries—which are not so responsive to business conditions here and abroad, continued to cause
a large outflow of dollars.
MERCHANDISE TRADE
Events in 1970 underline the extent to which the traditional U.S.
trade surplus had weakened during the period of excess domestic demand in the latter half of the 1960's and also show the sensitivity of
trade flows to economic conditions in other industrial countries.
Studies of the effects on U.S. trade of the demand inflation of the
late 1960's, which followed an extended period of relative price stability, suggest that a large part—perhaps most—of the deterioration
in the trade balance from its 1964 peak was associated with strong
and sustained upward pressures on prices and wages in U.S. markets.
The adverse effects of such developments in the international competitive position of U.S. industry can be overcome only with the passage
of time.
In 1970 the U.S. trade balance with other countries responded
well through midyear to the slowing of domestic demand and to the
strong growth of demand in most other industrial countries. For
most of the year policy in most countries was directed toward reducing inflationary pressures, and only as the year ended—with production in many industrialized countries flattening out—was attention
abroad shifting to the problem of averting a general slowdown in
economic growth. This course of events was reflected in the U.S.
trade performance—leading to some erosion of the gains made in the
first half of the year as foreign demands weakened.




53

16. I N D U S T R I A L P R O D U C T I O N

S e a s o n a l l y a d j u s t e d O E C D q u a r t e r l y data.

U.S. exports in 1970 benefited from record shipments of agricultural products and a spurt in exports of large jet aircraft. The major
support for foreign sales, however, was the demand in industrial
countries for machinery and industrial materials. Even so, as the
year progressed, and some slack developed in supply capabilities
abroad, demand for these products decreased. New orders for machinery tended to level off, and easier supply conditions for steel
abroad not only reduced U.S. exports but also supported a renewed
surge of shipments from Europe and Japan to the United States.
The level of U.S. imports tended upward during the year, but it
appears that perhaps three-quarters of the rise was accounted for by
higher prices of imports. In the last quarter of the year, even though
there was a decline in real economic activity, imports rose somewhat,
reflecting especially strong demand for foreign steel, automobiles,
and petroleum.
These trends indicate the difficulty of restoring a reasonable trade
balance after a long period of domestic inflation, especially when
growth rates and domestic demands in countries abroad are slowing.
There were, however, some favorable indications in 1970 for the future of the trade balance. Import prices rose more rapidly than U.S.
export prices, and while this factor may reduce the trade surplus in

54



current-dollar terms over the short run, over the longer run it may
benefit the trade position as the relative advantage of foreign goods
is diminished. With improved economic performance in the United
States and resumption of stronger economic growth rates abroad, the
U.S. trade balance should make further gains over time.
C A P I T A L FLOWS
Flows of capital between the United States and foreign countries also
respond to the cyclical situation. Indeed, the response may be so
large and rapid as to overmatch changes in the current account. This
is increasingly true of the immense stock of mobile funds that respond quickly to changes in interest rate levels in the important
monetary centers, utilizing the convenient mechanism of the Eurodollar market. Such flows of funds complicate the management of
monetary policy and result in sudden, large shifts of international reserves (largely dollar holdings) among central banks.
In 1970 the need for the United States to pursue a relatively expansionary monetary policy, while other countries did not move in
that direction until the closing months of the year, led to a return
flow to foreign commercial banks of some $6 billion of funds borrowed earlier by U.S. banks. This flow helped to restore needed reserves to some countries—notably the United Kingdom and France
—and added to the reserve gains of other countries with continued
strong basic positions—notably Germany.
These flows of liquid funds were not inspired—as were those of
other recent years—by financial crises and currency speculation, but
rather by market considerations. Under present-day conditions, when
investors and borrowers are free to seek the most advantageous market, such flows respond readily to changing interest differentials
among countries. These flows tend to be reversible as interest rate
relationships change, and they do not have the same significance for
the balance of payments as more deep-seated shifts in other transactions affecting reserves. A large part of the Euro-dollar reflows in
1970 represented a readjustment of the U.S. domestic banking system to its renewed regulatory and economic ability to compete for
funds in domestic money markets. As noted earlier, the Federal Reserve took steps to moderate the rate at which U.S. banks were repaying their borrowings, in order to help offset the unsettling effect
that might occur if large reflows continued over a short period.




55

Longer-term capital flows are also highly responsive to variations
in economic activity here and abroad, and also to corresponding variations in the cost of funds. The outflow of U.S. funds in response to
such variations remains inhibited by Government restraints, which
have been retained in 1971 because of the persistence of large deficits in the U.S. balance of payments. U.S. industrial firms have indicated that they plan to carry out major programs to expand their
foreign productive facilities in 1971. With domestic demand for
loans relatively weak, it is to be expected that U.S. banks would
wish to enlarge their foreign credits if there were no guidelines concerning foreign credit restraint. Though there was some increase in
the outflow of capital for these purposes in 1970, it was probably
much less than would have occurred without the restraint programs.
I n the case of U.S. purchases of foreign securities, the outflows were
smaller than in other recent years, in part because of the restraints
but also because Canadian borrowers made more use of their own
capital markets.
The principal change in flows of foreign capital in response to
changes in the economic situation—apart from flows of liquid funds
—was in transactions in U.S. equity securities. Foreign investors
shifted from net sales of $0.2 billion in the first half to net purchases
of $0.8 billion in the second half, once the U.S. equity market began
to show basic strength again.
Taking U.S. and foreign private long-term investments together,
there appears to have been a net increase in outflows of some $1.5
billion from 1969 to 1970. Of course, the adverse shift in flows of
short-term funds was much greater. Looking ahead, it seems likely
that the outflow of U.S. private capital will continue to be large in
1971, though the amount will be limited by the restraint programs.
However, with recovery in the U.S. economy, some increase in the
inflow of funds for investment in corporate securities would be expected. Also, there is much less scope for return flows of borrowed
private foreign short-term funds, after the attrition of 1970.

OVER-ALL

BALANCE

The net result of divergent changes in the U.S. trade and capital accounts in 1970 was a moderate improvement in the liquidity balance

56



—apart from special transactions and the initial allocation of SDR's.
Over the years there has been a tendency for the current and capital
accounts of the U.S. balance of payments to move in opposite directions, as the cyclical conditions favoring improvement in the current
account have, at the same time, tended to encourage net capital outflows. Given the large dollar outflows that are not related to economic conditions, large liquidity deficits tend to persist. From another point of view, the desire of foreign governments and private
holders of assets to add to their liquid reserves, with the dollar a
principal vehicle for doing so, is a factor in the continuation of U.S.
balance of payments deficits.
17. US. B A L A N C E OF P A Y M E N T S
SEASONALLY AOJUSTED ANNUAL RATES
BILLIONS OF DOLLARS

S E A S O N A L L Y ADJUSTED A N N U A L RATES
B I L L I O N S OF D O L L A R S

1
E x c l u d e s special transactions w i t h f o r e i g n g o v e r n m e n t s a n d the S D R
- Excludes S D R allocation.

allocation.

The U.S. balance of payments reflects a great diversity of economic and political decisions here and abroad—a diversity that is
unique because of the pivotal role of the dollar in the world's monetary system. The large flow of dollars into foreign official accounts in
1970 was accommodated with relative smoothness, though not without concern that the continuation of such flows would disrupt the




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progress being made toward an improved monetary system. Contributing to generally calm foreign exchange markets in 1970 were the
exchange rate adjustments accomplished in 1969, increased consultation and cooperation among national authorities, and the introduction of SDR's.
•

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Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102