View PDF

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

cMonetary

7T C
?
LL

A .

J^olicy
and
P
in

(Economy
1972

A Prelude to the Annual




the

Report




FED.

Contents
Monetary
Policy and the
U.S. Economy in 1972
3
15

15
16
19
20
21
23

INTRODUCTION
DEMANDS FOR GOODS A N D SERVICES

Real output
Consumer income and outlays
Business fixed investment
Inventories
Residential construction
Government outlays

25

MANPOWER

29

WAGES, LABOR COSTS, A N D PRICES

29

Wages

31
33

Productivity and labor costs
Prices

37

F E D E R A L FISCAL POLICY

41

M O N E T A R Y POLICY A N D F I N A N C I A L MARKETS

42
47
51
54
59

61
63

Monetary policy
Monetary aggregates
Intermediated credit flows
Demands on securities markets
U.S. B A L A N C E OF PAYMENTS

Goods and services
Capital flows







cMonetaryJ^olicy
ar c* Q a n ^
u. A.
Sconomy




LJ

in 1912




Introduction
The performance of the U.S. economy during 1972 was unusually
favorable. Most aggregate measures of economic behavior showed
the largest improvement since the mid-1960's.
• Real output of goods and services (GNP) grew by 7.6 per
cent from the fourth quarter of 1971 to the fourth quarter
of 1972. This was substantially more than the 5 per cent
growth during 1971 and was in sharp contrast to the small
over-all decline experienced during 1970.
• Total employment expanded by 2.4 million persons from
December 1971 to December 1972, and nonfarm payroll employment by 2.7 million, the largest gains since 1966. The
unemployment rate declined from nearly 6.0 per cent at the
beginning of the year to about 5.0 per cent at the close.
• The rate of inflation abated somewhat after imposition of
economic controls in August 1971. Over the six quarters
following mid-1971, the fixed-weight price index for gross
private product, which is the broadest available measure of
price behavior in the private economy, rose at an average
annual rate of 3.0 per cent. In the preceding six-quarter
period, the rise had been at a rate of 4.7 per cent.
• Real earnings of U.S. workers rose substantially. Over the 12
months ending December 1972, weekly earnings in the private nonfarm sector advanced by 6.2 per cent, while the
consumer price index rose 3.4 per cent. The slower advance
in prices relative to earnings resulted basically from a strong
gain in productivity, or output per manhour.
Moreover, the resurgence in economic activity was well balanced
and solidly based. Real output increased vigorously throughout the
year, as shown in Chart 1, and all major sectors of the economy contributed to the expansion in demand. The year featured large and
steady gains in consumption, a further substantial increase in residential building, and a sizable expansion in business fixed investment.
Government purchases rose 7.5 per cent from the fourth quarter of
1971 to the fourth quarter of 1972. State and local government units




3

1. I N D I C A T O R S OF E C O N O M I C PERFORMANCE
PER CENT

NOTE.—Gross n a t i o n a l product ( G N P ) and price index: Changes f r o m preceding quarter
c o m p o u n d e d at a n n u a l rates, b a s e d o n s e a s o n a l l y a d j u s t e d d a t a f r o m the D e p t . o f C o m m e r c e , B u r e a u o f E c o n o m i c A n a l y s i s . C h a n g e i n r e a l G N P i s b a s e d o n 1958 d o l l a r s .
O t h e r series: D e p t . o f L a b o r , B u r e a u o f L a b o r S t a t i s t i c s . E m p l o y m e n t d a t a are seas o n a l l y a d j u s t e d . E a r n i n g s are averages f o r p r i v a t e n o n f a r m p r o d u c t i o n w o r k e r s .

4




accounted for most of the increase—as shown in Chart 2 on page 6.
Business inventory accumulation was larger than in 1971, but it remained quite moderate relative to the expansion in sales.
Net foreign trade, however, continued to have an unfavorable impact on domestic business. While merchandise exports rose 14 per
cent in 1972, imports increased even more sharply. The vigorous expansion of the domestic economy accounted for much of the increase
in imports, but higher dollar prices for foreign goods following the
late 1971 changes in foreign exchange parities were also a factor. As
a result, the net U.S. balance on exports and imports of goods and
services was in deficit by about $4.5 billion, as compared with a small
surplus in 1971 and substantial surpluses in earlier postwar years. The
over-all U.S. balance of payments (as measured by official settlements) remained in heavy deficit—by about $11 billion (apart from
SDR allocations)—although this was much less than in 1971 when
extraordinary outflows of short-term capital had occurred.
The sharp rise in domestic spending put upward pressure on
interest rates in 1972 because such spending was financed in part
by very high levels of public and private borrowing. Short-term
interest rates rose considerably, as reflected by an increase in the
rate on 3-month Treasury bills from a low of 3.20 per cent early
in the year to an average of more than 5.00 per cent in December.
Long-term rates, however, changed relatively little over the course
of the year. Yields on new corporate bond issues and on municipal
securities declined moderately, on balance, while yields on longerterm Treasury bonds rose under pressure of increased supplies.
Mortgage rates were generally stable, as both the volume of savings
flowing into mortgage lending institutions and mortgage credit expansion continued at record levels.
Some narrowing in the yield spread between long- and short-term
securities is typical during periods of cyclical expansion in business.
But the markedly different behavior of rates in these two types of
markets in 1972 was attributable in part to special factors. First,
Treasury borrowing requirements, while somewhat smaller than
in 1971, did put greater pressure on domestic short-term credit
markets. Although foreign central banks continued to invest much




5

2. G O V E R N M E N T O U T L A Y S
B I L L I O N S OF DOLLARS

1970

1971

1972

N O T E . — N a t i o n a l I n c o m e A c c o u n t s ( N I A ) d a t a at s e a s o n a l l y a d j u s t e d r a t e s , f r o m D e p t .
of C o m m e r c e , B E A . T r a n s f e r p a y m e n t s i n c l u d e net i n t e r e s t p a y m e n t s , s u b s i d i e s , a n d net
deficits o f g o v e r n m e n t e n t e r p r i s e s . C o m b i n e d d e f i c i t s t h r o u g h o u t ( Q 4 '72 e s t i m a t e d ) e x c l u d e
s u r p l u s e s o f State a n d l o c a l g o v e r n m e n t
retirement
funds, which amounted to
$7.4
b i l l i o n ( a n n u a l r a t e ) i n t h e f i n a l q u a r t e r o f 1972.

of the expansion in their dollar reserves in U.S. Treasury debt,
the over-all total of such placements was far below that of 1971.
Moreover, these banks put three-quarters of the total into higheryielding coupon issues, in contrast to their 1971 emphasis on Treasury
bills. Second, the volume of private long-term security issues declined
appreciably, as the flow of internal funds available to corporations
from depreciation allowances and retained profits improved sharply.
Finally, efforts under Phase I I of the economic stabilization program to moderate the increase in wages and prices—along with the
slowing in inflation that actually took place—may well have induced
some decline in the inflation premium required by investors for longterm commitments of funds.
The behavior of wages and prices during 1972 was significantly
more favorable, on balance, than in other recent years. There was a

6



3. SELECTED INTEREST RATES
PER CENT PER A N N U M

1970

1971

1972

F o r notes, see C h a r t 16, p. 42.

temporary bulge in the first few months following termination of the
wage-price freeze in November 1971, but after that the increase in
both wages and prices moderated on balance. For example, the index
of average hourly earnings in the private nonfarm economy, adjusted
for overtime premiums in manufacturing and for interindustry shifts
in employment, rose at an annual rate of 5.9 per cent from January
1972 to January 1973. This compared with a 7.0 per cent rate of
increase before the freeze in 1971.
Consumer prices of nonfood commodities rose 2.5 per cent during
1972, compared with 4 per cent in the 12 months before the freeze;
increases in prices of services also slowed appreciably. Consumer
food prices, however, rose nearly 5 per cent during 1972, reflecting
the larger consumer demands associated with rising personal incomes
and the shortages in supplies of meats and some other foodstuffs in
the market. It should be noted that prices of raw agricultural products
were exempted from the controls because of the serious problems
inherent in balancing supply and demand at non-market-determined
prices in the absence of rationing.
A major factor contributing to moderation in the inflation of




7

nonfood commodity prices during 1972 was the stepped-up growth
in productivity. Real output per manhour in the private nonfarm
economy increased by 4.7 per cent, compared with a 3.5 per cent
gain in 1971 and minimal growth in the preceding several years.
Combined with smaller wage gains, this increase in output meant
that the rising trend in unit labor costs was slowed markedly, to only
about 1.5 per cent. The large rise in productivity resulted in part
from the sharp gain in total output, which permitted economies in
the use of manpower. Similarly, the upsurge in business volume
made it possible to spread overhead costs over more sales; this permitted a large increase in profits with only moderately larger profit
margins.
Thus, some slowing in inflation would probably have occurred
during 1972 even in the absence of formal controls. But restraints
on wages, prices, and profit margins also appear to have contributed
to the moderation that actually occurred. Permissible increases in
most wages and prices were limited by the program, and in some
instances there were enforced rollbacks of increases that had been
put into effect. Moreover, the existence of the program tended to
discourage inflationary behavior in the policies and plans of business firms and the public generally.
Phase I I I , announced in January 1973, introduced additional
flexibility into the program. But the intent remains one of strong
resistance to inflationary behavior, both on a broad scale and in
individual cases, and the goal is to reduce further the over-all rate
of inflation.
During 1972 both fiscal policy and monetary policy were directed
toward encouraging more vigorous expansion in economic activity
and achieving a higher level of utilization of the Nation's labor
and other economic resources. As a part of the new economic
program announced in August 1971, tax policy was liberalized in
several respects to stimulate demands by the private sector of the
economy and to provide additional spending incentives. The Federal
excise tax on automobiles was repealed, the investment tax credit
was reinstated at 7 per cent, and certain tax reductions that had
been scheduled for later were advanced to January 1, 1972. I n
addition, programmed Federal escpojditures were boosted, largely

8




with respect to transfer payments and grants to State and local
governments.
As a result of these changes, Federal outlays rose by $26 billion
in the calendar year 1972 as compared with an increase of $16
billion in calendar year 1971. It was expected that the changes
would result in a large Federal deficit for the calendar year 1972.
But in fact the deficit on a national income account basis declined
to $18.5 billion from $21.7 billion in the previous year. Tax revenues
were buoyed by the upsurge in economic activity and, in addition,
by a change in tax-withholding schedules at the beginning of the
year, which resulted in substantial, continuing overpayments on
individuals' taxes during all of 1972. Converted to a full-employment basis, which compares expenditures with the tax revenues
that would be produced by an economy operating at high employment, the fiscal position shifted from a $4 billion surplus in calendar
year 1971 to approximate balance in 1972.
Monetary policy also was in a moderately stimulative posture
through most of 1972. Reserves available to support private deposits (Chart 4, page 10) were increased by 9.7 per cent as compared with a 7.2 per cent expansion during 1971. The money
stock narrowly defined—that is, including currency and demand
deposits—also rose more rapidly during 1972—8.3 per cent as
against 6.6 per cent in 1971. This, of course, not only reflected
the more vigorous growth in activity during the period but also
helped to finance it. It should be noted, however, that when the
increase is calculated as the change from the fourth quarter of 1971
to the fourth quarter of 1972, the money stock rose less than either
real or current-dollar GNP.
The money stock more broadly defined—to include also consumer-type time deposits at commercial banks and other thrift
institutions—continued to expand at about the same high 13 per
cent rate as during 1971. And other sources of bank funds—
mainly large negotiable certificates of deposit (CD's)—provided
more funds for bank credit expansion than in 1971. Credit thus
was readily available from banks and other institutional lenders to
finance private and public spending. Expansion in credit and money
was not large enough to satisfy all demands, however, so short-term
interest rates rose considerably oyer the course of the year whereas




9

4. SELECTED M O N E T A R Y I N D I C A T O R S
PERCENTAGE CHANGE

16

1970
NOTE.—RPD's and M I
a d j u s t e d data_ R P D ' s are
h e l d o u t s i d e the T r e a s u r y ,
d e m a n d deposits o t h e r t h a n
Federal funds rate and

10



1971

1972

are q u a r t e r l y changes at a n n u a l rates, based o n seasonally
reserves t o s u p p o r t p r i v a t e n o n b a n k deposits. Mi
is c u r r e n c y
F . R . B a n k s , a n d the v a u l t s o f a l l c o m m e r c i a l b a n k s , p l u s
interbank and U.S. Government.
net b o r r o w e d reserves are m o n t h l y averages o f d a i l y figures.

interest rates on most long-term securities showed relatively little net
change.
Upward pressure on short-term interest rates continued into
early 1973, and the Federal Reserve discount rate was raised in
two steps of V2 percentage point each to 5V2 per cent. The discount
rate had not been changed in 1972 as short-term market rates
fluctuated around it, first falling below and then in the latter part
of the year rising above it.
Economic activity rose especially sharply in the closing months of
the year, with production, sales, and employment all expanding vigorously. Real GNP increased at an 8.0 per cent annual rate in the
fourth quarter, and the unemployment rate moved significantly lower.
By the year-end, the prospects seemed clearly to point in the direction of a continued substantial upward momentum in 1973.
Indications early in 1973 are that business outlays on new plant
and equipment will be rising rapidly and that inventory investment
may accelerate in line with the rising trend of business sales. Consumer spending, which was exceptionally strong in the fourth quarter
of 1972, will very likely be buoyed in coming months by sizable
refunds of Federal taxes overwithheld during 1972, as well as by
continuing gains in employment and income. State and local government expenditures are to receive substantial financial assistance
from the general revenue-sharing payments of the Federal Government, which commenced—with a retroactive disbursement—only
very late in 1972.
Only residential construction seems likely to be moving down
following 2 years of record-high activity. But both building permits
and housing starts, which lead construction outlays, remained
extremely strong through the end of 1972, so any appreciable
decline in such outlays is likely to be deferred until the latter part
of 1973.
The foreign trade outlook also appears more favorable than
in 1972. Exports should be stimulated by the high and rising levels
of economic activity prevailing in most major countries and by the
further improvement in competitive position likely to stem from the
10 per cent devaluation of the dollar announced by the President
on February 12, 1973. Domestic production that competes with
imports will also be stimulated as a result of the increase in dollar




11

prices of imported goods. Thus, the physical volume of imports will
tend to be limited, although—as in early 1972—the total dollar
value of imports may be inflated by these higher prices. Past experience, both here and abroad, indicates that progress toward a
better balance of payments position will be slow and gradual, but
the further change in dollar parity in February should make an
additional contribution toward that end.
Summarizing, there is good reason to believe that the U.S. economy will continue to expand at a relatively rapid rate in the period
ahead. And as the economy approaches maximum levels of practicable resource utilization, the nature of the demand-management
problem facing governmental policy will be in process of change.
Rather than the stimulus that was needed to encourage rapid economic recovery, the need increasingly may be to restrain the expansion in economic activity to insure that future growth will
moderate to a rate consistent with the Nation's longer-run potential.
The administration's new budget plans for the remainder of the
fiscal year 1973 and for fiscal 1974 recognize this need. If the
spending totals proposed are not exceeded, the rise in Federal
outlays during calendar year 1973 will be substantially smaller than
during calendar year 1972. Tax refunds will keep the deficit large
in the first half of 1973, but thereafter revenues will be expanding
in line with growth in the economy. Under these conditions, the
slower rise planned in Federal expenditures would imply appreciably
less fiscal stimulus by the second half of 1973 and on into 1974.
Monetary policy too must be responsive to the financial requirements imposed by the needed moderation in economic growth to
a more sustainable, noninflationary pace. Although expansion in
the monetary aggregates continued comparatively rapid in the latter
part of 1972 as demands for funds intensified, reserves to support
this expansion were being provided more reluctantly, and efforts
by banks to adjust their positions by other means put upward
pressure on short-term interest rates. Less of the recent rise in bank
reserves has stemmed from open market operations, and more
from further increases in the average level of temporary bank accommodation at Federal Reserve Bank discount windows.
If the past is any guide, the firming in monetary conditions over

12




recent months should soon result in moderation in the rate of
monetary expansion. Developing monetary restraint affects monetary growth and economic activity with some lag, since it takes
time for borrowers, lenders, and investors to adjust to changed
financial conditions. Thus, the cumulative effects of monetary
actions in 1972—particularly those initiated in the latter part of
the year—will be working for some time toward restraint of monetary
expansion and of aggregate demand in the future.
I n any event, prospects at the beginning of the year make it
unlikely that the needs of the economy in 1973 will or should call
for the degree of monetary stimulus provided in 1972. Monetary
policy is a flexible instrument for influencing the economic environment, however, and it will be in a position to respond to
changing needs as economic developments unfold during the year.




13




Demands for
and Services

Goods

The stepped-up pace of economic expansion that became evident
in the fall of 1971 strengthened measurably in 1972, and at the
year-end growth was continuing at a very rapid pace. The new
economic policy that had been initiated in August 1971, including
a freeze on prices and wages followed by Phase I I controls, contributed to the faster economic expansion as well as to the easing
of inflationary pressures.
As employment and incomes rose strongly and inflationary expectations abated, consumers became more optimistic and they
increased their spending appreciably. Demands for housing continued
strong, and residential construction activity surpassed to a substantial
extent the very high levels reached in 1971.
Business attitudes improved with the growth in sales and the
better prospects for profits. New orders increased, and business commitments and outlays for fixed investment began to add considerably
to the vigor of the expansion. As the year progressed, business also
stepped up the pace of inventory investment.
Governments, too, contributed to the large advance in over-all
spending in 1972. I n contrast to these generally expansive demands,
net exports shifted from a small surplus in 1971 to a sizable deficit
in 1972, as the increase in imports far exceeded that in exports.

REAL OUTPUT
Measured in current prices, GNP increased rapidly in 1972—
by almost 10 per cent for the year as a whole. A t the same time,
the rise in the GNP implicit price deflator slowed to 3 per
cent, as compared with a 5 per ccnt average increase for the two
preceding years. As a result, the increase in real GNP for the
year as a whole amounted to 6.4 per cent—more than twice the
1971 rise and the largest since 1966. Growth in real GNP was
rapid in every quarter of 1972; in the fourth quarter it was at an




15

5. CHANGES I N GNP
B I L L I O N S OF DOLLARS

40

30

20

10

0
ENT

10
5
+
0

5

N O T E . — B a s e d o n q u a r t e r l y d a t a ( c o n s t a n t - d o l l a r series, 1958 d o l l a r s )
at s e a s o n a l l y
adjusted a n n u a l rates, f r o m D e p t . o f C o m m e r c e , B E A . Changes are f r o m preceding quarter.

annual rate of 8.0 per cent, about double the economy's long-run
potential rate of expansion.
The surge of aggregate demands in 1972 resulted in sharp increases in industrial output and nonfarm employment and i n a
significant reduction in unemployment. Over the 12 months ending
in December industrial production increased more than 10 per
cent; consumer goods, business equipment, and materials all made
appreciable contributions to this expansion. Nonfarm payroll employment was 2.7 million persons, or almost 4 per cent, above a
year earlier. The unemployment rate declined during the second
half of the year to 5.1 per cent in December; a year earlier the
rate had been 6 per cent.

CONSUMER INCOME AND OUTLAYS
Personal income increased somewhat more sharply in 1972 than
in 1971—8.5 per cent for the year as a whole compared with
less than 7 per cent in 1971. Although the rate of growth in
average hourly earnings slowed, employment was up sharply and

16



Table 1: GROSS N A T I O N A L PRODUCT

1972 «
T y p e o f measure

1970

1971

1972
I

II

III

IV

1,164
796

1,195
812

I n b i l l i o n s o f dollars

C u r r e n t dollars
1958 dollars

976
722

1,050
742

1,152
790

1,109
767

1,139
784

Percentage change f r o m preceding period
(at a n n u a l rates)

C u r r e n t dollars
1958 dollars
I m p l i c i t deflator (1958 = 100). . . .

-

5.0
.5

7.6
2.7

9.7
6.4

12.0
6.5

11.4
9.4

8.9
6.3

11.0
8.0

5.5

4.7

3.0

5.1

1.8

2.4

2.8

1
Q u a r t e r l y data are seasonally adjusted a n n u a l rates.
NOTE.—Basic data f r o m D e p a r t m e n t o f C o m m e r c e , Bureau o f E c o n o m i c Analysis.

total wages and salaries increased by 9.5 per cent, compared
with less than 6 per cent the preceding year. Transfer payments—for example, social security benefits and unemployment
insurance—also increased substantially, but less than they had in
1971. However, the growth in disposable personal income was
somewhat less than in 1971, because the gain in such income was
held down by a change in Federal income-tax-withholding schedules,
which resulted in sizable overwithholdings.
Nevertheless, consumers stepped up their spending and borrowing briskly, responding to strong gains in employment, increased
overtime, and strengthened confidence as evidenced by surveys
relating to consumer attitudes about economic prospects and financial positions. The rate of personal saving for the year as a whole
declined to about 7 per cent of disposable income, from more than
8 per cent in 1971.
I n current dollars, consumer spending was about 8.5 per cent
higher than in 1971. Purchases of new autos and household durable
goods were especially strong, but spending for nondurable goods
and services also rose considerably. Increases in the physical volume
of purchases were sizable for all three major categories. In real




17

6. CONSUMER INCOME, OUTLAYS, A N D SAVING
PERCENTAGE CHANGE

N O T E . — I n c o m e a n d s p e n d i n g are changes f r o m p r e c e d i n g q u a r t e r , based o n q u a r t e r l y
data at seasonally a d j u s t e d a n n u a l rates, f r o m D e p t . o f C o m m e r c e , B E A . S a v i n g r a t e is
p e r s o n a l s a v i n g as percentage o f d i s p o s a b l e p e r s o n a l i n c o m e .

terms, total consumer spending was up 6 per cent, well above the
4 per cent increase recorded for 1971.
Sales of new automobiles—both domestic-type and imports—
reached a new high of 10.8 million units for the year, up from
10.2 million units in 1971. I n the fourth quarter total auto sales
reached an annual rate of 11.7 million units, the highest of the
year. The sharp increase in purchases of household durable goods
was associated not only with rising incomes but also with the record
number of new housing units being completed and occupied. This
large increase in consumer spending for durable goods was facilitated
by a record increase in the use of instalment credit.
Consumer demands were still exerting a stimulating influence
on the economy at the end of 1972. Incomes were advancing with
exceptional rapidity as a result of continued strong gains in output
and employment and of a 20 per cent boost in social security benefits, with initial payments on October 1. It is expected that the
unusually large amount of tax refunds anticipated for the first half

18



of 1973 because of overwithholding during 1972 will add to both
disposable incomes and spending.

BUSINESS FIXED INVESTMENT
A n important factor in the expansive thrust of the economy in 1972
was a marked increase in business spending for new fixed capital.
Outlays for new machinery and buildings were 14 per cent higher
than i n 1971; measured in real terms this represented an increasee
of 10 per cent.
The rise in spending for business fixed capital reflected a number
of factors: the strong expansion in industrial production and an
associated rise in the rate of capacity utilization; the greatly improved
performance of aggregate profits; and the stimulative effects of a
further acceleration in depreciation schedules and the late-1971
restoration of the investment tax credit, which applies to purchases
of new equipment. For the year as a whole purchases of machinery
and equipment in current dollars were about 16 per cent above
the 1971 volume. Because the increase in prices of such goods in
7. BUSINESS F I X E D I N V E S T M E N T
RATIO SCALE, BILLIONS OF D O L L A R S

N O T E . — Q u a r t e r l y d a t a , at seasonally a d j u s t e d a n n u a l
B E A . C o n s t a n t - d o l l a r series is in terms o f 1958 d o l l a r s .




rates,

from

Dept.

of

Commerce,

19

1972 was quite moderate, most of this large rise in outlays represented physical volume. I n the equipment category, truck sales were
especially strong; the number of units sold was up 25 per cent from
1971. The increase in business outlays for new construction was
more moderate, with little change in real terms.
Most of the increase in fixed investment outlays in 1972 occurred
outside of the manufacturing sector. Expenditures by public utilities
rose strongly, reflecting continued sizable gains in demands for
energy as well as more rigorous standards for pollution controls.
Communications and commercial firms also increased their investment sharply. The increase in spending for new plant and equipment
by manufacturing firms in 1972 was much more moderate; however, the rise of 4 per cent contrasted with a decline of about
6 per cent in 1971.
Late in 1972 businessmen's intentions to spend for plant and
equipment in the year ahead appeared to be in the process of
upward adjustment, reflecting—among other factors—rising orders
for hard goods and a growing backlog of such orders. The survey
taken by the Department of Commerce in December 1972 showed
plans for a 13 per cent rise in spending for new plant and equipment
in 1973, with larger increases being planned by manufacturers
than by other sectors of the economy. Earlier private surveys
taken in the autumn had indicated a rise of around 10 per cent.

INVENTORIES
A n upturn in inventory investment finally developed in 1972. As
a general rule, inventory investment increases rapidly early in a
cyclical expansion, but in this one such spending had continued
quite moderate throughout the first year of recovery following the
fourth-quarter 1970 trough. This reflected in part the absence of
any net liquidation during the 1969-70 recession. Although recovery in sales in 1971 had resulted in a decline in inventory/sales
ratios, at the end of 1971 such ratios were still rather high for that
stage of the cycle.
Businessmen began to increase inventory investment in the second
quarter of 1972 in response to the continued rapid increases in
sales and production, and the rate of such accumulation accelerated
as the year progressed. Toward the year-end, accumulation reached

20



8. BUSINESS I N V E N T O R I E S A N D SALES
CHANGE, B I L L I O N S OF DOLLARS

12

1.7

1.5
0

N O T E . — D e p t . o f C o m m e r c e d a t a : I n v e n t o r y c h a n g e ( N I A ) , q u a r t e r l y d a t a at seasonally
a d j u s t e d a n n u a l rates, f r o m B E A . I n v e n t o r i e s / s a l e s r a t i o , based o n b o o k v a l u e a n d
sales d a t a s e a s o n a l l y a d j u s t e d , f r o m B u r e a u o f t h e C e n s u s ; b o o k v a l u e , e n d o f q u a r t e r ;
sales, q u a r t e r l y average.

an annual rate of $10 billion, as measured in the N I A accounts.
With sales gains outstripping inventory increases, the ratios of
inventory book values to sales in a number of areas were reduced
further, and by the end of the year they were approaching historically
low levels. Further growth in inventory accumulation is suggested
by these low ratios, as well as by rising backlogs of unfilled orders,
by more numerous reports of delays in deliveries, and by continuing
rapid increases in sales.

RESIDENTIAL CONSTRUCTION
Outlays for private residential construction, which had increased
sharply in 1971, advanced further in 1972. A record supply of
mortgage credit, available at relatively stable interest rates and on
liberal terms, supported a strong expansion in demands for both
new and existing dwelling units. For the year, residential outlays rose
25 per cent in current dollars and about 20 per cent in real terms.




21

Private housing starts accelerated to a peak seasonally adjusted
annual rate of more than 2.4 million units in the first quarter of the
year, almost double the low rate reached 2 years earlier. While the
rate fluctuated thereafter below the first-quarter high, the 1972 total
came to 2.4 million units. This was 15 per cent more than in 1971,
the first year in which starts exceeded 2 million units.
Reflecting in part builders' attempts to adjust to further increases
in the cost of land and other items, multifamily structures—which
include condominiums—continued to account for more than twofifths of total starts. However, upgraded demands for these and
for other types of dwellings were also a conspicuous factor in
the over-all advance. Nonsubsidized units, which generally incorporate more space and other amenities than do units that receive
Federal subsidies, accounted for all of the rise in multifamily structures. I n contrast, the number of subsidized starts—for which new
commitments were suspended altogether in early 1973—dropped

9. R E S I D E N T I A L C O N S T R U C T I O N
RATIO SCALE, B I L L I O N S OF DOLLARS

60

N O T E . — D e p t . o f C o m m e r c e d a t a : E x p e n d i t u r e s , q u a r t e r l y d a t a at s e a s o n a l l y a d j u s t e d
a n n u a l rates, f r o m B E A . C o n s t a n t - d o l l a r series is i n t e r m s o f 1958 d o l l a r s . H o u s i n g
starts, m o n t h l y d a t a at s e a s o n a l l y a d j u s t e d a n n u a l rates, f r o m B u r e a u o f the Census.

22



appreciably in 1972 from the highs reached in 1970 and 1971.
Shipments of new mobile homes, which are not included in housing
starts or in residential construction outlays, also achieved a new
high in 1972. Such shipments totaled about 575,000 units, an increase of 15 per cent from 1971.
A t the year-end demands for housing remained strong, vacancy
rates were relatively low, and mortgage funds were still in ample
supply at rates little changed from a year earlier. However, it appeared unlikely that the number of starts in 1973 would match
the 1972 total in view of ( 1 ) the extent to which the backlog of
demand had been satisfied by sustained high levels of production
(2) the large and growing number of completions of earlier starts
in prospect, and ( 3 ) other factors.

GOVERNMENT OUTLAYS
Purchases of goods and services by the Federal Government rose
strongly in the first half of 1972 as the result of a Governmentwide pay increase in January and the rebuilding of defense inventories depleted by activities in Vietnam. In the second half of
the year, however, defense purchases dropped sharply and nondefense buying slowed; as a result, Federal purchases declined. For
the calendar year as a whole, Federal purchases rose about 8.5 per
cent—virtually all because of increased pay and higher prices.
State and local government purchases rose by about 10 per cent
in 1972—the same increase as in each of the past 3 years. Employee
compensation, as usual, accounted for much of the gain. Employment rose about 4.5 per cent; about one-third of this increase represented the number of jobs added under provisions of the Public
Employment Act—a program funded in large part by the Federal
Government. As in other recent years, there was little growth in
purchases of structures in 1972, in large part because the demand
for new educational structures has lessened.
During 1972 there was a dramatic improvement in the over-all
fiscal position of State and local governments. Although expenditures continued to rise rapidly, revenues rose even faster, especially
in the fourth quarter when the first payments under the Federal
revenue-sharing program were received. As a result, State and




23

local governments achieved a surplus of about $12 billion ( N I A
basis) for the calendar year compared with a surplus of less than $5
billion in 1971 and with deficits in 1967 and 1968. However, there
remained wide differences in the fiscal position of individual governmental units.

Table 2: CHANGES I N MAJOR COMPONENTS OF GROSS
N A T I O N A L PRODUCT
In billions of dollars

1972'
Item

1970

1971

1972
I

GNP

46 1

74 0

Personal consumption expenditures
D u r a b l e goods
N o n d u r a b l e goods
Services

37.3
— 3
18 5
19. 1

48
13
13.
21.

1
0
7
5

11

101.4

31.0

30 3

24.6

30 9

56.1
12. 6
21.4
22. 1

15.6
4. 9
4.9
5. 8

17
2
8
5

3
9
9
7

15.2
4.7
4. 8
5. 6

17
2.
8.
6.

8 0

8. 2

6. 9

F i x e d investment
Residential structures
Nonresidential

1 1
-1 4
2 4

16 1
II. 4
4. 9

26.2
11.4
14. 8

I n v e n t o r y change

- 2

Saving rate {level, in per cent)

Net exports o f goods and services
Exports
Imports
Govt, purchases of goods and services
Federal
Defense
Other
State a n d local

1

9

) 7
7 4
5 7
9
- 2
- 3
1
11

0
3
3
1
3

24



6. 4

6.4

7. 6

4 3
1 2
3. 1

3.2
1.6
1.5

7 9
2. 6
5. 4

4 6

3.0

2.3

T

-4.9
7. 6
12. 5

-2.5
7. 7
10. 2

8
3
7
8
5

21.8
8.0
4. 5
3.6
13. 8

8.5
5.0
4. 8
. 2
3. 5

D e r i v e d f r o m q u a r t e r l y totals at seasonally adjusted a n n u a l rates.
NOTE.—Basic data f r o m D e p t . o f C o m m e r c e , B E A .

1
2
4
5

7.2

3

13
1.
-3.
4.
12.

IV

10.5
4. 3
6. 3

- 2 9
3. 2
6

- 1

III

-1.3

_

6
7
1

1.8
4. 4
2.6

4 7
2. 4
1. 9
7
2. 3

1.5
-2.7
-3. 5
. 6
4. 2

—

2 3

_

1
5. 2
5. 3

3 7
- 1. 4
- 1. 9
6
5. 0

Manpower
Labor markets tightened significantly in 1972 in response to the
sharp rise in real output. Gains in employment were large and
persistent all year, but it was not until near midyear that the jobless
rate, which had held close to 6 per cent for a year and a half, began
to decline.
Growth in employment had begun to accelerate in late 1971,
and it continued at a rapid pace through most of 1972. By December
nonfarm payroll employment had risen by 2.7 million persons from
a year earlier. Gains in manufacturing were especially strong during
most of 1972, as increased spending for investment and strong
demands for autos and other consumer durable goods stimulated
rapid growth in employment in the major metal-producing and
metal-using industries. By December total manufacturing employment, at 19.4 million persons, had risen by some 900,000 over the
year, and the average factory workweek had increased appreciably.
But manufacturing employment was still 900,000 below the peak
level of 1969, when defense production was supporting a high level
of factory output.
Employment growth also accelerated in nonindustrial activities

10. N O N F A R M P A Y R O L L E M P L O Y M E N T
1968=100

NOTE.—Based

on




monthly

data,

seasonally

adjusted,

from

Dept.

of

Labor,

BLS.

25

in 1972. I n services, finance, and trade, the total number employed
rose by 1.2 million, about one-third more than during 1971. Federal
civilian employment was cut slightly, but State and local governments increased their payrolls by 475,000 over the year ending in
December—including about 150,000 jobs provided by the Federally
financed public employment program.
Little progress was made in reducing unemployment until early
summer, however, as much-larger-than-normal increases in the
labor force about matched the rise in employment. Rapid gains in
the civilian labor force in the winter and early spring reflected not
only a rise in participation rates in response to increases in employment opportunities but also the entry into the civilian labor market
of several hundred thousand young men as the size of the Armed
Forces was reduced further. Toward midyear, however, growth of
the civilian labor force slowed, in part because the size of the
11. LABOR FORCE, E M P L O Y M E N T , A N D U N E M P L O Y M E N T
M I L L I O N S OF PERSONS

N O T E . — B a s i c d a t a , D e p t . o f L a b o r , B L S . F o r c i v i l i a n l a b o r f o r c e a n d e m p l o y m e n t , 1970
a n d 1971 are changes f r o m p r e c e d i n g y e a r ; t h e 1972 changes are a n n u a l rates c a l c u l a t e d
f r o m h a l f - y e a r averages o f seasonally a d j u s t e d d a t a . U n e m p l o y m e n t rate is m o n t h l y , seasonally adjusted.

26



Armed Forces leveled off after a decline of 1.2 million from the
high in October 1968. Altogether, over the year ending in December
the civilian labor force increased by more than 1.8 million persons.
Reflecting continued strong gains in employment and slower growth
in the labor force, the unemployment rate declined irregularly after
May to 5.1 per cent in December.
The decline in unemployment was most pronounced among men
25 years of age and over—reflecting largely the strong recovery in
manufacturing and blue-collar employment. Nevertheless the jobless
rate for this age group, at 2.8 per cent in the fourth quarter, remained
above the exceptionally low rate of late 1969. Unemployment among
Negroes (10 per cent) and younger workers (about 16 per cent)
changed little from the high rates of late 1971 and early 1972.
I n 1973 the size of the Armed Forces is expected to decline only
a little further, and growth of the civilian labor force may be closer
to the 1.5 million expected per year on the basis of population
growth and trends in participation rates. Such a situation would
be conducive to a further reduction in the unemployment rate if
employment gains continue at a rapid pace.

Table 3: LABOR FORCE, E M P L O Y M E N T , AND UNEMPLOYMENT
Changes i n thousands o f persons, except f o r u n e m p l o y m e n t rates, w h i c h are m o n t h l y average rates i n
the final quarter o f each year.

Y e a r ending f o u r t h q u a r t e r o f —
Item
1969

1970

1971

1972 i

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

2,283
-53

1,408
-443

1,257
-353

1,608
-262

C i v i l i a n l a b o r force
Total civilian employment

2,336
2, 102

1,851
-64

1,610
1,409

1,869
2,344

3.6

5.8

5.9

5.3

1 .8
5.6
3.7
12.1

3.4
10.5
5.5
17.2

3.5
10.3
5.7
16.9

2.8
8.7
5.2
15.6

Whites
Negroes a n d others

3.3
6.2

5.4
9.2

5.4
10.1

4.7
9.9

Heads o f households
F u l l - t i m e workers

1.9
3.1

3.5
5.4

3.6
5.6

3.1
4.8

U n e m p l o y m e n t rates ( i n per c e n t ) :
Total
M e n , 25 a n d over
M e n , 20 t o 24
W o m e n , 20 a n d over
Teenagers, 16 t o 19

1
D a t a o n changes f r o m 1971 t o 1972 are a d j u s t e d t o a l l o w f o r the i n t r o d u c t i o n
estimates f o r p o p u l a t i o n .
N O T E . — B a s i c d a t a f r o m D e p t . o f L a b o r , B u r e a u o f L a b o r Statistics.




of

new

27




Wages, Labor

Costs, anrf

Prices

Progress was made in 1972 in reducing inflationary pressures. The
program of wage and price controls initiated in August 1971 contributed to a slowing of the rise of hourly compensation, and with
gains in productivity accelerating, the rise in unit labor costs
moderated sharply. Price developments, particularly as measured
by the comprehensive GNP fixed-weight index for the private
economy, reflected the more favorable labor cost situation and the
impact of price controls. The consumer price index posted a somewhat smaller increase during 1972 than in the pre-control period
of 1971, and the rise in industrial wholesale prices slowed appreciably. On the other hand, prices of farm products and processed
foods increased much more rapidly than before controls.
On January 11, 1973, the President requested a temporary
extension of the Economic Stabilization Act of 1970—the
legal underpinning of the wage and price control program—
and announced some important changes in the Phase I I
program. The new program—referred to as Phase III—is
intended initially to maintain, with some modifications, the
basic wage and price standards established in the early period
of controls, but heavier reliance is placed on voluntary
compliance and self-regulation. The requirement for prenotification of wage and price increases by large firms has
been eliminated. However, foods beyond the farm level,
health services, and construction remain under mandatory
controls. The Price Commission and the Pay Board were
abolished, and authority for the new program was centralized
in the Cost of Living Council.

WAGES
The Pay Board, as originally set up, was charged with the task
of limiting wage increases. Accordingly, it established standards
for generally permissible pay increases consistent with the announced
goal of reducing the rate of price increase to a range of 2 to 3




29

per cent. Including an allowance of about 3 per cent for long-term
growth in productivity, the general wage and salary standard established by the Board called for a limit of 5.5 per cent on increases
in wages and salaries and "covered" fringe benefits. I n addition,
the Board permitted increases in certain other qualified fringe benefits, and this in effect raised the over-all standard for compensation
to as much as 6.2 per cent. Considerable flexibility was also built
into the Board's regulations, including procedures for upward adjustment in the standards if necessary to correct gross inequities
and to deal with other special situations.
The rise in money wages was slower in 1972 than in 1971. For
the 12 months ending January 1973 (that is, the year following the
post-freeze bulge in wages), adjusted hourly earnings of production
and nonsupervisory workers in private nonfarm industries—the
measure that most closely approximates changes in wage rates—
increased by about 6 per cent; this compares with an annual rate of
increase of nearly 7 per cent both in the pre-control period of 1971
and from January 1971 to January 1972. But the slowing was concentrated in the interval from January through August. Thereafter,
the rise in wages was more rapid than earlier in the year. Because
of the moderation of price increases, real wages of production
workers in the private sector, which had begun to advance in 1971
following several years of little or no growth, rose more than 2.5
per cent over the course of 1972.
Experience in 1972 varied among individual industries, but over
Table 4: CHANGES I N AVERAGE H O U R L Y EARNINGS
Seasonally adjusted a n n u a l rates, i n per cent

Industry

A u g . 1970A u g . 1971

A u g . 1971Jan. 1972

Jan. 1972July 1972

July 1972Jan. 1973

Jan. 1972Jan. 1973

6.9

7.0

4.7

6.8

5.9

Mining
Construction
Manufacturing

6.8
7.8
6.5

9.2
6.8
6.5

4.4
3.2
4.9

8.9
10.5
6.3

6.7
6.9
5.7

Transportation and public utilities
W h o l e s a l e a n d retail trade
Finance, insurance, a n d real estate
Services

8.7
6.0
6.9
7.3

11.8
5.5
5.0
7.6

9.4
4.4
4.8
2.7

8.5
4.9
4.8
7.7

9.2
4.7
4.8
5.3

Total private n o n f a r m

NOTE.—Average h o u r l y earnings o f p r i v a t e n o n f a r m p r o d u c t i o n a n d s u p e r v i s o r y w o r k e r s , adjusted
f o r i n t e r i n d u s t r y s h i f t s a n d , i n m a n u f a c t u r i n g o n l y , f o r o v e r t i m e hours. Basic data f r o m D e p t . o f
Labor, BLS.

30




the entire 12 months the slowing of the rise i n wages was most
pronounced for the services and trade sectors. Hourly earnings i n
construction, which continued to be under the control of the Construction Industry Stabilization Committee, increased by about 7
per cent over the 12-month interval. I n manufacturing, hourly earnings rose appreciably less than in the immediate pre-control interval.
However, some industry groups realized larger increases i n 1972
than in 1971. This was true especially for transportation and public
utilities; in these industries there were large wage increases for
telephone workers, railroad workers, truckers, and dockworkers,
mainly as a result of deferred-wage increases under collective bargaining agreements negotiated before controls were introduced.
In most industries the rise in hourly earnings accelerated in the
closing months of 1972. The reasons for this are not entirely clear,
but the acceleration appears to reflect in part a clustering of both new
and deferred wage increases roughly a year after the 1971 freeze
and in part a generally stronger labor market.

PRODUCTIVITY AND LABOR COSTS
Productivity increased sharply in 1972, as is typical of periods of
strong growth in output. Output per manhour in the private nonfarm economy rose 5.1 per cent over the four quarters of 1972—
double the long-term trend of 2.6 per cent. This performance exceeded the sizable 4.4 per cent rise in productivity in 1971, and it
was in sharp contrast to 1969 and early 1970 when there was
virtually no growth.
Employee compensation, which includes both wages and fringe
benefits, increased 6.9 per cent over the course of 1972, compared
with 8.1 per cent over the first half of 1971. The stepped-up pace
of growth in productivity together with this slowing of the rise in
employee compensation resulted in a sharp reduction of the rate of
increase in unit labor costs. For the private nonfarm economy, such
costs rose only 1.6 per cent during 1972—and they were virtually
unchanged in the middle two quarters. This compares with increases
of more than 8 per cent during 1969 and 5 per cent during 1970.
I n 1973, gains in productivity may fall well short of those in 1972,
particularly if real growth moderates to a more sustainable rate, as
is widely expected. Further progress in restraining cost pressures is




31

12. P R O D U C T I V I T Y , C O M P E N S A T I O N , A N D COSTS
PERCENTAGE CHANGE

N O T E . — D a t a are f r o m D e p t . o f L a b o r , B L S ; changes are based o n h a l f - y e a r
o f s e a s o n a l l y a d j u s t e d q u a r t e r l y estimates f o r the p r i v a t e n o n f a r m e c o n o m y .

averages

thus heavily dependent on the changes in wages and other employee
benefits, emphasizing the importance of an effective Phase I I I
program.
In appraising wage prospects, it should be noted that measures to
restrain wage increases are continuing in Phase I I I . The fact that
workers covered under expiring contracts have realized significant
gains in real income may be conducive to some moderation in demands for higher wages. However, the number of workers involved in
major contract negotiations, which was relatively small in 1972, will
increase substantially in 1973. Contracts covering 4.7 million workers
either expire or provide for wage reopenings. These include such key
industries as trucking, railroads, rubber, electrical equipment, and
autos. Furthermore, a heavy round of bargaining is anticipated in the
construction industry, as many of the agreements signed in 1972
covered only one year.

32



PRICES
The moderation of the pace of price advance during 1972 was fairly
general, except for prices of farm products, foods, and some materials. The fixed-weight price index for gross private product rose at
an annual rate of about 3 per cent after a post-freeze bulge in the
first quarter; this compares with an average annual rate of about 5
per cent in the first two quarters of 1971 preceding the 90-day
price freeze.
Prices of food products at the farm level, which are not controlled,
increased 19 per cent during 1972—considerably faster than in any
other year since 1950. In December wholesale prices of livestock
were 22 per cent above a year earlier; eggs, 26 per cent; and grains,
44 per cent. Prices of processed foods and feeds, however, rose less
rapidly than those of farm products. Nevertheless, the average rise
for this category for the year ending December amounted to 11.5
per cent. Because of the sharp rise in prices of farm products and
foods, the total index of wholesale prices rose faster in 1972 than
in the pre-control period from December 1970 to August 1971.
On the other hand, the rise in prices of industrial commodities
moderated appreciably during 1972, reflecting mainly improvement
in prices of producers' finished goods and fabricated materials. Price
rises continued to be very sharp for many raw materials, including
such important commodities as hides, skins, and wool. Lumber and

Table 5: PRICE CHANGES
Seasonally adjusted a n n u a l rates, i n per cent

1972
Item

W h o l e s a l e prices, t o t a l
Industrial commodities
F a r m products, processed foods, a n d
feeds
C o n s u m e r prices, t o t a l
Foods
O t h e r c o m m o d i t i e s (less foods)
Services 1

Dec.
1969Dec.
1970

Dec.
1970Aug.
1971

Dec.Mar.

Mar.June

JuneSept.

Sept.Dec.

Dec.Dec.

2.2
3.6

5.2
4.7

4.9
4.2

4.9
4.9

6.7
3.2

9.6
2.0

6.5
3.6

-1.4

6.5

7.0

4.8

17.4

30.1

14.4

3.8
5.0
2.9
4.5

3.6
7.2
2.4
4.4

2.2
0.0
2.7
3.1

4.6
7.0
4.1
3.0

3.2
5.2
1.0
3.9

3.4
4.7
2.5
3.6

5.5
2.2
4.8
8.2
8.2

„

1

D e r i v e d f r o m data n o t adjusted f o r seasonal v a r i a t i o n .
NOTE.—Basic data f r o m D e p t . o f L a b o r , B L S .




33

13. PRICES
PERCENTAGE CHANGE

PRE-FREEZE

N O T E . — B a s e d o n d a t a f r o m D e p t . o f L a b o r , B L S . C h a n g e s m e a s u r e d f r o m last m o n t h
o f p r e v i o u s p e r i o d t o last m o n t h o f i n d i c a t e d p e r i o d . Pre-freeze i n t e r v a l e x t e n d s f r o m
D e c e m b e r 1970 t o A u g u s t 1971; Phase I I , f r o m N o v e m b e r 1971 t o D e c e m b e r 1972; changes
f o r b o t h i n t e r v a l s are a n n u a l r a t e s , based o n seasonally a d j u s t e d data.

plywood also advanced at very fast rates, but price advances for
other building materials and metals moderated.
Consumer prices rose 3.4 per cent over 1972 compared with an
annual rate of 3.8 per cent in the pre-control period of 1971. But
retail food prices advanced by almost 5 per cent and meat prices by
more than 10 per cent during 1972. In contrast to food prices, there
was a marked deceleration of the rise in the cost of services as well
as a more moderate slowing for nonfood commodities. The full
extent of the improvement in costs of services in 1972 compared
with the pre-freeze months of 1971 was masked by the sharp
decline in mortgage interest costs in the earlier period. When home
financing costs are excluded, the rise for service costs in 1972
dropped to about half the early-1971 rate. The slowing of the rise in
costs of medical care—which seems to reflect in considerable part
the impact of controls—was dramatic; and rents, utility costs, and
other major services rose at substantially reduced rates.
In early 1973 it appeared that a somewhat faster rise in prices

34



was in immediate prospect. As noted earlier, some pick-up in the
rise in unit labor costs seemed likely, following the marked slowing
in 1972. Indeed, such costs were raised at the outset of the year,
when the employer tax for social insurance was boosted sharply.
Prices of farm products rose sharply further in January, and food
prices are expected to continue to rise rapidly for some months.
More generally, strong domestic and world demands relative to
supply have been exerting increasing pressure on prices of materials,
especially of internationally traded commodities.
Following an upward spurt in prices of farm products and foods
in the early months of 1973, however, retail food prices may tend to
level off. Contributing to this is a prospective significant increase
in per capita food supplies, particularly of meats, in the second half of
1973.




35




Federal

Fiscal

Policy

In fiscal years 1971 and 1972 large Federal deficits were generally
accepted as appropriate, first to cushion the recession of 1970, and
then to stimulate recovery. As recovery turned into vigorous expansion, however, the administration recognized that continued sharp
increases in Federal spending and large deficits would be inappropriate in the developing environment of high and rising levels of
output and employment. A major effort was made, therefore, in
the budget document released in January 1973 to limit increases
in spending, and the expansionary thrust of fiscal policy is indicated
to moderate greatly as calendar year 1973 progresses.
The unified budget deficit of $23.2 billion that was realized for
fiscal year 1972, while large, was $15.6 billion less than had been
projected in the January 1972 budget document. Outlays did accelerate sharply in the spring of 1972, but the anticipated speed-up was
not fully realized. More than half of the $4.7 billion short-fall in
spending in fiscal year 1972 was due to the unexpected delay in the
enactment of revenue sharing and to lower payments on unemployment insurance. Defense spending, however, increased sharply in
the spring of 1972—about in line with budget projections.
Federal budget receipts in fiscal year 1972 turned out to be $10.8
billion higher than had been projected, in part because of the rapidity
of economic expansion but mainly because of an unusual amount of
overwithholding of personal income taxes related to the introduction
of a new withholding schedule in January 1972. This development
will reduce Federal net receipts in the spring of 1973 when individuals file their tax returns for 1972.
Prior to adjournment in October 1972, Congress enacted legislation that would increase outlays in fiscal year 1973 to a level some
$6 billion to $8 billion above the $250 billion proposed by the
administration in September 1972. The administration requested
Congress to enact a ceiling of $250 billion on outlays for the fiscal
year 1973. Although such a ceiling was not enacted, the administration has indicated that it intends to hold spending to that level by
adopting various economies, and by impounding appropriated funds,
if necessary. The new budget indicates that economies are planned




37

in fiscal years 1973 and 1974 in a large number of areas. I n addition, the budget calls for large sales of assets (negative outlays) in
these two fiscal years.
Spending in the first two quarters of fiscal year 1973 (that is,
the second half of calendar 1972) was in line with the proposed
$250 billion. Outlays for national defense, while still strong, fell
significantly below the levels attained in the latter half of fiscal year
1972. As expected, nondefense spending increased very sharply in
the last quarter of calendar year 1972, reflecting two factors: the 20
per cent boost in social security benefits, effective in October 1972,
which costs about $8 billion annually; and the first payment to State
and local governments under the new general revenue-sharing program, which is expected to cost more than $5 billion in the first full
year. However, payments made for revenue sharing in December
1972 and in January 1973 covered revenue-sharing accruals for all
of the calendar year 1972; quarterly payments, beginning in A p r i l
1973, will be much smaller.
The budget document issued in January 1973 anticipates that the
deficit in fiscal year 1973 will total about $25 billion—a little larger
than the deficits realized in fiscal years 1971 and 1972—but that
the deficit in fiscal year 1974 will be reduced to less than $13 billion.
The full-employment budget, on a unified budget basis, is projected
to show a deficit of around $2 billion in fiscal year 1973 and an
approximate balance in fiscal year 1974.1
1
The administration's estimate of full-employment receipts does not incorporate the effect of any overwithholding that is regarded as transitory.
Inclusion of such overwithholding would have reduced the full-employment
deficit in fiscal year 1972 and increased this deficit in fiscal year 1973.

T a b l e 6: F E D E R A L B U D G E T S U M M A R Y
Fiscal-year t o t a l s , i n b i l l i o n s o f d o l l a r s

1970

1972

188.4
211.4

208.6
231.9

225.0
249.8

256.0
268.7

-2.8

-23.0

-23.2

-24.8

-12.7

2.6

B u d g e t receipts

1971

193.7
196.6

Item

4.9

-3.9

-2.3

.3

Budget outlays

1973e

1974e

S u r p l u s o r deficit ( —)
F u l l - e m p l o y m e n t s u r p l u s , o r deficit ( —)
'' E s t i m a t e s .
N O T E . — D a t a f r o m t h e Budget

38



of the

U.S.

Government,

Fiscal

Year

1974.

14. C H A N G I N G P A T T E R N OF F E D E R A L O U T L A Y S
PER CENT OF T O T A L O U T L A Y S

1965

1967

1969

1971

1972

1973 1974

FISCAL YEARS

• T h r e e c o m p o n e n t s o f t h i s t o t a l are s h o w n b e l o w ( p l e a s e n o t e d i f f e r e n c e s
the t w o g r i d s ) .
N O T E . — D a t a f r o m the Budget of the U.S. Government,
Fiscal
Year
1974.

i n scales

for

As shown in Table 6, budget outlays are expected to be about
$250 billion and $269 billion in fiscal years 1973 and 1974, respectively. The projected growth of $18 billion to $19 billion in
spending in these two fiscal years amounts to about 7.5 per cent
annually. In the fiscal year 1972 budget outlays increased by 9.7
per cent, and the annual increase over the previous decade had
averaged about 8 per cent. Budget receipts are projected in the
budget document to increase to $225 billion and $256 billion, respectively, in fiscal years 1973 and 1974. No significant tax changes
are proposed in the new budget.
There has been a significant shift in the composition of Federal
outlays in recent years. Although outlays for national defense are
projected to increase absolutely, their proportion of total budget expenditures, as may be seen in Chart 14, has declined from more




39

than 40 per cent in fiscal years 1967 and 1968 to a projected
figure of about 30 per cent in fiscal years 1973 and 1974. On the
other hand, the proportion of total budget outlays devoted to "income security" has risen from less than 20 per cent a few years ago
to about 30 per cent. (Social security benefits, including medicare,
are the biggest component of this category, which includes also such
other supports to income as Federal retirement benefits, veterans'
benefits, unemployment insurance, and public assistance.) Federal
outlays for health programs have also risen as a percentage of
the total.
A broadly similar picture is evident when outlays ( N I A basis)
are shown as a proportion of full-employment GNP, as in Chart 15.
It is evident from this chart that direct Federal demands on resources
have decreased as a proportion of full-employment GNP along with
the relative decline in defense purchases. But this decline has been
offset by a large absolute and relative increase in spending for a
great variety of programs that add directly to incomes of individuals
without the provision of a current service—as in the case of transfer
payments—and by an advance in Federal grants-in-aid to help State
and local governments provide for a wide range of needs.
15. FEDERAL EXPENDITURES NIA
Relative to Full-Employment GNP
PER CENT

1965

1967

1969

1971

1972 1973 1974

F I S C A L YEARS

N O T E . — B a s i c d a t a o n e x p e n d i t u r e s are f r o m the Budget
of
Year 1974. D a t a o n f u l l - e m p l o y m e n t G N P are F . R . e s t i m a t e s .

40



the

U.S.

Government,

Fiscal

Monetary
Financial

Policy and
Markets

Federal Reserve policy in 1972 concentrated on fostering financial
conditions conducive to achieving sustainable growth in real economic activity and employment, consistent with the administration's
Phase I I objective of moderating inflationary pressures. To attain this
goal, the Federal Open Market Committee ( F O M C ) took actions
designed to provide reserves sufficient to support growth in the
monetary aggregates appropriate to a substantial gain in economic
activity and an improved rate of resource utilization.
Demands for money and credit were strong in 1972 as the
economy expanded vigorously. With demands large, the narrowly
defined money stock ( M , ) expanded at an 8.3 per cent rate, and
the bank credit proxy at a little under 12 per cent, somewhat more
rapid increases than in 1971. Reserve provision through open market
operations, as indicated by the rise in nonborrowed reserves to support private nonbank deposits, was more restrained than in the
previous year. As a consequence, short-term interest rates rose substantially after the winter of 1972 and upward pressures continued
into early 1973. The Federal Reserve discount rate was raised by
V2 percentage point to 5 per cent in mid-January of 1973 and by
another V2 percentage point in late February. Partly as a result of the
cumulative impact of 1972's developing monetary restraint, the rate
of monetary expansion moderated in early 1973.
Interest rates on long-term securities and residential mortgages
remained quite stable throughout 1972, reflecting in part the slower
rise in prices in the economy and the reduction of inflationary
expectations. In addition, demands placed on securities markets by
the U.S. Government, by State and local governments, and by businesses moderated. The total volume of external financing still remained historically high, however, and the bulk of this demand was
met through financial institutions—especially the demands for consumer and mortgage loans and business demands for bank loans.




41

16. I N T E R E S T RATES

N O T E . — M o n t h l y averages except H U D (based o n quotations f o r one d a y each m o n t h ) .
Y i e l d s : U . S . T r e a s u r y b i l l s , m a r k e t y i e l d s o n 3 - m o n t h issues; p r i m e c o m m e r c i a l p a p e r ,
d e a l e r o f f e r i n g r a t e s ; c o n v e n t i o n a l m o r t g a g e s , y i e l d s o n first m o r t g a g e s i n p r i m a r y m a r k e t s ,
u n w e i g h t e d a n d r o u n d e d t o nearest 5 basis p o i n t s , f r o m D e p t . o f H o u s i n g a n d U r b a n
D e v e l o p m e n t ; c o r p o r a t e b o n d s ( F e d e r a l Reserve s e r i e s ) , averages o f n e w p u b l i c l y o f f e r e d
b o n d s r a t e d A a a , A a , a n d A b y M o o d y ' s I n v e s t o r s Service a n d a d j u s t e d t o a n A a a b a s i s ;
U . S . G o v t , b o n d s , m a r k e t y i e l d s a d j u s t e d t o a 20-year c o n s t a n t m a t u r i t y b y U . S . T r e a s u r y ;
S t a t e a n d l o c a l g o v t , b o n d s ( 2 0 issues, m i x e d q u a l i t y ) , B o n d B u y e r .

MONETARY POLICY
In its day-to-day implementation of monetary policy during 1972,
the F O M C placed somewhat greater emphasis on bank reserves
while continuing to give weight to money market conditions. A t the
same time the longer-run financial objectives of System policy continued to be concerned with various monetary aggregates, interest
rates generally, and credit conditions.
The bank reserve measure emphasized by the F O M C was reserves
available to support private nonbank deposits (RPD's)—total member bank reserves less reserves required against U.S. Government
and interbank deposits. Because short-run fluctuations in the latter
two types of deposits have only limited impact on economic activity

42



and are often large and erratic, the System generally is prepared to
accommodate changes in demands for those deposits. I n view of the
inherent volatility of U.S. Government and interbank deposits,
growth in RPD's is considerably more stable on a month-to-month
and quarter-to-quarter basis than that for total reserves. However,
RPD's too fluctuate fairly widely in the very short run, because
week-to-week and month-to-month movements in private demand
deposits, which serve as the principal medium of exchange in the
economy, are highly volatile.
In the first quarter of 1972 System open market operations provided for fairly rapid expansion in RPD's, as monetary policy was
directed toward creating conditions favorable to rapid economic
recovery and toward making up for the shortfall in the growth of
(currency plus private demand deposits adjusted) late in 1971.
Since growth in the monetary aggregates had proceeded at very
high rates during February and March, however, the System subsequently provided nonborrowed RPD's more reluctantly, and RPD
growth slowed to an annual rate of about 6.5 per cent in the second
quarter—considerably less than in the first. Expansion in M , also
dropped substantially below its first-quarter rate.

Table 7: GROWTH I N BANK RESERVES
1972
Item

1971

1972
I

II

III

IV

I n per c e n t 1
T o t a l reserves
Reserves to support private deposits ( R P D ' s )
N o n b o r r o w e d reserves
Nonborrowed RPD's

7.2

10.6

10.4

12.6

3.6

14.2

7.2
8.1
8.2

9.7
7. 1
5.9

10.4
10.7
10.7

6.6
13.1
7.2

9.9
- .8
5.0

10.6
4.8
.4

360

789

I n m i l l i o n s o f dollars
MEMO:
B o r r o w e d reserves

-244

1,096

-20

-41

2

' Q u a r t e r l y changes, shown at seasonally adjusted a n n u a l rates, are calculated f r o m the average
amounts outstanding (adjusted for changes in reserve requirements) i n the last m o n t h o f each quarter.
A n n u a l changes calculated f r o m December averages.
2
Quarterly changes are calculated f r o m the average a m o u n t s o u t s t a n d i n g (seasonally adjusted a n d
adjusted f o r changes i n reserve requirements) i n the last m o n t h o f each quarter, n o t annualized. A n n u a l
changes calculated f r o m December averages.




43

In the second half of the year continued rapid expansion in
economic activity resulted in increased bank demands for reserves
to support additional credit and in monetary expansion. While the
growth rate of total RPD's rose again to the high levels reached in
the first quarter, reserve provision through open market operations
was increasingly restrained, and more of the reserve expansion late
in the year was the result of increased borrowing by member banks
from the Federal Reserve Banks. During the last quarter of the
year nonborrowed RPD's increased by a nominal amount, but banks
increased their average borrowings by more than $700 million.
Although bank reserves grew rapidly during 1972 as a whole,
growth in the demand for reserves was even greater, and this
contributed to a tightening of money markets as the year progressed.
Until about mid-February, short-term interest rates continued the
decline that had begun by the fourth quarter of 1971, as reserves
expanded rapidly. During the second quarter, however, demands for
money and bank credit increased faster than the Federal Reserve
was willing to supply reserves, and the excess demand for funds
generated upward pressures on market rates of interest. This pattern
continued during the remainder of the year, and by the end of
December most short-term rates had increased more than 2 percentage points from their February lows. Even so rates were still somewhat below the high levels experienced in July 1971.
Following the increase in open market rates, commercial banks
adjusted their prime rates upward in several stages—from a low of
AVi per cent in early spring to 6 per cent just before the year-end,
and then to 614 per cent in early 1973. (As already noted, the
Federal Reserve discount rate, unchanged at AVi per cent throughout 1972, had been raised to 5 per cent in mid-January 1973 and
to 5Vi per cent in late February.) While short-term rates increased,
most longer-term rates showed little change on balance, reflecting the
substantial flows of funds into capital markets and the continuing
moderation in long-term credit demands in securities markets during
most of the year.
I n addition to its strictly monetary policy actions the Federal
Reserve made several other regulatory changes in 1972 that had
significant effects on financial markets. One area of action related
to stock market credit. In the early months of 1972 total credit
extended by brokers and banks for the purpose of purchasing or

44



carrying securities had expanded substantially. When it subsequently
appeared that further growth in stock market credit might contribute
to inflationary pressures, the Board of Governors raised initial
margin requirements on stocks in an effort to forestall such growth.
This increase, effective November 24, raised requirements to 65
per cent from the 55 per cent level that had prevailed since December 1971. I n an earlier security credit action—effective September
18, 1972—the Board had introduced a technical amendment to its
margin regulations designed to improve the quality of stock market
credit; under the amendment, customers with low-margin accounts
must increase their equity when offsetting sales and purchases of
stock collateral are made on the same day.
On November 9 the Board instituted two key changes in its
Regulations D and J that affected the reserve positions of member
banks. These changes were not designed to meet any general monetary policy objective but rather to restructure reserve requirements
against Federal Reserve member bank deposits on a more uniform
basis (Regulation D ) and to speed up and modernize the Nation's
check-clearing system (Regulation J ) . In an effort to neutralize the
impact of the changes insofar as monetary policy was concerned,
implementation was timed to coincide with a period of regular
seasonal reserve needs and was coordinated with open market operations. The net effect of these two regulatory changes was to provide
about $1.1 billion of the seasonal reserve need.
Prior to the change in Regulation D there were two classifications
of banks for reserve purposes: reserve city and country. Most
banks in the major financial centers were classified as reserve city
banks, and all other banks were classified in the country bank category. Under that system some smaller banks carried the heavier
reserve requirements of a reserve city classification simply because
of their geographical location, whereas a few large banks benefited
from their country bank status.
Over the years the large reserve city banks have tended to exhibit
greater deposit volatility than the smaller country banks. Such conditions indicated a need for the reserve city banks to maintain greater
liquidity in the form of reserves, as protection against potentially
large deposit outflows. However, with the evolution of our modernday banking system, credit markets have become national in scope,
and reserve requirements based on geographical considerations are no




45

In the second half of the year continued rapid expansion in
economic activity resulted in increased bank demands for reserves
to support additional credit and in monetary expansion. While the
growth rate of total RPD's rose again to the high levels reached in
the first quarter, reserve provision through open market operations
was increasingly restrained, and more of the reserve expansion late
in the year was the result of increased borrowing by member banks
from the Federal Reserve Banks. During the last quarter of the
year nonborrowed RPD's increased by a nominal amount, but banks
increased their average borrowings by more than $700 million.
Although bank reserves grew rapidly during 1972 as a whole,
growth in the demand for reserves was even greater, and this
contributed to a tightening of money markets as the year progressed.
Until about mid-February, short-term interest rates continued the
decline that had begun by the fourth quarter of 1971, as reserves
expanded rapidly. During the second quarter, however, demands for
money and bank credit increased faster than the Federal Reserve
was willing to supply reserves, and the excess demand for funds
generated upward pressures on market rates of interest. This pattern
continued during the remainder of the year, and by the end of
December most short-term rates had increased more than 2 percentage points from their February lows. Even so rates were still somewhat below the high levels experienced in July 1971.
Following the increase in open market rates, commercial banks
adjusted their prime rates upward in several stages—from a low of
AVi per cent in early spring to 6 per cent just before the year-end,
and then to 614 per cent in early 1973. (As already noted, the
Federal Reserve discount rate, unchanged at AVi per cent throughout 1972, had been raised to 5 per cent in mid-January 1973 and
to 5Vi per cent in late February.) While short-term rates increased,
most longer-term rates showed little change on balance, reflecting the
substantial flows of funds into capital markets and the continuing
moderation in long-term credit demands in securities markets during
most of the year.
I n addition to its strictly monetary policy actions the Federal
Reserve made several other regulatory changes in 1972 that had
significant effects on financial markets. One area of action related
to stock market credit. In the early months of 1972 total credit
extended by brokers and banks for the purpose of purchasing or

44



longer appropriate. The change in Regulation D eliminated the
geographically based distinction between reserve city and country
banks for reserve purposes and established a new system of graduated reserve requirements for net demand deposits that is based
solely on the amount of deposits and is applicable to all member
banks.2
The effect of the change in Regulation D alone was to reduce
member banks' required reserves by roughly $3.2 billion in the
aggregate. With the exception of a few very large banks that had
previously enjoyed country bank status, each member bank realized
some reduction in its required reserves, with the exact amount
depending on the amount of the bank's deposits and its previous
status as reserve city or country bank.
Prior to the November 9 change in Regulation J, most member
and nonmember banks located outside Federal Reserve Bank or
branch cities had been required to remit funds one or more business
days after the checks were presented for payment by the Federal
Reserve. Most banks located within such cities, in contrast, had
been required to remit on the same business day the checks were
received.3 Initially, the reason some banks had been permitted to
remit on a delayed basis was because of transportation and communication problems. Specifically, banks that were located a considerable distance from Federal Reserve clearing facilities needed
additional time in order for remittance drafts to reach their Federal
Reserve office.
2
According to this system the required reserve ratios applicable to the
various portions of a bank's deposits are as follows:

A m o u n t of net demand deposits
(in millions of dollars)
2 or less
2-10
10-100

100-400
Over 400

Reserve percentage
applicable
8
10
12
13
IIV2

Previously the required reserve ratio on the first $5 million of net demand
deposits had been 17 per cent for reserve city banks and H V i per cent for
country banks, and the required ratio on such deposits of more than $5 million
had been 17V2 and 13 per cent, respectively.
3
Nonmember banks remit for checks presented by the Federal Reserve
through member bank correspondents.

46



However, expanded use of both carrier services and wire transfers of funds has greatly improved the communication among banks
and has removed the need for additional remittance time. Recognizing these developments, the change in Regulation J required essentially all banks to whom the Federal Reserve presents checks for
collection to remit on the same day that the checks are presented.
The effect of the change in Regulation J was therefore to give
rise to a once-and-for-all drain of reserves at the banks that had
previously benefited from delayed remittance for their checks. I n
the aggregate, before counting offsets, this drain amounted to
roughly $4.4 billion. Slightly more than half of this aggregate was
offset by reserve gains due to faster crediting by the Reserve Banks
on checks presented to them for collection that are drawn on banks
in the same Federal Reserve territory as the collecting bank. If
this partial offset is taken into account, the reserve drain for member
banks resulting from the change in Regulation J amounted to
about $2.1 billion. For those banks that experienced a significant
adverse effect, temporary waivers of penalties on reserve deficiencies
are being permitted to cushion the impact of the changes.

In addition to the 8.3 per cent growth in Af, already noted for
1972, the broadly defined money stock, M , ( M , plus commercial
bank time and savings deposits other than large negotiable CD's),
grew at a rate of 10.8 per cent, and M-, (M 2 plus deposits at mutual
savings banks and savings and loan associations) increased by 12.9
per cent.
The expansion in Mv was relatively even on a quarter-to-quarter
basis, but the month-to-month growth showed considerable variation. Because of essentially random factors that affect demand for
money in the short run, it is not unusual for months of large growth
or months of little growth to occur without any evident, clear cause
that would explain demand in the particular short period. For this
reason much less weight is given to monthly movements than to
quarterly movements as a factor to be considered in monetary policy
decisions.
The following examples indicate how extreme the monthly movements in the money stock may be—and some of the reasons. After




47

rapid expansion early in 1972, growth in M1 slowed in May and
June, reflecting not only System efforts to slow the rate of expansion
in RPD's but also the build-up in U.S. Treasury balances as a result
of higher withholding rates on 1972 personal tax liabilities. On the
other hand, in both July and December, expansion in M1 was unusually large. I n July most of the growth in M1 occurred around
the holiday period. I n December the rapid growth resulted in some
part from a contraseasonal increase in demand deposits held by
State and local governments that reflected the disbursements of
Federal revenue-sharing funds early in December. The December
expansion was followed by little net change in Mx on the average
in January 1973.
Consumer-type time and savings deposits increased sharply through
the early months of 1972 when market yields on competing assets
were falling relative to the rates offered on such deposits. Thus,
first-quarter growth rates of the broader measures of the money
stock, M2 and M 3 , were not only considerably above the growth
rate for M u but also at the highest levels since the first quarter

17. G R O W T H I N M O N E T A R Y AGGREGATES
PER CENT

MONETARY

AGGREGATES

M i : C u r r e n c y h e l d o u t s i d e the T r e a s u r y , F . R . B a n k s , a n d the v a u l t s o f a l l c o m m e r c i a l
b a n k s , p l u s 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 t .
My. M\ p l u s t i m e deposits at c o m m e r c i a l b a n k s other t h a n large certificates o f deposit.
My. M2 p l u s deposits o f m u t u a l savings b a n k s a n d savings c a p i t a l o f savings a n d l o a n
associations.

48



of 1971. Thrift deposits expanded somewhat less rapidly as 1972
progressed, but net inflows remained quite strong despite the increasing attractiveness of yields on competing open market securities.
Some larger commercial banks had lowered rates on consumer-type
accounts at the beginning of the year in an effort to keep such
accounts from experiencing excessive growth, but by July most banks
were offering rates at or close to ceiling levels.
Growth in bank credit during 1972—as measured by the adjusted
credit proxy 4 —was supported not only by increases in demand and
consumer-type time and savings deposits but also by a sharp rise
in net sales of CD's. Commercial banks bid aggressively for
such funds, and negotiable CD's outstanding increased by more
than $10 billion between January and December, an amount that
exceeded the sizable increase recorded in the preceding year. Banks
did not borrow any significant amounts in the Euro-dollar market
during 1972, in part because of the high marginal reserve requirement
4
Total member bank deposits subject to reserve requirements, plus Eurodollar borrowings, bank-related commercial paper, and certain other nondeposit items.

PER CENT

1970

1971
M3

1972 |
|

|

1970

1971

1972 |

ADJUSTED
CREDIT

PROXY

A d j u s t e d c r e d i t p r o x y : T o t a l m e m b e r b a n k d e p o s i t s s u b j e c t t o reserves, p l u s E u r o - d o l l a r
b o r r o w i n g s , bank-related c o m m e r c i a l paper, and c e r t a i n other n o n d e p o s i t items.
N O T E . — Q u a r t e r l y rates o f g r o w t h d e r i v e d f r o m d a i l y - a v e r a g e d a t a f o r last m o n t h o f
the q u a r t e r r e l a t i v e t o those f o r last m o n t h o f p r e c e d i n g q u a r t e r .




49

on this type of borrowing and in part because of the availability of
domestic CD's.
The expansion in CD's did not begin until after the first quarter,
when growth in other time deposits began to slow, but it continued
strong throughout the remainder of the year with only minor slowdowns occurring in June and October. As yields on alternative shortterm money market instruments began to rise, and as business loan
demands on banks continued strong, banks increased offering rates
on CD's in order to compete for additional funds. By the end of
December rates on negotiable CD's sold by prime New York banks
had reached 5V2 per cent—2 percentage points above the first-quarter

18. M A J O R SOURCES OF B A N K FUNDS, 1972
B I L L I O N S OF DOLLARS

N O T E . — T i m e a n d savings deposits other than large certificates o f deposit and p r i v a t e
d e m a n d d e p o s i t s are 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 d e p o s i t s o t h e r t h a n large
C D ' s e x c l u d e t h o s e d u e 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 a n d t o the U . S . G o v t , as w e l l as
b a l a n c e s 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 l o a n s . L a r g e C D ' s are n e g o t i a b l e C D ' s
issued i n d e n o m i n a t i o n s o f $100,000 o r m o r e b y m a j o r c o m m e r c i a l b a n k s . U . S . G o v t ,
d e p o s i t s a n d n o n d e p o s i t s o u r c e s o f f u n d s d a t a are f o r m e m b e r b a n k s o n l y .

50



low. With month-to-month fluctuations in total demand deposits
and total time deposits partly offsetting one another, the bank credit
proxy maintained relatively stable growth throughout the year, increasing at about a 10 to 12 per cent annual rate in each of the four
quarters.
INTERMEDIATED CREDIT

FLOWS

As a result of several factors—including the nature of credit
demands, the strong preference on the part of the public for demand
and time deposits, the associated developments in interest rates, and
others—financial institutions supplied a substantially larger volume
of funds than in 1971. Banks, other depositary institutions, and contractual institutions such as insurance and pension funds accounted
for more than four-fifths of the total advanced, an even larger share
Table 8: FUNDS SUPPLIED TO N O N F I N A N C I A L SECTORS I N
CREDIT AND EQUITY M A R K E T S
I n b i l l i o n s o f dollars

1972
Sector s u p p l y i n g

197

1972
1

A l l sectors

156 3

U.S. G o v t , a n d sponsored credit agencies.
Federal Reserve System
F o r e i g n sources
Private financial institutions
Commercial banking
Savings i n s t i t u t i o n s
Insurance a n d pension f u n d s
Other
N e t f u n d s raised in credit a n d equity
m a r k e t s by financial i n s t i t u t i o n s

6 0
8 8
27 3
124
49
42
30
2

. ..

Funds advanced by private
domestic
nonfinancial
sectors in credit and
equity markets'2
Households
N o n f i n a n c i a l business
State a n d local governments
MEMO: N e t change i n i n s t i t u t i o n a l
deposits a n d currency held by private
domestic n o n f i n a n c i a l sectors

9
8
1
2
8

168

I

8 9
2
10 8
153
65
49
32
5

2
3
6
8
5

139

II

4

1 10
3 8
17 2
137
57
49
27
3

5
3
5
2
5

9 6

19 6

9 7

- /
0
- 16 8
8 1
7 7

14 4
4
4 8
9 3

— 20 3
-27 5
- 1 2
8 4

95 7

107 2

122 0

161

III

2

153

IV

9

7 9
5 6
- 3 0

9 3
- 6 3
16 5

139
49
48
37
3

151
64
49
31
4

3
6
8
0
9

17 9

0
8
9
7
6

216

9

7 4
_ 2 2
12 7
184
89
50
35
10

S
1
1
?.
4

22 5

28 2

3
0
7
6

5 X
- 4 9
9
9 8

42 4
17 1
1 14
13 2

87 2

106 1

113 2

29
16
7
5

1
Bonds, notes, c o m m e r c i a l paper, loans f r o m h o m e l o a n b a n k s , equities, a n d m u t u a l f u n d shares.
Includes b o r r o w i n g by Federally sponsored credit agencies.
2
T o t a l f u n d s advanced less a m o u n t s supplied by g r o u p s a b o v e plus net credit a n d e q u i t y f u n d s raised
by financial i n s t i t u t i o n s .
N O T E . — D a t a f r o m f l o w o f f u n d s accounts. Q u a r t e r l y d a t a are at seasonally a d j u s t e d a n n u a l rates.




51

than in the preceding year. Funds advanced directly by domestic
nonfinancial sectors increased following a small decline in 1971, while
foreigners accounted for a substantially reduced—though appreciable
—volume of identified domestic credit supplies, a reflection of the
smaller accumulation of dollars by foreign central banks.
Total loans and investments at commercial banks rose substantially from the 1971 year-end level, exceeding by a sizable margin
the $50 billion growth during 1971. Banks channeled more than 80
per cent of the 1972 increase in their available funds into loan expansion and put less in securities than they had in 1971.
Strengthening of loan demands at banks was the principal reason
why banks showed less interest in acquiring securities in 1972.
However, another factor was that Treasury financings were smaller
than in 1971. After the first quarter of the year banks added only

19. B A N K C R E D I T , 1972
P E R C E N T A G E CHANGE

PERCENTAGE CHANGE

N O T E . — Q u a r t e r l y d a t a are c h a n g e s based o n s e a s o n a l l y a d j u s t e d t o t a l s at a n n u a l rates.
T o t a l l o a n s a n d i n v e s t m e n t s a n d business l o a n s h a v e been a d j u s t e d f o r t r a n s f e r s b e t w e e n
b a n k s a n d their h o l d i n g c o m p a n i e s , affiliates, subsidiaries, or foreign branches.

52



marginally to their holdings of U.S. Government securities. On the
other hand, acquisitions of other securities—primarily State and
local government issues, but also Federal agency securities—were
larger than those of Treasury securities, even though they too
remained well below the high rates of late 1970 and early 1971.
Banks channeled a considerable proportion of their increased
resources into business loans, which expanded at especially rapid
rates in the last two quarters of 1972. Early in the year, most of the
expansion in such loans was concentrated at banks outside New
York City, which tend to serve the needs of smaller regional firms.
Meanwhile, larger corporations continued to rely on other sources—
including a greater volume of internally generated funds—for financing. In the second half of the year, however, both banks in New
York City and those outside encountered strong credit demands
from corporations seeking working capital to finance inventories and
enlarged operations. As businesses sought more credit at banks, they
sought less in capital markets.
Consumers borrowed record amounts during 1972 to finance purchases of durable goods. As a result of their borrowing at commercial banks, the banks1 share of total consumer credit increased during
the year.
Real estate loans extended by commercial banks also rose
rapidly in a year when total mortgage debt was expanding at the
fastest rate since 1955. However, approximately two-thirds of the
growth in residential mortgage debt outstanding in 1972 was
accounted for by nonbank savings institutions, with savings and
loan associations maintaining their dominance in that market.
Despite the record level of demands, which carried housing starts
to a new high, contract interest rates on residential mortgages
remained relatively stable. This reflected the availability of mortgage
funds from both bank and nonbank sources and some secondary
support from Government sponsored agencies. Insofar as the volume
of net lending on Government-underwritten residential mortgages is
concerned, there was some further moderation, however, reflecting
in part increased competition from conventional mortgages on which
lower downpayments were instituted by savings and loan associations following further liberalization of regulations by the Federal
Home Loan Bank Board in 1971.




53

DEMANDS ON SECURITIES MARKETS
Demands on securities markets moderated in 1972, as total funds
raised by corporations and government units declined and corporations met a larger share of their reduced financing needs through
mortgages and bank loans. Flotations of securities by the U.S.
Government, by State and local governments, and by corporations
all fell below the substantial volumes issued in 1971. This reduction
of demand pressures on securities markets was an important factor
contributing to the stability of long-term interest rates during the year.
Table 9: FUNDS RAISED I N CREDIT MARKETS BY
N O N F I N A N C I A L SECTORS
I n billions o f dollars

1972
Sector, o r t y p e o f i n s t r u m e n t

1971

1972
I

II

III

IV

T o t a l funds raised

156.3

168 1

139. 4

161 2

153 9

216. 9

By sector:
U.S. G o v t . '
Other
N o n f i n a n c i a l business
State a n d l o c a l g o v e r n m e n t s
Households
Foreign

25.5
130.8
63.0
20.6
41.6
5.6

17
150
70
14
62
3

5
134
64
16
49
4

17 5
143 7
72 1
11 7
58.4
1 6

8 3
145 6
62 0
16.7
64 8
2 0

38
178
83
13
74
6

1
8
9
8
9
2

25.5
20.3
13.5
20.2
47.0
34.9
12. 1
13.0
- .4
10.4
6.9

17
13
12
14
64
46
17
21

3
0
8
1
2
6
5
0
5
7
3

38
14
11
13
70
52
18
35
1
26
6

1
3
4
5
2
1
0
6
0
1
8

By type of instrument:
U . S . G o v t , securities 1
Corporate and foreign bonds
Corporate equity
State a n d l o c a l g o v t , d e b t 2
Mortgages
Residential
Other
B a n k loans n.e.c
O p e n m a r k e t paper
Consumer credit
O t h e r loans

3
8
6
6
0
5

3
7
4
4
3
8
5
6
— 3
19 2
5 5

4
1
4
2
3
2

5.4
12.9
10 3
15 1
54
39 0
15 5
17 1
2 9
13 1
8 1

17
14
15
12
64
46
17
14

5
7
9
9
2
4
8
7
3
18 0
2 9

8
13
11
16
68
49
18
19
- 5
18
4

1
P u b l i c d e b t securities a n d budget agency securities.
- Includes b o t h l o n g - a n d s h o r t - t e r m b o r r o w i n g .
N O T E . — D a t a a r e f r o m f l o w o f f u n d s a c c o u n t s ; quarterly figures are at seasonally adjusted a n n u a l
rates.

Several developments that have already been mentioned helped to
hold down the Treasury cash deficit in 1972. One was the largerthan-anticipated increase in tax revenues. Another was that the
growth in Federal spending was restrained. As a result of these and
other developments, the Treasury was able to reduce its borrowing
from the public during the calendar year to about $15 billion, more

54



than $9 billion less than it had borrowed in 1971. This reduction was
a major factor in reducing supply pressures in the securities markets.
Continued weakness in the U.S. balance of payments and its associated impact on international flows of funds led to sizable accumulations of dollars by foreign central banks. Although these funds
would probably have been invested in U.S. markets in any event,
accumulation in central banks directed their investment in marketable
($4.3 billion) and nonmarketable ($3.8 billion) Treasury issues.
These purchases supplied more than half of the Treasury's total borrowing needs.
Table 10: U.S. GOVERNMENT FINANCE
I n billions o f dollars

Item

1971

11 4

Deficit
Amount

1970

financed

1972

24.8

17 4

24.8

15 3

by changes in cash
S

T o t a l borrowing from public
Net Federal Reserve purchases of
Treasury securities
Net Treasury b o r r o w i n g f r o m private
investors:
Marketable:
a. Foreign
b. Other
Nonmarketable:
a. Foreign
b. Other
B o r r o w i n g f r o m a l l sources by budget
agencies

Memoranda:
Net b o r r o w i n g by
Government
sponsored agencies
Federal
Reserve
purchases
of

11 8

2. 1

5 0

8. 1

7 5
- 1

15. 2
- 10. 3

4. 3
3. 6

1 9
3

11.1
2. 1

3. 8
3. 4

- 1 i

-1.4

—.

3

7

1. 1

3. 1

. 5

8. I

X

It should be noted, however, that acquisitions of marketable
Treasury debt by foreign official institutions had been much larger in
1971 than they were in 1972. Furthermore, the U.S. public had been
a large net seller of such debt in 1971. While acquisitions of marketable debt by the public in 1972 amounted to about $3.5 billion,
this represented a shift of nearly $14 billion from 1971 since the
public had sold more than $10 billion in that year.
Interest rates on short- and long-term Government securities followed divergent patterns during 1972. Short-term rates, which had




55

declined rather sharply following the imposition of the President's
new economic program in August 1971, reversed course in early
1972 and rose significantly over the last 9 months of the year in association with the large demands for short-term credit generated by
the accelerating economy and the progressive firming in monetary
policy.
Long-term rates, on the other hand, remained quite stable throughout 1972. The lack of significant upward yield pressure in this sector
enabled Treasury debt managers to be increasingly innovative in their
approach to financing the debt. One of their announced aims, in addition to maintaining the average maturity of the debt, was to develop a viable market in long-term Government issues. Toward this
end the Treasury issued a total of $3.4 billion of securities to the
public in the 10-year maturity area in the February, May, and August
refundings. In addition, it sold $625 million of 20-year bonds in early
January 1973; this was the longest maturity offered to investors in
about 10 years.
In contrast to the Federal sector, State and local governments
moved into a budget position of substantial surplus during 1972. Net
issues of securities by these governments declined from the peak
volume of 1971. There was relatively little growth in capital outlays,
and nonborrowed funds were readily available, as both tax revenues
and Federal grants increased. Expenditures rose less rapidly than did
receipts, and these governments were able to strengthen further their
liquidity positions, which had already been improved by the large
volume of securities sold in late 1970 and 1971.
Interest rates on long-term municipal bonds fluctuated in a narrow
range during 1972. Although banks reduced their acquisitions of
these securities during the year, the impact of this reduction on interest rates was offset by the decline in new-issue volume and by the
increase in purchases by fire, casualty, and marine insurance companies, which were seeking tax-exempt income.
Corporate nonfinancial businesses also benefited from the rising
pace of economic activity in 1972. The general improvement in earnings, the increase in capital consumption allowances under the Asset
Depreciation Range guidelines, and the slower-than-usual growth in
dividend payouts resulting from restraints applied by the Committee
on Interest and Dividends as part of the Phase I I controls program

56



all contributed to a substantial rise in the availability of internal funds
of corporations. Furthermore, like State and local governments, corporations had engaged in record amounts of long-term financing late
in 1970 and in 1971, and in that way they had restructured their
balance sheets and improved liquidity positions in the aggregate.
Corporations needed larger amounts of funds in 1972 because of
rising outlays for plant and equipment and growing needs for working capital. However, they reduced their dependence on securities
markets by financing a larger proportion of their needs with internally
generated funds, bank loans, and mortgages. Public offerings of bonds
by corporations dropped significantly, the drop more than offsetting
a slight increase in private bond placements and equity offerings. The
decline in capital market financings was particularly evident for
manufacturing corporations. Public utilities continued to rely on the
securities markets to meet their needs for growth and modernization,
and they utilized equity capital to a larger extent than usual. Financial
firms continued to enter the long-term bond markets in large numbers
in 1972, in order to improve their capital positions and to prepare for
the task of financing the growing short-term credit needs of the
economy.




57

all contributed to a substantial rise in the availability of internal funds
of corporations. Furthermore, like State and local governments, corporations had engaged in record amounts of long-term financing late
in 1970 and in 1971, and in that way they had restructured their
balance sheets and improved liquidity positions in the aggregate.
Corporations needed larger amounts of funds in 1972 because of
rising outlays for plant and equipment and growing needs for working capital. However, they reduced their dependence on securities
markets by financing a larger proportion of their needs with internally
generated funds, bank loans, and mortgages. Public offerings of bonds
by corporations dropped significantly, the drop more than offsetting
a slight increase in private bond placements and equity offerings. The
decline in capital market financings was particularly evident for
manufacturing corporations. Public utilities continued to rely on the
securities markets to meet their needs for growth and modernization,
and they utilized equity capital to a larger extent than usual. Financial
firms continued to enter the long-term bond markets in large numbers
in 1972, in order to improve their capital positions and to prepare for
the task of financing the growing short-term credit needs of the
economy.




57




U.S. Balance

of

Payments

Attention was focused in 1972 on the lack of progress toward equilibrium in the U.S. balance of payments after the realignments of exchange rates agreed to at the Smithsonian meeting in December 1971.
The year was relatively free of hectic speculative activity, but pressure on the pound sterling at midyear led to the temporary abandonment of a fixed rate for that currency and a renewal of speculative
flows into some other European currencies. Also, a large and persistent flow of funds to Japan, coupled with an undiminished Japanese
trade surplus, enormously swelled that country's international reserves. Though there were large inflows of foreign capital to purchase
U.S. securities, and some sizable inflows of liquid funds at times, for
the year as a whole there was no significant repatriation to the United
States of the capital that had moved to other currencies in 1971.
The failure of such a return flow to materialize reflected in part
the relatively higher levels of interest rates abroad, especially in the
early months of the year, and in part the continuing uncertainty about
the eventual effects upon U.S. exports and imports of the exchangerate changes of 1971. After early 1972, exchange rates against the
dollar of the currencies of most industrial countries remained above
their central rates or parities, and many countries adopted controls
or various types of special reserve requirements or other barriers to
protect them from large inflows of foreign capital.
Soon after the end of 1972 exchange markets became increasingly
unsettled, as the extent and persistence of the large U.S. deficit and
the counterpart surpluses of some other countries were more clearly
perceived. Speculation against the dollar in favor of other currencies,
primarily the German mark and the Japanese yen, rose dramatically
in late January and early February of 1973. In the light of these
conditions, and because of the need to achicve a speedier adjustment
of the underlying imbalance in U.S. international transactions, the
President announced on February 12 that he would request Congress
to authorize a devaluation of the dollar by 10 per cent. This step was
taken in consultation with other countries and in the expectation that
its effects on the exchange rates for the dollar in terms of the cur-




59

20. I N D U S T R I A L P R O D U C T I O N
RATIO SCALE. 1 9 6 3 = 1 0 0

180

1970
1972
N O T E . — S e a s o n a l l y a d j u s t e d q u a r t e r l y d a t a f r o m the O r g a n i z a t i o n f o r
t i o n a n d D e v e l o p m e n t . D a t a f o r f o u r t h q u a r t e r o f 1972 p a r t l y e s t i m a t e d .

Economic

Coopera-

rencies of other industrial countries would in general not be neutralized by other par-value changes. The Japanese yen was allowed
to float, and it quickly appreciated by about 16 per cent relative to
the U.S. dollar.
I n the course of 1972 economic activity rose in most industrial
countries but lagged somewhat behind the upswing in the U.S.
economy. In a number of European countries price inflation was
accelerating early in the cyclical advance. Monetary restraint was
commonly adopted as a countermeasure, and several countries moved
to offset interest-induced inflows of funds through special controls
or reserve requirements. In the United States also, short-term interest
rates were rising, as demand in most sectors of the private economy
strengthened rapidly.
A large over-all deficit was registered in the U.S. balance of payments in 1972, but it was not swollen by an enormous net outflow
of capital as had happened the year before. In terms of official settlements, the deficit for the year was $10.8 billion (apart from SDR
allocations) compared with more than $30 billion in 1971. The bal-

60



ance on current account and long-term capital (the so-called basic
balance) probably registered a deficit somewhat greater than the $9.3
billion deficit of 1971. There were divergent swings in the currentaccount and capital-account components of the basic balance: The
balance on goods and services worsened by about $5 billion in 1972,
to a deficit of about $4.5 billion, while net long-term capital flows
probably improved by a somewhat smaller amount.
21. U.S. B A L A N C E OF P A Y M E N T S
SEASONALLY ADJUSTED ANNUAL RATES
BILLIONS OF DOLLARS
OVER-ALL

MAJOR COMPONENTSOFFICIAL SETTLEMENTS
BALANCE

MERCHANDISE

SEASONALLY ADJUSTED ANNUAL RATES
BILLIONS OF DOLLARS
BALANCES

IMPORTS

merchandise
exports

BALANCE ON
CURRENT ACCOUNT AND
LONG-TERM CAPITAL

official
balance

all

1

Excludes

settlements
1

other

SDR

allocations.

GOODS A N D

SERVICES

A number of factors combined to push the U.S. trade balance to a
deficit of $6.8 billion in 1972—about $4 billion larger than the one
in 1971. The major influence was the rapid rise of economic activity
here in advance of similar developments abroad. In addition, prices
of U.S. imports rose sharply, responding to both the devaluation and
the general increase in world prices, while export prices in terms of
dollars increased much less. These changcs in relative prices were




61

only just beginning in 1972 to yield the reallocations of production
and consumption patterns necessary to halt the worsening trend in
the U.S. trade balance that had been developing since 1965.
The strongest feature of U.S. export performance in 1972 was the
rise in shipments of agricultural products—from $7.8 billion in 1971
to a total of $9.5 billion. By the last quarter of 1972 such shipments
were at an annual rate of $11 billion, reflecting the shortage of these
commodities in Russia and other countries and a very rapid rise in
their prices. Sales of agricultural products in 1973 are expected to
continue at a very high rate. Exports of machinery and industrial
supplies, supported by the build-up in economic activity abroad, were
rising during the year.
While the value of exports rose by 14 per cent from 1971 to 1972,
the value of imports rose by 22 per cent. Prices (as measured by unit
values) rose 3 per cent for exports and 7 per cent for imports. In
real terms, imports rose by about 14 per cent, about double the rise
in real GNP, a typical reaction of imports to a sharp step-up in demand. Increases in imports were registered in all major commodity
groups; a particularly significant feature was the acceleration of petroleum imports from $3% billion in 1971 to $4% billion in 1972.
During 1973 the trade balance should begin to benefit measurably
from the devaluation of 1971; the net effects of the further realignment of exchange rates early in 1973 will probably not be large until
the following year. Other strong influences will also be operating.
Most important will be the evolution of demand pressures and of
relative costs and prices in the United States and in other industrial
countries. This factor will be helpful if this country can continue to
moderate inflationary pressures, and if other countries move steadily
toward reasonably full utilization of their productive capacity. The
United States will also need to compete more effectively for the trade
of nonindustrial countries, many of which will be able to increase
their imports in 1973 on the strength of their reserve gains in recent
years and of a continuing rise in demand for their exports.
There was some reduction in the surplus in the nontrade elements
of the U.S. current account in 1972. Part of this resulted from smaller
net receipts of investment income, as interest payments to foreigners
—mainly interest paid to foreign official holders of claims against the
United States—rose faster than receipts from U.S. direct investments

62



abroad. There was also an increase in net U.S. military expenditures
as military sales fell off.

CAPITAL FLOWS
In 1972 the net outflow of long-term private capital from the United
States was probably less than $1 billion—a striking shift from the
recorded net outflow of more than $4 billion in 1971. One change
between the two years was in direct-investment outflows, which apparently declined from their record high in 1971. A striking feature
of developments in 1972 was the upsurge in foreign purchases of U.S.
corporate securities. For the year as a whole such purchases totaled
some $4.5 billion, including $2.4 billion of corporate stocks purchased
in U.S. markets, of which $1 billion came in the fourth quarter, and
$2 billion of debt issues offered by U.S. corporations in foreign markets, mainly to finance direct investments abroad.
Net outflows of U.S. Government grants and credits were somewhat less in 1972 than in 1971, but they were rising at the year-end
and they will probably be considerably larger in 1973.
Table 11: U.S. BALANCE OF PAYMENTS
I n b i l l i o n s o f d o l l a r s , seasonally adjusted

1972
Item

1971

1972

c

I

II

M e r c h a n d i s e t r a d e balance
Exports
Imports

- 2 7
42 8
45 5

- 6 8
48 8
55 7

- 1 7
1 18
13 5

Services, remittances, pensions, net
U . S . G o v t , g r a n t s a n d c r e d i t , net
L o n g - t e r m p r i v a t e capital, net

1 9
- 4 4
- 4 0

- 3

8
6
6

1
— 9
- 1 0

Balance o n c u r r e n t account a n d longterm capital

- 9

2

- 3

6

-

5
8
1

3

-

-10

N o n l i q u i d short-term private capital, net. .
- 2 4
E r r o r s a n d omissions
- 1 1 ()
L i q u i d p r i v a t e c a p i t a l , net
—7 8
Of which: L i a b i l i t i e s t o f o r e i g n
c o m m e r c i a l banks
O f f i c i a l settlement balance ( e x c l u d i n g
S D R allocations)

- 6

9

-30

5

- 1 5
- 2 8
3 7

3 9

-

10 8

III

- 1 .9
11 . 4
13 . 4

- 1 6
12 3
13 9

- 1 6
13 3
14 9
3
- 1 2
1
- 2

_ .0
.6
.8

—
-

3
8
1

1.8

- 2

2

.6
- 1. 1
1 .4

5

- 3

IV «

- 1 .0

5
- 1 9
2
-

- 1 0
6
2 6

3

2 1

8

- 1 6

1.0

4

6

- 4

_

F o u r t h - q u a r t e r data partly estimated.
N O T E . — D e p t . o f C o m m e r c e data w i t h some F . R . estimates. D e t a i l s 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 .




63

Recorded flows of private short-term capital in 1972 were inward,
on balance, in contrast to a net outflow of more than $10 billion in
1971. Whereas in 1971 there had been an outflow of nearly $7 billion
to commerical banks abroad when U.S. banks repaid all but a relatively small part of their borrowings in the Euro-dollar market, in
1972 there was a sizable inflow as the U.S. agencies and branches of
foreign banks brought in short-term funds from abroad. (The agencies and branches of foreign banks are not subject to the same reserve requirements on their liabilities to foreigners as are banks that
are members of the Federal Reserve System).
Large swings in the "errors and omissions" item in the accounts
provide a crude indicator of flows of funds in response to speculative
pressures. Apart from such flows this balancing item is usually negative, and its normal level in recent years has been around $1 billion.
According to early estimates, the balancing item in 1972 was larger
than normal, but far smaller than the $11 billion figure for 1971,
most of which had represented capital outflows through unrecorded
hedging and through leads and lags in commercial payments.

64



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