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cMonetary J^olicy
and the
ZI.X. Sconomy
^ in 1973
A Prelude to the Annual

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Report

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FED.

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Contents
Monetary
Policy and the
U.S. Economy in 1973
3

INTRODUCTION

12
14
17
19
21
22
23
24

DEMANDS FOR GOODS A N D SERVICES
Consumer purchases
Residential construction
Business fixed investment
Inventories
Exports and imports of goods and services
Federal Government
State and local governments

26

E M P L O Y M E N T A N D WAGES

29

PRICES, L A B O R COSTS, A N D PROFITS

31
33

First-half price developments
Second-half price developments

36
41
49
53

M O N E T A R Y POLICY A N D F I N A N C I A L MARKETS
Monetary policy
Disintermediation
Aggregate flows of funds

60

I N T E R N A T I O N A L DEVELOPMENTS

62
66

Progress toward equilibrium
International monetary scene







cMonetaryJ^olicy
and the
Sconomy
U. y
^ in 1973







Introduction
I n 1973 the U.S. economy was plagued by its worst inflation since
the end of World War II. Wholesale prices rose by 18 per cent during the year and consumer prices by nearly 9 per cent. A t the end of
the year inflation was still running strong, led by sharply higher
prices for foreign crude oil and petroleum products in U.S. markets.
The economic expansion, under way since 1971, slowed markedly
over the course of 1973 in response to more restrictive national economic policies and the adverse effects of the rapid advance in prices
on consumer buying power. Activity was also dampened in the latter
part of the year by the energy shortage, which generated widespread
buyer uncertainty and seriously disrupted longstanding patterns of
demand for autos and other goods and services.
The exceptional strength of the 1973 inflation stemmed mainly
from extraordinary shortfalls relative to world demand in the output
of agricultural products and in supplies of energy. Prices of foods
and fibers were affected by worldwide shortages, largely the result of
poor crop yields during the 1972 growing season in many producing
countries. A n d fuel prices were boosted by shortages of oil, which
were serious at times early in 1973 and acute in late autumn, following the cutbacks in Middle East output.
The devaluation of the dollar in February 1973, and the further
declines in the foreign exchange value of the dollar, which occurred
during the spring and summer, provided additional fuel for the inflation. Prices of foreign goods sold in the United States rose sharply,
and business demands for materials and supplies tended to shift to
this country from foreign sources. Moreover, the competitive position
of U.S. goods in world markets was enhanced further, stimulating
foreign demands for U.S. goods at a time when such demands were
already growing markedly in response to the previous devaluation of
the dollar in December 1971 and to the inflationary boom that was
under way in the economies of most industrial countries of the
world.
The economic situation that was developing in this country also
contributed to the inflation. The U.S. economy had expanded at a




3

very rapid rate in late 1972 and early 1973 as demands for goods
and services strengthened substantially further, partly in reaction to
public policies instituted to encourage greater utilization of the Nation's productive resources. A n d consumption demands were also

I N D I C A T O R S OF E C O N O M I C P E R F O R M A N C E
CHANGE, IN BILLIONS OF DOLLARS
CURRENT-DOLLAR

1971

GNP

1972

1973

N O T E . — C h a n g e s f o r c u r r e n t - d o l l a r G N P are f r o m p r e c e d i n g q u a r t e r a n d are based
o n 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. C h a n g e s f o r r e a l G N P ( b a s e d o n
d a t a expressed i n 1958 d o l l a r s ) are at a n n u a l rates. D a t a are f r o m D e p t . o f C o m m e r c e .
F i x e d - w e i g h t e d p r i c e i n d e x : C h a n g e f r o m p r e c e d i n g q u a r t e r 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 seasonally a d j u s t e d d a t a f r o m D e p t . o f C o m m e r c e .
U n e m p l o y m e n t rate: M o n t h l y data, seasonally adjusted, f r o m D e p t . o f L a b o r .

4



buoyed in the first half of the year when households received unexpectedly large refunds of Federal income taxes.
The strong final demands in the United States and abroad bolstered the needs of manufacturers for a wide array of raw materials,
and even though production of such materials increased sharply, demands often exceeded the available supplies. Thus, many producers
of basic materials reached practicable capacity limits well before the
over-all output potential of the U.S. economy came under strain. Inflationary conditions may have been heightened also by public response to the liberalization of the wage-price controls program early
in the year. I n retrospect, it appears that the move to Phase I I I of
the program, though intended to provide needed flexibility to changing economic conditions, was widely viewed as a virtual ending of
controls, and this attitude contributed to the bulge in prices that ensued.
Domestic economic stabilization policy could not have been expected to check fully these extraordinary forces of inflation. To have
halted the acceleration in the over-all price rise—influenced so importantly, as it was, by sharply higher prices for food, fuel, and
internationally traded industrial commodities—would have required
exceptionally stringent measures, with potentially disastrous consequences for employment and economic activity. Public policies did
move, however, to restrain the cumulative upward momentum in domestic economic activity—which had gained great force during the
previous fall and winter—and to dampen inflationary forces stemming from the overheating.
Monetary policy, which had begun to tighten in late 1972, became
progressively more restrictive through the summer of 1973. Thereafter, some actions were taken to moderate the intensity of monetary
restraint. Fiscal policy also turned somewhat more restrictive in
1973, as the rise in public expenditures was curbed and the volume
of tax receipts, produced by higher incomes and higher profits, grew
more rapidly than outgo. A n d wage-price controls, reintroduced on a
strict mandatory basis following the temporary price freeze in the
summer, were directed toward developing and making more diffuse
the price advances necessitated by continuing rapid increases in production costs.




5

I n the effort to avoid excessive monetary expansion during 1973
the Federal Reserve made use of all its instruments of monetary policy. Through much of the year open market operations were directed
toward achieving adequate restraint on the growth in bank reserves
and in the monetary aggregates. I n the process the Federal funds
rate moved from around 5.5 per cent at the beginning of the year to
a high of nearly 11 per cent in September. I n the late spring marginal reserve requirements were imposed on any expansion in certificates of deposits (CD's) and other money market sources of funds
at large banks beyond the amounts outstanding as of mid-May, and
such requirements were increased further in September. I n early July
reserve requirements were raised by Vi percentage point against the
demand deposits (above a $2 million base) of all member banks.
The Federal Reserve discount rate was raised, in successive steps,
from AVi per cent at the beginning of the year to IV2 per cent from
August on, to keep the cost of borrowing more in line with market
rates. And margin requirements on stock market credit, which had
been increased to 65 per cent late in 1972, were kept at that level
throughout 1973, despite a steady downward trend in the use of
such credit.
As a result of these efforts, the growth in money and credit slowed
markedly relative to the continuing expansion in domestic spending.
The narrowly defined money stock ( M ^ , 1 even after revision in early
1974 to reflect unexpectedly large growth in deposits at nonmember
banks, increased 6.1 per cent from the fourth quarter of 1972 to the
fourth quarter of 1973. If measures of money are expanded to include consumer-type time and savings deposits at banks ( M 2 ) and at
other depositary institutions ( M 3 ) , the resulting growth rates are 8.8
per cent and 8.9 per cent, respectively. I n each case these increases
were well below the 11 per cent growth in the gross national product
(and total domestic expenditures) over the same period, and also
appreciably smaller than those recorded in 1972.
With significantly slower growth in money and continued rapid
growth in total spending, interest rates were subject to marked up-

1

Currency held outside the Treasury, F.R. Banks, and the vaults of all
commercial banks, plus demand deposits other than interbank and U.S.
Government.

6



ward pressure over the first 9 months of the year. Short-term market
rates, as represented by 3-month Treasury bills, rose by nearly 400
basis points from the 1972 year-end level, peaking out at just above
9 per cent in August. The interest rate charged by banks on their
prime loans—those to large business customers with the highest
credit rating—increased by a similar amount, from 53A per cent to

M O N E Y STOCK A N D T H E F E D E R A L FUNDS R A T E
PERCENTAGE CHANGE

N O T E . — M o n e y s t o c k , a n n u a l rates o f g r o w t h c a l c u l a t e d
all 3 m o n t h s o f the quarter. F e d e r a l funds rate, m o n t h l y
d e f i n i t i o n s o f M 1 a n d A f : , see n o t e s t o c h a r t o n p . 42.




f r o m d a i l y - a v e r a g e figures
averages o f d a i l y
figures.

for
For

7

10 per cent. Long-term bond yields rose less dramatically but still
substantially, by around 100 basis points. A n d yields on F H A and
V A mortgages sold in the secondary market increased by about 150
basis points—to more than 9 per cent—before declining moderately
in the closing months of the year.
Because of the sharp rise in market yields, savings flows began to
shift increasingly into market instruments and away from the depositary institutions (where the interest rates that can be paid are constrained by regulatory ceilings). Accordingly, in early July the Board
and other Federal regulatory agencies, after consultation, raised rate
ceilings applicable to commercial banks, mutual savings banks, and
savings and loan associations. In addition, these financial institutions were permitted to issue ceiling-free, 4-year time deposit instruments, so that they could compete actively for funds against highyielding market instruments. This ceiling-free authority was
withdrawn later, following congressional action that required the imposition of ceiling rates on all deposits of less than $100,000. But
the array of rate ceilings applicable to the various types of time and
savings deposits issued by banks and nonbank institutions remained
significantly higher than it had been before midyear.
Partly as a result of these increases in maximum rates, deposit inflows to the institutions—though substantially slowed—dropped less
drastically than during tight money periods in the 1960's. Nevertheless, and despite a liberal lending policy by the Federal home loan
banks and support from the Federal National Mortgage Association
and other Federal agencies, a marked contraction developed in the
availability of mortgage credit and its cost rose sharply.
The tightening in mortgage credit, together with, much higher
prices for houses and the sustained high level of building during the
two preceding years, combined to reduce housing starts sharply over
the course of the year. Declining residential construction, however,
was not the only source of weakness in the economic situation. Newcar sales had begun to fall off even before the news of a prospective
011 shortage, and they dropped sharply further thereafter. Growth in
consumer spending for other goods declined on balance in real terms
after the first quarter of 1973, reflecting higher prices and a gradual
reduction in real take-home pay of the average worker. In the autumn the developing energy shortage, resulting from the embargo on

8



direct and indirect shipments of oil from the Middle East to the
United States, created new uncertainties and new fears about continued economic stability both at home and abroad.
The result was a marked slowing in over-all economic growth as
the year progressed. Expansion in real GNP moderated from an unsustainably high 8.7 per cent annual rate in the opening months of
the year to an annual rate of about 3 per cent in the second and
third quarters combined. This reflected not only the leveling off in
consumer demands but also shortages in supplies of foodstuffs and
raw materials and the limitations of capacity in some critical industrial sectors. In the fourth quarter real growth slowed further, to
only about 1.5 per cent (annual rate). Growth in employment also
slowed toward the end of the year, and the unemployment rate—
which had declined through most of the year—began to rise.
In view of these developments monetary policy in the autumn
began to back away from its earlier posture of substantial restraint.
Open market operations became a little less restrictive, and interest

SELECTED I N T E R E S T R A T E S
PER CENT PER A N N U M

N O T E . — F o r n o t e s see c h a r t o n p . 37.




9

rates edged down in both long- and short-term markets. Savings
flows to the depositary institutions improved as interest rates on market instruments were reduced, and the mortgage market eased in
terms of both interest rates and the availability of funds. I n December the Board reduced the marginal reserve requirement on CD's
and other money market funds at large banks from 6 to 3 per cent,
and in early January 1974 it cut margin requirements on stock
market credit from 65 per cent to 50 per cent. The interest rate on
Federal funds declined from its September high of nearly 11 per cent
to about 9 per cent by February of 1974.
The move to a moderately less restrictive monetary policy was
warranted by the leveling-off in the economic expansion and by the
evidence of developing weakness in the economy caused by the oil
shortage and other factors. But the continuation of rapid inflation
and the persistence of serious supply shortages, not only in oil but
also in many other product lines, counseled against any aggressive
easing in policy.
I n early 1974, weakness in economic activity appeared to be
growing, dominated by a slowing in consumer expenditures for the
goods and services most closely associated with the use of gasoline
and oil products. This situation may worsen for a time; or the problem may wane, if consumers shift to the purchase of other goods and
services, or if the oil shortage is eased. There is also uncertainty
about the prospects for the foreign trade balance following the dramatic improvement in the export position of the United States during
1973. The quantum jump in the price of foreign oil will raise the
Nation's bill for oil imports very substantially, even without a resumption of oil shipments from the Middle East. A n d the substantial
recovery in the international value of the dollar since the autumn of
1973, along with indications of economic slowing abroad, may curb
foreign demands for U.S. exports, though the effects of these factors
on the trade balance may be offset by a weakening in U.S. import
demands.
A t the same time important sources of continuing support remain
in the U.S. economy. Business is planning sizable increases in capital
spending, and additional projects may well be stimulated by efforts
to economize on the use of energy and by the evident need for a
major effort to expand domestic capacity in the energy field and in

10




other basic materials industries. Businesses generally have followed
conservative inventory policies, and with many commodities still in
very short supply, the ratio of stocks to sales remains close to its
lowest level in many years. Residential building activity is likely to
show some recovery later in the year from its present depressed
state, as there is further improvement in the availability of mortgage
money, materials, and labor.
The inflationary problems of the U.S. economy remain severe,
however. Prices of materials—not only of oil but also of many other
commodities—have continued to rise at a rapid pace. A n d many
shortages remain that are capable of disrupting production schedules
and deliveries. Moreover, the rise in unit labor costs has accelerated
in recent quarters as increases in wage rates have been substantial
and gains in productivity have come to a halt.
The outlook for inflation is not entirely bleak, however. Adjustments in relative prices of the dimensions witnessed over the past
year should not be expected to continue indefinitely, since the effect
of the higher prices is to induce larger output and constrain demand. I n the case of oil and other fuels, the price response to shortage conditions may still have some distance to go. I n other areas,
however, the outlook seems more promising. Agricultural output has
been rising, and crop yields around the world generally appear to
have been much more favorable in 1973. The upsurge in international demand for industrial raw materials shows clear signs of moderating, and the dollar has strengthened again in foreign exchange
markets. I n any event, lasting improvement in supply conditions for
foods and other raw materials will be dependent on long-run structural processes that encourage increases in investment, output, and
efficiency in these sectors and economy in the use of their product.
The job for monetary policy—and for economic stabilization policy generally—therefore, is to steer a course that will not exacerbate
present and prospective inflationary forces, but at the same time will
avoid an unacceptably severe or extended weakening in economic activity that might develop from the energy crisis. Given the many uncertainties that confront the economy, this is not likely to be an easy
task. Monetary policy, however, is by its nature a flexible and adaptive instrument that can be shaped promptly to the Nation's
emerging economic needs.




11

rates edged down in both long- and short-term markets. Savings
flows to the depositary institutions improved as interest rates on market instruments were reduced, and the mortgage market eased in
terms of both interest rates and the availability of funds. I n December the Board reduced the marginal reserve requirement on CD's
and other money market funds at large banks from 6 to 3 per cent,
and in early January 1974 it cut margin requirements on stock
market credit from 65 per cent to 50 per cent. The interest rate on
Federal funds declined from its September high of nearly 11 per cent
to about 9 per cent by February of 1974.
The move to a moderately less restrictive monetary policy was
warranted by the leveling-off in the economic expansion and by the
evidence of developing weakness in the economy caused by the oil
shortage and other factors. But the continuation of rapid inflation
and the persistence of serious supply shortages, not only in oil but
also in many other product lines, counseled against any aggressive
easing in policy.
I n early 1974, weakness in economic activity appeared to be
growing, dominated by a slowing in consumer expenditures for the
goods and services most closely associated with the use of gasoline
and oil products. This situation may worsen for a time; or the problem may wane, if consumers shift to the purchase of other goods and
services, or if the oil shortage is eased. There is also uncertainty
about the prospects for the foreign trade balance following the dramatic improvement in the export position of the United States during
1973. The quantum jump in the price of foreign oil will raise the
Nation's bill for oil imports very substantially, even without a resumption of oil shipments from the Middle East. A n d the substantial
recovery in the international value of the dollar since the autumn of
1973, along with indications of economic slowing abroad, may curb
foreign demands for U.S. exports, though the effects of these factors
on the trade balance may be offset by a weakening in U.S. import
demands.
A t the same time important sources of continuing support remain
in the U.S. economy. Business is planning sizable increases in capital
spending, and additional projects may well be stimulated by efforts
to economize on the use of energy and by the evident need for a
major effort to expand domestic capacity in the energy field and in

10




Demands for
and Services

Goods

1973 was a year of dramatic developments in the nonfinancial sector
of the economy. For the year as a whole, GNP in current dollars increased by about 11.5 per cent, but higher prices accounted for
nearly half of this rise. The increase of 6 per cent in real GNP was
about the same as in 1972. But after reaching exceptionally rapid
and unsustainable rates in late 1972 and the first quarter of 1973—
averaging about 8.5 per cent per year—growth in real terms slowed
abruptly. In the fourth quarter it was down to an annual rate of
about 1.5 per cent.
The rapid pace of expansion early in the year was broadly based
among consumers, business, foreign trade, and government. The subsequent slowing was attributable in part to the emergence of severe
pressures on supplies of many major materials, which acted to limit
output increases in key demand sectors. Output of materials was apTable 1: GROSS N A T I O N A L PRODUCT
1973 i
T y p e o f measure

1971

1973

1972

I

II

III

IV

1,305
841

1,338
845

I n billions o f dollars

Current dollars
1958 d o l l a r s

1,056
745

1,155
791

1,289
837

1,243
829

1,272
834

Percentage change f r o m p r e c e d i n g p e r i o d
(at a n n u a l rates)

Current dollars
1958 d o l l a r s

8.0
3.2

9.4
6.1

11.6
5.9

15.2
8.7

9.9
2.4

10.6
3.4

10.5
1.6

I m p l i c i t deflator

4.7

3.2

5.4

6.1

7.3

7.0

8.8

1

Q u a r t e r l y d a t a are seasonally a d j u s t e d a n n u a l rates.
N o t e . — D e p t . o f Commerce data.

12



proaehing practicable capacity limits by late spring, with capacity
utilization rates for major materials industries reaching their highest
levels since World War I I . These pressures on capacity, and the related tightness of supplies, were maintained throughout the remainder
of the year. The moderation of expansion in aggregate real output
during 1973 was broadly paralleled by a slowing of growth in industrial production—to an annual rate of little more than 1 per cent
in the fourth quarter, from a 10 per cent rate in the first quarter.
Although supplies and capacity in a number of industries were
subject to severe strains in 1973, demands in some important sectors
moderated over the course of the year. In particular, the volume of
consumer real purchases slowed after an extraordinarily large increase in late 1972 and early 1973. Toward the close of the year—
when the oil shortage began to affect output and employment adversely, both directly and through its effects on expectations—sales
of large-size automobiles in particular were sharply reduced. Purchases of fuel and some services were also down, and for the fourth
quarter as a whole total consumer purchases in real terms declined.
Another factor contributing importantly to the over-all slowing in

INDUSTRIAL PRODUCTION
1967=100

N O T E . — F e d e r a l Reserve indexes, seasonally




adjusted.

13

real growth was a sharp drop i n residential construction activity i n
the second half of the year.
I n contrast, business demands for fixed capital were strongly expansive throughout the year. I n fact, business equipment was the
only major category of industrial production that increased virtually
throughout 1973. But here too there were indications late in the year
of a slowing in the rate of expansion, in part because of supply
factors. A n d until late in 1973, supply constraints held inventory
investment at exceptionally low levels for a period of cyclical expansion.
A major feature of 1973—and one that contributed materially to
over-all expansion—was a turnaround i n net exports of goods and
services to surplus from a sizable deficit in 1972. Merchandise exports increased much faster than did imports, stimulated by strong
demand conditions in Western Europe and Japan, by crop shortfalls
in some countries, and by the decline i n the value of the U.S. dollar
in foreign exchange markets.
Pressures on industrial resources, tight supplies of farm products
and other materials, strong demands abroad, and the oil crisis combined to intensify inflationary pressures. Increases in unit labor costs
were also an important factor i n the price rise, as gains in productivity came to a halt after the first quarter of the year while increases in
average compensation per employee rose faster than they had in 1972.
Demands for labor continued very strong until late in the year.
Payroll employment showed an exceptionally large increase, and the
unemployment rate in the fourth quarter averaged 0.6 of a percentage point less than a year earlier; toward the end of the year, however, unemployment was moving upward.

CONSUMER PURCHASES
Consumer spending was a dominant factor in shaping the contour of
GNP expansion in 1973. Consumer purchases of goods and services
rose to a 15 per cent annual rate in the first quarter—equivalent to a
9 per cent rate after adjustment for price increases. These large increases were major influences in the strong first-quarter advance
shown i n both current-dollar and real GNP. Expansion in consumer
spending slowed thereafter—to an annual rate averaging close to 10

14



per cent for the second and third quarters, and then to 4.5 per cent
for the fourth quarter. Moreover, continued price advances largely
eroded these increases. For the year as a whole, however, real consumer purchases increased by 5 per cent following a 6 per cent rise
in 1972.
The first quarter of 1973 was characterized by exceptionally
strong advances in consumer purchases of both durable goods and
nondurable goods. Continuation of the housing boom provided an
impetus to sales of furniture and appliances. In addition, unit sales
of new autos (domestic and foreign) reached a record 1214 million
annual rate. A sharp increase in purchases of nondurable goods reflected in part an acceleration in food prices, but sales of some other
items—such as apparel—rose even faster in both current dollars and
real terms.
Outlays for both durable and nondurable consumer goods were

CONSUMER O U T L A Y S A N D S A V I N G R A T E
PERCENTAGE CHANGE

15

10

5

+

0

5
7

5
0

N O T E . — O u t l a y s : C h a n g e s f r o m p r e c e d i n g q u a r t e r b a s e d o n 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 r a t e s ; c o n s t a n t - d o l l a r c h a n g e s are b a s e d o n 1958 d o l l a r s . S a v i n g rate is pers o n a l s a v i n g as a p e r c e n t a g e 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 . A l l d a t a are f r o m D e p t . o f
Commerce.




15

maintained at relatively high levels during the second and third quarters. Auto sales eased somewhat, however, and there was some decline in real purchases of food, reflecting in part sharply rising prices
and the reduced availability of meat. Expenditures on services continued to increase throughout the first three quarters in both current
and constant dollars.
A n outright decline—at an annual rate of close to 5 per cent—in
real consumer purchases in the fourth quarter, following the earlier
marked slowing, was attributable for the most part to emerging energy developments. Consumers cut back their purchases of new automobiles to an annual rate of 10 million units, off considerably from
the 11.7 million rate of the second and third quarters; smaller models were in strong demand, but dealers' stocks of large cars mounted.
Real purchases of gas and oil also declined, reflecting the administration's conservation program and rising prices.

AUTOS

N O T E . — S a l e s : M o n t h l y d a t a at a n n u a l r a t e s , s e a s o n a l l y a d j u s t e d b y F e d e r a l R e s e r v e ;
d o m e s t i c - t y p e i n c l u d e s sales i n t h e U n i t e d States o f cars p r o d u c e d i n C a n a d a . I n v e n t o r y
d a t a , s e a s o n a l l y a d j u s t e d , a r e f o r d o m e s t i c - t y p e cars o n l y . Sales, f r o m W a r d ' s
Automotive
Reports',
inventories, f r o m M o t o r Vehicles Manufacturers Association.

16



Contributing to the upsurge of consumer demands in early 1973
were large gains in employment and wages, as well as the anticipation of unusually large refunds of personal income taxes during the
first half of the year, resulting from a step-up in withholdings in
1972. Strong growth in income helped to provide the basis for a
sharp increase in spending financed with instalment credit. The large
increase in social security benefits in late 1972 also stimulated consumer spending to some extent.
Although consumer attitudes became more pessimistic as the year
progressed, consumer spending kept pace with the increase in nominal income in the middle two quarters, and the saving rate remained
close to the 5.9 per cent rate of the first quarter. With consumer demands weakening appreciably in the fourth quarter, the saving rate
rose sharply to more than 7 per cent.

RESIDENTIAL CONSTRUCTION
Outlays for private residential construction, which had advanced
steadily since mid-1970, peaked early in the first half of 1973 and
fell sharply in the fourth quarter. The decline reflected a slowing of
demands in response to sharply higher interest rates and less favorable nonrate mortgage terms as well as to a substantial further rise in
the costs of houses. The tightening of credit terms was particularly
evident after midyear as inflows of funds to mortgage lending institutions were adversely affected by high yields on competitive investments. For the year as a whole, however, construction outlays were
down only slightly from the 1972 total in real terms and were 7.5
per cent higher in current dollars.
Private housing starts held at a near-peak seasonally adjusted annual rate of 2.4 million units in the first quarter; after that they declined rapidly to an annual rate of less than 1.6 million units in the
fourth quarter. For the year the number of starts totaled around 2
million units, about the same as in 1971 but down appreciably from
the record 2.35 million in 1972. Multifamily structures, including an
increased number of condominiums, accounted for nearly 45 per
cent of total starts in 1973. The continued relatively high proportion
of multifamily units was in part a response to further advances in
costs, especially for land and for building materials.




17

RESIDENTIAL CONSTRUCTION
RATIO SCALE, B I L L I O N S OF DOLLARS

1971

1972

1973

NOTE.—Expenditures:
D e p t . of C o m m e r c e d a t a at seasonally
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: Q u a r t e r l y averages based o n m o n t h l y figures
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 .

adjusted
at

annual

seasonally

rates;

adjusted

Nonsubsidized starts, which include larger and more expensive
units, accounted for more than 90 per cent of the private residential
total—an appreciably higher figure than in other recent years. Federally subsidized starts—new commitments for which remained largely
under a moratorium instituted early in the year—were reduced to
the lowest level since 1968. Domestic shipments of new mobile
homes, which are not included in residential outlays or housing starts
even though they provide living accomodations, dropped considerably through 1973 after reaching a peak in the first quarter. Nevertheless, the annual total of mobile home shipments was slightly
above the previous record of 576,000 units in 1972.
Mortgage markets tightened markedly through the summer of
1973. Although interest rates in such markets showed some easing
during the fourth quarter, they still remained at historically high levels and continued to be a deterrent to new building and to sales of
old houses—particularly in States with relatively low usury ceilings.

18



By late in the year, moreover, the energy crisis had raised new questions about methods of heating and the adequacy of transportation
—creating uncertainties for the future plans of lenders, builders, and
potential home-buyers alike.

BUSINESS FIXED INVESTMENT
Business fixed investment continued to provide strong support to the
economy during 1973. For the year as a whole, such investment rose
15 per cent in current dollars and about 10 per cent i n real terms.
Both major categories of investment—equipment and construction
—recorded current-dollar increases of about 15 per cent over their
1972 levels. Replacement needs and net expansion each continued to
absorb about one-half of total outlays.
Many producers, after having added little to their capacity in recent years, approached capacity constraints during the year. This was
particularly true of such major materials industries as steel, cement,
petroleum, and paper and was a significant stimulus to investment. A
strong corporate cash flow, a continued stimulus from the investment
tax credit, and a heightening of inflationary expectations also contributed to the increase in such spending. Had it not been for materials shortages—caused in part by increased demands from abroad

CAPACITY UTILIZATION RATE
PER CENT

1971

1972

1973

N O T E . — A v e r a g e o u t p u t o f m a j o r m a t e r i a l s i n d u s t r i e s , seasonally
c e n t a g e o f t h e i r p o t e n t i a l c a p a c i t y o u t p u t . F e d e r a l Reserve d a t a .




adjusted,

as a p e r -

19

and efforts on the part of domestic users to shift back to domestic
sources—capital spending probably would have shown an even
greater increase, as suggested by the fact that throughout the year
actual spending consistently fell short of earlier anticipations.
Plant and equipment expenditures rose much faster in manufacturing industries than in the nonmanufacturing sector, in contrast to the
pattern in 1972. Many manufacturers, particularly major materials
producers, increased outlays so that they could meet the strong demands for their products and also bring production facilities up to
the standards required by environmental regulation. Investment was
very strong for the primary metals, paper, and stone, clay, and glass
industries. Outside of the manufacturing sector, mining and public
utilities registered the strongest increases.
Toward the end of the year various surveys of plant and equipment spending all pointed to sizable further increases in such spending during 1974, with manufacturers expected to continue the strong

BUSINESS F I X E D I N V E S T M E N T
RATIO S C A L E , BILLIONS OF D O L L A R S

130

110

90

1971

1972

N O T E . — D e p t . o f C o m m e r c e d a t a at
i n v e s t m e n t is i n t e r m s o f 1958 d o l l a r s .

20



1973
seasonally

adjusted

annual

rates.

Constant-dollar

advance of 1973. However, the surveys were conducted before the
impact of the energy shortage could have been fully reflected in business plans. Accordingly, as 1974 unfolds, further revisions i n plans
are likely; some will be to take account of the availability and cost of
energy supplies, while others will be to meet the needs for increased
domestic energy output.

INVENTORIES
Inventory investment, which usually shows strong increases in a cyclical recovery, remained very modest during the first three quarters of
1973, averaging an annual rate of only $4.5 billion as measured in

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

N O T E . — 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 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
Dept. of Commerce.
Inventories/sales r a t i o , based o n D e p t . o f C o m m e r c e seasonally adjusted d a t a — e n d - o f
q u a r t e r b o o k v a l u e f o r i n v e n t o r i e s , a n d q u a r t e r l y averages o f m o n t h l y d a t a f o r s a l e s — f o r
m a n u f a c t u r i n g a n d trade establishments.




21

the national income accounts ( N I A ) . Increases in the book value of
inventories were much larger than the increases as measured on the
N I A basis; the difference reflected the very large inventory valuation
adjustments resulting from the sharp and widespread price increases
during the period. The dollar volume of sales advanced even more
rapidly than the book value of inventories, however, and the
inventory/sales ratio reached its lowest level since early in the Korean war.
Inventory accumulation was held to a low rate during most of the
year mainly by the influence of strong final demands and shortages
of major materials. Stocks of finished goods, for instance, were
drawn down in the primary metals and chemical industries; and unfilled orders rose by exceptional amounts in many industries.
I n the fourth quarter of 1973, inventory investment accelerated to
an annual rate of $18 billion. The step-up in inventory accumulation
appears attributable for the most part to the slowing of final demands—particularly by consumers for large autos, and for residential construction. A large part of the accumulation was probably involuntary, notably for new large-size automobiles. Nevertheless, at
the end of the year the inventory/sales ratio for total manufacturing
and trade remained quite low by historical standards.

EXPORTS AND IMPORTS OF GOODS AND
SERVICES
The U.S. balance of trade position underwent a dramatic transformation during 1973. Exports of goods and services rose by around 40
per cent from the previous year, while imports were up about 25 per
cent. As a result the balance on goods and services shifted from a
deficit of close to $4.5 billion in 1972 to a surplus of around $6 billion in 1973. Net exports, which had risen throughout the year,
jumped in the fourth quarter to an annual rate of about $13 billion,
reflecting some special developments in the services sector as well as
an improved U.S. trade position. I n real terms, exports of goods and
services rose by about 20 per cent, with gains continuing through the
year. Real imports rose by less than 5 per cent, but after reaching a
peak in the first quarter they drifted down. While the favorable trade
balance contributed to expansion of the economy in 1973, it also

22



added to inflationary pressures by placing further demands on already hard-pressed domestic capacity as well as on domestic supplies
of farm products and industrial products; in addition, the prices of
imports increased appreciably.
The turnaround in foreign trade reflected both the strong economic expansion in Western Europe and Japan and the cumulative
effects of the depreciation of the dollar i n terms of foreign currencies. Expansion i n exports was sharpest for agricultural products,
which were strengthened in part by widespread crop failures
abroad. But exports of nonagricultural products also rose sharply in
both current dollars and real terms. By year-end the value of the
dollar had risen substantially from its midyear low in terms of foreign
currencies. A n d large increases in the dollar value of imports were
in prospect because of sharp advances in petroleum prices.

FEDERAL GOVERNMENT
After registering a deficit of nearly $16 billion in calendar year
1972, the Federal budget ( N I A basis) moved into balance in the
spring of 1973 and then into surplus i n the second half of the year.
This shift was the result both of curbs on increases in expenditures
and of large revenue gains generated by rising incomes and prices.
Federal purchases of goods and services, which enter directly into
the GNP, rose by about 2 per cent in 1973, less than half as much
as in the previous year. I n real terms, purchases declined about 6
per cent, as outlays for national defense dropped sharply. Nondefense purchases, which are much smaller in dollar terms, rose less
than in 1972. A n increase in total Federal grants-in-aid to State and
local governments reflected the fact that general revenue sharing, introduced in the latter part of 1972, was in effect for all of 1973;
other grant-in-aid programs declined somewhat. A moderate increase
in wages and salaries paid by the Federal Government reflected
higher pay scales; during the year there was a slight decline in the
Federal civilian work force as a result of sharp cutbacks of civilian
employment in the Department of Defense.
Federal receipts rose by about $37 billion in 1973, compared with
$30 billion in 1972. Corporate profits tax accruals were up more
than 30 per cent for the year, although they changed little after the




23

Table 2: CHANGES I N MAJOR COMPONENTS OF GROSS
N A T I O N A L PRODUCT
I n billions o f dollars

1973 »
Item

1971

1973

1972

II

I

III

IV

GNP

78.4

99.7

133.9

43.3

29.5

32.5

33.0

Personal consumption expenditures. .
Durable goods
Nondurable goods
Services

49.6
12.3
14.9
22.3

59.3
13.8
21.2
24.3

77.5
13.4
36.0
28.1

26.8
9.3
11.5
6.0

16.2
.6
8.1
7.6

20.4
.0
11.3
9.0

9.2
-7.2
8.0
8.4

Saving rate (level in per cent). .
Fixed investment
Residential structures
Nonresidential

8.1

6.2

6.2

5.9

5.9

15.4
11.5
3.8

25.2
11.3
13.8

21.9
4.0
18.0

8.7
2.1
6.6

3.8
.6
3.2

.1

2.0

-3.6

Net exports of goods and services...
Exports
Imports

-2.8
3.4
6.2

-5.4
7.2
12.6

10.4
28.5
18.1

3.5
10.0
6.5

Govt, purchases of goods and services
Federal
Defense
Other
State and local

14.8
1.9
-3.0
4.9
12.9

20.7
6.3
2.8
3.6
14.3

22.1
2.2
.5
2.6
20.0

7.9
2.8
1.9
.9
5.0

Inventory change

1.6

-

-

-

5.7

-1.4
-5.2
3.8

.2

13.3

4.8
7.3
2.6

5.2
11.9
6.6

3.7
.5
.0
- .4
4.2

6.6
.0
-1.2
1.1
6.6

.1
2.8
7.5
4.7

-

6.7
1.8
.1
1.9
5.0

7.3

3.6
- .4
3.9

-

1

Derived f r o m quarterly totals at seasonally adjusted annual rates.
N o t e . — D e p t . o f Commerce data.

second quarter. Contributions for social insurance recorded similarly
large increases, in part because of an increase i n tax rates. Personal
tax receipts and indirect business taxes, however, showed only moderate growth. I n 1972, personal tax receipts had been boosted because of substantial overwithholding.

STATE AND LOCAL GOVERNMENTS
State and local government expenditures continued to be strongly expansive in 1973, rising by about 13 per cent. I n real terms the
increase was about half of that. Employee compensation and purchases of goods and services accounted for the major portion of the
increase. Employment rose by nearly 400,000, a smaller advance
than that recorded i n 1972. This smaller growth reflected a reduction
in the number of State and local employees hired under provisions
of the Public Employment Act. State and local construction expendi-

24



tures were up by 8 per cent in 1973, but most of this was the result
of increased prices.
During 1973 the States and localities combined recorded a budget
surplus of $11 billion, $2 billion less than in 1972. Federal general
revenue sharing helped these governments to maintain a strong fiscal
position in 1973 and at the same time to reduce substantially the
amount of their long-term borrowing. Furthermore, it provided funds
that were used for tax relief, a trend that is expected to continue in
1974.




25

Employment

and

Wages

Labor markets continued to tighten through most of 1973. Strong
demands for workers were associated with a rapid expansion in employment and a moderate decline in unemployment. Near the yearend, however, a slowdown in production and the onset of the energy
crisis resulted in layoff announcements in automobiles, airlines, and
hotels and in a number of related industries. Growth in over-all employment slowed, and there was a rise in the unemployment rate.
The civilian labor force expanded sharply in 1973 in response to
the generally strong demands for labor. The increase of 2.7 million
during the year compares with 2 million in 1972 and an anticipated
normal growth of 1.6 million, based on long-term demographic and
participation-rate trends. Most significant in the sharper rise in 1973
was a speed-up in the number of women 25 to 54 years of age in
the labor force. The need to increase family income to help maintain real incomes in the face of sharply rising prices was a factor
in this trend, as was the strong demand for labor. Labor force increases for most other groups were at about the same pace as in
1972—with continued large increases among teenagers and young
adult women.
During the first part of the year gains in total employment about
matched the large increases in the labor force, and the unemployment rate remained at about 5 per cent. In the spring and early summer, labor force growth slowed a little and the unemployment rate
declined somewhat. In October the rate was 4.6 per cent, the lowest
in 3 Vi years. Declines were evident among most labor force groups.
The unemployment rate for white workers edged down to 4.2 per
cent in the fourth quarter. Employment gains were also substantial
among black workers during 1973, and the jobless rate for such
workers declined to 8.6 per cent as compared with 9.9 per cent a
year earlier. Even so, over-all jobless rates remained well above
those that had been recorded during the period of extremely tight
labor markets from 1966 to 1969. Near the end of 1973 the unemployment rate began to edge up as demand for labor slackened
and layoffs increased; and in January 1974 there was a further substantial rise.

26



L A B O R 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
1970 Q M 00

1970

1971

1972

1973

NOTE.—Seasonally adjusted data f r o m D e p t . of L a b o r .

The rapid increase in nonfarm payroll employment in 1973 continued an expansion that had begun in the fall of 1971; the total
rose by 2.7 million over the four quarters of 1973—about the same
increase as during the preceding year. The employment advance was
led by a vigorous increase—of three-quarters of a million—in manufacturing jobs, which brought factory employment back close to the
peak level reached in mid-1969. The rise in manufacturing employment was particularly rapid in the first half of 1973. Gains were concentrated in those industries most affected by strength in materials
output and business investment. But as production slowed in the latter half of the year, the pace of the increases in manufacturing employment also moderated and the factory workweek edged off from
the relatively high level reached earlier in the year.
Employment growth was also strong in nonindustrial activities in
1973. In services, finance, and trade the total number employed rose
by 1.3 million, slightly more than during 1972. Federal civilian employment edged off, continuing the downtrend that had begun in




27

1970. State and local governments increased their payrolls substantially over the four quarters of 1973 but at a slower pace than in the
preceding year.
I n response to tightened labor markets as well as rising prices,
wages increased at a somewhat faster pace in 1973 than in 1972.
The increase was appreciably more rapid after the first quarter than
earlier. Thus, the adjusted hourly earnings index—the measure that
most closely approximates average changes in wage rates—increased
by an average 7.5 per cent over the last three quarters compared
with about 5.5 per cent over the preceding five quarters. Gains in
money wage rates were eroded by accelerating prices and higher
social security taxes; the purchasing power of weekly take-home pay
was 3 per cent less at the end of 1973 than a year earlier.
Table 3: CHANGES I N A V E R A G E H O U R L Y EARNINGS I N D E X
Seasonally adjusted annual rates, i n per cent

Industry

Total private nonfarm
Mining
Construction
Manufacturing
Transportation and public utilities
Wholesale and retail trade
Finance, insurance, and real
estate
Services

M a r . 1973Dec. 1973

1972 Q I V 1973 Q I V

5.6

7.4

6.7

5.2
5.5
5.4

9.4
7.9
7.1

7.8
6.7
6.6

11.6
5.4

9.2
5.0

7.6
7.0

7.7
6.8

4.8
6.9

4.0
4.7

8.2
6.9

5.8
6.1

Aug. 1970Aug. 1971

Aug. 1971Jan. 1972

Jan. 1972M a r . 1973

6.9

6.5

6.7
7.8
6.5

9.5
6.5
6.3

8.7
5.9
6.9
7.4

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 and supervisory w o r k e r s ,
adjusted t o exclude effects o f shifts o f w o r k e r s among industries and fluctuations i n overtime p r e m i u m s i n m a n u f a c t u r i n g . Basic data f r o m D e p t . o f L a b o r .

Contract bargaining activity was heavy in 1973 with about 43A
million workers affected in many of the key, pattern-setting industries.
In the environment of accelerating price increases, new or improved
cost-of-living clauses became a major bargaining issue. Negotiations
also focused on substantial gains in fringe benefits—particularly on
early retirement, higher pension payments, and increased medical
coverage.

28



Prices, Labor

Costs, and

Profits

Inflationary pressures were exceedingly strong in 1973, with prices
showing the largest sustained increases since 1946. The fixedweighted price index for private GNP—a broad measure of price
change—increased almost 8 per cent from late 1972 to late 1973,
more than double the increase over the preceding year, and wholesale and consumer prices rose at close to record rates. Strong demands in this country and abroad exerted extraordinary pressures on
supplies. World supplies of foodstuffs were short, and industrial activity rose to very high levels in Western Europe and Japan,
generating strong demands for U.S. exports and high prices for imports—a situation aggravated by the decline in the value of the dollar relative to other currencies. In this country, unit labor costs rose
much faster than in 1972. Supplies of livestock products declined,
and shortages of materials were acute throughout 1973. Late in the
year the embargo on oil shipments to the United States by Middle
East producers precipitated a crisis, and prices of petroleum and
products began to rise sharply.
Prices of raw materials soared in 1973, reflecting a business boom
of worldwide proportions. Spot prices of raw industrials rose nearly
60 per cent after an increase of about 25 per cent in 1972, with especially large increases for nonferrous metals, steel scrap, and cotton.
The cost of many semiprocessed materials, such as chemicals, textiles, and paper, also rose rapidly as operations neared the upper
limits of plant capacity. Wholesale prices of finished goods rose less
rapidly than did materials until an upsurge in prices of petroleum
products in the fourth quarter brought the increase for the year for
nonfood finished goods to about 15 per cent.
Unit labor costs exerted increasing pressure on prices in 1973.
In the fourth quarter such costs in the private nonfarm sector
were 7 per cent above their late 1972 level, compared with an increase of only about 2.5 per cent during the preceding year. Failure of productivity to grow in the private nonfarm economy was the
major factor in the acceleration of labor costs. Growth in output per
manhour came to a standstill in the second and third quarters, as the




29

expansion of real output slowed in the private nonfarm sector, and
in the final quarter there was an actual decline in productivity. Altogether, growth in productivity amounted to only 1 per cent from
late 1972 to late 1973. But in addition, growth in compensation per
manhour increased somewhat, from about 7 per cent during 1972 to
8 per cent in 1973, in part because of increased costs to employers
from higher social security taxes.
Part of the rise in prices in 1973 also reflected widening profit
margins. Corporate profits before taxes rose rapidly in the first half
of 1973, to an annual rate almost one-third above the 1972 level.
Then they leveled off. A good part of the gain in reported profits reflected the increased value of inventories resulting from sharply rising
prices. Adjusted for inventory valuation, the estimated rise for the
year 1973 was 20 per cent. The share of profits adjusted for inventory valuation in the value of output of nonfinancial corporations im-

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

1970

1971

1972

N O T E . — A n n u a l rates o f c h a n g e f o r t h e p r i v a t e n o n f a r m
p r e c e d i n g h a l f y e a r o r q u a r t e r a n d are b a s e d o n s e a s o n a l l y
Labor.

30



1973
e c o n o m y ; c h a n g e s are f r o m
adjusted data f r o m Dept. of

proved slightly during the year. Nevertheless, it was less than it had
been in 1969 and was considerably smaller than in years prior
to 1969.
Table 4: PROFITS OF N O N F I N A N C I A L
CORPORATIONS
Share o f value o f p r o d u c t , i n per cent

Item

1969

1971

1972

1973'

Product originating
Profits before tax 2
Other charges against product. . .
Compensation o f employees.
Interest
I n d i r e c t taxes 3
Capital consumption
allowances

100.0
12.5
87.5
65.7
2.5
9. i

100.0
10.7
89.3
65.9
3.0
9.9

100.0
11.1
88.9
66.2
2.8
9.5

100.0
11.7
88.3
66.3
2.8
9.2

9.9

10.5

10.4

10.0

22.4

21.2

21.4

21.7

A d d e n d u m : Profits plus c a p i t a l
c o n s u m p t i o n allowances

1

Preliminary.
Including inventory valuation adjustment.
I n c l u d i n g transfer payments t o persons less subsidies received.
NOTE.—Dept. o f Commerce data.

2
3

FIRST-HALF PRICE

DEVELOPMENTS

The first half of the year began with a liberalization of Phase I I
price controls in early January and ended with a price freeze in
June. The sharp price rise in this period was led by an extraordinarily rapid increase in wholesale prices of farm products and foods—a
seasonally adjusted annual rate of almost 50 per cent from December to June. Prices of crops reacted to a rapid rise in the volume of
exports of wheat, corn, and soybeans—which brought stocks in this
country down to exceedingly low levels. Livestock prices also rose
very sharply, for the most part in response to declining supplies.
I n order to restrain rapidly rising meat prices, ceilings on red meat
were imposed at the end of March for processors and distributors.
This slowed the increase for meats, but food prices as a whole continued to rise very fast until a general freeze was put into effect in
June. Unfortunately, price controls and the steep further climb in
prices of feeds and feed grains, which had begun in late 1972, contributed to the drop in supplies of livestock and also of poultry,
eggs, and milk.




31

W H O L E S A L E PRICES

FUELS AND RELATED
PRODUCTS AND POWER

FARM PRODUCTS
AND FOODS

TOTAL
INDUSTRIAL COMMODITIES
1970

1971

1972

1973

1970

1971

NOTE.—Based o n seasonally adjusted indexes f r o m D e p t . o f L a b o r .

A t the same time the rate of increase in prices of industrial commodities was accelerating to an annual rate of almost 13 per cent;
this contrasts with an increase of only 3.6 per cent for all of 1972.
The acceleration in 1973 followed the introduction of Phase I I I price
control regulations in early January. A temporary and short-lived
bulge in prices had been expected—to correct some of the distortions that had arisen under Phase I I — b u t as the months progressed,
price advances showed no indications of slowing.
The underlying factors responsible for the stepped-up pace of the
increase in industrial prices were much more fundamental than relaxation of controls. As noted earlier, one important influence was that
the value of the dollar depreciated further in terms of other major
currencies to a level more than 20 per cent below its May 1970
value. In addition, a more rapid rate of price increase abroad than in
this country was helping to make U.S. exports generally more competitive in world markets while raising the dollar price of imports.
This shift in relative prices affected all traded commodities, but it
was most notable for materials costs, which soared in dollar terms in
response both to the drop in the foreign exchange value of the dollar
and to strong world demands.

32



CONSUMER PRICES
JANUARY 1 9 7 0 = 1 0 0

NOTE.—Based o n seasonally adjusted indexes f r o m D e p t . o f L a b o r .

The rise in consumer prices also accelerated in the first half of
1973, reaching an annual rate of 8 per cent. Food prices, rising at
an annual rate of more than 20 per cent, contributed most to the
speed-up. The rise in prices of nonfood commodities, however, was
also faster than in 1972.

SECOND-HALF PRICE DEVELOPMENTS
I n an effort to brake the surge in prices, a general price freeze of 60
days was imposed in mid-June; the only exemptions among domestic
prices were rents and farm products at the initial point of sale.
The freeze in retail prices tended to hold down prices at the farm
level, and a profit squeeze on producers developed when feed and
other costs continued to rise. T o avoid disruptions in supply, the
freeze on prices of food was relaxed in mid-July to allow retailers
and distributors to pass through to consumers the higher cost of
commodities at the farm level (except for beef). Prices of livestock
and meat rose dramatically after this move. A t the same time world
shortages were causing a further upward surge in prices of wheat,
corn, and soybeans. Between mid-July and mid-August the increase in
prices of farm products was the most rapid since World War I.




33

Between mid-August and December the onset of favorable harvests removed fears of a serious shortage in food and feed grains in
the 1973-74 crop year. Wholesale prices of farm products declined
accordingly, although they were still 36 per cent higher in December
than a year earlier.
Wholesale prices of industrial products increased relatively little
during the freeze, but thereafter resumed a more rapid pace of advance in response to a continued increase in production costs. Price
increases were substantial and widespread, but especially large increases were recorded late in the year for petroleum and other fuels.
Over the fourth quarter fuels accounted for more than half of the increase in (wholesale prices of industrial commodities.
In the latter half of the year controls were removed from such important items as lumber, cement, fertilizers, and many nonferrous
metals and from new autos following an agreement with major producers to limit increases during the 1974 model year. I n early 1974
controls were removed from some other items and the administration
indicated that it planned to permit price and wage controls to lapse
after the A p r i l 30 expiration date of the enabling legislation—except
for health care and petroleum.
Consumer prices meanwhile increased at an annual rate of 9.6 per
cent in the second half of the year, with retail prices of foods again

Table 5: PRICE CHANGES
I n per cent

Dec.
1970Dec.
1971

Dec.
1971Dec.
1972

Dec.
1972Dec.
1973

W h o l e s a l e prices, t o t a l
Industrial commodities
F a r m products
Processed f o o d s a n d feeds

4.0
3.2
8.1
4.7

6.5
3.6
18.7
11.6

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

3.4
4.3
2.3
4.1

3.4
4.7
2.5
3.6

Series

NOTE.—Based o n d a t a f r o m D e p t . o f L a b o r .

34



1973
(Seasonally a d j u s t e d a n n u a l rates)

Dec.Mar.

Mar.June

JuneSept.

Sept.Dec.

18.2
14.8
36.1
20.3

21.1
10.2
77.3
37.1

23.4
14.9
61.0
31.9

13.2
4.5
67.3
14.8

15.5
31.3
-28.1
1.3

8.8
20.1
5.0
6.2

8.6
28.6
4.0
3.6

7.4
14.7
5.4
4.5

10.3
28.8
2.6
7.4

9.0
9.2
7.9
9.4

tures were up by 8 per cent in 1973, but most of this was the result
of increased prices.
During 1973 the States and localities combined recorded a budget
surplus of $11 billion, $2 billion less than in 1972. Federal general
revenue sharing helped these governments to maintain a strong fiscal
position in 1973 and at the same time to reduce substantially the
amount of their long-term borrowing. Furthermore, it provided funds
that were used for tax relief, a trend that is expected to continue in
1974.




25

Monetary
Markets

Policy and

Financial

In the early months of 1973 the need for further measures to restrain excessive economic expansion and a growing inflationary momentum seemed clear. Real output in the domestic economy was
growing at an unsustainably rapid rate, key industrial sectors were
approaching effective production ceilings, and prices were moving
sharply higher. Although much of the steep price advance in the first
half of the year resulted from increased dollar price quotations on
internationally traded commodities—reflecting the decline in the foreign exchange value of the dollar—general pressures on resources
from domestic demands were also high. Since money and credit had
grown rather rapidly in 1972, the need for slower growth in 1973
was evident.
The Federal Reserve began strengthening its resistance to excessive monetary expansion near the end of 1972. This shift was intensified early in 1973 and then extended through a series of tightening
actions until late summer. The principal policy thrust, as usual, came
from open market operations, but successive increases in the Federal
Reserve discount rate—from 4Vi per cent at the end of 1972 to I V i
per cent in late August of 1973—supplemented and reinforced the
open market initiative. In addition, several selective increases in
bank reserve requirements were introduced in the late spring and
summer to reinforce the pattern of general tightening.
Late in the summer, with real growth in the economy having moderated and with further slowing apparently in prospect, the System
moved away from its policy of persistent tightening. This change was
prompted by concern that the cumulative effects of earlier restrictive
actions might eventually result in a greater dampening of real economic activity than was desired. Near the end of the year repercussions of the Middle East oil embargo added a special depressant to
domestic activity but at the same time heightened expectations of
further price increases.
During the period of policy tightening, growth in the key monetary aggregates slowed significantly, both in absolute terms and in re-

36



lation to the expansion of GNP. Mu for example, grew at an average
annual rate of about 5 per cent over the first three quarters of 1973,
while current-dollar GNP was expanding at close to a 12 per cent
annual rate. In contrast, during 1972 Mx had grown somewhat more
than 8.5 per cent, while GNP had increased 9.5 per cent.
For the shorter period from June to September of 1973, growth in
M 1 dropped to around zero. Although it accelerated in the following
quarter to about a 7.5 per cent annual rate, temporary factors were
influencing the results in both quarters. A more accurate reflection of
the trend of policy is thus provided by the 3.7 per cent annual
growth rate over the two quarters combined. During 1973 as a
whole, A/a increased by 5.7 per cent; meanwhile the broader meas-

I N T E R E S T RATES
PER CENT PER A N N U M

N O T E . — M o n t h l y averages e x c e p t f o r h o m e m o r t g a g e s ( b a s e d o n q u o t a t i o n s f o r o n e d a y
e a c h m o n t h ) a n d F . R . d i s c o u n t r a t e . 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 3m o n t h issues; 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 f i r s t 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 ; A a a u t i l i t y bonds ( F e d e r a l Reserve series), averages o f n e w , p u b l i c l y o f f e r e d
bonds rated A a a , A a , and A by M o o d y ' s Investors Service and adjusted t o an A a a basis;
U.S. G o v t , bonds, m a r k e t yields adjusted to a 20-year constant 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 (20 issues, m i x e d q u a l i t y ) , B o n d B u y e r .




37

ures of money — M 2 and M 3 —both grew by a relatively moderate
8.6 per cent.
In the course of policy tightening, interest rates trended upward
—especially in short-term markets where credit demands tended to
concentrate. The weekly average yield on 90-day Treasury bills, for
example, reached a peak of nearly 9 per cent by August, some 3.9
percentage points above its level at the end of 1972. Over roughly
the same period the comparable quotation on 90- to 119-day commercial paper—to which some large commercial banks relate their
prime lending rate—rose 4.9 percentage points to 10.5 per cent.
Until early summer bond yields showed a relatively small response
to the upward thrust of short-term rates. This sluggishness reflected
the combination of a moderate volume of new bond offerings and
widespread market expectations that less rapid economic expansion
would lead to lower interest rates late in the year. As the summer
progressed, however, sharp further increases in short-term rates were
reflected in sizable advances in both bond yields and mortgage rates;
the weekly quotation on new corporate bonds (adjusted to an Aaa
basis) rose to a peak of 8.52 per cent, and the F N M A auction yield
on F H A and V A home mortgage commitments rose to a high of 9.37
per cent.
These advances in rates during the summer were triggered primarily by a growing realization among market participants that inflationary pressures in the economy were much stronger than had been anticipated. With the monetary aggregates having grown rapidly during
the spring, market participants concluded that monetary policy
would be tight for a longer period than previously expected. Among
other things, this changed outlook raised questions whether financial
intermediaries might not be facing another round of disintermediation. Rising rates on market instruments had already produced a
moderate slowing of consumer savings flows to banks and other
thrift institutions during the first half of the year. The squeeze intensified rapidly in the early summer and brought threats of sizable net
outflows, particularly at nonbank institutions. In order to limit the
impact of sharply rising market rates on flows to intermediaries, Federal supervisory agencies raised ceiling rates payable on thrift accounts, effective in July.

38



Later, when it became evident that domestic economic expansion
was continuing to moderate, that growth in the monetary aggregates
had slowed, that the U.S. balance of payments was strengthening
dramatically, and that monetary policy was no longer tightening,
market interest rates receded significantly from their summer highs.
These declines, in combination with the earlier increases in ceiling
rates at thrift institutions, relieved pressures on the financial intermediaries. By the year-end short-term rates were generally 1.5 percentage points or more below their summer highs, with long-term rates
down roughly 0.5 of a percentage point from theirs.
A special factor affecting the structure of short-term credit flows
during the year was the program of the Committee on Interest and
Dividends ( C I D ) regarding the rates that banks charge on loans to
their prime business customers. Early in the year, when C I D constraints prevented the prime loan rate from keeping pace with advances in commercial paper rates, prime rate customers turned in-

B A N K CREDIT, 1973
PERCENTAGE CHANGE

PERCENTAGE CHANGE

TOTAL

N O T E . — Q u a r t e r l y d a t a ; changes are 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 a t a n n u a l rates.
T o t a l b a n k c r e d i t a n d business l o a n s h a v e b e e n 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
t h e i r h o l d i n g c o m p a n i e s , affiliates, s u b s i d i a r i e s , o r f o r e i g n b r a n c h e s .




39

creasingly to their bank lines as the cheaper source of credit. To
help meet these enlarged demands, banks were forced to bid aggressively for short-term funds at rising rates. Meanwhile the outstanding
volume of more costly commercial paper declined sharply.
When the resulting upsurge in bank credit began to produce an inordinate expansion of business loans at the expense of other borrowers, the C I D in mid-April introduced a "two tier" approach to rates
on business loans. This system allowed rates on large prime loans to
move in concert with advances in market rates, but at the same time
limited rate increases on smaller loans. Changes in the outstanding
volume of large prime loans tend to be more volatile than for
other loans and thus frequently require banks to bid for needed
loan funds at high marginal rates—for example, in the market for

SHORT - T E R M BUSINESS B O R R O W I N G
A N D S E L E C T E D I N T E R E S T RATES
CHANGES, IN BILLIONS OF DOLLARS

N O T E . — B u s i n e s s b o r r o w i n g : Q u a r t e r l y changes i n seasonally a d j u s t e d c o m m e r c i a l a n d
i n d u s t r i a l l o a n s at c o m m e r c i a l b a n k s a n d i n n o n - b a n k - r e l a t e d c o m m e r c i a l p a p e r issued
t h r o u g h d e a l e r s . I n t e r e s t r a t e s : M o n t h l y averages o f d a i l y figures f o r b a n k p r i m e r a t e ( r a t e
charged large-business customers w i t h the highest credit r a t i n g ) and f o r c o m m e r c i a l paper
( r a t e o f f e r e d b y d e a l e r s o n 30- t o 5 9 - d a y p a p e r ) .

40



large CD's. By late summer resulting upward adjustments i n the top
"tier" had moved the prime rate back into fairly close alignment
with market rates. Subsequently, when market rates receded faster
than the prime rate, business loan growth at banks was substantially
reduced and commercial paper expanded again.
Two other financial developments in 1973 also bear special mention. One was the sharp reversal—from the first half to the second
half—in the value of the U.S. dollar in foreign exchange markets.
The other was the large decline in prices of corporate stocks in this
country.
Depreciation of the dollar during the first half of the year—in addition to having a major impact on commodity prices, as discussed
earlier—tended during the periods of peak dollar outflow to dampen
growth in the monetary aggregates and to widen spreads between
Treasury bill and other short-term interest rates. Bill rates rose less
than other short-term rates because foreign central banks concentrated their reinvestment of dollar acquisitions largely in Treasury
bills. Later in the year, when the dollar improved dramatically,
these temporary influences on the aggregates and on Treasury bill
rates reversed direction.
The drop in stock prices from the yearly high reached i n January
to the yearly low of early December amounted to 25 per cent in the
New York Stock Exchange index, the largest downswing in this series since the 1969-70 recession. On other stock exchanges and in
the over-the-counter market price declines were even larger. This
general erosion of stock values was attributable to a complex of influences, including the energy crisis and the special economic uncertainties introduced by changes in the administration's price control
program, as well as the more traditional concerns about stock values
when interest returns on alternative types of investment instruments
are high and rising.

MONETARY POLICY
The economic situation with which monetary policy was confronted
in 1973 was an exceptionally difficult one. Since so much of the inflationary pressure that emerged as the year progressed was the result of developments in world markets not directly amenable to U.S.




41

monetary controls, the Federal Reserve had to do its limited best to
constrain the pressures that were building up within the economy
while at the same time avoiding possible dislocations in the functioning of the domestic financial system.
I n the day-to-day implementation of monetary policy, the Federal
Open Market Committee ( F O M C ) continued to rely on a number of
indicators to guide its actions. These included various measures of
the money stock; bank credit; interest rates; and bank reserves. Occasional erratic short-run behavior in each of these required a continuing check on changing relationships among all of them in order
to spot temporary aberrations in particular series. Thus, while a good
deal of emphasis was placed on growth in the narrowly defined
money stock as a guide to policy, this was always done within the
context of a continuing assessment of the relationship of this measure
to other key variables.
Monetary aggregates. The behavior of Mx in 1973 again gave rise
to difficulties in interpreting the short-run course of monetary policy.

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

I
I

1971

|

I
1972

1973 |

|

1971

I
1972

I
1973 |

Mi
MEASURES OF MONEY

M i : C u r r e n c y h e l d outside the Treasury, F . R . Banks, and the vaults o f all c o m m e r c i a l
banks, plus d e m a n d deposits o t h e r than i n t e r b a n k and U.S. G o v t .
M2: Mi p l u s t i m e deposits at c o m m e r c i a l banks other than large certificates o f deposit.
Mr.
M'2 plus deposits o f m u t u a l savings banks and savings c a p i t a l of savings and l o a n
associations.

42



On both a month-to-month and a quarter-to-quarter basis its growth
pattern showed large variations attributable to special factors other
than basic transactions demand.
I n January, for example, growth in M 1 slowed when State and
local governments shifted revenue-sharing funds, which had been received in December, from demand deposits into time deposits and
other investment instruments. Also, speculation prior to and following the dollar devaluation in February, and the subsequent floating
of major currencies against the dollar, resulted in massive transfers
of private funds to foreign assets, which may have reduced holdings
of domestic cash balances temporarily.
The first-quarter slowing of growth in Mx was followed by an upsurge during the second quarter to an annual rate of about 11.5 per
cent. Although part of this acceleration may have reflected an adjustment to compensate for slower growth in money balances over the
previous 3 months, unusually large refunds of personal income taxes
in April and May also may have swelled demand balances and contributed to the faster second-quarter growth.

PER CENT

|

ADJUSTED
CREDIT PROXY

A d j u s t e d credit p r o x y : T o t a l member b a n k deposits subject t o reserves, plus 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 o t h e r nondeposit items.
NOTE.—Seasonally adjusted quarterly rates o f g r o w t h derived f r o m daily-average data
f o r last m o n t h of the quarter relative to those f o r last m o n t h o f preceding q u a r t e r ,
annualized.




43

Given this unusually strong April-May performance, some slowing
in the growth of the money stock during the second half was to be
expected, as the impact of high and rising interest rates in the spring
and summer induced people to reduce non-interest-earning cash balances to minimum levels consistent with transactions needs. While
the actual third-quarter slowdown was substantially larger than could
be accounted for by these influences, the subsequent acceleration of
growth in M 1 during the fourth quarter also seems to have been affected by special factors. Uncertainties related to the oil embargo
may have led the public to increase its desired holdings of cash during November and December. Also, the post-Christmas and postNew-Year holidays in Europe seem to have led to some temporary
build-up of uncleared foreign demand balances in U.S. banks at the
year-end.
Table 6: A L T E R N A T I V E MEASURES OF
Q U A R T E R L Y GROWTH I N
T H E M O N E Y STOCK
A n n u a l rates, i n per cent

Mi

Mi

Mi

Period
Q

1972—IV

9.9

8 4

10.6

10.2

11.8

11.8

I
II
Ill
IV

3.8
11.5
.2
7.5

7
7
5
3

6.9
11.1
5.2
10.1

8.8
8.7
7.9
8.5

9.4
10.4
4.5
9.2

10.7
9.1
7.2
7.3

1973—

M

M

M

0
5
5
9

Q

Q

M = Rates calculated f r o m daily-average levels i n the final m o n t h s
o f the c u r r e n t a n d the preceding quarters.
Q = Rates calculated f r o m daily-average levels for all 3 months o f
the quarter.

Expansion in broader measures of the money stock also showed
considerable monthly and quarterly variation over the course of
1973—though to a lesser extent than M x . While shifts in M 2 and M 3
were affected by the underlying pattern of movements in Mu flows of
funds into consumer-type time deposits also exhibited significant
changes during the year. These variations in the growth of thrift accounts reflected changes in the relative appeal of such deposits to
savers, as spreads between ceiling rates on such accounts and the

44



yields on competing market securities widened and then narrowed
again over the course of the year.
The preceding review of changing growth patterns in the monetary
aggregates has focused on rates of change between months at the
ends of successive quarters. Because this approach provides a relatively current measure of recent tendencies, it has often been stressed
by the FOMC in taking current policy action. To gain better
perspective on the longer sweep of growth trends in the aggregates,
however, it is useful to consider changes in average growth rates
from one quarter to the next, where all months in the quarter are included. While this approach does not give quite so timely a measure
of recent developments, it is less affected by temporary aberrations.
Thus it provides a better perspective on the underlying thrust of policy. When data for 1973 are arrayed on the latter basis, they show
more clearly (than the month-end to month-end measures) the underlying trend toward slower growth of the money stock during the
year. Recent changes for both measures are shown in Table 6.
Bank credit and bank reserves. Changes in the bank credit proxy
and in reserves against private nonbank deposits (RPD's) were also
affected by special influences over the course of the year. For example, during the first quarter of 1973 when commercial paper rates
rose relative to bank loan charges, encouraging such a rapid growth
in bank loans to businesses, the expanded sales by banks of large
CD's to accommodate these business demands contributed to a sharp
acceleration in growth of the credit proxy. While this influence moderated significantly after introduction of the two-tier prime rate,
growth in the proxy remained quite rapid during the second quarter,
as the chart on page 43 suggests. In the fall, however, when commercial paper became cheaper than bank credit as a source of business
funds, growth in business loans at large banks, in CD's, and in the
credit proxy all slowed abruptly.
During 1973 the FOMC continued to use RPD's as an operating
tool to help guide the Manager of the System Open Market Account
in making the day-to-day adjustments in bank reserves needed to
achieve the Committee's objectives for longer-run growth in the
money and credit aggregates. However, relationships between given
changes in the supply of RPD's and desired growth rates in M l 9 M 2 ,




45

Table 7: G R O W T H I N B A N K RESERVES

1973
Item

1972

1973
III
A n n u a l rate, i n per cent

10.6

Reserves required t o
(RPD's)

7.8

6.4

6.9

10.6

6.1

10.1

T o t a l reserves

9.3

7.8

12.5

14.2

1.4

1,086

111

288

s u p p o r t private deposits

I n m i l l i o n s o f dollars
Memoranda:
T o t a l change i n R P D ' s

1

.

2,938

2,692

568

927

B y type o f deposit:
R e q u i r e d reserves f o r :
Private d e m a n d deposits 1
T i m e deposits other t h a n large negotiable
CD's
L a r g e negotiable C D ' s a n d nondeposit
sources o f f u n d s 1
Excess reserves.

1,481

539

30

154

67

871

896

139

187

309

261

487

1,232

470

559

730

-527

100

25

-70

27

-21

89

• Figures have been adjusted f o r changes i n reserve requirements.

and the credit proxy were even more difficult to predict than usual.
The rapid expansion of large CD's in the spring and early summer,
and their subsequent sharp contraction—at the higher marginal reserve requirement in effect since May—first absorbed and then later
released large amounts of reserves. Because of these added complications, greater stress was placed in the implementation of monetary
policy on the performance of the money and credit aggregates themselves as intermediate targets and less on RPD's.
Interest
rates. I n addition to focusing on the behavior of the
money and credit aggregates, the F Q M C took into account movements in market rates of interest. In the short run the Federal funds
rate provides an especially sensitive guide to monetary policy since it
is directly responsive to Federal Reserve actions. This is the rate that
member banks that are temporarily short of deposits at the Federal
Reserve pay to borrow such reserves for one day from member

46



banks that have temporary excesses. When the System acts to expand or contract the total supply of reserves available to banks, its
actions are quickly reflected in changes in the level of the Federal
funds rate.
The general pattern of changes in interest rates also reflects the
strength of credit demands. Consequently, when current and prospective credit demands are large, as they were in 1973, pressures on the
financial institutions supplying funds tend to become cumulative and
to lead to general advances in the whole complex of interest rates.
This pattern of change is clearly indicated by the chart on page 37.
A l l short-term rates followed the steep rise of the Federal funds rate
during the first three quarters of 1973, although—for the reasons
noted earlier—the bank prime rate lagged behind the commercial
paper rate until early fall, and spreads between the Treasury bill rate
and other short-term rates varied at key points in the year. The abrupt rise in long-term rates during the summer—with home mortgage
rates experiencing the steepest advance—is also shown in the chart.
Some of the 1973 rise in interest rates to new historical highs undoubtedly reflected investor expectations of further inflation in domestic prices. However, long-term rates, which are the ones most
affected by inflationary expectations, showed a relatively modest increase until the third quarter. Although such rates did move up rapidly in that quarter, the increase was largely reversed after shortterm rates turned down in the fall.
Other policy actions. General advances in short-term market rates
and aggressive efforts by banks during the first quarter of 1973 to
finance large demands for business loans forced rates on longermaturity bank CD's of $100,000 or more up against their regulatory
ceilings early in the second quarter. Since rate ceilings on shorterterm CD's had been suspended much earlier—in the summer of
1970—the question arose whether such ceilings should be reimposed
or whether the remaining CD ceilings should be suspended.
The Board of Governors elected in mid-May to suspend rate ceilings on all large CD's. This action was taken as part of a regulatory
approach designed to minimize distortions in financial markets by restraining credit expansion through rising costs of funds, rather than




47

through the quantitative limitations inherent in interest rate ceilings.
To make this cost effect more significant, the Board imposed a supplementary reserve requirement of 3 percentage points on the
amount by which the outstanding volume of CD's and similar instruments exceeded the average of such deposits outstanding at midMay, or $10 million, whichever was greater.1 By late August, when
the offering rate on CD's reached 10.50 per cent, this action had increased the cost of CD funds to banks by more than 35 basis points.
A further supplementary 3 per cent reserve requirement was imposed
in late September, following a sharp, further rise in outstanding
CD's, and then removed in early December when the Middle East oil
crisis raised questions about the economic outlook.
The suspension of rate ceilings and the imposition of supplementary reserve requirements on CD's had the combined effect of permitting banks to bid freely for CD funds, while at the same time increasing the cost of such funds. These costs were passed on to
customers—chiefly large business borrowers—in the form of higher
interest rates, and in this way they exerted a marginal constraint on
credit expansion. A t the same time, adoption of this new technique
put the banks on notice that additional marginal increases in reserve
requirements might be forthcoming if bank credit were to expand too
rapidly.
I n addition to these marginal reserve requirement actions, a more
general change in reserve requirements was adopted in June (to become effective in July) as a means of reinforcing the increasingly restrictive thrust of open market operations. In this case reserve requirements were raised by V2 percentage point on all member bank
1
A t the same time Euro-dollar reserve requirements were reduced f r o m 20
to 8 per cent and the reserve-free base for Euro-dollars was reduced in several steps that would result in its complete elimination by March 1974. These
changes made the requirements on Euro-dollar funds comparable to those on
CD's and similar finance instruments (including the marginal 3 per cent
requirement).
When the Board imposed the new reserve requirement on member bank
CD's in May, Chairman Burns, on behalf of the Board, sent a letter to key
nonmember banks requesting their cooperation in conforming to the new
regulations. Specifically, such banks were requested to hold reserve deposits
against increases in large CD's and in net borrowings from foreign banks in
excess of base-period levels.

48




MAJOR SOURCES OF B A N K FUNDS, 1973
C U M U L A T I V E CHANGE, B I L L I O N S OF D O L L A R S

J

F

M

A

M

J

J

A

S

O

N

D

N O T E . — T i m e a n d savings deposits o t h e r t h a n l a r g e c e r t i f i c a t e s o f d e p o s i t a n d 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 s a v i n g s d e p o s i t s o t h e r t h a n l a r g e
C D ' s e x c l u d e those due 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 t h e 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 sources 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 .

demand deposits in excess of $2 million. The action absorbed a little
more than $850 million of bank reserves.
DISINTERMEDIATION
As noted earlier, rising market rates during the spring began to exert
growing pressures on flows of funds into consumer-type thrift accounts at financial intermediaries. Because the boom in the housing
market had created a huge demand for mortgage credit, and because
the level of mortgage commitments outstanding at savings and loan




49

associations and mutual savings banks had expanded to record levels, this deceleration in deposit growth placed these intermediaries in
a substantial bind. Moreover, it appeared that still greater pressure
was likely to develop in the months ahead unless depositary institutions were given greater leeway to bid for funds. I n these circumstances the Federal Reserve, Federal Home Loan Bank Board
( F H L B B ) , and the Federal Deposit Insurance Corporation ( F D I C )
moved in early July to raise rate ceilings on thrift accounts.
Ceiling levels were increased for all maturities of time deposits—
in most instances by V2 percentage point. In all but two cases differentials favoring the nonbank thrift institutions were maintained or increased. One of the exceptions was the passbook rate differential,
which was cut from V2 to Va- percentage point; the other was that all
three types of institutions were permitted to issue a new category of
4-year, $1,000 minimum-denomination certificates on which no ceiling rate was specified. The new ceiling-free deposits were introduced
on an experimental basis. Their purpose was to allow institutions
greater room for innovation as a means of competing with market
instruments attractive as alternatives to saving in deposit form, and
at the same time to permit small savers an opportunity to receive a
return on their savings more consistent with the value the market
was placing on those funds.
Following the liberalization of rate ceilings, depositary institutions
moved aggressively to counter the effects of rising market rates on
their deposit flows. Promotion of the 4-year, ceiling-free deposits was
particularly active. While there was considerable variation in the
terms offered on such accounts—with a few institutions linking their
rates to price indexes, to market rate series, or to the commercial
bank prime rate, and quoting rates as high as 9 per cent—the bulk
of the rates offered ranged between 7 and IV2 per cent.
During the summer all types of depositary institutions suffered declines in passbook accounts. But these run-offs were offset in varying
degrees by inflows to certificate accounts—largely the ceiling-free deposits. Commercial banks fared best—maintaining the same 10.4
per cent seasonally adjusted annual rate of growth for all consumertype time and savings deposits as had been recorded in the second
quarter. Deposits at nonbank thrift institutions, which would have

50



registered a substantial decline had it not been for interest crediting
in this period, grew at a seasonally adjusted annual rate of only 2.0
per cent for the quarter.
Although rates on ceiling-free accounts that were tied to various
indexes were most prevalent at banks, thrift institutions generally
were offering average rates as high as, or higher than, those at
banks. This may indicate that banks had somewhat greater success
than thrift institutions in holding their old accounts. If so, the inter-

SELECTED INTEREST RATES A N D
T H R I F T DEPOSIT G R O W T H

N O T E . — I n t e r e s t r a t e s : M o n t h l y d a t a . T r e a s u r y b i l l s , a v e r a g e s o f d a i l y rates o n 6 - m o n t h
b i l l s . T h r i f t i n s t i t u t i o n s , averages o f h i g h e s t c e i l i n g r a t e s p a y a b l e o n
consumer-type
d e p o s i t s a t m u t u a l savings b a n k s a n d savings a n d l o a n a s s o c i a t i o n s . D u r i n g t h e p e r i o d
J u l y 1 - O c t . 31, 1973, w h e n t h e r a t e c e i l i n g o n 4 - y e a r , $1,000
minimum-denomination
c o n s u m e r - t y p e c e r t i f i c a t e s o f d e p o s i t was s u s p e n d e d , m o s t i n s t i t u t i o n s o f f e r e d r a t e s n o
h i g h e r t h a n I V 2 p e r cent o n these deposits.
N e t flows are q u a r t e r l y changes, a t s e a s o n a l l y a d j u s t e d a n n u a l r a t e s , i n c o n s u m e r - t y p e
t i m e a n d s a v i n g s a c c o u n t s a t c o m m e r c i a l b a n k s , i n t o t a l d e p o s i t s at m u t u a l s a v i n g s b a n k s ,
a n d i n savings c a p i t a l at savings a n d l o a n a s s o c i a t i o n s .




51

est rate differential that has long existed in favor of the nonbank
thrift institutions may have resulted in a concentration of the more
interest-sensitive consumer-type funds in those institutions, which
would suggest that competition from high market rates was greater
for them than for banks. Active efforts by the nonbank institutions in
recent years to expand their high-yielding, certificate-type accounts
no doubt contributed to this apparently higher degree of interest sensitivity.
The lack of new deposit inflows necessitated sharp adjustments in
the portfolios of nonbank thrift institutions. Liquidity ratios declined
significantly, facilitated in the case of the savings associations by a
lowering of liquidity requirements by the FHLBB. Commercial bank
lines of credit were utilized, and the F H L B System provided a record amount of advances to its member associations.
As general pressures on the liquidity positions of depositary institutions intensified, the Board of Governors on September 6 approved
in principle a contingency plan for emergency credit assistance to
savings and loan associations and other nonmember depositary institutions. Action to implement this plan, however, did not become
necessary in 1973.
A t the start of the experiment with 4-year, ceiling-free accounts,
only savings and loan associations had been restricted as to the
amounts of such accounts they might offer; the F H L B B had established a limit at 5 per cent of an association's outstanding deposits.
Depositors sought the ceiling-free accounts in substantial volume,
however, and a number of associations soon found themselves close
to their limits and in a potentially weaker competitive position compared with other depositary institutions. To prevent distortions of
flows among institutions, the Board and the F D I C placed comparable 5 per cent restrictions on ceiling-free accounts at commercial and
mutual savings banks.
Despite this regulation, commercial banks achieved better deposit
flows than nonbank thrift institutions during the summer, and this
led in October to legislation requiring the Federal regulatory bodies
to place rate ceilings on all categories of consumer-type time and
savings accounts. To implement this legislation, ceilings of llA per
cent for commercial banks and IV2 per cent for mutual savings

52



banks and savings and loan associations were established on the 4year accounts, effective November 1.
By late September, however, the worst of the deposit outflow
problem for the nonbank thrift institutions had already passed. By
that time short-term interest rates had eased from their historic
peaks, and a considerable proportion of interest-sensitive deposits
apparently had been shifted into market instruments. Deposit growth
at thrift institutions accelerated in October and attained an 8.0 per
cent rate over the fourth quarter, while consumer-type time and savings deposits at commercial banks grew at a 12.5 per cent rate.

AGGREGATE FLOWS OF FUNDS
Funds raised by nonfinancial sectors of the economy during 1973 are
estimated to have totaled $183 billion, compared with $166 billion
in 1972. Although the increase in total funds raised was not appreciably different from the increase in 1972, there were considerable differences in credit market conditions in the 2 years. One clue to these
differences is that the ratio of the flow of funds to nonfinancial
sectors to GNP fell from 1972 to 1973, as it usually does during a
period of increased credit stringency, rather than rising as it had in
1972. Furthermore, while total funds raised increased persistently
from quarter to quarter in 1972, they dropped steadily in 1973 from
a first-quarter peak. A n d beneath the aggregate data there were
significant changes in the composition of fund flows that reflected
governmental policies on interest rate ceilings, the differential effects
of monetary policy on various sectors, and other factors.
One important change in the flow of funds in 1973 was the reduced role of the private financial institutions as providers of credit.
Commercial banks, thrift institutions, insurance and pension funds,
and other private financial intermediaries accounted for 66 per cent
of the credit obtained by nonfinancial sectors—down from 83 per
cent in 1972. I n contrast, the portion supplied by private domestic
nonfinancial lenders—notably households and businesses—rose from
about 6 to 15 per cent. This, of course, is the counterpart of the
phenomenon of disintermediation noted earlier.
Another sector accounting for an increased proportion of the Nation's credit supply was the Federal Government and the Federally




53

sponsored credit agencies. Because of the important role that these
agencies have come to play in supplying credit to the secondary
mortgage market as well as to primary market lenders, the share of
total funds supplied by the Federal sector reached 20 per cent in the
third quarter, when deposit flows to thrift institutions were weakest;
this was a sharp rise from the first-quarter ratio of 7 per cent.
Table 8: FUNDS RAISED I N CREDIT A N D E Q U I T Y MARKETS
BY N O N F I N A N C I A L SECTORS
I n billions o f dollars
1973
Sector, or type o f instrument

1972

1973
I

II

III

IV

Total funds raised

166.1

183.2

219.2

175.6

171.8

170.1

By sector:
U.S. Government 1
Other
N o n f i n a n c i a l business
State and local governments
Households
Foreign

17.3
148.8
69.8
12.3
63.3
3.4

9.7
173.5
87.0
8.8
70.9
6.7

32.7
186.5
94.2
6.4
71.7
14.3

1.2
174.4
87.9
6.3
73.1
7.1

-9.7
181.5
91.8
12.1
77.0
.7

14.7
155.3
78.0
10.7
61.8
4.8

By type of instrument:
U.S. Government securities
Corporate and foreign bonds
Corporate equities
State and local govt, debt 2
Mortgages
Residential
Other
Bank loans n.e.c
Open market paper
Consumer credit
Other loans

17.3
13.2
10.0
11.9
67.3
50.0
17.4
21.8
-1.6
19.2
7.0

9.7
11.8
5.5
8.9
72.2
52.0
20.2
41.3
2.5
22.9
8.5

32.7
8.7
4.0
6.1
68.3
50.5
17.8
75.1
-10.8
25.7
9.6

1.2
12.5
6.0
6.5
81.4
60.5
21.0
33.9
4.0
24.7
5.4

-9.7
13.5
3.9
12.3
80.0
56.8
23.2
36.4
4.0
22.5
8.9

14.7
16.1
8.2
10.7
59.0
40.4
18.6
19.8
12.8
18.8
10.0

1

Public debt securities and budget agency securities.
Includes both long- and short-term borrowing.
NOTE.—Data are f r o m flow o f funds accounts; quarterly figures are at seasonally adjusted annual
rates.
2

The proportion of credit supplied by the foreign sector changed
over the course of 1973; after an extended period as a net supplier
of funds, the rest of the world became a net demander during the
last three quarters. In 1972 and the first quarter of 1973—before the
U.S. dollar was allowed to float in foreign exchange markets—foreign central banks engaged in operations to support the dollar and
through these actions they accumulated large holdings of dollars.
These dollar accumulations were invested in U.S. securities, primarily

54



marketable and nonmarketable Treasury issues. As the year progressed, however, the U.S. dollar gained strength—first on the basis
of improved trade and balance of payments statistics, and later
because of the differential impacts of the Middle East oil embargo.
This led foreign central banks that were seeking to maintain exchange parities of their currencies to liquidate large amounts of their
dollars assets.
The volume of credit supplied by the commercial banking sector
was exceptionally large, but it declined strikingly as the year progressed. Expansion of bank loans and investments occurred at a rapid
pace in the first quarter, moderated in the next two quarters, and
then slowed to a very modest rate in the last quarter of the year.
Loans outstanding increased by $69 billion over the year. While
Table 9: FUNDS SUPPLIED TO N O N F I N A N C I A L SECTORS I N
CREDIT A N D E Q U I T Y MARKETS
I n billions o f dollars

1973

Sector supplying

1972

1973

I

A l l sectors
U . S . G o v t , a n d sponsored credit agencies. .
F e d e r a l 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
I n s u r a n c e a n d pension f u n d s
Other
N e t f u n d s raised i n credit a n d e q u i t y
m a r k e t s b y financial i n s t i t u t i o n s 1 . . . .
Funds advanced by private domestic nonfinancial
sectors in credit and equity
markets2
Households
N o n f i n a n c i a l business
State a n d l o c a l governments
MEMO: N e t change i n deposits a n d c u r rency h e l d b y private domestic n o n financial sectors

II

III

IV

166.1

183.2

219.2

175 6

171 8

170 1

8.3
.2
10.7

21.7
9.3
4.6

14.9
20.5
36.7

23 2
3 5
1
- 8

34 8
1 4
- 7
6

14 3
12 0
- 2
5

183 0

151 4

126 8

88 6
42 0
35 4
17 0

79 8
22 7
33 2
15 7

58 5
19.9
37 7
10 7

55

69

19

165.8

168.9

214.2

69.8
49.3
32.5
14.2

85.3
35.6
35.9
12.1

114.2
57.3
37.7
5.0

28.4

48.7

50.3

9.6

28.3

-16.7

3.1
4.6
2.0

12.5
14.3
1.5

- 1 9 . 2
6.2
- 3 . 7

102.2

90.6

124.7

2

9

3

29 2

61 8

38 9

16.0
15 4
- 2
1

40 4
16.0
5 3

13 0
19 5
6 3

97.0

66.8

74

0

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 groups 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 institutions.
NOTE.—Data f r o m flow o f f u n d s accounts; quarterly d a t a are a t seasonally adjusted a n n u a l rates.




55

bank investments in "other" securities also expanded—by about $11
billion—all but $2 billion of this portfolio increase was offset by liquidation of Treasury issues.
I n an examination of the composition of the demand for funds in
1973, strength of business, mortgage, and consumer instalment credit
stands out clearly, as the chart on page 39 shows. This strength was
most pronounced in the first half of the year when real economic activity was strongest and before interest rates rose to their highest levels. I n contrast, the credit demands of State and local governments
and of the Federal sector were relatively moderate. Most State and
local units enjoyed more comfortable financial positions as a result of
Federal revenue sharing and of large tax revenues generated by rapidly rising incomes. The volume of tax-exempt bond offerings was
down slightly from 1972, despite the continued rapid growth of industrial revenue bonds for pollution control. I n the Federal sector
rapid growth of tax revenues, in combination with restraints on expenditures, reduced the Treasury's unified budget deficit to a level

Table 10: U.S. G O V E R N M E N T F I N A N C E
I n billions o f dollars

Calendar year
Item
1971
Deficit

1972

1973
7.9

24.8

17.4

24.8

15.3

7.9

.3

8.6

15.5
-11.9

4.5
3.4

-5.4
-4.1

10.9
2.2

3.9
3.8

5.6
3.2

1.1

3.5

16.3

.5

.8

.6

A m o u n t financed by changes i n cash
2.1
Total borrowing from public
N e t Federal Reserve purchases o f
Treasury securities
N e t Treasury b o r r o w i n g f r o m private
investors:
Marketable:1
Foreign
Other
Nonmarketable:
Foreign
Other
Memoranda:
N e t b o r r o w i n g by
Government
sponsored agencies
Federal Reserve purchases o f agency
issues

8.1

-

1
Includes Treasury securities as well as securities issued directly by
budget agencies. The ownership distribution is approximate.

56



far below earlier projections; thus the limited demands of the Treasury provided an offset to the substantial needs of Federally sponsored credit agencies.
Consumer demands for durable goods remained exceptionally
strong in the first quarter of the year. The $25.3 billion annual rate
of increase in consumer credit outstanding during that quarter was
only slightly below the record of the previous quarter; commercial
banks accounted for more than one-half of the gain. As was indicated earlier, the growth in consumer expenditures for durable goods
declined after the first quarter and became negative in the fourth
quarter when auto sales declined markedly, for the most part because of the fuel shortage. As of mid-1973 the ratio of consumer
indebtedness to disposable personal income stood at a record high,
and loan delinquencies were unusually large for a business cycle
expansion.
Also adding to the debt burden of the household sector was the
massive growth of mortgage debt. Growth of such credit reached a
record volume in the second quarter of 1973, but it continued to expand at nearly as fast a pace in the third quarter, as borrowers took
down prior commitments for loans. As the year progressed, however,
the rate of growth in mortgage debt was affected by the cutback in
housing starts that had begun in the spring. While thrift institutions
played their customary role as the leading providers of residential
mortgage credit during 1973, commercial banks accounted for a substantial proportion of the flow of funds to the mortgage market. For
the year as a whole these banks supplied $18.9 billion of mortgage
credit, up from $16.8 billion in 1972; in contrast, the amount of
funds supplied by the thrift institutions declined from $37.6 billion
to $32.3 billion. A n increase in credit from Federally sponsored
agencies provided a partial offset to the reduced participation of the
thrift institutions.
The nonfinancial business sector acquired $87 billion from the
credit and equity markets in 1973, a 25 per cent increase over the
preceding year. The exceptionally large flow to businesses in the first
quarter was attributable in part to the use of bank loans to finance
purchases of higher-yielding liquid assets, such as large CD's, and to
reduce outstanding commercial paper debt. For the year as a whole,
however, the dominant factor in explaining business demands in the




57

credit and equity markets was the growing gap between capital
outlays and internal funds generated. Needs for external funds normally expand at a rapid rate in the advanced stages of a business
cycle, but during 1973 special factors were also limiting the growth
of internal funds—notably, exhaustion of available tax-loss carryforwards and the liberalization in mid-1973 of C I D restraints on
dividend payouts.
The external financing requirements of businesses in 1973 were
met largely in the debt markets—in particular, short-term debt markets. Equity financing was not attractive because share prices showed
substantial declines during most of the year. Offerings of corporate
bonds were considerably less than in 1972; in fact, the volume of
publicly offered bonds was the smallest since 1969. Given the
improvement in their liquidity positions over the period since 1970,
corporations apparently felt that they could, without undue risk,
postpone long-term financings in the hope of obtaining lower longterm rates later. As short-term rates remained relatively high toward
the end of 1973, and as prospects for inflation worsened, calendars
of issues of new corporate bonds began to build up—perhaps indicating a shift in interest rate expectations and a movement to fund
short-term debt.
The initial focus of the heavy demands by businesses for shortterm credit was on the commercial banking system. Restraints
imposed by the C I D on the bank prime rate had led, by late 1972,
to the development of a rate spread that favored borrowing from
banks as opposed to the sale of commercial paper. Thus large corporations were heavy demanders of bank loans, and so too were
smaller firms for which banks are the only regular source of credit.
Furthermore, as market rates of interest rose and commercial banks
raised their offering rates on large CD's, some prime borrowers perceived an opportunity to arbitrage by borrowing at the artificially low
prime rate and then relending at the CD rate. As a result, the expansion of business loans at commercial banks reached a record level in
the first quarter of 1973 while commercial paper outstanding
dropped sharply. Total business credit, however, still increased at a
record rate.
During the late spring and summer, rate differentials began to shift
in the direction of favoring borrowing in the commercial paper mar-

58



ket—a movement that was influenced by the two-tier prime rate concept introduced by the C I D in April, and by the imposition of marginal reserve requirements on large CD's and selected nondeposit
liabilities, noted earlier. Growth in business loans at banks decelerated in the second and third quarters, while commercial paper gradually resumed a positive trend. In September, however, market rates
of interest dropped sharply, causing commercial paper rates to
decline relative to the bank prime rate. During the fourth quarter
business loan growth at banks was quite moderate, as commercial
paper expanded rapidly.




59

International

Developments

During 1973 the U.S. balance of payments registered steady gains in
the goods and services balance, and net flows of private long-term
capital were inward for the year. As a result the basic balance
(current account plus long-term capital flows) for the year moved
into surplus for the first time since 1957, a striking reversal of the
$10 billion basic deficit in 1972.
I n the early part of the year, however, confidence that the balance
of payments would recover was at a low ebb and massive flows of
funds into other currencies precipitated a second devaluation of the
dollar in February. Subsequently six of the members of the Euro-

U.S. B A L A N C E OF P A Y M E N T S
b i l l i o n s of d o l l a r s

1
Excludes S D R allocations.
Note.—Dept. of Commerce
partly estimated.

60



data

at

seasonally

adjusted

annual

rates;

fourth

quarter

pean Economic Community (EEC) allowed their currencies to float
against the dollar, while remaining fixed among themselves. After a
period of stability in the spring, the six EEC currencies, led by the
German mark, appreciated against the dollar as well as against the
Canadian dollar, the British pound, and the Japanese yen. By July
the dollar had dropped substantially relative to E E C currencies, and
on a weighted average basis the dollar exchange rate against 10 leading foreign currencies was about 23 per cent below the level of May
1970 and 15 per cent below the level at the start of 1973.
Exchange rates stabilized after the middle of July following moderate amounts of intervention by the Federal Reserve and the
German Federal Bank. In the autumn the exchange rate for the
dollar began to appreciate markedly, reflecting improvement in the
U.S. trade balance. A major new impetus to the strengthening of the
dollar was imparted by the actions of the Middle East oil producers
in announcing limitations on production in October, followed by the
more than threefold boost in the price of oil exports by the producing countries in two steps in October and December.
Limitations on supply, even if applied most severely to the United
States, were expected to be more harmful to the economies of other
countries more dependent on oil imports as a source of energy for
industry. When increases in production were resumed, attention
shifted to the huge increases in the monetary reserves of oil-producing countries that would result if the new price structure were sustained, and the general view was that these asset accumulations
would tend to strengthen the dollar relative to other currencies
because of the likelihood that U.S. money and capital markets would
provide the best opportunity for absorbing investment flows of such
potential magnitudes, both directly and through the Euro-dollar
market.
Recovery in the U.S. balance of payments was supported by the
continuing effects of the exchange rate changes that had begun in
1970, and also by the steep rise in the quantity and price of agricultural exports. Economic activity abroad continued to advance, supporting export gains, while real output in the United States was
slowing down, reflecting in part supply bottlenecks. The improvement in the trade balance during the year, in real terms, was a con-




61

siderable offset to the slackening in the growth of effective demand
in other sectors of the economy. However, while rising demands
abroad aided the U.S. trade balance, they also added to upward
pressures on prices, especially for world-traded basic commodities,
and helped to expose a growing problem of imbalances between
demand and available supply.
Despite supply problems and the gyrations in exchange rates,
world trade in real terms grew at a phenomenal rate in 1973. A t
times pressures on particular exchange rates became severe and led
either to sizable interventions by monetary authorities or to wide fluctuations i n exchange rates, but on the whole the successive crises
were accommodated by the market without major disruption.
As the year ended, the improvement in the exchange value of the
dollar accelerated, despite large sales of dollars by some foreign
monetary authorities. During January 1974 the weighted-average
exchange rate for the dollar came near the rate at the beginning of
1973. I n view of the change in the balance of payments outlook, the
controls on outflows of U.S. private capital were relaxed in December 1973 and terminated in January 1974. A moderate drop in the
exchange value of the dollar followed the termination.

PROGRESS TOWARD EQUILIBRIUM
The U.S. trade balance swung into a small surplus in 1973, the first
surplus in more than 2 years and a dramatic turnaround from the $7
billion deficit in 1972. Exports rose very steeply, by nearly 45
per cent, while imports increased by a more moderate 25 per cent.
The expansion in exports was paced by an exceptionally large rise
in shipments of agricultural commodities as harvests outside the
United States were far below normal and the U.S.S.R. and People's
Republic of China became large purchasers of U.S. farm products.
Price increases accounted for over two-thirds of the increase in the
value of agricultural exports in 1973, as world demand exceeded
available supplies.
Exports of nonagricultural commodities also rose quite sharply—
by over 30 per cent—in 1973. More than half of the increased value
of such exports reflected larger volume. Major reasons for the
growth in nonagricultural exports were the strong economic expansion abroad and the cumulative effects of the depreciation of the

62



GOODS A N D SERVICES
B I L L I O N S OF D O L L A R S

10

+

0

10
N O T E . — D e p t . o f C o m m e r c e d a t a at seasonally a d j u s t e d a n n u a l r a t e s .

dollar that had begun in 1970 and had made U.S. goods much more
competitive in world markets. Also the tightening of price controls in
June held domestic prices of some goods below world prices (in dollars) of comparable products, encouraging export sales at higher
dollar prices by domestic producers of fertilizers, chemicals, and various metals. This incentive to export was partially removed later in
the year as the Cost of Living Council removed or relaxed domestic
price controls on metals and fertilizers.
As a result of the exceptionally rapid growth in the volume of
U.S. exports of manufactures, the U.S. share of total world trade in
manufactures rose in 1973, after many years of decline.
The increase in the value of imports in 1973 stemmed almost
entirely from higher prices; import volume remained stable except
for fuels, which increased steadily throughout most of 1973. Near
the end of the year, however, the volume of oil imports dropped as a
consequence of the embargo by Middle East oil-producing countries.
The volume of nonfuel imports in 1973 was very slightly higher
than in 1972, and this behavior was evident in most major import
commodity categories—automobiles and other consumer goods,
industrial materials (other than fuels), and foodstuffs. Only in capi-




63

tal equipment did the volume of imports rise strongly. The decline in
the import volume of other types of finished goods is probably
attributable in large part to the increasing effect of the dollar depreciations, combined with some supply difficulties encountered by foreign producers as they attempted to meet stronger domestic
demands.
With respect to nonfuel industrial materials, the quantity imported
rose only slightly, much less than would have been expected from
past relationships to the rate of domestic economic expansion. Shifts
of user demands to U.S. sources, as well as worldwide shortages of
these goods, apparently were responsible in part for this stability.
Increased availability of some metals (particularly aluminum) from
U.S. Government stockpiles may also have been a factor.
Improvement in the U.S. trade balance in 1973 was reflected in
balances with most areas. The trade deficit with Japan, which
had persisted for many years and had totaled $4 billion in 1972,
fell to about $1V4 billion in 1973, with only small monthly deficits
recorded in the second half. The trade balance with Western Europe,
which had shifted from a traditional surplus with those countries to a
deficit in 1972, swung back into a substantial surplus in 1973. The
trade balance with the less developed countries as a group also
improved in 1973. The balance with Latin America and the Middle
East countries improved despite the increase in oil imports from
those regions, but a trade deficit with Africa developed because of
larger oil imports from that area. A considerably enlarged trade surplus with Eastern Europe in 1973 reflected the heavy shipments of
grain and soybeans to the U.S.S.R.
The outlook for the U.S. trade position in 1974 depends, to a
considerable degree, on the effects of the present energy crisis. The
import bill for petroleum could rise to more than $20 billion in 1974
compared with about $8 billion in 1973, even if quantities continue
to be reduced by the embargo. Prospects for exports are clouded by
the possibly severe effects of the energy problem on economic
growth in other industrial countries and on the import capabilities of
some developing countries whose oil import costs may be especially
burdensome. In addition, one effect of the recovery in the value of

64



the dollar in the exchange markets since mid-1973 is likely to be the
erosion of some of the competitive shift derived from the earlier rate
movements.
The usual U.S. surplus from investment income and services
increased substantially in 1973, rising to a total of nearly $6 billion, more than double the surplus in 1972. Returns on U.S. investments abroad rose very sharply (in terms of dollar amounts) as a
result of the change in exchange rates, stronger economic activity
abroad, and higher petroleum prices. Interest payments to foreigners
on their assets in the United States also rose in 1973, but more moderately. Sales of military equipment to foreigners increased sharply
while military expenditures abroad showed little change. Also,
receipts from foreign travelers to the United States rose more than
expenditures abroad by U.S. travelers.
Flows of long-term private capital tended to strengthen the U.S.
balance in 1973, despite a major outflow of U.S. direct-investment
capital early in the year when further depreciation of the dollar was
expected. Thereafter outflows by U.S. investors diminished, while
foreign investors placed record amounts in the United States to purchase equity securities and to finance growing foreign direct investments in this country. Net foreign purchases of U.S. corporate stocks
were nearly $3 billion for the year.
Inflows of foreign capital for direct investment, that is, investment
involving a substantial voice in management, appear to have
approached $2 billion in 1973—far exceeding any previous experience. Such inflows were spurred in part by the lower exchange value
of the dollar and the consequent rise in the relative advantage of
producing goods in the United States. There may also have been
some inflows directly or indirectly out of the rising revenues of the
oil-producing countries. However, a factor of growing importance
may have been the restoration of confidence in the comparative
strength and stability of the U.S. economy.
Flows of U.S. private capital in shorter-term forms were strongly
outward in the first quarter of the year—including large unrecorded
outflows—but were a less significant element thereafter. After market
rates of interest in the United States moved up sharply in the first
half of the year, and the dollar strengthened in the market, there
were inflows of foreign funds to U.S. banks.




65

Table 11: U.S. B A L A N C E OF PAYMENTS
I n billions o f dollars, seasonally adjusted

Item

1972

1973
1973 •
I

Merchandise trade balance
Exports
Imports

-

6.9
48.8
55.7

.7
70.3
69.6
5.8
6.4

Services, net
Balance on goods and services

-

2.3
4.6

Remittances and pensions
U.S. G o v t , grants and capital, net
L o n g - t e r m private capital, net

-

1.6
3.5
.2

-

9.8

-

1.6
- 3.1
3.5

Balance on current account and long-term
capital
N o n l i q u i d short-term private capital, net. .
Errors and omissions
L i q u i d private capital, net
Of

which: Liabilities t o foreign commercial banks

Official settlements
S D R allocations)

balance

-

1.0
15.3
16.3

1.8
3.6
.9
1.9

-

4.0
5.8
2.6
2.9

-

5.3

-

III

.3
16.8
17.0

.7
18.2
17.4

1.2
20.0
18.9

.9
.7

-

1.1
.2

-

3.9

II

IV «

1.4
2.2

2.3
3.5

.4
.6
.3

.4
.9
1.7

.4
.7
-0)

-

-

.9

-

.6

2.5

-

1.8
3.8
3.9

-

1.4
.4
1.9

.2
1.2
.6

1.9

.7

.8

3.2

-10.5

.3

2.1

2.7

-

.6
1.5
.4

-

1.0
1.2
4.0

.9

(excluding
-11.1

-

e

Estimated.
Less than $50 m i l l i o n .
NOTE.—Dept. o f Commerce data w i t h some Federal Reserve estimates. Details m a y n o t add to
totals because o f rounding.
1

Late in 1973 a broad relaxation of the restraints on capital outflows from the United States was announced—and such controls
were terminated in January 1974. A t the same time other countries
were reducing their barriers against inflows of foreign capital, reflecting the shift that had been occurring in balance of payments positions.

INTERNATIONAL MONETARY SCENE
During 1973 financial and foreign exchange markets were alfected
strongly by changes in the outlook for the balance of payments of
the United States and other major industrial countries. Early in the
year the U.S. dollar came under severe selling pressure, as there was
continuing skepticism about the prospect for adequate improvement
in the U.S. trade balance in response to the Smithsonian realignment
of exchange rates. Large flows of funds from the United States to
EEC countries with strengthening trade positions—notably Germany

66



—produced a U.S. deficit on official reserve transactions of more
than $8 billion in the first 2 weeks of February. Following the February 12 devaluation of the dollar by 10 per cent, there was a partial
reversal of the earlier flows, but by early March renewed heavy
demand for European currencies led to further large reserve gains by
EEC countries; all official intervention in exchange markets ceased;
and these markets were officially closed.
I n early March six EEC countries (Germany, France, Belgium,
Luxembourg, the Netherlands, and Denmark) plus Norway and
Sweden agreed to maintain a fixed exchange rate relationship among
their currencies, while permitting them, as a group, to float against
the dollar. After exchange markets were officially reopened on
March 19 on the new basis, the exchange rate for the dollar against
these EEC currencies remained relatively stable until mid-May, when
demands for EEC currencies increased sharply, reflecting in part
political and economic uncertainties in this country and in part the
strong German trade account and the progressive tightening of financial policies in Germany.
With the demand for German marks pulling rates for all EEC currencies higher against the dollar than they otherwise would have

I N T E R N A T I O N A L V A L U E OF T H E U.S. D O L L A R
MAY 1970 PARITIES=100

1970

1971

1972

1973

'74

N O T E . — M o n t h l y - a v e r a g e m a r k e t e x c h a n g e r a t e o f U . S . d o l l a r a g a i n s t 10 m a j o r f o r e i g n
c u r r e n c i e s w e i g h t e d b y f o r e i g n t r a d e i n 1972. T h e w e i g h t f o r e a c h c u r r e n c y is t h e s h a r e
o f t h a t c o u n t r y ' s t o t a l t r a d e ( e x p o r t s p l u s i m p o r t s ) i n t h e t o t a l t r a d e o f t h e 10 c o u n t r i e s
p l u s t h e U n i t e d States.




67

been, by mid-1973 the dollar had depreciated against the EEC currencies by an average of 15 per cent from its February level. The
German mark was revalued at the end of June. However, the dollar
remained strong against the currencies of our major trading partners
—Japan and Canada—and, reflecting sales of dollars by Japan while
most other central banks were not intervening in the market, there
was actually a reduction in U.S. official reserve liabilities in the
second quarter of the year.
By early July exchange markets for the dollar against EEC currencies had become disorderly. Beginning July 10 the Federal
Reserve undertook intervention to stabilize the exchange rate for the
dollar, drawing on recently enlarged swap lines, and sold $273 million of foreign currencies (marks, French francs, and Belgian
francs) by the end of the month. This action was reinforced by coordinated purchases of dollars by the German Federal Bank and relaxation of a credit squeeze in the German interbank market. The
appearance of central bank intervention, together with the joint statement on July 18 of the Chairman of the Federal Reserve Board of
Governors and the Secretary of the Treasury that intervention would
take place "in whatever amounts are appropriate for maintaining
orderly market conditions," helped to restore exchange markets to
more normal functioning. The dollar strengthened by about 3 per
cent during the first weeks of August, and the Federal Reserve purchased the currencies required to repay the drawings it had recently
made on the swap network.
Thereafter the exchange value of the dollar against EEC currencies changed little through late October; this stability reflected in part
further Federal Reserve intervention totaling $236 million in marks,
particularly following the revaluation of the Dutch guilder in midSeptember. A t that time there were large flows of funds among those
European countries that were maintaining fixed exchange rates,
although these flows were smaller than the flows and reserve changes
that had occurred in February when the exchange rate for the dollar
had also been fixed. The relative stability of the dollar also reflected
continued sales of dollars by the Bank of Japan to support the yen.
These sales led to an official settlements payments surplus for the
United States of $2 billion in the third quarter.

68




A t the end of October the demand for dollars began to increase
markedly, reflecting a fundamental reassessment of the underlying
strength of the U.S. balance of payments. The proximate cause for
the shift was publication of a large trade surplus for the month of
September, but of more lasting importance was the shift in market
judgment concerning the impact on international payments of sharply
higher oil prices. Between late October and the year-end the dollar
had appreciated by 8 per cent on the average, despite central bank
sales of substantial amounts of dollars. As a result the United States
had a surplus of nearly $3 billion in the official reserve transactions
balance during the final quarter of 1973. From year-end 1973
through late January 1974 the dollar appreciated still further,
accompanied by heavy foreign central bank intervention. Following
the removal of U.S. capital controls on January 29, and the subsequent decline in U.S. interest rates, however, the dollar depreciated
and by late February was back to slightly below its year-end levels.
The periods of exchange market pressure during the year were
accompanied by sharp increases in the market price of gold. When
exchange markets stabilized, these increases were partly reversed, but
the price of gold rose sharply again in early 1974. I n mid-November
1973 the United States and the other participating European countries agreed to terminate the agreement of March 1968 regarding
official gold transactions, removing an obstacle to official sales in the
private market and thus permitting greater flexibility of action in the
future.
Against the background of adjustment and accommodation to the
strong forces that were influencing payments developments during
1973, officials continued to work on the development of agreed rules
under which the international monetary system might function with
more stability in the years ahead. The Committee of Twenty of the
International Monetary Fund presented a First Outline of Reform at
the Fund's annual meeting in Nairobi in September. This report
set forth the general shape of a possible reformed system. Among
other things it suggested a regime of stable but adjustable exchange
rates, with provision for floating exchange rates in particular situations. After the Nairobi meeting, technical groups were organized to
examine in detail various aspects of the system. These include the




69

process of adjustment of payments imbalances; provisions for the
settlement of international payments imbalances and for official intervention in exchange markets; global liquidity and the possible consolidation of outstanding reserve currency balances; and the transfer
of real resources to developing countries.
While discussions of monetary reform issues look to the future
functioning of international economic relationships, they are continuously influenced and modified by the changing economic environment and, in turn, provide one of the forums for dealing multilaterally with pressing current problems. The effects of the energy crisis
on economic activity, and especially on international trade and financial relationships, were a major concern of the meeting of the Committee of Twenty in January 1974 and of the special conference on
energy problems held in Washington in February.

70









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