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APRIL
1957
-EDERAL RESERVE
BANK OF
PHILADELPHIA
MONETARY POLICY:
OUR CHANGING ECONOMIC ENVIRONMENT
The role o f the central bank has changed in the past few decades.
So has the economic environment in which it operates.
This article deals with significant changes in commercial banking,
other financial institutions, the money market, and the
importance of federal finances.
SPRING
The usual spring pick-up in automobile sales is late this year.
We talked to about 40 district dealers during the last week in
March and this article summarizes the situation as they saw it.
CURRENT TRENDS
Housing has been sensitive to changes in money policy.
Monetary policy— Federal Reserve actions to in
ognition of the need for some institution to regu
fluence the supply, availability, and cost of credit
late credit and the money supply in the interest of
— seems to be a subject of growing public interest.
economic stability led to the establishment of cen
One aspect frequently mentioned recently is the
tral banks in many countries in the first half of the
import for monetary policy of basic economic
present century. The Federal Reserve System was
changes during the past few decades. It may be
created in 1913, and since World War I approxi
helpful, therefore, to review briefly the changing
mately 50
role of central banking and the changing environ
banks. In addition to the growth in numbers, cen
countries have established central
ment in which it has operated. No attempt will be
tral banks were given added responsibilities as
made in this article to cover all significant eco
countries attempted to develop programs and pol
nomic changes of the past few decades; instead, it
icies to iron out the upward and downward swings
deals only with those changes of more significance
in business activity and employment.
for the operation of monetary policy. Although
Viewed broadly, the evolution of the concept of
the analysis deals primarily with conditions in the
what a central bank should do may be classified
United States, it has, in many respects, a broader
into three stages: preserving the gold standard,
application.
preventing excessive credit expansion and booms,
Before going into economic changes of the past
few decades, let us take a brief look at changes in
and positive and continuous action to help main
tain stability and growth.
our concept of what a central bank should do.
Protecting the gold stan d ard
EXPAN DIN G ROLE O F CENTRAL BA N KIN G
For a considerable period prior to the Great De
Central banking has a fairly long history. Banks
pression, most of the leading countries of the
performing some of the functions of a central
world were on a gold standard except during and
bank existed in most of the countries of Europe
immediately following
for many years prior to this century. Growing rec
thought that by maintaining the gold standard,
2
World War I. It was
b u sin ess re v ie w
over-issue of the currency and excessive expansion
although concerned mainly with internal eco
of credit would be prevented. The responsibilities
nomic conditions, was more passive than in recent
of the central bank were viewed as being rather
years. There was more emphasis on “ policing”
limited. Its principal task, within the limits im
conditions believed to be inimical to enduring
posed by the gold standard, was to regulate credit
stability such as checking booms, preserving the
in such a way as to minimize fluctuations in
quality of bank credit, and preventing the use of
foreign receipts and payments, and thereby pro
credit for speculative purposes. The concept of the
tect the gold reserve.
job of the central bank did not yet encompass con
The chief instrument of central-bank policy was
tinuous efforts to adjust the flow of credit and
the discount rate. An increase in the rate, by dis
money to the flow of goods and services in such a
couraging credit expansion and encouraging an
way as to help maintain over-all economic stabil
increase in foreign receipts relative to payments,
ity.
tended to induce an inflow of gold or check an
outflow. A reduction in the discount rate had the
S ta b ility and grow th
opposite effects. Economic instability within the
The severe and prolonged depression of the thir
country was of little concern in determining cen
ties focused attention on the problem of unemploy
tral-bank credit policy.
ment. It dispelled the formerly widely held view
that loss of a job was primarily one of personal
T o w ard in tern al sta b ility
responsibility; instead, unemployment came to be
In its early years, the Federal Reserve’s responsi
regarded as resulting largely from the defective
operation of our economic system. Hence, the
bilities were viewed rather narrowly. The coun
try’s external position had less influence in shap
problem of unemployment and unused resources
ing Federal Reserve policy perhaps than was the
could not be solved by uncoordinated individual
case in a number of foreign central banks. At
actions— only by centralized and coordinated
times, System actions were directed toward pro
policies directed toward removing the causes of
tecting the gold reserve. Official statements re
fluctuations in the volume of production and em
vealed more concern with objectives such as ac
ployment.
commodating commerce and business at reason
One result of this shift in opinion was that gov
able rates, safeguarding the quality of credit, and
ernment began to accept increasing responsibility
preventing an excessive use of credit for specu
for maintaining conditions which would promote
lative and other nonproductive purposes. The
full employment. World War II diverted attention
problem
of
internal
economic
stability
was
to problems of defense, but the end of the war re
viewed mainly as one of preventing excessive ex
vived fears of large-scale unemployment. The Em
pansion— of avoiding or checking a boom. By so
ployment Act of 1946 committed the Federal
doing, it was thought that a subsequent depression
Government, in cooperation with state and local
could be avoided. Depression policy usually con
governments and private industry, to coordinate
sisted of relaxing restraints imposed during the
its activities toward the objective of promoting
preceding boom. It did not include vigorous action
“ maximum employment, production, and purchas
to cushion the decline and promote recovery.
ing power.”
Federal Reserve policy prior to the depression,
Primary reliance for achieving the goals of the
3
b usin ess r e v ie w
Employment Act has been placed on monetary,
Commercial banking has undergone some far-
fiscal, and debt-management policies. Monetary
reaching changes in the past few decades: in the
policy thus became one of the primary tools— not
structure of its earning assets, and the composi
merely for preventing booms, but for maintaining
tion of the loan portfolio.
stability at high levels of production, employment,
Shift in earning assets. Prior to the Great De
and income. This ultimate objective was soon
pression, approximately three-fourths of the earn
modified to include growth. Stability is not
ing assets of commercial banks were in loans. In
enough. We want a growing economy, too.
Thus in the almost universal quest for internal
1914, for example, investments totaled nearly $4
billion as compared to over $13 billion in loans.
economic stability the Federal Reserve, as most
central banks, has emerged with a sizable and com
plicated task. It has the responsibility of using its
DISTRIBUTION OF EARN IN G ASSETS
ALL COMMERCIAL BANKS 1 9 1 4 -1 9 5 6
powers over credit and the money supply to ad
PER CENT
just total spending in such a way as to help
achieve the multiple objective of: keeping the
price level stable, maintaining “ full employment”
of labor and resources, and promoting economic
growth.
CH A N G IN G ECON OM IC ENVIRONM ENT
Concepts of the role of the central bank reflect, in
large part, the economic environment in which it
operates. Changes in the economy may also affect
the ability of the central bank to achieve its ob
jectives. We turn now to some of the more signifi
cant economic changes of the past few decades,
particularly in our financial structure.
Moreover, holdings of non-Government securities
were much larger than U. S. Government issues.
Com m ercial banking
Two significant shifts emerged from the depres
Commercial banks provide the bulk of our money
sion of the thirties. Loans began a downward
supply in the form of checking accounts— check
trend, both in total amount and relative to invest
book money. It is primarily by altering the lend
ments. Depression and then stagnation brought a
ing and investing capacity of commercial banks
sharp drop in the private demand for bank credit.
that Federal Reserve actions affect the money
Private demand continued at a low level during
supply, which in turn influences the total spending
World War II as manpower and resources were
of consumers, business firms, and others. Thus the
shifted to war and defense production.
credit activities of commercial banks— the pri
Investments in contrast to loans rose during
mary source of deposit money— play an important
most of the thirties and during the war period. The
role both in determining and in transmitting the
gold inflow of the thirties and the weak demand
impact of monetary policy on spending.
for credit built up large excess reserves. Banks
4
b usin ess re v ie w
were seeking an outlet for excess funds, especially
consistent with this theory, were regarded as
liquid, short-term investments. Deficit financing
liquid and readily convertible into cash.
by the Federal Government during the depression
In 1920, about 30 per cent of bank loans were
and World War II brought a sharp rise in Treas
against securities, the remainder being mostly
ury securities outstanding. This combination of
commercial loans. The stock-market boom of the
factors— ample reserves, a weak demand for
late twenties siphoned more bank credit into the
loans, and an increasing supply of Treasury issues
market, and in 1929 nearly one-half of bank loans
— resulted in a large increase in bank holdings of
was on securities. The earlv concept of appropriate
Government securities.
types of loans confined bank credit to narrow
By the end of the war, the relative position of
bank loans and investments had just about been
reversed. About three-fourths of earning assets
were in investments, mostly U. S. Governments,
and less than one-fourth was in loans. The post
war rise in business activity brought a sharp in
crease in the demand for bank credit, and loans
rose substantially. To obtain some of the funds
segments of the economy.
The situation banks found themselves in during
the depression nudged them into new types of
loans as well as investments. Many commercial
banks began moving into the consumer-credit
field, making loans for the purchase of automo
biles and other consumer durables. FHA insur
ance and adoption of the amortization principle
made home mortgages more suitable for banks.
needed for loans, banks reduced their holdings of
They began adding increasing amounts of these
securities, especially Treasury obligations. Com
loans to their portfolios. Technological progress
mercial banks still hold nearly $60 billion of Gov
created a growing demand for intermediate and
ernment securities, however, and investments are
longer-term credit for the purchase of machinery
considerably more important than they were in
and other equipment. To meet this need and to
the twenties.
New types of loans. A commercial bank in ex
tending credit creates a deposit and acquires an
MEMBER BANK LO A N S — U. S.
PERCENTAGE DISTRIBUTION 1 9 3 8 -1 9 5 6
PER CENT
asset. A breakdown of the loan portfolio shows the
types of economic activity being supplied with
bank credit.
Available data indicate that in the early part of
the century, bank loans consisted mostly of short
term credits to business firms, especially for
financing the trading and storage of commodities,
and loans against marketable securities. The loan
portfolio reflected the accepted principle of the
time that commercial banks, with liabilities pay
able on demand or short notice, should make only
short-term,
self-liquidating
commercial
loans.
Loans against securities, although technically in
5
b usiness re v ie w
compete more effectively with savings institutions,
chasing securities. The same is true with respect
hanks began making term loans to business. Term
to the time deposits of commercial banks. Savings
loans— usually repayable in instalments in from
institutions differ from commercial banks, how
one to five years— were better suited to the longer-
ever, in two important respects: they cannot create
term credit needs of modern industry. These newer
new money, and the total amount of credit they
types of loans, which emerged in the thirties, ex
can extend is limited by their net inflow of savings
panded rapidly in the post-war period.
instead of the availability of reserves to support
In 1938 a revision of the data reported by mem
newly created deposits. For our purposes, it is the
ber banks provided for a more detailed break
growth of these institutions and how they employ
down of loans. At the end of that year, consumer
their funds that are important.
loans were 14 per cent and non-farm home loans
In 1920, the combined assets of life insurance
18 per cent of total member-bank loans. Although
companies, savings banks, and savings and loan
not reported separately, independent surveys re
vealed that term loans to business had also in
associations were $15.6 billion— only one-third of
creased substantially. Home mortgage, consumer,
and term loans now account for over one-half of
sion and retirement fund assets for that date are
the assets of all commercial banks. Data on pen
member-bank loan portfolios.
Another significant change in commercial bank
ing is in methods employed in adjusting their re
ASSETS OF S A VIN G S INSTITUTIONS
A N D COMMERCIAL BANKS 1 9 2 0 -1 9 5 6
serve positions; however, this will be considered
BILLIONS $
in a later section dealing with changes in the
money market.
G row th of o ther fin an cial institutions
Another significant development of the past few
decades is the growth of non-bank financial insti
tutions. We shall consider briefly only three of the
more important groups: savings institutions such
as life insurance companies, savings banks, sav
ings and loan associations, and pension and retire
ment funds; institutions lending to consumers
such as sales finance companies, consumer finance
companies, and credit unions; and federal credit
agencies, most of them established in the thirties
to help alleviate the credit crisis which then
existed.
Savings institutions. These institutions are pri
marily financial intermediaries. They mobilize the
savings of millions of people and make them avail
able to borrowers either by direct loans or by pur
6
b usin ess re v ie w
DISTRIBUTION OF ASSETS
OF S A V IN G S INSTITUTIONS
DECEMBER 3 1 , 1 9 5 6
mainly in home mortgages and longer-term loans
PER CENT
$ 4 3 BlL.
business securities, primarily bonds. This repre
$33 BU-
100
to business.
The biggest block of life-insurance assets is in
$ 9 6 BIL.
Other
G o v t.*
80
sents mainly long-term credit extended to corpora
tions for the acquisition of fixed assets. Mortgages,
chiefly on homes, are their next largest asset. Life
insurance companies also hold a sizable amount
60
Business
of Government securities, mostly the longer-term
issues.
40
----- _
20
Mortgages
SAVINGS &
LOAN ASSOCS
MUTUAL
SAVINGS BKS.
LIFE
INSURANCE COS.
‘ Government consists primarily of U.S. Treasury obligations
Mutual savings banks are principally mort
gage lenders. About three-fifths of their assets are
in mortgages, mostly on residential properties.
About one-fourth of their assets is in Government
securities, and 15 per cent are in other securities,
mostly corporate bonds.
Savings and loan associations are predomi
nantly mortgage lenders. At the end of last year,
not available; however, they were quite small be
84 per cent of their assets were in mortgages—
cause the establishment of such funds did not get
under way on a large scale until later.
mostly to home owners.
Non-insured, corporate pension funds are in
The resources of these savings institutions have
vested mainly in corporate securities. On the other
increased substantially since 1920. They continued
to grow during most of the depression period, al
though at a slower rate. In the early thirties the
sharp decline in commercial-bank loans brought
DISTRIBUTION OF ASSETS OF PENSION
FUNDS— 19 5 5
bank assets down almost to the combined total of
PER CENT
the savings institutions.
100
$ 14 BILLION
$ 10 BILLION
‘"O th e r
The rise in the assets of both banks and savings
State & Local
Govt. Securities
institutions in the post-war period has been rapid.
At the end of last year, total resources of the sav
75-
ings institutions were four-fifths of the total assets
of commercial banks. In addition, the assets of
non-insured, corporate pension funds and state
U. S. Govt.
Securities
50-
and local government retirement funds totaled $24
billion in 1955.
4 ...... -
25-
Savings institutions, with less need for liquid
Corporate
ity than commercial banks, employ more of their
funds in longer-term loans and investments. Their
direct loans overlap those of commercial banks
CORPORATE
STATE & LOCAL
GOVERNMENTS
7
b usin ess r e v ie w
hand, the bulk of state and local government re
unions get practically all of their funds from the
tirement funds is put into U. S. and state and local
savings of members, but they are a small factor in
government securities. Social security funds man
total consumer lending.
aged by the Treasury are invested in U. S. Gov
ernment securities, mostly special issues.
Federal credit agencies.
Numerous
federal
credit agencies were established in the thirties,
Institutional savings, including pension and re
most of them for the purpose of alleviating the
tirement funds, have become an increasingly im
credit crisis of that priod. Many of these institu
portant source of credit during the past few
decades. Most of their funds, however, goes into
ence is most important in housing and agricul
real-estate mortgages, to corporations, to the Fed
tural credit.
tions, however, are still in existence. Their influ
eral Government, and to state and local govern
These agencies are similar to other non-bank
ments. Such funds are also primarily a source of
lenders in that they cannot directly create deposits
long-term rather than short-term credit.
and expand the money supply. The volume of their
Consumer lenders. Sales finance companies, one
direct loans is quite small but their influence on
of the first in the instalment credit field, have be
credit terms extended by private lenders is more
come an important source of consumer credit for
significant.
the purchase of automobiles and other durable
Direct loans made by federal credit agencies
goods. Last year, they accounted for 24 per cent
account for only a very small fraction of total
of all consumer instalment credit extended. At the
credit extended except in the field of agriculture.
end of 1956, sales finance companies held 29 per
Outstanding loans of Government credit agencies
cent of such credit outstanding, four-fifths of their
to aid agriculture are roughly one-third of total
holdings consisting of automobile paper.
agricultural loans. The largest amount of loans
Other financial institutions such as consumer
is by the Rural Fdectrification Administration. The
finance companies and credit unions also extend
next largest is the Commodity Credit Corporation,
consumer credit. These institutions have grown
which makes loans against commodities as part of
over the years, but each of these types of institu
the Government’s program of supporting the
tions is a much less important source of consumer
prices of selected farm products. The volume of
credit than either commercial banks or sales
CCC loans tends to rise when the prices of farm
finance companies. Collectively, however, they ac
commodities are weak and decline when farm
counted for 24 per cent of instalment loans to con
prices rise above the support level.
sumers last year, and at the end of the year held
Federal credit agencies derive their funds pri
20 per cent of consumer instalment credit out
marily from two sources: from the sale of secu
standing.
Most of these non-bank consumer lenders differ
rities in the market and from the Treasury. The
sale of their own securities, either directly or in
from savings institutions in that a substantial part
directly, to commercial banks tends to add to
of their lendable funds is derived, either directly
deposits and expand the money supply. Sales to
or indirectly, from commercial banks. To the ex
non-bank investors may tap idle balances, and to
tent that funds are derived from commercial
that extent increase total spending. The results are
banks, newly created deposits instead of savings
similar in the case of funds obtained from the
are transferred to consumer borrowers. Credit
Treasury if the latter is forced to borrow by selling
8
b usin ess re v ie w
securities. In view of the small amount of direct
loans being made by Government credit agencies,
however, the impact of obtaining the necessary
FEDERAL G O V T . EXPENDITURES AS PER CENT
OF G NP 1 9 1 4 -1 9 5 6
PER CENT
funds is relatively minor.
The principal influence of federal credit agen
cies is on the policies of private lenders. More
liberal terms on home mortgages— for example,
smaller down payments, lower interest rates, and
longer maturities— have tended to expand the de
mand for housing credit. People unable or un
willing to meet more rigid terms are induced to
borrow. On the other hand, Government guaran
FEDERAL G O V T . DEBT AS PER CENT OF TOTAL
DEBT (NET PUBLIC & PRIVATE) 1 9 1 6 -1 9 5 6
PER CENT
tees and insurance increase the availability of
credit for selected purposes. Private lenders pro
tected against losses are induced to make credit
available on easier terms and to less creditworthy
borrowers than they would be willing to do other
wise.
The bulk of Government guaranteed and in
sured loans has been made in the field of housing.
Such protection, together with popularization of
the amortized loan, have made home mortgages
more acceptable to both borrowers and lenders.
Forty-four per cent of all home loans outstanding
are insured or guaranteed by the Federal Housing
and Veterans Administrations. Government in
surance and guarantees are of minor importance,
however, in other types of lending.
Federal credit agencies may affect also the dis
Fiscal and d e b t-m a n ag e m e n t policies
In 1916, Federal Government expenditures were
$700 million or 1.5 per cent of gross national ex
penditure (G .N .P.). The federal debt amounted
to $1.2 billion, only 1.5 per cent of all public and
private debt oustanding. The financial operations
of the Federal Government were thus a relatively
unimportant force in shaping the course of eco
nomic activity.
tribution of the available supply of credit among
Two world wars and a severe depression brought
borrowers. Insurance and guarantees do not in
drastic changes. World War I pushed federal ex
crease the total supply of credit; however, they do
penditures to a peak of $18.5 billion for the year
tend to increase the amount made available for
ending June 30, 1919— about 26 times the pre
the types of loans that are guaranteed or insured.
war level. As always in a major war, the federal
Fixed maximum rates— e.g., FHA and VA mort
debt jumped also— to a peak of over $25 billion
gages— tend to divert a larger part of available
in 1919. Both expenditures and the debt declined
credit in periods of tight money into conventional
in the twenties but then began to rise in the de
mortgages and other loans affording a higher rate
pression-stricken thirties. As a result of World
of return.
War II, both federal expenditures and the debt
9
b usin ess re v ie w
soared to new all-time peaks. There was some re
by them, both the deposits and reserves of com
trenchment in the early post-war years,, bringing
mercial banks are reduced. When used to redeem
reductions in both expenditures and the debt. The
Treasury obligations held by commercial banks,
outbreak of hostilities in Korea and the “ Cold
banks regain reserves drained away by receipts
War,” however, brought another rise.
but there is no immediate increase in deposits held
For the current fiscal year, the Federal Govern
by the public. Thus the use of a surplus to retire
ment is expected to spend nearly $70 billion, and
Government securities held by the banking system
the debt is close to the wartime peak. To meet the
needs of a growing and shifting population, state
private expenditure. If, however, Government
and local government expenditures have also risen
securities held by non-bank owners are redeemed,
substantially. Federal expenditures are now equiv
there is no direct effect on total bank reserves or
tends to reduce the amount of funds available for
alent to 16 per cent of G.N.P., and if state and
the amount of funds in the hands of the public. A
local government expenditures are included, the
cash deficit increases the amount of funds in the
percentage is almost 25. The federal debt now con
hands of the public only when it is financed by
stitutes one-third of all public and private debt
borrowing from the banking system. Borrowing
outstanding. It is obvious that the fiscal and debt-
from others than banks may increase total spend
management operations of the Government have
ing, however, if it draws idle balances into use.
become a far more powerful economic force than
a few decades ago.
Treasury operations also affect the distribution
of both income and expenditures. Receipts take
Government financing affects the amount of
funds away from taxpayers or the purchasers of
funds at the disposal of the public, both directly
Government securities. Whose spending power
and indirectly. Treasury receipts, whether from
is reduced depends on where the Treasury gets
taxation or the sale of securities to non-bank in
its money. The progressive income tax, the most
vestors, siphons funds from individuals and busi
important source of receipts, tends to siphon more
ness firms. The direct effect is a shift of spendable
funds from the higher than the lower income
funds from the public to the Government. On the
groups.
other hand, every dollar paid out gives someone
Treasury expenditures also affect the distribu
another dollar to spend. Expenditures tend to re
tion of total spending. It is most unlikely that
turn funds drained away by receipts, although not
funds transferred to the Government are distrib
necessarily to the same persons or business firms.
uted in the same way that taxpayers would have
The direct effect on the total amount of funds at
used the money. Large budgets for national secu
the disposal of the public depends primarily on
rity have tended to channel spending into the hard
whether the Treasury takes in more than it pays
goods industries such as aircraft, munitions,
out. An excess of receipts tends to reduce spend
machinery, and equipment. In effect, a part of
able funds in the hands of the public; an excess of
personal and corporate income, which otherwise
expenditures tends to increase them. The final
would have been used to purchase other types of
effect, however, depends on how the surplus is
goods and services, has been diverted to the pur
used or the deficit is financed.
chase of defense supplies and equipment.
If a surplus is held on deposit in the Federal
Treasury, fiscal, and debt-management opera
Reserve Banks or used to redeem securities held
tions may affect total spending indirectly through
10
b u sin ess re v ie w
their influence on bank reserves and the money
the refinancing of maturing issues might well en
market. Treasury receipts tend to reduce privately
danger the success of the operation. If in fixing
held deposits and also bank reserves. The drain
the terms on a new issue the Treasury misjudges
on reserves occurs when Treasury balances are
the market and puts the rate too low, the Federal
transferred from commercial banks to the Federal
Reserve may have to make purchases in order that
Reserve Banks or when receipts are deposited
the offering will be successful.
directly in the Reserve Banks. When the Treasury
pays out checks drawn on the Reserve Banks in
The m o ney m a rk e t
meeting its expenses, privately held deposits and
In simple terms, the money market is the place
bank reserves are increased as the checks are col
where deposit balances are transferred through
lected. The immediate tendency is for a surplus to
purchases and sales of short-term paper and secu
reduce bank reserves and a deficit to increase
rities. Excess funds can be exchanged for liquid
them, although the ultimate effect depends largely
assets that earn income, and short-term securities
on how the surplus is used or the deficit is
can be exchanged for cash. Through the money
financed. The Treasury tries to minimize the im
market, the temporary excess funds of some are
pact of its day-to-day operations on bank reserves
made available to meet the short-term needs of
by keeping its balance in the Reserve Banks steady.
others.
Debt-management operations also affect interest
The money market has undergone marked
rates and may have an important bearing on the
changes since World War I. There has been an
effectiveness of monetary policy. The Treasury in
almost complete change in the types of credit in
choosing the types of new securities to be offered,
struments traded in the market; the market has
both in new borrowing and in refunding maturing
become much broader; and the development of
issues, may influence the distribution of Treasury
new trading techniques and practices has in
obligations between bank and non-bank holders.
creased the mobility of short-term funds.
If it chooses to issue securities attractive to the
Money-market instruments. Prior to the Great
banks, the tendency is to increase bank holdings
Depression, call loans and to a lesser extent time
and the money supply. Long-term issues, however,
loans to brokers and dealers constituted the most
are more likely to siphon in funds from savings
important part of the money market. The bulk of
institutions and other non-bank investors. Treas
ury borrowing and refinancing also affect the
M O N EY MARKET INSTRUMENTS
(END OF YEAR)
interest-rate structure and prices of securities,
PER CENT
both Government and private.
100
$ 5 B IL ■
Commercial Pape
Fiscal and debt-management policies may have
a significant influence on the effectiveness of
Acceptances
75 -
:L75..BI L.' Acceptances,
Commercial Paper
& Brokers’ Loans
Other Govts.
Within 1 Year
monetary policy. A restrictive policy may be seri
ously weakened by a federal deficit which tends to
50
Treasury Certificates
add to the money supply and vice versa. Frequent
Treasury refunding operations create administra
Brokers’ Loans
25
Treasury Bills
tive difficulties for the monetary authorities. Re
strictive monetary actions, for example, during
1926
11
business re v ie w
these loans was made by the large New York City
ments, and banks usually do not call such loans
banks both for their own account and for the ac
to meet a deficiency. Commercial paper and ac
count of others. Most of the loans were callable at
ceptances are still traded but account for only a
the option of either the lender or the borrower,
small part of the total volume of money-market
and marketable securities were pledged as col
transactions.
lateral.
The Treasury bill and other short-term Treas
The call-loan market served as an important
ury issues now account for the bulk of all trans
outlet for the excess reserves of commercial banks.
Interior banks with excess funds tended to deposit
actions in the money market. Commercial banks
and other institutions adjust their reserve and
them in larger correspondent banks. The latter, in
turn, would redeposit these balances with other
cash positions mainly by buying and selling Treas
ury bills and other short-term instruments.
correspondents so that ultimately a good part of
A broader market. The call-loan market was
excess reserves ended up in a few large banks in
used directly as a source or an outlet for funds by
New York City. Such balances were the primary
a relatively small number of commercial banks
source of funds for call loans to brokers and
and other institutions. Indirectly, through the sys
dealers. A withdrawal of balances by interior
tem of correspondent bank balances, it reached a
banks was usually met by calling some of the loans
considerably larger number. Banks also held a
to brokers. Brokers usually obtained the funds for
large part of the commercial paper and accept
repayment by borrowing elsewhere. The call-loan
ances outstanding.
market was the principal facility for adjusting
The growth of the federal debt was accom
bank reserve positions— providing an outlet for
panied by a wider distribution of the ownership
their temporary excess funds and a source of
of U. S. Government securities. Sales promotion
funds for meeting their short-term needs.
campaigns during the two world wars induced
The call-loan market, although performing
many to buy Governments who would not have
these functions fairly well in ordinary times, broke
done so otherwise. In recent years, many institu
down in periods of crises. To meet a wave of with
tions, including commercial banks, other financial
drawals by interior banks, the New York banks
institutions, large business corporations,
and
would have to call a large amount of brokers
foreign
loans, which in turn would set off heavy liquida
Treasury bills and other short-term Governments.
tion of the securities pledged as collateral. As secu
These institutions regard their holdings of short
rities prices declined, margins were impaired,
Governments as a liquid reserve to be drawn on
to meet both expected and unexpected needs for
touching off still more sales.
institutions, have become holders of
Short-term commercial paper and bankers’ ac
funds. Institutions temporarily in need of funds
ceptances were also bought and sold in the money
thus become sellers and those with excess balances,
market. The total volume outstanding, however,
buyers of short-term Governments. The wider dis
was usually considerably smaller than the amount
tribution of short-term Government securities has
of call loans.
given a growing number of institutions access to
The call loan has ceased to be a significant part
of the money market. The amount outstanding is
small as compared to other money-market instru
12
the money market, thus enabling them to even out
their flow of receipts and expenditures.
Trading techniques. In the earlier part of the
b u sin ess re v ie w
century, funds were put into and withdrawn from
the bank or corporate buyer as compared to an
the money market mainly by the granting and re
outright purchase of bills are that the risk of price
payment of brokers loans. Note brokers bought
fluctuation is eliminated, the interest rate usually
short-term paper from the issuers and re-sold it
compares favorably with the prevailing market
mostly to commercial banks with surplus funds to
rate on bills, and the purchaser can usually termi
invest. But only a minor part of money-market
nate the agreement at such time as he chooses.
transactions represented the purchase and sale of
short-term paper.
CO N CLU D IN G COMMENTS
Today, outright purchases and sales of short-
Three things stand out in this brief review of the
dated Government securities account for a good
expanding role of the central hank and significant
part of the activity in the money market. Other
changes in our economy. First, the responsibilities
techniques, however, have been developed to meet
of the Federal Reserve, as other central banks,
the needs of market participants. In the past few
have expanded as increasing attention has been
years, the market for federal funds— deposit bal
directed toward methods for achieving a stable
ances in the Reserve Banks— has grown rather
and growing economy. Secondly, Government, re
rapidly. This market enables banks with excess
flecting the impact of two world wars and a severe
reserves to lend them, typically for one day, to
depression, has become big business. Its financial
banks and others in need of immediate funds. A
operations and policies exert tremendous influ
market for federal funds developed much earlier
ence on the level and the distribution of income
but fell into disuse during the thirties when banks
and expenditures. Thirdly, the growth of com
had a plentiful supply of excess reserves, and dur
mercial banks and other financial institutions has
ing World War II and the early post-war years
greatly enlarged the pool of available credit, and
when the policy of supporting the prices of Gov
developments in lending policy have made this
ernment securities gave member banks access to
Reserve Bank credit at very low cost. The funds
credit available for financing more types of eco
nomic activity. At the same time, developments in
market enables banks to put idle balances to work
the money and capital markets have increased the
even for one day, whereas it might be unprofitable
mobility of funds both among regions and among
to buy bills one day and sell them the next because
institutions.
of the spread between the bid-and-asked quota
tions.
Another technique which seems to be growing
Whether and to what extent these environmental
changes have influenced the effectiveness of mone
tary policy can be answered only by an extensive
is the sale of short-term securities under repur
and thorough study of the many factors involved.
chase agreement— the seller agreeing to buy the
Some of the changes apparently have facilitated
securities back within a stated period or at the
achievement of the goals. The trend toward loans
option of the buyer. Many of these transactions
of longer maturity has resulted in the total volume
are also for one day, although some are for a
of commercial-bank loans being geared less closely
longer period. Selling securities under a repur
to short-term fluctuations in business activity.
chase agreement is used especially by Government
Likewise, the policy of investing residual funds in
securities dealers to tap the temporary idle funds
Government securities has had a similar result. In
of banks and large corporations. Advantages to
periods of recession, when the demand for loans
13
b usin ess re v ie w
is usually weak, banks increase their holdings of
inflow of savings, in contrast to commercial banks
Governments. In good times, when the demand for
which are limited by the amount of reserves they
loans is strong, banks liquidate Governments to
have to support the new deposits created. The
obtain funds for loans. As a result of this compen
growth of these financial intermediaries has not
satory movement of loans and investments, total
impaired the ability of the Federal Reserve to reg
bank credit outstanding has become more stable.
ulate the only type of credit that expands or con
The impact of bank credit has broadened as banks
tracts the total supply of spendable funds at the
have granted loans to more and more types of eco
nomic activity. Thus the total volume of bank
disposal of the public. Non-bank lenders, however,
may affect total spending by transferring to bor
rowers, funds which would not have been spent
credit has become less volatile and its impact on
the economy more pervasive.
otherwise. In this case, the stimulus to spending
The growth of the money market along with
arises from an increase in the rate of turnover in
more widespread holdings of Government secu
stead of an increase in the quantity of money.
rities has increased the mobility of funds. Funds
The enlarged financial activities of the Federal
are readily shifted from regions and institutions
Government may either contribute to or impair
with temporary surpluses to those with temporary
achievement of the goals of monetary policy, de
deficits. Thus the impact of monetary actions is
pending on how well the two are coordinated.
transmitted more promptly to various sectors of
Treasury surpluses and deficits of the proper
the economy. On the other hand, larger holdings
amount and appropriately timed contribute mate
of Government securities and the more efficient
rially to efforts to iron out business fluctuations.
mobilization of excess funds through the money
Advance preparation of the budget and the diffi
market have increased liquidity with the result
culty in forecasting business and financial devel
that the bite of
opments make such timing extremely difficult,
restrictive actions may be
cushioned while excess liquidity is being ab
however. It is also difficult to conduct debt-man
sorbed.
agement operations solely with regard to helping
The effects of the growth of non-bank financial
maintain economic stability. The policies of fed
institutions and the sharp rise in federal expendi
eral credit agencies, although unimportant in
tures and the debt on monetary policy are not so
terms of the volume of their direct loans, influ
clear. Non-bank lenders such as savings institu
ence the terms on which private credit is extended
tions are not directly subject to Federal Reserve
and therefore the demand for credit. Fiscal, debt
regulations. An increase or decrease in the loans
management, and other financial operations of the
and investments of these financial intermediaries
Government, if properly coordinated with mone
does not expand or contract the money supply, as
tary policy, can make a significant contribution
in the case of commercial banks. The total amount
toward achieving the common goal of stable
of credit they can extend is limited by their net
economic growth.
14
b usin ess re v ie w
WAITING FOR SPRING:
The Automobile Picture
As District Dealers See It
Robins aren’t enough. Automobile dealers need
had noticed any signs, sales or otherwise, that the
further signs before they know spring is coming.
spring selling season was beginning nor were they
They look for flocks of interested showroom vis
optimistic about the future. Only a third expected
itors, requests for demonstrations and, most of all,
a “ good” spring; the rest said, “ fair” or “ poor.”
a seasonal surge in sales.
Total registration figures substantiate these in
They are more interested in spring than most of
dividual experiences. The chart shows new pas
us because that’s when business is best. The
senger-car registrations in Philadelphia County
weather melts winter-bound sales resistance and
for 1956 and 1957. The first quarter of this year
people begin to think of riding around in a shiny
was about 25 per cent below 1956, with a drop of
new car— and many of them buy one.
34 per cent from March to March.
The spring season often determines the success
of the whole year. Sales for the crucial months of
March through June were disappointing in 1956
SALES IN 1 9 5 7 ARE WELL BELOW 1 9 5 6 LEVELS.
and the year’s total fell below expectations. The
story that spring 1957 will tell is eagerly awaited.
How are things going in the District? To find
out, we talked to about 40 dealers during the last
New passenger car registrations—Philadelphia
County
THOUSANDS
week in March. Some were doing well but most
were discouraged.
This attitude is a change from the atmosphere
of confidence that surrounded the debut of the
1957 models. Dealers were smiling; the public
liked the cars, and initial sales appeared to show
it.
Then smiles faded. The usual March pick-up
didn’t materialize. Spring came to the calendar but
not to the showroom. More than 40 per cent of the
Philadelphia dealers told us March sales were run
ning at or below mid-winter levels.
At the time we interviewed them, few dealers
15
b usin ess r e v ie w
Reports from dealers in other sections of the
niscent of the immediate post-war period, have
District indicate that conditions are spotty. Local
been revived for the most popular makes.
conditions, such as the settlement of a long strike
Yet these successes don’t bulk large in the ag
or a big lay-off, are bound to be reflected in a
gregate; they don’t offset the majority of dealers
particular area’s automobile sales. Yet even from
who aren’t doing so well.
scattered sections a general feeling can be detected.
The District’s over-all tone, though better than
W H Y SALES ARE DOW N
Philadelphia’s, does not sound good.
At this writing, we have only January and Feb
caused sales to decline this year. We got a lot of
ruary registration figures for eastern Pennsyl
answers.
We asked the dealers what, in their opinion,
vania— they are down 15 per cent from a year ago.
Lack of equity was the most frequent explana
This drop compares favorably with Philadelphia
tion. Many people still owe a large sum on their
County’s 20 per cent but is worse than the esti
present car, sometimes more than its trade-in
mated national decrease of about 4 per cent.
value. “ A guy drives in and says he owes $1,500
on his car,” says one dealer. “ When we tell him
SOME BRIGHT SPOTS
we can only give him $1,300 on it, that kills the
We have been speaking of the over-all scene and
deal right then and there.” Most drivers don’t buy
that seems pretty bleak. There are some bright
a new car until their old one is almost paid for or
spots, however.
at least until they can get enough from its sale to
Despite poor sales, inventories are in fairly
provide a down payment.
good shape. Very few dealers considered their
Why do owners have less equity than usual?
new-car stocks excessive or unmanageable. Evi
The main answer lies in the extended maturities
dently production cuts have taken much of the
and low down payments that were used to spur
pressure off dealers. This bodes well for saner
sales in the record year of 1955. Easy-term selling
selling tactics, since high inventory levels often
in 1955 is keeping some people out of 1957’s
instigate “ blitz” sales and “ crazy” deals.
market.
Many dealers are happy about their used-car
Philadelphia’s experience appears to underline
operations. Demand is strong, generally better
the significance of financing terms. The next
than for new cars. Prices seem to be holding firm
chart shows that Philadelphia registrations, as a
and inventories are normal to low.
percentage of the national total, have been on a
Chrysler Company dealers say they are having
downward trend since early 1956. Reports in
a good year. The public likes the new styles, “ fins”
dicate that liberal terms, especially 36-month
and all. Sales are strong and some dealers can’t
maturities, were more prevalent here than in the
get enough of “ hot” models, like Plymouth Belve
country as a whole. Perhaps these easier terms
deres and station wagons.
gave Philadelphia a special boost in 1955, and
High-priced, prestige cars, such as Cadillacs
the consequent slower equity build-up helps to ac
and Continentals, are also in demand. So are
count for our declining sales percentage since then.
many foreign cars. Small economy models from
Quite a few dealers think buyer resistance to
abroad are selling like the stack of hot cakes they
the higher prices of new cars has hurt sales. Basic
somewhat resemble. Customer waiting lists, remi
cars are more costly and many expensive acces-
16
b usin ess re v ie w
We asked if tighter credit conditions for custo
PHILADELPHIA’ S SHARE OF THE N A T IO N ’ S A U T O
MOBILE SALES HAS BEEN DEC LINING SINCE
EARLY 1 9 5 6 .
mers were a reason for the sluggish sales. The
New passenger car registrations—Philadelphia
County as a per cent of the United States
at all, while about 30 per cent gave an equally
PER CENT
replies were mixed. Over 50 per cent said no, not
emphatic yes. The remaining 20 per cent thought
tighter credit might have had some slight effect
on their sales.
Curiously, a number of dealers, including some
who felt their sales were reduced by tighter credit,
were in favor of it. “ Helps keep out the risky deals
we wouldn’t want anyway,” they said.
Finally, the dealer himself, by conscious de
sign, may have had something to do with his
downward sales trend. He has sold a lot of cars in
the past few years but has had to “ discount” away
part of his profit to do it. He’s getting tired of the
high-sales-low-profit paradox. Several dealers told
us this year will be different. This year they’re
sories have become almost standard equipment.
going to put the emphasis on profits not volume,
The customer gets more but he also has to pay
more and some customers are beginning to balk.
aiming for fewer sales but more profit on each.
Dealers give valid evidence of price resistance.
A SUCCESSFUL YEA R ?
They report a trend toward “ trading down” to
We didn’t hear a cheerful story when we talked to
cheaper cars; former owners of medium-priced
District dealers last month. The spring selling sea
cars are buying low-priced makes, and low-priced
son was weeks overdue and they were discouraged.
owners are settling for late-model used cars. Our
Yet things may not be so bad as they seem;
survey results substantiate this trend. We found
spring may just be a little late this year. Sales
that dealers in the middle-price field were especi
may perk up any day now and bring back deal
ally pessimistic about sales while used-car dealers
ers’ smiles. There’s still plenty of time for a
enjoyed a brisk demand.
successful year.
The customers seem to be holding back, was a
Among the encouraging signs are manageable
common observation. Dealers noticed an unusual
inventories which may enable the dealer to con
degree of public caution or buyer apathy for this
centrate on profits rather than volume. Lack of
time of year. It was hard to explain, for incomes
equity, which is now slowing sales, is self-correct
are high and the new models have been generally
ing. A few more monthly payments may do the
well received. One dealer tried to pin it down by
trick and bring many repeat customers back in the
saying that recent depression talk has shaken
market later in the year.
public confidence. He believed that people are re
While the year’s total sales will probably be
luctant to go in debt and are holding on to their
lower than expected, the dealer himself might not
money with a “ wait and see” attitude.
do so badly after all.
17
CURRENT
TRENDS
Talk about the business outlook has changed con
Most
siderably since the turn of the year. At that time
tight money is the big reason for the fall in hous
builders
and
real-estate
operators
say
most “ business outlookers” were anticipating an
ing starts. They’ll acknowledge that rising costs
other year of growth— a year during which the
and prices, plus not as many marriages as a few
very broad totals would move in the same direc
years back, are factors in the decline. But to them,
tion and by about the same magnitude as in 1956.
it’s still tight money that’s put the real crimp in
For the past month or so “ business outlookers”
housing.
have been telling a more subdued story. 1957 is
They say housing has been quite sensitive to
now to be a year during which the broad totals
changes in credit conditions for the past few years.
will move sidewise from fourth quarter 1956
They point out that in 1953 housing starts fell
levels.
below 1952 levels in spite of the generally more
Strangely, the facts do not seem to have changed
nearly so much as the talk itself. Government
favorable business climate. Money was tight over
most of 1953.
spending still looks as though it’s going to rise by
Starting in the fall of 1953, residential construc
about twice as much as in 1956. Business spending
tion activity began perking up. That was about the
on plant and equipment is expected to increase,
same time that total spending in the economy
according to the latest survey. The rise is not to be
headed downward and was some months after
nearly so large as in 1956, but this was generally
general credit conditions began to ease.
acknowledged at the turn of the year. Businessmen
Throughout 1954 easy money conditions pre
are revealing some hesitancy in their inventory
vailed and housing boomed along unperturbed by
buying. Their stock-sales ratios last December
the slump in other business activity. Ready avail
foreshadowed this consequence. Consumer buying
ability of funds on easy terms encouraged builders
so far this year has been somewhat lacklustre,
to go ahead with large-scale programs. Lower
but not exactly disappointing. If automobile sales
down payments and longer maturities reduced
pick up they would put a whole new face on the
out-of-pocket and monthly costs of buying new
consumer sector.
homes.
Housing— belo w ex p ectatio n s
strength generated by easy money conditions that
Housing zoomed in 1955 to some extent on the
One major segment of the economy seems to be
prevailed in 1954. As 1955 progressed, it became
falling below most projections— housing. Private
more and more apparent that the very strong
housing starts in February fell below 1 million on
showing was due to a flying start. In the fall of
a seasonally adjusted annual basis for the first
1955, housing starts began consistently falling be
time in over 5 years. Preliminary reports indicate
hind year-ago totals. Ih 1955 money conditions
that the seasonally adjusted figure in March also
grew progressively tighter.
will be below 900,000.
18
Last year, with tight money all the way, hous
b u sin ess r e v ie w
ing starts declined by 16 per cent. Expenditures
and VA rates hold steady, these mortgages attract
on housing fell by 8 per cent as rising costs and
funds.
larger houses offset some of the decline in starts.
It has proven difficult for the FHA and VA to
So far this year, the situation in housing has
encourage starts within an overall tight money
continued to get worse. Recently some moves have
situation. In 1956 for example, FHA and VA
been made to ease the mortgage credit situation.
raised maximum maturities to 30 years, and FHA
For example, the FHA rate has been raised to 5
reduced the required down payment on homes
per cent in an attempt to make these mortgages
priced at $9,000 or less from 7 to 5 per cent. Just
more attractive to lending institutions.
recently further relaxations have been made. Most
G o ve rn m en t in su red show w id e sw ings
smothered by the fact that institutional lenders
builders say these moves could aid starts, but are
It is signficant that over these past few years of
shifting business and money policies, the big
changes in housing starts have taken place in the
Government insured and guaranteed portions. In
1956, FHA insured and VA guaranteed starts were
down 31 per cent from the level in 1955. Conven
tionally financed housing starts were just 1 per
cent lower over the same period. On the other
hand, FHA and VA starts were 43 per cent higher
in 1954 than they had been in 1953. Convention
ally financed housing was down 6 per cent.
find so many other more profitable uses for their
funds.
M ore funds fo r ho using?
Some expect that as 1957 progresses mortgage
money will ease. Competition for funds from
businessmen for inventory and plant and equip
ment needs should not be as keen as in 1956,
though state and local governments may take up
much of that slack.
In any event, housing people hope the rise in
the FHA rate to 5 per cent will “ sweeten” those
The “ stickiness” of interest rates on FHA and
mortgages enough to attract funds going else
VA mortgages seems to be the main cause of the
where. If mortgage money does ease perceptibly,
wider swings in starts with such mortgages. When
it will be interesting to see if housing shows
interest rates generally are on the rise and FHA
the same sensitivity as in the recent past. Give the
and VA rates are held steady, these mortgages are
industry a few months to adjust to the changed
less attractive to institutional lenders. Conversely,
situation and it still seems a good bet that housing
when interest rates generally are falling and FHA
will go up if interest rates generally go down.
19
F O R THE R E C O R D . . .
BILLIONS *
MEMBER B A N K S 3R D ER.D.
»
BANKING
7'
/.V .
DEPOSITS
A
8
> V /v
T
1\a ~J\
Y
~ V
i
CHECK PAYMENTS
C20 CITIES)
1
6
5
LOANS
i
3_
t
IN VESTM EN TS
2 YEARS
AGO
Third Federal
Reserve District
Per cent change
February
195 7 from
February
195 7 from
SUMMARY
O UTPUT
M anufactu ring pro d u ctio n . . . +
C o a l m in in g ................................ EM PLOYM ENT A N D
IN C O M E
Factory employment ( T o ta l) .. .
TRADE**
Departm ent store sales............ -
year
ago
1
4
-3
-6
-4
-7
0
0
0
+ 3
0
+ 2
2
1
+ 1
+ 2
+ 1
0
+ 2
+ 7
+ 1
- 1
-2
- 1
-1
- 1
-4
—1 5 1
ot
mo.
ago
+
+
2
2
year
ago
2
2
+ 2
-5
0
+ 1
4
1
+ 3
+ 2
+ 9
- 5
- 5
- 3
+ 10
+ 2
+ 9
-5
-6
-3
+ 9
+
+
+ 4
+ 3
+
-
0
-
1
1
+ 2
+ 7
-2
-1
-3
+ 4t
0
0
- 1
- 1
+ 1
-1 3
+ 4{
0
0
2
mos.
1957
from
year
ago
+
+
C onsum er..................................... +
* *A d ju s te d for seasonal v a ria tio n .
20
1t
+ 4t
t2 0 C ities
{P h ila d e lp h ia
4
4
CH AN G ES
Departm ent Store
Payrolls
Sales
Stocks
Per cent
Per cent
Per cent
change
change
change
February
February
February
1957 from 1957 from 1957 from
Per cent
change
February
1957 from
mo.
ago
year
ago
mo.
ago
year mo.
ago ago
mo.
ago
+1
-1
-3
+
year
ago
0
+ 4
+ 4
+ 18
0
-3
+ 2
-
1 -1 2
P h ila d e lp h ia ..
0
+ 1
+ 1
+
7
0 -
0
+
+ 3
-1
-2
Scranton.......... + 2
+ 1
T re n to n ............
Per cent
change
February
1957 from
mo.
ago
year
ago
-1 0 +
6
-1 7
+
4
7 + 14
-2
-1 1
-
2
2 +
9
+ 4
-1 5
-
2
2 -
5 + 12 +
9
+ 3
-1 3
-
4
+
6 +
9 +
9
+6
-
8 +
8
-
2 +
+ 2
+ 2
+
6 -1 0 +
3 -
2
+2
- 1 0 + 20
W ilk e s -B a rre . + 2
-1
+ 1
+
5 +
4 +
4 +
4
-2
-1 5
W ilm in g to n . . .
-3
0
+
3 +
6 +
4 + 12
+ 7
- 1 5 + 12
+
1 -
3 +
6 +
+ 1
-1 2
Y o rk .................
0
year
ago
8
Lancaster. . . .
R e a d in g..........
PRICES
PEB
1957
Check
Payments
Employ
ment
LO CAL
mo.
ago
B A N K IN G
( A ll member banks)
D eposits........................................
Loans............................................
Investments..................................
U.S. G ovt, securitie s..............
O th e r .........................................
Check payments.........................
Factory*
U n ited States
Per cent change
2
mos.
1957
from
year
ago
YE AR
M50
0
-1
-2
-1
9
-
-
1
8
* N o t restricted to c o rp o ra te limits of cities but covers areas o f one or
more counties.
@FedFRASER