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May 31,1974

The Treasury made news during May
with a successful $4.1 billion financ­
ing to replace several issues of
maturing notes and bonds, with a
net paydown of $1.6 billion. The
refunding package included two
intermediate-maturity notes as well
as a $300-million issue of 25-year
bonds, which attracted a good re­
sponse from small investors with a
$1,000 minimum and an enticing
81 per cent coupon rate. During
/2
the refunding, the Federal Reserve
followed its usual practice of main­
taining "even keel."

simply debt-management objec­
tives. Prior to that date— especially
during World War II— the Fed's
primary function was to insure that
the rapidly growing Government
debt would be marketed at low
cost and would find a good recep­
tion in the financial markets. In this
environment, increased government
debt led to increased Fed purchases
of government securities, which in
turn led to an inflationary increase
in the money supply. The price paid
was an aggravation of the inflation
of the middle 1940's.

The Fed's even-keel objective is to
avoid overt actions that may under­
mine a Treasury financing. In par­
ticular, during even keel, the System
avoids operating in the open market
in a manner which the market might
interpret as reflecting a change in
monetary policy. At the same time,
the Reserve Banks make no
changes in discount rates, and the
Board of Governors makes no
change in reserve requirements.
As one benefit of even keel,
government securities dealers and
trading banks— which, in effect,
privately underwrite Treasury
financings— encounter only normal
financial risks, not sudden changes
in interest rates due to a change in
monetary policy.

When the Korean War erupted in
1950, inflation became severe again
in response to scare buying in this
country as well as worldwide short­
ages of raw materials. Under these
new circumstances, an independent
monetary policy seemed essential,
so that the Federal Reserve regained
its freedom of action under the
Accord. At the same time, the
monetary authorities promised that
when the Treasury went into the
market, the Fed would not change
monetary policy in such a way as
to complicate the Treasury's ability
to sell its securities. In this fashion,
even keel was born.

Birth of even keel
The use of the even-keel concept
dates back to the Treasury-Federal
Reserve Accord of March 1951,
which gave the Fed the freedom to
conduct monetary policy primarily
in accordance with economicstabilization objectives rather than
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Use of even keel
Even keel is not maintained on all
Treasury financings. By and large,
it is not considered to be necessary
for small offerings or for most offer­
ings of bills and shorter-maturity
notes. Instead, even keel has been
limited principally to the large
quarterly refundings and to a few
other offerings involving longerdated coupon issues.
(continued on page 2)

Opinions expressed in this newsletter do not
necessarily reflect the views of the management of the
Federal Reserve Bank of San Francisco, nor of the Board
of Governors of the Federal Reserve System.

Coupon issues are treated differ­
ently from Treasury bills, since the
longer maturity means that a rela­
tively small change in the yield is
associated with a larger change in
the price of the security and, there­
fore, a greater risk to the bond
dealer. Moreover, these issues
require several weeks to distribute
completely, so that the dealer is
exposed to a greater risk for a
greater length of time. Also, when
the Treasury issues securities on an
announced-yield basis (the usual
case until recent years) rather than
an auction basis; any mistake in
pricing the issue could lead dealers
to ignore the issue and cause the
refunding to fail. Normally, the
time span of even keel includes
the initial period of marketing and
distribution of new issues by private
underwriters— roughly from the
announcement date until payment
date or perhaps, on occasion, a
little beyond.

such direct support has been ruled
out by the System since the early
1950's, except when considered
absolutely necessary to head off the
development of potential disorder
in the market. No such direct sup­
port has, in fact, been undertaken
since 1958. The System conducts
its open market operations during
even-keel periods through pur­
chases and sales of the outstanding
stock of Treasury securities already
in the marketplace.
Consequence?
In view of the central importance
of monetary policy in the nation's
economic stabilization efforts, some
observers question whether even
keel may not at times interfere with
this more important Federal Reserve
role. Especially when the Treasury
raises new money, there is a net
increase in demands for funds,
which tends to raise interest rates.
If the Fed attempted to dampen
this increase in rates, the result
could be an expansion in openmarket purchases of Treasury securi­
ties and ultimately in the money
supply— an increase which may
not be completely offset after the
even-keel period.

Two common misconceptions about
even keel may be noted. First, even
keel does not completely rule out a
rise in interest rates during a
Treasury financing. Such a rise may
be brought about by forces external
to the Federal Reserve. Moreover,
Normally, this is not a major prob­
the current trend or posture of
lem. Most increases in Treasury new
monetary policy may be continued
money demands occur during reces­
during even keel, even if that trend
sion periods, when monetary policy
happens to be one of tightening.
tends to be easier in any event. But,
Second, even keel does not require
at times, even keel considerations
the Fed to buy part of a Treasury
may result in a faster expansion of
offering in order to ensure the suc­
cess of the offering. On the contrary,2 the money supply than stabilization
objectives might have dictated,

2
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especially if the Fed is emphasizing
interest rates— rather than monetary
aggregates— as targets. Indeed,
some critics argue that this happened
several times during the 1967-68
period, when there was a heavy
amount of war-related borrowing
at a time of full employment.
Possible changes
One major debt-management
change recently introduced has
been the use of auctioning for
Treasury notes and bonds, analo­
gous to the traditional way of
handling Treasury bills. When mar­
ket participants bid, knowing the
size of the issue, the chances of the
issue being absorbed at that price
are much greater than if the Treasury
established a price ahead of time
in the hopes the market would
absorb the entire amount. Thus,
the auction method tends to shorten
the even-keel period, by making it
less necessary to maintain even keel
prior to the auction date.
It has also been suggested that the
Fed should completely abandon the
observance of even keel. If the
System should substantially tighten
policy during Treasury financing
periods, however, private under­
writers might well suffer heavy
capital losses. Such an eventuality
could have adverse consequences
for the Federal Reserve. First, such
losses might undermine the ability
and willingness of the private
market to underwrite future Treas­
ury financings, and there would
be great pressure for the Federal

3

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Reserve itself to perform this
underwriting function. If the system
were forced to acquire new Treasury
issues, it might have to supply more
in the way of reserves than it wished
and it would run the risk, in particu­
lar, of losing control over the mone­
tary aggregates. Second, the gov­
ernment dealers “ make" the market
in which the System carries out its
open-market operations, and any
substantial weakening of the
dealer network could seriously
hamper these operations.
If the Fed withdrew from the evenkeel function, there would be a
substantial increase in the risks of
making a market in government
securities. Some dealers may leave
the business while others would
strive for larger profit margins to
cover the increased risks. Some ob­
servers consider it would be better
to permit dealers a larger rate of
return than to ease their plight by
a more expansionary monetary
policy than may be justified on
domestic stabilization grounds.
In any event, the importance of the
System's even-keel commitment has
diminished considerably over the
last twenty years, due to the decline
in the size of the outstanding
Treasury debt relative to the overall
size of U.S. financial markets. If
this trend persists, the importance
of even keel may well continue to
decline— and with it any difficulties
it may cause the Fed in implement­
ing monetary policy.
Michael W. Reran

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BANKING DATA— TWELFTH FEDERAL RESERVE DISTRICT
(Dollar amounts in millions)

Selected Assets and Liabilities
Large Commercial Banks
Loans (gross) adjusted and investments*
Loans gross adjusted—
Securities loans
Commercial and industrial
Real estate
Consumer instalment
U.S. Treasury securities
Other Securities
Deposits (less cash items)— total*
Demand deposits adjusted
U.S. Government deposits
Time deposits— total*
Savings
Other time I.P.C.
State and political subdivisions
(Large negotiable CD's)

Weekly Averages
of Daily Figures

Amount
Outstanding
5 /1 5 /7 4
82,573
64,280
1,251
23,063
19,112
9,231
5,132
13,161
78,496
21,867
736
54,650
17,860
26,919
7,222
13,824

Change
from
5 /8 /7 4
-

+
+
—

+
+
—

+
—
—

+
-

+
—

+

Week ended
5 /1 5 /7 4

Change from
year ago
Dollar
Percent
+ 9,579
+ 8,827
—
114
+ 2,880
+ 3,036
+ 955
—
882
+ 1,634
+ 7,709
+ 1,547
—
110
+ 6,166
330
+ 6,933
—
471
+ 4,614

326
89
72
107
99
7
437
22
294
240
300
148
20
200
121
58

Week ended
5 /8 /7 4

+ 13.12
+ 15.92
—
8.35
+ 14.27
+ 18.89
+ 11.54
—
14.67
+ 14.18
+ 10.89
+
7.61
—
13.00
+ 12.72
1.81
+ 34.69
—
6.12
+ 50.10
Comparable
year-ago period

Member Bank Reserve Position
Excess Reserves
Borrowings
Net free ( + ) / Net borrowed ( - )

+
+
-

16
109
93

+
+
-

45
196
151

+ 19
+ 217
-1 9 8

+

872

+

886

+ 449

+

300

+

308

+ 103

Federal Funds— Seven Large Banks
Interbank Federal funds transactions
Net purchases ( + ) / Net sales ( —)
Transactions: U.S. securities dealers
Net loans ( + ) / Net borrowings ( —)
* Includes items not shown separately.

Information on this and other publications can be obtained by calling or writing the
Administrative Services Department, Federal Reserve Bank of San Francisco, P.O. Box 7702,
San Francisco, California 94120. Phone (415) 397-1137.
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