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March 2,1973 Firmer Monetary Policy The world of February 1973 is considerably different from that of August 1971. Policymakers during the days of the unfolding New Economic Policy found themselves dealing with conflicting goals— stimulating a sluggish economy on the one hand, and curbing price increases on the other. But today, with the inflationary pressures of a second devaluation added to those generated by a booming domestic economy, their policy role becomes quite evident. The perennial task of "leaning against the wind" is no longer complicated by any uncer tainty about the direction from which the wind is blowing. the strong credit demands— and rising money-market rates— generated by the business boom, a hike in the discount rate "was called for in furtherance of the objectives of economic stabilization." Mean while, the System has had to contend with the turmoil in the money markets that accompanied the recent international crisis. The firmer Federal Reserve policy stance can be discerned from the recently released minutes of the December meeting of the Federal Open Market Committee, the key policymaking body. The committee agreed in December that the economic situation called for a slowdown in the growth of the monetary aggregates, in contrast to the 8V2-percent annual growth of the money stock recorded in the latter part of 1972. Devaluation impact The devaluation crisis had the short-run effect of widening the gap between the Federal-funds rate and the discount rate. (The former is the rate at which member com mercial banks borrow unused reserves from each other, and the latter of course is the rate at which they borrow from the Federal Reserve.) As the German and other foreign central banks absorbed large amounts of dollars, they utilized those dollars for substantial purchases of U.S. Government securities, both marketable and nonmarketable. Their purchases of Treasury bills were so large as to cause the three-month bill rate (daily average basis) to decline by 23 basis points in the week ending February 14 alone. Then last weekend, the Federal Reserve System began to move to a 51 /2-percent discount rate— the second increase this year— in contrast to the 41 -percent rate that /2 was maintained between December 1971 and January 1973. In view of Foreign central banks' payments for nonmarketable Treasury issues caused member-bank reserves at the Federal Reserve to decline by about $3 billion. This substantial withdrawal of reserves forced the Fed into direct open-market (continued page 2) 1 o C =0 purchases as well as repurchase agreements with dealers. (The latter represents purchases from dealers* who agree to buy the securities back at some later date.) The Treasury meanwhile attempted to offset the reserve contraction, reflected in a trading rate of over 7 percent for the Fed-funds rate, by moving cash balances at the Fed into Treasury tax-and-loan accounts at commercial banks. In addition, foreign central banks' purchases of marketable Treasury securities accentuated the difficulty of conducting open-market operations, because these purchases dried up the collateral which dealers use for repurchase agreements and which banks use to collateralize tax-and-loan accounts. Because of their inability to take on certain types of repur chase agreements, member banks increased their borrowings heavily at the Federal Reserve discount window; in the week ending February 14, borrowings averaged $2.0 billion (several times the level of mid-December) and average net borrowed reserves jumped to $1.8 billion. Prime rate quandary With the prime rate at 6 percent until recently, some short-term bor rowers turned away from the commercial-paper market, where rates on 90-119 day dealer paper were hovering around 61 percent, A and began to borrow instead from the commercial banks. Thus, com mercial and industrial loans began to grow at a rapid pace; during the first week of February, for example, such loans increased by more than $1 billion, as against a $37-million gain in the comparable week of 1972. The need to satisfy new loan demands has caused banks to expand their search for funds, with special reliance upon negotiable certificates of deposit. The primary market rate on 90-day certificates has risen 60 basis points since the beginning of the year. A liquidity problem could have resulted had commercial banks paid 61 percent A for 90-day CD money and then lent those funds out at 6 percent to prime borrowers. However, the recent discount-rate hike to 51 /2 percent and the accompanying prime-rate increase to 61 percent /4 diminishes the possibility of a squeeze of this type. Bankers now have three-guidelines to follow in dealing with the prime rate, according to Arthur F. Burns, in his second capacity as chairman of the Committee on Interest and Dividends. These guidelines help explain the delayed and relatively modest increase in the prime rate this past week. "First, if increases in the prime rate occur, they should be decidedly less than for related open-market interest rates because institutions 2 operate with certain relatively stable costs that can be spread over a rising volume of business. Second, such adjustments should be de layed until it becomes clear that the increase in open-market rates is not a temporary phenomenon. Third, if any rise in the prime rate occurs, special moderation should be ob served in any adjustments of in terest rates on small business and agricultural loans as well as on home mortgage and consumer loans." Policy stance today The December FOMC directive called for "bank reserve and money market conditions that will support slower growth in monetary aggregates over the months ahead than appears indicated for the second half of this year." The second half of 1972 saw the narrowly defined money stock, Mi— demand deposits plus currency in the hands of the public — grow at an 8V2 -percent annual rate. A firmer policy stance has been strongly evident since the December meeting. Mj remained unchanged during January, and has grown only moderately in February. Also, the discount rate has now risen twice, each time by one-half percentage point, to the present 5 V2 percent. But although the discount rate affects total borrowed reserves, its impact on M/s growth rate is less evident. Member-bank borrowing is only a small portion of the total "monetary base," which is 3 Digitized for F R A S E R composed not only of borrowed reserves but also of nonborrowed reserves and currency held by the nonbank public. The greatest impact of Fed openmarket operations falls upon the non-borrowed reserve portion of the monetary base. While unanticipated member-bank borrowing may make open-market operations more difficult for the Fed, the major movements in the monetary base are caused by open-market purchases and sales of Treasury securities. Raising the discount rate to 5 V2 percent may moderate the growth of borrowed reserves, but open-market policy still will determine the growth of total reserves and the monetary base. Today, unlike August 1971, the economy is expanding vigorously, and continued growth seems all but certain in the months ahead. Like August 1971, however, fears of accelerating inflation appear to be spreading— and with much stronger reason, because of the quickening tempo of business activity and the recent upsurge in food prices. In these circumstances, monetary and fiscal policies must play their basic role in keeping the expansion within bounds. This means not only a firmer hand on the Federal budget, but also a firmer monetary policy stance. Joseph Bisignano uoi§u|qsE/v\ • q ein • uoSaJO • EpEAajsj . oqepi IIEMEpi • BIUJOp|E3 . EUOZUV • E>)SE|V BANKING DATA— TWELFTH FEDERAL RESERVE DISTRICT (D ollar amounts in m illions) Selected Assets and Liabilities Large Com m ercial Banks Loans adjusted and investments* Loans adjusted— total* Com m ercial and industrial Real estate Consum er instalm ent U.S. Governm ent securities O ther securities Deposits (less cash items)— total* Demand deposits adjusted U.S. Governm ent deposits Tim e deposits— total* Savings O ther time I.P.C. State and political subdivisions (Large negotiable CD 's) Am ount O utstanding 2/14/73 69,455 51,458 18,424 15,268 7,897 6,770 11,227 67,723 20,617 1,852 44,160 18,032 17,498 6,279 7,079 Change from 2/7/73 + + + + + — + +1 + + — — + — + 157 176 417 60 19 42 23 ,103 339 927 25 40 41 33 36 Change from year ago D o llar Percent + 8 ,3 7 5 + 8 ,4 3 4 + 2 ,5 1 7 + 2 ,4 8 7 + 1 ,3 9 4 + 58 — 117 + 7 ,6 7 5 + 1 ,8 3 4 + 1 ,1 6 5 + 4 ,5 5 8 + 160 + 3 ,0 5 9 + 811 + 2 ,0 4 8 13.71 19.60 15.82 19.46 21.44 0.86 — 1.03 + 12.78 9.76 + 69.58 + 11.51 0.90 + + 21.19 + 14.83 + 40.71 + + + + + + 1 W eekly Averages of D aily Figures W eek ended W eek ended Com parable 2/14/73 2/7/73 year-ago period Member Bank Reserve Position Excess reserves Borrowings Net free ( + ) / Net borrowed (— ) Federal Funds— Seven Large Banks Interbank Federal funds transactions Net purchases ( + ) / Net sales (— ) Transactions: U.S. securities dealers Net loans ( + ) / Net borrow ings (— ) 4 20 — 16 67r 101 + 34r + — 34 +507 — 638 +71 +315 +128 5 0 5 •Includes items not shown separately. Information on this and other publications can be obtained by callin g or w riting the Administrative Services Departm ent. Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco, California 94120. Phone (415) 397-1137.