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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.