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July 6,1973 The monetary authorities an nounced several actions last week that had the intent of tightening policy several more notches. By raising the discount rate and im posing higher reserve requirements on demand deposits, the Federal Reserve acted to restrain the "con tinuing excessive expansion in money and credit" amidst the worldwide concern over the infla tionary expansion of the American economy. Most analysts expect that the anti inflation fight will get some help from a slowdown in the GNP growth rate, since second-quarter statistics should show the annual rate of increase falling somewhat below the 8.0-percent annual rate recorded in each of the past two quarters. However, with the economy now close to effective full employment, it would be difficult to match the pace of last winter and spring. Usable industrial capacity and experienced manpower are both being worked to the limit, so that the opportunities for further accelerated growth are somewhat limited. Constraints on that other necessary economic resource— money— may soon become equally evident as the policy-tightening measures take hold. To date, however, abundant availability has been the rule, judging from the evidence provided by the Commerce Department's index of sensitive financial flows, a leading indicator of cyclical activity. (The index consists of changes in the money supply and changes in business, mortgage and consumer loans.) The level of this index was no higher in 1970 than it was in 1967, but it increased 9 percent between early 1971 and early 1972, and then jumped 17 percent be tween first-quarter 1972 and firstquarter 1973. According to early indications, this indicator moder ated in April but then surged up ward again in May. Money problems In this atmosphere of headlong credit expansion, the monetary au thorities have shown growing con cern over the recent rapid growth of the various monetary aggregates, such as the narrowly-defined money supply (demand deposits plus currency). From a rapid 8V2 percent annual rate during the fourth quarter of 1972, the money supply grew at less than a 2-percent rate over the first quarter of this year, but then grew at more than a 9-percent rate over the statistical quarter just ended. A statistical fluke related to the early-1973 international monetary crisis was partly responsible for this recent shift. Treasury bank depos its, which are not counted in this measure, were built up during the first quarter but were then shifted into private demand deposits during the second quarter, ex panding the money supply. In April and May alone, Treasury tax-andloan accounts dropped from $7.4 billion to $3.9 billion. Yet even after allowing for this factor, the mone tary aggregates have still shown an over-rapid rate of growth, necessi(continued on page 2) m O C=3 tating further attempts to cut the monetary cloth to the dimensions of the real economy. 1/2-percentage point. (The increase was applied to all but the first $2 million of net demand deposits.) In its initial attempts to counter the inflationary boom, the Federal Re serve tightened open-market policy early last winter. The flavor of these actions is found in the published minutes of the December through March meetings of the Federal Open Market Committee. These actions were supplemented in mid May, when the System turned its attention to the increasing commer cial-bank reliance on money-market sources of funds— in particular, large negotiable CD's. At that time, the Board of Governors imposed a supplemental 3-percent reserve requirement on large CD's and re lated instruments in excess of those held in the mid-May base period. The same weapon was used for credit-tightening purposes in early 1968 and again in the spring of 1969, as requirements were raised l/2-percentage point on each occasion to counter the Vietnam inflation. Thereafter, requirements affecting large (reserve city) banks were left unchanged, although a structural change was made last fall (Regula tion D), which generally reduced requirements for small and me dium-sized banks. Cutting the base Last week's action was a logical next step, as the Board moved to impose an across-the-board increase in re serve requirements on memberbank demand deposits, effective July 19. Reserve requirements were raised from 171/2 to 18-percent for the largest banks—those with de posits of more than $400 million— and the requirements applicable to smaller banks were similarly raised These changes in reserve require ments represent the use of the heavy artillery in the System's ar senal of policy weapons. According to the Board's statement, last week's action will remove about $800 million from the reserves that support the banks' loan and deposit structure. It should be added, how ever, that if the System follows its usual practice of replacing reserves through open-market operations, only the banks' profits would be immediately affected. Raising the rate The discount-rate hike draws atten tion to another increasingly used policy weapon. The rate had re mained at 41/2 percent for more than a year until last January, but has since been raised six times— twice during June alone—and now stands at 7 percent. At that point, it matches the record reached during the 1920-21 tight-money period and C=3 compares with the 6-percent high reached during the difficult 1969-70 period. More importantly, the in crease restores the discount rate's traditional relationship with the 90day Treasury bill rate and other money-market rates. The recent action permits the dis count rate to support and strengthen the effectiveness of System open-market policy. In an inflationary period like today, the Federal Reserve uses open-market operations to hold down the supply of reserves in relation to swelling credit demands, and thus acts to push market interest rates upward. In this situation, when member banks find their reserve positions under increasing pressure, they have an incentive to expand their borrowings from the Reserve banks. (Borrowings this past spring have been about three times the level of last fall and considerably above the 1969 peak.) The System thus can reinforce open-market policy by raising the discount rate, in order to discourage the creation of addi tional reserves through borrowing —and instead, to encourage the adoption of more cautious lending policies and the reduction of avail able credit. Other approaches Today's inflation problem is so in tractable that it dictates the adop tion of several other approaches besides the monetary approaches described above. Federal Reserve Chairman Burns referred to some of these possibilities in Congressional testimony last week. He referred in particular to new fiscal measures designed to cool the economy by soaking up private purchasing power. One proposal, which could have ecological as well as economic benefits, would be a tax on autos based on horsepower. Another would be the lowering of the 7-percent investment tax credit as a means of curbing the business spending boom. In addition, he proposed a compulsory saving plan, that would force corporations in inflationary times to turn over a certain proportion of their profits to a Federal Reserve escrow account, and that would then provide for a return flow of funds in less buoyant times. All these measures, designed as they are to smooth out the ex tremes of the business cycle, would provide welcome reinforcement to the anti-inflation battle right now. In their absence, continued stress must be placed upon the weapons of monetary policy, and upon such "jawbone" approaches as Chairman Burns' May letter asking banks to resist "excessive" credit demands and to exercise "prudence" in ac quiring CD's and other loanable funds. William Burke o ucn3uji|se/v\ • MBin • uoSaJO • epcAaN . oqepi neMen • emjo.p|i?3 • euozuy • e>jse|v Z£L 'ODSiDuejj ues O N llW 83d aiva 3 D V lS O d *sn 1IVW SSV1D JLSBId BANKING DATA—TWELFTH FEDERAL RESERVE DISTRICT (Dollar amounts in m illions) Selected Assets and Liabilities Large Commercial Banks Loans adjusted and investments* Loans adjusted— total* Commercial and industrial Real estate Consum er instalment U.S. Treasury securities Other securities Deposits (less cash items)— total* Demand deposits adjusted U.S. Governm ent deposits Time deposits— total* Savings Other time I.P.C. State and political subdivisions (Large negotiable CD 's) Weekly Averages of Daily Figures 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 ( - ) Am ount O utstanding 6/20 / 73 Change from 6/13 / 73 + + + + - 72,915 55,867 20,113 16,372 8,311 5,651 11,397 70,717 21,019 986 47,651 17,965 20,145 6,882 9,565 Change from year ago Dollar Percent + 9,536 + 10,071 + 3,345 + 2,742 + 1,351 725 + 190 + 8,641 + 1,950 + 58 + 6,670 — 141 + 4,835 + 1,152 + 4,390 833 717 150 102 33 67 49 275 445 566 262 29 110 105 138 W eekended 6 / 20 / 73 W eekended 6/13 / 73 + 15.05 + 21.99 + 19.95 + 20.12 + 19.41 -1 1 .3 7 + 1.70 + 13.92 + 10.23 + 6.25 + 16.28 - 0.78 + 31.58 + 20.10 + 84.83 Com parable year-ago period 23 235 - 258 - 18 229 -2 4 7 + 9 0 9 + 509 + 626 - 645 + 608 + 575 - 8 - * Includes items not shown separately. Inform ation on this and other publications can be obtained by callin g or w riting the A d m in istrative Services Departm ent. Federal Reserve Bank of San Francisco, P.O . Box 7702, San Francisco, California 94120. Phone (415) 397-1137. O p in io n s expressed in this newsletter do not necessarily reflect the views of the Federal Reserve Bank of San Francisco.
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