Full text of Economic Perspectives (Federal Reserve Bank of Chicago) : January/February 1980, Volume IV, Issue 1

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January/February 1980

Review and outlook: 1979-80
CONTENTS

January/February 1980, Volume IV, Issue 1

ECONOM IC PERSPECTIVES
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The start of a new decade
traditionally provides a convenient
point for assessments of the economic
outlook for the longer-term future.
After the long period of economic
expansion in the second half of the
1970s, most observers believe that a
recession has now begun, although they
expect it to be short and shallow. Con­
cern with inflation is worldwide, and the
primary constraint on supply is the
availability of energy essential for vir­
tually any human activity. The inflation
and energy questions are closely related
to the widening crisis in the Middle East,
which has led the President to call for
substantial increases in military outlays.
B usin e ss: t h e e x p a n s io n slow s
G o v e r n m e n t : federal g o v e rn m e n t focuses
o n inflation a n d e n e r g y
Agriculture: em b a rg o u n d e rm in e s strong
w o r l d d e m a n d fo r a g r ic u lt u r e

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E c o n o m i c e v e n ts in

7979—a

chron olog y

In tern a tio n a l: inflation a n d s l o w i n g g r o w t h
p la g u e t h e w o r l d e c o n o m y
F in a n c e : restraint v ers u s inflation
Perils o f th e 1980s

Review and outlook:
1979-80
Business: the expansion slows
tion, partly a result of three successive severe
Despite sharp cutbacks in the auto and hous­
winters.
ing industries, the economy finished 1979 sur­
While employment and production were
prisingly strong. Employment continued to
better last year than most observers expected,
rise. Industrial production remained on a
price inflation exceeded the highest rates ex­
high plateau. Business capital spending
remained vigorous. And consumers con­
pected even by pessimists. The turmoil in Iran
tinued to spend freely on most items.
touched off a rapid escalation of world oil
Early in 1980, however, evidence began
prices that played a large role in boosting U.S.
to accumulate that a cyclical downturn was, at
price indexes. But oil stringencies were only
long last, under way. Manufacturers' order
part of the problem. Other factors were
backlogs had begun shrinking in the fourth
government deficits, spreading government
quarter. Surveys of consumer and business
regulation of business, excessive growth in
attitudes showed widespread foreboding for
private credit, large increases in worker com­
the new year.
pensation in the face of declining worker
productivity, and restrictions on the use of
The Midwest did not fare generally as
natural resources.
well as the nation in 1979. The difference
reflected, in the main, con­
centration of motor vehicle
production in Michigan and
Inflation has accelerated while
Indiana. Centers specializing
real growth has slowed
in vehicles and components
had recessions starting in the
percent change, year to year
spring. Activity continued
high in m ost ce n te rs
specializing in producer
goods, Milwaukee, for exam­
ple. But the picture was
marred by labor disputes in
the farm and construction
e q u ip m e n t in d u s trie s .
Lengthy strikes depressed in­
comes in affected areas. Also
contributing to the relatively
poor performance of the
Midwest was the greater
1970
71
72
73
74
75
76
77
78
79
'80*
decline in housing construc­
•Projected.

Federal Reserve Bank of Chicago




3

Industrial production has been
on a high plateau
FRB index, 1967=100

and sellers were more careful than in 1974 in
placing and accepting orders for items with
long lead times.
Lean inventories and order backlogs free
of duplications help explain why the
economy did not skid downward in 1979,
despite severe strains in some sectors. Con­
servative mananagment policies will also tend
to moderate the adjustment that seems to be
under way now.
Output and prices

Caution pays off

Forecasts of an impending recession
were heard frequently in late 1978. Some
analysts believed the decline would start early
in the new year. As 1979 unfolded, the
economic picture was confused by severe
winter weather, oil stringencies, and a series
of unsettling developm ents abroad.
Recession-minded forecasters responded by
pushing the date further and further ahead.
Memories of the sudden decline in de­
mand that hit business in the fourth quarter of
1974 are still fresh. Inventories that seemed
reasonable as long as sales were rising
suddenly became burdensome in late 1974.
Order backlogs that had appeared firm
melted away in a rash of cancellations. Capital
goods producers, particularly, were caught in
this predicament. Market gluts quickly
replaced the shortages of the spring and
summer.
Managers kept a tight rein on inventories
all through 1979. High carrying costs, re­
flecting record interest rates, provided an ad­
ditional incentive to avoid excess ac­
cumulations. Most manufacturers chose not
to boost production if use of high-cost
marginal resources was required. Both buyers

4




The gross national product, spending on
goods and services plus additions to inven­
tories, totaled almost $2.4 trillion in 1979,11.5
percent more than in 1978. But with prices
averaging 9 percent higher, the increase in
physical volume was only about 2.5 percent.
Increases in real GNP have been less every
year since 1976, the first full year of recovery
after the 1974-75 recession. While growth in
output has slowed since the 6 percent gain in
1976, price inflation has accelerated every
year. Last year's 9 percent price rise was the
largest since 9.5 percent in 1974 and 1975.
Transportation, manufacturing, and con­
struction were hampered in the first quarter
last year by extreme cold and winter storms
that afflicted most of the northern states, es-

Business investment rise
continued through 1979
billions of 1972 dollars

Economic Perspectives

pecially the great industrial areas of the
M idwest and Northeast. Nevertheless,
measured by real GNP, activity increased
slightly during that period.
As the weather improved, the economy
faced a new problem—shortages of gasoline
and diesel fuel associated with the cutoff of oil
shipments from Iran. Long lines of vehicles
formed at gas stations, especially on the East
and West coasts. Motor transport was slowed
by the reduced availability of diesel fuel, and
the slowdown was reinforced by strikes of
independent truckers protesting high fuel
prices and private rationing.
Fuel prices rose sharply, with gasoline up
more than 40 percent in the first half of the
year. In June, per-gallon prices passed the$1 a
gallon mark for the first time. Higher prices
for fuel and, even more, concern over ability
to obtain fuel had a dramatic effect on some
sectors. Sales of large cars, light trucks, and
recreational vehicles plummeted. Tourism
was hard hit. Housing sales were also affected,
especially in areas far from urban centers.
The upshot was a one-quarter recession.
Real GNPdeclined in thesecond quarteratan
annual rate of about 2 percent.
The third quarter saw a modest revival.
Fuel supplies improved, mainly because of
conservation. Construction crews made up
most of the time lost during the winter. But
businessmen and consumers were still
cautious in making new commitments.
Improvement in activity in the third
quarter appeared at first to be mainly a reac­
tion to problems encountered earlier in the
year, with the underlying trend still down. But
further growth was apparently achieved in
the fourth quarter. Final sales were buoyed by
business spending on plant and equipment
and consumer spending on nondurable
goods and services.
In retrospect, the economy stood up well
to the weather and fuel problems of 1979. But
the effects are far from over. Nearly all
doubters are now convinced that energy
stringencies are real and likely to become
more pressing in years to come. The impact
on patterns of consumption and business
investment will be profound.

Federal Reserve Bank of Chicago




Consumer price rise accelerates

The Consumer Price Index (CPI) for all
urban consumers averaged 11.3 percent
higher than in 1978, a substantially faster rate
of rise than for the general price level
measured by the GNP deflator. Mainly
reflected in the difference are the fixed
weights for the CPI, which do notvary asconsumers adjust to changes in relative prices.
The deflator is weighted every quarter. Also,
the CPI assigns more importance to costs of
fuel and homeownership, both upsharply last
year.
Trends in the CPI are crucially important,
because the index is used in automatically es­
calating wages and other payments covered
by cost-of-living adjustments (COLAs), often
in addition to other agreements to increase
compensation. Even without a contractual
obligation, employersmay looktotheCPI asa
guide when raising wages or pensions. COLA
adjustments, becoming steadily more com­
mon, have the effect of building in past infla­
tion and fueling future inflation.
Up from 7.7 percent in 1978, the 11.3 per­
cent rise in the CPI last year was almost twice
the rise in 1976. It slightly exceeded the rise of
1974, then by far the largest for any year since

The rise in the Consumer Price
Index accelerated last year
index, 1967=100, middle month of quarter

5

World War II price controls were removed in
1946.
In November, the CPI was 12.6 percent
higher than a year earlier. Unlike some years,
the main culprits were not costs of food and
medical care, both rising less than 10 percent.
Apparel rose less than 4 percent. The main
culprits were energy, up 36 percent, and
homeownership, up 18 percent. For many
families, these costs rose much more, par­
ticularly if they heated with oil or negotiated a
new home mortgage.
Unlike a year ago, few analysts expect
consumer price inflation to moderate this
year. Higher oil and natural gas costs are only
partially reflected in retail prices so far, and
further increases in basic fuels are inevitable.
Housing is in short supply, with costs rising
rapidly. Advancing incomes enable many
consumers, however, to maintain their buy­
ing patterns without difficulty.
Employment and spending

Despite sizable layoffs in the motor ve­
hicle industry, jobs remained plentiful
throughout 1979, except for depressed innercity areas. Take-hom e pay of most
autoworkers was maintained, temporarily at
least, by public and private unemployment
benefits.
Total employment rose 300,000 in
December to reach 98 million. The 12-month
rise was 2 million, after increases of 3 million
in 1978 and 4 million in 1977. Since 1975,
employment has risen an unprecedented 13
million. Unemployment, people without jobs
and seeking work, was estimated at 5.9 per­
cent of the labor force in December, about
the average for the year, and well below the
8.5 percent average for 1975.
Personal consumption expenditures rose
almost 12 percent in 1979, slightly more than
in each of the three previous years. In real
terms, the rise was only about 2.5 percent,
however, the smallest increase since 1975.
Higher consumption expenditures mainly
reflected higher disposable (after-tax) in­
come, up almost 11.5 percent last year. But a
drop in the savings rate also helped. Savings is

6




Large wage gains and poor
productivity boost costs and prices
percent change, year to year

defined as disposable income not spent on
consumption. Savings dropped to 4.5 percent
of disposable income last year, down from 5
percent in 1977 and 1978 and over 7 percent in
the early 1970s, to the lowest rate since 1949.
The low savings rate of recent years partly
reflects heavy use of instalment credit, and
sometimes mortgage credit, to finance con­
sumer purchases. Willingness to incur debt, in
turn, reflects both confidence in future in­
come and the belief that inflation will con­
tinue to erode the buying power of money.

Nonfarm employment shows
vigorous growth
million workers

Economic Perspectives

Most households are protected, more or
less, against the risks of sickness, old age, and
unemployment. Many also benefit from
government subsidies for food, housing,
heating, transportation, and education. The
preference for spending over saving fuels in­
flation both by adding to total spending and
by reducing the volume of funds availablefor
investment.
Because employment is expected to
decline in 1980, at least in the first half, growth
in consumption spending is likely to
moderate. Individual incomes, however, are
likely to grow faster. Total compensation per
hour in the private economy, including non­
wage income, rose 9 percent last year—more
than in any year since 1975. The 7 percent
guideline for increases in compensation, a
dampening influence on some sectors last
year, is expectd to be raised. Unions are in­
creasingly militant and successful. Pressure to
meet union gains in nonunion sectors is
growing. Partly because of leveling or declin­
ing output, productivity changes are likely to
continue to be small or negative. As a result,
increases in compensation will tend to be ful­
ly reflected in unit labor costs and, therefore,
selling prices.

Construction and housing

Outlays on new construction increased
about 9 percent last year. Corrected for infla­
tion, however, the data show construction
down about 3 percent. Broad categories of
construction showed remarkable differences.
Nonresidential private construction was up
about 8 percent in real terms. Residential con­
struction was down 6 percent, and public
construction was down 10 percent.
Within the nonresidential private sector,
construction of office buildings soared 25
percent in real terms. Stores and other com­
mercial structures were up 14 percent. The
boom in office buildings, a revival after the
sharp drop of the mid-1970s, was concen­
trated in the downtown areas of major cities,
with Chicago a leading example.
As in past periods of higher interest rates,
housing was affected more than other types

Federal Reserve Bank of Chicago




Instalment credit growth outpaced
outlays in consumer durables
billion dollars

1975

1976

1977

1978

1979

•Estimated.

of construction. New housing construction
had held up surprisingly well in 1978 despite
tightening credit markets as thrift institutions
tapped new sources of funds through sales of
money market certificates and "jumbo" CDs.
Also, a large volume of securities collater­
alized by home mortgages were sold in the
capital markets.
About 1.7 million new residential units
were started in 1979, down 16 percent from
1978 and well below the 1972 peak of 2.4
million. Starts were down more than 40 per­
cent in theChicago area and about 28 percent
in the North Central region. The larger
decline in this region reflects relatively slower
growth, less speculative building, more con­
servative lending practices, and the bad
weather of recent years.
The construction outlook for 1980 is for
continued strength in nonresidential
building, at least for the first half. Contracts
have already been awarded for most of this
work and firm financial commitments are out­
standing. New mortgage loan commitments,
however, were hard to obtain for any kind of
construction project in late 1979 as recordhigh interest rates attracted funds to the
short-term money markets. As a result, non­
residential construction may slow later this
year, despite a scarcity of high-quality, well-

7

Housing starts begin downward trend
million units
3.0 "

located commercial and industrial buildings.
Public construction will be sluggish again
this year, depending in part on the release of
funds for federally sponsored programs. Most
municipalities have a long list of needed pro­

jects that they have been unable to finance.
Arresting the deterioration of roads and
bridges throughout the country will require
billions of dollars, but funds are lacking now,
partly because of reduced collections of fuel
taxes.
Residential construction was dropping
sharply in late 1979, even with the allowances
for seasonal trends. Most analysts are
forecasting starts on 1.4 million units this year,
with the annual rate maybe as low as 1.2
million in the first or second quarters. Even so,
that will be better than the 1972-75 period,
when starts dropped more than 50 percent.
Federal subsidies will directly aid starts of
200,000 units in 1980, mainly apartments. Any
easing of credit will help the private market.
No large volume of unsold single and mul­
tifamily units overhangs the market as in 197374. An accelerating rate of household for­
mations requires a high level of residential
construction to prevent a serious housing
shortage in the years ahead.

Government: federal government
focuses on inflation and energy
Fiscal policy of the federal government was
aimed all year at attacking inflation. The
Economic Report of the Presidentand the ad­
ministration's budget message for fiscal 1980,
both presented to Congress in January, show­
ed the attack was to be carried out along two
related lines.
• The federal deficit was to be progressive­
ly reduced, reaching a balanced budget in
fiscal 1981.
• Budget outlays were to be reduced as a
proportion of GNP from 22.1 percent in 1978
to 21.2 percent in 1980 and 20.3 percent in
1982.
When these plans were laid a year ago,
the administration expected unemployment
to average 6.2 percent for 1979 and inflation,
as measured by the consumer price index, to
run about 7.5 percent. On the basis of these
expectations, the administration had forecast

8



outlays of $493.4 billion for fiscal 1979 and a
deficit of $37.4 billion, about $11 billion less
than the fiscal 1978 deficit.
Fiscal 1979—the outcome

For the first time in several years, federal
spending was close to the estimate made in
January. When the fiscal year ended in
September, actual outlays were $493.6 billion,
only $200 million less than expected nine
months earlier. It seems likely, however, that
had it not been for rapid inflation and higher
interest rates, the shortfall of expenditures
from the levels projected (a regular event for
the past several years) would have occurred
again in fiscal 1979. As late as July, the Office
of Management and Budget was estimating
outlays $3 billion higher than they turned out.
The combined impacts of lower un­

Economic Perspectives

employment and higher inflation raised
revenues over the expected $456 billion to an
actual $465.9 billion, leaving a deficit of $27.7
billion, nearly $10 billion less than thejanuary
forecast. When the budget for fiscal 1979 was
first presented in January 1978, the proposed
deficit was $61 billion. The difference
between the deficit originally proposed and
the actual deficit represents a significant
change in the administration’s view of how
fiscal policy should be used to affect the
general economy.
Increased revenue sources

Major tax changes reducing income tax
rates for individuals and corporations but
increasing payroll taxes became effective
January 1, 1979. Because of the way income
taxes are paid, the full impact of the changes
did not show up completely in fiscal 1979 or
even calendar 1979. Final settlement of 1979
personal income taxes will not be made until
April 1980. Corporations will not settle until
June 1980. It is estimated, however, that total
receipts for fiscal 1979 were $11 -$12 billion
less than if the rates had not been reduced.
With the differences in timing taken into
account, the increase in personal income tax
receipts was over 20 percent more than in
fiscal 1978. Withheld income taxes, which
make up about three-fourths of all income tax
receipts and are closely related to wage and
salary payments, rose 18.2 percent. During
that time, wage and salary payments rose just
under 12 percent.
Thus, despite the tax cut, which lowered
the withholding payments at any given salary
level, the progressiveness of the taxes with
income combined with higher salary and
employment levels to raise personal income
taxes substantially. Some analysts suggest that
the tax withholding levels understated the
effect of the tax reduction so that refunds this
spring may be higher than usual.
Similar increases were made in receipts
from Social Security taxes. The basic tax rate
was increased only slightly, from 6.05 percent
in calendar 1978 to 6.13 percent in 1979. The
maximum income on which the tax was due

Federal Reserve Bank of Chicago




increased, however, from $17,700 to $22,900,
with the result that revenues went up to 15.5
percent.
Corporate income tax payments did not
go up as much. They rose a little over 9 per­
cent, about the same as in fiscal 1978, and less
than they would have without the tax cut.
Personal income and payroll taxes
provide the main receipts. Corporate income
taxes are the third largest source. Together,
these three tax sources provided over 86 per­
cent of the tax revenue in fiscal 1979, up
steadily each year from just under 84 percent
in 1976.
Where the federal money went

Income maintenance programs still make
up the largest single classification of federal
spending, as they have since they first exceed­
ed defense spending in fiscal 1974. Close to a
third of net federal spending wentfor income
maintenance in fiscal 1979. That was nearly
$45 billion more than went for national
defense. Of the $160.5 billion spent on
income maintenance, payments generally
thought of as Social Security (federal old age
and survivor benefits and federal disability
payments) accounted for the largest share. Up
more than over 11 percent from fiscal 1978,
they exceeded $100 billion for the first time.
The third largest outlay was $52.6 billion
paid for interest expenses, up 19.5 percent
from 1978. Next was expenditures on health,
at $49.6 billion, up 13.6 percent. Except for
spending on education, training, employ­
ment, and social services, no other category
of spending was as large as 5 percent of net
total outlays.
In a few categories, spending was less
than in fiscal 1978. Agriculture outlays, for
example, were down about 16 percent to $6.4
billion. Spending on commerce and housing
credit was also down, as were outlays for com­
munity and regional development.
The outlook— fiscal 1980 and beyond

The objectives of progressively lower
deficits leading toward balanced budgets and

9

lower government spending as a share of GNP
remain in the forefront of theadministration's
fiscal plan. It now appears unlikely, however,
that the budget can be balanced before fiscal
1982. When fiscal 1980 began, both the ad­
ministration's projections and the second
congressional budget resolution suggested a
deficit in the neighborhood of $30 billion. Re­
cent estimates indicate the deficit is more
likely to approach the $40 billion level.
Expectations vary slightly, depending on
assumptions about the general economy.
Receipts will also depend on the final version
of the “ windfall profits" tax on the oil in­
dustry. Outlays will be effected by how fast
receipts from the tax are appropriated to new
spending.
The dependence of both receipts and
outlays on general economic conditions com­
bined with the cost of the Soviet grain em­
bargo and the impact of the problems in Iran
and Afghanistan suggest that the deficit will
be larger than either Congress or the ad­
ministration originally expected.
Some private political observers suggest
that, as 1980 is an election year, there may be a
tax cut of as much as $30 billion. The ad­
ministration has consistently taken the view,
however, that a tax cut would be a severe set­
back in the fight against inflation, and there
has been no significant work on legislation to
enact such a cut.
Barring far worse performance of the
economy than expected in the next few
quarters, it seems unlikely that a tax cut could
be enacted in time to have any significant
effect on fiscal 1980. Even a tax reduction bill
passed before the November elections with
retroactive provisions would have most of its
effect in fiscal 1981.
Maybe more significant than receipts,
outlays, and the deficit expected for fiscal
1980 is the shift in priorities for 1980 and the
years beyond. Almost every year since the
Viet Nam War, the proportion of the budget
allocated to defense has declined. Adjusted
for inflation, defense spending has stayed
relatively flat since 1973.
Beginning in 1980, it is planned for
defense outlays to increase 3 percent a year,

70




after adjustment for inflation. Spending could
increase even faster in later years. Plans call
for budget authority (allocation of funds for
spending in future years) to increase 4.5 per­
cent in fiscal 1981. Increases in defense spend­
ing combined with pressure to lower total
government spending relative to GNP means
spending on categories other than defense
must increase significantly slower than
growth of the total economy. Since many
programs, particularly Social Security, have
legislated ties to the inflation rate, there will
be severe pressure to reduce programs fund­
ed year to year.
With the emphasis on defense and the
pressure for a balanced budget coming
together in an election year, establishing a
program for fiscal 1981 could entail a difficult
struggle. The President's budget message in
late January is expected to call for a deficit of
about $15 billion, few new spending
programs, and rather tight limits on existing
programs other than defense.
The energy program

Shortly after midyear, the President
outlined a modified and extended energy
program. The program still stressed conserva­
tion as a major means of reducing demand for
energy. It also stressed accelerated develop­
ment of a subsidized synthetic fuel program,
however, added funds for public transporta­
tion, solar and other unconventional energy
sources, a stepped-up shift to coal, financial
assistance to low-income families, and a
board to expedite the various review and en­
vironmental procedures to speed construc­
tion of energy facilities. The program was to
be financed entirely by the “ windfall" oil
profits tax, actually an excise tax on domestic
oil production, the tax being tied to the cost
of imported oil and graduated according to
when the oil was discovered.
Introduction of the program came when
the Three Mile Island incident, long gasoline
lines, and the rapid runup (and instability) in
imported oil prices made the need for putting
together a complete energy plan generally
accepted.

Economic Perspectives

The year ended with three major bills es­
sential to implementation of the program in
Senate-House conference committees: the
Windfall Tax Bill, which in its final form may
implement other aspects of the program as
well; the Energy Mobilization Board Bill,
which would create a board with power to ex­
pedite major energy installations; and the
Energy Security Corporation Bill, which
would set up the means of financing and con­
trolling synthetic fuel production.
Although none of these elements of the
administration’s program are likely to take
quite the form proposed in the President’s
energy message, they will represent a major
move along the lines he proposed. Itcould be
well into the second session of Congress,
however, before full details of the energy
program are complete.

State and local government

Measured on the national income ac­
count basis, state and local governments
generally operated at near-balance in 1979,
though not as comfortably near as in 1977 or
1978. Their overall surplus in 1979 has been
estimated at about $24 billion, down about $3
billion from 1978. As this surplus was less than
the surplus expected in their social insurance
funds, they had an operating deficit of
possibly $2-$3 billion, instead of the operating
surpluses of the previous two years.
Total receipts increased about 7 percent.
Outlays increased about 8.5 percent. As this
rate of increase in spending was about the
same as the inflation rate applicable to state
and local government, there was almost no

Federal Reserve Bank of Chicago




growth in spending measured in constant
dollars.
Some other state and local governments
followed up on California’s Proposition 13
movement to limit tax or spending increases.
The tax revolt, however, did not become the
national movement some observers were
forecasting a year ago.
California took another step toward fiscal
austerity by passing a second proposition
restricting spending. Local governments in
California can no longer increase spending
faster than the combined rise in inflation and
the population served, without approval by
referendum.
Some local governments continued to
have financial problems. The most serious was
in Chicago, where the public school system
was unable to sell short-term notes in
November after a close examination of its
prospectus caused the Board of Education’s
credit rating to be lowered. While the
problem in Chicago is not of the magnitude of
New York City’s problems, the procedures
that led to it were much the same—persistent
use of funds assigned to capital costs and
previously incurred debts to meet operating
expenses.
The school system was unable to meet its
payroll for the second half of December. Es­
timates suggest the system will need between
$350-$400 million to pay outstanding debt and
operate the rest of the school year.
Meanwhile, some combination of higher in­
come and lower outlays is needed to put the
system in sound financial condition. The most
likely source of the income needed is an in­
crease in the property tax rate, already at the
legal ceiling.

11

Agriculture: embargo undermines
strong world demand for agriculture
Last year marked the fifth consecutive year of
record domestic crop production. Huge
crops of grains and oilseeds— in light of the
embargo on shipments to the Soviet Union—
are more than enough to meet prospective
utilization. As a result, carryover stocks will
increase substantially, possibly weighing
heavily on crop prices in the year ahead.
Livestock production was nominally
larger than in 1978, and a further increase is
likely this year. Beef production dropped
sharply to a six-year low and may be slightly
lower again this year. But large increases in
pork and poulty production more than offset
the decline in beef production, and further
increases this year are expected to bring
higher production of all meats. Small in­
creases in milk and egg production are ex­
pected again this year.
The financial perspective

Developments in agricultural finance
were highlighted last year by high earnings
and continued sharp increases in farmland
values and farm debt. Thecomposite of prices
received by farmers averaged about 240
(1967=100), up 14 percent from 1978. Larger
marketings complemented the higher prices,
boosting cash receipts from marketings 17
percent. Earnings for crop farmers rose the
most, but livestock producers also saw a
significant rise in receipts.
Preliminary estimates show net farm
income rose from $28 billion in 1978 to $32
billion last year. Nearly all the increase,
however, traced to non-money sources, such
as the increased value of inventories, the
higher rental value of farm dwellings, and the
value of farm products consumed directly in
farm households. Current estimates suggest
that nearly all the increase in marketing
receipts was offset by a $2 billion decline in

12




government payments to farmers and a rise in
production expenses from $98 billion in 1978
to $114 billion in 1979. Fuel and interest costs,
which together account for a sixth of ex­
penses, led the rise in production costs.
Earnings of farmers in states of the
Seventh District were mixed. Except for fuel
and interest, the rise in the costs of producing
crops was fairly modest. Earnings from crops
were supported by higher corn and soybean
prices and by the larger marketings made
possible by bountiful harvests in 1978 and
1979. Livestock producers were affected by
higher feed costs throughout the district.
With milk prices up 14 percent, dairymen had
another year of favorable earnings. Budgets
prepared by Iowa State University indicate,
however, that earnings of hog producers and
cattle feeders turned sharply lower in the
latter part of the year. Net returns for hog
producers were negative during most of the
second half because of sharply lower hog
prices. For cattle feeders, the earnings
squeeze was due mostly to the high prices
paid for feeder cattle during the first half of
the year.
Farmland values made big increases
again last year, continuing a trend that
highlighted agricultural developments of the
1970s. Estimates by the USDA show a 16 per­
cent increase nationwide last year. If that is
right, the year capped a decade in which peracre values rose at a phenomenal compound
annual rate of nearly 13.5 percent. Quarterly
surveys by the Federal Reserve Bank of
Chicago suggest values in the district
parallelled the rise in farmland values
nationwide. Year-to-year gains ranged from 7
percent in the district portion of Illinois to 18
percent in Iowa.
Farm debt rose substantially again last
year, topping out a threefold increase for the
decade. Government estimates show farm

Economic Perspectives

1979 farm commodity prices in perspective
Hogs

Cattle

All commodities

dollars per cwt.

index, 1967=100

Corn
dollars per bushel

Soybeans
dollars per bushel

■ A nnual average, 1979
• A nnual average, 1978

debt reached $158 billion, up 15 percent from
the year before. Higher input prices, ex­
panded production, strong capital expen­
ditures,and higher land values all contributed
to the rise.
There was wide variation in the contribu­
tion of major lenders to the rise in farm debt.
Rural banks struggled to meet the strong farm
loan demand. The liquidity pressures that had
been building at rural banks in recent years
intensified last year as deposit growth slowed
and soaring interest rates compounded
bankers’ problems of liquidating securities to
fund new loans. Evidence suggests that with
loan-to-deposit ratios well above the levels of
a few years ago, farm debt held by banks at the
end of the third quarter was up less than a
tenth from a year before. By contrast, the debt
held by the cooperative farm credit system
was up nearly a fifth. That held by life in­
surance companies was up a sixth. Govern­
ment lending continued strong last year,
fueled by the availability of funds through
various disaster and emergency lending

Federal Reserve Bank of Chicago




programs and more liberal ceilings on
traditional farm lending programs. Overall,
farm debt held by government agencies rose
a third. This was despite a marked decline in
farm loans held by the Commodity Credit
Corporation.
The inflationary perspective

Food was one of the main factors
boosting consum er prices. Although
pressures eased substantially in the second
half, the index of retail food prices averaged
about 11 percent higher than in 1978. That
made 1979 the fourth year of double-digit in­
creases in food prices in the 1970s. Retail beef
and veal prices led the rise last year with
average increases of a fourth.
Raw food commodity prices trended
lower during the second half. But retail food
prices continued to edge higher because of
the escalating costs of processing and dis­
tributing food. The third-quarter index of
utility costs (fuel, power, and lights) to food

13

marketing companies was up a fourth from
the year before. Food container and packag­
ing costs were up 11 percent and rising. Rail
freight charges for food products were up 22
percent in October from a year earlier. Labor
costs for processing and distributing food
were up 12 percent last year. Together, labor,
transportation, utilities, and packaging ac­
count for more than 70 percent of the costs of
marketing domestically produced food.
Nearly half of the retail spending on domestic
food goes for these four items.
Overall, consumer demand for food was
fairly strong last year, due to continued
growth in employment, large nominal gains
in disposable income, and huge increases in
food-stamp benefits. One area of consumer
food demand showed considerable softness,
however. That was for food eaten away from
home. Sales at eating and drinking places
averaged 12 percent higher than a year earlier
in thefirstquarter. Butthatgain wascutin half
during the late springand summer as concern
over gasoline supplies and prices forced
changes in vacation plans. The gain widened
some in the fall. Nevertheless, the increase in
sales was still less than the rise in prices of food
eaten away from home, indicating a signifi­
cant decline in the amount of food eaten out.

Another banner year for
crop production . . .

Com m odity highlights

The cropping season was characterized
by rain-delayed plantings, late developing
crops, and a late harvest. The outcome was,
nevertheless, phenomenal. Current estimates
show crop production up a tenth
nationwide—and that from the previous
year’s peak. Feed grain production (corn,
sorghum, oats, and barley) was up 8 percent
to a new all-time high. Food grain production
(wheat, rye, and rice) was up 16 percent and
above the previous high in 1975. Oilseed
production (soybeans, cottonseed, peanuts,
flaxseed, and sunflowers) was up 20 percent
from the peak in 1978.
The bumper harvest was equally ap­
parent in district states, which account for
more than half the nation’s corn and twofifths of its soybeans. Per-acre corn yields
reached new highs in all district states, except
Wisconsin. For the five states, corn yields
averaged 120 bushels, nearly 22 bushels per
acre more than the average forall othercorngrowing states. Soybean yields for the five dis­
trict states averaged 37 bushels per acre, over
a fourth more than the average for other soy­
bean producing states.
Last year's record domestic grain and

. . . promises to boost carryover
stocks of grain substantially

index,1967=100

1970

71

72

73

74

75

76

77

78

79
grain marketing year ending in
• U S D A p r o je c t io n

14




Economic Perspectives

oilseed harvest was particularly fortunate,
considering the situation worldwide. Wheat
production in the Southern Hemisphere set
new records last winter, but bottlenecks in
transportation kept producing countries from
sharing proportionately in the burgeoning
world market. Production of coarse grain was
no better in the Southern Hemisphere last
spring than the year before. It was even lower
in the top exporting countries. Contrary to
expectations, Brazil's soybean harvest was
only marginally better than the weatherdevasted crop of the year before.
Except in the U nited States, grain produc­
tion in the Northern Hemisphere was off ap­
preciably last summer. The most evident
downturn was in the Soviet Union, where
production fell from the record 237 million
metric tons in 1978 to an estimated four-year
low of 179 million tons. Although wheat
production reached a new high in India,
production of coarse grains and rice (by far
the dominant crop) fell nearly a fifth. In
Canada, the grain harvest fell 14 percent to a
five-year low. Western Europe had a bumper
grain crop, but the harvest was still 4 percent
less than in 1978. In Eastern Europe, a sharp
decline in wheat reduced the total grain
harvest 5 percent.
World demand and prices for U.S. grains
and soybeans proved stronger than expected
because of the adverse crop developments
throughout much of the world. The value of
U.S. agricultural exports rose 17 percent to
$32 billion in fiscal 1979 boosting the
agricultural trade surplusto nearly $16billion.
That closed a decade that had seen
agricultural exports increase nearly sixfold
and the agricultural trade surplus nearly 18fold. Grains and oilseeds accounted for over
two-thirds of the exports last year.
Strong world demand—and significantly
greater domestic utilization—led to higher
crop prices, despite record domestic supplies.
Monthly corn prices received by farmers
averaged $2.37 a bushel, compared with $2.10
in 1978. Soybean prices averaged $6.86 a
bushel, against $6.28 in 1978. Prices varied
between regions more than in 1978, however.
A 12-week strike at the Duluth/Superior port

Federal Reserve Bank of Chicago




facilities and bankruptcies and strikes on ma­
jor rail lines contributed to smaller price gains
in western and northern areas of the Midwest.
For livestock producers, last year ended
the downturn in the cattle cycle and brought
forces that could end the upswing in the hog
cycle this year. Improved prospects for cowcalf operators led to a one-third decline in
cow and calf slaughter. As a result, cattle
numbers are up slightly from the very low
level a year before. A similar increase is ex­
pected in this year's calf crop, following the
16-year low set last year. These developments
provide the base for an increase in beef
supplies in another year or two.
Commercial feedlot activity turned lower
last year, resulting in an 8 percent decline in
fed cattle marketings. That, plus the decline in
cow slaughter, pulled beef production to a
six-year low, 11 percent less than a year
before. Per capita beef consumption, as a
result, fell to a 12-year low.
Even with the downturn in beef, in­
creases in pork and poultry production raised
per capita consumption of meat 1 percent
back to the 1977 record. Broiler and turkey
production increased a tenth. Pork produc­
tion, paced by year-to-year gains of more
than a fifth in the second half, rose 16 percent.
These large increases sharply lowered prices,

Lower production pulled per capita
beef consumption to a
12-year low in 1979
pounds per capita*

‘ Retail weight basis.

15

------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ T “

Economic events in 1979— a chronology'
Jan 1 M inimum wage rises from $2.65 to $2.90. (On January
1, 1980, minimum wage rises to $3.10.)
Jan 1 Social Security tax rate rises from 6.05 to 6.13 percent,
and taxable income rises from $17,700 to $22,900. (On January
1, 1980, tax base rises to $25,900.)

Apr 20 Federal court declares bank ATS accounts illegal and*
sets January 1, 1980, deadline for Congressional action. ¥ y
Apr 30 Israeli ship passes through Suez Canal, first since
Israel was founded in 1948.
•
*
May 4 Margaret Thatcher becom es Britain’s Prime Minister.

Jan 1 Mandatory private retirement age rises to 70 .

May 4 Long lines develop at California gas stations.

Jan 3 Secretary Schlesinger urges energy
because of the cutoff of oil from Iran.

May 23 Crude oil sells in spot markets abroad at over $^0. T

conservation

May 24 Strike ends at United Airlines after 55 days.

» r

Jan 15 Chicago temperature falls to a record low of minus 19
degrees; heavy snows in Midwest snarl transportation.

May 24 Diesel fuel shortages slow truck traffic.

Jan 16 The Shah leaves Iran.

May 25 DC-10 crashes after takeoff at O ’Hare— 274 die in
worst air disaster in U.S. history.
*

Jan 24 Department of Energy (DOE) urges states to e n ­
courage natural gas hookups to save oil.

Jun 1 Long lines reported at gas stations on the E a stC ^ t^

Jan 30 Chinese VicePrem ierTengbeginsofficial visitto U .S.

Jun 4 Independent truck drivers halt traffic, protesting price
and availability of diesel fuel.
'A

Jan 31 Religious leader Khomeini returns to Iran.

^

Feb 5 Farmers in Washington, protest low farm prices.

Jun 6 FAA grounds all DC-10s operated by U.S. airlines. (Bari,
lifted July 13.)

Feb 5 Gold jumps to a record $246.50.

Jun 7 Carter again rules out wage and price controls. ” ^

Feb 13 Iranians attack U.S. embassy in Tehran.

Jun 15 United States and Russia sign SALT pact in Vienn*. v

Feb 18 China invades Vietnam border area.

Jun 17 United Nations projects world population at 4.3
billion in 1980 and 6 billion in 2000.
f

Feb 19 Heavy snows impede traffic on East Coast.
Feb 20 Federal Reserve’s report to Congress projects
monetary growth for 1979 at V/2 to 4V2 percent for M-1, 5 to 8
percent for M-2, and 6 to 9 percent for M-3.

Jun 20 Emmett J. Rice joins Federal
succeeding Stephen S. Gardner.

Reserve

Board*

Feb 22 DOE predicts serious gasoline shortage.
Feb 26 Airlines reduce flights because of fuel shortages.

Jun 27 In W eber case, Suprem e Court rejects a “ reverse dis­
crimination” plea.

Feb 28 M ajor oil companies curtail fuel allocations.

Jul 1 Social Security and welfare payments rise 9.9 percent.

Mar 13 Nuclear Regulatory Commission orders five large
East Coast nuclear power plants closed.

Jul 1 Passbook savings rate ceiling raised to 5.5 percent 5t *
thrifts and 5.25 percent at banks, four-year floating rate cer­
tificate authorized, and other regulations are eased.

Jun 27 O PEC raises basic oil price to $18, plus surcharges.

Mar 13 European Monetary System goes into effect.
Jul 2 Circulation of Susan B. Anthony dollar coins begins*
Mar 21 Rail transport of fresh foods deregulated.
Jul 11 Skylab falls into Australian desert.
Mar 21 Supreme Court rules, 6-3, that states can pay un­
employment compensation to strikers.

r

r

Jul 16 Thermostats in nonresidential buildings ordered set at
78 in summer, 65 in winter.
* ~

Mar 22 Iran cancels $700 million in contracts with U.S.
Mar 26 Egypt and Israel sign peace treaty in Washington.
Mar 27 O PEC votes 9 percent rise in base price for crude oil.
M ar 28 Accident closes nuclear plant at Three M ile Island.
Apr 5 Carter proposes phase out of oil price controls, along
with a “ windfall’' profits tax.
Apr 11 Teamsters end 11-day strike.
Apr 12 M oody’s reduces rating on Chrysler bonds.
Apr 16 Jane Byrne takes office as mayor of Chicago.
Apr 17 UAW official denounces price-wage guidelines.

16




Jul 17 Carter announces receipt of resignations of his entir^
cabinet and senior staff. (Most are retained.)
Jul 17 Treasury auctions gold at a record $296.

'*

Jul 17 Federal Reserve’s report to Congress retains 19£9y
monetary growth ranges announced February 20 and sets
similar ranges for 1980.
r y
Jul 18 Frederick H. Schultz confirmed as Vice Chairm an of
the Federal Reserve Board, succeeding Philip C. Jackson, Jry
as Governor and Stephen S. G ardner as Vice Chairm an, y
Jul 19 G. William M iller, Federal Reserve Board Chairm an,
named to replace Blumenthal as Secretary of the Treasury.'*

Economic Perspectives

-?------------------------------------------------------Jul 19 Federal Reserve announces increase in discount rate
from 9.5 to 10 percent.

Nov 1 Britain’s Conservative government announces sharp
cuts in welfare outlays.

* W 25 Paul Volcker named to succeed M iller as Chairm an of
Federal Reserve Board.

Nov 1 Com pany-w ide strikes start at Caterpillar and Inter­
national Flarvester.

' f u l 26 L e g isla tio n
^Negotiations.

Nov 4 Iranian “ students” invade U.S. embassy in Tehran and
seize.hostages.
Nov 5 Iranian Premier Bazargan resigns.

im p lem en ts

M u ltila te ra l

Trad e

Aug 1 Chrysler reports large operating losses and asks
■federal financial aid.
Aug 1 RPs of less than $100,000, maturing in 90 days or more,
made subject to Regulation Q interest rate ceilings.
" Aug 15 Andrew Young resigns as ambassador to the U.N.
^Aug 16 Federal Reserve announces increase in discount rate
to a record 10.5 percent.

Nov 8 Illinois law suspends mortgage usury rate.
Nov 12 Carter bans oil
shipments to U.S.

imports from

Iran;

Iran

halts

Nov 14 Chicago school financial crisis begins.
Nov 14 U.S. freezes Iranian financial assets.

f^ug 17 Price controls end for “ heavy” crude oil.
California lettuce growerssign pacts with United Farm
W orkers, raising wages by about two-thirds over three years.
* '"Sep 12 M ajor bank raises prime rate to 13 percent.
-Sep 14 General Motors agrees to boost compensation 34
percent over three years, assuming 8 percent annual inflaticfn.
H

Nov 7 Prime rate rises to 15.5 percent.
Nov 8 Big Three auto makers announce further layoffs.

Sep 18 Gold rises to $382 and silver rises to $16.
¥■r

Sep 18 Federal Reserve announces increase in discount rate
* A) 11 percent.
%
Sep 25 F1UD raises ceiling on government-backed residen­
tial mortgages to 10.5 percent.

Nov 16 Prime rate rises to 15.75 percent.
Nov 19 Lane Kirkland is elected president of the A FL/C IO ,
succeeding George Meany.
Nov 21 Mob burns U.S. embassy in Islamabad. Pakistan,
acting on an unfounded rumor.
Nov 26 FNMA auctions conventional mortgage funds at a
record 13.35 percent.
Nov 26 Major bank cuts prime rate to 15.5 percent.
Dec 5 IMF auctions gold at $426.
Dec 9 Brazil devalues cruzeiro by 30 percent.

Sep 26 Duluth grain elevator strike ends after 12 weeks.

Dec 13 Venezuela and Saudi Arabia raise basic oil price from
$18 to $24. (Spot price is $40.)

Sep 27 A u to m anu facturers
schedules to cut inventories.

assembly

Dec 13 Canada’s Conservative government falls on vote
over austere budget.

•*dct 1 Federal workers receive general pay boost of 7 per­
cent, in addition to annual step increases.

Dec 14 Financial authorities authorize banks and S&Ls to
issue 21
/2-year certificates with rates tied to yields on Treasury
bonds, and no minimum balance, effective January 1.

again

reduce

O ct 1 Panama’s sovereignty extended over the Canal.
*bct

1

Gold jumps to $416, double year-earlier price.

€>ct 5 Dow industrial stock index closes at 898, high for the
year. (Low of 797 reached on November 7.)
<5ct 6 Federal Reserve takes strong actions to slow inflation:
discount rate rises to 12 percent, marginal reserve re­
quirements are established on increases in “ managed
liab ilities," and monetary policy emphasis is shifted to co n ­
trol of member bank reserves.
fact 15 Libya raises oil price to $26.27, exceeding O P E C ’s
v $^3.50 ceiling.
O ct 17 1,800 M arines reinforce Guantanamo Naval Base,
* following reports of Russian troops in Cuba.

Dec 14 Major bank cuts prime rate to 15 percent.
Dec 19 Caterpillar strike ends after 79 days; strike continues
at International Flarvester.
Dec 20 Congress passes bill providing for a $1.5 billion loan
guarantee for Chrysler, conditional on other steps.
Dec 20 O PEC nations adjourn meeting at Caracas without
agreement on a price for crude oil.
Dec 21 Chicago transit strike ends after four days, with dis­
puted cost-of-living adjustment to be arbitrated.
Dec 21 Chicago school employees are not paid.
Dec 26 Gold closes in New York at $506, first time over $500.

O ct 22 Treasury 90-day bills hit record 12.93 percent.

Dec 28 Legislation temporarily overrides court decision
banning ATS accounts at banks, and suspends state mortgage
usury ceilings, etc.

O ct 23 M ajor banks raise prime rate to 15 percent.

Dec 30 Soviet troops invade Afghanistan.

^ c t 18 John D eere strike ends after 18 days.

‘'O c t 23 Britain terminates long-standing exchange controls.

Federal Reserve Bank of Chicago




Dec 31 Silver hits $35, up from $6 a year earlier.

17

triggering income losses late in the year
among hog and broiler producers.
Monthly choice steer prices at Omaha
averaged about $67.65 per hundredweight,
compared with $52.34 in 1978. By contrast,
hog prices fell from $48.50 per hundred­
weight in 1978 to an average of $42.50 in 1979.
Milk production increased about 1 per­
cent last year, spurred by a favorable
milk/feed price ratio. Milk prices received by
farmers averaged more than $12 per hun­
dredweight, 14 percent higher than in 1978.
The higher prices resulted mostly from strong
commercial demand, but they also reflected
higher government support prices.
What lies ahead?

Trends that could develop in the year
ahead suggest the need for caution. Con­
sumer demand for food could ease if the
economy turns down as expected. Con­
sumers' food budgets would be strained by
rising unemployment and continued price
increases for energy and other essentials.
Although food demand usually weathers
recessions fairly well, partly because of foodstamp and other government aid programs,
downturns sometimes impact on demand for
more preferred foods, such as beef and fresh
fruits.
World demands for agricultural com­
modities will continue strong this year. Much
of the strength was undermined, however, by
the unexpected embargo on shipments to the
Soviet Union imposed in early January. The
embargo applies to all agricultural com­
modities except the unshipped portion of the
8 million metric tons of corn and wheat
authorized in the five-year U.S.-USSR grain
agreement. The loss in shipments to the
Soviet Union will amount to 17 million tons of

grain, plus a small amount of soybeans and
related products.
Until the embargo, grain and oilseed
exports were projected to rise 17 percent in
fiscal 1980. The projected increase has been
cut in half as a result of the embargo.
The Soviet Union has accounted for a
large part of the world market for U.S. grains.
For the past two years, corn shipments to the
Soviet Union have accounted for more than a
fourth of all corn exports and more than 6
percent of corn production. The impact of the
embargo on such a large customer is not yet
certain. For the short run, it appears the
government intends to isolate from free
market supplies a large part of the lost Soviet
sales. Such actions would reduce the
downward pressure on grain prices. For the
longer term, production adjustments will
likely be necessary if the embargo is not lifted.
Underlying inflationary pressures will
continue to swell farmers' operating expenses
and may limit the hoped-for easing in retail
food prices. With the cost pressures facing
food processing and distribution companies,
it is doubtful that this year's rise in retail food
prices can be held much below the double­
digit level. Farmers will find the inflationary
pressures most evident in fuel, fertilizer, and
interest costs.
The USDA has projected a one-fifth
decline in net farm income this year. That
projection assumes small gains in marketing
receipts and an increase of more than a tenth
in production expenses. Few analysts argue
about the direction of the change of income,
and—in light of recent events—more are
beginning to accept the magnitude of the
change. Although world events regarding
crop production or political developments
may alter subsequent projections, it now
appears that the agricultural sector will start
the 1980s under less favorable conditions.
■■■■■■■■■■■■
■■■■■■■■■■■

18




Economic Perspectives

International: inflation and slowing
growth plague the world economy
Inflation cast a deep shadow over the world
economy in 1979. Rapidly rising prices of
goods and services in nearly every country in
the world eroded the purchasing power of
consumers everywhere, disrupted business
investment decisions, left deep marks on the
balance of payments and external values of
currencies of individual countries, and,
together with the rising political tension in
the world, contributed to the skyrocketing
price of gold. A growing concern of
governments in industrial countries over the
pernicious impact of inflation on their
economies led, in many instances, to the
adoption of increasingly stringent monetary
and fiscal policies. These policies tended to
impede the industrial countries' economic
growth, and—given the high degree of
econom ic interdependence in today's
w o rld — stym ied e co n o m ic progress
worldwide. In the meantime, a sharp increase
in oil prices by OPEC during the year gave a
new boost to inflationary pressure
everywhere and severely disrupted progress
toward regional equilibrium in the world's
balance of payments. And so, the world
economy entered 1980 with the gloomy
prospects of declining economic activity, ris­
ing unemployment, high inflation, and major
disequilibria in balance of payments.
Rising inflation . . .

In the closing months of 1979, the
average rate of inflation in the 24 major
countries comprising the Organization for
Economic Cooperation and Development
was a two-digit figure for the first time since
1974-75 when a fourfold increase in the price
of oil and sharply rising commodity prices
boosted the rate of increase in consumer
prices to those levels. Rising prices of com­
modities in general, and oil in particular,

Federal Reserve Bank of Chicago




again played a significant role in last year's
resurgent inflationary pressures in the in­
dustrial countries.
From January to October, the food com­
modities index increased about 23 percent
and exceeded the previous high in April 1977
by nearly 15 percent. Short supplies of grains
in the Soviet Union, coupled with continued
strong demand for grain elsewhere, pushed
corn and wheat prices upward throughout
most of the year. Beef prices worldwide in­
creased dramatically, continuing an upward
trend that began in 1977. Coffee prices soared
again after declining from the record levelsof
early 1977 as an early frost in Brazil raised ex­
pectations of short supplies.
The industrial commodities price index
had increased about 25 percent by early O c­
tober. Large price increases in copper, lead,
rubber, and tin were primarily responsible for
the upward movement in the index. Upward
pressures on prices came in response to fairly
strong industrial demand for metals and tight
supplies resulting from extended strikes and
political unrest in some producing countries.
OPEC's formal action at midyear, raising
the price of oil some 60 percent, combined
with the disruption of supplies from Iran and
with the continued strength of world de­
mand, led to a steep runup in prices of energy
around the world, giving a further boost to in­
flation.
Also contributing to the upward thrust in
prices in the industrial countries were sharply
increasing labor costs as lagging productivity
gains were outrun by rising wage demands.
. . . leads to slower growth . . .

Efforts to restrain the emerging in­
flationary pressures by applying restrictive
monetary and fiscal policies led to a slow­
down in real economic growth in the in-

19

dustrial world. In the second half of 1979, the
combined GNP of the 24 industrial countries
comprising the OECD was growing at an an­
nual rate of around 3 percent, compared with
4.3 percent in the second half of 1978. A
further significant slowdown to less than 1
percent growth is projected for the industrial
countries in 1980.
The slowdown in growth was and is ex­
pected to be particularly pronounced in the
United States and in the United Kingdom,
where growing labor problems contributed
to the sluggishness of the economy. The
combined weight of these two countries
significantly influenced the aggregates for the
area as a whole, both in 1979 and the projec­
tions for 1980. Other countries that fared fairly
well in 1979, however, are expected to share
in the decline in economic activities in 1980
and to experience rising unemployment.

strapped with heavy external debt. For the
past several years, developing countries have
financed their largely oil-related balance-ofpayments deficits by loans from banks in in­
dustrial countries. As a result, their combined
debt to these banks rose from around $33
billion in 1974 to an estimated $150 billion at
the end of 1979. In 1980, the combined deficit
of the nonoil-developing countries has been
estimated to run well in excess of $60 billion.
Some of this deficit will no doubt be financed
from foreign exchange reserves that are, in
the aggregate, much higher than they were
only a few years ago. But a good portion must
be financed by borrowing. In light of the ap­
parently growing reluctance of commercial
banks around the world to continue lending
to these countries, new sources of financing
must be found if the developing world is to
avoid severe economic problems in the com­
ing year.

. . . and balance-of-payments disequilibria
U.S. balance of payments improves . . .

Rising prices of oil and other com­
modities sharply boosted the import bill of
Developments in the United States both
the industrial countries. This, combined with
influenced and were influenced by
a substantial decline in their exports to OPEC,
developments in the world economy.
caused their aggregate trade balance to swing
Somewhat faster economic activity abroad
from a $5 billion surplus in 1978 to a $34 bil­
lion deficit in 1979. A broader measure, the U.S. trade deficit declines
current account balance (which includes not
billion dollars, f.a.s. census basis
only trade in goods but also trade in services,
im portsother
aid, and unilateral transfers) reflected this
transportation equipment
exports
deterioration. It moved from a $9 billion sur­ A)U|— rt* i machinery
manufactured goods
plus to a $30 billion deficit. The current ac­
chemicals
-2 8 .4 *
count deficit of the nonoil-developing coun­
.
fuels
tries also deepened, from $36 billion in 1978 to
agricultural
— 5*
26
$47 billion in 1979.
A direct counterpart of the deterioration
120
in the international accounts of industrial and
developing countries was the increase in the
current account surplus of OPEC countries. It 80
rose from $7 billion in 1978 to $65 billion in
1979. Further substantial increases in the
OPEC surplus—and accompanying deficits 40
for the rest of the world—are projected for
1980.
These trends have led to renewed con­
1977
1978
1975
1976
‘ Annual trade balances.
cern over the financing of the deficits, par­
“ Category data are based on January-November at an
ticularly for developing countries already
annual rate.

1

20




Economic Perspectives

contributed to a reduction in the U.S. trade
deficit from $34 billion in 1978 to around $28
billion in 1979. This improvement came as U.S.
exports to industrial countries and nonoil­
exporting developing countries increased
nearly a third while imports from these areas
increased less than half that fast. Much of the
improvement in the U.S. trade balance
recorded elsewhere was blunted, however,
by declining exports to the oil-exporting
countries and an increase of about a third in
the value of oil imports.
Petroleum imports still dominated U.S.
import trade. The nearly one-third increase in
the value of petroleum imports last year was
due primarily to increases in the price. The
amount of oil imported increased only about
2 percent. But by November, the per-barrel
price of imported oil had been boosted more
than 70 percent.
Although oil prices werestill being raised
by individual OPEC members when the year
ended, the slowdown in the world's
economies and expanding inventory ac­
cum ulations in consuming countries
appeared to have had some moderating
effect on oil spot prices, if not on the official
prices set by OPEC members.
A continued increase in the surplus in
trade in services contributed substantially to
the reduction in the current account deficit.
In the first nine months of the year, the ser­
vices surplus totaled more than $25 billion—
$7 billion more than in the same period a year
earlier. The dramatic increase in the services
surplus came mainly from a more than 50 per­
cent increase in receipts of income of U.S.
assets abroad over payments to foreigners of
income from foreign assets in the United
States.

value of the dollar between June and O c­
tober, the U.S. government announced, on
November 1,1978, a series of measures signal­
ing its determination to defend the external
value of the dollar. Through the last two
months of 1978, the dollar was rising steadily
from its October 31 low, and the momentum
carried it well into 1979, as the initial, largely
psychological impact of the November
package was reinforced by rising U.S. interest
rates and by the improving U.S. balance-ofpayments position. By the end of May, the
value of the dollar had increased by 8 percent
over its October low, relative to the German
mark, 13 percent relative to the Swiss franc,
and almost 19 percent relative to the Japanese
yen. On the trade-weighted basis (which
takes into account the dollar value relative to
currencies of 14 major U.S. trading partners,
weighted by the respective volumes of trade)
the dollar improved more than 6 percent. By
the end of May, its value stood only 1.6 per­
cent below the point at the inception of the
general floating of major currencies in
February 1973.
The dollar began weakening in early
June, however, as the gap in interest rates
between the United States and major foreign
money markets narrowed. The change came
with the increasingly tight monetary policy

Dollar volatile— ends 1979
above year earlier
percent change

. . . and the dollar steadies

Improvement in the U.S. international
accounts was partly responsible for the mark­
ed improvement in the trends in the value of
the dollar relative to other major currencies in
the first half of 1979. The stage for the im­
provement was actually set in late 1978 when,
after a precipitous drop in the international

Federal Reserve Bank of Chicago




NOTE: Data are percentage changes, relative to the
dollar, from November 1, 1978 base.

21

abroad that caused net capital outflows from
the United States and rising U.S. inflation that
reduced confidence in the dollar. The
weakening continued through the summer
but was sharply reversed in early October
when the Federal Reserve announced a
package of credit-tightening measures to
dampen inflation in the United States. Some
post-October gains in the value of the dollar
were partially offset in the final weeks of the
year as tension between the United States and
Iran deepened. Nevertheless, the dollar end­
ed the year at roughly the same value (on the
trade-weighted basis) as at the beginning—
some 2.5 percent below its value in February
1973.

Foreign claims of district banks
continue to rise

Banking in the district

The past decade saw a rapid increase in
foreign lending through overseas branches.
Banks in the district operated six overseas
branches in 1967. By 1979, there were over 70
branches operated by 20 district banks. Assets
of these district maintained branches totaled
$36.8 billion in September, compared with
$25.6 billion a year earlier.
Chicago has expanded steadily as an in­
ternational financial center since 1973, when
Illinois passed legislation allowing foreign
banks to establish offices in Chicago. Since
then, 34 offices of foreign banks have opened
in Chicago. At year-end these offices had
assets of over $5 billion.

International banking activity picked up
in the Seventh District last year, continuing
the expansion that began in the early 1960s.
Foreign assets of banks in the district in­
creased more than twofold in the past four
years, totaling $45.1 billion in September,
compared with $31.8 billion a year earlier.
Domestic offices of district banks held claims
on foreigners totaling $6.2 billion, up from
$5.2 billion a year earlier. Liabilities to
foreigners totaled $4.7 billion, an increase of
$2.8 billion over the previous 12-month
period.

•As of October 1979.

■■■■■■■■■■■■■■■■■
■■■■■■■■■■■■■■■■■

22




Economic Perspectives

Finance: restraint versus inflation
Inflation was a dominating force in financial
markets in 1979. Despite a slowing economy,
credit flows were only slightly less than the
record growth reached in 1978. Against the
Federal Reserve’s intensified efforts to fight
inflation by monetary restraint, credit
demands pushed interest rates far higher than
the country had seen in thiscentury. But infla­
tion itself, combined with the public’ssinking
hopes that it would diminish much in the
foreseeable future, was an important element
contributing to high interest rates.
Although expensive, credit remained
generally available in most sectors of the
financial markets—even for residential
mortgages, which had been severely affected
in earlier periods of tight money. As usual in
the late expansion phase of the business
cycle, business increased its share of the total
demands on credit markets, and commercial
banks became more important as suppliers of
funds, financing their own growth mainly by
increased reliance on money market sources
and the six-month money market certificates.
Reflecting the combination of high interest
rates and regulatory ceilings on savings and
small time deposits, many consumer funds
were recycled to lending institutions through
money market mutual funds. The funds were
heavy buyers of large CDs, which are not sub­
ject to rate ceilings.
Actions to restrain rapid expansion in
money and bank credit—to combat inflation,
speculative activities, and a weakening
dollar—intensified in early October. At that
time the Federal Reserve announced that all
its restrictive policy tools were being brought
to bear in an effort to reduce credit growth
and keep monetary aggregates from ex­
ceeding the target ranges set in February for
the year as a whole. Money and credit growth
moderated significantly in the fourth quarter.

because of weakness in the fourth quarter
when conditions were tighter. Despite higher
inflation, net funds raised in the debt and
equity markets by nonfinancial sectors were
an estimated 5 percent lower than in 1978.
This financing amounted to 16 percent of
nominal GNP, down from 19 percent in 1978.
Of the major nonfinancial sectors, only
business increased its effective credit
demands. Combined net business borrowing
and equity sales totaled about $150 billion,
more than in 1978. As their external financing
needs increased, firms relied more on short
and intermediate-term borrowing both in the
commercial paper market and from banks.
Commercial bank loans accounted for about
a third of the net new business financing, the
dollar increase exceeding the earlier record
set in 1973. Commercial mortgage financing
also rose sharply. The paceof bond financing,
on the other hand, remained moderate as
corporations avoided increasing their long­
term debt at prevailing high interest rates.
Households, with borrowings at $160
billion, remained the biggestcredit users. This
debt rose about 2 percent less than in 1978,
however, mainly because of the slower

Less funds raised by all
sectors but business
dollar amounts in billions

funds raised by:

$400 (100%
)

Credit market financing down

Aggregate credit flows were down last
year for the first time since 1974, largely

Federal Reserve Bank of Chicago




1978

1979*

•Preliminary.
NOTE: Totals may not add due to rounding.

23

growth in auto loans. Despite record-high
nominal mortgage interest rates, home
mortgage lending remained close to the
historically high 1978 gain.
As record-high short-term interest rates
constrained mortgage lending at savings and
loan associations—the single most important
source of funds to the home mortgage
market—thrift institutions’ share of this
market declined. Many savers switched from
S&L deposits to such higher yielding in­
vestments as Treasury securities and money
market mutual fund shares. Exacerbating
S&Ls' problems was the elimination of their
rate advantage over commercial banks in sell­
ing money market certificates. In mid-March,
the rules were changed to eliminate the
quarter-point differential when the ceiling
rate is 9 percent or more. At the same time,
both banks and savings institutions were
prohibited from compounding interest on
money market certificates. At times during
the year, some S&Ls chose to limit their
mortgage lending while directing more funds
to money market instruments. This was a
response to the pressure on earnings as the
marginal cost of funds exceeded the thencurrent mortgage loan rates, a problem made
worse in some areas by state usury ceilings.
Moreover, as mortgage rates accelerated
sharply late in the year, demand for mortgage
credit declined. The rapid increase in
mortgage pools ($28billion in 1979against$18
billion in 1978) played a major part in main­
taining the flow of funds into home
mortgages.1
Credit demands of government were
drastically lower last year. Combined federal,
state, and local government net borrowing
was nearly 40 percent less than in 1978. Total
government borrowing accounted for 13 per­
cent of the funds raised by all nonfinancial*
’These are mortgage poolsagainstw hich marketable
securities have been issued. Timely payment of interest
and principal is guaranteed by either the Governm ent
National Mortgage Association or the Federal Home
Loan Mortgage Corporation. The mortgage pools are
m ade up p redom inately of single-family home
mortgages. Some, however, are composed of multifamily
or farm mortgages.

24



sectors. That was the lowest percentage of the
total since 1973.
Commercial banks supplied about onethird of total credit market financing—slightly
more than in 1978 despite a reduced share in
the final quarter. An increased portion of
household savings was channeled into credit
markets through money market mutual
funds. Assets of these funds increased more
than $30 billion. Direct investments by
households in credit market instruments and
equities increased about $50 billion, only
slightly less than in 1978.
In contrast to 1978, when foreign sources
supplied credit markets $40 billion, foreigners
liquidated investment in credit market in­
struments last year by more than $5 billion.
Strength of the dollar relative to foreign
currencies, especially during the first half of
the year, greatly reduced foreign exchange
market intervention by central banks, thereby
reducing their demand for U.S. government
securities.
Interest rates to record highs

Both short and long-term interest rates
ended the year sharply higher than at the
beginning. Most interest rates passed the
peaks reached the previous interest rate cy­
cle. Movements responded to comparatively
strong credit demands, increased inflationary
expectations, and action taken by the Federal
Reserve to curb monetary and credit growth.
By year-end, the Federal Reserve’s discount
rate stood at a record 12 percent, up 250 basis
points during the year.
The inverted yield curve that emerged in
the fall of 1978 continued through the end of
1979, reflecting investor expectations that
rates would soon decline. In the previous cy­
cle, a similar yield curve pattern lasted from
mid-1973 through late 1974.
With the economy showing signs of
weakening and only a modest uptick in the
federal funds rate (then the key operating
target of Federal Reserve open market
policy), other short-term interest rates were
quite stable in the first half of 1979. Later, as
the Federal Reserve responded to rapid

Economic Perspectives

rates were raised to maintain profit margins.
monetary growth accompanied by continued
In addition to the increases in contract rates,
high inflation and a stronger-than-expected
nonprice forms of mortgage credit rationing,
economy with a more restrictive monetary
policy, short-term interest rates increased. In­
such as larger downpayments and shorter
creases ranged from 250 basis points on sixmaturities, became widespread.
month Treasury bills to 400 basis points on the
Monetary aggregates and policy actions
bank prime loan rate. Late in the year, these
rates eased down slightly as credit demands
Last year was the first year that monetary
subsided.
Bond yields, as measured by standard
policy decisions were reviewed within the
rate series, rose by as little as 80 basis points on
framework of the Full Employment and
Balanced Growth Act of 1978. This act
long-term municipals to more than 200 basis
(Humphrey-Hawkins) provides for a more
points on new high-grade utility issues. As
formal coordination between monetary and
with short-term yields, most of the increases
were late in the year. Except in the municipals
fiscal policy.
In February, the Federal Open Market
market, long-term yields exceeded historical
Committee set target monetary and credit
highs by more than 100 basis points. The taxaggregate growth ranges for the period from
exempt market benefited from a reduction in
the fourth quarter of 1978 to the fourth
gross offerings. The amount offered would
quarter of 1979. In the judgment of the comhave been still less, except for the continued
issuance of mortgage revenue
bonds. Demand for municipal
Most long-term interest rates and . . .
securities was especially strong
percent
from property and casualty in­
surance companies.
Yield spreads between
long-term Treasury and cor­
porate issues widened, partly
reflecting the reduction in
Treasury financing as the deficit
narrowed. Quality spreads also
widened but far less than when
interest rates approached their
peaks in 1974.
. . .short-term interest rates
Mortgage interest rates,
surpass previous cyclical highs
already at record highs when
percent
the year began, rose another 250
basis points before it ended. By
year-end, rates on standard new
mortgages averaged around 13
percent, plus points. Mortgage
demand remained strong as
consumers continued to view
housing purchases as an infla­
tion hedge. Many state usury
ceilings were lifted or suspend­
ed to sustain the supply of
mortgage funds. Further, as the
cost of funds increased for
mortgage lenders, mortgage
•Beginning November 1979, 90-day maturity.

Federal Reserve Bank of Chicago




25

M-1 and M-3 within 1979 ranges

• • •
billion dollars

billion dollars

. . . but M-2 and bank credit above
billion dollars

billion dollars

J

M

M

J S
1978

N

J

M

M

J S
1979

N

NOTE: Ranges specified from 3-month average in fourth quarter
credit data adjusted for breaks in series due to reclassifications.

mittee, monetary expansion within these
ranges would be consistent with achieving
the broader economic objectives that were
also stated goals of fiscal policy—the gradual
unwinding of inflationary pressures, the
maintenance of a stronger position for the
dollar in foreign exchange markets, and the
encouragement of moderate economic
growth. The following ranges were specified:
M-12

................................

M-2 ...................................
M-3 ...................................
Bank credit .....................

V/2-AV2 percent
(3-6, adjusted)
5-8 percent
6-9 percent
71
/2-101 percent
/2

2
M-1 includes currency and commercial bank de­
mand deposits held by the public. M-2 includesM -1, plus
commercial bank savings and time deposits other than
large negotiable CD s. M-3 includes M-2, plus deposits of
mutual savings banks and shares at savings and loan
associations and credit unions.

26




J

M

M

J
1978

S N

J

M M J
1979

S N

to 3-month average in fourth quarter 1979. Bank

The M-1 range specified in February
assumed that shifts from demand deposits to
automatic transfer from savings (ATS) ac­
counts and New York negotiable orders of
withdrawal (NOW) accounts, first authorized
in November 1978, would reduce M-1 growth
in 1979 by 3 percentage points.3 Such shifts
were later estimated to have reduced M-1
growth in 1979 by only 11 percentage points.
/2
The equivalent longer-term M-1 growth
range, therefore, is 3 to 6 percent.
The actual increases over the policy
period were about 51 percent for M-1, 814
/2
percent for M-2, and 8 percent for M-3, com­
pared with 7.2, 8.7, and 9.5 percent, respec­
tively, in 1978. Bank credit rose about 1214
3 federal court ruled in April that ATS accounts,
A
credit union share drafts, and S&L point-of-sale terminals
would be illegal after 1979. In late Decem ber, Congress
extended the deadline to M arch 31, 1980.

Economic Perspectives

percent in 1979. Although credit also slowed
from the pace of the previous year, it exceed­
ed the upper end of the range specified.
While monetary expansion was generally
within the targets over the year as a whole,
there was considerable variation in growth
rates during the year. Because of the volatility
of money demand over short periods, the
Federal Reserve responded gradually, its ac­
tions tempered by incoming evidence
regarding the strength of the economy and
associated inflationary pressures.
Monetary growth slowed significantly in
the first quarter. M-1 declined ata 1.3 percent
annual rate, while M-2 expanded at only 2.8
percent and M-3 only 5.3 percent. With infla­
tion accelerating, however, the Federal
Reserve took no stim ulative action.
Throughout the first quarter, reserves were
supplied to the banking system at around a 10
percent federal funds rate.
As monetary growth accelerated sharply
in the second quarter, the Federal Reserve
became less accommodative. Reserves were
supplied at a federal funds rate of 10V a percent
from late April through most of June. Not only
were there indications of a weakening
economy, but further restraint in the second
quarter was not called for under the long­
term growth targets. Because of the firstquarter slowdown, monetary aggregates at
midyear were still near the lower limits of
their long-term growth ranges.
Growth in money continued to
accelerate in the third quarter. Inflation,
moreover, continued at a torrid pace and in­
coming economic information suggested
some bounce-back in production and in­
come. Over the third quarter, the Federal
Reserve took several restrictive steps. Every
month of the quarter, the discount rate was
increased 50 basis points, pushing the rate to a
record 11 percent. In addition, reserves were
supplied at a progressively higher federal
funds rate. By the end of September, the rate
was around 11V2 percent, up VA percentage
points over the quarter.
Despite these actions, inflationary forces
in the economy remained strong; the dollar
came under additional pressure in the foreign

Federal Reserve Bank of Chicago




exchange markets; and speculative excesses
associated with deeply entrenched in­
flationary expectations appeared in thefinancial and commodity markets. In light of these
developments—and to give public notice of
its determination to take a firm stand against
inflation—the Federal Reserve announced a
three-part program on October 6 designed to
ensure better control of monetary and credit
growth.
First, the discount rate was raised a full
percentage point to a record 12 percent.
Second, a marginal reserve requirement of 8
percent was imposed on increases (above the
larger of $100 million or the base period level)
in the total managed liabilities of member
banks, Edge corporations, and U.S. agencies
and branches of foreign banks.4 Finally, the
FOMC approved a change in the target used
in determining day-to-day open market
transactions. Instead of focusing on the es­
timated price of reserves (the federal funds
rate) consistent with a desired path for
money, the new method focuses on the es­
timated quantity of reserves consistent with
that path.
Interest rates increased sharply after O c­
tober 6 and fluctuated over broader ranges
than before. The federal funds rate, now free
to reflect demand relative to the volume of
reserves provided, rose to a high of 15.61 per­
cent (on a weekly average basis) in late O c­
tober and ended the year trading around
131 percent. A significant reduction in the
/2
rate of expansion in the monetary and credit
aggregates in the fourth quarter attested to
the initial success of the program.
Despite the improved performance of
the aggregates relative to predetermined
goals, concern remained over whether those
aggregative measures (as currently defined)
adequately represent the funds actually
available to the public for spending. Financial
innovations and regulatory changes over the
past decade have tended to blur the distinc4Managed liabilities include large denomination
time deposits with maturities of less than a year,
Eurodollar borrowings, repurchase agreements against
U.S. government and federal agency securities and
borrowings of federal funds from institutions other than
members of the Federal Reserve System.

27

tions between different types of deposits,
deposits at different types of institutions, and
between deposits and other liquid assets.
Early last year, the staff of the Board of Gover­
nors proposed new definitions for the
monetary aggregates. That proposal has since
been under study, and newdefinitionsare ex­
pected to be adopted early this year.
Bank portfolio shifts

As in 1978, loans accounted for most of
the expansion in total bank credit. Despite
heavy credit demands from businesses and in­
creased monetary restraint, the commercial
banking system did not, on balance, liquidate
securities. Total loans, in fact, did not rise as
fast as in 1978 and investments grew faster.
More than two-fifths of the 13 percent in­
crease in loans last year was business loans,
compared with a third in 1978. Commercial
and industrial loans expanded at a 20 percent
annual rate during the first three quarters
before leveling off in the fourth quarter.
Business loans were up about 17 percent for
the year, compared with 16 percent in 1978.
Corporate borrowing strengthened at
money center banks and accelerated further
at U.S. branches and agencies of foreign
banks. These institutions were generally
aggressive in seeking to increase their loan

Total bank credit expansion slows
despite faster pace in business
loans and investments
10

-

percentchange
0 +
10

20

i--------- 1
--------- 1
--------- 1
--------- 1
--------- 1
--------- 1

Total loans and inves
loans:
business
real estate
consumer
all other

investments:
U.S. Governm ent
securities
all other securities

28




business. Until October 6, many domestic
banks were offering certain credits at less than
the prime loan rate to meet competition from
foreign-related banking institutions. Some
term loans were made at fixed rather than
floating rates.
Most large banks wereable to pass on the
rising cost of funds, thus maintaining their
earnings margins. By mid-November, the
prime rate reached 153 percent, 375 basis
4
points above its mid-1974 peak, before easing
down to 1514 percent at year-end. After O c­
tober 6, many banks tightened their terms of
lending (price and nonprice) because of their
higher cost of funds. Some borrowers were
effectively priced out of the loan market, but
competition continued to temper restrictive
policies. Credit was still widely available for
normal business needs, and there was
evidence that special arrangements were
being worked out for weaker customers that
would have been severely hurt by money
market interest costs.
While bank loans to businesses increased
in 1979, loans to other borrowers slowed. Real
estate loans at com m ercial banks,
nevertheless, rose 15 percent over the year
and consumer loans rose 11 percent.
Sources of loanable funds

Growth in demand deposits was modest
last year, but as market interest rates rose, out­
flows of savings deposits picked up. Some of
the outflow went into small denomination
time deposits, which provided an estimated
$60 billion of loanable funds, compared with
$20 billion in 1978. All the net growth in small
CDs could be attributed to increases in sixmonth money market certificates, which rose
about $80 billion at commercial banks
nationwide.
Large CDs were allowed to run off in the
first half of the year, as the 2 percent marginal
reserve requirements imposed in late 1978 in­
creased the cost of funds from this source.
Late in the year, however, issuance of CDs
resumed. The faster growth in CDs in the
second half resulted from several factors, in­
cluding strong third-quarter loan demands,

Economic Perspectives

District bank asset and deposit changes
weakness in other time
reflect area differences in credit demands
and savings deposits,
Time and
Loans as
and the rising cost of
Demand
savings
percent of
fu n d s fro m o th e r
Loans1
Securities
deposits
deposits
deposits
sources. To a con­
(percent change, Nov. 29,1978 to Nov. 28,1979) 11/78 11/79
siderable degree, the
savings funds flowed
Large banks2
back to large banks
95.7
-1.1
110.3
16.7
3.3
5.6
Chicago
71.7
6.2
22.6
3.5
73.8
2.5
through CD purchases
Detroit
-4.1
72.8
80.6
- 7.0
8.5
Indianapolis
14.9
by m oney m arket
9.4
86.1
6.2
0.6
3.7
83.3
O ther cities
mutual funds.
Other "managed
O ther member banks
liabilities" were tapped
4.7
65.8
65.5
Illinois
2.0
-1.0
-2.6
71.2
73.1
Michigan
5.7
-2.3
-1.9
4.5
extensively. These non­
66.8
6.1
5.5
1.7
9.1
67.3
Indiana
deposit sources—which
Wisconsin
6.6
4.4
68.7
74.0
11.2
include federal funds
70.7
3.4
68.6
4.6
-1.8
-2.4
Iowa
and security repurchase
agreements with non­
E xclu d e s fed funds sold.
banks, net Eurodollar
2Largeweekly reporting member banks w ith domestic office assets of $750 million or
borrowings, and sales
more as of D ecem ber 31,1977.
of loans to nonbank
affiliates—rose over $45
than small banks. Loans expanded faster at
billion in the first three quarters, financing
large banks than at small and medium-sized
more than 40 percent of the increase in bank
banks, where demands had been strong the
credit over that time. The new marginal
three previous years. Real estate lending was
reserve requirements were intended to slow
still the strongest element of growth in bank
the credit expansion financed by these
loans, although business lending picked up at
sources. Given the basic weakness of "core"
the largest Chicago banks.
demand and savings deposits in a high
Although ratios of loans to deposits,
interest-rate environment, however, finan­
often used as an inverse indicator of liquidity,
cing any resurgence in loan demand is likely
rose more at large banks and were con­
to require further additions to managed
siderably higher, these institutions had many
liabilities.
sources of liquidity. Many were still below
Banking in the district
their desired loan levels. Smaller banks, close
to what they considered loaned-up positions,
Credit at member banks in the Seventh
were more constrained in their lending. Net
District expanded less than in 1978. Excluding
time and savings inflows were less at large
interbank loans but including loans sold to
banks, as some large denomination deposit
affiliates, total loans and investments of
certificates were not replaced at maturity.
Most of the growth in time and savings
member banks in the district rose 7.9 percent,
deposits at large banks was due to a $2.5
compared with 10.5 percent in 1978. Loans
billion increase in money market certificates.
accounted for most of the rise. Unlike 1978,
In the year ended in November, total
when there was a net reduction in total bank
deposits at all district member banks were up
holdings of securities, district banks acquired
only 3 percent, leaving most of the growth in
securities in 1979. Total bank loans expanded
loans to be financed by nondeposit sources.
9.4 percent, compared with an expansion of
At Chicago banks with assets totaling $1
15.7 percent in 1978.
billion or more, these sources provided about
The district data illustrate the greater im­
$5 billion of loanable funds.
pact of cyclical fluctuations on large banks
—

Federal Reserve Bank of Chicago




29

District holding company activity

During 1979, 102 applications were
decided on involving Seventh District holding
companies. Fifty-eight one-bank formations
were approved, and 27 banks became sub­
sidiaries of multibank holding companies.
At the national level, 547 applications
were decided on in 1979, up from last year's
total of 523 completed cases. Holding com­
panies nationwide currently control 52.6 per­
cent of the 50,422 commercial banking offices
in the United States.
Four holding company applications in­
volving district banks were denied on the
basis of adverse competitive factors. One, for
the formation of a one-bank holding com­
pany in Iowa, involved a chain banking situa­
tion. The Board took the position that ap­
proval of the application would perpetuate a
situation that was already anticompetitive,
further removing the possibility that banks in
the chain could compete in the future.
Two applications by multibank holding
companies to acquire additional banks were
denied—one in Iowa and another in
Michigan—on grounds that significant ex­
isting competition would be eliminated
without enough outweighing convenience
and needs factors.
One merger application was denied on
grounds not of existing competition but con­
cern over the concentration of statewide
banking resources and the elimination of
potential competition. Proposed was the
merger of the sixth and twelfth largest bank­
ing organizations in Michigan. Completion of
the merger would have given the resulting
organization control of 5.1 percent of the
deposits in the State. The Board determined
that both holding companies had the poten­
tial for expanding de novo into the other’s
markets and that several of the markets were
attractive for de novo entry.
Eight of the applications completed in
the district were the subjects of substantive
protests. Five of the applications were filed by
the same Michigan multibank holding com­
pany, and all were contested under the new

30




Community Reinvestment Act (CRA) by a
community group in Detroit.
The group protested the proposed ac­
quisitions of an existing bank and four de
novo banks on grounds the banking
organization had done little lending in low
and moderate-income areas in the Detroit
SMSA. The protests also charged racial dis­
crimination in the lending pattern and
challenged the delineation of one subsidiary
bank's lending community. These were the
first CRA protests filed against a holding
company in the Seventh District.5
The Board approved the applications in
November but directed the holding company
to broaden its lending and marketing efforts
in low and moderate-income areas. The
holding company had contended that its
lending performance before November 6,
1978, when CRA became effective, should not
be considered. The Board found, however,
that the convenience and needs analysis had
meeting the credit needs of its community.
Also, stressing the importance of technical
com pliance with the act, the Board
reprimanded the holding company for
technical violations regarding, for example,
failure to post CRA notices and not making
CRA statements available.6
Other CRA protested cases outside the
Seventh District are pending Board action.
Resolution of these cases will provide ad­
ditional insights into the regulatory
parameters used in evaluating a bank's
lending record under CRA.
5
The Board had ruled on two CRA-protested
applications from other districts. See Board O rd er of June
16,1978, approving the merger of Com m erce Bancshares,
Inc., Kansas City, Missouri, with M anchester Financial
Corporation, St. Louis (64 Federal Reserve Bulletin 576).
Also see Board O rd er of May 31, 1979, approving the
merger of the O h io Citizens Trust Com pany, Toledo, and
The Peoples State Bank, W auseon, O h io (65 Federal
Reserve Bulletin 517).
6See Board O rd er of November 30,1979, approving
the acquisition of the following five Michigan banks by
M ichigan National Corporation, Bloomfield Hills,
M ichigan: Litchfield State Savings Bank, Litchfield;
Michigan Bank-Livingston, Brighton; M ichigan BankMidland, Midland; M ichigan Bank-Northwest, Petosky;
and Michigan Bank-South M etro, Lincoln Park.

Economic Perspectives

Perils of the 1980s
The start of a new decade traditionally
provides a convenient point for assessments
of the economic outlook for the longer-term
future. Since World War II, such projections
typically have been characterized by a spirit of
optimism. Output usually was expected to
rise steadily with accompanying increases in
productivity and consumption. In early 1980,
however, confident optimism is a rare com­
modity. Sanguine expectations of perpetual
economic growth and rising living standards
have given way to apprehension that the
existing level of consumption cannot be
maintained.
Concern with a cyclical decline bears less
heavily upon consumers and businessmen
than in the past. The second half of the
decade of the 1970s was a period of economic
expansion, one of the longest on record.
Now, most observers believe that a recession
has begun. Typically, they expect the decline
to be short and shallow with upward forces
reasserted before year-end. Income supports
will help keep spending at a high level. If a
more serious adjustment appears to be
developing, most people believe that the
federal government will move speedily to cut
tax rates and accelerate outlays, and that the
Federal Reserve System will ease the supply of
money and credit.
Since World War II, fears of the
recurrence of a 1929-33 model depression
have been gradually put to rest. Along with
other industrialized nations, the United States
has learned that high levels of consumption
can be supported by maintaining consumer
buying power through stimulatory monetary
and fiscal policy. Unfortunately, a satisfactory
program for containing the inflationary con­
sequences of such policies has eluded all ma­
jor nations.
Concern with inflation is worldwide.
Frenzied efforts of individuals to maintain the
real worth of their assets are reflected in wild

Federal Reserve Bank of Chicago




fluctuations in the prices of gold and silver.
The number of people speculating in
precious metals, however, is small, compared
to the number who have purchased houses
and farmland at prices that cannot be justified
by the revenues currently earned by these
properties. Efforts to “ hedge against infla­
tion” show a deep distrust in the ability of the
nation to deal with its problems. Such efforts
add to price pressures by diverting resources
from productive to speculative channels.
The primary constraint on supply is the
availability of the energy that is essential for
agriculture, manufacturing, mining, transpor­
tation, space heating, and air conditioningin fact, virtually any human activity. Oil
provides about half of U.S. energy, and almost
half of this oil is imported. Prices of imported
oil have doubled in the past year, a develop­
ment quite unforeseen. Oil imports are the
cause of the now-chronic deficit in the U.S.
balance of international trade. Downward
pressures on the value of the dollar abroad
complicate the situation. Attempts to lessen
U.S. dependence on oil have been hampered
by restrictions on the construction and opera­
tion of power plants, the mining and burning
of coal, and by other environmentalist
regulations. Energy will remain the basic con­
straint determining the level of output and
consumption. Monetary and fiscal policy can
do little to ameliorate this situation.
The inflation and energy questions are
closely related to the widening crisis in the
Middle East. The State of the Union address
called for substantial increases in military out­
lays to meet the threat of further Russian en­
croachments in this vital area. Congress and
the people seem to approve. Because the
United States has little in the way of surplus
materials, facilities, or trained workers, the
military buildup may preempt resources
destined for consumption or private invest­
ment, and alter economic forecasts.

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