Full text of Economic Policy Review (Federal Reserve Bank of New York) : April 1971, Vol. 53, No. 4

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FEDERAL RESERVE BANK OF NEW YORK

T h e B u s in e s s S itu a tio n
The recent performance of most business indicators
suggests that domestic economic activity remains fairly
sluggish. Indeed, in February the index of industrial pro
duction declined despite higher output of automobiles and
steel. Moreover, personal income posted only a slim rise
in February, and the data for March suggest that the
underlying situation in the labor markets remains on the
sluggish side. The latest Department of CommerceSecurities and Exchange Commission survey of plant and
equipment spending intentions for 1971 indicates a 4.3
percent rise in such outlays. While this increment is
slightly larger than that indicated in the previous survey,
the magnitude of the increase scheduled for 1971 is still
quite modest.
On a more positive note, the inventory-sales ratios in
several key sectors have improved somewhat in recent
months. Of course, a significant near-term strengthening
of sales would pave the way for a more expansionary pace
of inventory spending. Moreover, the prospect for such
a strengthening in business sales has been enhanced by
recent fiscal policy changes. In particular, the new social
security legislation will boost social security payments by
10 percent retroactively to the beginning of the year while
deferring until 1972 a $2.5 billion increase in social se
curity tax payments that had been budgeted for this year.
Recent consumer price developments have been some
what encouraging. For the first two months of 1971 the
rate of increase in consumer prices slowed considerably
from its earlier rapid pace, thus raising the hope that the
inflation rate may, at last, be moderating. However, similar
improvements in the price situation have emerged in the
past only to be sharply reversed. Moreover, in March,
industrial wholesale prices rose at a seasonally adjusted
annual rate of 3.0 percent, almost double the rise recorded
in the prior month. Thus, it is not yet clear that a trend
toward a more acceptable pattern of price performance
has been firmly established. Moreover, in light of the heavy
collective bargaining schedule for 1971, and the large wage
gains which will take effect this year on the basis of con
tracts written in prior years, wage pressures on the price
level are likely to remain serious for some time to come.

P R O D U C T IO N , IN V E N T O R IE S , A N D O R D E R S

During February, the Federal Reserve Board’s index of
industrial production edged downward to 164.8 percent
of the 1957-59 base, a fall of 0.4 percent on a seasonally
adjusted basis. In the previous month, this index had
increased as higher automobile and steel output more than
outweighed declines in other industry groupings. In Feb
ruary, however, a small gain in automobile output and a
3.9 percent jump in steel production were not sufficient to
offset the continued weaknesses in other sectors. Exclud
ing both the automobile and steel components, industrial
output fell by 0.6 percent, with production moving lower
in virtually all other major groupings. For example, out
put of consumer goods exclusive of automobiles fell by
0.9 percent, the production of business and defense equip
ment continued its downward trend, and materials pro
duction showed little change.
While the lackluster performance of industrial produc
tion in recent months has reflected a broad range of fac
tors, a significant cause has been the failure of post-strike
gains in automotive production and sales to meet earlier
expectations. New passenger car production in March was
about unchanged from the February level of a shade under
9 million units on a seasonally adjusted annual rate basis
(see Chart I). These production levels are below the vol
ume of output which had been tentatively scheduled for
this period at the turn of the year. The failure to meet
these earlier production schedules was largely a response
to the disappointing level of automobile sales. In the first
quarter, sales ran at a seasonally adjusted annual rate of
somewhat more than 8 million units, although they
strengthened considerably toward the end of March. The
first-quarter sales volume was above the depressed level
for 1970 but well below the sales volume recorded in 1969.
Moreover, because automotive production in each of the
four months since the termination of the General Motors
strike has exceeded sales, dealer inventories of new pas
senger cars accumulated over the first quarter. Thus, un
less there is a sustained strengthening in automobile sales,
there is little likelihood of any large near-term thrust in

MONTHLY REVIEW, APRIL 1971

production stemming from higher automotive output.
The recent strike-induced movements in automobile
production and inventories have tended to distort the
overall relationship between sales and inventories. To
place these recent developments in better perspective,
Chart II shows the inventory-sales ratios for durables
manufacturers and retailers both including and excluding
the automobile group. As the chart indicates, the
durables manufacturers’ ratios have improved somewhat
in the last three months relative to their very high levels
of November 1970. However, at their February positions,
both of these manufacturers’ ratios still appear a bit
high, compared with the experience of the past three
years. On the basis of January data, inventory-sales posi
tions of durable goods retailers—both including and ex
cluding the automobile group— are more in line with the
behavior experienced in the second half of 1968 and early
1969. In fact, the ratio for durables retailers excluding
automobile outlets is below the level that prevailed in the
second half of 1969 and early 1970, when inventory
spending at these outlets underwent its last significant
downward correction. Of course, any substantial strength
ening in retail sales would tend to move the ratios lower,
thereby paving the way for a more expansionary pace of
inventory spending.
In February, new orders for manufactured goods in
creased by $0.3 billion on a seasonally adjusted basis.

C h art I

DOMESTIC A U T O P R O D U C T I O N A N D SALES
S e a s o n a lly a d ju s t e d a n n u a l ra te s
M illi o n s o f c a rs

M illi o n s o f ca rs

C h a r t II

INV EN TO R Y - SALES RATIOS
S e a s o n a lly a d j u s t e d
M o n t h s o f s a le s

M o n t h s o f s a le s

Note-. M a n u fa c tu rin g d u ra b le s p lo tte d th ro u g h F e b ru a ry ; re ta il d u ra b le s p lo tte d
th ro u g h J a n u a ry .
S o u rc e: U n ite d S ta te s D e p a rtm e n t o f C o m m e rc e , B u rea u o f th e C e n s u s .

This gain in orders stemmed almost exclusively from a
rise in bookings by nondurables manufacturers. In the key
durable goods sector, new orders were essentially un
changed from their January level, as a $0.4 billion increase
in producers’ capital goods orders offset a large drop in
steel mill bookings. This gain in capital goods orders was
strongly influenced by a large increase in orders in the
shipbuilding industry. Meanwhile, the volume of un
filled orders for durables manufacturers continued to rise
slightly but remained substantially below the levels that
had prevailed in early 1970. In short, the overall orders
situation was little changed in February and still does not
suggest a significant near-term strengthening in production.
B U S IN E S S IN V E S T M E N T A N D R E SID E N T IA L
C O N ST R U C T IO N

Source-. W o r d ' s A u t o m o t i v e R e p o r t s , s e a s o n a l l y a d j u s t e d a t t he F e d e r a l R e s e r v e

The most recent Commerce-SEC survey of plant and
equipment spending intentions indicates that business
firms are planning to increase their plant and equipment
expenditures by a modest 4.3 percent in 1971, with most
of the gain scheduled for the second half of the year. If
these spending intentions are realized, the year-over-year

FEDERAL RESERVE BANK OF NEW YORK

rise in this spending component in 1971 would be some ufacturing firms are— among other things— a reflection of
what smaller than the 5.5 percent increase registered in sluggishness in output relative to industrial capacity, which
1970. Moreover, in real terms, this increment in spending has characterized the last year and a half. Indeed, recent
may imply no change in the accumulation of new capital data show that manufacturing firms have been operating
goods in the current year.
at a rate utilizing only about three fourths of their capacity
The rise in spending reported in February is somewhat (see Chart III). Depressed levels of corporate profits have
higher than the level indicated in the survey taken last also tempered the willingness of business establishments
fall that had reported a slim 1.4 percent planned increase to embark on major new capital spending projects.
in spending for 1971. In part, however, the larger in
The sluggish near-term outlook for manufacturers’
crement now scheduled is a reflection of the fact that spending for plant and equipment portrayed in the
actual spending in the fourth quarter of 1970 fell below Commerce-SEC survey is consistent with the latest Con
the level of outlays that had been projected in the No ference Board survey of capital appropriations by large
vember survey. This shortfall in expenditures was partly manufacturing firms. The latter survey shows a relatively
attributable to reduced purchases of motor vehicles by large 7.2 percent drop in net new appropriations in the
businesses during the GM strike.
fourth quarter of 1970 to a level of $5.7 billion (see
In terms of industry groupings, all of the increase in Chart III). These appropriations, which are often a useful
expenditures planned for 1971 is scheduled for the non advance indicator of future capital spending, had peaked
manufacturing sector, with more than half of the gain at $7.5 billion in the second quarter of 1969.
In February, private housing starts remained virtually
arising in the public utilities sector. Despite the general
sluggishness in the economy, capacity strains in the public unchanged at the 1.7 million unit seasonally adjusted
utilities sector have remained quite severe. In contrast, annual rate recorded in January. However, the average
among manufacturing firms, the February survey indicates number of starts initiated in the first two months of 1971
that plant and equipment outlays in 1971 will be slightly was about 18 percent above the average for 1970 as a
less than the spending level reached last year with vir whole. Moreover, the February composition of starts
tually every durables industry group in the manufacturing shifted toward single-family structures. In fact, single
sector scheduling declines in early 1971. Of course, the family starts rose to a seasonally adjusted annual rate of
more distinct weaknesses in spending intentions by man- 975,000 units which— except for the unusually high De
cember 1970 figure— was the largest number of single
family structures begun in any month since December
1968. Normally, a shift toward single-family structures
implies a somewhat stronger course of spending for resi
C h c rt III
dential construction, since these units typically have a
MANUFACTURING APPROPRIATIONS AND UTILIZATION
Seasonally ad justed
higher per unit value than do multifamily housing units.
Billions of dollars
Thus, while housing starts failed to rise in February, the
evidence remains convincing that the increased availability
N e t new a p p ro p ria tio n s *
and reduced cost of mortgage credit will continue to
-------Scale
stimulate spending for residential construction in the com
ing
months.
_
—I,
Percient
90

__ 85

s *.

__ 8 0

C a p a c ity o f u tiliz a tio n
S c a le ------- ►

_ L _ I ______
1968

. L..

1
1969

1
1970

* For th e th o u s an d la rg e s t m a n u fa c tu rin g firm s.
Sources: The C o n fe re n c e B o a rd , Inc., an d B o ard o f G o v e rn o rs o f the
F e d e ra l R es erv e System.

E M P L O Y M E N T , P E R S O N A L IN C O M E , A N D P R IC E S

In March the unemployment rate edged upward by 0.2
percentage point, thereby erasing the drop which had oc
curred in February. The rise in the unemployment rate
reflected a decline of 62,000 in the number of employed
persons as measured by the household survey and a fairly
small rise in the size of the labor force. Among the prin
cipal labor force components, the most significant increases
in unemployment rates occurred among women in the 20
to 24 age-bracket and among teen-agers of both sexes.
For the first quarter as a whole, the unemployment rate

MONTHLY REVIEW, APRIL 1971

averaged 5.9 percent, unchanged from the fourth quarter
of 1970. According to the payroll survey, total employ
ment was essentially unchanged in March, as small in
creases in some sectors offset a decline of 63,000 in man
ufacturing employment. Since last September, manufac
turing employment has declined by 630,000 workers or
by about 3.3 percent. The March payroll survey also in
dicates that the average workweek of production workers
in manufacturing rose 0.4 hour from the February figure.
Hours worked in February had dropped sharply, probably
as a result of seasonal adjustment problems associated
with the Lincoln’s Birthday holiday. On balance, however,
the labor market data for March and for the first quarter
as a whole do not indicate any improvement in the under
lying situation. At best, the data suggest that the sharp
deterioration of labor market conditions which character
ized much of 1970 may have stabilized.
The growth in personal income, which was restrained by
the declines in employment and hours worked, amounted
to $2.2 billion in February. This increment in personal
income was only about three fifths of the average monthly
rise in income last year. Overall wage and salary dis
bursements rose by about $1.6 billion. In the manufactur
ing sector, however, wage and salary payments actually
declined, as particularly large decreases in payrolls were
recorded in the apparel, fabricated metals, machinery,
and chemical industries. All the nonwage and salary com
ponents of personal income showed little change in Feb
ruary, thus rounding out a rather dismal performance of
personal income in that month.
For the second consecutive month the rate of increase
in consumer prices lessened significantly in February rela
tive to the very rapid increase experienced in the past
several years. On a seasonally adjusted basis, the overall
consumer price index rose at an annual rate of 2.0 percent

following the 3.4 percent rate of increase in January. The
slowing in consumer price increases in February material
ized despite the fact that food prices— which make up
about one fourth of the overall index— rose at an annual
rate of 5.2 percent. In contrast, prices of nonfood com
modities on a seasonally adjusted basis declined at a 1.0
percent annual rate, the first such fall in this measure
of prices since February 1965. Services prices also mod
erated appreciably in February, posting their smallest
monthly increase since April 1967. In large part, how
ever, the moderation in services prices reflected the sharp
drop in rates on home mortgages. On the whole, the
performance of consumer prices in February, coming on
the heels of the January improvement, raises the hope that
the inflation rate may at last be moderating. However, it
would be a mistake to draw sweeping conclusions from two
months’ data. Only last year, a similar slowdown in the
rate of consumer price increases in July and August was
followed by the resumption of rapid inflation.
In March, industrial wholesale prices rose at a season
ally adjusted annual rate of 3.0 percent, almost double
the increase registered in February. Most of this accelera
tion was caused by higher prices for materials used
in construction, including lumber and structural steel.
For the three months ended in March, industrial whole
sale prices increased at an annual rate of 2.8 percent,
significantly below the pace for 1970 as a whole but still
a rapid increase considering the sluggishness in the econ
omy. Wholesale agricultural and food prices rose at a
seasonally adjusted annual rate of about 1 percent in
March, after having posted very large gains in the two
preceding months. Reflecting this marked slowing in food
price increases, the overall wholesale price index also
moderated in March and posted a gain of 3.3 percent on
a seasonally adjusted annual rate basis.

FEDERAL RESERVE BANK OF NEW YORK

T h e M o n e y a n d B o n d M a r k e t s in M a r c h
Interest rates in the capital markets fell substantially in
March, although they reversed direction and rose some
what toward the end of the month. A record volume of
$4.2 billion of new corporate bonds was publicly offered
during March. Yields on new Aa-rated utility issues de
clined by about 60 basis points over the first three weeks
of the month and then backed up by about one fourth of
that amount. Yields on long-term Treasury bonds fell by
19 to 57 basis points. The Weekly Bond Buyer's index
of twenty municipal bond yields fell by 31 basis points
over the month. Indeed, except in the corporate sector,
the decline in yields erased the increases posted during
February and left yields on some long-term securities near
their lowest levels in more than two years.
In contrast to long-term yields, most short-term inter
est rates were relatively steady in March. However, the
sharp drop in short-term interest rates over recent months
has brought them to levels far below comparable rates in
many European countries. This has prompted United
States banks to reduce further their liabilities to their
foreign branches. Foreign corporations and subsidiaries
of United States corporations operating abroad have
drawn on Euro-dollar credits, as rates have fallen, and
many of these have then been converted into foreign cur
rencies. Such conversions have led to an accumulation of
dollars by foreign central banks and have increased the
United States balance-of-payments deficit on the official
settlements account basis.1
Beginning in January 1971, sales of notes by the
Export-Import Bank to foreign branches of United States
banks helped to prevent the reduction in commercial
bank liabilities to their foreign branches from adding to
the accumulation of dollars by foreign central banks.
During the first quarter of 1971, two such sales were held
totaling $1.5 billion. However, as short-term interest rates

1 For a further discussion, see Charles A. Coombs, “Treasury
and Federal Reserve Foreign Exchange Operations”, this Review
(March 1971), pages 43-57.

in the United States dropped over the first quarter, com
mercial banks reduced their liabilities to their foreign
branches by $3.6 billion, substantially more than the
$1.5 billion absorbed by the Export-Import Bank note
issues. Partly as a result of this, dollar holdings of for
eign central banks continued to swell. Marketable United
States Government securities held in custody by the Fed
eral Reserve Banks for foreign and international accounts
rose to $15.1 billion on March 31, up $1.9 billion from
four weeks earlier and an increase of $3.8 billion since
December 30, 1970. To help avert an additional increase
in foreign central bank dollar holdings, on April 1 the
Department of the Treasury announced plans to offer $1.5
billion in three-month certificates of indebtedness to foreign
branches of United States banks.
THE M ONEY M ARKET

Most rates were relatively steady in the money market
during March, in contrast to the precipitous declines
experienced in other recent months (see Chart I). The
effective rate on Federal funds averaged 3.71 percent in
March, virtually unchanged from February’s average.
Unexpected firmness developed on the eve of the quar
terly statement date at the month end. But, in general,
the steadiness in the money market climate allowed most
short-term rates to move in a trading range that con
solidated the sharp declines of earlier months. Rates
on three-month Treasury bills, bankers’ acceptances, and
directly placed commercial paper moved narrowly, ending
somewhat higher over the month.
To align their lending rates more closely with other
market interest rates, commercial banks cut the prime
rate in March by Vi percentage point to 5lA percent.
This was the fifth consecutive month in which the prime
rate was lowered, and the reduction brought the rate to
its lowest level since March 1966. Despite the prime rate
reductions in November and December, commercial bank
business loans actually declined during the last quarter
of 1970 on a seasonally adjusted basis. Although modest
growth resulted in January and February, demand was

MONTHLY REVIEW, APRIL 1971
Table I
FACTORS TENDING TO INCREASE OR DECREASE
MEMBER BANK RESERVES, MARCH 1971

In millions of dollars; (-f) denotes increase
(—) decrease in excess reserves
Changes in daily averages*
week ended
Net
Changes

Factors
March
3
“ Market” factors
M em ber ban k re q u ired
reserves .......................................
O perating tra n sa ctio n s
(su b to tal) .................................
F e d e ra l R eserve f l o a t .........
T reasury operations* ------G old a n d foreign acco u n t
Currency outside b an k s .
O ther F e d e ra l Reserve
lia b ilitie s a n d c a p ita l -----

March
10

+ 227

— 700
— 749
— 99

4- 152
4 - 183
— 105

+ 17
- f 220

4—

R epurchase a g re e m en ts:
T reasu ry s e c u r i ti e s .............
B a n k e rs’ a c c e p ta n c e s .........
F e d e ra l agency o bligations
M em ber b a n k borrow ings ----Other F e d e ra l Reserve

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

4- 255
4 - 46
4 - 348
— 186

—
—
4—
—

4- 230

288
392
508
5
628

March
31

4 - 40

— 177

— 337
— 60
— 41
4- 421

—
—
4—
—

—

4 - 110

+ 578

4 - 744

4 - 158
—

4- 429

+ 6
554
43
90
43

4 - 372

4- 277

44—

4 - 20

4 - 90
— 131

—
—
—
4-

4 - 50

4 - 20

4- 271
-f- 327
— 5
— 41
_
1

4 - 892
— 310
—

4- 132

— 104
— 15
—
7
4 - 163
— 15

- f 326

Excess reserves ..........................

4- 604

4 - 66

4 - 122

13
36
76

deficit ( - ) §

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

29,542
29,372
170
258

29,403
29,322
82
421

),284

4 - 20
4- 7
4- 169

4 - 811

4 - 546

4- 921

- 152

4- 357

4- 103

Monthly
averages

Daily average levels
Member bank:
T otal reserves, including
v au lt cash .......................... ..
R equired reserves ..................
Excess reserves ........................
B orrow ings .................................
F re e, or n e t borrow ed ( — ),
reserves ........................................
N onborrow ed reserves ...........
N et carry-over, excess or

858
947
58
7
72

202

as se ts t ..............................................
T otal

March
24

— 371

+ 2

T o tal “ m ark et” factors

Direct Federal Reserve
credit transactions
Open m ark et o p erations
(su b to tal)
.....................................
O u trig h t holdings:
T reasu ry securities ...........
B a n k e rs' a c c e p ta n c e s .........

March
17

29.927 1 29,501
29,693 ; 29,438
63
234
290
333

2,9,979
29,559
420
257

29,670$
29,477$
194$
312t

— 270
29,168

163
29,722

— 118t
29,359$

— 56
29,637

187

107$

N ote: B ecause of rounding, figures do no t necessarily ad d to totals.
* Includes changes in T reasury currency a n d cash,
t Includes assets d en om inated in foreign currencies.
$ Average for five weeks ended M arch 31.
5 N ot reflected in d a ta above.

quite sluggish again in March. Over the four statement
weeks ended March 24, which include the March 15 cor
porate tax payment date, business loans (adjusted for sales

to affiliates) at weekly reporting banks grew by only $0.5
billion. This contrasts with increases of $1.3 billion and
$1.0 billion during the corresponding periods in 1969 and
1970, respectively.
The monetary aggregates continued to grow very rapidly
in March, although at rates somewhat below the extra
ordinarily high growth rates posted in February. Since these
series are erratic and subject to revision, longer time spans
are more useful than monthly movements in examining the
behavior of the monetary aggregates. In this vein, over
the first quarter of 1971 the narrowly defined money sup
ply (M i)— currency plus demand deposits held by the
public— expanded at a seasonally adjusted annual rate of
about 8 percent (see Chart II), compared with the 5.4
percent increase recorded over 1970 as a whole. This
brought the growth rate in Mi over the last six months to
about 5 Vi percent. Commercial bank savings and time
deposits other than large certificates of deposit (CD’s)
have been growing much faster than the narrow money
supply. Consequently, M2— a broader measure of the
money supply which includes commercial bank time de
posits held by the public less CD’s—rose at an extremely
rapid seasonally adjusted annual rate of about 17 Vi percent
over the first quarter of 1971, compared with an 8.3 percent
growth posted over 1970. Over the last six months, this
aggregate expanded at a seasonally adjusted annual rate
of about 13 Vi percent. Largely reflecting the decline in
liabilities to foreign branches and commercial paper issued
by bank holding companies or other affiliates, the adjusted
bank credit proxy has grown less rapidly than M2 in recent
months. Over the first quarter of 1971, the adjusted bank
credit proxy increased by about 10Vi percent, bringing the
growth rate over the last six months to about 10 percent.
TH E G O V E R N M E N T SE C U R IT IE S M A R K ET

Treasury bill rates edged downward in the first half of
March but at a much slower pace than in recent months.
A somewhat cautious atmosphere prevailed, as market
participants appeared uneasy about the recent sharp rate
declines that brought them to their lowest levels in seven
years. The hesitancy was partially dispelled when one
major bank slashed its prime rate by Vi percentage point.
However, the March 16 announcement of offerings of new
Treasury bills totaling $5 billion without Tax and Loan
Account privileges caused a brief reaction in rates.
The Treasury’s offering was divided into three seg
ments: $200 million increments to the regular weekly
offering of six-month bills for four weeks beginning March
22 through April 12, a $2.0 billion issue of April 22 tax
anticipation bills auctioned on March 24, and a strip

FEDERAL RESERVE BANK OF NEW YORK

totaling $2.2 billion auctioned on March 31 (comprising
additions of $200 million each to eleven outstanding
regular issues due from July 8 to September 16). The new
financing package was somewhat larger than had been
expected, and rates on many bills rose by nearly V\ per
centage point on the day after the announcement.
A more cautious tone prevailed in the Treasury bill
sector during the remainder of the month, as the weight of
additional supply was felt. By the month end, rates on most
issues were 10 to 20 basis points higher than at the begin
ning of the month. The rise in yields over the second half
of March followed the downward trend that dated from
the beginning of 1970, but still left Treasury bill rates
at the close of the month near their lowest levels since
1963.

Yields on Treasury notes and bonds fell steadily until
late in the month. Market sentiment was bolstered early in
the month by System purchases of coupon-bearing issues
and discussion of possible cuts in the commercial bank
prime rate. There was also talk of possible reductions in
reserve requirements and the discount rate. On March 11,
one major bank cut its prime rate to 514 percent and yields
on Treasury securities plunged in brisk trading. The effect
of the prime rate reduction was especially pronounced
in the intermediate-term securities market, where yields
on some issues dropped as much as 15 basis points in
a single day. The rally faltered briefly, as most major
banks lowered their prime rates to only 5 Vi percent. How
ever, yields resumed their downward trend on March 15,
when several other major banks reduced their prime rates

Chart I

SELECTED INTEREST RATES
P«rc«nt

M ONEY M ARKET RATES

Ja n u a ry

Feb ru a ry

Jan u a ry-M a rch 1971

M arch

BOND M ARKET YIELDS

Ja n u a ry

F eb ruary

Percent

M arch

N o te : D a t a a r e s h o w n fo r b u s in e s s d a y s o n ly .
M O N E Y M A R K E T RATES Q U O T E D : B id ra te s fo r t h r e e -m o n t h E u r o -d o lla rs in L o n d o n ; o f fe r in g

d a i ly a v e r a g e s o f y ie ld s on s e a s o n e d A a a - r a t e d c o r p o r a t e b o n d s .- d a i ly a v e r a g e s o f y ie ld s

r a te s fo r d ir e c t ly p la c e d f in a n c e c o m p a n y p_ap_er; th e e f f e c t i v e r a te on F e d e r a l fu n d s (th e

on lo n g -te rm G o v e r n m e n t s e c u ritie s (b o n d s d u e o r c a lla b le in ten y e a r s o r m o re) a n d on

r a te m o st r e p r e s e n t a t iv e o f th e t r a n s a c tio n s e x e c u te d ); clo s in g b id ra te s ( q u o te d in te rm s

G o v e r n m e n t s e c u ritie s d u e in th re e to f iv e y e a r s , c o m p u te d on th e b a s is o f c lo s in g b id

o f r a te o f d is c o u n t) on n e w e s t o u ts ta n d in g th r e e -m o n t h T r e a s u ry b ills .
B O N D M A R K E T YIELDS Q U O T E D : Y ie ld s on n e w A a - r o t e d p u b lic u tility b o n d s (a rro w s p o in t
fro m u n d e r w r itin g s y n d ic a te re o f f e r in g y i e ld on a g iv e n is su e to m a r k e t y ie ld on
th e s a m e is su e im m e d ia te ly a f t e r it h a s b e e n re le a s e d fro m s y n d ic a te re s tric tio n s );

p ric e s ; T h u r s d a y a v e r a g e s o f y ie ld s on tw e n ty s e a s o n e d t w e n t y - y e a r ta x -e x e m p t b o n d s
( c a rry in g M o o d y 's r a tin g s o f A a a , A a , A , a n d B a a ).
S o u rc es : F e d e r a l R e s e rv e B a n k o f N e w Y o rk , B o a rd o f G o v e r n o r s o f th e F e d e r a l R e s e rv e S y s te m ,
M o o d y ’ s In v e s to rs S e r v ic e , a n d T h e W e e k ly B o n d B u y e r.

MONTHLY REVIEW, APRIL 1971

C h a r t II

C H A N G E S IN M O N E T A R Y A N D CREDIT A G G R E G A T E S
S e a s o n a lly a d ju s t e d a n n u a l ra te s o f c h a n g e
P e rc e n t

P e rc e n t

II
III
1970
N o te :

I
1971

II
III
1970

1971

1970

1971

D a ta fo r 1971-1 a re p re lim in a ry .

^ C u r r e n c y p lu s d e m a n d d ep o s its h e ld b y th e p u b lic .
^ C u rre n c y plus d e m a n d an d tim e d e p o s its h eld by th e p u b lic less n e g o tia b le
c e rtific a te s of d e p o s it issued in d e n o m in a tio n s o f $ 1 0 0 ,0 0 0 o r m o re .
"f T o ta l m e m b e r b a n k d ep o s its su b je ct to re s e rv e re q u irem e n ts p lus n o n d e p o s it
lia b ilitie s , such as E u ro -d o lla r b o rro w in g s a n d co m m erc ial p a p e r issu ed by
b a n k h o ld in g co m p a n ie s or o th e r a ffilia te s .
So u rce:

B o ard o f G o v e rn o rs o f the F e d e ra l R es erv e System .

to 5X
A percent, and the Federal Reserve Board announced
that the industrial production index had declined in Feb
ruary by 0.4 percent following a two-month gain.
Market participants were also encouraged by favorable
developments in the corporate and municipal bond mar
kets, and yields continued to fall until the last week of the
month. However, yields rose moderately at the close of
the month, in part because of profit taking by short-term
investors. On balance, yields on intermediate-term Trea
sury securities declined by 33 to 44 basis points over the
month, while yields on long-term issues fell 19 to 57
basis points. The decline in long-term bond yields more
than erased the rise in February; by the end of the month
the average yield on long-term Treasury bonds was at
the lowest level since December 1968.

during February, and the decline in the industrial produc
tion index. The decline convinced many investors that the
economy was still weak, that monetary policy would re
main stimulative, and that corporate securities offerings
would decrease over the next few months. Some evidence
that the supply of new corporate issues was beginning
to wane was already apparent, and this further bolstered
investor confidence. The schedule of dealer-placed cor
porate bond offerings for April is about $2 billion, less than
half the record monthly volume for March but about equal
to the monthly average in 1970.
Encouraged by these favorable developments, under
writers bid aggressively for new issues. Yields on newly
issued prime corporate bonds plunged 62 basis points over
the first three weeks of the month, nearly retracing the
70 basis point increase for February. During the final
week of the month, however, yields backed up by about
15 basis points. The Weekly Bond Buyer's twenty-bond
index of municipal bond yields fell to 5.00 percent in
the third week of the month, the lowest level since Feb
ruary 1969. Although the index rose over the remainder
of March, by the month end it stood at 5.03 percent, 31
basis points below its level at the end of February.
The fundamental tone of the corporate and municipal
sectors was still weak at the beginning of the month, as
the market labored under mounting supply pressure and
heavy dealer inventories. Investors were cautious and a
number of new issues were released from syndicate price

Table II
AVERAGE ISSUING RATES*
AT REGULAR TREASURY BILL AUCTIONS

In percent
Weekly auction dates— March 1971
Maturities

T h re e-m o n th
S ix -m o n th . .

March
1

March
S

March
15

March
22

March
29

3.347
3.467

3.307
3.359

3.307
3.416

3.331
3.481

3.521
3.695

O TH ER SE C U R IT IE S M A R K E T S
Monthly auction dates— January-March 1971

Strong investor demand reemerged in the corporate
and municipal bond markets in March. A record vol
ume of new issues was marketed at declining yields until
late in the month, when a cautious atmosphere reemerged
and yields moved higher. Investors responded enthusias
tically to reductions in the commercial banks’ prime rate,
the modest rate of increase in the consumer price index

N in e -m o n th
O ne-year . . .

January
26

February
23

March
25

4 .2 6 8

3.691

3.507

4 .2 4 8

3.675

3.586

In te re s t ra te s on b ills a re q u o ted in term s of a 360-day year, w ith th e d iscounts from
p a r as th e re tu rn on th e face am o u n t of th e b ills pay ab le a t m atu rity . B ond yield
eq u iv alen ts, re la te d to th e am o u n t a c tu a lly in v ested , w ould be slig h tly higher.

FEDERAL RESERVE BANK OF NEW YORK

restrictions, resulting in sharp upward yield adjustments.
However, strong investor demand developed on March
9, when a large telephone company offering met an excel
lent reception. Two days later, when the V2 percentage
point reduction in the prime rate was initiated, many other
new securities issues sold quickly. The prime rate reduc
tion prompted underwriters to offer an electric utility issue,
rated Aa and priced to yield 7.42 percent, 45 basis points
below two similarly rated corporate utility bond issues
marketed on February 24. The aggressive pricing caused
investors to hesitate, and less than half of the bonds were
sold on the first day. But with further optimistic news,
including announcements that several other major banks

had reduced their prime rates by V2 percent, sales picked
up. The remainder sold on March 17, when another Aarated utility issue was marketed at a yield of 7.25 percent.
This new issue also met first-day buyer resistance but sold
out one week later.
Investor resistance to further rate declines stiffened
toward the end of the month. For example, a $40 million
Aa-rated utility bond issue drew a cool response from
buyers, when priced to yield 7.10 percent on March 23.
At the end of the month, this issue was only about 40
percent sold. When the issue was released from syndicate
price restrictions on April 1, its yield rose to 7.42 percent
in initial trading.

P e r J a c o b s s o n F o u n d a tio n L e c tu r e
The Per Jacobsson Foundation in Washington, D.C., has made available to the Federal Re
serve Bank of New York a limited number of copies of the 1970 lecture on international monetary
affairs. In sponsoring and publishing annual lectures on this topic by recognized authorities, the
Foundation continues to honor the late Managing Director of the International Monetary Fund.
The seventh lecture in this series was held at the University of Basle on September 14, 1970
in Basle, Switzerland. William McChesney Martin, former chairman of the Board of Governors of
the Federal Reserve System, spoke on “Toward a World Central Bank?” Discussion on the subject
was presented by Dr. Karl Blessing, former President of the German Federal Bank; Alfredo Ma
chado Gomez, President of the Mercantile and Agricultural Bank of Caracas, Venezuela (and for
merly President of the Central Bank of Venezuela); and Dr. Harry G. Johnson, professor of eco
nomics at the University of Chicago and the London School of Economics.
This Bank will mail copies of the lecture without charge to readers of this Review who have
an interest in international monetary affairs.
Requests should be addressed to the Public Information Department, Federal Reserve Bank
of New York, 33 Liberty Street, New York, N.Y. 10045. French and Spanish versions are also
available.

MONTHLY REVIEW, APRIL 1971

M o n e t a r y A g g re g a te s and F e d e ra l R e s e rv e O p e n M a r k e t O p e ra tio n s
By P a u l M e e k a n d R u d o l f T h u n b e r g *

In 1970 the Federal Open Market Committee (FOMC)
began to establish longer term objectives for the growth of
selected monetary and credit aggregates as an integral
part of its instructions for the conduct of open market
operations in Government securities and other short-term
credit instruments. This move was a natural extension
of the Committee’s greater emphasis on such quantities
in recent years, but it did not imply any lack of concern
with interest rates and financial flows in the credit mar
kets generally. Indeed, the Committee gave precedence
to calming financial markets in May through July, and
beginning in August underscored its expansive monetary
policy by calling for an easing in credit markets over the
months ahead. The FOMC also continued to eschew sig
nificant policy changes during large Treasury financings.
The greater emphasis on aggregates involving the bank
ing system did bring about changes in the Committee’s
formulation and tracking of its policy strategy. It also
required some modification in the conduct of open mar
ket operations by the Manager of the System Open Market
Account and his staff at the Trading Desk of the Federal
Reserve Bank of New York. The present paper describes
the nature of these changes.
T H E C H A N G E I N T H E F O M C ’S I N S T R U C T I O N S

The focal point of change was the second paragraph
of the directive to the Federal Reserve Bank of New
York, which is voted at each FOMC meeting.1 For sev

eral years prior to 1970, the Committee’s operating
instruction usually called for the maintenance of specified
money market conditions until the next FOMC meeting,
subject to a proviso clause that called for modifying
operations if bank credit appeared to be deviating sig
nificantly from current projections.2 This instruction meant
that the Manager would begin by seeking to hold mainly
the following within ranges designated by the Committee:
the Federal funds rate, member bank borrowings from the
Reserve Banks, and free or net borrowed reserves (excess
reserves less such member bank borrowings). With dis
count window administration within the framework pro
vided by Regulation A and the discount rate in force, the
Committee, in effect, established the terms and conditions
on which reserves were to be made available to member
banks through open market operations.3 The Federal Re
serve chose the opportunity cost of reserves to commer
cial banks as its instrumental variable for affecting the
monetary and credit aggregates and interest rates in the
credit markets.

The proviso clause, which originated in 1966, intro
duced a conditional element into the instructions to the
Manager. It rested on a quantitative staff estimate of
the growth in a selected aggregate over the weeks ahead
that would result from maintenance of the specified money
market conditions. When the FOMC was concerned about
overly rapid growth in the aggregate, usually the bank

-T h e directive issued on December 16, 1969, for example, had
the following second paragraph: “To implement this policy, Sys
tem open market operations until the next meeting of the Com
mittee shall be conducted with a view to maintaining the prevailing
firm conditions in the money market; provided, however, that
operations shall be modified if bank credit appears to be deviating
1 “Monetary Aggregates and Money Market Conditions in Open significantly from current projections or if unusual liquidity pres
Market Policy”, Federal Reserve Bulletin (February 1971), pages sures should develop.”
79-104, gives a detailed account of the evolution of the directive
and the role of the aggregates in 1970. System policy makers have,
3 Paul Meek, Discount Policy and Open Market Operations
of course, used data on the monetary aggregates in their analysis
(Fundamental Reappraisal of the Discount Mechanism), pages
for many years.
4-8.

* Assistant Vice President, Open Market Operations and Trea
sury Issues function, and Manager, Domestic Research Depart
ment. The authors are indebted to Stephen Thieke for assistance
in assembling and summarizing certain data.

FEDERAL RESERVE BANK OF NEW YORK

credit proxy,4 it expected the Manager to move toward a
higher Federal funds rate and higher member bank bor
rowings at the discount window whenever the aggregate
persistently expanded more rapidly than expected. Con
versely, if the FOMC were concerned with shortfalls, it
would expect the Manager to relax the pressures on bank
reserve positions when the aggregate was weak. The Com
mittee’s discussion gave the Manager guidance as to what
constituted a significant deviation.
The FOMC’s new approach to the directive in 1970
is exemplified by the second paragraph of the directive
adopted at its March 10 meeting:

expected to foster conditions at the short-term end of the
credit markets that would tend to work in time toward an
easing of long-term interest rates.
T H E A P P R O A C H TO PO L IC Y S T R A T E G Y

The 1970 directives embody a shift of emphasis in
policy making, rather than a basic change in Committee
members’ analytical views of how the economy works.
To be sure, the Committee made the rates of growth
to be achieved in the money supply and/or the adjusted
bank credit proxy over a longer run period, often a
calendar quarter, the focal point of its policy discussion.
But the framework thus provided left each participant
To implement this policy, the Committee desires
in the policy process free to assess the relative impor
to see moderate growth in money and bank credit
tance of fiscal policy, interest rates, the total flow of funds,
over the months ahead. System open market opera
or the monetary and credit aggregates themselves. Since
tions until the next meeting of the Committee shall
the economic and financial analysis reviewed at each
be conducted with a view to maintaining money mar
meeting looks four to six quarters into the future, the
ket conditions consistent with that objective.
calendar quarter or somewhat longer provided a useful
The policy record for that meeting indicates that the time horizon for policy implementation.
The directive helped make clearer the distinction
Committee was setting as its objectives a growth rate of
3 percent for the money supply (currency outside banks between the intermediate financial objectives of policy
and private demand deposits) and 5 percent for the and the instrumental variables for realizing them. The
adjusted bank credit proxy over the second quarter. The intermediate objectives are desired rates of growth in
Manager was told to adjust money market conditions the monetary and credit aggregates over a specified time
as might be needed to achieve these longer run objec period, supplemented or even supplanted on several occa
tives. The Committee’s discussion provided guidance as sions in 1970 by special attention to credit market
to the trade-off between the two quantitative objectives conditions. One would expect the quarterly objectives
should one or both diverge from the growth rate desired. to change only infrequently, as the Committee changes
Beginning in its August meeting, the Committee added its evaluation of the economic outlook or its estimate
“some easing of conditions in credit markets . . . over of the relation between the intermediate policy objectives
the months ahead” as an objective of open market opera and ultimate economic goals. In 1970, the Committee
tions. The coupling of this objective with the quantita did, in fact, change its objectives only gradually over the
tive objectives represented an amplification of the Com year.
The form of the directive has fostered a willingness on
mittee’s policy intent, emphasizing its commitment to a
moderately expansionary policy. It was recognized that the part of the FOMC to change money market conditions
the capital markets, in particular, were subject to supply, as this seemed necessary to the achievement of its objec
demand, and expectational factors as well as to the influence tives, whether couched in terms of growth rates of aggre
exerted by System open market operations. Within the gates or credit market conditions. The directive itself
context of the quantitative objectives, the Manager was incorporates a conditional instruction to the Manager to
make such changes if necessary. And the FOMC has also
changed the settings of the instrumental variables at its
regular meetings.
The Committee pursued its quantitative objectives
quite flexibly in 1970, fully mindful of its responsibility
for fostering a smoothly functioning financial system and
4 Originally, the bank credit proxy was total member bank
for protecting it from unusual strains. As will be dis
deposits subject to reserve requirements. As nondeposit liabilities
became important sources of funds for money market banks, such
cussed more completely below, open market operations
liabilities were added to deposits to comprise an adjusted bank continued to strive for reasonably steady money market
credit proxy. They include Euro-dollar borrowings and commer
conditions from day to day in the face of large short-run
cial paper issued by bank holding companies or other affiliates.

MONTHLY REVIEW, APRIL 1971

fluctuations in the factors affecting the demand for, and
supply of, bank reserves. Beyond this, the Committee
directed that operations moderate, first, the pressures that
developed in the bond markets in May and, then, the
liquidity pressures that grew out of the insolvency of
the Penn Central Transportation Company in June. The
addition of easier credit market conditions to its objectives
in August added a further dimension to the stimulative
thrust of the Committee’s policy.
The policy process did not change a great deal under
the 1970 directives, but the aggregates did provide a focus
for policy discussions.5 The directive that emerged from
the FOMC meeting carried with it the emphases of the
meeting itself—for example, the trade-offs between the
various aggregates or the degree of concern with financial
markets.6 There was also a specification of both the inter
mediate objectives and the instrumental money market
variables to be pursued in the short run. For each aggre
gate there was a path of monthly values that the staff
projected as consistent with the target for the quarter or
other time period. From April on, this was supplemented
by a path of weekly values spanning the period until the
next Committee meeting. It is perhaps appropriate to call
these values tracking paths rather than target paths. The
staff was aware that a tracking path could not be derived
with great precision, and the Committee was well aware that
the Manager could not hit these values. But it did expect
him to respond to significant deviations of the aggregates
from the path unless the validity of the path appeared
dubious because of unforeseen Treasury operations or
other developments.
THE STR A TEG Y OF O PE N M ARK ET O PE R A T IO N S

In implementing the Committee’s decisions, the Man
ager of the System Open Market Account pursues an
operational strategy whose targets depend upon the length
of the time period involved.7 For each statement week,
money market conditions provide a target that the Man

ager can usually approximate, although large errors in
trying to predict the factors affecting nonborrowed reserves
sometimes make it difficult to achieve the desired con
ditions. For each quarter, the aggregates provide a target
to be approached through successive changes in money
market conditions. This strategy thus aims at control of
quantities over a longer time period— a procedure which
many students of monetary policy have concluded is desir
able. But it does so without trying to iron out week-to-week
fluctuations in the aggregates. Indeed, no evidence has been
presented that these short-run changes in money and credit
interfere with, rather than facilitate, economic stability.
During the first statement week after the FOMC meet
ing, the Manager seeks to maintain money market con
ditions within the ranges specified by the Committee.
Essentially, this strategy involves using open market
operations to accommodate week-to-week changes in
required reserves by varying nonborrowed reserves so
that member bank borrowings at the discount window
and/or the Federal funds rate remain within the desired
range. A key part of the Manager’s operational problem
is the practical difficulty of forecasting the behavior of
the market factors affecting the nonborrowed reserves
of member banks.8 Given the variability from year to
year of patterns in the behavior of Federal Reserve float,
currency in circulation, the Treasury’s balances at the
Reserve Banks, and other factors affecting reserves, the
confidence limits that surround the statistician’s best esti
mates are wide. The daily average deviation of the actual
reserve effect of the market factors each week from the
projections made by the New York Bank staff at the be
ginning of the statement week was about $250 million
during 1970. (See Chart I for an illustration for the
fourth quarter.) The choice of an accommodative weekly
strategy rests to a considerable degree on the fact that
this margin of uncertainty is large relative to the incre
ments to the reserve base called for by a policy of
achieving specified growth rates for the aggregates. (The
average weekly addition to total member bank reserves
in 1970 was less than $25 million.)
In this environment the Manager finds the Federal
funds market an invaluable source of information con
cerning the current impact of market factors on non-

5 For a detailed description of the procedures at FOMC meet
ings, see “Monetary Aggregates and Money Market Conditions
in Open Market Policy”, op. cit.
6 See Alan R. Holmes, “A Day at the Trading Desk”, this
Review (October 1970), pages 234-38.
7 Jack M. Guttentag argued persuasively in “The Strategy of
Open Market Operations”, The Quarterly Journal of Economics
(February 1966), pages 20-26, that a complete strategy should
involve different targets for control periods of different lengths.

8 The term, market factors, is used to designate sources and
uses of nonborrrowed reserves other than System open market
operations. By definition, week-to-week changes in nonborrowed
reserves are the sum o f changes in market factors and the Sys
tem’s portfolio.

FEDERAL RESERVE BANK OF NEW YORK

C h a rt I

C H A N G E S IN U N C ON TR OL LE D FACTORS
AFFECTING N O N B O R R O W E D RESERVES
PRO JECTED A N D A C T U A L
C a lc u la te d fro m w e e k ly a v e r a g e s o f
d a i ly fig u r e s , n o t s e a s o n a lly a d ju s t e d
M illio n s o f d o lla r s

M illi o n s o f d o lla rs

1970
N o te : U n c o n tro lle d facto rs in c lu d e F e d e ra l R eserve flo a t, cu rren cy in c ircu la tio n ,
T rea su ry c u rren cy o u ts ta n d in g . T rea su ry cash h o ld in g s , T re a s u ry d ep o s its a t
F e d e ra l R eserve B anks, fo re ig n a n d o th e r n o n m e m b e r b a n k d ep o s its a t the
F e d e ra l R es erv e Banks, o th e r F e d e ra l R eserve assets a n d lia b ilitie s , a n d cash
h eld in th e va u lts o f m e m b e r b an k s two w e ek s e a rlie r, b ut e x c lu d e F e d e ra l
R es erv e h o ld in g s o f secu rities.
Sources: B o ard o f G o v e rn o rs o f the F e d e ra l R eserve System a n d F e d e ra l R eserve
Bank o f N e w York.

borrowed reserves. The Manager begins each statement
week with full knowledge of the required reserves of
member banks since these depend upon deposits in a
prior period. Given some idea of the frictional volume
of excess reserves likely to be needed in the banking
system, the Manager knows approximately what total
member bank reserve needs for the week will be. Accord
ingly, a burgeoning demand for Federal funds in relation
to supply strongly suggests a shortfall in nonborrowed
reserves below the level needed to keep member bank
borrowings at the discount window in the FOMC’s range.
Failure to supply nonborrowed reserves through open
market operations in this instance will tend to result in a rise
in the Federal funds rate and in member bank borrowings
at the Federal Reserve Banks, since excess reserves are
already near a frictional minimum. Conversely, an abun
dance of reserves in the Federal funds market suggests
that market factors are supplying a greater volume of
nonborrowed reserves than is needed to stabilize the
Federal funds rate or to maintain borrowing at the dis
count window within a given range. Failure to absorb
nonborrowed reserves will lead to a decline in the Federal

funds rate and in borrowing at the discount window un
less it is already at a frictional minimum. If borrowing
is at such a minimum, a rise in excess reserves is bound
to result.
The System’s weekly strategy insulates the banking
system reasonably well from swings in nonborrowed
reserves due to market factors, but it accommodates
week-to-week changes in required reserves at the same
time. This approach enables the banking system to re
spond very flexibly to the volatile short-run demands of its
customers for money and credit, since the System supplies
and absorbs reserves on demand in an effort to keep the
Federal funds rate within its prescribed range.9 Under
this accommodative posture, the week-to-week changes
in the money supply clearly stem from shifts in demand
rather than from reserve injection. These shifts do, in
fact, produce large variations in the money supply. The
absolute change in the narrowly defined money supply,
before seasonal adjustment, averaged $2 billion from
week to week in 1970. This compares with long-term
growth that averaged about $200 million per week for
the year as a whole.
Keeping a close tab on the aggregates provides a pro
cedure for trying to assure that an open market strategy
designed to accommodate short-run shifts in demand does
not lead to a significant departure of the aggregates from
their desired growth rate over the span of several months.
Operationally, one is left with the problem of deciding
whether the aggregates are departing significantly from
their desired path. Then, there is the question of how
much money market conditions are to be changed in an
effort to nudge the aggregates back in the desired direction.
As both 1969 and 1970 demonstrated, one must also be
alert to the possibility that changes in banking practices
lead to distortions of the underlying data.
Taking the money supply as an example, the basic point
of departure is the weekly tracking path, covering the
period between FOMC meetings. This path is presented
by the Board staff as likely to be consistent with attain
ing the level desired by the Committee for the terminal
month of its time horizon, often the calendar quarter. It
is essentially a judgmental path, subject to a wide margin
of error, which combines the desired growth and the staff’s
best estimate of the likely impact on the money supply of
such factors as Treasury cash receipts, expenditures, and

9 See Paul Meek and Jack W. Cox, “The Banking System—
Its Behavior in the Short-Run”, this Review (April 1966), pages
84-91.

MONTHLY REVIEW, APRIL 1971

financings as projected at the time of the meeting. The
weekly values may jump around considerably, and the
possibility of poor specification exists.
Each Friday morning the Manager of the Account
receives new data on the past behavior of the money
supply and new projections of its future behavior. The
Board staff reports preliminary daily average data for
the statement week ended on the latest Wednesday
and also revised data for the previous statement week.
In addition, both the Board staff and the New York
Bank staff prepare revised projections of the behavior
that they expect over the weeks through the next FOMC
meeting on the assumption of no change in the money
market conditions recently prevailing. Similarly, they give
their projections of how the aggregates will behave for
each month of the calendar quarter, assuming the continu
ation of those conditions.
These projections are subject to large revisions from
week to week, as new data become available and as past
data are revised. In addition, sometimes wide differences
open up between the projections of the two staffs. Given
the considerable uncertainty over the accuracy of the
projections and the validity of the tracking path, the Man
ager does not change money market objectives between
Committee meetings unless a pattern of deviations seems
to be emerging. In practice, such changes typically in
volve shifting the target for the Federal funds rate range
by V4 to V2 percentage point. A further shift in the same
direction would depend on the extent to which the deviation
that prompted the shift persisted or grew.
SO M E EXA M PLES FROM 1 9 7 0

The FOMC pursued a moderately expansive monetary
policy in 1970. The first step away from the restrictive
policy of 1969 took place at the January 15 meeting
when the Committee voted to aim for modest growth
in money and bank credit. Subsequently, the money
supply turned out considerably stronger than expected
in January, and projections of growth for the first quar
ter were strengthened. On the other hand, projections
of the adjusted credit proxy were lowered successively
over the period between Committee meetings. In the
circumstances, the Manager continued to foster firm
money market conditions— notably a Federal funds rate
that averaged 9 Vs percent in the four weeks ended
February 11, compared with an average of 8% percent
in the previous four weeks. Meanwhile, the Board of Gov
ernors had announced on January 20 an upward revi
sion of the Regulation Q ceilings on interest rates payable
on time deposits to bring them somewhat more in line

with going yields on market securities.
At the February 10 meeting, the FOMC set “moderate
growth in money and bank credit over the months ahead”
as its objective and directed the Manager to move to
ward somewhat less firm conditions in the money market.
In doing so, the Committee not only chose greater growth
in the aggregates than at the preceding meeting but also
changed its targets for the money market variables in a
way intended to bring about this growth. In following
instructions, the Manager was frustrated initially by a
large shortfall of nonborrowed reserves below projections
and by conservative management of bank reserve positions
around the Lincoln’s Birthday holiday. By February 20,
however, System injection of reserves succeeded in push
ing the Federal funds rate down to 8 V2 percent. Mean
while, the incoming money supply data appeared weak rela
tive to the Committee’s intentions, and the adjusted bank
credit proxy appeared likely to grow a shade less rapidly
than desired over the quarter. Accordingly, the Manager
exerted still more downward pressure on the Federal funds
rate, so that it averaged 7% percent in the week ended
March 11. As the conviction spread among market par
ticipants that a shift in monetary policy was in process,
short-term interest rates fell and the attrition of certificates
of deposit (CD’s) outstanding at banks under way since
December 1968 halted at the beginning of February. The
groundwork was laid for the resumption of growth in the
adjusted credit proxy that developed in March.
At the March 10 and April 7 meetings, the Committee
adopted directives that called for maintaining money mar
ket conditions consistent with moderate growth in money
and bank credit. In April the Committee chose secondquarter growth rates of 3 percent for the money supply
and 5.5 percent for the adjusted bank credit proxy as
appropriate, compared with preliminary estimates that
these aggregates had grown by 3 percent and 0.5 percent,
respectively, over the first quarter.10 By the Friday after
the Tuesday meeting, revised data for the week ended
April 1 and preliminary data for the following week in

10 The data used in the examples taken from 1970 are those
which were before the FOMC and the System Account Manager
at the time. The November 1970 revision of the data increased
the rate of growth in the narrowly defined money supply by 1.7
percentage points in the first ten months over the 3.8 percent rate
originally reported. The fact that money supply data are subject
to significant revision— sometimes with a lengthy time lag— adds
another dimension of caution in interpreting the significance of
short-run movements in the series.

FEDERAL RESERVE BANK OF NEW YORK

dicated that both the money supply and the adjusted
credit proxy were well above the tracking paths expected
to be consistent with the Committee’s objectives (see
Chart II) .11
With the terms of the Treasury’s May financing sched
uled to be announced later in the month, the Manager
undertook to nudge the Federal funds rate up promptly
by about V2 percentage point to an 8- 8 V2 percent range
to give time for market participants to adjust their ex
pectations before the financing itself. In subsequent weeks,
both the money supply and the bank credit proxy re
mained stronger than desired. As the firmer money market
tone persisted, observers began to suspect it reflected
System action, and some linked it to greater concern
with the aggregates, since the Committee’s January di
rective had just been published. A rise in short-term rates
began, but it was moderate and orderly at first. In large
part, this reflected dealers’ expectations of heavy Treasury
bill buying from state and local governments and from
the reinvestment of $3 billion in tax anticipation bills being
redeemed on April 22. When such bill buying proved
disappointing in relation to dealers’ swollen inventories,
dealers sold bills aggressively in the market so that
Treasury bill rates rose abruptly by about V2 percentage
point. The appearance of data suggesting greater economic
strength and concern that fiscal policy was turning stimula
tive, reinforced by the wage settlement with the postal
workers, contributed to the sharp revision of market ex
pectations. The rise in short-term rates made CD’s un
competitive and the growth in CD’s slowed down.
At this point the Trading Desk had to give primary
attention to moderating the turbulence in the Government
securities market to provide a semblance of steadiness
against which the Treasury could price its new issues for
sale to dealers and investors. In fact, market participants
initially seemed receptive to the Treasury’s offering of a
$3.5 billion eighteen-month note for cash and of two
notes in exchange for maturing issues. However, the an
nouncement on April 30 of the entry of United States
troops into Cambodia generated market fears that placed
the Treasury’s financing in jeopardy. The Manager once
again intervened by buying Treasury bills in quantity,

bringing to $1.7 billion the volume of bills purchased in
the six days preceding the Committee’s May 5 meeting.
In the main these reserve injections were offset by reserve
drains from other factors. Staff estimates at the May 5
meeting suggested that annual rates of growth of about
4 percent for both the money stock and the adjusted
credit proxy might be attained over the second quarter
with money market conditions similar to those prevailing.
The FOMC in three meetings during May and June
found it necessary to give special emphasis to moderating
pressures in financial markets, although it continued to
specify tracking paths for the aggregates. By the July 21
meeting, however, the Committee felt that it could in
crease the emphasis placed on achieving the long-run
growth rates in the monetary aggregates that were con
sidered appropriate to the economic situation. The FOMC
decided that growth in the money supply at a 5 percent
annual rate or somewhat more would be desirable in the
third quarter. (The Committee considered a rapid growth
in the credit proxy acceptable because of the shift of credit
flows, from the commercial paper market to the banks,

C h a r t II

M O N E Y SUPPLY A N D ADJ US TED B A N K CREDIT P R O X Y
TARGETED A N D ACTUAL
W e e k ly a v e ra g e s of d a ily figures, seaso n ally ad ju sted
Billions of dollars

Billions of dollars

A p ril

M ay
1970

11 In part, the rise in the money supply in the April 1 week
reflected a decline in cash items in process of collection because
of the closing of European money markets on the Friday and
Monday surrounding Easter Sunday. However, the money supply
remained high even after the effect of this special factor— incor
porated in later revisions— declined.

N o te : M o n e y su p p ly is p riv a te d e m a n d d e p o s its a n d cu rren cy o u ts id e b a n k s .
" A c tu a l" m o n ey su p p ly fig u re is b e fo re N o v e m b e r 1 9 7 0 re vis io n o f series.
A d ju s te d b a n k c re d it p ro x y is to ta l m e m b er b an k d ep o s its s u b je c t to re se rve
re q u ire m e n ts plus ce rtain n o n d e p o s it item s , p rin c ip a lly E u ro -d o lla r lia b ilitie s
an d b a n k -r e la te d c o m m erc ial p a p e r.
Source:

B o ard o f G o v e rn o rs o f the F e d e ra l R eserve S ystem .

MONTHLY REVIEW, APRIL 1971

then under way in the wake of the Penn Central insol
vency.) As the period unfolded, the money supply fell
persistently short of its tracking path.12 The Manager
allowed some relaxation of money market conditions, so
that the Federal funds rate fluctuated chiefly in a 6 V2 to
7 percent range rather than the 7 to 75/s percent range
prevailing in the preceding interval between meetings.
Member bank borrowings from the Reserve Banks con
tinued high during the interval at about $1.2 billion,
primarily because of special accommodation extended at
the discount window to banks lending to firms having
trouble rolling over their maturing commercial paper.
Reviewing developments at its August 18 meeting, the
Committee decided that some further easing of money
market conditions would be necessary to achieve the
desired growth of 5 percent or more in the money supply
over the third quarter. The FOMC also included an eas
ing of conditions in the credit markets as an objective
of open market operations. In consequence, the Manager
supplied reserves liberally, pushing down the Federal
funds rate to a 6 Vs-6 Vs percent range early in the
latter part of August. While technical factors around
the Labor Day weekend led to a stiffening of the Federal
funds rate for a time, member bank borrowings at the
Reserve Banks dropped back to about $650 million in
the four weeks ended September 16— in part because
of a further decline in special accommodation at the
window as the pressures in the commercial paper market
abated further. On balance, yields on most short-term in
struments and Treasury notes and bonds declined by the
September 15 FOMC meeting, while yields on corporate
and municipal bonds changed little as the volume of new
offerings in these markets continued heavy.
At each of the next three meetings, from September
15 to November 17, the FOMC repeated its call for still
easier conditions in the credit markets. Such easing was
considered desirable to encourage recovery in residential
construction and state and local government spending as
well as to foster moderate growth in money and attendant
bank credit expansion. At the September 15 and October
20 meetings, the FOMC set a growth target of 5 percent
for the narrowly defined money supply over the fourth

quarter, with about double that rate of growth being con
sidered appropriate for the adjusted bank credit proxy.
From mid-September to mid-November, the Federal funds
rate declined by about 3A percentage point to 5% per
cent and the three-month Treasury bill rate fell by a full
percentage point to about 5 V4 percent. Long-term interest
rates declined only modestly, however, before midNovember. Until early November, it appeared that the
FOMC’s money supply target for the fourth quarter would
be achieved, but then it was learned that the October
level had turned out lower than expected and projections
for November were revised sharply downward.
By the time of the November 17 FOMC meeting, staff
projections indicated money supply growth of only 2V2-3
percent over the quarter, given prevailing money market
conditions. Without giving up its target of 5 percent
growth in the money supply over the longer run, the
Committee was prepared to accept a 4 percent growth
rate in the fourth quarter, rather than embrace the sharply
lower money market rates that the staff thought would be
needed to achieve the original objective within the few
remaining weeks. The FOMC expected faster growth in
the money supply in the first quarter of 1971 when the
economy would presumably be rebounding from the Gen
eral Motors strike. The FOMC called for some further
easing of money market conditions to achieve the 4 per
cent goal. From mid-November to mid-December, the
Federal funds rate fell by about 3A percentage point to 5
percent and the three-month Treasury bill rate fell by V2
percentage point to about 43A percent. Longer term in
terest rates also finally moved decisively lower. For ex
ample, the average yield on long-term Treasury bonds fell
by about x/i percentage point, The Weekly Bond Buyer's
index of yields on twenty tax-exempt bonds fell by an even
greater margin, and yields on new high-quality utility bonds
declined by nearly a full percentage point.
Data on the money supply were strengthened pro
gressively to the point that, by the time of the December
15 FOMC meeting, the Board staff was projecting a 5
percent growth rate for the fourth quarter with no further
easing in money market conditions. The Committee de
cided that the recently attained comfortable money mar
ket conditions should be maintained, provided that the
expected rates of growth in money and bank credit at least
be achieved. In fact, the money supply appeared about
on track until December 28, when the Manager learned
of a sizable shortfall in the December 23 week. While
12 There was a growing awareness around this time that pay a shift toward slightly easier conditions was made at this
ment practices in New York City in connection with transfers
of international funds were distorting the money supply data. point, one could hardly expect such action to have much
The effect on the third-quarter growth rate was not known until
effect on the December money supply, and the fourtha number of weeks later, however, when new data had been col
quarter
growth rate turned out to be 3.4 percent.
lected and analyzed.

FEDERAL RESERVE BANK OF NEW YORK

SO M E L E S S O N S OF TH E 1 9 7 0 EX PE R IE N C E

87
C h a r t III

C H A N G E S IN M O N E Y SUPPLY

With a full year’s operations as a background, it is
possible to make a few observations on the actual work
ings of open market operations under the directives
adopted by the FOMC in 1970. The quantitative approach
facilitated the development of a policy strategy directed at
a longer time horizon than the period between meetings.
The experience of the past year lends some encouragement
to the view, moreover, that targets of quarterly growth
rates of the aggregates can be pursued by means of a
money market conditions strategy of open market opera
tions that is accommodative in the very short run. The
narrowly defined money supply, for example, expanded at
rates of 5.9 percent, 5.8 percent, and 6.1 percent in the
first three quarters of the year, before registering 3.4 per
cent in the final quarter.13
The 1970 experience also made clear a number of
problems. There was the problem of measurement that
led to the upward revision of money supply growth from
3.8 percent to 5.5 percent for the first ten months of the
year. Whereas the money supply moved roughly in line
with the Committee’s desires in terms of the data avail
able at the time, the ex post growth rate of the money
supply (as revised) exceeded during the first three quar
ters the Committee’s intentions at the time. And in the
final quarter the growth rate fell short of the Commit
tee’s target of a 5 percent annual rate despite a progres
sive relaxation of money market conditions over the
quarter. One should not claim too much precision— even
over a period of several months—for the influence ex
erted by the central bank over the narrowly defined
money supply.
Somewhat greater emphasis on the aggregates did not
involve attempts to stabilize the growth rate of the money
supply or bank credit aggregates on a weekly or even a
monthly basis. Indeed, the weekly and monthly variability
of the aggregates continued to be quite wide in 1970
(see Chart III). The experience of 1970 suggests strongly
that tight short-run control over the aggregates— even if
it were possible— is not necessary to achieve a reasonable

P E R C E N T A G E C H A N G E S A T A N N U A L R A TE S
C a lc u la t e d fro m a v e r a g e s o f d a i ly fig u r e s , s e a s o n a lly a d ju s t e d
P e rc e n t

P e rc e n t

1970

S ou rc e: B o a r d of G o v e r n o r s of t h e F e d e r a l Re se rv e Sy st em.

degree of control over periods of a quarter or longer.
Attempts at tighter short-run control over the aggre
gates would probably entail unacceptable side effects and
would almost certainly be doomed to failure. Even if one
assumed away the major operational problem of coping
with the variability of float and other market factors, a
strategy of weekly control would require that information
on the targeted aggregates were up to date and accurate,
that weekly noise could be screened out effectively in judg
ing the significance of deviations from targeted paths,
and that there were a highly predictable and extremely
rapid linkage between System action and the particular
quantity targeted. None of these conditions seem likely to
be fulfilled unless the time period for control of the ag
13 These represent the growth rates after the annual revision
gregates is extended to several months.
announced on November 27 (which was also intended to eliminate
The first problem encountered in seeking to control the
an understatement of the money supply stemming from the effects
of certain international transfers on cash items in the process
narrowly
defined money supply or bank credit in the
of collection). See “Revision of the Money Stock”, Federal R e
short run is that the current levels of these aggregates are
serve Bulletin (December 1970), pages 887-909. Before this
revision the narrowly defined money supply was reported to have
unknown. Quite apart from the major revision in the
grown at annual rates of 3.8 percent, 4.2 percent, and 5.1 percent
money supply series mentioned above, there are often
in the first three quarters of the year.

MONTHLY REVIEW, APRIL 1971

large differences between projections of the aggregates
made at the beginning of a statement week, the pre
liminary estimates of the actual figures available at the
end of the statement week, and the revised figures avail
able several weeks thereafter. The difference between the
projected and estimated, or between the estimated and
final, levels frequently far exceeds the incremental amount
by which the money supply or bank credit proxy would
have to be increased weekly to keep it on a path of con
stant week-to-week growth.14
Aside from the confidence limits attached to weekly
preliminary data, week-to-week shifts in the demand for
money generate considerable statistical noise that renders
it difficult to make a sensible judgment of the trend on
the basis of a single week’s preliminary data. To respond
to each week’s numbers would only foster sharp shortrun variation in the Federal funds rate and increase the
uncertainties within which commercial banks have to man
age their individual reserve positions. It is difficult to see
what gain would accrue from such a modus operandi, which
would force the banking system to accumulate a larger
buffer of excess reserves as insulation from the variability
of central bank action.
Even if control of the aggregates in the short run were
attempted, the present state of the art does not provide
any means of hitting short-run targets. Stated differently,
at present the precise linkage between day-to-day open
market operations and short-run changes in the money
supply is not known. Research conducted at this Bank
has indicated that weekly movements in private demand
deposits (the principal component of the money supply)
are strongly influenced by variables relating to Treasury
receipts and disbursements and seasonal factors. Changes
in nonborrowed reserves—the variable most immediately
affected by open market operations—have little direct
measurable effect on weekly changes in demand deposits,
although they assume greater significance over monthly or
quarterly periods.
The attention paid to the aggregates has underscored
strongly the System’s need to find operational answers in
quantitative terms to some of the most basic questions of
monetary policy. For example, what rates of growth in
which of the monetary and credit aggregates seem most
likely to help achieve the desired performance in the real
economy, and what lags are involved? How much should

14 Subsequent revisions of seasonals, of course, change weekly
data still further from that known to the FOMC and its staff at
the time.

the behavior of the credit markets and long-term interest
rates condition the specification of the target growth rates
of the aggregates? How does one translate quarterly target
rates into monthly and weekly tracking paths to be used
to help determine the significance of weekly developments?
What rules of response should the Manager of the Open
Market Account follow to avoid either under- or over
reacting to weekly deviations in the aggregates? A great
deal of further research and further practical experience
is needed to find satisfactory answers to fundamental ques
tions such as these.
Despite greater emphasis on the aggregates, the FOMC
continues to be concerned with money market conditions.
The Committee has been somewhat more willing to allow
changes in such conditions than before, and it has fostered
changes in a sustained and purposeful manner that re
inforced its basic policy thrust. The Committee has
eschewed sharp changes in money market conditions late
in a quarter, even when the quarter’s goal for the aggregates
seemed unlikely to be achieved. Instead, it has tended to
fold this information into the formulation of its targets for
the subsequent quarter. On the whole, this approach has
made for continuity in money market conditions and has
helped avoid fluctuations that might well have whipsawed
market expectations and added to the problem of achieving
target rates of change in the aggregates.
The greater steadiness in the growth of the narrowly
defined money supply in 1970 does not seem to have been
at the cost of larger week-to-week movements in interest
rates than in the past. To be sure, interest rates— espe
cially short-term rates— moved down significantly during
the past year, but this reflected the shift to an expan
sionary monetary policy gradually interacting with the
lessening of demand pressures on the credit markets. The
accommodative strategy of open market operations in the
short run— even while aiming at targeted growth rates of
aggregates over longer periods— meant that operations
were not a source of week-to-week variability in interest
rates.
There were occasions, to be sure, when shifts in the
thrust of open market operations were reflected in sharp
movements in interest rates. The most notable example
occurred in April, when open market operations shifted
toward greater restraint as it appeared that the aggregates
were growing significantly faster than desired by the Com
mittee. The sharp reaction in market rates was, of course,
only partly the result of the System’s shift in emphasis.
Market participants were just beginning to become aware
of the System’s greater concern with the aggregates, and
some feared that the new emphasis in open market opera
tions might foreshadow a wrenching of short-term rates

FEDERAL RESERVE BANK OF NEW YORK

back and forth in an effort to keep the aggregates on a
straight and narrow path. Thus, the problems of April
were partly transitional in nature. With greater market
awareness and understanding of the new approach to open
market operations, market reactions to the shading of
money market conditions might reasonably be expected
to be less exaggerated in the future.
There were times when market participants interpreted
the data as suggesting a possible future need for System
action. For example, the sluggishness of the money sup
ply in October and November tended to confirm expec
tations that monetary policy would remain stimulative,
leading to portfolio accumulation by banks and others. At
other times, concern over the rapid growth of the money
supply in late August-early September may well have re
sulted in some liquidation of short-term holdings. In any
case, market participants seem to have become less sensi
tive to moderate changes in money market conditions,
considering them as only one component of the broader
analysis needed of the economic determinants of policy
objectives.
The experience of April through June suggests that
one must always bear in mind the shifts in demand for
reserves that can occur within a period of a few months.
At the time, the Desk was providing reserves much more
aggressively than it would have had it been guided solely
by an aggregates target. In retrospect, it appears that
(abstracting from the subsequent revision in the figures)

the System’s action was necessary to maintain the desired
growth in the face of a significant increase in liquidity
demand arising out of the Cambodian and Penn Central
crises. One should not exaggerate the ability of the Ac
count Manager and the staff to discern the underlying
thrust of these forces on a week-to-week basis.
C O N C L U D IN G C O M M E N T

In summation, the Committee’s increased attention to
the monetary aggregates in 1970 should be viewed more as
part of a continuing effort to improve policy making and
its implementation than as the end product of that effort.
The year’s experience offered hope that judicious use of
the aggregates might improve policy response to changing
circumstances, although financial markets must remain an
important concern. There remained a number of problems
involved in defining and measuring different variants of the
money supply and bank credit. The short-run volatility of
the aggregates often made for considerable operational
uncertainty in open market operations. Important analyti
cal problems continued in assessing the behavior of the
aggregates in relation to the FOMC’s long-range eco
nomic objectives. The Committee used the monetary ag
gregates flexibly, not rigidly, in pursuit of its policy aims
in 1970. A flexible approach may well lead to further
shifts in operational emphasis from time to time, as per
ceptions of economic relationships and conditions change.

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MONTHLY REVIEW, APRIL 1971

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Full text of Economic Policy Review (Federal Reserve Bank of New York) : April 1971, Vol. 53, No. 4

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