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70

MONTHLY REVIEW, APRIL 1975

Monetary Policy in a Changing Financial Environment:
The 1974 Annual Report of the Manager of
the System Open Market Account

Editor’s Note: The following is adapted from a report submitted to the Federal
Open Market Committee by Alan R. H olm es, Executive Vice President of the
Federal Reserve Bank of New York and Manager o f the System Open Market A c ­
count. Sheila Tschinkel, Manager, Securities Department, was primarily respon­
sible for preparation of the report. John S. Hill, Chief, Securities Analysis Division,
contributed to its development, and his staff, under Anne Rowane’s direction ,
prepared the data used herein .

Federal Reserve policy in 1974 acted to temper the
conflicting forces of inflation and weakness in real eco­
nomic activity. The Federal Open M arket Committee
(FO M C ) sought to ensure moderate expansion of the
monetary aggregates to bridge the lengthy and difficult
transition to sustainable economic growth. Policy became
restrictive early in the year as the Committee responded
to evidence that inflationary pressures were again gaining
momentum and monetary aggregates were growing too
rapidly. Although interest rates climbed sharply, financial
institutions continued meeting excessive demands for money
and credit and their dependence on short-term market
borrowing increased. A secular decline in liquidity in all
sectors of the economy became even more pronounced.
Problems of the Franklin National Bank and difficulties
encountered by several borrowers in refinancing debt sur­
faced in the spring and deepened concerns about cumulat­
ing liquidity strains on the financial system. Expectations
that debt could become an increasing drain on the health
of the economy as inflation persisted intensified a cutback
in spending and investment plans.
M onetary growth decelerated over the summer, and the
financial markets began to recover as demand pressures
abated. Financial institutions started to exercise restraint
on their own, and restoring liquidity, rather than expand­
ing borrowing, became the focus of attention. As infla­
tionary pressures moderated and signs of generalized
economic weakness appeared, the Committee in the
closing months of the year acted to stimulate a resump­




tion of monetary expansion and thereby to provide for the
rebuilding of liquidity.
Monetary expansion remained quite rapid over much of
the first half of 1974, but later became persistently slug­
gish. The narrowly defined money stock (M x) — defined
as private demand deposits plus currency in circulation—
increased by W 2 percent over the year, well below the
9 percent and 6 percent rates experienced in 1972 and
1973, respectively (see Chart I ) . 1 Record-high interest
rates on market instruments cut into time and savings de­
posit flows over a good part of the year. M 2— M t plus
commercial bank time and savings deposits other than
large-denomination certificates of deposit (C D s)— grew
at a 7 Vi percent rate, down from 9 percent the year before.
Growth in the credit proxy— total deposits plus non­
deposit liabilities at member banks— at just over 10 per­
cent was a shade slower than in recent years due to a
very pronounced deceleration as the year drew to a close.
Bank credit— total loans and investments at all commer­
cial banks— showed a similar pattern and actually con­
tracted in the final quarter (see Chart II ).

1 Growth rates for all measures in the introduction use data that
incorporate revisions made in January 1975. The data used in
describing operations during the year are those available at the
time.

FEDERAL RESERVE BANK OF NEW YORK

71

THE FINANCIAL ENVIRONMENT SINCE 1970

C h a rt I

M O N E Y SUPPLY A N D ADJUSTED B A N K CREDIT PROXY
S e a s o n a lly a d ju s te d a n n u a l ra te s
P e rc e n t

“ 10

A D JU S T E D B A N K CREDIT PROXY

The Federal Reserve has continually grappled with the
problems of achieving its policy objectives in a dynamic
economic setting. In recent years, the System has sought to
implement its goals for the economy by targeting the
longer run growth of the monetary aggregates, particular­
ly Mi but also including broader measures. This emphasis
has generated considerable discussion on how policy in­
struments should be used to achieve intermediate money
and credit growth objectives and on the relationships
between these monetary aggregates and the economic
variables which policy makers seek ultimately to influence.
The System impacts on its aggregate objectives and ulti­
mate goals with a lag through the financial markets, whose
changing structure reflects the response of institutions to
economic developments and to the System’s policies. An
understanding of the role of the aggregates in this inter­
active process is crucial to the setting of policy instruments
and objectives.

H
1969

1 97 0

1971

1972

1973

1 974

II

III
C h a rt II

1974

BA N K CREDIT C O M P O N E N TS
M l = C u r r e n c y p lu s a d ju s te d d e m a n d d e p o s its h e ld b y th e p u b lic .

S e a s o n a lly a d ju s te d a n n u a l ra te s on a q u a r te r ly a v e r a g e ba sis

M 2 - M l p lu s c o m m e r c ia l b a n k s a v in g s a n d tim e d e p o s its h e ld b y th e p u b lic ,
le s s n e g o t ia b le c e r tific a te s o f d e p o s it is s u e d in d e n o m in a t io n s o f $ 1 0 0 ,0 0 0

P ercent

P ercent

o r m o re .
A d ju s te d b a n k c r e d it p r o x y = T o ta l m e m b e r b a n k d e p o s its s u b je c t to r e s e rv e
re q u ir e m e n ts p lu s n o n d e p o s it s o u r c e s o f fu n d s , s uch as E u r o - d o lla r
b o r r o w in g s a n d th e p r o c e e d s o f c o m m e r c ia l p a p e r is s u e d b y b a n k h o ld in g
c o m p a n ie s o r o th e r a f filia te s .
S o u rc e :

B o a r d o f G o v e r n o r s o f th e F e d e ra l R e s e rv e S y s te m .

The monetary aggregates remained a central focus of
policy formulation and implementation over 1974 as they
have for the past five years. The Committee continued to
frame its longer run objectives for the aggregates with
reference to changing assessments of the economic and
financial situation.
In 1974, policy makers were confronted with the need
to allow for im portant changes in bank and corporate
behavior. The financial system had been adapting to a
prolonged period of inflation and to the intense com­
petition for funds that it generated. But these adjustments
reached a point in 1974 where they strained the capability
of the financial mechanism to function. The transmission
of monetary policy in a changing financial environment
provides the setting for understanding monetary develop­
ments over the year.




A d ju s te d fo r lo a n s s o ld to a f f i li a t e s .
" ("A d ju s te d to r e fle c t th e s a le o f F r a n k lin N a tio n a l B a n k 's $1.5 b i l l i o n o f lo a n s
and
S o u rc e :

in v e s tm e n ts to F e d e r a l D e p o s it In s u ra n c e C o r p o r a tio n .
B o a r d 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 .

72

MONTHLY REVIEW, APRIL 1975

C h a rt III

G R O W T H IN B A N K CREDIT

9 6 0 - 6 4 1 9 6 5 -6 9
A v e ra g e

S o u rc e :

1970

1971

1972

197 3

1974

1st
2nd
h a lf h a lf
1 974

B o a r d 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 .

The FOM C pursues its aggregative objectives primarily
through its instructions to the M anager of the System
Open M arket Account. The M anager translates these into
weekly and daily decisions affecting bank reserves that
reflect the FOM C’s concern with the unfolding behavior of
the aggregates. Im portant institutional and structural
changes over the past five years have affected importantly
the transmission mechanism set in motion by the System’s
operations.
The credit market environment has become dominated
by bank emphasis on liability management. The suspen­
sion of Regulation Q constraints on large CDs, in two
stages between 1970 and 1973, gave banks the ability to
meet growing credit demands. Banks were able to enhance
their competitive position by extending loan commitments
and lines of credit, thereby accommodating enlarged
business demands during upswings in business activity
(see Charts II and III). The ability of business to obtain
such lines at banks provided a foundation for the addi­
tional growth of short-term borrowing in the commercial




paper market. As the cost of issuing CDs varied and
business borrowing became more responsive to interest
rate differentials, the prime rate of banks began to respond
faster to changing market rate patterns. Some banks
adopted a practice of relating their lending rate to short­
term market rates and, in general, loan terms adjusted more
quickly. The enhanced ability of both banks and business
to meet financing needs, albeit at potentially increasing
costs, made them willing to permit their liquidity to de­
teriorate. As a result, the relationship between the size of
the cash balances and the level of expenditures was al­
tered. This was reflected in variations in the velocity of
money and in the divergence between the growth of credit
and the money stock over the past several years.
Inflation and its attendant pressures on short-term inter­
est rates also impacted on credit flows. As the upward
price trend became imbedded in investor expectations,
investors showed some reluctance to commit funds to long­
term securities. The increased dependence of borrowers on
short-term markets contributed to the illiquidity of the
economy. Sectors primarily dependent on long-term fi­
nancing— most notably housing and construction— ex­
perienced particular difficulty. This problem was accentu­
ated as individuals were attracted to high rates of return
on open market instruments, at several stages, and funds
were diverted from banks and thrift institutions (see Chart
IV ). But individuals became less liquid when their savings
were put into market instruments, since such commit­
ments are often difficult to reverse in comparison with
drawing down a deposit. This showed up in the slow
growth of M 2 and M 3 M 2 plus deposits at savings and
—
loan associations and mutual savings banks— for certain
extended periods over the past five years.
The imposition of wage and price controls in different
forms also affected the financial atmosphere. Interest rates
dropped sharply immediately after the announcement of
control measures in August 1971. In ensuing months, de­
mands for credit and money abated, given the reduced
need to make expenditures in anticipation of rising prices.
As shortages of goods emerged, however, credit demands
rebounded and then accelerated. The slow rise of the
prime rate over much of 1973, partly in response to ef­
forts by the Committee on Interest and Dividends to tem­
per increases in administered interest rates, brought with
it a rapid escalation in business borrowing at banks. Banks
responded by scrambling to raise funds in the CD market
and rates on these instruments climbed. F or a time, the
rise in CDs outpaced the expansion of other financial
instruments and the composition of credit in the economy
was skewed toward banks. The System undertook to tem­
per bank credit expansion in 1973 by placing marginal

FEDERAL RESERVE BANK OF NEW YORK

reserve requirements on CDs for the first time.
The expansion of foreign credit markets and their in­
creased internationalization also changed the course of
credit flows in the domestic economy. Large multinational
firms were able to shift their cash balances and financing
demands from market to market in response to interest
rate differentials and to changing expectations about ex­
change rates. The rising standard of living in foreign
countries placed greater demands on many domestic sec­
tors, such as agriculture.
The growth of foreign banking institutions in the
United States and the expansion of domestic banks abroad
extended channels of speculation between money markets.
Episodes of intense speculation against various currencies
were often financed by borrowed funds and contributed to
accelerated credit growth. The lifting of the Voluntary
Foreign Credit Restraint Program in this country en­
couraged a further expansion of international dollar and
foreign currency lending. The Euro-dollar market, which
is not subject to the direct control of any central bank,

C h a rt IV

INTEREST RATE DIFFERENTIALS A N D S A V I N G S FLOWS
B asis p o in ts

Basis p o in ts

P e rc e n t

S o u rc e :

P e rc e n t

B o a r d o f G o v e r n o rs o f th e F e d e r a l R e s e rv e S y s te m .




73

expanded and became more integrated with the domestic
financial markets. In general, national monetary authori­
ties may have had difficulty in adjusting their domestic
policies adequately for the rapid internationalization of the
money and capital markets and the attendant growth of
international credit throughout much of the period.
SYSTEM POLICY FORMULATION SINCE 1970

Monetary policy exerts its dynamic influence on the fi­
nancial environment and the economy through its impact
on the expectations of households, businesses, and finan­
cial institutions. Their behavior interacts with the System’s
monetary and regulatory stance to determine the course
of the monetary aggregates and the economy. The Sys­
tem’s emphasis on aggregate targeting in recent years has
itself been one of the institutional changes affecting the
generation of expectations among economic units.
The System has specified objectives for the monetary
and credit measures as a means of quantifying the leverage
it wishes to exert on the economy. The experience accu­
mulated from targeting the aggregates has led the Com­
mittee to focus on longer run growth targets for the aggre­
gates on the grounds that temporary aberrations in mone­
tary expansion were likely to have negligible effect on the
course of economic activity. The Committee also refined
the ways it gives instructions to the Manager. Evidence
illustrated the long and variable lag between System action
and the behavior of the aggregates. Several econometric
models showed that changes in short-term interest rates
exerted most of their influence on money demand only
after a number of months. Estimates showed that the size
of the impacts and the length of the lag were variable with
respect to changes in nonborrowed reserves and the Fed­
eral funds rate. Shifts in the underlying financial structure
could also affect the behavior of the money supply. There
was growing understanding over time of the difficulty of
forecasting accurately the impact of a particular oper­
ational strategy on M x and the other aggregates.
The Committee since 1970 has tried alternative means
of formulating its monthly instructions to the M anager.2
A basic part of its instructions described how the M an­

2 Alan R. Holmes, Open Market Operations in 1973, 1972, and
1971: Federal Reserve Bulletin (May 1974), pages 338-50; (June
1973), pages 405-16; and (April 1972), pages 340-62, respectively.
For the year 1970, Paul Meek and Rudolf Thunberg, “Monetary
Aggregates and Federal Reserve Open Market Operations”, M onthly
Review (Federal Reserve Bank of New York, April 1971),
pages 80-89.

74

MONTHLY REVIEW, APRIL 1975

ager should respond to incoming data on the aggregates.
Soon after its move to aggregate targeting, the Committee
adopted weekly and monthly tracking paths to be used
as reference points against which strength or weakness in
the measures could be gauged. These paths were designed
to be consistent with the FOM C’s longer run aggregate
objectives, although the M anager often had to allow for
unanticipated developments that could affect the shortrun behavior of the various measures. In early 1972, the
FOM C began to specify acceptable ranges for reserves
against private deposits (R PD ) as a means of fostering
the desired growth in the aggregates. The ranges described
growth in this variable over the month of the meeting and
the ensuing month. The Committee found, however, that
the actual relationship between RPD and M 1 often failed
to develop as expected, at least in the time period from
one meeting to the next. As a result, the Committee and
the M anager gradually came to place more emphasis on
underlying deposit behavior as a guide for his response.
The RPD experiment encouraged the FOMC to adopt
two-month tolerance ranges for M 1 and M 2 toward the
end of 1972, and these were still being used two years later.
In its operational instructions, the Committee has tended
to place the most emphasis on M 1 although by the end
?
of 1974 this emphasis was coming under question. At the
same time, the FOMC has guided the extent and the
timing of the M anager’s response to incoming data to
allow for financial market developments and other policy
considerations. The Committee at its meetings has often
widened the tolerance ranges for the aggregates by raising
or lowering one of the bounds so that the M anager’s re­
sponses would remain consistent with underlying policy
intent. This approach served to avoid generating market
reactions to day-to-day policy implementation that would
be out of step with the longer run direction of policy.
The Manager reacted to new information on the aggre­
gates by altering supplies of nonborrowed reserves in a
way that produced an orderly rise or fall in the Federal
funds rate. Over the period between FOM C meetings, per­
missible variation in the Federal funds rate was constrained
by the FOM C— although the allowable range could be,
and often was, amended between meetings. The direction
and extent of the change in the funds rate were governed
by the observed behavior of the aggregates relative to their
desired behavior and by conditions in the financial mar­
kets. The ability of the M anager to vary the nature of
reserve-supplying operations marked an extension of the
specifications in the proviso clause form of the directive
used from 1966 through 1969, which provided for a re­
sponse to developments in various aggregates in the peri­
ods between meetings. Over the years since 1970, the




Committee has often made room for greater variation in
the funds rate over a month to promote the achievement
of its objectives for the aggregates. Growing awareness of
the System’s emphasis on the aggregates and of the M an­
ager’s response to incoming information began to have an
im portant impact on expectations in the economy. Finan­
cial market participants began to follow the behavior of
the money supply in forming their anticipations of interest
rate movements. They looked to the Federal funds rate for
confirmation of their expectations about System action.

THE FINANCIAL SYSTEM AND MONETARY POLICY
IN 1974-OPEN MARKET OPERATIONS AND THE
MONETARY AND CREDIT AGGREGATES

Events in 1974 put the ability of financial institutions
to adapt to changing circumstances to a severe test. The
already overextended financial system was confronted with
inventory financing and other credit demands in an atmo­
sphere of international scarcities of materials and sharply
higher prices. M onetary policy sought to deal with points
of pressure without relaxing its efforts to restrain the un­
derlying forces of inflation that were causes of financial
strain. Later, as recessionary tendencies began to cumu­
late, the System became willing to support the rebuilding
of liquidity needed for healthy economic growth. To high­
light significant developments in 1974, the following dis­
cussion of policy and the financial system separates the
year into three chronological sections.
j a n u a r y -m a r c h .
The outlook for the economy was
murky when the year began. The oil embargo was pro­
ducing fuel shortages and working to reduce real economic
activity. Several sectors of the economy, including hous­
ing and durable goods, appeared weak. Scarcities of needed
materials were adding to inflation and curtailing output in
other industries. Responding to this outlook, the Commit­
tee included a slightly higher rate of M t growth in its
longer run objectives for the aggregates and decided that
the M anager should seek a slight easing of money market
conditions unless growth in the aggregates appeared
stronger than expected. The same objective for M t in the
first half of the year was retained in February, and the
FOM C at both meetings specified two-month tolerance
intervals for the aggregates that were associated with pro­
gressively lower ranges for the Federal funds rate.
While the Manager had made little change in his ap­
proach to reserve management in the opening weeks of the
year, he moved promptly to attain some easing of money
market conditions shortly after the January FOM C meet­
ing. These moves were intensified when it initially seemed

FEDERAL RESERVE BANK OF NEW YORK

that Mi and RPD would fall below their DecemberFebruary ranges of tolerance. By early February, Federal
funds were trading at 8 3 percent to 9 percent and the
A
effective rate had declined by 75 basis points.or so from
the start of the year (see Chart V ).
It first appeared likely that this trend could continue
after the February meeting, but
moved above its twomonth range and estimates of M 2 and RPD rose to near
the upper bounds of their respective ranges. This ordi­
narily would have prompted the Manager to permit the
funds rate to rise to the 9Vi percent top of its range of
variation. However, with the publication of successive
weekly Mi bulges in February, the financial markets had
become very apprehensive about the likelihood of a re­
versal of the System’s interest rate posture. The FOM C

C h a rt V

M O N E Y MARKET CONDIT IO NS A N D G R O W TH IN M l
jn t

M illio n s o f d o lla rs

N A R R O W M O N E Y STOCK ( M l|^
T w o -m o n th g ro w th ra te

D e ce m b e r - F e b ru a ry

2

9

16

23

30

6

J a n u a ry

13

20

F e b ru a ry

27

6

13
M a rc h

1974
♦ in c lu d e s e m e rg e n c y b o r r o w in g .
‘t 'S h a d e d b a n d s a r e th e F e d e r a l O p e n M a r k e t C o m m it te e ’ s s p e c ifie d
r a n g e s o f to le r a n c e .




20

75

agreed on M arch 1 that reserve operations should be con­
ducted in a manner consistent with maintenance of the
funds rate around 9 percent. But ten days later, when
additional data showed that rapid monetary growth was
persisting, the full range for the funds rate was restored
though the Manager was instructed to proceed very
cautiously in restraining reserve growth. By the March
FOM C meeting, the funds rate had risen to about 9.35
percent and was approaching the level that prevailed just
before the start of the year.
In the financial markets, expectations that the oil short­
age would significantly weaken the economy were quite
pronounced when 1974 began. While the rapid 8.7 per­
cent money supply growth of the final quarter of 1973
had been somewhat worrisome, short-term credit demands
were more moderate than earlier in that year. Banks
started to rebuild holdings of securities in expectation of
a lessening of monetary restraint. The prime rate was
adjusted downward late in January, and it fell by %
percentage point to 8 3 percent over the next four weeks.
A
But it lagged declines in open market rates, and borrowing
demands at banks thus decelerated.
Business and financial market participants were gen­
erally anticipating interest rate declines, and there was
some move to refund short-term liabilities by borrowing in
the capital markets. A downtrend in rates became estab­
lished by the end of January as the Trading Desk’s moves
to supply nonborrowed reserves more readily became evi­
dent and as a nearly 3 percent decline in M 1 for that
month was observed in the published data. Short-term
interest rates fell appreciably— averaging 70 to 80 basis
points lower in February in comparison with the month
before (see Chart V I). Securities dealers began to take
on substantial inventories, and the issues offered in the
Treasury’s February refunding were bid for aggressively.
Long-term rates declined only slightly, however, as infla­
tion worries and increases in supply dampened sentiment
in the bond markets. New highly rated utility issues were
offered to return around 8 Vs percent, 10 basis points
lower than in January, and yields on older issues were
little changed.
As the winter progressed, concern about prices began to
have stronger impact. It became apparent that the slow­
down in the economy was related mainly to oil and that
otherwise demand was strong. The expected returns on
holding inventories of many goods were revised higher and
demands for short-term credit expanded. Borrowing in
the commercial paper market began to grow rapidly.
Some began to reassess sentiment about the course of
monetary policy and interest rates. The revision in expecta­
tions grew more widespread when extremely rapid mone-

76

MONTHLY REVIEW, APRIL 1975

C h a rt V I

SELECTED M O N E Y RATES

S o u rc e s :

followed the M arch FOM C meeting. The growth of M t
remained quite rapid, expanding at a 6.7 percent rate in
the second quarter. The System’s efforts to retard money
growth amidst strengthening expectations about the course
of economic activity and prices brought interest rates to
unprecedented levels. The financial markets experienced
considerable duress and liquidity considerations became
paramount. While the Committee continued seeking to
restrict rapid monetary expansion, it acted to reaffirm the
Federal Reserve’s role in maintaining the viability of the
financial system.
The strong credit and monetary expansion that emerged
in the first quarter of the year underscored the impact of
the very rapid and entrenched rate of inflation. Looking
ahead, it appeared that the lifting of the oil embargo in
mid-March might give support to greater personal con­
sumption expenditures and could have an expansive ef­
fect on economic activity by the summer. Government
spending was likely to continue at a substantial rate, and
business investment demands remained strong. In conse­
quence, at the M arch FOM C meeting, the staff noted that
retention of the longer run objectives for the aggregates
was likely to entail an extension of the upward thrust in
interest rates. At the same time, estimates of the demand
for money over the months ahead were subject to more

B o a r d 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 , 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 , a n d M o o d y 's In v e s to r s S e rv ic e , Inc.

SE LE C T ED IN T E R E S T R A TES
In percent

tary growth emerged and was confirmed during February.
As the M anager’s response to the aggregates became
clear in the Federal funds rate, other interest rates began
to rise at a rapid pace. Banks began to revise estimates of
the likely course of credit demands, and securities dealers
started to cut inventories substantially. By the time of the
March Committee meeting, the three-month Treasury bill
rate was near the 8 percent level of the previous Novem­
ber, after having fallen below 7 percent five weeks earlier.
Long-term rates were pressing against the record highs
recorded in August 1973, with new Aaa-rated utility
bonds offered at close to 8 Vi percent. Yields on highcoupon United States Government bonds were rising to
and above the earlier records. A seven-year note auctioned
in the February refunding at 6.95 percent was yielding
close to IV i percent.
m a r c h - s e p t e m b e r . The dynamics of change in the finan­
cial mechanism became very evident in the months that




1973

1974

R ates
Dec.
28

Feb.

July

Dec.

3

Aug.
27

Sept.

13

30

31

F ederal funds—weekly average
effective rate ..........................................

9.52

8.93

13.55

11.84

11.12

7.35

T hree-m onth T reasury bill:
A verage bond yield equivalent

7.65

7.31

8.07

10.31

6.58

7.34

D iscount rate— F ederal R eserve
Bank of New Y ork .............................

7.50

7.50

8.00

8.00

8.00

7.75

Three-m onth certificates ‘
of deposit ................................................

9.22

8.08

12.15

12.45

10.69

9.25

U nited States G overnm ent
securities ................................................

6.47

6.50

7.12

7.30

7.27

6.78

Recently offered A aa-rated
utility bonds ..........................................

8.10

8.19

9.79

10.26

10.27

9.67

State and local governm ent bonds:
“ M oody’s” A aa bonds .....................

4.85

5.05

6.20

6.35

6.40

6.70

Federal H ousing A dm inistration
mortgages:
Secondary m arket rates ....................

8.78

8.54

9.85

10.30

10.38

9.51

Short-term

Long-term

FEDERAL RESERVE BANK OF NEW YORK

error than usual. In addition to the uncertainty about the
economic outlook, there were the problems of assessing
how borrowers, lenders, and savers would react to the
recent and prospective rates of inflation. These related
uncertainties remained through the summer, though the
ongoing rise in interest rates was expected to exert
restraint on monetary growth as time went on.
At its March meeting, the FOM C voted to moderate
growth in the aggregates over the months ahead. Expan­
sion in M 1 had been substantial in February, and the im­
petus to rapid growth was evidently continuing. To allow
for greater progress toward the achievement of a mod­
erate growth objective, the FOM C reduced the lower ends
of the two-month tolerance ranges for the various m ea­
sures relative to those suggested by the staff. This action
meant that the M anager would not respond to lower
growth rates which might be temporary. The same ap­
proach was taken at subsequent meetings through July,
and each time the FOM C raised the range for the Federal
funds rate relative to the one specified at the previous
meeting. At times in the interval between meetings, the
Committee agreed to let the funds rate increase further
than initially contemplated.
By August, monetary growth had moderated substan­
tially and had fallen below the desired expansion. The out­
look for the rest of the year suggested a resumption of
faster expansion but not at a pace that was likely to call
forth further increases in interest rates. The FOM C at that
time was able to reduce slightly the upper end of the range
of variation in the funds rate— for the first time in six
months— while retaining its earlier objective for M x and
the other measures.
The Manager began soon after the March meeting to
restrict the availability of nonborrowed reserves, given
evidence that overly rapid
growth was continuing (see
Chart V II). Such actions were extended through early
May, but they became increasingly conditioned by finan­
cial market considerations. Widespread evidence of strong
inflationary pressures in the economy made financial m ar­
ket participants especially sensitive to the ensuing rise in
the Federal funds rate. Banks began to bid more aggres­
sively for reserves, and the funds rate rose to around
IOV2 percent by mid-April. Thereafter, the Manager
found it increasingly difficult to temper the rise in the
funds rate, as banks sought to limit borrowing at the dis­
count window. The Desk found that supplies of securities
were often insufficient for open market operations as
dealers had sharply reduced their inventories. The Com­
mittee agreed to permit the funds rate to move higher
than contemplated at its April meeting rather than conduct
reserve-supplying operations on a scale that would risk




77

market misinterpretation of the System’s policy intent.
While the Desk had been anticipating a Federal funds rate
of around 11 percent as the next meeting approached, it
rose considerably more and reached a record weekly aver­
age of 11.46 percent in mid-May.
Business borrowing at banks became extraordinarily
large, as economic activity turned out considerably
stronger than had been expected earlier. By the spring,
the credit proxy was expanding at an unprecedented rate,
the prime rate was up to II V 4 percent, and banks were
bidding intensely to obtain needed funds in the money
markets— raising over $10 billion in April and May in
the CD market. Most banks continued to confine activity
to the shorter maturity area, often driving rates on CDs
and Euro-dollars well above the Federal funds rate and
making rollovers a persistent problem. The drive to issue
CDs extended nationally, and smaller banks began to rely
increasingly on the money market for funds.
These pressures soon extended past the banking system
and yields in the credit markets began to rise dramatically.
Commercial paper rates jumped by 250 basis points be­
tween mid-March and early May, with the rate on 90-day
dealer-placed paper reaching 11 percent. Bankers’ accep­
tance rates rose similarly amid extremely heavy activity.
Treasury bill rates rose by relatively less than rates on
other money market instruments, but both the three- and
six-month issues were auctioned at rates in excess of 9 per­
cent by the second week in May. Individual investors
channeled more funds into bills and soon bought substan­
tial amounts of Treasury coupon and agency issues. In
the May refunding, small investors purchased $1.5 bil­
lion of the new issues, over one third of the amount being
offered.
The nature of market pressures was significantly al­
tered, as news of the difficulties being faced by the Frank­
lin National Bank became widespread by early M ay.3 The
substantial growth that had taken place in CDs and the
attendant reduction in bank liquidity were disturbing.
Investors began to show preference for instruments of
only the largest and most well-known banks. Concern
over the financial stability of some open market bor-

3 On May 12, the Federal Reserve indicated that it would
advance funds to Franklin National if that bank experienced
unusual liquidity pressures. As its deposits and other liabilities
fell, Franklin’s use of the discount window grew substantially
and reached about $1.75 billion by early October, when it was
taken over by the European-American Bank. At that time, the
Federal Deposit Insurance Corporation assumed Franklin’s liabili­
ties to the Federal Reserve.

78

MONTHLY REVIEW, APRIL 1975

C h a rt V II

M O N E Y M A R K E T C O N D I T I O N S A N D G R O W T H IN M l
P e rc e n t

M illi o n s o f d o lla r s

1 5 .0 0 -

4000

P e rc e n t

M illio n s o f d o lla r s

1 5 .0 0

I

4000

F e d e r a l fu n d s

W e e k l y a v e r a g e e f f e c t iv e r a te

1 4 .0 0

3500

1 4 .0 0

3500

S c a le

/
1 3 .0 0

3000

F e d e r a l fu n d s

1 3 .0 0

3000

12.00

2500

11.00

2000

10.00

1500

W e e k l y a v e r a g e e f f e c t iv e r a te

12.00

**------ S c a le

M e m b e r b a n k b o r r o w in g s *

11.00

2500

V

2000

S c a le '

10.00

1500

9 .0 0

1000

8.00

500

1000

9 .0 0
S c a le

i mu

7 .0 0

M e m b e r b a n k b o r r o w in g s *

0

8.00
7 .0 0
14

P e rc e n t
14

N A R R O W M O N E Y STO CK ( M l) t

I

500

P e rc e n t
14

N A R R O W M O N E Y S T O C K (M 1)+
T w o -m o n th g r o w th r a te

12

T w o - m o n th g r o w th r a te

10
M a y - J u ly

F e b r u a r y - A p r il I
M a rc h -M a y

M a y - J u ly

8

\J

A p r i l- J u n e

J u ly - S e p t e m b e r
June - A u g u s t

6
4

1

2

- A c tu a l

I
27

3

M a rc h

10

17

- A c tu a l

1

24

1

A p r il

8

i

15
M ay

22

0

j

29

5

12

19

June

1974

26
June

3

10

17

24

14

J u ly

i
21

August

28
S e p te m b e r

1974

^ I n c l u d e s e m e r g e n c y b o r r o w in g .
+ S h a d e d b a n d s a r e th e F e d e r a l O p e n M a r k e t C o m m it t e e ’ s s p e c if ie d r a n g e s o f t o le r a n c e .

rowers emerged, and it became more difficult to re­
finance maturing liabilities. Real estate investment trusts
and utility companies encountered particular problems.
The yield differentials between instruments with dif­
ferent credit ratings widened appreciably in both the
short- and long-term debt markets. In the Government
securities market, the growing preference of investors for
less risky obligations led to yield declines. Some began to
think that these pressures would soon lead banks to re­
strain asset growth, so that the rapid rate of monetary
expansion would moderate and lead to a modification of
System policy.
The Manager moved cautiously in restricting reserve




supplies over the rest of May and well into June. The
aggregates generally stayed on the high side of their
ranges, and the funds rate was around 11 3 percent by
A
mid-June. Conditions in the securities markets had stabi­
lized to some degree.
But, in late June and early July, liquidity pressures
erupted again and there was a significant deterioration in
domestic and international financial market conditions.
The failure of a bank in Germany renewed apprehension
in the markets. Pronounced shifts in borrowing and lending
patterns occurred, and many institutions reduced the
amounts that they would lend to individual borrowers.
Banks acted to reduce borrowing at the discount win­

FEDERAL RESERVE BANK OF NEW YORK

dow, apparently to preserve this privilege for later use and
managed their reserve positions cautiously, preferring to
risk excess reserves rather than deficiencies. In these cir­
cumstances, the average Federal funds rate jumped by
158 basis points to over 13Vi percent in one week in
early July, well above the 12 percent level then intended.
While the M anager pumped in nonborrowed reserves
almost continually and at a pace that would have pro­
duced an acceptable rate under normal circumstances, the
rate showed little tendency to edge lower. It became in­
creasingly clear that more massive reserve-supplying
operations would be needed to push the funds rate back
down. The Committee on July 5 instructed the Manager
to continue efforts to bring the rate down to within its
U V a to YIVa percent range of tolerance but not to the
extent of flooding the market with reserves. But these
pressures persisted and the funds rate remained well above
13 percent. One week later, the FOM C agreed that opera­
tions should be undertaken promptly to reduce the funds
rate to 13 percent and to permit it to decline further
should market factors work in that direction. After
steadily and regularly pumping in reserves, the pressures
finally gave way around the time of the FOM C meeting
in mid-July.
After the exceptionally taut money market conditions
had faded, the Manager directed operations at maintaining
a Federal funds rate of around \2X percent until the next
A
meeting of the Committee in August. Growth in the aggre­
gates moderated significantly in the summer months so
that by late August most measures had fallen below their
tolerance ranges. The Manager thus sought some easing
in bank reserve conditions, and the Federal funds rate de­
clined to 113 percent— near its level three months earlier.
A
The intense demands for liquidity that emerged in the
banking system in early July had a profound impact
on the credit markets. Concern over the safety of assets
was heightened, and investors became exceptionally re­
luctant to lend on all but the most secure instruments.
Commercial paper rates rose to 12V4 percent in early
July, and dealers began encouraging borrowers to use
bank lines of credit. The prime rate soon rose to an un­
precedented 12 percent. The largest banks were able to
accommodate more loan demands as they found CD and
other short-term funds readily available, but smaller banks
encountered difficulty in refinancing maturing liabilities.
M ajor money center banks paid as much as 1 2 ^ percent
on short-term CD maturities and raised $2.8 billion of
new funds in July. In the bankers’ acceptance market, the
suspension of operations by the largest dealer added to the
difficulties of lesser known banks in selling their paper.
Rates rose sharply and a tiered market developed, al­




79

though the situation was relieved by increased System buy­
ing of acceptances under the enlarged leeway adopted by
the FOM C on July 18.
Money market pressures ebbed as the summer pro­
gressed, though the markets were thin and volatile. But
by early September, CD and commercial paper rates were
moving back toward earlier highs, reflecting concern over
the size of forthcoming maturities. To encourage banks to
rebuild liquidity by extending the maturity structure of
their liabilities, the Board of Governors of the Federal
Reserve System amended Regulation D on September 5
to remove the 3 percent marginal reserve requirement on
time deposits and other obligations maturing in four
months or longer.
In the debt markets, prices fell substantially during the
summer amid growing apprehension about their ability to
withstand cumulating liquidity pressures. Stability reemerged, but the concern about liquidity pressures resur­
faced periodically and remained a critical factor in the
markets. Uncertainty about the level of yields needed to
attract buyers prompted underwriters to sell issues on a
negotiated basis and also encouraged certain issuers,
mainly banks, to sell notes whose returns were tied to
Treasury bill rates. Postponements and reductions of cor­
porate and tax-exempt issues had little impact as they
only added to a mounting calendar of future offerings.
By early September it took 10 percent to market a new
long-term Aaa-rated telephone offering, compared with
the 8.80 percent yield offered by the parent concern in
May. In addition, the volume of short-term notes reach­
ing the market increased.
The safety and liquidity of Government securities had
initially generated some additional yield declines in late
June and July. This tendency was later reversed, as supply
pressures mounted and as demand for such issues by oilexporting countries turned out less strong than many had
anticipated. Treasury bill rates set at the August 26 weekly
auction rose to records of 9.91 percent and 9.93 percent
for the three- and six-month issues, after falling below
8 percent on several occasions earlier in the summer.
Demand from small investors absorbed a high proportion
of substantial new offerings of Government and Federal
agency issues. In the August refunding, the Treasury
placed unprecedented 9 percent coupon rates on two note
offerings and small investors purchased $2.3 billion of
the $4.3 billion sold. The 33-month and six-year issues
were awarded at rates of 8.59 percent and 8.75 percent,
respectively. An additional $400 million of 8 V2 percent
bonds was issued at 8.63 percent, compared with the
8.23 percent yield set when the bonds were first issued in
the May refunding. Rates on new Federal agency issues

80

MONTHLY REVIEW, APRIL 1975

reached new highs, as borrowing by the housing-related
agencies increased. While the markets remained under
pressure, the deceleration in the growth of the money sup­
ply over the summer and into September provided hope
that interest rates could soon move lower.
s e p t e m b e r -d e c e m b e r . The substantial and widespread
erosion of liquidity produced a strong response which
emerged toward the close of the year. Monetary expan­
sion remained slow, and the Committee’s efforts to
achieve more rapid growth met with limited success.
Even though the System encouraged substantial interest
rate declines, both through open market operations and
regulatory changes, banks sought to exercise restraint of
their own by limiting loan commitments and asset growth.
Concern over the adequacy of bank capital and the finan­
cial prospects of borrowers increased. These considera­
tions were also evident in the debt markets amid a
sharp contraction of real economic activity toward the end
of the year.
The outlook for the economy at the September FOMC
meeting suggested that the weakness in real economic
activity would persist in the fourth quarter of the year
and in the first half of 1975. The unemployment rate had
begun to edge up, and it was expected that a contraction
in housing would continue while demands in other sectors
would moderate. Although inflation was still rapid, the
behavior of prices appeared to be showing signs of im­
provement. In view of this situation, the Committee de­
cided to seek growth in the monetary aggregates at rates
slightly higher than those contemplated earlier and raised
its longer run objectives for Mi and other measures. A
staff analysis suggested that money m arket conditions
should ease in the period ahead if M x were to reach the
expansion desired over the longer run.
In the months that followed, estimates of the decline in
interest rates that would be needed to spur a resumption
of monetary growth became successively larger as the
economic outlook worsened. Mi had grown at less than
a 2 percent rate over the third quarter and it remained
below its desired expansion, increasing at 4.3 percent in
the final three months of the year. Declines in market
interest rates fostered better inflows of time and savings
deposits, and M 2 rose appreciably but at a slower pace
than in the first nine months of the year. Banks permitted
maturing CDs to run off, and growth in the credit proxy
slowed further. The Committee became steadily more
willing to see money market conditions ease, and each
month it lowered significantly the range of variation al­
lowed for the Federal funds rate. On two occasions it
made provision for further declines in the period between




meetings. The Board also restructured and reduced reserve
requirements in mid-November. In early December, it ap­
proved a reduction in Federal Reserve Bank discount
rates from 8 percent to 7% percent, the first cut in three
years. Staff assessments presented at the December meet­
ing suggested a significantly larger contraction in economic
activity than had been anticipated earlier, and the Com­
mittee raised its longer run objectives for M ± and other
measures.
When the monetary aggregates moved near or below
the ranges of tolerance after the September FOM C meeting,
the Manager acted to attain some further easing in money
market conditions (see Chart V III). The funds rate had
declined by nearly 3 percentage point to 11 percent by
A
early October and then fell quickly to just under \0 V4
percent over the next two weeks, the new lower limit
agreed upon by the Committee on October 4. While the
aggregates moved toward the upper end of their ranges
after the October meeting, the FOM C reemphasized its
concern with the underlying sources of weakness in the

C h a rt V III

M O N E Y MA RKET C O N D IT IO N S A N D G R O W T H IN M l
M illio n s o f d o lla r s
15.0 0

4000

1 4 .0 0

3500
3000

13 .0 0
F e d e r a l fu n d s

12.00

2500

W e e k ly a v e r a g e e f fe c t iv e r a te
S c a le

11.00

\

10.00

2000

M e m b e r b a n k b o r r o w in g s *
S c a le —

500

1000

9 .0 0

500

8.00

L:K :i 0

7 .0 0

P erc e n t
14
12

N A R R O W M O N E Y S TO C K ( M l) t
T w o -m o n th g ro w th ra te

i

N o v e m b e r -~

|

J a n u a ry

O c to b e r - D e c e m b e i
S e p te m b e r N ovem ber
August

O c to b e r

r I I
A c tu a l.

18

25

S e p te m b e r

2

9

16

23

30

6

O c to b e r

13

20

N ovem ber

27

4

11

1974
^ I n c l u d e s e m e rg e n c y b o r r o w in g .
i~ S h a d e d b a n d s a r e th e F e d e r a l O p e n M a r k e t C o m m it te e ’ s s p e c ifie d
r a n g e s o f to le r a n c e .

18

D ecem ber

25

FEDERAL RESERVE BANK OF NEW YORK

economy and agreed, on November 1, that the M anager
take actions that would lower the funds rate from 9%
percent to 9 V2 percent. The strength in M 1 turned out to
be temporary, and the Manager became steadily more
accommodative in providing nonborrowed reserves over
the rest of the year. By the final week, he was seeking
availability consistent with a funds rate of around 8 per­
cent or below, nearly 3 percentage points less than its
level three months earlier and the lowest in over a year
and a half.
The Manager often had difficulty in encouraging the
Federal funds rate to decline as the year drew to a close.
Substantial additions to nonborrowed reserves facilitated
bank efforts to reduce discount window borrowing. M ar­
ket churning around tax and oil payments dates often
generated enlarged demands for excess reserves, and bank
actions to improve the appearance of their balance sheets
on statement dates were more evident than in other recent
years. The resultant money market pressures were par­
ticularly intense in the final week of 1974 when Federal
funds traded near 9 percent until the rate fell to less than
4 percent on the final day of the year— when the banking
system emerged with excess reserves averaging over $600
million for the statement week.
Short-term interest rates declined quite sharply in the
final months of the year, but the downtrend was often
interrupted. While the slow growth of the monetary ag­
gregates, the M anager’s operations, and System regulatory
changes generated favorable expectations about the inter­
est rate outlook, the perpetual refinancing of maturing
debt and the more selective preferences of investors
worked against this trend. Banks became more concerned
about liquidity and sought to restrain asset growth. R e­
ductions in the prime rate lagged those on open market
rates, and bank investment portfolios continued to con­
tract. Periods of heavy CD maturities were often preceded
by drives to refinance these obligations well ahead of
time. CD rates fell by over 250 basis points to as low as
8 V2 percent on thirty-day maturities at one point. But they
rose over a good part of December, and major banks paid
as much as 9 V2 percent to bolster deposit totals over the
year-end. Some effort to extend the maturity of these obli­
gations became apparent in the early weeks of 1975.
While large money center banks found themselves m ak­
ing loans to industries with special problems, other banks
actively discouraged borrowing. The resultant shift of
some refunding to the commercial paper market worked
to slow the decline in these rates. Although dealer-placed
90- to 119-day paper had fallen to 9 Vs percent by midDecember, down from 11% percent in early September,
most of this drop occurred shortly after the end of the




81

third quarter. While the Federal funds rate in December
averaged 8.53 percent, almost IV2 percentage points be­
low its level a year earlier, rates on private money market
instruments were only 15 to 30 basis points lower.
The long-term debt markets faced a growing volume
of financing as businesses began to refund short-term bor­
rowing. The continued hesitancy of investors to commit
funds and concern about the impact of a slowing econ­
omy on the financial prospects of borrowers added to
upward pressure on yields. While yields declined in Octo­
ber and part of November, they moved back up amid sub­
stantial additions to current and prospective supplies. Deal­
ers were reluctant to underwrite new offerings in view of
their substantial losses earlier in the year. New Aaa-rated
utility issues were sold at around 9 V2 percent in late De­
cember, about 5 percentage point above their low in the
/s
quarter and 150 basis points above yields one year earlier.
Investors continued to scrutinize the particular aspects of
different borrowers, and utility firms had to offer consider­
ably more than industrial borrowers in order to sell issues.
The yield spreads between firms with different ratings also
remained quite wide. The tax-exempt market came under
particular stress as the year drew to a close, due partly to
the failure of bank demand to materialize as expected in
this stage of the cycle. The long-term financial problems
faced by many municipalities in an inflationary environ­
ment were galvanized by the publicity given to difficulties
in New York City. The Bond Buyer’s index on tax-exempt
yields rose to a record 7.15 percent in mid-December, 2
percentage points above its level near the start of the
year.
Government securities continued to fare relatively bet­
ter, though the prospects of large Federal budget deficits
and attendant Treasury borrowing tempered market sen­
timent. Dealers added substantially to inventories in the
November Treasury refunding, but the distribution phase
proceeded slowly. Demand from institutional investors
and banks remained modest, while noncompetitive tenders
fell off in view of the reduction in yields since the sum­
mer. The Treasury sold new three- and seven-year cou­
pon issues at yields of about 7% percent, some 65 basis
points below earlier highs. At the year-end, yields on in­
termediate coupon securities were around IV4 to 7%
percent, still about V2 percentage point above levels at
the end of 1973. Additional 8 V2 percent bonds were
issued in November at 8.21 percent, close to their yield
in the previous May and 75 basis points above the yield
on a new twenty-year issue the previous February. Trea­
sury bill rates generally moved in concert with short-term
rates over the final months of 1974 and thus closed well
below levels one year earlier. Most of the declines oc­

82

MONTHLY REVIEW, APRIL 1975

curred soon after the System’s moves toward a more
accommodative interest rate posture became evident. After
falling from around 9 percent to near 6 V2 percent from
September to early October, the three-month bill closed
the year at 7.29 percent, compared with 7.71 percent one
year earlier.
OBSERVATIONS

Experience over the past several years has demon­
strated the complexity and variability of the relationships
between interest rates, the growth in the different monetary
aggregates, and the path of real economic activity. The
use of aggregate targeting has probably contributed to the
clarity of monetary policy discussions, but policy making
itself has not proved easier. Evidence of structural changes
in the financial system has reduced the policy m aker’s con­
fidence in the stability of the linkage between operational
instructions and desired long-run economic goals. This
raises questions about how the intermediate monetary
variables may best be used in a dynamic setting.
For most of the past five years, banks were considerably
more aggressive than earlier in supplying credit and de­
posits. After the de facto lifting of Regulation Q ceilings
on large CDs in 1970, banks became more confident of
their ability to meet loan commitments. Their develop­
ment of escalator clauses on loan contracts and a floating
prime rate increased the profit incentive for loan expan­
sion during upswings in economic activity. Overly rapid
growth in money and credit was often sustained for some
time after interest rates began to increase. Rates had to
rise to a much greater extent, and possibly for a longer
period of time than previously, in order to induce the
asset adjustments by banks that were needed to stem bank
credit and money supply expansion. The use of marginal
reserve requirements added to the cost of funds, but the
size of the changes did not seem large enough to affect
significantly bank policies. Only as credit risks increased
with the high level of interest rates and the slowing econ­
omy did banks move toward more conservative loan
policies.
This reassessment of the value of liquidity— or the risk
of illiquidity— worked to retard a resumption of monetary
growth in the latter part of 1974. Lagging reductions in
the prime rate encouraged borrowers to repay their loans
and thereby cut compensating balances. But banks showed
little inclination to undertake the significant expansion of
investments which previously occurred in this stage of
the cycle. Although nonborrowed reserves increased and
short-term interest rates fell substantially after the sum­




mer, the size of the banking system changed little, and
this worked to restrict the growth of deposits.
System-induced changes in interest rates also exert in­
fluence on money growth by affecting the public’s demand
for liquid assets. But the extent of this response appears
variable, perhaps because the demand for a particular
form of money is also affected by changes in the financial
system. The substantial growth in alternative short-term
investments may alter the public’s desired holdings of de­
posits. Shifts into the newer forms of market assets during
the periods of high interest rates may lead to enlarged
demands for Mi as a compensation for the ongoing loss
of liquidity. Thus, some periods of rapid M x expansion
have been accompanied by slower rates of increase in M 2.
At other stages, the rebuilding of consumer time and sav­
ings balances as market interest rates fall may be accom­
panied by a shift out of demand deposits, which limits M x
growth relative to that of M 2. The availability of new
types of time deposits on occasion may also impact on the
public’s desire for the different categories of deposits at
given interest rates and income levels.
While emerging forces can often cause inexplicable
shifts in the behavior of a particular aggregate, a group
of measures will generally track the economy reasonably
well. Financial change has evidently affected and will con­
tinue to impact on the supplies of, and demands for,
monetary assets. In these circumstances, it is doubtful that
any single measure qualifies as the “best” intermediate
monetary target because the linkages between System op­
erations and the aggregates— and between these measures
and the economy— are not likely to remain unchanged or
predictable over time.
The Committee’s adoption of aggregate targeting in
1970 established a means of making open market opera­
tions more sensitive to emerging trends in the economy.
While the Committee has placed most emphasis on M x,
it often recognized that this measure was not an unfailing
guide. It did not adopt unvarying “rules” for setting M x
objectives or for achieving them, despite many suggestions
to this effect. The FOM C allowed some flexibility to re­
spond to the possibility that the behavior of other m ea­
sures in the period between meetings could provide
grounds for a reconsideration of a response to M 1 From
(
the M anager’s standpoint, the experience in recent years
suggests that it would be useful to extend this flexibility.
It should be possible to weigh more evenly several of the
aggregates in the specifications given to the Manager. By
capturing a broader range of information, the Commit­
tee’s instructions might then become even more attuned to
the underlying economic conditions that it seeks to affect.

FEDERAL RESERVE BANK OF NEW YORK

83

The Business Situation
Economic activity continues to contract. While per­
vasive weakness in final demand has been a contrib­
uting factor, the dominant depressant in recent months
has been the liquidation of inventories. Indeed, at the
present time, the inventory correction appears to be the
most important single factor restraining production and
employment. In February, industrial production fell 3
percent, marking the fifth consecutive monthly decline.
No doubt this protracted contraction in output has oc­
curred in response to the sizable cutbacks in business
capital spending and to the unusually steep decline in
orders for other manufactured goods. Conditions in the
labor market have lately evidenced a pronounced weak­
ening, with the unemployment rate rising from 8.2 per­
cent in February to 8.7 percent in March.
Despite the decidedly downward thrust of the economy,
a few encouraging signs have appeared. Retail sales have
staged an advance in recent months, even after allowing
for concurrent price increases, and many retailers report
improving inventory positions. Automobiles sales, boosted
by the fall in effective prices, were comparatively brisk
in February and have led to a noticeable reduction in
the overhang of automotive inventories. The enlarged
flow of funds into thrift institutions should eventually give
rise to a recovery in residential housing construction,
once the surplus of unsold new homes has been reduced a
bit. These encouraging signs are quite tentative, however.
While an economic upturn is in prospect, its timing and
magnitude are still in question.
In coming months, further impetus to an economic re­
covery will derive from the tax-cut bill that was enacted
by the Congress and signed into law by President Ford
at the end of March. On balance, the new bill will amount
to an estimated $22.8 billion reduction in personal and
business taxes in 1975 and 1976. Included in the new
legislation are several provisions that will benefit individ­
uals. First, one provision calls for a 10 percent rebate
on personal income taxes for 1974, totaling about $8.1
billion. While all taxpayers will benefit to some extent,




those with adjusted gross incomes of $20,000 or less will
receive greater tax relief. Second, in 1975, personal
income tax liabilities will be reduced by about $7.8
billion. This reduction will be effected through a $30
tax credit for every taxpayer and his dependents and
through increases in the standard deduction. Third,
a tax credit for low-income families with children
will reduce personal tax liabilities by about $1.5 billion
in 1975. Fourth, at an estimated cost of $1.7 bil­
lion, all social security recipients, railroad retirement pen­
sioners, and aged, blind, and disabled welfare recipients
are scheduled to receive a $50 cash payment sometime in
the summer. Fifth, unemployed workers will be able to
draw unemployment compensation for an additional
thirteen weeks, extending the period of eligibility to
sixty-five weeks. Sixth, a 5 percent tax credit of up to
$2,000 will apply toward the purchases of new houses
that had been built or were under construction by March
25 and that are to be principal residences. Designed to
stimulate residential construction, this measure will de­
crease personal income taxes in 1975 by about $0.6 bil­
lion.
Taken together, the other provisions in the new legis­
lation will lower business taxes by about $3.1 billion.
First, the investment tax credit for purchases of equip­
ment is to be increased to 10 percent for two years, up
from th e '7 percent credit that had been in effect for most
businesses and the 4 percent credit for utilities. Also, the
amount of used equipment eligible for the credit was
raised from $50,000 to $100,000, a change that will pri­
marily benefit smaller businesses. These and other related
provisions will reduce business tax liabilities by an esti­
mated $3.4 billion. Second, the reduction in the tax rate
applied to the first $50,000 of their profits will result in
a $1.4 billion decrease in corporate tax liabilities. Partly
offsetting these tax breaks, however, are two other mea­
sures that will increase the tax liabilities of some busi­
nesses. The oil depletion allowance was eliminated for the
large oil companies and will be gradually phased out for

84

MONTHLY REVIEW, APRIL 1975

many smaller firms. And major changes were made in the
tax treatment of multinational corporations. In the aggregate, the personal and corporate tax reductions provide
a needed element of prom pt economic stimulus. However,
their implications for the long-term health of the economy
are problematic. The tax bill substantially reduces the
number of tax-paying citizens and decreases the Government’s revenues from important sources. While these
changes are presently considered temporary, they would
constitute a marked erosion of the tax base with inflationary overtones should they become permanent fiscal
arrangements.
On the price front, the outlook continues to be encouraging. Recent developments suggest that the combination
of plummeting materials prices and slackening demand
has begun to exert a dampening effect on finished goods
prices. Consumer prices rose during February at a 7.7
percent annual rate, mainly because of a considerable soft­
ening in retail food prices. And wholesale prices in March
declined for the fourth consecutive month. The prices of
farm products and related items accounted for much of
the weakness, although prices of industrial commodities
increased at only a 2.2 percent annual rate.

crease is attributable to a $479 million growth in the
often volatile orders for defense equipment. However,
orders for primary metals and household durables also
showed significant advances. The 6.9 percent rise in
orders for primary metals suggests that inventories of
these metals are finally running down, which could stimulate an upturn in their production. The increase in orders
for household durables was also the first in several months
and, although it is but one indicator, it could reflect
improvement in consumer confidence, which has deteriorated steadily over the past year. Another favorable sign
in durable goods is that orders for nondefense capital
goods were little changed in February. These orders had
declined on balance over the previous five months, falling
by 14.9 percent during the September-January period,
The book value of total business inventories declined in

C h a rt I

C HA NG ES IN MA N U F A C T U R E R S ’ INVENTORIES
BY STAGE OF FABRICATION
B illio n s o f d o lla rs

S e a s o n a lly a d ju s te d a n n u a l rates

B i||ions o f d o ||ars
40

INDUSTRIAL PRODUCTION, ORDERS, AND
30

INVENTORIES

20

Industrial production fell 3 percent during February.
This decline, the fifth in a row, brought the Federal Re­
serve’s index of industrial production to 110.3, 12 per­
cent below its September 1974 level. As in previous
months, the February decline in manufacturing output was
more noticeable in durable goods. Since September, the
production of durable goods has fallen 15 percent, while
nondurables are off about 11 percent. The production of
automobiles and parts fell again in February but at a
somewhat slower rate than in recent months. The
February decline was 4.7 percent, compared with an
average monthly reduction of 11.5 percent since October.
The output of business equipment was reduced again
in February and has fallen 9.8 percent since September.
In addition to the cutbacks in durable goods production,
the output of industrial materials was noticeably reduced
both in February and during the preceding few months.
The production of industrial materials fell 3.8 percent
during February, bringing the total decline during the
past five months to 17.9 percent.
New orders for durable goods increased by $900 mil­
lion during February. This rise reversed a five-month trend
during which durable goods orders declined by $13 bil­
lion, or 27 percent. A good portion of the February in-




10

0
25

20
15

1
0
5

0
15

10
5

0
-5

20
15

10
5

0
-5

S o u rc e :

U n ite d S ta te s D e p a r tm e n t o f C o m m e rc e , B u re a u o f th e C e n s u s .

FEDERAL RESERVE BANK OF NEW YORK

January for the first time in over four years. The Jan­
uary decrease was $148 million, compared with a sea­
sonally adjusted $3.9 billion increase in December and a
$45 billion gain over the previous twelve months. The
January decline in all business inventories was caused by
substantial reductions in the wholesale and retail trade
sectors. Apparently, the pattern in recent months of
declining orders to manufacturers against relatively stable
wholesale and retail sales has resulted in a running-down
of inventories at the wholesale and retail levels. Should
this pattern continue, one would expect a restoration of
orders to manufacturers in the near future and eventually
a higher rate of industrial production.
Approximately one half of the January decline in retail
inventories is attributable to automobiles. Automobile
dealers’ inventories fell even further in February, and at
the month end their inventories amounted to sixty days of
sales. This is the lowest inventory-sales ratio since Sep­
tember and is substantially below the November level,
when dealers held inventories equal to 101 days of sales.
Of course, the February figure was lowered by the price
rebate program which stimulated sales.
M anufacturers’ inventories increased in February but by
only 0.1 percent, their smallest gain in three and one-half
years. Stocks of finished goods actually declined by $30
million, and work in progress fell by $30 million as well
(see Chart I). The entire inventory increase was in mate­
rials and supplies, which rose by $245 million. Presumably,
the failure of materials stores to decline is partly explained
by the fact that some manufacturers are taking advantage
of increasingly attractive materials prices.
PERSONAL INCOME, CONSUMER DEMAND, AND
RESIDENTIAL CONSTRUCTION

Personal income increased in February by a seasonally
adjusted $2.9 billion to an annual rate of $1,194 billion.
The February increase was somewhat larger than the gain
recorded in January; however, it was quite small compared
with the average monthly gain for 1974. Reflecting recent
declines in production, payrolls in manufacturing and other
commodity-producing sectors dropped at a seasonally ad­
justed annual rate of $5.7 billion. Income in the service
and distribution industries increased at a $2.5 billion rate,
however, and limited the decline in total private payrolls to
$3.2 billion. Unemployment benefits, which have climbed
quickly with the unemployment rate in recent months, in­
creased by $2.7 billion in February. This jump, along with
a rise in social security, unemployment, and veterans’ bene­
fits, brought the increase of total transfer payments to an
annual rate of $6.7 billion. Farm income moved lower in




85

C h a rt II

RETAIL SALES
S e a s o n a lly a d ju s te d
B illio n s o f d o lla rs

S o u rc e :

B illio n s o f d o lla rs

U n ite d S ta te s D e p a r tm e n t o f C o m m e rc e , B u re a u o f th e C e n s u s .

February for the fifth consecutive month, falling 12 percent
to a $23 billion annual rate. Over the twelve-month period
ended in February, farm income has fallen by 41 percent.
Consumer spending at retail stores registered a m ar­
ginal increase of $210 million during February. This was
the third consecutive month in which retail sales have
risen (see Chart II). However, the gains have been quite
small, and sales have yet to regain their level of last
September. Of the February increase, approximately two
thirds was in the durable goods category and was accounted
for by automobile sales. During that month, passenger car
sales, reflecting the effects of the price rebates offered by
most manufacturers, proceeded at an annual rate of 7.2 mil­
lion units, compared with an average of 6.2 million units
during the previous four months. In March, after many of
the special sales programs ended, automobile sales declined
sharply to a 6 million unit annual rate, the slowest sales
pace since November.
The housing picture is still decidedly weak. Housing
starts fell by 2 percent in February to an annual rate of
977.000 units from January’s 996,000. This pace of
starts was somewhat higher than December’s low of
880.000 starts, but it was 48 percent below the level of last
February. Permits to build new housing units were down

86

MONTHLY REVIEW, APRIL 1975

in February to a record-low annual rate of 673,000 units.
Permits to construct multifamily dwellings fell to 106,000,
80 percent below the level of last February. Meanwhile,
permits for single-family residences increased for the sec­
ond consecutive month to an annual rate of 514,000.
Sales of new single-family houses increased by 2 per­
cent in January to 395,000, compared with December’s
387,000 sales. By the end of January, the combination of
low housing starts and somewhat faster housing sales had
reduced the inventory of unsold single-family houses to
approximately 400,000 units, nearly 50,000 houses fewer
than the inventory of a year ago but, because of the recent
slow pace of sales, the ratio of inventory to sales in January
was somewhat higher than it had been a year earlier.

capacity has been influential during business cycles in the
past, and it will doubtless condition the real output and
price performance of the economy in the near future.
Nowhere has unused capacity been more evident than
in the basic materials industries where utilization rates
fell from an average 93 percent in 1973 to 79.3 percent
in the fourth quarter of 1974, the lowest level in more
than thirteen years. With the exception of the paper in­
dustry, which has continued to operate at nearly full ca­
pacity, this decline has been broadly based as well. T o cite
a few examples, utilization in the chemicals industry
dropped from 90 percent in the fourth quarter of 1973 to
72 percent one year later, and metal producers were oper­
ating at 84.5 percent of capacity in the October-December
1974 period, down 8.7 percentage points from the peak
reached in the final three months of 1973.
Judging from previous years, however, the capacity con­
straints and materials shortages which characterized 1973
were unusually severe. Materials producers’ capacity utili­
zation rates rose above 90 percent during each of the four

SUPPLY OF BASIC MATERIALS

Against the backdrop of a weakened economy and
excessive inventory accumulation, substantial amounts of
excess capacity have developed. The existence of unused

C h a rt III

CAPACITY UTILIZATION A N D WHOLESALE PRICES OF BASIC MATERIALS INDUSTRIES

i i 1i i i I i i i 1 i ii 1 i i i 1 i i i 1 i i i 111i ) i i i I n n i ii 1 i i il i i i 1 iii
W H O L E S A L E PRI CES F OR B A S I C M A T E R I A L S
P e rc e n t a g e c h a n g e at a n n u a l r ate

1952
N o te :

53

54

55

56

57

58

59

60

61

62

63

64

65

66

67

S h a d e d a r e a s r e p r e s e n t r e c e s s io n p e r io d s , i n d ic a t e d b y th e N a t i o n a l B u re a u o f E c o n o m ic R e s e a rc h c h r o n o lo g y .

S o u rc e s :

U n ite d S ta te s D e p a r tm e n t o f L a b o r , B u re a u o f L a b o r S t a tis tic s ;




B o a r d 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 .

FEDERAL RESERVE BANK OF NEW YORK

post-World War II economic booms, and forward com­
mitments of purchasing agents lengthened considerably.
But, while a maximum of only 50 percent of purchasing
agents believed it necessary to order materials more than
ninety days in advance during each of the three earlier
booms, 65 percent believed such a lead time necessary in
1973. In retrospect, the unusually tight bottlenecks that
occurred at the end of 1973 are probably attributable to
the effects of the Economic Stabilization Program and
the devaluation of the United States dollar.
In any event, supply constraints similar to those that
developed in 1973 are not likely to reappear in the near
future. As indicated in Chart III, while changes in the
utilization rate for materials producers tend to mirror
swings in overall economic activity, slack has often per­
sisted beyond the onset of recoveries. Moreover, since
materials prices are extremely sensitive to prevailing sup­
ply conditions, inflationary pressures have eased for sev­
eral quarters beyond the business-cycle troughs as well.
After falling rather sharply during the contractions in
1953-54 and 1957-58, for example, capacity utilization
picked up, but it did not return to its earlier cyclical
peak until four quarters after the economy started to
rebound. Although materials prices immediately began
rising in response to the improvement in economic activ­
ity in the third quarter of 1954 and in the second quarter
of 1958, these increases were smaller than they had been
during each of the previous expansions. In 1961 the de­
cline in utilization was not nearly so dramatic, since a
large amount of surplus capacity already existed and only
two quarters passed before the earlier peak was attained.
Despite this, materials prices remained quite stable, fail­
ing to rise significantly until the end of 1964. More re­
cently, the mild decline in utilization which occurred in
1970 required two full years before capacity utilization
approached the peak established in the fourth quarter of
1969 and materials prices began to accelerate.
Cyclical declines in plant utilization have tended to
stretch beyond general economic contractions partly be­
cause of the bursts in capital investment that typically
have occurred during the prior expansion. As measured
by the Commerce Department, over the year preceding
each of the four postwar cyclical peaks, capital spending
by major materials producers rose an average $1.1 billion
above year-earlier levels. However, since fairly long
periods must expire before new plant and equipment
emerge from these expenditures, additions to capacity
have rarely surfaced until recoveries were under way. In
this respect, a very similar pattern seems to be unfolding
for 1975. Capital spending in 1973 rose $3.1 billion
above the 1972 level and, while a portion of the increase




87

was caused by inflation, even in real terms there was a
substantial jump. As a result, a sufficient amount of new
capacity should emerge during 1975 so that the current
slack in utilization may persist for a time, thus helping to
temper a rekindling of inflationary pressures.
PRICE DEVELOPMENTS

Consumer prices increased at a seasonally adjusted
annual rate of 7.7 percent during February. This was
the second consecutive month in which the consumer
price index rose at this rate, providing additional evidence
that inflation has fallen back from the rates in excess of
10 percent that were experienced during 1974. The Feb­
ruary increase brought the annual rate of consumer price
rise for the three-month period since November to 7.8
percent, compared with 12.4 percent for the previous
three-month interval. During the twelve months ended
in February, consumer prices advanced 11.1 percent.
Retail food prices increased at only a 0.7 percent annual
rate during February, their slowest rise since last July. This
break in the rate of food inflation reflects, among other
factors, a working-forward of the lower wholesale food
prices that have been observed during recent months. For
example, for the three-month period ended in February,
wholesale prices of farm products and processed foods
and feeds fell at nearly a 33 percent annual rate.
Excluding foods, the consumer price index advanced
at a 10.3 percent annual rate in February, compared with
7.9 percent in January. The prices of nonfood commodi­
ties increased at a 10 percent rate, while service prices
rose at a 9.7 percent pace. Among the commodity group,
price rises were most pronounced among durable goods,
which rose at a 12 percent annual rate. Looking at energy
prices, consumer fees for gas and electricity increased
at a 17.3 percent annual rate, while the prices of fuel
011 and coal declined at a 0.5 percent pace.
Wholesale prices fell at a seasonally adjusted annual rate
of 7.4 percent in March, sustaining a decline that set in last
December. As in previous months, the reduction was due
entirely to lower agricultural prices. Wholesale farm and
feed prices dropped at a 30.4 percent annual rate in
March, bringing the decline over the last three months to
33.1 percent. Moreover, with spot prices of foodstuffs
moving down in recent weeks, the prospect of additional
declines at the wholesale level appear likely. At the same
time, wholesale prices of industrial commodities slowed to
a 2.2 percent annual-rate gain in March. Over the past
six months, industrial commodities prices have increased
at a 6.5 percent annual rate, well below the 31.5 percent
advance posted over the first half of 1974.

88

MONTHLY REVIEW, APRIL 1975

LABOR MARKET DEVELOPMENTS

Unemployment in M arch rose to 8.7 percent of the ci­
vilian labor force, after having held steady at 8.2 per­
cent the preceding month. The number of unemployed
persons increased by almost 500,000 to nearly 8 million,
the largest number of workers without jobs since 1940.
The latest rise in unemployment was caused both by a
sizable number of entrants into the labor force and by a
reduction in employment. During March, the civilian labor
force expanded by 320,000 persons to 91.8 million, while
the number of persons employed dropped by 180,000 to
83.9 million workers. All of the major categories of work­
ers experienced higher unemployment in March; however,
reflecting the continuing fall in industrial production, blue
collar workers were especially hard hit. The unemploy­




ment rate among blue collar workers rose to 12.5 per­
cent, compared with 10.9 percent in February.
Average hourly earnings increased in M arch at their
fastest rate in nine months. The M arch gain was at a 12.9
percent annual rate, compared with increases of 6.5 per­
cent in January and February. Earnings moved higher in
all major industries. The gains were especially large in
construction, where earnings rose at more than a 30 per­
cent annual rate, after having declined at about a 13 per­
cent rate during February. Reflecting the low level of con­
struction activity over the past year, earnings in construc­
tion have risen more slowly than in other industries. For
example, since March 1974, average hourly earnings in
construction increased 8.5 percent, compared with an 11.4
percent rise in manufacturing and a 13.7 percent advance
in mining wages.

FEDERAL RESERVE BANK OF NEW YORK

89

The Money and Bond Markets in March
The decline in short-term interest rates that character­
ized the past several months continued in March. Most
short-term rates decreased only slightly, however, from
their levels of the preceding month. The average rate on
large-denomination certificates of deposit (CDs) fell by
only 25 basis points in March from its level in the previ­
ous month. Similarly, the rate on commercial paper aver­
aged but 27 basis points less than its average in February.
The Federal funds rate averaged 5.54 percent in March,
down 70 basis points from its average in February. Early
in the month, the Board of Governors of the Federal
Reserve System approved a reduction in the discount rate
A
from 6 3 percent to 6V4 percent at all Federal Reserve
Banks.
While private demand for short-term credit remained
sluggish in March, huge corporate and Treasury borrow­
ing weighed on the bond market. A record of $4.6 billion
of bonds was issued in the corporate sector, and $10
billion net was raised by the Treasury. Among the new
Treasury issues was $1.25 billion of fifteen-year bonds.
This, in conjunction with the abundance of newly issued
corporate bonds, caused long-term yields to rise sharply
over the period, in most cases back to their mid-January
levels. Estimates of the future Federal deficit were revised
upward during the month. Yields on Government coupon
securities increased, and Treasury bill rates rose despite
declines in other money market rates. The tax-exempt
market was also subject to these influences, although new
issue activity was moderate. In addition, the effects of the
financial difficulties of the New York State Urban Devel­
opment Corporation (U D C) and concern over the finan­
cial position of New York City weighed on the market.
Preliminary data indicate that growth of the narrowly
defined money stock (M x) accelerated sharply in March.
This is the second month in a row that
has experienced
relatively rapid growth. The strong performance of M x in
March was accompanied by rapid expansion of the more
broadly defined money stock (M_.).




THE MONEY MARKET, BANK RESERVES, AND
MONETARY AGGREGATES

Interest rates on most money market instruments gen­
erally followed a downward course in March, as they had
in recent months (see Chart I). The effective rate on
Federal funds moved about 50 basis points lower at the
beginning of the period and then fluctuated around the 5 Vi
percent level for the remainder of the month. For March
as a whole, the funds rate averaged 5.54 percent, its lowest
level since December 1972. Rates on CDs in the secondary
market also moved downward over the month, although
they backed up at the end of March. In the commercial
paper market, interest rates were unchanged at the be­
ginning of the month but fell as the period progressed.
For example, after holding steadily at 6V4 percent early
in March, the rate on 90- to 119-day dealer-placed com­
mercial paper moved down by 35 basis points in a series
of steps that brought it to 6 percent near the end of the
month. The bid rate on bankers’ acceptances also declined
and closed the month at 53 percent, down 30 basis
A
points from its end-of-February level.
Business demands for short-term credit remained slug­
gish in March. At weekly reporting commercial banks,
business loans fell by $179 million over the four state­
ment weeks of the month, bringing the total decline in such
loans thus far in 1975 to about $5.6 billion. In part, the
drop in business loans at banks over the January-M arch
period resulted from shifts of some business borrowing to
the commercial paper market, as banks’ prime lending
rates have lagged the fall in commercial paper rates. How­
ever, over this three-month period, the combined total of
business loans at weekly reporting banks plus nonfinancial
commercial paper outstanding has fallen $3.5 billion, in
contrast to an increase of $6.4 billion over the comparable
period of 1974. Along with the weakness in business loan
demand in March, most major banks reduced their prime
lending rate by 1 percentage point to 7Vi percent. Major

MONTHLY REVIEW, APRIL 1975

90

SELECTED INTEREST RATES
Ja n u a ry - M a rc h 1975
P e rc e n t

M O N E Y M A R K E T RATES

J a n u a ry

N o te :

F e b ru a ry

B O N D M A R K E T Y IE LD S

M a rc h

J a n u a ry

F e b ru a ry

P e rc e n t

M a rc h

D a t a a r e s h o w n f o 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 R ATES Q U O T E D :

P r im e c o m m e r c ia l lo a n r a te a t m o s t m a jo r b a n k s ;

o f f e r i n g r a t e s ( q u o te d in te rm s o f r a t e o f d is c o u n t) o n 9 0 - to 1 1 9 - d a y p r im e c o m m e r c ia l

s t a n d a r d A a a - r a t e d b o n d o f a t le a s t t w e n t y y e a r s ' m a t u r i t y ; d a i l y a v e r a g e s o f
y ie ld s o n s e a s o n e d A a a - r a te d c o r p o r a te b o n d s ; d a ily a v e r a g e s o f y ie ld s on

p a p e r q u o t e d b y t h r e e o f th e fiv e d e a le r s t h a t r e p o r t t h e i r r a te s , o r th e m id p o i n t o f

l o n g - te r m G o v e r n m e n t s e c u r it ie s ( b o n d s d u e o r c a l l a b l e in te n y e a r s o r m o re )

th e r a n g e q u o t e d i f n o c o n s e n s u s is a v a i l a b le ; th e e f f e c t iv e r a t e o n F e d e r a l fu n d s

a n d o n G o v e r n m e n t s e c u r it ie s d u e in th r e e to f iv e y e a r s , c o m p u te d o n th e b a s is

(th e r a t e m o s t r e p r e s e n t a t iv e o f th e t r a n s a c t io n s e x e c u t e d ) ; c lo s in g b id r a te s ( q u o te d
in te r m s o f r a t e o f d is c o u n t) o n n e w e s t o u t s t a n d i n g th r e e - m o n t h T r e a s u r y b ills .

o f c lo s in g b i d p r ic e s ; T h u r s d a y a v e r a g e s o f y i e l d s o n t w e n t y s e a s o n e d t w e n t y-

B O N D M A R K E T Y IE LD S Q U O T E D :

Y ie ld s o n n e w A a a - r a t e d p u b l i c u t i l i t y b o n d s a r e b a s e d

o n p r ic e s a s k e d b y u n d e r w r i t i n g s y n d ic a te s , a d ju s t e d to m a k e th e m e q u i v a l e n t to - a

banks became somewhat more active in issuing CDs, and
the volume of CDs outstanding rose in M arch by $969
million. Member bank borrowings from the Federal Re­
serve fell by $26 million in the four-week period ended
M arch 26, averaging $113 million for the same period
(see Table I).
According to preliminary data, the money stock mea­
sures advanced in M arch at a relatively rapid pace for the
second month in a row. After increasing at a seasonally
adjusted annual rate of 6.8 percent in February, M x
—
private demand deposits adjusted plus currency outside
banks— rose at a 14.7 percent annual rate in the fourweek period ended M arch 26 from its average level in the
four weeks ended February 26. The demand deposit com­




y e a r t a x - e x e m p t b o n d s ( c a r r y 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 e s :

F e d e r a l R e s e rv e B a n k o f N e w Y o r k , B o a r d 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 r s S e r v ic e , In c ., a n d T h e B o n d B u y e r .

ponent of Mj. participated in the surge, rising over the
same period at a 15.1 percent pace, while the currency
component increased 13.3 percent. However, M 1 had ac­
tually fallen sharply in January, so that the rapid growth
registered in the subsequent two months left
in March
only 3 percent higher, at an annual rate, than its level
of thirteen weeks earlier (see Chart II ). Over the year
ended in March, M 1 rose 4.3 percent.
Mo— which adds to Mj time deposits less large nego­
tiable CDs— continued to grow rapidly in March. Partly
as a result of lower short-term interest rates, which
boosted flows into time and savings deposits, M grew
_>
at a 13 percent seasonally adjusted annual rate dur­
ing the four weeks ended March 26 from its level

FEDERAL RESERVE BANK OF NEW YORK

over the four statement weeks in February. In the thirteenweek period ended M arch 26, M 2 rose 8 percent at an
annual rate. In contrast to the money stock measures, growth
of the adjusted bank credit proxy— which includes member
bank deposits subject to reserve requirements plus certain
nondeposit liabilities— remained sluggish in March, as the
drop in the seasonally adjusted volume of CDs outstand­
ing partially offset advances in member bank demand and
time deposits.
During the month, the Federal Open M arket Commit­
tee announced that it had voted to speed up publication
of the records of policy actions taken at each of its
monthly meetings. Henceforth, policy records will be re­
leased with a delay of approximately forty-five days,
rather than with the ninety-day lag previously followed.
At the January meeting, the Committee decided that the
economic situation and outlook called for more rapid
growth in the monetary aggregates over the months ahead
than occurred in recent months. It adopted ranges of
tolerance for the growth of M r and M.., respectively, over
the January-February period of 3V£ to 6 V2 percent and
7 to 10 percent.

91
Table I

FACTORS TENDING TO INCREASE OR DECREASE
MEMBER BANK RESERVES, MARCH 1975
In millions of dollars; (4 ) denotes increase
and (—) decrease in excess reserves
Changes in daily averages—
week ended

Net
changes

Factors
March
5

March
12

March
19

March
26

“ Market" factors
60 4- 143 — 225 — 201

— 223

_ 893 —3,348

—1,541

Federal Reserve float ................................

— 60 4 4- 425 — 125 — 303

— 607

Treasury operations* ..................................

4 677 42,260

Gold and foreign account ........................

_ 40

23 —

44

—

Currency outside banks ..........................

4 210 — 355 — 827 _

73

—1,045

and capital ..................................................

_ 252 4- 350 — 125

69

-f

Total “ market” factors ............................

+

Member bank required re serv es..................

-f

Operating transactions (subtotal) ..............

— 9 42,709

4- 207 —2,996

30 u_

4

4- 148
77

Other Federal Reserve liabilities

51 42,852

4

—1,118 —3,549

42

—1.764

Direct Federal Reserve credit
transactions
Open market operations (subtotal) ............

- f 193 —3,025 4

677 43,678

Treasury securities ....................................

— 232 —1,840 4

411 43,024

Rankers' acceptances ................................

+

41.523

Outright holdings:
THE GOVERNMENT SECURITIES MARKET

M arch was marked by a sharp increase in the yields
on intermediate- and long-term Government securities.
This occurred as the Treasury raised $10 billion in new
cash in the month, with clear intentions of raising more
in the future. Furthermore, estimates of the Federal deficit
in 1975 and 1976 were repeatedly revised upward dur­
ing the month, and shorter term rates rose in the last
stretch of the period as the revised estimates of the pro­
spective Federal deficit affected a wide spectrum of the
Government securities market.
Yields in the intermediate- and long-term Government
securities markets were fairly steady during the first half
of the month, partly because bill rates were edging down­
ward. From the first to the third weekly auctions, the
three- and six-month bill rates fell by 26 and 27 basis
points, respectively (see Table II ), while longer term
yields showed little change. Shortly after midmonth, how­
ever, long-term rates began to rise sharply, and the ad­
vance continued for the remainder of the month. For
March as a whole, yields on long-term Government securi­
ties rose by about 40 basis points on average, and yields
on three- to five-year Government securities increased 23
basis points. Treasury bill rates fluctuated within a narrow
band over much of the month. Some upward pressure
from expectations of large future Treasury funding was
felt at the end of March, although for the entire period the




—

24

Special certificates ....................................
Federal agency obligations ......................

4

238 4

- f 291 4-

53 —

41,363
+

3

11

4

10 _

343

277 — 515
1

Repurchase agreements:

[

Treasury securities ....................................

b6 —1,095

4

838

Rankers' acceptances ................................

-f

40 — 178

4

159

Federal agency obligations ......................

4- 133 — 203

4

175

+
+

21
105

12

—

26

2

—

A
4

Member bank borrowings ............................
Seasonal borrowingsf ................................
Other Federal Reserve assetsj ..................
Total

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

Excess reserves* ..............................................

— Ill

__

g 4

i
_

__

2

_

2

13

4- 136 +
| 218

!

106 —
I

4

4

4 269 — 169

132 —

4

' ’

— 320

i

915 43.646

— 203 4

4 - 261
4-1.758
g

97

M onthly
averages§

D a ily average levels

1

Member bank:
Total reserves, including vault cashj . . . .

34,825

34,513

Required reserves ..........................................

34,397

34,254

reserves ..............................................

428

259

Total borrowings ............................................

70

Seasonal borrowingsf ................................

9

61
7

Nonborrowed reserves ....................................

34,755

34,452

Excess

Net carry-over, excess or deficit (—) || . . .

I

28 |

34,535

1

206 ,

34,833

34,677

34,479

34,680

34 453

56

153

224

155

113

j
5!

167

34,368
141

Note: Rccau.se of rounding, figures do not necessarily add to totals.
* Includes changes in Treasury currency and cash,
t Included in total member bank borrowings.
t Includes assets denominated in foreign currencies.
§ Average for four weeks ended March 26, 11)75.
|| Not reflected in data above.

7

7

34,678

34,563
I

10 !

96

92

MONTHLY REVIEW, APRIL 1975

yield on three-month bills averaged 5.49 percent, about
unchanged from its average in the previous month. The
yields on longer term Treasury bills responded more
sharply to expectations of future Government financing.
They generally rose by 25 basis points at the tail end of
the month and closed at about end-of-February levels.
The Treasury held four auctions of coupon issues during
the month as part of its program to fund the current Fed­
eral deficit. Its new issues were fairly well received, although
yields were established at rising levels. On M arch 11, the
Treasury auctioned $1.75 billion of additional 1 3 percent
A
notes due November 15, 1981. Considerable interest was
generated among market participants when suggested yield
levels rose above 7.50 percent. A total of $3.4 billion of
tenders was received, and the average yield was set at
7.51 percent. On M arch 13 another auction was held, at
which $1.5 billion of 6 percent fourteen-month notes was
sold at an average yield of 5.98 percent. The sale at­
tracted good bidding interest, with $2.9 billion of tenders
being received. Bidding proved to be less than most had
expected, however, at the Treasury auction on March 18.
An average yield of 6.51 percent was set on a $2.2 billion
issue of two-year notes, with the volume of bids being a
modest $2.6 billion. In contrast, the widely anticipated
Treasury sale of $1.25 billion of fifteen-year bonds, oc­
curring on M arch 20, went well. With $2.9 billion of
tenders being received, an average yield of 8.31 percent
was established. On April 1 the Treasury held another
auction at which it sold $1.5 billion of twenty-month
notes. With tenders totaling $3.8 billion, an average yield
of 7.15 percent was set. The Treasury announced on the
last day of the month that it might require about $17.5
billion in new cash by June 30.
New Federal agency issues were given mixed receptions
in March. In the first week of the month, the Government
National Mortgage Association had difficulty attracting
buyers for $300 million of l lA percent mortgage-backed
securities priced to yield 7.96 percent. On the other hand,
the Federal National Mortgage Association (FNMA) en­
countered strong demand for its four-month commitments
to purchase home loans at an auction held at midmonth.
The average yield on commitments to buy Governmentbacked mortgages fell to 8.78 percent, the twelfth con­
secutive decline. However, a $300 million FNM A offering
of capital debentures with a l 5 percent coupon sold only
/s
moderately well. Furthermore, at a second FNM A auction
of four-month commitments to purchase Governmentbacked mortgages, yields rose to 8.85 percent, the first such
increase since September 1974. The Housing and Urban De­
velopment Department (H U D ) entered the market, selling
$747.3 million of tax-exempt notes for local public hous­




ing authorities. With an average maturity of 8.1 months,
the notes yielded on average 3.67 percent, up from the
two-year low of 3.49 percent registered last month. Later
in the month, HUD sold $553.4 million of tax-exempt
urban-renewal notes with an average maturity of 7.7
months at an average interest rate of 3.52 percent, down
from the 3.57 percent set at February’s auction. A good
reception was accorded a $1.7 billion offering of ninemonth bonds by the Federal Intermediate Credit Banks
(FIC B ) and a $313.7 million offering of six-month bonds
by the Banks for Cooperatives (B C ), with coupons set
respectively at 6.05 percent and 5.85 percent. These farm
credit agencies made additional sales later in the month,
with the BC selling $4 million of 8.05 percent bonds due
June 2, 1975 and the FICB selling $55 million of 7.35
percent bonds due October 1, 1975 and $15 million of
8.05 percent bonds due September 2, 1975.

C h a r t II

C HA NG E S IN MONETARY A N D CREDIT AGGREGATES
S e a s o n a lly a d ju s te d a n n u a l ra te s
P e rc e n t

P e rc e n t

15

10
5

0
—
5
15
10
5

0
25

20
15

10
5

0

_________________

1973
N o te :

1974

19 7 5

G r o w th ra te s a r e c o m p u te d on th e b a s is o f fo u r -w e e k a v e r a g e s o f d a ily

fig u r e s fo r p e r io d s e n d e d in th e s ta te m e n t w e e k p lo tte d , 13 w e e k s e a r lie r a n d
52 w e e k s e a r lie r . T he la te s t s ta te m e n t w e e k p lo tte d is M a rc h 2 6 , 19 75 .
M l = C u rre n c y p lu s a d ju s te d d e m a n d d e p o s its h e ld b y th e p u b lic .
M 2 = M l p lu s c o m m e rc ia l b a n k s a v in g s a n d tim e d e p o s its h e ld b y th e p u b lic , less
n e g o tia b le c e r tific a te s o f d e p o s it iss u e d in d e n o m in a tio n s o f $ 1 0 0 ,0 0 0 o r m o re .
A d ju s te d b a n k c r e d it p r o x y = T o ta l m e m b e r b a n k d e p o s its s u b je c t to re s e rv e
re q u ir e m e n ts p lu s n o n d e p o s it s o u rc e s o f fu n d s , such as E u ro - d o lla r
b o r ro w in g s a n d th e p ro c e e d s o f c o m m e r c ia l p a p e r issu e d b y b a n k h o ld in g
c o m p a n ie s o r o th e r a ffilia te s .
S o u rc e :

B o a rd o f G o v e rn o rs o f th e F e d e ra l R ese rve S ystem .

FEDERAL RESERVE BANK OF NEW YORK

93
Table II

THE OTHER SECURITIES MARKETS

Yields on corporate securities rose sharply in M arch,
as a large backlog of undistributed inventories in dealers’
hands coupled with a record volume of new offerings
weighed heavily on the market. M oody’s index of yields
on seasoned Aaa-rated corporate bonds rose 20 basis
points over the period. Larger gains were registered
on newly issued securities, as dealers attempted to quicken
their inventory turnover. Over the course of the month,
$4.6 billion of new corporate bonds was publicly offered.
This represented about $1 billion more than the sizable
volume of new issues recorded in February and was nearly
twice the average monthly volume of offerings experi­
enced in 1974 as a whole.
New issues received mixed receptions in the corporate
market early in the month. A $300 million offering of
Aaa-rated debentures, priced to yield 8.33 percent in
thirty years, sold out quickly. However, a $250 million
issue of Aaa-rated ten-year debentures sold slowly when
priced to yield 7.75 percent, a yield that was just a shade
above those available on some Federal agency issues with
similar maturities. With bulging inventories and with ex­
pectations of additional large new offerings, dealers began
to release slow-selling issues from syndicate price restric­
tions, and yields in many cases moved sharply higher.
On M arch 20, General Motors Corporation (G M ) brought
to market $300 million of 8% percent debentures due
2005 and $300 million of 8.05 percent notes due 1985.
This represented the largest financing ever by an indus­
trial firm and was the first time in over twenty years that
GM had tapped the bond market. Although both of GM ’s
issues were originally considered to be attractively priced,
initial demand for them was slow, as their yields were
close to that on the Treasury’s fifteen-year issue sold on
the same day. The introduction of the new bonds,
with huge supplies already existing in the market, further
dampened prices in both the primary and secondary m ar­
kets, and the situation was somewhat aggravated by a
greater sense of uncertainty concerning the outlook for
peace in the Middle East.
In the last several days of the month, supply pressures
eased somewhat in the corporate bond market. Moreover,
the Federal Reserve entered the Government securities
market to buy intermediate- and long-term Treasury and
Federal agency issues. This action, in conjunction with
the announced postponement of several corporate offer­
ings, enabled some new issues to meet favorable recep­
tions. A $300 million Aaa-rated offering, consisting of
$150 million of 8.2 percent ten-year notes and $150 mil­
lion of 8.85 percent thirty-year debentures, sold out.




AVERAGE ISSUING RATES
AT REGULAR TREASURY BILL AUCTIONS*
In percent
W eekly auction dates— March 1975
M aturity
March
3

March
10

March
17

March
24

March
31

Three-month ........................................

5.637

5.622

5.376

5.542

5.562

Six-month

5.742

5.655

5.473

5.669

5.786

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

M onthly auction dates— January-M arch 1975
January
S
Fifty-two weeks ..................................

February
5

March
5

6.378

5.313

5.637

* Interest rates on bills are quoted in terms of a 360-day year, with the discounts
from par as the return on the face amount of the bills payable at maturity. Bond
yield equivalents, related to the amount actually invested, would be slightly higher.

Other issues that moved well included $100 million of
Aaa-rated thirty-year first-mortgage bonds with a 9Vi
percent coupon and $60 million A-rated thirty-year de­
bentures priced at par with a 95 percent coupon. How­
/s
ever, expectations of large amounts of new corporate
and Treasury issues in the near future continued to de­
press prices as the month closed.
Uncertainty over the future of the UDC continued to
overhang the tax-exempt market in March, although it
did not uniformly affect all municipal securities. Early
in the month, the State of Tennessee offered $100 million
of A aa/A a (Moody’s/Standard and Poor’s)-rated bonds.
Although the issue was aggressively priced to yield from
3.70 percent in 1976 to 6.25 percent in 1995, it at­
tracted-good demand. A favorable reception was also
afforded a $125 million issue of revenue bonds by the
Washington State Public Power Supply System. Having
recently been awarded Aaa rating, the revenue bonds
were scaled to yield between 6.6 percent and 6% percent
over a range of maturities. Some price reduction was re­
quired, however, to sell unsold balances remaining in
dealers’ inventories. The New York State Housing Finance
Agency was strongly affected by the market’s reaction to the
financial problems of the UDC. After postponing a
$94.8 million sale of new short-term notes, bids were
received for only $54 million at the delayed sale. The net
interest cost soared to 7.41 percent, compared with 4.29
percent paid to sell $111 million of similar notes on Febru­
ary 5. New York City also fared poorly when it sold $537
million of bond anticipation notes at a net interest cost

94

MONTHLY REVIEW, APRIL 1975

of 8.69 percent, the highest rate ever paid by the city for
this type of borrowing. Later in the month, New York
City accepted a somewhat lower interest cost of 7.99
percent in selling a $375 million note issue. Other cities
were also hurt by the quality-conscious market; for ex­
ample, one large city rescinded a bond offer of $22 million




when it received a 9.25 percent interest rate bid.
F or the month as a whole, The Bond Buyer index of
twenty municipal bond yields rose 40 basis points, closing
the month at 6.95 percent. The Blue List of dealers’ ad­
vertised inventories finished the month at $539 million.
It declined by $113 million for the month.