The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
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.