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FEDERAL RESERVE BANK OF NEW YORK 259 The B usiness Situation The recent moderation of demand pressures is appar annual rate of increase dropped to 8 per cent in the second ently continuing. Nevertheless, with defense expenditures quarter and to 516 per cent in the four-month July to pointed upward, the economy still faces the problem of October period. The slowdown in the growth of produc excess demand. Unemployment remains at a very low level tion has been especially marked in the consumer goods and skilled labor is in short supply, while industry is oper sector, where automobile assemblies and the production ating close to capacity. Even though industrial wholesale of television and radio sets trended downward. The pro prices have been stable since the summer, consumer prices duction of materials has also weakened. Business and have increased further, labor costs per unit of output have defense equipment output, on the other hand, has con risen sharply, and wage pressures have accelerated. tinued to increase at a very rapid rate throughout the year, Although retail sales have remained on a high plateau as investment outlays remained on their steeply rising for some months now, there is considerable buoyancy in curve and the military requirements for the Vietnam war the economy. Disposable income is rising very rapidly, mounted sharply. industrial production has apparently resumed its upward These longer run trends were, by and large, also re course after a temporary pause in September, and new flected in the results for the month of October. A notable orders received by durables manufacturers remain ex exception was the steep 20 per cent rise in automobile tremely high. New survey information on the spending production from depressed September levels to a rate plans of consumers and businesses, while suggesting slower almost as high as that of the exceptional first quarter. In growth in such spending, nevertheless underscores the November, however, the rate of auto assemblies was basic strength of the private sectors of the economy. reduced somewhat. On the other hand, the October output Businesses expect to increase their spending on plant and of furniture and some household appliances declined equipment still further in the first half of 1967. Consumer again, while equipment output, for both business and intentions to buy new automobiles and major household defense purposes, continued to advance. Finally, materials durables within the next six months have weakened per production declined slightly further as iron and steel out ceptibly, perhaps as a consequence of uneasiness about the put moderated for the third consecutive month. economic outlook, but consumers remain optimistic about The overall volume of new orders received by durables the growth of their incomes, which is the prime determi manufacturers fell by $1.2 billion to a $24.1 billion sea sonally adjusted total in October, after increasing by nant of consumer demand. $1.8 billion in September. Much of the fluctuation in new orders in recent months has been ascribable to defense PR O D U C T IO N , O R DERS, A N D C O N S T R U C T IO N orders. New durables orders for civilian goods, after Industrial output rose in October, after the pause declining substantially from March through August, ap recorded in the preceding month. The Federal Reserve parently rose in both September and October. Shipments Board’s seasonally adjusted production index advanced by all durables manufacturers increased in October to by 0.5 percentage point to 158.6 per cent of the 1957-59 a new record but still fell short of new orders bookings. average. The most recent increase was moderate in com Consequently, the backlog of unfilled orders rose once parison with the average gains experienced earlier this more, although the October increase of $600 million was year, extending the gradual trend toward a more sustain one of the smallest recorded in the past year. able rate of growth of production. Thus, while industrial Construction outlays continued to decline in October, output rose at an annual rate of 14 per cent from the with the bulk of the easing again concentrated in private fourth quarter of 1965 to the first quarter of 1966, the residential construction, which fell by 2.7 per cent. While 260 MONTHLY REVIEW, DECEMBER 1966 the most recent declines in both total and residential con struction outlays were considerably smaller than those occurring in the preceding three months, some further easing, especially in residential construction, seems highly likely. Thus, private nonfarm housing starts dropped by 21 percent in October,and residential construction awards were off by 5 V2 per cent. New contracts for commercial and industrial construction, which had risen substantially in September, fell off by even more in October and were 5 per cent below their year-ago level. IN C O M E , S A L E S , E M P L O Y M E N T , A N D P R IC E S Personal income, which advanced strongly in September at a time when other indicators were showing some hesi tancy, registered another substantial increase in October. A further large rise in Federal transfer payments, under Medicare and other programs, brought the increase in Chart I DISPOSABLE PERSONAL INCOME AND RETAIL SALES Seasonally adjusted annual rate Billions of dollars Billions of dollars Note: Disposable personal income data are quarterly; retail sales data are monthly. Source; United States Department of Commerce, Bureau of the Census. total personal income to a seasonally adjusted annual rate of $4.6 billion, equaling the September gain and only moderately below the August advance of $5.4 billion. There has been a marked acceleration of the growth of personal income during the last three months to an annual rate of 10 per cent, compared with less than 7 per cent from December to July. This development reflects in part the fact that Medicare payments have recently boosted income. The rapid pace of advance in wage and salary disbursements, which account for some two thirds of total personal income, has continued unabated. Retail sales rose slightly in October, according to pre liminary data, following a moderate seasonally adjusted increase of 0.3 per cent in September (see Chart I). In both months, declines in the sales of durable goods stores were more than offset by increased sales at non durable goods outlets. Within the durables category, sales of furniture and household appliances were down in October for the second consecutive month, at least partly due to the slump in residential construction, and auto mobile dealers reported a substantial drop in new car sales. Domestic new car sales declined to a seasonally adjusted annual rate of slightly over 8 million units during October, down from 8.6 million in September and the lowest level since last May. Dealer sales recovered to 8.4 million units in November, but still remained below previously antici pated levels. As a consequence, auto producers have cut back their November assemblies by 6 per cent to a sea sonally adjusted annual rate of 8.5 million units; 8.8 mil lion units are scheduled for production in December. The latest survey of consumer buying intentions points to the possibility of a continuation of somewhat less buoyant auto sales in the coming months. In October of this year, the proportion of families reporting plans to purchase a new car within six months was lower than in either October 1965 or October 1964, but still well ahead of the percentages in earlier years (see Chart II). The percentage of families planning to buy a new car within three months, however, was about the same as in the pre ceding two October surveys, and the overall decline was almost entirely in plans for purchases three to six months in the future, or at some as yet undecided time within the six-month period. There are a number of reasons which might explain this divergence. First-quarter automobile sales were exceptionally strong in 1965, when consumers were purchasing the cars that had not been available dur ing the preceding strike period, and in 1966 when pur chases soared in part as a result of the reduction in the automobile excise tax. (This excise tax cut was repealed in March 1966.) The strength of buying in tentions revealed by the 1964 and 1965 October surveys 261 FEDERAL RESERVE BANK OF NEW YORK is undoubtedly explained to a large extent by these fac tors, and some letdown is hence not very surprising. The latest survey, however, may also denote a feeling of uneasiness about the economic outlook beyond 1966, and perhaps also the expectation of an income tax increase early next year. These factors are apparently also reflected in the buying plans for household durables. Indeed, while the proportion of families intending to purchase within three months one or more of the seven big-ticket items in cluded in the survey was virtually unchanged from the high percentages of October 1965 and 1964, the proportion planning to buy in three to six months, or at an undeter mined point within the coming six months, dropped sharply below the levels of the last two years. The survey also dis closed that the proportion of families expecting to have higher incomes a year from the survey date had remained as large as it was in October 1965, and considerably ahead of the percentages recorded in the preceding years. Since income is the main factor determining how much people will buy, the apparent contradiction between income ex pectations and purchase plans might be a further evidence of consumer uneasiness regarding business prospects. The expectations of further rises in personal income revealed by the survey may have been based in part on the very strong employment conditions that prevailed dur ing the past year. The situation remained taut in this respect during November, when employment rose substan tially and the overall unemployment rate fell by 0.2 per centage point to 3.7 per cent. This level has already been reached twice early this year, but was otherwise the lowest in thirteen years. The unemployment rate for married men, at 1.7 per cent, hit its lowest level on record. The continued tightness in the labor market, along with substantial increases in the cost of living, has generated strong pressures on wages. The median wage increase provided for in major labor contracts negotiated in the first nine months of each year has risen sharply during this expansion from only 2.3 per cent in 1963 to 3.0 per cent in 1964, 3.3 per cent in 1965, and 3.8 per cent in 1966. This trend, furthermore, appears to be continuing, and could easily lead to a serious problem of cost inflation. Labor costs per unit of output in manufacturing have risen steeply since the summer— at an annual rate of 8 per cent in the last two months alone— and are likely to keep on increasing since smaller productivity gains are likely to continue. This, of course, creates a grave threat both to the future of the expansion and to the efforts to bring our balance of payments into equilibrium. Meanwhile, the prices paid by consumers have been advancing month after month at a rate not matched since Chart II CONSUMER INTENTIONS TO BUY NEW AUTOMOBILES AND HOUSEHOLD DURABLES WITHIN SIX MONTHS Per eerst Per cent Note: Buying plans are expressed as the ratio of the number of families who indicate they intend to buy to the total num berof families in the survey. Source: United States Department of Commerce, Bureau of the Census. the inflationary bout of the midfifties. The October rise in the consumer price index was 0.4 per cent, bringing it to a level fully 3.7 per cent above a year ago. Prices of food in grocery stores declined slightly in October, al though less than seasonally, but the prices of all major nonfood categories increased. The prices of services, in particular, continued on their upward trend, and nonfood commodity prices rose once more. Apparel prices increased again, and the prices of new automobiles jumped in Octo ber, in large part because in September dealers had extended substantial discounts on 1966 models. Taking new safety features and other quality improvements into account, the prices of 1967 models are estimated to average about the same as the prices for 1966 model cars at the time of their introduction. B U S IN E S S IN V E S T M E N T Recent survey data suggest the probability of some slowdown during 1967 in the rate of growth of business spending on plant and equipment, but next year’s growth is nonetheless likely to be substantial. The Department of Commerce-Securities and Exchange 262 MONTHLY REVIEW, DECEMBER 1966 Commission survey of plant and equipment expenditures taken in November indicates that businesses are now ex pecting to spend $63% billion (seasonally adjusted annu al rate) in the first half of 1967, or some 8 per cent more than in the corresponding period of 1966 (see Chart III). While such a growth rate is appreciable, it nevertheless falls well short of the gains achieved in the preceding three years. The slightly downward-revised estimates for 1966, for instance, place this year’s advance over 1965 at fully I 6 V2 per cent. Businesses, moreover, apparently plan smaller increases in plant and equipment expenditures in the second quarter of 1967 than in the first. The slower growth anticipated for the first half of next year by the Commerce-SEC survey is not inconsistent with the earlier McGraw-Hill fall survey of preliminary plans for capital spending. The latter survey found that businesses are currently planning to spend $63.8 billion during the entire year 1967, or 5 per cent more than this year. The current plans of businessmen covered in this survey are, of course, subject to continuous revision as the new year unfolds. Throughout this expansion, such revisions have been considerable and in each year on the upside. There are, however, a number of forces now at work to slow down the capital spending boom and, if the plans for 1967 revealed by the McGraw-Hill fall survey are upgraded, it may consequently be by a lesser amount than in the past years of the expansion. Indeed, the rapid increase of corporate profits and cor porate cash flow has halted since the spring of this year. After-tax profits remained unchanged in the second quarter at $48.7 billion (seasonally adjusted annual rate) and then declined slightly to $48.3 billion in the third quarter, partly as a reflection of lower sales by automobile producers. Thus, even though corporate capital consumption allow ances continued to rise steadily while dividend payments advanced only slightly in the second quarter and not at all in the third, the increase in corporate cash flow slowed down, and the third-quarter gain— $0.2 billion to $66.3 billion— was extremely small. Although both profits and cash flow remain at historically high levels, their near stability, coupled with tight credit conditions, places a damper on the increase in the capital spending of many firms. At the same time, the very rapid rate of capital expansion of the last three years has helped relieve ca pacity pressures in a number of industries (although the overall capacity utilization rate, newly published in the Fed eral Reserve Bulletin, has remained unusually high through out 1966). In addition to these forces, the recent suspen- Chart III PLANT AND EQUIPMENT EXPENDITURES S e a so n ally adjusted annual rates Billions of dollars Billions of dollars Sources: United States Department of Commerce; Securities and Exchange Commission. sion until 1968 of the tax credit on new machinery and equipment and of accelerated depreciation on new business structures has also helped postpone investment plans. The McGraw-Hill survey indicates that plant and equipment spending plans for 1967 were cut back by as much as $1 Vi billion because of these fiscal measures, which thus reduced next year’s planned increases in capital outlays by fully one third. A survey of the capital appropriations of the 1,000 larg est manufacturing corporations recently conducted by the National Industrial Conference Board seems to confirm the expectation of a slower growth in capital spending in 1967. Net new capital appropriations, which had risen by 14 per cent in the second quarter of the year, declined by 16 per cent in the third quarter, but still remained very high. Even though actual capital expenditures by these large corporations rose to record levels in the third quar ter, they were nevertheless again lower than net new appro priations. The backlog of unspent authorizations conse quently increased, albeit by a relatively small amount. FEDERAL RESERVE BANK OF NEW YORK 263 The M oney and Bond M ark ets in N o vem ber The money market was relatively firm in the first half of November and short-term interest rates were under some upward pressure, despite an increase in overall net reserve availability in the banking system. In large part, the firmness reflected the fact that money center banks were moving into unusually deep basic reserve deficits, while the reserves that were available were widely dis persed. As the increased nationwide net reserve availability persisted and reserve positions of the money center banks improved in the second half of the month, somewhat easier conditions emerged in the money market and short term interest rates declined, with Treasury bill rates record ing especially sharp decreases. By late November, many market participants began to feel that the Federal Reserve was permitting some relaxation of the degree of pressure prevailing earlier in the fall. Rates on Treasury bills exhibited considerable move ment during November. After having declined sharply in October, bill rates moved higher in a generally cautious market atmosphere in early November. Demand fell off from the levels which had prevailed in October, and dealers made more aggressive offerings in the firm money market environment. Investment demand subsequently ex panded again, to which were added sizable purchases by the Federal Reserve toward the end of November. At the same time, money market conditions also became a little easier. In this environment, bill rates declined sharply, and at the month end three-month bills were bid at a rate of 5.16 per cent, down 29 basis points from the mid month peak and 6 basis points below the comparable rate at the end of October. In early November, an atmosphere of renewed caution emerged in the capital markets, largely in response to a sizable buildup in the calendar of scheduled offerings of corporate and tax-exempt bonds following the general respite of the preceding weeks. Some talk that the sale of Federal agency participation certificates might be resumed before the year-end, and a feeling for a time that a tax in crease had become somewhat less likely, also were de pressing influences. The Treasury executed a successful refunding operation at the very beginning of the month, although even then prices of outstanding Treasury issues were declining.1 Prices of long-term issues continued to decline in subsequent days, and investors exhibited a gen erally indifferent response to a number of corporate and tax-exempt offerings despite rising yields. The improve ment in the bill market around midmonth helped bring some price firming in the shorter term coupon sector. Subsequently, discussion of a possible change in the mix of fiscal and monetary policy and of the slightly easier conditions that had already emerged in the money market led to an improved atmosphere throughout the Treasury coupon market. Over the month as a whole, prices of short- and intermediate-term Treasury notes and bonds showed mixed changes, while the gains in prices of longer term issues at the end of the month offset only part of the large declines earlier in November. M O NEY M ARKET A N D BANK RESERVES As was the case in some other recent months, indicators of monetary conditions moved in somewhat divergent pat terns in November. Nationwide net borrowed reserves, on the one hand, averaged somewhat lower over the month than in the preceding several months, and member banks as a group also borrowed less, on average, from their Re serve Banks (see Table I). With the reserves that were available dispersed for a good part of the month outside the money centers, however, and with a fair amount of churning in the markets— partly related to Trea sury financing operations— short-term interest rates came under some upward pressure for a time. The Federal funds rate and dealer loan rates posted by the New York City banks moved in a higher range in the first half of November than at the end of October, and Treasury 1 For the terms and results of the financing operation, see this Review (November 1966), pages 252-53. 264 MONTHLY REVIEW, DECEMBER 1966 Table I Table H FACTORS TENDING TO INCREASE OR DECREASE MEMBER BANK RESERVES, NOVEMBER 1966 RESERVE POSITIONS OF MAJOR RESERVE CITY BANKS NOVEMBER 1966 In millions of dollars: (+) denotes increase, (—) decrease in excess reserves In millions of dollars Daily averages—week ended Factors affecting basic reserve positions Changes iin daily averages— Vveek ende d Nov. 2 Nov. 16 Nov. 9 Nov. Nov. 23 “ Market” factors + 19 + 124 + 173 + 53 — 20 + 349 — 192 — 273 — 533 — 6 + 61 + 48 + 262 + 120 — 481 — 548 + 154 — 41 — 17 — 950 — 141 + 405 — 61 — 842 Operating transactions Total “market" factors.. + 112 — 28 + 78 + 499 + 13 + + 14 — 5 — 677 — 88 — 20 — 74 — 15 — 50 — 59 — 156 — 29 — 309 — 173 — 409 + 167 + 315 — 501 — 601 33 Direct Federal Beserve credit transactions Open market instrument* Outright holdings: Government securities Bankers’ acceptances . . . . . Repurchase agreements: Government securities ----- + 243 1 + 323 — + — 18 4 + 182 + Member bank borrowings.......... Other loans, discounts, and Excess reserves* ........................ + 76 4- 1 2 — + 52 — — 16 — 2 — 306 + 212 — + 456 1 — 43 + 1 + 65 — 132 + 10 — 272 + 338 + 28 + 197 + 277 + 43 + 118 + — 1 — + 305 + 508 + + 132 + 99 + 1 2 Nov. 9 Nov. 16 Nov. 23 Nov. 30* Eight banks in New York City 30 Member bank reauired Federal Reserve float . . . . . . . Treasury op erational.......... • • Gold and foreign account----Currency outside banks* . . . . Other Federal Reserve accounts (net) t .................. Nov. 2 Net changes Factors Average of five weeks ended Nov. 30* — — 1 * — 697 + 772 + 892 + 171 — 382 + 271 + 291 Reserve excess or 8 22 deficiency ( - ) t .......... ......... 28 25 17 Less borrowings from Reserve Banks .................... 213 43 152 90 Less net interbank Federal funds purchases or sales(—-). 624 233 835 446 - 74 Gross purchases .............. 1,053 1,221 1,551 1,315 1,083 Gross sales ....................... 598 820 716 869 1,157 Equals net basic reserve surplus or deficit(—) ............ -2 6 8 - 820 - 965 - 418 9 Net loans to Government securities dealers ................ 501 255 441 326 227 20 100 413 1,245 832 - 492 350 Thirty-eight banks outside New York City Reserve excess or deficiency ( - ) f .................... 20 144 - 18 20 12 36 Less borrowings from Reserve Banks .................... 144 108 238 153 131 142 Less net interbank Federal funds purchases or sales(—).. 602 1,095 887 1,052 888 805 Gross purchases ........... . 1,603 2,088 1,943 2,247 1,953 1,967 Gross sales ....................... 1,001 994 1,056 1,195 1,148 1,079 Equals net basic reserve surplus or deficit(—) ............ - 7 2 5 -1,182 —1,113 -1,039 — 965 -1,005 Net loans to Government securities dealers ................ 367 320 239 123 142 238 Note: Because of rounding, figures do not necessarily add to totals. * Estimated reserve figures have not been adjusted for so-called “as of” debits and credits. These items are taken into account in final data, t Reserves held after all adjustments applicable to the reporting period less required reserves and carry-over reserve deficiencies. Table III Daily average levels AVERAGE ISSUING RATES* AT REGULAR TREASURY BILL AUCTIONS Member bank: In per cent Total reserves, including Required reserves* ...................... Excess reserves* .......................... Free reserves* ............................ . Nonborrowed reserves* .............. 23,380 23,101 279 594 — 315 22,786 23,855 22,977 S78 646 — 268 22,709 23,353 22,804 549 711 — 162 22,642 22,918 22,751 167 439 — 272 22,479 23,209 22,771 438 636 — 198 22,573 23,2435 22,8815 3625 6055 — 2435 22,6385 Weekly auction dates—November 1966 Maturities Three-month ........................ ..... Changes in Wednesday levels System Account holdings of Government securities maturing in: — 268 — + 785 — 268 — 272 __ + 950 +7,605 —6,457 +6,410 — —6,457 47 — 272 + 950 +1,148 — Note: Because of rounding, figures do not necessarily add to totals. * These figures are estimated, t Includes changes in Treasury currency and cash. t Includes assets denominated in foreign currencies. § Average for five weeks ended November 30. Nov. 14 Nov. 21 Nov. 28 5.432 5.459 5.252 5.202 5.705 5.695 5.501 5,337 Monthly auction dates—September-November 1966 + 785 Total ................ ................. Nov. 7 September 27 October 25 November 23 5.807 5.567 5.552 5.806 5.544 5.519 ♦ Interest rates on bills are quoted in terms of a 360-day year, with the dis counts 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. FEDERAL RESERVE BANK OF NEW YORK bill rates rose through midmonth. Subsequently, these rates dropped back toward, or even below, their late Oc tober levels. Throughout the month, demand for bank credit did not appear particularly strong. The major banks were able to replace a sizable proportion of their maturing negotiable certificates of deposit during November, but even so they suffered a net loss in outstanding certificates in the five weeks ended November 30 amounting to $429 million. Moreover, a good part of the certificates issued during No vember apparently continued to be of relatively short ma turity, in many cases running for only a month, thus building up December maturities to an estimated %5 V2 bil lion. The first half of November v/as marked by a shift in the distribution of reserves away from the banks in the central money market. The major banks in New York City, which had been in a fairly comfortable reserve posi tion in late October, experienced sizable basic reserve deficits in the following several weeks— and on a larger scale than in similar periods in other recent years. Their deficit reached nearly $1 billion in the week ended No vember 16 (see Table II). In contrast, the net reserve deficit of the banking system as a whole was declining during this period, with net borrowed reserves falling to an average of $162 million in the November 16 statement week. Some of the extra reserve availability in the banking system during this period remained lodged outside the money centers. Thus, excess reserves of “country” banks in the week ended November 16—the first week of a new biweekly settlement period— rose to an average of $490 million (preliminary). A large amount of reserves flowed back into the money centers, however, via the Federal funds market, where trading was mostly in a 53A to 6 per cent range. As a result, borrowings by the major money center banks from the Federal Reserve expanded only modestly. Government securities dealers were also able to locate a sizable amount of money at rates below those posted in New York City to finance their enlarged bill positions and make payment at midmonth for their allot ments of Treasury notes won in the November refunding. The rates posted by the New York City banks for new call loans to Government securities dealers were generally in a 6 V2 to 6% per cent range during the first half of the month, and as high as 6% per cent on several days around mid month. A somewhat more comfortable tone reemerged in the money market over the final two weeks of November. Net borrowed reserves were a bit higher on average in these two weeks than at their midmonth low, but reserves shifted 265 back toward the money center banks, and there was a plentiful supply of money in the Federal funds market at rates generally between 5 and 53A per cent. In the Novem ber 23 statement week, a large part of these funds came from country banks, which ran their excess reserves down to an average of $82 million (preliminary) in the second week of their reserve settlement period, following the con siderably higher level the week before. The ready avail ability of money enabled banks as a group to reduce their borrowings from the Federal Reserve to an average of $439 million in the November 23 statement period, the lowest level since February. A number of banks borrowed fairly heavily from their Reserve Banks over the final weekend of the month, but borrowings subsequently fell off again when easier conditions persisted in the money market. TH E G O V E R N M E N T SE C U R ITIE S M A R K E T In the Treasury bill market, where rates had declined progressively in October, a more cautious tone emerged during the early part of November. Investment demand for bills abated somewhat at the lower rate levels that had emerged, and dealers began to focus on the additions to the supply of bills that would be forthcoming when the Trea sury met the remainder of its fall cash needs. Although dealers were able to finance much of their enlarged posi tions in bills at fairly attractive rates outside New York City, the higher loan rates being posted by the New York City banks exerted a cautionary influence. Against this background, dealers became more aggressive in their of ferings of bills, and rates edged irregularly higher through midmonth when the latest three-month bill reached a rate of 5.45 per cent (bid), compared with 5.22 per cent at the end of October. (See the left-hand panel of the chart on page 266.) The first step in rounding out the Treasury’s fall financ ing needs came on November 10 with the announcement of an auction on November 17 (for payment on Novem ber 25) of a $1.2 billion “strip” of bills maturing in March, April, and May 1967. The offering represented a $400 million addition to each of three outstanding bill issues, with subscribers required to take equal amounts of the reopened maturities. Commercial banks were per mitted to make full payment for their purchases in the form of credits to Treasury Tax and Loan Accounts. This announcement was well received by market participants, who were encouraged by the smaller-than-expected size of the offering, the maturities chosen, and the Tax and Loan Account provisions of the operation. By the time the strip was auctioned on November 17, MONTHLY REVIEW, DECEMBER 1966 266 SELECTED INTEREST RATES MONEY MARKET RATES S e p te m b e r O cto b er Sep tem b er-N ovem ber 1966 N ovem ber S e p te m b e r BOND MARKET YIELDS O cto b er N ovem ber Note: Data are shown for busine ss d a y s only. * M O N EY MARKET RATES Q UO TED: D a ily ran ge of rates posted by major New Y o rk City banks point from underw riting syn d icate reo fferin g yield on a given issue to market yield on the on new call loans (in Fed eral funds) secured by United States G overnm ent securities (a point sam e issu e im m ediately after it has been rele ased from syndicate restrictions); d a ily ind icates the ab sen ce of an y ran ge); offering rates for directly p lace d finance com pany p ap er; the effective rate on Federal funds (the rate most representative of the transactions executed); a v e ra g e s of yield s on lo n g -term Governm ent securities (bonds due or c a lla b le in ten years o r more) and of G overnm ent securities due in three to five ye ars, computed on the b a sis of closing bid rates (quoted in terms of rate of discount) on newest o utstanding three- and six-month clo sin g bid prices; T hursday av e ra ge s of yield s on twenty seaso n ed twenty-ye a r tax-exem pt Treasury b ills . bonds (carrying M oody’s ratings of A a a , A a , A , and Baa). BO N D MARKET YIELD S Q UO TED: Y ie ld s on new A a a - an d A a-rated p ub lic utility bonds a re plotted around a line show ing d a ily a v e ra g e y ie ld s on seasoned A aa-ra ted co rp o rate bon d s (arrows a better atmosphere had reemerged in the bill market. Investment demand for outstanding bills improved, partly reflecting some reinvestment demand from holders of the Treasury coupon issues which matured on November 15. Bidding for the strip by commercial banks seeking the accompanying Tax and Loan Account deposits was quite aggressive, and an average issuing rate of 5.318 per cent was set. Following this auction, demand for outstanding bills strengthened further, scarcities started to develop, particularly in the short-term maturity area, and bill rates began moving downward. In this environment, there was fairly aggressive bidding in the regular monthly auction of new nine- and twelve-month bills on November 23. Average issuing rates on the new bills were set at 5.552 per cent and 5.519 per cent, respectively, 2 and 3 basis Sources: Fe d e ra l Reserve Bank of New Yo rk, Board of G overno rs of the Federal Reserve System, M oody's Investors Se rvice, and The W eekly Bond Buyer. points below average rates set a month earlier. Bill demand picked up even further in subsequent trad ing sessions, partly reflecting month-end reserve injections by the Federal Reserve. These purchases by the System, along with the somewhat more comfortable conditions prevailing in the money market, were increasingly inter preted as suggesting that the Federal Reserve had relaxed its restraint a bit. Dealers became very aggressive in their bidding in the final regular weekly auction of the month held on November 28. As a result, average issuing rates were set in the auction at 5.202 per cent on the threemonth issue and 5.337 per cent on the six-month bills, down 3 and 18 basis points from the average rates set at the final weekly auction in October (see Table III). These were the lowest auction rates since early September for the FEDERAL RESERVE BANK OF NEW YORK three-month bills and since mid-August for the six-month issue. Moreover, bill rates moved still lower over the final two days of the month as many participants, who had missed with their bids in the auction, subsequently sought to purchase bills in the secondary market. By the month end, three-month bills were down to a rate of 5.16 per cent (bid) and six-month bills were bid at 5.25 per cent. The late November spread between three- and six-month bills was the narrowest since midsummer. After the close of the market on November 30, the Treasury announced that it would auction $800 million of additional June tax anticipation bills on December 6 for payment on December 12. The Treasury indicated that it contemplates no further borrowing in the open market to raise new cash during the rest of calendar 1966. Initial reaction to the offering, which was slightly smaller than market participants had expected, was favorable. A cautious atmosphere developed in the market for Treasury notes and bonds— especially in the longer term sector— during the first half of November, prompted in large part by indications of a sizable buildup in prospec tive demands on the capital markets for the period ahead. Of particular concern to market participants were the steady stream of additions to the future corporate and taxexempt bond calendar and discussion of the possibility that the Federal National Mortgage Association might renew sales of participation certificates before the end of the year. In this environment, investor offerings expanded. There was outright selling of outstanding issues as well as some switching into the new 55/s per cent notes of 1968 and the 5% per cent notes of 1971, both of which had been offered in the Treasury’s November cash refinancing. Out right sales of the new notes by short-term holders were also in evidence. Although dealers tended to be willing to maintain their positions, enlarged by their allotments of the new Treasury notes, they were reluctant to add to their holdings except at declining prices. Prices of the new notes dropped below par during the period, and prices of outstanding issues fell by as much as 21%2 points through midmonth. (The right-hand panel of the chart illustrates the rise in yields which accompanied this decline in prices.) Paralleling the improvement in the Treasury bill sector, prices of short-term Treasury issues began moving upward around mid-November. An important influence was rein vestment demand from holders of the maturing November 15 issues for other short-term coupon securities. The im provement spread gradually to the intermediate-term sec tor of the market as participants focused on reports of further weakness in various economic indicators, includ ing automobile output and new housing starts. With con 267 tinued additions to the calendar of future capital market financing, however, the atmosphere in the longer term sector remained heavy until quite late in the month. By then, increasing discussion of a possible shift in the mix of fiscal and monetary policy prompted some investment and dealer demand, and prices of long-term issues rose by %2 to 2%2 of a point on the final three days of the month. Prices of Government agency obligations moved ir regularly in November, with prices of short-term issues narrowly mixed and longer term issues down somewhat on balance. New offerings which reached the market during the month totaled about $1.7 billion and were generally accorded good investor receptions at somewhat higher yields than had been offered in late October. Toward the close of the month, the Federal National Mortgage As sociation offered $550 million of debentures at a yield of 5.98 per cent, with $300 million of the issue floated in the open market and $250 million sold to Treasury trust accounts. Approximately $93 million of the proceeds was used to refund a maturing issue. The offering was sold out immediately in the better atmosphere prevailing in the bond markets generally, and on the final day of the month the debentures traded about fs 2 above the initial offering price. OTH ER SE C UR ITIES M A R K E T S The cautious atmosphere pervading the Treasury secur ities market in November to a great extent reflected the heavier tone that developed in the market for corporate and tax-exempt bonds during the month. In the wake of the price advances which had been recorded in both sec tors in October, investors became more resistant in early November to new and recent offerings carrying the some what lower prevailing yields. This investor apathy, in turn, generated caution on the part of dealers whose inventories of unsold issues were expanding. As the month progressed, large-scale additions were made to the calendar of cor porate and tax-exempt flotations scheduled for the months ahead, and market sentiment became even more cautious. In this atmosphere, a number of recent issues were re leased from syndicate price restrictions with substantial upward yield adjustments, and new issues generally were accorded mediocre receptions despite progressively higher reoffering yields. The markets steadied somewhat on the final days of the month and a better atmosphere emerged, though they did not share in the price improvement that was experienced in the Treasury sector. The sizable future calendar of corporate issues and the large amount of un sold tax-exempt bonds still on dealers’ shelves continued to exert a measure of restraint. The Blue List of advertised 268 MONTHLY REVIEW, DECEMBER 1966 dealer inventories of tax-exempt bonds totaled $512 mil lion at the month’s close, compared with the relatively low $300 million to $375 million range which had predomi nated in October. Over the month as a whole, the average yield on Moody’s seasoned Aaa-rated corporate bonds rose by 2 basis points to 5.37 per cent. The Weekly Bond Buyer’s series for twenty seasoned tax-exempt issues, carrying ratings ranging from Aaa to Baa, increased by 17 basis points to 4.00 per cent (see the right-hand panel of the chart). These indexes are, however, based on only a limited number of seasoned issues and do not necessarily reflect market movements fully, particularly in the case of new and recent issues. R ecent Econom ic Policy M e a su re s in Industrial Countries A bro ad The stem austerity program implemented by the United Kingdom in July was the major economic policy develop ment abroad during the last six months.1 At the same time, a number of other countries— including Canada, Ger many, the Netherlands, Belgium, Sweden, and Switzerland —have also maintained or intensified policies of restraint. It now appears that the restraining measures have cut into aggregate demand in these countries, and price pressures have moderated somewhat (see Chart I). On the other hand, economic policy in France, Italy, and Japan has continued to be expansionary. The remaining slack in their domestic economies has provided for strong— although recently diminishing— surpluses on external current ac count. Italy and Japan, however, have experienced rising capital outflows, partly in connection with the relative liquidity of their domestic money and capital markets. TH E U N IT E D K IN G D O M Early in the summer, when Britain was apparently mak ing little progress in solving its basic economic problems— excess demand, inadequate growth of productivity, price and wage inflation, and a stubborn payments deficit—the pound sterling was again subject to heavy selling pressure in the exchange markets. The British authorities responded in July with a far-reaching austerity program, which in 1 For a discussion of foreign economic policy measures in 1965 and early 1966, see “Recent Monetary and Financial Policies Abroad”, this Review (November 1965), pages 239-45, and “Re cent Economic Policy Measures in Industrial Countries Abroad”, ibid. (June 1966), pages 144-49. eluded measures (such as the price and wage standstill) seldom applied in a democratic society during peacetime. The program was essentially designed to reduce excessive domestic demand. It was hoped that the new measures, in combination with those already in force, would instill con fidence in the pound and provide a basis for longer term internal and external adjustments. These adjustments would come through redeployment of labor and an in crease of industrial efficiency and productivity. Recent evidence shows that the program has been effective: de mand pressures have been waning, and the pound has had a healthier look in the exchange markets. In the first half of 1966, gross domestic product in Britain rose by only 0.5 per cent over the second half of last year (on a seasonally adjusted basis). Industrial production had leveled off, as had private investment. At the same time, British industry was operating near full capacity, with the unemployment rate reaching a low of 1.2 per cent of the labor force. The continued rise in de mand (coming from both the household and public sec tors) was pushing up prices and spilling into imports at an increasing rate. In addition, some sizable wage settlements suggested that further spiraling of costs and prices would be forthcoming. The May budget,2 the major impact of which was to come in the fall, was a step toward relieving the underlying demand pressures in the British economy, but events in the exchange markets did not allow the time needed for these measures to become effective. The basic balance-of-payments deficit deepened in the 2 Described in this Review (June 1966), page 146. FEDERAL RESERVE BANK OF NEW YORK first half of 1966 on a seasonally adjusted basis. The cur rent account deteriorated, reflecting particularly the ac celerated rise in imports and a slight fall in exports in the half year as a whole, partly attributable to the seamen’s strike which started in May and lasted for seven weeks. Moreover, the uncertainties of the Rhodesian crisis, to gether with tight money conditions in overseas centers, were damaging to the pound in the exchange markets. In July, a new attack on sterling developed and the British government moved quickly to assemble an even more severe series of restraining measures, most of which were announced on July 20. The various measures put into ef- Chart I CONSUMER PRICES IN MAJOR COUNTRIES 1957-59=100 269 CHANGES IN SELECTED FOREIGN CENTRAL BANK DISCOUNT RATES, 1966 In per cent Country Date New rate Change 4-% Belgium ...................................... June 2 5V4 Canada ....................... ........... March 14 5V4 Germany .................................... May 27 5 +1 Netherlands ........................ ...... May 2 5 +V4 Sweden ..................................... June 10 6 Switzerland ............................ . July 6 3H +1 United Kingdom ....................... July 14 7 +1 feet since June can be divided into three groups: monetary and fiscal measures, a price and income standstill, and measures directly affecting the balance of payments. MONETARY AND FISCAL MEASURES. On July 12 it Was announced that the ceiling on bank advances— 105 per cent of the March 1965 level—would be continued until at least March 1967, and thereafter until further notice. Furthermore, it was announced that monetary policy would not be eased to offset any tightness resulting from the initial payments of the Selective Employment Tax in troduced in the May budget. (Such payments began in September. Refunds to those industries which qualify for them and premium payments to manufacturing industries will begin early next year.) Two days later the Bank of England raised its discount rate to 7 per cent (see table) from the 6 per cent in effect since June 1965. At the same time, the special deposits that the banks must hold with the central bank were doubled, thus mopping up some $280 million equivalent of liquidity. On July 20, instalment credit downpayments were raised and maximum repay ment periods shortened. This measure was expected to re duce consumer expenditures by about $450 million a year. On July 20, fiscal measures were also introduced, pro viding for increased taxes and cuts in planned expendi tures. The taxes payable on alcoholic beverages, gasoline, and a broad range of other consumer products were in creased by 10 per cent. Postal and telephone charges were raised as well. These measures are expected to yield some $475 million annually in additional revenue. On the expenditures side, it was announced that spending by the central and local governments and by nationalized indus tries in 1967-68 is to be reduced by some $420 million from planned levels. p r i c e a n d i n c o m e s t a n d s t il l . As set forth on July 20, and as detailed in a white paper on July 29, the freeze 270 MONTHLY REVIEW, DECEMBER 1966 The July 29 document stated also that the first half of 1967 will be regarded as a period of severe restraint, and a second white paper, issued on November 21, spelled out the new guidelines. From January 1 through June 30, 1967, wage increases will be allowed only for workers in firms having clearly demonstrated productivity gains, for workers who had obtained a definite commitment before July 20 for a pay raise during the second half of 1966, and for those in the lowest pay brackets. As regards prices, some increases will be permitted for firms which, in the opinion of the government, have made a genuine attempt, but have been unable, to absorb increases in costs. external m e a s u r e s . On July 20, the government pledged to reduce its overseas expenditure by at least $280 million in 1967; the basic allowance for travel out side the sterling area and that for cash gifts to nonsterlingarea residents were each slashed to $140 (from $700) per person per year; and the provisions for emigrants taking funds out of the United Kingdom were severely tightened. To restrict the outflow of short-term funds, the Bank of England on August 3, effective August 30, partially re duced the ceiling on foreign exchange positions that li censed dealers are permitted to carry. of prices, wages, and other forms of income was intended to be a voluntary program. It quickly became evident, however, that an entirely voluntary approach would not work, and the Prices and Incomes Act (passed in August) gave the government twelve-month standby authority, which it has already invoked, to issue orders to prevent specific price and wage increases and to roll back increases already made. Until the end of this year, the freeze applies generally to prices, rents, employment income for workers and management (in both the private and the public sec tors), fees of the self-employed, and company dividends. Since the July measures, there has been considerable evidence of dampening of pressures in the domestic economy. From mid-July to mid-November seasonally ad justed advances by London clearing banks to private bor rowers fell by about V /i per cent. The unemployment rate has risen, reaching 1.8 per cent of the labor force (sea sonally adjusted) in mid-November. Retail sales have been declining. Industrial production rose slightly in July and August, but plummeted in September to the level of June 1965 (see Chart II), and new orders have been de clining. British business has now substantially cut back plant and equipment spending plans for the next twelve months. However, to prevent too great a sag in invest ment, the British authorities in early December decided to increase investment allowances. Externally, despite some distortions in the aftermath of the seamen’s strike, British trade figures have begun to improve, with exports starting to rise faster than imports. Indeed, for the first time since last December, a trade surplus was registered in October (on a seasonally ad justed basis). The slowdown in imports may have been partly due to the deferral of purchases from abroad until the removal of the 10 per cent import surcharge on No vember 30. Nevertheless, the generally firmer tone of sterling in exchange markets in recent months is testimony to the improvement in confidence that has taken place. FEDERAL RESERVE BANK OF NEW YORK R E S T R A I N T IN O T H E R C O U N T R I E S A resurgence of inflationary pressures in Canada has prompted the Canadian authorities to apply further re straint through fiscal policy, while the tight posture of monetary policy has been maintained. After an unusually strong advance in the first quarter of 1966, GNP growth slowed considerably in the second quarter. From its peak in April, industrial production declined through July, and a rebound in August may well have been merely due to an earlier-than-usual start on new automobile production. New orders, residential construction, and automobile sales have also shown some softening. Recently, the current ac count deficit narrowed somewhat, primarily because ex ports rose more rapidly than imports. But even though the growth of aggregate demand has slowed, prices have con tinued to rise much more rapidly than last year. Labor negotiations have been particularly hard fought this year, and several wage settlements have been extremely large. Because of the persistence of this inflationary atmosphere, the Finance Minister announced in September a program calling for an immediate cutback in budget expenditures, which included the postponement until July 1968 of the Canadian medicare program and cuts in the defense bud get and in Federal subsidies for forestry, research, and education. Also additional taxes, the amount of which is still undecided, will reportedly be provided in an interim budget to be submitted to Parliament before the end of January 1967. In Germany, the restrictive measures taken in the first half of the year, including a discount rate increase in May, have begun to show some effect. Although economic ac tivity remains at a high level, some signs of easing have appeared. Industrial production has fluctuated below the peak recorded in April. The rise in consumer prices has moderated; the increase in the cost-of-living index from January to September was only 1.6 per cent, compared with a 3 per cent rise in the same period last year. Labor market pressures have also eased somewhat, and wage in creases appear to be smaller this year than last. A further slackening of domestic demand was indicated by the grow ing trade surplus in the first nine months of the year, as ex ports rose rapidly and import growth slowed somewhat. German monetary policy remained firmly on the side of restraint until early December, when a slight easing took place through a modest reduction in reserve requirements. The Netherlands has also continued the restraining mea sures put into effect earlier. These included a central bank discount rate increase, the trimming of budgetary expendi tures, and a ceiling on wage increases of 7 per cent under 1966 labor contracts. (Some unions were pressing for 271 wage increases up to 10 per cent.) These restraints had been prompted by the fact that the economy had become generally overheated, with demand pressures showing up in sharply rising prices and wages and in a clear deteriora tion of the trade balance. Some easing in price and la bor market pressures has now become evident. The budget for calendar 1967 to be presented to Parliament by the new Prime Minister, Professor Zijlstra, is reported to be considerably more restrained than the one which brought down the previous cabinet in October. The new budget will reportedly attempt to reduce the size of the deficit by speeding up by six months, to January 1, 1967, sales and turnover taxes already planned, and postponing for six months, to July 1, 1967, planned cuts in income taxes. Belgium adopted a series of stabilization measures last May and June, including a discount rate hike, quantitative limits on bank credit expansion, and direct price controls. Since then, conditions in the skilled labor market have eased slightly, though wage pressures are still gen erally strong. Industrial production has drifted below the previous high levels. The rise in consumer prices has been checked, partly as the result of the price freeze decreed in May, and wholesale prices have edged slightly downward. Partly in recognition of these developments, the govern ment on September 5 rescinded the price freeze, reintro ducing until the year-end a former system of requiring of ficial approval for any proposed price increase. The ordi nary budget proposed for the fiscal year beginning April 1, 1967 is to be in equilibrium after two consecutive years of deficit; however, a sizable increase in capital expenditures is expected to bring the overall deficit to about the same size as that estimated for the current fiscal year. The Swedish economy has continued to operate close to full capacity. Industrial production has been rising at a slower rate than last year. During the first half of this year, the consumer price level continued on an upward course and the current-account deficit widened. With domestic credit demand holding strong and with interest rates rising rapidly abroad, market rates in Sweden also moved up ward in the first six months of the year. Thus, for internal and external reasons, on June 10 Sweden’s central bank raised its discount rate to 6 per cent from 5 V2 per cent, the rate in effect since April 1965. Since early summer, price, unemployment, and import trends have indicated some easing of tensions in the economy. In the period under review, Switzerland maintained a policy of cautious restraint. In the first half of 1966 in ternal demand was on the rise, partly on the basis of ex panding central and cantonal government expenditures, and this was reflected in increased credit demand. Foreign 272 MONTHLY REVIEW, DECEMBER 1966 demand for funds was also strong and, with interest rates generally higher abroad, a capital outflow from Switzerland developed. Against this background, the Swiss National Bank increased its discount rate on July 6 by 1 per centage point to 3V2 per cent and raised its rate on ad vances on securities by Vz percentage point to 4 per cent (the first change in these rates since July 1964). Avail able data for the third quarter seem to indicate some easing of tensions in the economy, particularly in the investment and construction sectors, as well as some moderation in price and wage increases. There are also indications that the capital outflow has been reduced or reversed. In mea sures designed to liberalize capital movements, the Swiss Federal Council in June eased its regulations so that non residents could invest in domestic bond issues. In October, nonresidents were also allowed to purchase Swiss shares and investment trust certificates. to hold, buy, and sell these instruments. The market will be supported by the government-sponsored Credit Foncier, which will trade only in instruments of no less than tenyear maturity. In addition, the government proposed in November that minimum cash reserves for the banking system be substituted for the present liquidity coefficient (under which a proportion of a bank’s assets must be held in the form of Treasury obligations, medium-term paper, and certain other obligations). The French au thorities anticipate that the new system will prove more effective as a credit control mechanism. On the international side, the French authorities took several steps in November to give commercial banks further flexibility in their foreign operations. A 1963 ordinance forbidding them to pay interest on nonresident accounts denominated in francs was rescinded, and they were allowed to make longer term loans to nonresidents and to engage in forward exchange operations of longer maturity. At the same time, the authorities stated that they C O U N T R IE S W IT H PO L IC IE S OF R E LA T IV E EA SE would soon allow commercial banks to obtain central bank The French economy has continued to expand with no rediscount facilities on loans to finance French invest serious strains on wages and prices though with some re ments abroad. In November, it was announced also that duction of the balance-of-payments surplus. Under the international securities issues would be permitted in stimulus of growing domestic investment, and strong France, subject to the same Treasury control as domestic external demand in the first half of the year, industrial out issues. French borrowers, too, would be freer to raise put has risen to considerably higher levels than last year. funds abroad through securities issues denominated in for Even so, manpower reserves and growing productivity have eign currencies. The Italian economy has been gathering momentum kept labor costs within tolerable bounds. So far this year, prices, still subject to official controls, have risen at the under the stimulus of domestic and foreign demand, and same moderate annual rate as last year (somewhat less the expansion has spread to the formerly lagging capital than 3 per cent). In recent months France’s trade account equipment and construction sectors. Industrial production has deteriorated as imports have risen faster than exports, is strongly on the rise and unemployment has been de and for the year so far the overall balance-of-payments clining. However, with ample available resources, wage surplus, though sizable, is smaller than last year’s. pressures have been very moderate. From January to Sep Against this background, French economic policy has tember, consumer prices rose by less than 1 per cent. The remained cautiously expansionary. Although French in trade deficit has recently widened as imports have begun terest rates have been rising in response to rising rates to rise more rapidly than exports. But, with a strong elsewhere and increasing domestic demand, short-term tourist account and increased worker remittances from rates have remained lower than in many European money abroad, the current-account surplus during the first nine markets. In order to hold the line on prices by more months of this year was about the same as that of the flexible means than direct controls, the Finance Minister same period in 1965. Within this context of a fairly bal has been empowered to enlarge import quotas for goods anced expansion, monetary policy has remained relatively easy. Banks still have ample liquidity, some of which they subject to very strong price pressures. During the period under review, significant institutional are placing in the Euro-dollar market. Longer term capital reforms were made in France or were announced for outflows have also developed in substantial volume, re implementation in the near future. Further steps were flecting the rise of interest rates abroad as against the taken to develop a mortgage bond market. Several types fairly steady rates in Italy. In October, the Italian Trea of banking institutions are now authorized to issue mar sury was able to avail itself of domestic liquidity by float ketable instruments against the mortgages they hold, and ing a record $1.1 billion equivalent issue of nine-year banks as well as insurance companies, pension funds, bonds— $480 million of which was to refund maturing debt and other nonbanking financial intermediaries are allowed —which was eagerly subscribed by the public and the com FEDERAL RESERVE BANK OF NEW YORK mercial banks. However, the destruction resulting from the almost unprecedented November floods may slow down the expansion. To meet the most pressing needs of relief, the government has ordered for one year an across-the-board 10 per cent increase in income and other direct taxes, a similar increase in gasoline taxes, and a reimposition (next January 1) of the requirement that certain employers pay social security contributions, which have been paid by the government since the 1963-64 recession. In Japan, policy has remained on the side of cautious ease. Largely buoyed by booming exports, industrial pro duction has been rising almost steadily since October 1965, when the downswing of the earlier part of 1965 was reversed. Industrial production during January-September 1966 was more than 10 per cent above that of the compar 273 able period last year. Although consumer prices have not risen as steeply as last year, wholesale prices have recently begun climbing more rapidly. Japanese interest rates, which have moved down from previous high levels, are now more roughly in line with those of other countries, and the usual inflow of capital has been reversed by a large margin. To reduce short-term outflows without dampening domestic growth, the Japanese authorities have acted to prevent short-term rates from falling further while allowing long term rates to continue on a downward trend. In July, all interest rate ceilings were removed on commercial banks’ Euro-dollar borrowing. In August, in an effort to combat developing price pressures without tightening monetary policy, the government expanded import quotas in some sectors and restricted exports of some metals. Federal R eserve Accounts, M oney Supply, and Bank Credit Total loans and investments at all commercial banks continued to expand during the twelve months ended in September 1966, as they had over the previous four and one-half years of economic advance. However, largely as a result of the Federal Reserve’s policy of restraint, the rate of growth in bank credit over the year declined to 7.5 per cent from the 9.4 per cent rate attained during the preceding year.1 The slackening in the rate of growth was particularly noticeable toward the end of the period. In fact, during September and October, bank credit actually declined. The charts on page 275 are designed to highlight some of the key magnitudes and relationships involved in the 1 Th& figures used in this article are based on data reported in Federal Reserve releases. Thus, they reflect the changed Federal Reserve regulations concerning hypothecated deposits. Beginning with the data for June 1966, about $1.1 billion of “deposits ac cumulated for payment of personal loans” was excluded from time deposits and deducted from loans at all commercial banks. If $1.1 billion is added back into the change in bank credit, the rate of growth is about 7.9 per cent. For a review of the changes in Federal Reserve accounts, the money supply, and bank credit in earlier years, see this Review (December 1964), pages 250-54, and (De cember 1965), pages 267-70. The articles in this series are not strictly comparable because of data revisions and changes in Fed eral Reserve regulations and reporting requirements. growth of commercial bank assets and liabilities between September 1965 and September 1966. The financial inter relations to be discussed are, of course, highly complex. All magnitudes shown in the charts are determined mu tually and simultaneously through additions to member bank reserves by the Federal Reserve and the demands for, and supplies of, funds generated by the banking sys tem and the nonbank public. Where one breaks into this interrelated system to describe what has actually hap pened during a particular period is largely a matter of choice. The approach taken here is to begin with the cre ation of bank reserves by Federal Reserve operations and then to work “forward” through the banking system to the nonbank public. In retracing this analysis with the aid of charts, it should be kept in mind that a numerical accounting of what actually happened should not be in terpreted as a causal chain of past events or a mechanical prediction of future events under similar circumstances. Eventual reactions to the creation of additional bank re serves by the Federal Reserve System depend—most broadly— on the demand for additional bank liquidity, the public’s demand for credit, and the respective costs of borrowing from banks and from other sources. On the liabilities side, the relative preference of the public for cur rency, demand deposits, and time deposits, as well as a 274 MONTHLY REVIEW, DECEMBER 1966 number of technical factors, has a bearing on the final numerical outcome. Nevertheless, ex post facto analysis of the type presented here can be illuminating, provided its limitations are kept in mind. SO URCES A N D U SE S OF B A N K RESERVES The gross increase in reserves made available by the Federal Reserve during the twelve-month period ended in September 1966 amounted to slightly less than $4.2 bil lion, as can be seen by adding the figures in the left-hand column of Chart I.2 As usual, the largest portion (87 per cent) was provided through net System purchases of United States Government securities and bankers’ accep tances. The remainder came about as a result of member bank borrowings and changes in other Federal Reserve ac counts. However, as has been true in the past, not all the additional reserves were available to support an expansion in member bank deposits. Indeed, more than half ($2.1 billion) of the increase in Federal Reserve credit was ab sorbed by the continuing growth in the public’s demand for currency. In addition, another sizable portion was needed to offset the loss in reserves associated with the $600 million outflow of gold in partial settlement of the nation’s balance-of-payments deficit during the period. Finally, the Federal Reserve’s increases in member bank reserve requirements against time deposits in excess of $5 million also served to absorb reserves. As a result of these increases, member bank required reserves at the end of the period were about $880 million greater than they other wise would have been.3 Thus, as can be computed from the data in Chart I, only $550 million of the increase in Federal Reserve credit was used as the basis for a multiple expansion of bank deposits and credit. At the same time, member banks more fully utilized the reserves that they held, as indicated 2 The data in the charts have been compiled from several re leases containing information that is not wholly consistent. Thus, some of the underlying data are available on a daily average basis, while other items can be obtained only on a last-Wednesday-ofthe-month basis. The figures presented have been derived from balance sheets as close as possible to the two weeks ended on Sep tember 29, 1965 and the two weeks ended on September 28, 1966. 3 This represents the difference between the actual required re serves against time deposits in excess of $5 million under the pres ent 6 per cent ratio and the amount of reserves that would have been required against the same volume of deposits at a 4 per cent ratio. The change in the reserve requirement from 4 per cent to 6 per cent was accomplished in two steps. During July, the ratio was increased from 4 per cent to 5 per cent, and it was increased once again from 5 per cent to 6 per cent in September. by the fact that excess reserves declined by $70 million over the period.4 In terms of actual developments during the period, ap proximately $920 million in reserves was required to support the expansion in private demand and time de posits as well as in net interbank deposits at member banks. (This figure does not reflect the previously men tioned change in the reserve requirements against time deposits.) Total reserves required to support additional deposits rose by a somewhat smaller amount, however, as a sharp drop in United States Government deposits at member banks— $1,890 million of the $1,920 million total drop for all commercial banks shown in Column 4 of Chart III—released some $300 million of reserves (Chart I, column 5 ). It is also worth noting that, although reserve requirements against demand deposits are substan tially higher than those against time deposits, a larger amount of the additional reserves was used to “back” the increase in time deposits. T H E G R O W T H IN T H E M O N E Y S U P P L Y The $380 million increase in reserves required against private demand deposits during the period under consid eration was associated with a rise of about $2.8 billion in such deposits at member banks (see Chart II, columns 1 and 2). The ratio of the increase in reserves to the in crease in demand deposits of 13.7 per cent represents a weighted average of the demand deposit reserve require ment percentages at reserve city and “country” banks. This figure is less than the simple average of the two re serve requirement percentages, since the dollar increase in demand deposits at country banks was greater than at reserve city banks. This represents a continuation of the trend that existed over the four and one-half years ended in September 1965. In addition to the $2.8 billion increase in private de mand deposits at member banks, there was an expansion of some $1.3 billion in such deposits at nonmember banks.5 Adding the growth in total private demand deposits to the 4 Included in these figures are reserves released by the changed ruling on hypothecated deposits discussed in footnote 1. The re serves freed by this change amounted to about $30 million. 5 Since nonmember banks do not maintain their reserves at Fed eral Reserve Banks, the figures for required reserves shown in the charts do not include these reserves. The banks do, however, have to comply with state-imposed reserve requirements, and part of the reserves supplied by the Federal Reserve System in effect served to support expansion of nonmember bank deposits and credit. FEDERAL RESERVE BANK OF NEW YORK 275 C h a rt li C h a r t! CHANGES IN FEDERAL RESERVE ACCOUNTS CHANGE IN THE MONEY SUPPLY S e p t e m b e r 1 9 6 5 -S e p te m b e r 1966 S e p t e m b e r 19 6 5 -S e p te m b e r 1966 M illio n s of d o lla rs M illio n s of d o lla rs R E Q U IR E D R ESER V E C O M P O N E N T S A g a in s t ad d itio n a l net --------------^ ^ interbank deposits Excess reserves R equired reserves -7 0 Reserves su p p lied through other factors (net) 1,430 —------ 40 -300 . 1,500 380 A ga in st United States Governm ent deposits 500 X Currency held by the nonbank public 3,630 140 ..A g a in s t ad dition al private dem and deposits Cu rrency held by 2,140 the nonbank pub lic ___.A g a in st additionaltime deposits ___ _ A bsorbed by increases in the reserve requirem ents for time deposits in excess of $5 million Total member bank reserves Federal Reserve's h o ldings of United States Governm ent securities and bankers' acce ptance s MONEY SUPPLY COMPONENTS Money supply Nonm em ber b ank dem and deposits rr 2,140 Foreign deposits at the Federal Reserve 6,360 1,310 M ember bank dem and deposits Required reserves a ga in st member b ank private dem and deposits j G o ld I outflow I 600 I 2,770 380 C h a rt III C h a rt IV CHANGES IN BANK ASSETS AND LIABILITIES S e p t e m b e r 1 9 6 5 -S e p te m b e r 1966 CHANGE IN COMMERCIAL BANK CREDIT BY COMPONENTS M illio n s of d o lla r s S e p t e m b e r 1 9 6 5 -S e p te m b e r 1966 B illio n s of d o lla rs or p e r cent 1,620 ! r A il other assets and adjustm ents 2,380 A ll other lia b ilitie s and adjustm ents Com position of change in total b an k credit 1,430 Member b ank reserves 9% 2,650 Borrow ings Nonm em ber b an k credit Bank cap ital 4,550 Total ban k credit Nonm em ber b ank savin gs and time deposits 3,280 Member bank credit 21.4 53% M ember bank sa v in g s and time depo sits I 16,860 Business loans Total loans 19.4 Business loans 12,180 Loans other than business loans United States G overnm ent dem and deposits (Other) securities Dem and deposits in money supply Nonm em ber bank 1,310 - United States Governm ents 1,920 L_ Member bank 2,770 1 2 3 4 5 6 Note: Minor items are not shown sep a rate ly in order to sim plify the presentation. Sources: Board of Governors of the Fe d era l R eserve System ; Fed eral Reserve Bank of N ew York. 38% 276 MONTHLY REVIEW, DECEMBER 1966 increase in foreign demand deposits at the Federal Reserve and to the very large increase in currency holdings of the nonbank public yields a gain in the money supply of nearly $6.4 billion (see Chart II, column 6 ).6 This represents a 3.9 per cent rise in the money supply, only a little smaller than the rate of gain in recent years. The more rapid rise in the currency component reflects, as it has over the past several years, the fact that currency has been gaining again in relative importance in the money supply after the fairly steady downtrend following World War II. While currency represented slightly less than 22 per cent of the total money stock in September 1965, this component ac counted for one third of the increase in the stock during the period. Another shift in the relative importance of the various components of the money supply occurred within the deposit category. In early 1961, at the begin ning of the current business expansion, only about 18 per cent of the total demand deposits included in the money supply was held at nonmember banks. Over the first four and one-half years of expansion, however, non member banks accounted for nearly 39 per cent of the gain in total private demand deposits. During the past year their contribution to the increase has been somewhat smaller, but it was still much larger than the share of de posits attributable to nonmember banks in 1961. The major counterparts of this growth in bank credit and other assets are shown in the staggered columns 3 through 6 of Chart III. First, there was the $4.1 billion increase in private demand deposits that has already been shown in Chart II as a component of the rise in the money supply. Total demand deposits at commercial banks went up by a substantially smaller amount over the period, how ever, as the decline in United States Government deposits of $1.9 billion offset some of the gain in the private ac counts. Commercial bank time and savings deposits, how ever, were considerably more important in the growth of the banking system. Over the year ended in September 1966, time and sav ings deposits at all commercial banks rose by more than $15.4 billion, or by some 11 per cent. While this rate of growth is high by most standards, it is substantially less than the 16 per cent rate achieved last year.7 The reduc tion in the growth of these deposits during the present period can be attributed largely to the increase in interest rates on marketable securities relative to the maximum rates payable on time and savings deposits. Another factor which may have had some effect near the end of the period was the increase by the Federal Reserve in member bank reserve requirements against time deposits in excess of $5 million. The effect of this action was to increase the cost of time deposits to banks, and perhaps to dampen some of the enthusiasm for acquiring funds C O M M E R C IA L B A N K A SS E T S A N D C O U N T E R PA R T S through such deposits. IN B A N K L I A B I L I T I E S A N D C A P I T A L The growth in bank capital and bank borrowings rep An essential characteristic of a fractional reserve re resent two other important counterparts to the increase in quirement is to permit a multiple expansion of bank credit bank credit (see Chart III, column 6). Although the sum and deposits on the basis of given reserve increases. Thus, of the increases in these items was about the same as in even though member bank reserves available to support the prior twelve-month period, the relative importance of new deposits went up by only $620 million during the each was practically reversed. Thus, the increase in bank period, this rise— combined with the large increase in capital of $1.8 billion was $700 million less than the in bank capital and nondeposit liabilities (discussed below) crease in the preceding year. On the other hand, the in — was sufficient to support an increase in member bank crease in bank borrowings of $2.7 billion exceeded the credit of nearly $16.9 billion (see Chart III). In addition, previous year’s figure by about $1 billion. The nature of nonmember banks increased their loans and investments bank borrowings has also changed within the past two by almost $4.6 billion. The 80 per cent contribution of years. During the twelve-month period ended in Septem member banks to the total increase in bank credit during ber 1965, the increase in bank borrowings consisted the period is approximately the same as it was during mainly of greater interbank indebtedness, more member bank borrowings from the Federal Reserve, and the issue earlier stages of the current upswing in business activity. of short-term promissory notes by banks. The present 6 The money supply is technically defined as including: (a) de mand deposits at all commercial banks, other than deposits due 7 The estimates of the growth in bank credit and time deposits to domestic commercial banks and the United States Government, less cash items in the process of collection and Federal Reserve reported here exclude the $1.1 billion resulting from the change float; (b) foreign official balances at Federal Reserve Banks; and in the regulation concerning hypothecated deposits. If this amount (c) currency outside the Treasury, the Federal Reserve System, is added to the growth in time deposits, the resulting increase is $16.6 billion, or 11.7 per cent. and the vaults of all commercial banks. FEDERAL RESERVE BANK OF NEW YORK period, however, has seen a large increase in repurchase agreements between banks and nonfinancial corporations and the elimination of short-term promissory notes. The latter is the result of a Federal Reserve ruling which classified such borrowings as deposits. Consequently, re serves are required against these liabilities, and they are subject to the regulations governing the payment of in terest on deposits. In addition, there has been a substantial increase in the liabilities of United States banks to their own foreign branches. These liabilities are included in the “all other liabilities and adjustments” category and account for approximately three fourths of the growth in the cate gory during the year. B A N K C R E D IT The major components of the change in bank credit over the year ended in September are presented in Chart IV. Most notable among the movements in the com ponents has been the growth of business loans. Despite the slower rate of growth in total bank credit, the rise of $11.3 billion in business loans during the year was $500 277 million more than during the previous twelve-month pe riod. As a result, this single loan category accounted for nearly 53 per cent of the expansion of total bank credit from September 1965 to September 1966, compared with 44 per cent during the previous year. There was also a reduction in the rate at which banks liquidated United States Government securities as their holdings of these securities approached the level required as collateral against Government deposits. The net decline in these securities of $2.6 billion was little more than half of the decline over the preceding twelve months. Evaluation of the other components of bank credit is made difficult because of the changed Federal Reserve rul ing concerning hypothecated deposits (see footnote 1) and the reclassification of certain financial assets from the “other loans” category to the “other securities” category. To gether these reporting changes produce an understatement of the reported increase in other loans of somewhere in the neighborhood of $2 billion and an overstatement of the rise in other securities of about $1 billion. Even if al lowance is made for these two changes, the growth in these components remains smaller than last year. MONTHLY REVIEW, DECEMBER 1966 Publications of the Federal R eserve Bank of N ew Y ork The following is a selected list of publications available from the Public Information Department, Federal Reserve Bank of New York, New York, N. Y. 10045. Copies of charge publications are avail able at half price to educational institutions, unless otherwise noted. 1. m o n e y : m a s t e r o r s e r v a n t ? (1966) by Thomas O. Waage. Revised edition. A 48-page booklet explaining the role of money and banking in our economy. Includes a description of our mone tary system, tells how money is created, and relates how the Federal Reserve System influences the cost and availability of credit. No charge in limited quantities. 2. m o n e y , b a n k i n g , a n d c r e d i t i n e a s t e r n e u r o p e (1966) by George Garvy. A 167-page booklet which examines the role of banking and credit policy in seven communist countries and focuses on developments arising from the recent changes in economic policy. $1.25 per copy (65 cents per copy to educational institutions). 3. k e e p i n g o u r m o n e y h e a l t h y (1966). Revised edition. A 16-page illustrated primer on how the Federal Reserve System works to promote price stability, full employment, and economic growth. 4. m o n e y a n d e c o n o m i c b a l a n c e (1965). Revised edition. A 27-page teacher’s supplement to Keeping Our Money Healthy that provides a fuller explanation of how the economy operates and how the Federal Reserve works. 5. t h e n e w y o r k f o r e i g n e x c h a n g e m a r k e t (1965) by Alan R. Holmes and Francis H. Schott. A 64-page booklet about the New York market for foreign exchange, and the large exchange opera tions in that market. 50 cents per copy. 6. e s s a y s i n m o n e y a n d c r e d i t (1964). A 76-page booklet containing eleven essays on tech nical problems of monetary policy, Treasury debt and cash operations, and the Federal Reserve’s daily work. It also contains several analyses of money and securities market instruments and of banking prob lems and policies. 40 cents per copy. 7. o p e n m a r k e t o p e r a t i o n s (1963) by Paul Meek. A 43-page booklet describing for the inter ested layman how open market operations in United States Government securities are used to cope with monetary stresses and promote a healthy economy. No charge in limited quantities. 8. t h e m o n e y s i d e o f “ t h e s t r e e t ” (1959) by Carl H. Madden. A 104-page booklet giving a layman’s account of the workings of the New York money market and seeking to convey an under standing of the functions and usefulness of the short-term wholesale money market and of its role in the operations of the Federal Reserve. 70 cents per copy. Subscriptions to the m o n t h l y r e v i e w are available to the public without charge. Additional copies of any issue may be obtained from the Public Information Department, Federal Reserve Bank of New York, New York, N. Y. 10045.
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