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246 MONTHLY REVIEW, DECEMBER 1969 T h e B u sin e ss S i t u a t io n The business statistics indicate that some further slowing of the econom y’s rate of growth is under way, but on a longer view expansionary forces seem still domi nant. The consumer appears to have become cautious about the econom ic outlook: retail buying has been sluggish for some time now, and recent surveys of spending plans have found further evidence of consumer restraint. Inventories at retail have risen relative to sales, and production of consumer goods— particularly of automobiles— appears to be in the process of adjustment. Partly for this reason, in dustrial production has declined moderately over the past three months, but strikes have also played a part in reduc ing output. A t the same time, home-building activity re mains under pressure from tight conditions in the mortgage market, although the readings 011 new housing starts over the past few months suggest that the rate of decline may have slowed as demand for new homes and apartments has becom e even more intense. On the stronger side, busi nessmen’s plant and equipment spending plans indicate that capital outlays are likely to continue rising at a fast clip— a finding that is supported both by new survey evi dence and the recent strong performance of new orders for durable goods. Moreover, looking further ahead, the ex piration next year of the surtax on personal income and corporate profits will add stimulus to the economy, as will the prospective large increase in social security benefits. Meanwhile, price and cost pressures are as severe as ever, and expectations of continuing inflation appear to remain an overriding element in much econom ic deci sion making, including collective wage bargaining. P R O D U C T IO N A N D C O N S T R U C T IO N The volume of industrial output declined in October for the third consecutive month. The Federal Reserve Board’s index of industrial production fell 0.4 percent in October to a seasonally adjusted level of 173.3 percent of the 1957-59 average (see chart). In the decade of the sixties, output has fallen three months in a row only twice— during the mini-recession in 1967 and in the 1960 recession. The August-October decline amounted to only 0.7 percent, however, much milder than the downward movement in either 1960 or 1967. Furthermore, the recent drop has been partially the result of strikes. Consumer goods production in October was off V2 percent from September and more than IV2 percent from July. Scattered strikes in the automobile industry contrib uted to this decline, but auto production schedules for the fourth quarter— originally set below 1968 actual levels— have been cut back further. On a unit basis, output of new cars fell from a seasonally adjusted annual rate of 8.7 mil lion in September to 8.4 million in October, and in N ovem ber were off an additional IOV2 percent to 7.5 million units. Production of other consumer goods also eased in October. After rising in September, output of business equipment remained strong despite the General Electric strike. The overall materials index was about unchanged, and the iron and steel component was also steady at the September level. Following a very strong first half, iron and steel output has moved down from its June peak. In dustry spokesmen, however, continue to predict strength through the end of the year, and data on steel ingot pro duction indicate that output rose slightly in November. Total construction activity continues at a high level, with private nonresidential building providing much of the strength. Residential construction spending moved higher in September and October, after declining steadily in the preceding four months. However, home building remains under pressure from very tight mortgage market condi tions. During the third quarter, private nonfarm housing starts averaged 1.4 million units at an annual rate, down from 1.7 million in the first quarter, and the starts rate fell further in October to 1.3 million units. Moreover, steady declines in the number of building permits issued by local authorities suggest continued weakness in home building over the near term. Permits volume has trended FEDERAL RESERVE BANK OF NEW YORK down each month since April, and in October the number of permits issued was the lowest since early 1967. I N V E N T O R I E S , O R D E R S , A N D C A P IT A L , S P E N D I N G Total business inventories1 rose $1.0 billion in Septem ber from an upward revised August level, with retail and manufacturing inventories each increasing $48 0 million. 1T h e D e p a r tm e n t of C om m e rc e has revised u p w a rd its thirdq u a r te r estimate of gross n ational p rod uct ( G N P ) by $0.5 bil lion to $942.8 billion. T he estimate fo r inventory accum ulation was raised fr o m $9.4 billion to $10.7 billion, and consum ption ex penditures were revised do w n w ard fro m $581.6 billion to $579.8 billion. 247 For the retail sector, this was the fourth successive month of large accumulation averaging $445 million per month. Both durable and nondurable retail stores built up their stocks in September, with virtually all the increase at durables stores due to higher inventories held by auto dealers. Since retail sales have been sluggish overall, the large in ventory accumulation recently has been reflected in an appreciably higher inventory-sales ratio than was the case earlier in the year. At the manufacturing level, on the other hand, a substantial jump in shipments in September, particularly of durable goods, caused the inventory-sales ratio to fall despite the rapid increase of inventories. As a result, the ratio for all businesses was about unchanged in September and remained well within the range prevailing over the past year or two. The October data for manu facturing indicate that inventory building in the sector was again very large, but shipments also gained and the inventory-sales ratio rose only slightly. N ew orders received by manufacturers of durable goods continued strong through October. During the third quarter, incoming orders averaged $31.2 billion per month, up $1.2 billion from the April-June period. In September, volume advanced sharply to a record $32.1 billion as machinery and equipment buying surged. As was to be expected, new durables orders dropped a bit in October following the strong September performance, but at $31.8 billion they remained above the third-quarter average. Business capital spending plans for 1970 point to further substantial growth, but also suggest that price inflation may absorb much of the planned increase in outlays. The fall survey by McGraw-Hill found that businessmen plan to spend 8 percent more on plant and equipment in 1970 than in 1969. Furthermore, a very recent survey conducted by the Department of Commerce and the Securities and Ex change Commission presents an even stronger picture. The Commerce-SEC study found that businessmen plan a 13 Vi percent spending increase (at an annual rate) between the fourth quarter of this year and the second quarter of 1970. In the McGraw-Hill survey, however, businessmen re ported that they expect prices of plant and equipment to rise 7 percent in 1970, which implies that purchases in real terms would be up considerably less than dollar spending. It should be noted in assessing the plant and equipment outlook that plans for next year are still some what indefinite for many businesses, and that substantial revision could occur before orders are placed and con struction contracts signed. However, the several surveys conducted consecutively over the past few months clearly indicate that businessmen have been upping their estimates of 1970 spending as the year draws closer. Growing fears of sharply higher capital goods prices, giving rise to a “buy MONTHLY REVIEW, DECEMBER 1969 248 now” or “build now” attitude, may have played a role in this upgrading. On the other hand, if internal funds for financing capital programs continue under pressure from declining profits, the extremely tight conditions now prevailing in the fi nancial markets may take on a more critical role in influ encing capital spending decisions. In this connection, after-tax corporate profits turned in a second consecutive decline in the third quarter to a seasonally adjusted annual rate of $50.0 billion, the lowest level in a year. E M P L O Y M E N T , P E R S O N A L IN C O M E A N D R ETA IL S A L E S In the labor market, signs of a slight easing have remained numerous, even though the unemployment rate fell back sharply in November after several months of increase. From June to November, nonagricultural pay roll employment rose only 64.,000 per month, compared with the exceptionally large average gains of 2 3 8 ,000 in the first half of the year. While the services and trade sec tors registered sizable increases in jobs, construction payrolls in November remained at June levels and manu facturing payrolls were below June levels. Sluggishness in manufacturing was further evidenced in October and November by a large seasonally adjusted decline of 0.3 hour in the average workweek of factory workers. Data from the household survey of employment and the labor force also point to some letup in the very tight conditions in the labor market that have prevailed over the last year. The labor force increased by fully 1 million persons from June to October on a seasonally adjusted basis, a rate about half again faster than that of the first half of the year. During the same period there was a 0.4 million in crease in the number of unemployed, bringing the total count of unemployed to 3.2 million. Thus, in October, 3.9 percent of the labor force was unemployed, down 0.1 percentage point from September but still significantly higher than the 3.4 percent averaged in the first half of this year. The sharp November decline in the aggregate rate to 3 V percent resulted largely from a fall in the labor 2 force, as employment increased only moderately. The movement was centered in the adult women category, where the unemployment rate fell 0.5 percentage point to 3.5 percent, equaling the low for the year. The rate for adult men also dropped to 2.2 percent from 2.4 percent but still far exceeded the previous low of 1.8 percent set last December. Personal income moved up slowly in October, increasing by only $2.4 billion, the smallest monthly rise in over a year. Despite an upward revision in the September esti mate, the September and October gains in wages and salaries were substantially smaller than those earlier this year. Had it not been for the midyear Federal pay increase, the July change would also have been quite modest. Octo ber’s small $1.6 billion rise in wages and salaries reflect ed, in part, the decline in the average workweek in manu facturing. Consumer demand continues to show little buoyancy. In October, according to the revised estimate, retail sales increased to a new record level of $29.6 billion but were still only about V percent above the previous peak reached 2 last April. Moreover, the AV2 percent dollar gain in re tail sales since last December has probably been associated with unchanged volume in real terms, since consumer goods prices have risen at about the same pace. Weak ness is particularly apparent in the durables sales figures, which are below the levels of early this year. Sales of domestically produced new automobiles rose to an annual rate of 9 million units in September, but then fell back in October and November to less than 8 V million units, 2 in line with the slow pace of the months prior to Septem ber. Sales of other consumer durables have edged down further since July, when there was a large drop. W AGES A N D PR IC E S The price situation remains critical. Steep advances continue at wholesale and consumer levels, and wage pressures appear to be intensifying at a time when pro ductivity growth is lagging. During the third quarter, labor compensation per manhour in manufacturing rose at a seasonally adjusted an nual rate of 6.3 percent, well in excess of the IV2 percent annual rate of productivity increase in the quarter. These widely divergent trends resulted in a 5 percent growth in the labor cost per unit of output, on an annual rate basis, compared with 3 percent in the second quarter. Moreover, negotiated wage settlements point to mounting cost pres sures. In the first nine months of 1969 the median nego tiated settlement provided for a 7.4 percent per year gain in wages and fringe benefits over the life of the contract. This is well above the median increase of 6.0 percent per year negotiated in 1968 and more than twice as great as the median provided by 1965 contracts. N ego tiated settlements were larger in nonmanufacturing than in manufacturing, with construction workers receiving par ticularly sizable boosts in wages. The labor contracts of recent years typically have provided for bigger pay raises in the first year of the contract than later, and this trend appears to be continuing. Thus, while the average annual increase in wages (excluding fringe benefits) under agree FEDERAL RESERVE BANK OF NEW YORK ments signed this year is 6.6 percent over the life of the contract, the median increase in the first year is a full 8.0 percent. Cost-of-living escalator clauses may, of course, add to the scheduled raises beyond the first year of many contracts. W holesale prices of industrial commodities continue un der severe pressure. The index of industrial goods prices advanced at a sharp 6.4 percent annual rate in October. A particularly steep price increase in transportation equip ment resulted from the higher prices on 1970-m odel cars, which took effect that m onth.InNovem ber, industrial prices moved up further at a 4.2 percent annual rate, according to the revised estimate. Thus, the average annual rate of rise during the first two months of the fourth quarter was 5.3 percent, compared with a 3^2 percent annual rate in the third quarter. Consumer prices continue to climb at excessively high rates, although there has been some slight moderation since the first half of the year. From June through October, the average annual rate of increase of the consumer price index was 5.2 percent, compared with 6.3 percent in the first six months of 1969. In October, prices rose at an an nual rate of 4.6 percent as food prices fell for the first 249 time in eight months, a largely seasonal phenomenon. Excluding the food component, prices moved up at a 7.4 percent rate. A major factor in the October rise was the price increase on domestically produced 1970-m odel cars. PER SPEC TIV E * 6 9 Each January this Bank publishes Perspective, a brief, informative review of the performance of the economy during the preceding year. This booklet is a layman’s guide to the econom ic highlights of the year. A more comprehensive treatment is presented in our Annual Report, available in March. Perspective ’6 9 will be available without charge from the Public Information Department, Federal Reserve Bank of N ew York, 33 Liberty Street, New York, N .Y . 10045. (A copy will be mailed with the January 1970 issue of the Monthly Review.) 250 MONTHLY REVIEW, DECEMBER 1969 T h e M o n ey and Bond M a rk e ts in N o vem b er The rapid drop in prices of intermediate- and long-term securities, which began in the latter part of October fol lowing a rally earlier that month, carried market yields in many sectors to new highs during November (see Chart I ) . Vietnam and inflation continued to dominate market attention, and in large measure the sharp price declines during the month were fueled by discouragement over the absence of apparent progress in either area. In addition, market participants increasingly came to feel that fiscal restraint was lessening and that the prospect of any near-term relaxation of monetary restraint was re mote. Borrowing demands continued to be very heavy, and the response of institutional investors to new offer ings was often indifferent. Even at progressively higher offering yields, which reached as much as 60 basis points above those at the beginning of the month, many corporate flotations could not be fully placed. When unsold portions were released from underwriting syndicates to trade in the secondary market, their yields soared further. New offerings of tax-exempt issues also moved slowly despite record-high interest rates, and a considerable volume of flotations was again held off the market because of statutory rate ceilings. Yields on most Treasury bills also climbed sharply higher to new record levels in November, with many in creases ranging from 40 to 50 basis points. The bulk of the advances took place after midmonth, when auctions of bills on three successive business days— November 21, 24, and 2 5 — taxed the capacity of the market. Upward bill rate pressures also resulted from large demands for new short-term funds by Federal agencies and tax-exempt bor rowers and from sales of Treasury bills by foreign holders. Only in the short end of the bill market did strong demand place a damper on the rate advances. Prices of intermediateand long-term Government securities dropped sharply, and yield increases of from 20 to 30 basis points were not un common. In the process, long-term bond yields registered new record highs, although yields on higher coupon intermediate-term issues failed to reach the early-October peaks. Bank reserve positions continued to be hard pressed during November, and member bank borrowings re mained sizable. Federal funds traded above 9 percent until late in the period, rates on three-month Euro-dollars climbed sharply around midmonth, and other short-term rates were as much as Vi percentage point higher at the end of November. BANK RESERVES AN D THE M ONEY M ARKET Nationwide bank reserve availability remained relatively unchanged on balance during November. Member banks’ net borrowed reserves averaged around $1 billion and their average borrowings at the discount window were $1.2 billion, both about the same as in October. Federal funds traded generally at 9 percent or above until the last week of the month, when the effective rate averaged below 8 V percent. Operating factors absorbed member 2 bank reserves in each of the statement weeks ended in November (see Table I ). The amount absorbed— over $2 billion— was considerably greater than usually occurs in November, partly because foreign central banks made large repayments of previous drawings under the Federal Reserve swap network. As an offset to the reserve absorp tion by market forces, the Federal Reserve injected reserves through open market operations, primarily by outright purchases of Treasury securities. Money center banks, particularly those in New York City, experienced large deposit outflows early in the month, and in the week ended on November 12 the net basic reserve deficit of the forty-six major banks soared to $5.3 billion (see Chart I I ), the highest level of 1969. The combination of this sw'ing and the aggregate reserve ab sorption by market forces placed heavy strains on the Federal funds market, where rates averaged 9 lA percent for the first two weeks of the month. That the rate did not push higher was due in part to recourse by the large banks to borrowings from Federal Reserve Banks. During the week of November 12, average borrowings for the fortysix banks reached $646 million (see Table I I ), the highest volume since the beginning of the year. The large banks were slow to recoup their deposit losses FEDERAL RESERVE BANK OF NEW YORK after midmonth, and until the week of November 26 the Federal funds rate generally held steady around l per A cent. During that week, reserve deficits were pared con siderably and, with a relatively small net shift in reserves caused by market factors, Federal funds rates eased a bit to a 7 to 9 percent range. Most short-term money market rates moved higher over the month. Although ninety-dav finance company paper remained around 1 3 percent, bankers’ acceptances and A prime four- to six-month dealer-offered commercial paper each rose Vi point. The three-month Euro-doilar rate was steady at 10 percent until midmonth, then jumped to around 11 percent for most of the balance of the period. In part, demands for Euro-doilar funds were spurred by the prospect of closer regulation of member banks’ use of the commercial paper market.1 At the end of October the volume of bank-related commercial paper outstanding approximated $3,6 billion, up over $1 billion during the month and $2.4 billion higher than in June. Monetary aggregates moved up in November. Accord ing to preliminary data, the narrow money supply ex panded at about a 5 percent annual rate after several months of little change, and total member bank deposits subject to reserve requirements (adjusted to include Euro dollar liabilities) advanced 11 percent. 9 T H E G O V E R N M E N T S E C U R I T I E S 8VSARXET Rates on most Treasury bills recorded their sharpest rises of the year in November and, in the process, swept to new all-time high levels. The advances reflected the spreading belief that monetary policy would have to re main restrictive for a protracted period before inflationary pressures would recede. Heavy Treasury and agency finan cing and bill sales by foreign holders also contributed to pressures in the short-term markets. Only in the very short bill maturities, where strong demand was in evidence, did rates fall. Over the month as a whole, one-month bill rates ^On O ctober 29 the Board of G ove rn ors of the Federal Reserve System annou nced that il had de termined that comm ercial paper and similar obligations issued by subsidiaries of m e m b e r banks were, unde r the provisions of Regulations Q and D, subject to interest-rate limitations and reserve requirem ents to the same extent as obligations issued directly by m em b e r banks. T h e Board subsequently announced measures for the a cco m m o dation of an orderly adjustm ent by m em b er banks to that d eterm ination, i n an oth e r action on O ctober 29, the Board announced that it was considering amending the provisions of Regulation Q to apply to funds received by m em b e r banks from the sale of com m ercial paper or similar obligations by either the p arent holding co m pan y or a collateral affiliate of a m e m b e r b a nk in a holding co m p a n y system. 251 fell 35 basis points to 6.65 percent, while rates on threemonth and one-year bills climbed 52 and 47 basis points, respectively, to 7.51 percent and 7.50 percent. Most of the upward rate movement in bills came after midmonth, when the concentration of bill auctions on three successive business days, November 21, 24, and 25, contributed to an abrupt upsurge. Early on Monday, N o vember 17, the Treasury announced that it would auction an additional $2.5 billion of April and June tax anticipa tion bills (T A B ’s) on November 21. The announcement immediately pushed longer bill rates higher and, in the reg ular weekly auction held later on Monday, the average rate of discount on the six-month bill reached a record 7.518 percent, 8 basis points higher than the week before (see Table III). In the TAB auction four days later the $1 billion of the April maturity commanded an average rate of 7.815 percent, and the rate on the $1.5 billion of the June maturity averaged 7.975 percent— 53 and 77 basis points higher than the rates that had been set for the same maturities at two auctions during October. These were the highest auction rates ever recorded for new TAB issues. In the span of the four business days from Novem ber 20 through November 25— which encompassed the of fering of the T A B ’s and the regular weekly and monthly bill auctions— rates on issues maturing in three months or more soared as much as 25 to 35 basis points. These pressures pushed the new-issue rates to new highs in the auctions on November 24 and 25. On November 24 the auction rates for the new three- and six-month issues averaged 7.476 percent and 8.027 percent, respectively, up 34 and 51 basis points from the previous week’s auction. The 8.027 percent rate was the highest ever set on any maturity in a Treasury bill auction. Then, on November 25, the new nine- and twelve-month bills were auctioned at average rates of 7.778 percent and 7.592 percent, re spectively, 53 and 47 basis points higher than a month earlier. At the higher rates, considerable investor and dealer interest materialized in the longer maturing bills. At the close of the month the bid rate on the new sixmonth bills was 7.81 percent, down 22 basis points from the November 24 auction rate. Yields on intermediate- and long-term Treasury coupon issues also forged higher in November— in many cases to record highs. The pressures generated by the large volume of Federal agency and corporate new-issue flotations were an important contributing factor. In addition, disappoint ment over the President's November 3 speech, which was interpreted in the market to mean that no new develop ments in Vietnam were in the offing, prompted dealers to lighten positions. Yields rose 20 to 35 basis points in light 252 MONTHLY REVIEW, DECEMBER 1969 Chart I SELECTED INTEREST RATES September-November 1969 Percent MONEY MARKET RATES September O ctober BOND MARKET YIELDS N ovem ber September O ctober Percent N ovem ber Note: Data a re shown for business d ays only. M O N EY MARKET RATES QUOTED-. Bid rates for three-month Eu ro-do llars in London; offering rates for directly p laced fin an ce com pa n y pap er; the effective rate on Fe d e ra l funds (the rate most representative of the transactions executed); closing bid rates (quoted in terms of rate of discount) on newest outstanding three-month and o ne-year Treasury bills. BO N D MARKET YIELDS Q U O TED : Y ields on new A a a - an d A a -ra te d p ublic utility bonds (arrows point from underwriting syndicate reoffering yield on a given issu e to market yield on the same issue im m ediately after it has been released from syndicate restrictions]; trading, with the 4V4 percent bond of 1987-92 reaching a record 6.86 percent during the month. Although the rise in rates in the intermediate-term sector was somewhat sharper than that of long-term, deep-discount bonds, yields on the high-coupon notes failed to reach the peaks registered in late September and early October, and yields on most intermediate-term issues moved lower during the last few days of November. O T H E R S E C U R IT IE S M A R K E T S Yields on new corporate securities moved sharply up ward almost without pause during November, leaving a wake of unsuccessful underwriting ventures as evidence of d a ily ave ra g e s of yield s on seasoned A a a -ra te d co rporate bonds; d aily ave ra g e s of y ie ld s on long-term Governm ent securities (bonds due or c a lla b le in ten ye a rs or more) and on Governm ent securities due in three to five y e a rs , computed on the basis of closing bid prices; Thursday ave rag e s of y ie ld s on twenty seaso n ed twenty-ye a r tax-exem pt bonds (carrying M oody's ratings of A a a , A a , A , and Baa). Sources: Fed eral Reserve Bank of New York, Board of G o vernors of the Fe d e ra l Reserve System, M oody’s Investors S ervice, and The W e e k ly Bond Buyer. increasing congestion in the market. The continued mani festations of the strength of inflation cast a pall over market sentiment, and the fact that the President’s November 3 address failed to contain encouraging news about immedi ate peace prospects was an additional disappointment. The heavy volume of financing demands and the un wieldy positions of dealers and underwriters discouraged any rush by institutional investors to initiate new com mitments. Utility offerings, which have tended to glut the market of late, were again under especially heavy pressure. The feature of the early part of the month was a $125 million offering on November 12 by South Central Bell Telephone Company. The issue carried an 8 V percent 2 coupon and yielded investors 8.45 percent, 20 basis points 253 FEDERAL RESERVE BANK OF NEW YORK above the previous record high for a Bell System offering set in September. Initial investor interest was light, how ever, and when the unsold portion was released from syn dicate price restrictions on November 18, the yield soared as high as 8.67 percent in early secondary market trading. Only when new-issue yields approached the 9 percent level did investor interest quicken, but even then recep tions were mixed. Two finance subsidiaries of large retail firms each offered $50 million of A-rated debentures at 9 percent, and sales were brisk. In contrast, on November 19 a very weak reception was accorded another utility, Pacific Gas and Electric Company, which offered $80 million of 9 percent mortgage bonds to yield 8.81 percent, a new record for Aa-rated issues. The next day, however, a quick sellout greeted the $50 million issue of Boston Edison Company, offered with a 9 percent coupon to yield 8.90 percent to investors. While much of the interest was reported to be from individuals, som e institutional support again emerged. Although this response contributed to some added sales of the Pacific Gas and Electric offering, when the issue was finally released from pricing restric tions after the month end, the yield jumped 23 basis points. The generally unreceptive condition of the market, to which a succession of syndicate terminations testified, prompted Commonwealth Edison to defer a $100 million bond offering, which had been scheduled for November 25. A t the month end, demand pressures remained very strong and the beginning of a seasonal slackening in the volume of scheduled offerings afforded little relief to the market. In the last week of November the four-week vis ible supply of forthcoming corporate financings approxi mated $1.3 billion. Federal agency financings continued to be sizable, and new offerings provided an upward thrust to rates in both short- and long-term markets. The highlight of the month was a $1.1 billion financing on November 13 by the Fed eral Hom e Loan Banks. The issue, which raised $600 million in new funds, consisted of an 8% percent tenmonth note, an 8.20 percent 2 Va-year bond, and an 8 percent five-year bond. The offering encountered investor resistance, in part because of the overhang of other im minent agency flotations, and at the close of the period bid-price discounts were %2, and 1%2> respectively. In the tax-exempt market, statutory interest-rate ceil ings, which have restricted new offerings throughout much of the year, again curtailed activity. A large volume of new issues carried short maturities as a means of tapping a less congested sector, where financing was less costly and rate ceilings less constraining. Indeed, some issues were sold at rates lower than earlier in the fall. In con trast, long-term bonds with serial maturities encountered investor resistance which resulted in higher costs and, in some cases, cancellations or postponements. On November 6, for the second consecutive occasion, a 6 percent interest-rate ceiling impeded the flotation of tax-exempt Federally guaranteed housing bonds through the Federal Housing Assistance Administration. Only about $33 million of an offering totaling $139 million was awarded to bidders, and the issue cost averaged 5.996 percent— a record. However, short-term Federally guar anteed notes issued under the auspices of the Department of Housing and Urban Development (H U D ) fared con siderably better than the longer term housing bonds. On November 12, local renewal agencies marketed almost $330 million of project notes having an average maturity of about 9 V months at an average interest rate of 5.49 2 percent. This cost was about 10 basis points lower than that in an October financing. H U D announced that no placement fees had been paid, although such an option is open in the event borrowing costs exceed the 6 percent interest-rate ceiling generally applicable on these notes. In another financing on November 18, local public hous ing authorities sold almost $300 million of project notes Chart II BASIC RESERVE POSITION OF M A JO R MONEY MARKET BANKS Billions of dollars Billions of dollars Note: Calculation of the basic reserve position is illustrated in Table ii. MONTHLY REVIEW, DECEMBER 1969 251 Table I II Table FACTORS TENDING TO INCREASE OR DECREASE MEMBER BANK RESERVES, NOVEMBER 1969 RESERVE POSITIONS OF MAJOR RESERVE CITY BANKS NOVEMBER 1969 In millions of dollars; ( 4 ) denotes increase (—) decrease in excess reserves In millions of dollars Daily averages— week ended on Nov. Nov. 26 — 480 273 729 198 — 4— — — — 174 19 52 283 - Total “ market" factors ........................... 1,002 4- 358 - - 722 — 197 4- 67 4 25 — 191 — 424 — 294 4 . 597 4- 94 266 104 34 1 — 10 — 557 — 419 333 4 — 774 | — 364 - 243 19 Nov. 26 Eight banks in New York City " M a r k e t ” factors Member bank required reserves .................. Operating transactions (subtotal) ............. Federal Reserve float ................................. Treasury operations* ...................................... Gold and foreign account ........................... Currency outside banks ............................... Other Federal Reserve accounts (n e t)t-- Nov. 26 Nov. 12 Nov. 19 12 5 Nov. Nov. 5 Net changes Factors Nov. Average of four weeks ended on Factors affecting basic reserve positions Changes in daily averagesweek ended on — 372 — 2 ,0 1 1 4- 306 — 47 — 5 — 1,133 — 1,130 96 121 1,583 224 -1 ,8 5 4 670 3 54 79 350 199 1.731 1,532 Reserve excess or deficiency (— )* . . . Less borrowings from Reserve Ranks , Less net interbank Federal funds purchases or sales (— ) ............................. Gross purchases ............................... Gross sales ............................................... Equals net basic reserve surplus or deficit ( — ) ............................................... Net loans to Government securities dealers ........................................ Net carry-over, excess or deficit (— ) t 614 70 - 120 1,396 2,519 1,124 2,200 937 2,051 1,752 1,184 1.114 1,002 - 528 60 503 22 579 37 31 39 — 389 I 438 387 -2 ,3 8 3 Thirty-eight banks outside New York City Direct Federal Reserve credit transactions 4-1,075 ! 4 . 381 j 4 - 735 Open market operations (subtotal) Outright holdings: Government securities : .............................! 4 Bankers’ acceptances ............................... - f Federal agency obligations ........... .. . J 4 Member bank borrowings ............................... 4 Other loans, discounts, and advances......... Total ^ *i 261 — 194; 7i — 1 — 4-2,352 + § 67 — 4 8 ; — 10 83 — 172 4 - 135 4 4 298 I - f 563 4 304 4-2,384 18 • — — ................................................................ 4 1 .2 1 9 Excess reserves ..................................................... 4 ^ 4-2,360 -4 164 4- 5 j I 7^8 j 4 - 585 ! 4 ^15 ’j Backers' acceptances ............................. Repurchase agreements: ; Government securities ...................... .... • i 4 - 4 - 169 217 4* 57 296 2,780 4,346 1,566 3,213 5.164 1,951 2,753 4.820 2,067 2,196 4,130 1,935 2,736 4,615 1.880 — 3,152 —3,452 —3,181 — 2,665 — 3,113 178 138 43 161 37 216 14 173 6 — 10 53 425 22 24 + 55 | — 211 Reserve excess or deflciencv (— )* . . . . . Less borrowings from Reserve Banks ,. Less net interbank Federal funds purchases or sales (— ) ............................... Gross purchases ................................... Gross sales ................................................... Equals net basic reserve surplus or deficit (— ) ..................................... .. Net loans to Government securities dealers ............................................ N et carry-over, excess or deficit (— ) t - - N ote: Because of rounding, figures do not necessarily add to totals. * Reserves held after all adjustm ents applicable to the reporting \ 'equircd Not reflected in data above. D aily average levels Table III AVERAGE ISSUING RATES* vT REGULAR TREASURY BILL AUCTIONS Member bank: 27,662 27,365 297 1 1,327 1,030 Free, or net borrowed <~ •), reserves........... - — | 26,335 52 Net carry-over, excess or deficit 27,696 ■ 27,342 354 : 1,244 ! — 890 26.45? J 181 27,965 27,822 . 143 ; 1,072 — 929 ■ 26,893 i 211 i Total reserves, including vault cash ......... Required reserves ........... ! 27.547 27,464 83 1,207 -1 .1 2 4 26,340 108 27,7171 27.498J 2191 1 , 212 + — 9!>3t 26,505* In percent Weekly auction dates— November 1 96 5 Maturities 138J Nov. i Chamjes in Wednesday levels Three-m onth. Six-m onth. ... System Account holdings of Government securities maturing in : Less than one year More than one year 6.998 7.281 N ov. 17 10 \ 157 '.435 Nov. 24 7.141 7.518 Nov, 7.476 8.027 Monthly auction dates— September-November 1969 4-1.471 | — ; 1 | " ~j 43 | 4-1.647 — 1 - 1 .1 4 1 — _ ! — ■ ■ Not e: 1’“cause of rounding, figures do not necessarily add to totals. 95 4-3,066 — 1 .H 1 95 Sent 23 4 -1.9 25 N ine-m onlh. One-year. . . Oct. 28 Nov. 25 7.357 7.350 7.244 7.127 7.778 7.592 * Includes changes in Treasury currency and cash. 1 Inem des assets denominated in foreign currencies. + Average for four weeks ended on November 20. § Not reflected in data above. nterest 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 am ount actually invested, would be slightly higher. FEDERAL RESERVE BANK OF NEW YORK with an average maturity of 6 V months at an average rate 2 of 5.36 percent. This cost was almost 50 basis points below that in October. N ot only did interest-rate ceilings block some flotations, but one recently raised ceiling proved barely high enough to allow a sale. The instance in question involved the Penn sylvania State Public School Building Authority, which in October had its ceiling raised from 6 percent to 7 percent. An offering of $53 million by the Authority was awarded at a net interest cost of 6.996 percent and was moderately well received by investors at yields ranging from 5.60 per cent in 1972 to 7 percent in 2008. The Blue List of dealer-advertised inventories advanced in November from the already sizable levels of October. At midmonth a new record 1969 high of $632 million was registered, and inventories were usually above $550 million throughout the period. Moreover, the four-week visible supply of forthcoming new financings generally ex ceeded $900 million until late in the month. Both fur nished clear evidence of the congestion of the tax-exempt sector— a condition also reflected by The Weekly Bond Buyer's index of twenty municipal bond yields, which closed November at 6.58 percent, up 45 basis points over the month. 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, 33 Liberty Street, New York, N.Y. 10045. 255 256 MONTHLY REVIEW, DECEMBER 1969 R e ce n t Econ o m ic P o licy in Industrial C o u n tries A b ro ad The two most serious econom ic policy problems con fronting industrial countries over the past year or so have been large international payments imbalances and acceler ating inflationary trends. Major steps taken this year to resolve these difficulties have included the French devalua tion in August, the German revaluation in October, and a gradual swing to monetary and fiscal restraint in all the major countries. While it is too soon to judge the ulti mate results of these measures, exchange markets have recently been more orderly. The pattern of international payments has also benefited from a British swing into surplus after a period of heavy payments deficits. This welcom e change stems in part from the 1967 sterling devaluation and a subsequent policy of increasingly severe econom ic restraint. On the other hand, the massive balance-of-payments deficit of the United States continues to be a major concern. The external payments imbalances which the recent cur rency readjustments were designed to reduce have, of course, been rooted in the inevitable differences in eco nomic conditions among the major industrial nations and in the varying priorities they have assigned to domestic policy objectives. In November 1968, when payments disequilibria were large and currency speculation intense, the strength of the mark reflected Germany’s successful pursuit of price stability in the face of more inflationary conditions elsewhere. In France, on the other hand, massive labor disturbances in the spring of 1968 had resulted in large wage increases and other expansionary measures. Strong inflationary pressures in the United States were being re flected in current-account balance-of-payments deteriora tion, and rising consumer demand in Britain was slowing the realization of gains from that country’s 1967 devalua tion. (The trends in consumer prices and in the currentaccount balance of payments of the major countries are shown in Charts I and II.) Following the Bonn conference of November 1968, all industrial countries took some measures to reduce pay ments imbalances. France and Germany adjusted their taxes to produce the effect of a small devaluation and revaluation, respectively, and the United Kingdom added a temporary boost to the import price effects of the 1967 sterling devaluation by requiring interest-free de posits on imports of manufactures. Further, while all countries turned toward economic restraint late in 1968 and in 1969, those where inflationary pressures had been strongest— notably the United States, Canada, France, and the United Kingdom— applied especially severe fiscal and monetary restraints. However, m ost countries found their monetary policy complicated by flows of funds through the Euro-dollar market. On the one hand, intensified monetary restraint in the United States caused large American banks to draw heavily on Euro-dollars as a source of funds to lend in the United States. On the other hand, there were intermittent but heavy speculative flows into German marks and out of French francs and other currencies. Both flows tended to raise Euro-dollar rates to levels higher than believed desirable in any national credit market. Countries losing funds acted to protect their domestic financial conditions and their foreign exchange reserves by direct control of international capital flows. Germany, by contrast, confronted with unwelcome capital inflows, took steps to discourage or rechannel them or, failing that, to offset their inflationary impact. The recent French and German parity adjustments will, of course, contribute more substantially than the earlier measures could to reducing current-account balance-ofpayments disequilibrium of those countries and of their trading partners. The adjustments have also reversed the disturbing speculative capital flows caused by anticipation of these moves. However, the accelerating pace of infla tion in many countries during 1969 continues to retard international payments adjustment. Hence, most coun tries are maintaining or strengthening their policies of eco nomic restraint. GERMANY At the time of the November 1968 currency crisis, German economic policy faced a dilemma. There was a need, on the one hand, for domestic restraint to con tain incipient inflationary pressures and, on the other, FEDERAL RESERVE BANK OF NEW YORK Ch art I CONSUMER PRICES IN M AJO R COUNTRIES 1963=100 Note.- The countries ore ranked from top to bottom by the size of their overall price increases since the beginning of 1967. Sources: O rganization for Economic Cooperation and Development; for ease to encourage capital outflows that would offset Germany’s very large and persistent current-account sur plus. It was widely assumed that this dilemma, arising from Germany’s understandable reluctance to accept the degree of inflation prevalent in other countries, would be resolved by a mark revaluation. A t that time, Germany was rounding out a year of industrial growth unequaled since 1951— an expansion spurred by rapidly rising ex ports (especially to the United States) and by the after effects of expansionary monetary and fiscal measures un dertaken in 1967 to overcome the 1966-67 slump. As output pressed against capital and labor resources, price and wage increases did accelerate but remained less rapid than in most other countries, and the current-account 257 surplus widened. The January 1968 switch from a turn over to a value-added tax system may also have con tributed to this increased surplus. The change had little effect on export prices but gave rise to substantially increased border taxes on imports. Official efforts to off set the current-account surplus by encouraging foreign bond flotations were frustrated by offsetting short-term capital inflows arising from both cautionary leads and lags in current payments and outright currency speculation. Although the German government decided against a fullfledged revaluation in 1968, it did reduce for a limited period of time the export rebates and border taxes associ ated with the value-added tax. The authorities hoped this de facto revaluation of about 3 percent for merchandise trade would significantly reduce the current-account sur plus. But, since this process clearly required time, it re mained necessary to balance the growing need for domes tic restraint against the continuing need for large capital outflows. A moderate shift toward fiscal restraint served both domestic restraint and balance-of-payments purposes. The deferral and subsequent cancellation of about 2 per cent of Federal expenditures that had been planned for 1969, an acceleration of corporate tax payments, and rising tax yields served to swing the cash accounts of the Federal and provincial governments (with whom tax re ceipts are shared) from deficit to surplus. These changes tended to reduce domestic demand for goods and services and, at the same time, made more room for foreign bor rowing in German capital markets. The authorities also allowed domestic money and capital markets to be tight ened by the unwinding of speculative mark positions and by a record volume of mark-denominated foreign bond issues early in 1969, and supplemented these influences in February by discontinuing open market support for long term government bonds. By this past April, however, the rate of foreign bond issues had becom e so heavy that the semiofficial West German Capital Committee announced a temporary suspension of foreign issues and plans for slowing the future pace of such borrowing. At about the same time, monetary policy was further complicated by another wave of massive short-term capi tal inflows spurred by doubts regarding the effectiveness of Germany’s border tax adjustments in reducing its currentaccount surplus and reports that mark revaluation was under official consideration. As in November, the German Federal Bank attempted to discourage and deflect these inflows, but with indifferent success. Requirements that 100 percent reserves be held against increases in foreignowned bank deposits tended to shift speculative inflows to nonbank channels. Providing German banks with forward cover at favorable rates encouraged bank place 258 MONTHLY REVIEW, DECEMBER 1969 ments abroad but may also have facilitated further capital inflows. (These swaps were sometimes suspended as in M ay.) Firm official rejection of the revaluation idea tem porarily ended capital inflows in May, but the flows were only partially reversed in subsequent months. T o reduce the inflationary impact of short-term capital inflows, the central bank raised deposit reserve requirements at banks and other financial institutions in June and again in August, and reduced rediscount quotas in July. It also raised the official discount rate—-to 4 percent (from 3 percent) in April, then to 5 percent in June, and to 6 per cent in September. As a result, the wide gap between short-term interest rates in Germany and those prevailing in other money markets in 1968 and early 1969 was re duced to small proportions (except vis-a-vis Euro-dollar ra te s). However, the differential between yields on markdenominated and dollar-denominated Euro-bonds was little changed. Despite these moves toward monetary restraint, bank liquidity continued ample, and money and credit tended to grow about as rapidly as the year before. As the strain on economic resources intensified, price and wage in creases accelerated. Thus it seemed increasingly unlikely that Germany would regain the desired control over do mestic monetary and price developments until the external value of the mark had been officially readjusted, or until internal inflation had eliminated the necessity for such a readjustment. In September, it was decided to allow the mark to “ f lo a t1 until after the establishment of a new gov ernment. Then, on October 26, the mark was officially re valued by 9.3 percent. As the outflow of speculative funds gathered momentum thereafter, the Germ an Federal Bank reduced reserve requirements in November, and again in December, to steady the German financial markets. Very recently the central bank also raised sharply, from IV 2 percent to 9 percent, its rate for loans against government securities and requested banks to exercise restraint in lending at home and abroad as well as to repatriate m a turing foreign placements. To protect German farmers from lower price imports, a border tax, now 8V2 per cent, has been applied to agricultural imports since the mark rate was temporarily floated. This arrangement is expected to be superseded soon by a subsidy for G erm an farmers to which the European Economic Community ( E E C ) would contribute. FRANCE At the end of 1968, France found itself headed for the inflationary end of the international price spectrum after several years on middle ground. The proximate cause was the Grenelle wage agreement, aimed at restoring industrial peace after the crippling student and labor dis turbances of May and June. This agreement resulted in a 16 percent increase in wage rates during 1968. Faced with such a dramatic wage explosion, the official strategy for the period through November 1968 was to apply strong fiscal and monetary stimulus to push the economy toward fuller utilization of plant and labor resources than had pre vailed early in the year. Improved price surveillance, tem porary import quotas, export subsidies, and exchange controls (briefly) were employed to minimize transitional strains. It was hoped that the productivity gains result ing from rapid economic expansion would largely offset the rise in wages, thus preserving the real value of wage concessions and at the same time protecting France’s trade position. The authorities expected to have taken up most of the slack in the economy by the end of 1968, at which time withdrawal of policy stimulus and protection was to result in a self-sustained and slower rate of expansion. At the time of the Bonn conference, the effects of F ra n c e ’s expansionary policy were beginning to emerge. Bank credits were about 25 percent higher than a year earlier, and industrial output was up 13 percent. M o re over, labor productivity in manufacturing was 15 percent higher than a year earlier, nearly sufficient to offset the 16 percent wage increases granted for 1968. However, the close to 5 percent rise in consumer and export prices d ur ing 1968 placed France in the forefront of inflationary countries, and the trade account was deteriorating as im ports spurted ahead of exports. Then, just as France was completing the initial expansionary phase of her original program, the early N ovember speculative rush into G er man marks, exacerbated by fears regarding the political and economic outlook for France, made serious inroads on F rance’s international reserves. Folio wing the Bonn conference, the French govern ment decided against a devaluation. However, tax changes were made which had a total effect on trade equivalent to a roughly 2 percent devaluation, and foreign exchange controls on capital transactions and travel were reimposed in tighter form. In addition, the authorities moved strongly toward monetary and fiscal restraint. Minimum reserve requirements and liquidity ratios were raised, discount quotas were reduced, and credit ceilings were imposed which, in effect, limited short-term bank credit to the private sector to temporary accommodation of seasonal needs. Also, the official discount rate was raised from 5 percent to 6 percent. Fiscal policy was adjusted by re ducing subsidies to the nationalized gas, electric, and rail road industries and by increases in the value-added tax. In the hope that private investment would be maintained FEDERAL RESERVE BANK OF NEW YORK despite the reduced rate of economic expansion, invest ment incentives were left intact. During the first seven months of 1969, the French economy failed to respond to fiscal and monetary restraint as quickly as it had earlier to expansionary policies. Bank credit rose almost as rapidly as in 1968, partly because bank financing of the government— and others exempt from the credit ceilings— was heavier than anticipated, but the credit ceilings themselves were also breached. Further, the investment tax incentive had proved unex pectedly potent. Although initial labor-management dis cussions in March regarding a second nationwide wage adjustment had proved inconclusive, labor shortages were forcing locally negotiated wage increases running close to a 10 percent annual rate. Moreover, retail sales— espe cially of durable goods— continued to rise. Given these ex pansionary developments, imports continued upward and the trade deficit widened somewhat. In May, therefore, the authorities initiated a new series of restraint measures by tightening consumer credit regulations. In June, all bank credit ceilings were extended and the official discount rate was increased from 6 percent to 7 percent. In July, the government established a countercyclical investment fund which, in effect, postponed part of its expenditures until such time as the economy required a fiscal stimulus. Early in August, following Mr. Pompidou’s election as president, the new government devalued the franc by 11.1 percent. A month later it outlined the major features of its overall economic strategy. It intensified restraint on consumption by further tightening instalment credit re strictions for a five-month period and by offering new tax incentives to purchasers of life insurance and long term fixed-interest securities. Previously revised bank credit ceilings were reinforced by tying the banks’ impor tant rediscount privilege to ceiling compliance. In October the official discount rate was raised to 8 percent. Although the brunt of the restrictive burden was borne by monetary policy, the government also impounded more public invest ment authorizations in the countercyclical fund, and— de parting from previous policy— moved to dampen private investment by terminating the special tax incentive three months early in September. But devaluation was the key stone of the overall strategy. It was adopted in the hope that it would permit the shift of resources, required to pro duce external balance, to be made with less sacrifice of economic growth and, hence, with less ultimate damage to the French standard of living than would otherwise be the case. Although contributing to attainment of general balance-of-payments equilibrium, the French devaluation did upset the EEC policy of common agricultural prices, which were fixed in terms of a common unit of account. 259 CURRENT-ACCOUNT BALANCE OF PAYMENTS OF M A JO R INDUSTRIAL COUNTRIES* r 500 p ' 0 -5 0 0 M illio n s of dollars 1 [ Ger many 1000 7^1 ! ....._ J ______ J_______L .1 ...... 1 ______J _ 1000 ml Pm 500 1 -5 0 0 I 1000 Japan P m 500 __, 0 ! .....1 . .. ! -5 0 0 500 II 1 United Kingdom 1§ 0 P I ....J .... L. _ ..L -5 0 0 1000 i .J KS3 - ... 1 J PI KSSSl ^ 500 ! 1 1■ 1 1 1 1 Pil it H Italy " n ^ [._.. -5 0 0 500 1 -5 0 0 1000 - 500 M - L . -5 0 0 500 . 1 ...1 _J_ _ J _ 1__ I_ L . .. -5 0 0 500 Netherlands l— LA - L i\\\; -I | 1__L . 1 _ . 500 i----1 -1 J. 1 ! 1 1 Belgium 0 k\Vvl -5 0 0 l v v vt ....... . 1 500 1 r-r-T -t -T L ..... ! - 1I .... ..L.J..._L_ . ^ ^ i^s ^ ... 1 ..J_...L _ 500 _ -5 0 0 500 Switzerland^ -5 0 0 -5 0 0 500 _ L ...1___L 1 . 1 ! 500 500 C anada H I -5 0 0 f 1M ' ............ E j ______ i 500 J i m :1 I... 1 _ ! _______ .._ i 1 ! I 0 " '^ 3 1 -5 0 0 500 ES3 " ! -5 0 0 I 500 France^ 0 -5 0 0 I- -5 0 0 500 Sweden 1 1 ! 1967 ! 1 X 1968 ^ Ex cep t for France and Switzerland. ^ Trade account only; imports CiF, exports FOB. ^ Trade account only; imports FOB, exports FOB. Source: National statistics. S, 1969 , 260 MONTHLY REVIEW, DECEMBER 1969 To avoid undue stimulation to French agriculture and heavier subsidy costs for its EEC partners, France was exempt from the uniform price requirement for twentyeight months and was required to tax exports and sub sidize imports in order to offset the difference between French and other EEC agricultural prices. U N IT E D K IN G D O M By the end of 1968, a full year after the 14.3 percent sterling devaluation, the hoped-for balance-of-payments surplus had not yet appeared. Prior to devaluation the United Kingdom had suffered chronic payments deficits, partly as the result of a poor price and productivity record relative to her major competitors, especially Ger many. This tendency had forced Britain to choose be tween a slow rate of growth, in the interests of external balance, and the payments deficits which attended strong econom ic growth. The government had expected that de valuation would resolve the dilemma and permit modest econom ic growth to coexist with a developing balance-ofpayments surplus, needed to repay indebtedness incurred to finance previous deficits. The strategy, which was ex pected to produce a surplus by the second half of 1968, was outlined in the March budget presentation. The plan called for a maximum 4 percent growth in gross domestic product (G D P ) from the second half of 1967 to the second half of 1968 and for a resource shift from con sumption to exports and investment. Restrictive fiscal, monetary, and incomes policies were undertaken to rein force devaluation by cutting back consumption. While the GDP target was achieved in 1968, the external basic balance was still slightly in deficit at the year-end. A major difficulty had been that domestic consumption had in creased by 1 percent, rather than, declining by 2 percent as planned, and had pulled in extra imports. In retrospect, the authorities recognized that sizable monetary expan sion, despite ceilings on certain bank loans, had facilitated the breaching of the incomes policy and assisted consumer resistance to fiscal restraint. In the light of the 1968 experience, a modified strategy was worked out between November 1968 and April 1969, when objectives for the year were set out in the budget message. Between the second halves of 1968 and 1969, real GDP growth was to be no more than 2.6 percent, real public and private consumption (taken together) were to be roughly unchanged, and the increase in invest ment was to be pulled back to less than 3 percent. Real imports were to be held level and, with rising exports, a current-account balance-of-payments surplus was ex pected to emerge in the second half of 1969. Measures to implement the new strategy took effect in the NovemberApril period. To curb consumer expenditures, consumer credit regulations were tightened and purchase taxes on alcohol, gasoline, tobacco, and a broad range of durable goods were increased by 10 percent in November 1968. The April budget also raised the “selective employment tax” (which hits the consumers’ services sector hardest). To reduce domestic investment incentives, special tax con cessions were allowed to lapse in December 1968, and the new budget included an increase in corporate taxes. Attack ing imports directly, a six-month interest-free deposit with the government, equal to 50 percent of the value of their imports, was required of importers of manufactures begin ning in December 1968; the interest to be thus forfeited probably added 1 to 2 percent to the cost of imports. More generally, the government aims— by means of fiscal, debt management, and monetary policy— to limit “domestic credit expansion” to no more than $960 million equivalent in the financial year ending in March 1970, compared with the $2.8 billion increase in the preceding year. This total includes credit extended to public and pri vate borrowers by the domestic banking sector and foreign lending to the public sector (including public corpora tions). Fiscal policy— based on relatively stable expendi tures and a rise in tax rates and tax yields— is designed to permit a sizable reduction of government debt, includ ing that held by banks. Tax exemptions have been granted on capital gains from the sale of government bonds, with the intent of encouraging government debt ownership by nonbank investors. As for monetary policy, bank credit ceilings have been set in order to reduce loans to the private sector, and the buildup of import deposits in early 1969 absorbed substantial liquidity. (The deposit require ment has recently been renewed until the end of 1970 but at the reduced rat eof 40 percent of import value). The official discount rate has been maintained at 8 percent since February. On the basis of fairly complete information about the first half of 1969, and preliminary indications for the second half, it appears that the British economy is, in the main, holding to the course plotted. “Dom estic credit expansion” is running well below the intended limit, with a sharper than planned reduction in government borrow ing more than offsetting continued breaching of credit ceilings. Consumption and investment are probably close to planned levels, and output is rising modestly. The tend ency of exports to hold their own in rapidly expanding world markets (in contrast to many years of declining shares before devaluation), and the stability of imports in 1969, helped to swing the basic balance of payments to a $686 million surplus in the second and third quarters of 1969, FEDERAL RESERVE BANK OF NEW YORK taken together. This is close to the $72 0 million balanceof-payments surplus originally hoped for in the year ending in March 1970. A t present, therefore, the United Kingdom appears to be achieving modest growth and a balance-ofpayments surplus. ITA LY Despite Italy’s expansionary monetary and fiscal policies and strongly rising exports in 1968, domestic demand and imports continued sluggish through much of that year and price increases remained moderate. Although the current-account surplus had increased, political uncer tainties stimulated a capital outflow so large that the financing of domestic investment may have suffered. Fur thermore, uneven regional growth and continued unem ployment were contributing to growing social unrest. In view of all of these factors, Italy’s econom ic policy re mained predominantly expansionary well into 1969. Con siderable reliance has been placed on increases in govern ment expenditures which have recently been directed largely to raising old-age pensions and the wages of gov ernment workers. The Bank of Italy continued to en courage domestic credit expansion but, at the same time, took steps to force repatriation of bank funds and dis courage capital outflows. In March, commercial banks were requested to bring their net foreign position into bal ance by the end of June, while their participation in in ternational bond consortia was temporarily suspended. The purchase of foreign mutual fund shares was restricted. T o reduce the differential between domestic and foreign interest rates, the Bank of Italy withdrew support from the treasury bill market. During the early months of 1969, domestic consumption responded strongly to expansionary policies, price and wage increases accelerated, and there was some reduction in Italy’s current-account surplus. In view of developing inflationary pressures and continued heavy capital outflow, the Bank of Italy in July raised from 3 Vi percent to 5 percent its official penalty discount rate for banks whose average rediscounting during the preceding six months exceeded 5 percent of their minimum reserve require ments. On August 14 the basic discount rate for banks not subject to this penalty was raised from 3 V2 percent to 4 percent, the first change since June 1958. OTHER EU R O PE A N C O U N T R IE S During 1968, strongly rising demand in the larger in dustrial countries had been rapidly transmitted to the smaller industrial countries of Europe— the Netherlands, 261 Belgium, Sweden, and Switzerland. By the end of the year, plant capacity was becoming strained, labor shortages were emerging, and price and wage increases were accelerating. As restrictive monetary policies initiated in the larger countries late in 1968 began to affect the money markets of the smaller industrial countries, they also moved toward monetary restraint. Thus, official discount rates were gradually shifted upward, but the timing and the size of the rate changes were, of course, influenced by differing domestic considerations. The National Bank of Belgium made an upward discount rate adjustment in December 1968 and again in March, May, July, and September 1969 for a total increase of 3 3 percentage points to IV2 percent. A The Netherlands Bank raised its discount rate in Decem ber, April, and August 1969 for a total of IV2 percentage points to 6 percent. Sweden, whose business cycle lagged somewhat behind that of other countries, moved in Feb ruary and July to raise its discount rate 2 percentage points to 7 percent. In Switzerland, the authorities permitted the interest rate on three-month commercial bank deposits to move upward by 1 percentage point to 5 percent in the first six months of this year, but did not adjust the official discount rate until September, when it was increased by % percentage point to 3% percent. (This was the first change in the official discount rate since the V percentage 2 point reduction in July 1967.) Since none of the monetary authorities of these smaller European countries were prepared to accept a level of interest rates as high as that in the Euro-doilar market, measures were taken to pull back short-term capital previ ously placed in that market. In April, the Belgian central bank requested commercial banks to cut nearly in half by the end of June important components of their foreign ex change position. In August, the central bank abandoned its preferential discount rate for certain export paper and tightened foreign exchange regulations. A lso, the Nether lands Bank, in July, obtained a voluntary agreement from commercial banks that they would cut back their foreign exchange position during the second half of the year. In Sweden, capital flows were already subject to exchange controls, but these controls were applied more strictly in 1969 than earlier. Introducing an element of credit rationing, the monetary authorities also established a ceiling on the permissible expansion of bank credits to the private sector. The Netherlands Bank obtained agreements from the commer cial and agricultural credit banks which limited their 1969 short-term credit expansion to 10 percent. The National Bank of Belgium imposed ceilings on both the rediscount privileges it extends to commercial banks and the permis sible volume of commercial bank loans outstanding. Swe 262 MONTHLY REVIEW, DECEMBER 1969 den’s Riksbank in July recommended a cutback in most bank credit. The Swiss National Bank had hoped for parliamentary approval of a proposed law which would have given the bank added powers, including the right to set mandatory credit ceilings. After the proposal was re jected in June, the central bank developed the customary “gentleman’s agreement” limitation on bank credit. In most cases, fiscal policy has also moved moderately in the direction of restraint. The general approach has been to limit the increase in expenditures, rather than to make any major changes in tax rates. However, the Neth erlands and Sweden, as previously planned, switched from a turnover to a value-added tax, which the EEC countries and some other European countries are in the process of adopting. In the inflationary atmosphere which existed in the Netherlands when the tax change was launched, the tax was often simply added to the sales price. This helped produce a 6 percent increase in consumer prices during the first four months of 1969, which in turn necessitated sizable compensatory wage increases. To arrest the infla tionary spiral, the Netherlands authorities imposed a com prehensive price freeze from April to September. In view of the Dutch experience, Belgium and Italy have an nounced plans to postpone their planned changeover to a value-added tax until inflationary pressures in their coun tries have abated. Economic developments in the smaller industrial coun tries of Europe reflect both the timing and the character of the restraint measures adopted. Belgium, Switzerland, and Sweden continue to experience lower than average increases in consumer prices, while Dutch prices, after an initial increase, were stabilized by the freeze. The currentaccount balance of payments of Sweden, Switzerland, and Belgium deteriorated somewhat in the first part of 1969, but the Netherlands current account improved. JAPAN The 1968 rate of industrial growth in Japan, had, as usual, exceeded that of any other industrial country, and wages in manufacturing also rose faster than in most coun tries. In the export and capital goods industries, these increases were apparently covered by productivity gains so that prices remained stable; but, in the less dynamic consumer goods industries, wage increases produced a substantial rise in the cost of living. Because of rising exports to the United States, Southeast Asia, and the Middle East, and long-standing import restraints, the current account had improved strongly. In view of this generally favorable situation, Japan made no substantial change in fiscal policy in 1969 and continued until late in the year the moderately expansionary monetary policy to which she had turned in September 1968. Since the cur rent account continued strong, the authorities sought to offset this by stimulating capital outflows. The Bank of Japan, in April, issued a “yen shift” guideline to the banks, encouraging them to reduce liabilities to foreigners and to assume the financing of foreign trade previously financed abroad. The ensuing yen shift, which exceeded $700 mil lion in the second quarter of the year, temporarily reduced official reserves. By the summer of this year, signs of domestic strain and inflationary pressures began to emerge, and on September 1 the Bank of Japan moved toward restraint, raising the discount rate from 5.84 percent to 6.25 percent. The de velopment of domestic inflationary pressures, without any accompanying current-account deterioration yet apparent, is a novel experience for Japan. The persistence of the payments surplus has stimulated considerable discussions as to whether any change in trade or domestic develop ment policy, or further promotion of capital exports, is required in the interests of external equilibrium or whether further reserve accumulation would be desirable. CANADA The Canadian economy had moved ahead very briskly in 1968, stimulated by rising exports to the United States and by a construction boom. Monetary policy had been easy since midyear and, although the government had planned to eliminate its fiscal deficit, rising prices and un expected difficulties in cutting back expenditures frustrated that intention. Both price and wage increases quickened disturbingly. In 1969, therefore, both fiscal and monetary policy moved toward restraint. The government’s cash budget swamg into surplus, owing to firm expenditure con trol and to higher tax yields and tax rates. Deferral of capital cost allowances provided a tax disincentive to commercial construction. On the side of monetary policy, the Bank of Canada followed international interest-rate trends quite closely, raising the official discount rate from 6 percent to 6 V percent in December 1968, to 7 percent in 2 March 1969, to IV2 percent in June, and to 8 percent in July. However, it proved possible to hold Canadian inter est rates somewhat below Euro-dollar levels. In part this was because guidelines for banks, other financial institu tions, and nonfinancial corporations limited investment in Europe. (These guidelines were originally established in 1968 to prevent an outflow of capital from the United States through Canada to third countries.) In July, the FEDERAL RESERVE BANK OF NEW YORK central bank created a further barrier to capital outflow by imposing a freeze on “swapped deposits”,1 which had financed substantial capital outflows to the United States and Europe. A s the result of fiscal and monetary re straint, the growth of bank credit, which had been very X “swapped deposit” is a U nited States dollar-denom inated A tim e deposit accom panied by a United States dollar-Canadian d o l lar swap which leaves the depositor with Canadian dollars at the end o f the term. 263 strong in the winter and spring, tapered off at midyear. However, inflationary tendencies have not abated. A wave of strikes, especially severe in the mining and metal in dustries, held back industrial growth. Strike settlements in October and November, which resulted in large wage and price increases, threatened a further inflationary surge. A Prices and Incomes Commission, established in the summer to study the inflation problem, has proposed a system of voluntary restraint for both wages and prices. This idea has met with considerable resistance, especially from the labor unions.
