Full text of Economic Policy Review (Federal Reserve Bank of New York) : December 1975, Vol. 57, No. 12

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274

MONTHLY REVIEW, DECEMBER 1975

The Dilemmas of Monetary Policy
by P a u l A. V o l c k e r
President, Federal Reserve Bank of New Y ork

Remarks delivered to the Economic Club of New York
in New Y ork City on Wednesday, November 12, 1975

Fellow New Yorkers:
I am emboldened to use that simple salutation tonight
for more than one reason.
At the most personal level, I was reminded the other
day where my own roots lay. I heard a tape recording of
some remarks I had made. After spending three quarters
of the past sixteen years in Washington, I confess to be­
ing startled by what I heard— the full, rounded tones of
a homegrown New York accent.
Perhaps it is just that I am a bit more conscious of
that fact today than I would have been in other circum­
stances. I have returned to this great city just in time to
see it struggling with its greatest challenge. That chal­
lenge comes packaged in financial wrappings. But there
can no longer be any doubt that, underneath the wrap­
pings, there are issues that run deep into the economic
and social fabric of the city and its relationships to the
state, the nation, and even the world.
My intent tonight is not to dwell at length on the prob­
lems of the city. After all we have read and heard, to try
to describe the current situation would risk tedium and
being dated by tomorrow’s papers at the same time— no
mean trick. What I hope we have learned is that financial
acrobatics cannot ultimately substitute for hard, definitive
decisions and actions on the substance of the problem.
That illusion has brought us to the edge of an abyss, the
nature of which none of us can clearly foresee.
W hat does strike me, as I have observed the debate on
New York, is that we are seeing here in sharpened and
exaggerated form, issues closely relevant to the broader
debate on national monetary and economic policy.
It would be easy to generalize too far. Our local prob­
lems have been aggravated by the particular pressures




endemic to older urban centers. They have been thrown
into sharp focus by the special history and traditions of
this proud place, seeking to maintain itself in the fore­
front of social progress, even while its enormous com­
mercial advantages and base of wealth have, in relative
terms, been eroded. After allowing for all those special
circumstances, the competing cries that we hear for “more
financing”, on the one hand, and for “more adjustm ent”
in services and in budgets, on the other, seem to me to
parallel some larger dilemmas in national policy. In the
country as in the city, there are, in my judgment, no
purely financial solutions to those dilemmas.
Quite obviously, economic performance in recent years
— not just in the United States, but in other countries as
well— has fallen far short of the standards we set for
ourselves. We have seen at the same time in this country,
the highest levels of unemployment and the highest levels
of inflation of the postwar period. While the seventies
have seen boom as well as recession, real growth has
slowed to 2 percent in the past five years as a whole, and
productivity growth has sagged. Real take-home pay of
the average man and woman at work and real profits
have both declined over the past two years, a most un­
usual combination of circumstances.
I have not described a pretty picture.
Measured against the exuberant hopes of a decade ago,
it seems even more disquieting.
The m id-1960’s, you will recall, seemed the golden age
of economics. Leading practitioners— particularly as they
left government service— could lecture with apparent jus­
tice about how we had destroyed the old mythology and
had finally learned to apply the lessons of modern eco­
nomics to practical policy. Growth would be assured; we

FEDERAL RESERVE BANK OF NEW YORK

could extend all those trend lines showing a rise of about
4 percent a year in the real gross national product almost
indefinitely. Deviations around the trend would be con­
tained. We could calculate, if we wished, a “trade-off”
of a little more inflation for a little more employment, or
vice versa, depending on our social preferences.
It was almost as if, after proving we could go to the
moon, we could somehow run the economy at the con­
sole of a computer as well. The new challenges were said
to be income distribution and social justice— not macroeconomic policy.
Well, it did not take long to shatter those visions. To­
day, we make more forecasts; we wrap them up in more
mathematics; we use more complicated “models” ; and
we use up much more computer time. Yet somehow we
have much less confidence in the results. In frustration,
we are tempted to ask if the textbooks have relevance
and whether our economic theories are in need of whole­
sale revamping.
Why have events diverged so much from the expecta­
tion?
One approach to the answer seems clear enough. We
have permitted ourselves to get caught up in an inflation­
ary process.
Some of the ways inflation has impaired our economic
performance and prospects, particularly by distortions in
financial markets, can be measured more or less directly.
As prices have risen, businesses and financial institutions
have found their balance-sheet totals expanding at a rapid
pace. In the process, liquidity was impaired as lenders
shied away from longer term commitments. Even more
strikingly, the base of equity capital has not kept up.
Strong wage and cost pressures— particularly when they
collided with a weakening in real demand— squeezed
profits and profit margins, making it harder to raise equity
and to justify new investment at inflated prices. As infla­
tion became imbedded in market thinking, long-term
interest rates became “sticky” at historically high levels,
even when the supply of financial capital improved during
recession.
Less measurable, but perhaps more insidious, a perva­
sive air of uncertainty came to surround longer term com­
mitments. As consumers and businessmen began to feel
that their economic well-being and the results of their
investment decisions were as dependent upon the trend
of prices as upon their own productivity and business
judgment, we began to see reactions that seem perverse
by accepted axioms of economic behavior. Policy­
makers have been faced with the possibility that monetary
and fiscal actions intended to stimulate may be interpreted
as aggravating inflation. The result may be to push up




275

interest rates or encourage precautionary savings, under­
cutting the purpose of the actions.
A central banker citing the evils of inflation hardly
provides a fresh perspective, nor does deploring inflation
seem to me to provide an adequate answer to the ques­
tion I have posed. We have to push the m atter further.
We have to ask ourselves why the inflation arose in the
form that it did, and whether the distortions in financial
markets are not symptomatic of some broader currents
in our economic life.
When I was in college, some older economists were
still fond of talking about a “long cycle” in economic
affairs with protracted periods of buoyancy and exuber­
ance eventually giving way to periods of uncertainty, slow
growth, and outright contraction. When these long cycles
were mechanically related to such esoterica as the appear­
ance of sun spots, debunking was easy. But I wonder if
there is not more than a germ of truth, in terms of human
behavior, in some of their observations.
It took a long time after World War II to convince
ourselves that prosperity was really here, that a relapse
into a great depression was not a significant probability.
By the mid-1960’s, confidence had replaced these doubts
— and, as it did, the very serenity we felt about our eco­
nomic future led us into patterns of behavior that have
now turned out to be unsustainable. None of us individu­
ally would want to plead guilty. But we have to ask our­
selves whether, collectively, we did not permit the general
feeling of economic security and even euphoria to divert
us from norms of prudent conduct— from a sense of lim­
itation and restraint on risk taking— essential to ordered
growth and stability.
In raising this question of attitude and psychology, I
do not want to ignore some obvious concrete facts of the
history of this period. Our failure to face up to the financ­
ing of the Vietnam war in a timely way— against the pre­
ponderance of economic advice— has often been rightly
cited as one key factor in setting off the subsequent infla­
tion. Much more recently, we have had the shock of
increased energy prices. But even in those decisions,
where political considerations plainly intruded heavily on
economic judgment, the latter may have been weighed
too lightly, partly just because there has been a sense that
the future was assured and that we had the tools and the
knowledge to repair any temporary damage.
With the benefit of hindsight, the evidence of over­
reaching— of putting aside traditional cautions and taking
new risks— is now clear in the financial markets them­
selves. For instance, as the cult of performance took hold,
active trading of securities replaced a sense of long-term
investment commitment. We lost sight of the fact that

276

MONTHLY REVIEW, DECEMBER 1975

“perform ance” was always dependent on access to highly
liquid markets and on being among the first in and the
first out. The glow of success could last only as long as
most, in fact, did not want out. As the game broke down,
the actual result was more instability and less perceived
liquidity in many investment markets. Those facing the
need to raise new capital found their task greatly com­
plicated.
Even when market conditions were highly favorable,
however, many business managers seemed to attach less
importance to raising equity capital. W hether in financial
institutions or elsewhere, they began to rationalize de­
partures from old standards of capital adequacy and
liquidity. In a world where “downside risk” seemed
diminished, the attractions of high leverage were natural.
We began to hear the theory that the only thing that
m attered is that you were no worse off than your competi­
tors; after all, in the last analysis, the government would
need to step in to prevent catastrophe anyway.
In such a climate, regulatory restraints chafed even
harder. With considerable justification, there was con­
certed effort to eliminate outmoded, archaic, and anti­
competitive rules and regulations. In the banking world,
in particular, relaxation of interest rate ceilings and the
vogue for liability management seemed to open new vistas
for expansion without clear limitation. Freed from old
restraints, loan officers could move more aggressively
at home and abroad, and their activity often seemed to
support the objectives of national policy as well. But it is
possible to question whether the enthusiasm for eliminat­
ing the old and outmoded was matched, by the regulated
or by the regulators, with recognition of the need to retain
or shape safeguards suited to today’s conditions.
Similar psychological processes were at work else­
where. In a world in which workers are told an average
rise in real income of about 3 percent a year is virtually
assured, few will be satisfied to remain below the average
and many will find easy justification to exceed it. We
seized opportunities to take giant steps forward on behalf
of the old, the infirm, and the unemployed. Altogether,
the new demands exceeded the capacity of the economy.
We were hardly prepared for a situation in which ex­
ternal forces, whether because of poor crops or an
oligopoly-imposed increase in oil prices, inexorably
squeezed the living standards of most workers.
To return to home, some of this same psychology must
have accounted for the willingness of the city and its
citizens to seek ever higher levels of services, despite a
weakening economic base, without the alarm bells ringing
at a much earlier time. Against a background of pro­
longed prosperity and high priority for social objectives,




what could be more natural than to make full use of wel­
coming bond markets? If such resort involved some abro­
gation of irritating budgetary and financing conventions,
could this not be accepted in an era of “creative” and
“innovative” finance? In the long run, after all, growth
and inflation would smooth over any difficulty.
I recognize the danger of abstract theorizing about
human psychology. Nevertheless, in retrospect, attitudes
developing over the past decade do help to explain some
of the dislocations and difficulties today.
It was not so much a conscious willingness to take
large new risks, but that the consciousness of risk was
itself reduced. It was not so much that we saw ourselves
acting without a sense of prudence, but that the defini­
tion of prudence was itself changed. It was not so much
that we thought the laws of economics had been repealed,
but that we could manipulate them to our will.
I recognize there is a school of thought that would
lay the blame much more directly at the feet of monetary
policy. According to this thesis, “inflation is always and
everywhere a monetary phenom enon” . There is no need
to look further for culprits or to seek explanation in
changes in economic structure or attitude.
Now I am not about to deny the correlation between
growth in the money supply and the price level; over a
long enough period of time, excessive growth in the
money supply is bound to bring higher prices.
Taken alone, the monetary explanation seems to me
seriously incomplete. For one thing, the correlation be­
tween money and prices is far from perfect. There is no
way that even the relatively rapid monetary expansion of
1972 and 1973— averaging IV 2 percent— can by itself
explain double-digit increases in consumer prices and
the much stronger surge in wholesale prices last year.
Clearly, nonmonetary factors can have an important im­
pact on inflation— and an impact that is “tem porary”
only from a more Olympian time perspective than most
of us can afford to assume.
Monetary policy does not work in a vacuum, political
or economic. Inflation, once started, can become em­
bedded in the fabric of expectations. W hether the initial
impetus is monetary or nonmonetary, the expectations
vastly complicate the job of bringing inflation under con­
trol.
It seems to me unrealistic to the point of being mean­
ingless to say, for instance, that monetary policy can
always press to whatever point may be required to bring
price stability. We have to consider whether the result
of that action would be consistently higher unemploy­
ment, prolonged inability to finance the investment needed
to support a growing economy, or even dislocations in

FEDERAL RESERVE BANK OF NEW YORK

our basic financial structure. If monetary policy has to
bear the load alone, cutting across the grain of other
deep-seated elements of economic behavior, those con­
sequences cannot be ruled out.
To take the other side of the coin, neither can the
monetary authorities reasonably accept whatever they
find in the way of price expectations and other economic
pressures and proceed within that context to provide the
money and credit to finance ever higher levels of business
activity. Such an approach can only reinforce inflation and
require that we validate every excess in the behavior of
large economic units. The result, it seems clear, might
be to postpone the day of reckoning, but not to avoid it.
In important respects, the problem from a national
perspective is not all that different from the problem of
how best to deal with the situation facing New York. At
one extreme, to ask for and to receive financing without
real adjustments in the underlying economic and bud­
getary situation would merely pave the way to a larger
crisis in the future. To expect adjustment so quick and
draconian that new financing will not be required over a
transition period may be equally shortsighted.
Faced with such dilemmas, there is a natural longing
to look toward new avenues for easing the “adjustment
problem”. On a national scale, the list of proposals is a
long one: (1) Removal of the evident and numerous
obstacles to efficiency and productivity would obviously
help; we all can make a list as long as our arm. (2) Im ­
proved competition in labor and product markets could
reduce rigidities in costs. (3) We can and should review
regulatory practices— not only those lingering from an
earlier era, but those growing out of more recent environ­
mental and consumer concerns— to see if they are achiev­
ing worthwhile objectives at acceptable cost. (4) I suspect
we have too long neglected exploring techniques— some
long established in other countries— that might improve
the atmosphere at the bargaining table. For instance, as
we look with admiration at the postwar German economic
performance, can we dismiss entirely the ideas of “co­
determination” and “concerted action” developed in that
country as methods of achieving more understanding
among business and labor? (5) Potentially most impor­
tant in my view, those elements of our tax structure that
serve as a drag on investment activity, and particularly
penalize equity financing, need review and reform. But
citing these five areas suggests their limitations for resolv­
ing our current dilemmas. However attractive in the ab­
stract, in their specifics they will be fiercely debated.
Whatever their future potential, they must be longer
range measures.
In the here and now, the chances for improved per­




277

formance in the nation and in the city seem to me to rest
on changes in attitudes that have been nurtured over a long
period of prosperity and stability. The harsh reality is that
such changes seldom take place except under the pressure
of events.
In our market system, these pressures for change— the
signals for action— typically come in financial form. A
business or a government exhausts its credit resources;
individuals cannot spend beyond their income for very
long; the unprofitable and undercapitalized firm eventu­
ally capsizes in an economic squall.
In theory, we could, of course, organize our economy
differently, so that financial pressures did not play so
prominent a role. Carried to one extreme, direct pressure
and force can be applied by a government, as they are
in a communist society. All of us would reject that.
Western governments, including our own, have more
pragmatically experimented with “incomes policy”—
guidelines or controls of varying degrees of severity over
prices and wages. I am hardly in a position to be doc­
trinaire on that subject, having in 1971 advocated the
freeze precisely to help change inflationary expectations.
Whatever the merits of that experiment, I see no credi­
bility in a renewed attempt now or in the foreseeable
future in this country. Moreover, experience here and
abroad in peacetime suggests strongly that milder con­
trols cannot be effective for long when inconsistent with
market pressures and when they too easily can be in­
voked as a substitute for other essential action.
So, it seems to me an illusion that we can find the
path to renewed stability other than through the disci­
plines inherent in the market. We cannot expect the
process to be smooth and steady. But we can be sure that
it will be speeded and eased to the extent individuals,
businesses, and governments recognize the need for
changes in behavior and attitudes that rest on conditions
that no longer exist. Our success will depend as well on
the skill and wisdom we can marshal in shaping our
monetary and fiscal policies.
The setting in some respects is propitious. We can
shape our policies against the background of a rapid re­
bound in business activity. Despite some nasty surprises,
the overall picture on inflation this year is at least better
than last. Moreover, the improvements in productivity
that should accompany expansion offer some prospect
that the rise in labor costs per unit of output could mod­
erate for a period, even as business improves.
Nevertheless, both in production and prices, the out­
look for 1976 and beyond seems to me hardly assured.
The vigor of business recovery so far has been heavily
dependent on the cessation of heavy inventory liquidation.

278

MONTHLY REVIEW, DECEMBER 1975

Consumer spending, spurred in part by the tax cut, has
helped, but sustained growth will depend on incomes gen­
erated by other sectors of the economy.
A “norm al” sequence for sustained business recovery
would look to housing and later business investment to
become driving forces. It can happen that way again, but
we would be blind to ignore factors that could interrupt
the sequence. The renewed sharp pace of wholesale price
advances in October is warning enough— if any is needed
— that cost and price pressures are still strong and could
undermine prospects for continuing strong recovery.
Backwash from the financial difficulties of New York
City and of New York State and its agencies could com­
plicate the job of financing expansion in markets already
suffering from inflation and past excesses.
All of this points up critical questions for the Federal
Reserve— questions that deserve answers. To me, the
answers to those questions become a good deal clearer—
and perhaps not even very controversial— if examined
from the longer perspective of the basic functions of the
Federal Reserve System. The first of those functions—
and the one that attracts so much comment year in and
year out— is to maintain overall supplies of money and
credit at levels conducive to growth and stability. The
second— sometimes almost forgotten except in times of
strain— is to ensure the orderly functioning of the credit
and payments system through thick and thin and to guard
the stability of the banking structure.
Dilemmas or even conflicts can arise in discharging
these functions. Today, in providing money and credit
we do not face the textbook alternatives of dealing with
unemployment or with inflation, but we have to face
them both at the same time. But, I would suggest, there
is a reasonable approach to that dilemma.
I must confess to a certain natural past (and I suspect
future) skepticism about announcing money supply “tar­
gets” or ranges over a substantial period of time ahead.
Set too narrowly and followed slavishly, they may imply
too little operational flexibility to meet changing circum­
stances. As a matter of concept, they may imply a de­
gree of faith in the crudest forms of monetarism— that
policy can be set and judged in terms of the money sup­
ply alone— that I do not share.
Nevertheless, in the situation we face today, I believe
it is distinctly helpful to set out the general dimensions
of our intended policies in such quantitative and rela­
tively unambiguous terms. Those making economic de­
cisions— whether businessmen, governments, consumers,
or those in financial markets— can then shape their deci­
sions in a context of fuller knowledge about the inten­
tions of the policymakers.




I will not attempt to debate here the appropriateness
of the precise numerical ranges, such as the 5-7Vi percent
growth target range currently in effect for the narrowly
defined money supply— whether it could be a bit higher
or lower, or whether the range itself is too narrow or
broad. But I will defend strongly the general implications
of these numbers: The Federal Reserve will not willingly
finance new excesses and increases in the rate of inflation;
nor will it insist immediately on limiting money growth to
rates fully in line with growth of our real productive poten­
tial in circumstances where the strong forward momentum
of price increases in “the pipeline” must be given some
weight.
Over time, a return to price stability necessarily im­
plies a slower growth of money and credit than our pres­
ent objective. But our present policy of steering between
the extremes— a policy that has perhaps inadequately
been described as “m oderation”— seems to me both clear
in intent and fully defensible. And I believe the numeri­
cal ranges help provide the longer perspective needed for
those of you who try to interpret, literally from day to
day or week to week, the significance of the gyrations in
reported money and credit data.
' In present circumstances, it is worth remembering that
it is the second of our functions— to protect the payments
system— that was enshrined in the original Federal R e­
serve Act, adopted after a series of banking crises had
disrupted the economy. Essentially, the broad economic
policy responsibilities, so much debated in its specifics
today, were grafted onto this original function over the
years, rather than the reverse. But I assure you this basic
statutory function, which demands special concern for
the functioning and health of the banking system, is not
forgotten.
That continuing concern finds its reflection in part in
the day-to-day— sometimes dull but never forgotten—
discharge of our responsibilities for the supervision and
regulation of banks. The more dramatic, but seldom re­
quired, role is sometimes described as the “lender of last
resort”. Because in recent years recourse to the Fed for
credit has so rarely been required on any scale, clarity in
our approach in that respect would be useful too.
The law provides the Federal Reserve with only very
limited emergency powers to lend to nonbank borrowers
for rather closely defined short-term liquidity needs. In a
sense, the presumption is against such assistance. Con­
sequently, short-term credit for liquidity purposes has
not, for instance, fit the particular circumstances of New
York City, where the credit need has been for a substan­
tial period, where the budgetary problem has been central,
and where the difficulties have not arisen as a result of

FEDERAL RESERVE BANK OF NEW YORK

market disturbances elsewhere but from basic problems
of the city itself.
By statute and policy, the presumption is quite the re­
verse should the stability of the payments and banking
system be questioned; indeed, it is a central legal and
policy duty of the Federal Reserve to assist banks in
coping with pressures created by extraordinary economic
strains and, particularly, to maintain the depository func­
tion unimpeded. I emphasize this side of our responsi­
bilities in recognition of the concern that some have ex­
pressed about the impact of a default of New York City
on the local money market banks. It would, of course, be
more accurate to describe those banks as national and
international institutions that happen to have their home
offices in the city. They hold city securities— slightly over
$ 1 billion in the aggregate. But that amounts to less than
3A of a percent of their earning assets and to little more
than 9 percent of their total capital and reserves.
Should these securities be substantially impaired in
value over a long period, there are some obvious implica­
tions for future profits. But it is by no means obvious—
or perhaps even likely— that serious impairment will last.
Doubts on that score have led the supervisory authorities
to decide to defer for up to six months following any de­
fault a mandatory write-down of the value of those securi­
ties. Even then, an unavoidable impact on profits— which
have generally risen in recent years— is quite a different
thing from the default of New York City affecting the
basic stability of the banks; the holdings are simply not
that large. The problem, if it exists, would lie in psycho­
logical apprehensions, and the classic response of the
Federal Reserve would be to act— forcefully and freely—
to provide an alternative source of liquidity.
A ll o f this falls in the c a teg o ry o f co n tin g e n c y p la n n in g .

As matters stand, I have been encouraged in recent
days that the state and the city are coming to grips more
directly with the budgetary problems that underlie the
financial crisis in their affairs. In my judgment, questions
about the financial health of the state can be resolved, and
the marketability of its securities can be restored in a
reasonable time frame. Even now, with the clock running
all too fast, the needed combination of stern budgeting
and residual financing for the city should not be wholly
beyond the reach of those interested in solving the prob­
lem and in limiting and containing its repercussions.
Indeed, I would go further. The kind of agonizing
adjustments in practices and attitudes the city and state
are facing in the most acute form find their counterparts




279

in other areas of our national economic life. While the
problems differ in detail and scope, the process will never
be quick and painless. But our collective response can
lay— is laying— the basis for a return to stability and
prosperity.
In business and public life, most of the men and women
in this room— and I do not exclude myself— have for a
long time seen their horizons and preoccupations extend
to the nation and the world. For too long, those few labor­
ing for the financial and economic strength of this city—
away from the spotlight and amid the frustrations— have
had too little support. Today, we begin to realize a simple
truth— that honor and fortune alike rest ultimately on
the good health and prosperity of our city.
Out of this travail, I for one believe we can help make
New York an example, not of default and decay, but of
how to learn from experience, respond to adversity, and
restore stability. Call it whether in irony or praise Fun
City, the Big Apple, or the Capital of the World, we can
be sure that whatever we do here will be more than a
symbol. It can be a real turning point, not just for New
York, but for the nation as a whole.

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Glossary is available without charge from the
Public Inform ation Department, Federal Reserve
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N. Y. 10045.

280

MONTHLY REVIEW, DECEMBER 1975

The Business Situation

Economic activity is continuing to expand, but the up­
ward impetus is narrowly based and has slackened some­
what in recent months. In October, there was a discern­
ible slowdown in the pace of the recovery from that re­
corded for the third quarter.* While industrial production
rose for the sixth consecutive month, the October advance
was less than half as large as the average of the earlier
months and was also not so broadly diffused. Similarly,
there was an appreciable slowing in the growth of nonagricultural employment in November. Yet, because of a
large drop in the civilian labor force in that month, the
unemployment rate declined to 8.3 perccnt, the same level
that had prevailed in September.
The latest readings of the other monthly business sta­
tistics also point to a temporary lull in the economic re­
covery. Retail sales have been relatively sluggish since
July, following several months of very large increases. Con­
sumption spending may be buoyed in months to come,
however, by continued advances in personal income.
Single-family housing starts have recovered substantially
during the past six months, but construction of apartment
buildings remains slow. Capital spending has also remained
weak. There are increasing signs that inventory liquidation
is drawing to a close. Businesses have clearly gone a long
way toward paring their excess inventories and have suc­
ceeded in establishing a much better balance between sales
and inventories.
Despite the occasional monthly flare-ups, the inflation
rate appears still to be hovering around the 7 to 8 percent
range. While this is unusually rapid by historical stan­

*
A ccording to revised estim ates, the increase in real gross na­
tional pro d u ct (G N P ) am ounted to a 13.2 percent annual rate in
the third qu arter, up 2 percentage points from the p relim inary esti­
m ate. T he rate of inventory liquidation was revised dow nw ard, while
the advance in real final sales w as revised upw ard. T he rate of
grow th o f the im plicit price deflator fo r G N P was also adjusted
dow nw ard slightly to a 4.7 p ercent an n u al rate. R eleased along
w ith the G N P revisions w ere p relim inary estim ates of co rp o ra te
profits in the th ird quarter. P retax co rp o ra te profits, expressed
at an annual rate and adjusted fo r changes in inventory v a lu a ­
tion, increased an estim ated $17.6 billion to $122.5 billion.




dards, it still represents a major improvement over the
prolonged double-digit increases recorded last year. Con­
sumer prices, led by a fairly stiff increase in retail food
prices, accelerated a bit in October. Excluding food, how­
ever, the October rise in consumer prices was actually be­
low the average for the previous six months. Wholesale
prices were unchanged in November, as the large drop in
agricultural prices offset the moderate advance in the
priccs of industrial commodities. Looking ahead, there
appears to be little reason to anticipate a fresh burst in
the rate of inflation in the coming months. There has, in
fact, been some easing in the rate of increase in nonfood
consumer commodity prices in recent months, and retail
food price increases are currently expected to slow con­
siderably as the record 1975 crops come to market. Also,
the large gains in productivity typically associated with
the early phases of economic recovery may help to blunt
some of the inflationary pressures arising from the sizable
increases in wages. Moreover, the substantial slack in the
labor market is likely to exert a restraining influence on
wage increases for some time to come, particularly in less
organized sectors of the economy. However, there are
major questions surrounding the large number of major
collective bargaining agreements scheduled for 1976.
IN V EN TO RIES AND IN D U STRIA L PR O D U C TIO N

It appears that most of the once massive inventory
overhang has largely been eliminated, and some busi­
nesses have begun to replenish their depleted stockpiles.
M easured on a GNP basis, the real inventory-sales ratio
for the business sector declined further in the third quar­
ter to the lowest level since the opening quarter of 1974
(see Chart 1). This level, it may be noted, is in line with
past experience at similar stages of cyclical recoveries.
At the same time, the rate of inventory liquidation was
much reduced from what it had been earlier in the year.
Within the trade sector, while wholesalers were still re­
ducing their real inventory stocks during the third quarter,
retailers had actually begun to add to theirs. However,
the book value data suggest that a turnabout in inventory
investment may have occurred in the wholesale trade

FEDERAL RESERVE BANK OF NEW YORK

C h a rt I

REAL INVENTORY INVESTMENT AND REAL INVENTORY - SALES
RATIOS IN THE GNP ACCOUNTS
Season ally a d ju sted a n n u a l rates
Billions of 1958 dollars

Billions of 1958 d o llars

10

REAL IN V E N T O R Y IN V E S TM E N T:
TRADE

H ■
II. M i l ■III ill

5

0

■

1 1
II;

LLI

1

1 .L

1

1

...1... J__ __

1. 1 ..
1

1.1

1 _L i
10

M A N U I :A C T U R IN G

-

ml
1.

.

. . l l ■III I l l l

.

' 1"
J
1

i __ I__

! 1 1.J

.

11I

...

5

0

I1

-5

1 1 1 .-J___ L J __ -10

RATIO O F REAL BUSINESS IN V E N T O R IE S TO REAL FINAL SALES
O F B USINESS G R O S S N A T IO N A L PRODUCT (GNP)

1970

1971

1972

1973

Source: United S ta tes Departm ent of Commerce.

sector as well at the end of the third quarter. Within the
manufacturing sector, the liquidation of real inventories
continued in the third quarter but at about half of the
pace of the preceding quarter. In October, nondurables
manufacturers posted their third consecutive monthly
gain in the book value of inventories. The book value of
durables m anufacturers’ inventories, however, registered
another decline. This drop more than offset the gain for
nondurables manufacturers, but the net decline for the
total manufacturing sector was the smallest this year.
The Federal Reserve Board’s index of industrial production posted a moderate 0.4 percent gain in October. While
this marked the sixth consecutive monthly rise, the October
advance was less than half as large as the average of the
earlier months and was also not so broadly distributed,




281

Consumer goods output continued to climb in that month,
but the output of capital goods and defense equipment
slipped back after previous advances. Symptomatic of the
more sluggish growth in the production pipeline, the
increase in output of materials in October was less than
one fourth as large as the average gain for the previous
four months. Iron and steel have once again resumed
the declining pattern evidenced throughout most of 1975
and interrupted only briefly in August when there was a
bunching of purchases by steel mill customers, an effort
apparently aimed at stocking up before the announced
price increase took effect on October 1. If output were
to continue to grow at the markedly slower October pace,
it would take quite a while before production recovered
the ground lost during the recently ended recession. As
of October, industrial production was still 8.6 percent
below the November 1973 peak. Furtherm ore, the W har­
ton index of capacity utilization for the industrial sector
stood at 80.3 percent in the third quarter, 16 percentage
points below the peak recorded two years earlier.
PER SO N A L INCOM E, CO N SU M E R SPEN D IN G , AND
RESID EN TIA L CON STRUCTION

Personal income posted another solid gain in October,
amounting to $12.7 billion at a seasonally adjusted an­
nual rate. Wage and salary disbursements rose by $8.7
billion, and this marked the eighth consecutive month of
growth. About $2 billion of the October increase in
wages and salaries was attributable to a pay raise for
Federal Government employees. The rest of the increase
in wage and salary disbursements was widespread across
payroll categories.
After fairly rapid growth earlier in the year, consump­
tion spending has been flat in recent months. Retail sales
in October were only slightly above the level of July, and
this sluggish pattern for the monthly sales figures has
characterized both durables and nondurables sales categories. Domestic automobile sales also exhibited little
buoyancy over the July-November period. To be sure, the
succession of sizable monthly advances in personal in­
come continues to provide the wherewithal for further
gains in coming months. Perhaps, though, consumers’
lingering uncertainties about employment prospects and
inflation may be tempering the strength of the recovery in
consumer spending. For example, while the index of consumer sentiment, as measured by the Survey Research
Center at the University of Michigan, rebounded in the
second quarter from the all-time low recorded in the first
quarter, it showed little further progress in the third quarter and remained at a low level by historical standards.

282

MONTHLY REVIEW, DECEMBER 1975

Thus, the relatively flatter pattern for retail sales since
midsummer may be an indication that consumers have
taken cautious wait-and-see attitudes at this early point in
the recovery.
Residential construction appears to be showing some
tentative signs of improvement. To date, the recovery in
housing starts compares rather favorably with the up­
swings in past housing cycles, although the current re­
covery has proceeded from a very depressed level. In
October, housing starts were running at a 1.46 million
unit annual rate, up slightly more than 200,000 units
from the third-quarter rate. Almost all of the increase
was in single-family starts. Building permits, which had
risen about 10 percent in September to their highest level
since June 1974, were essentially unchanged. Yet, despite
the rebound in housing starts, a number of factors sug­
gest that the rate of recovery in housing in the near term
will be more sluggish. Although the overhang of unsold
new single-family homes has been reduced considerably,
the backlog nevertheless remains high. Even more im­
portantly, mortgage terms have remained tight despite
large savings inflows. Lenders seem hesitant to issue new
mortgages, perhaps because of fears of rising interest rates
and induced outflows. At the same time, demand remains

weak as buyers face large uncertainties over the economic
outlook and high home prices, and the run-up in energy
costs probably continues to discourage prospective buyers.
NEW O R D ER S, CAPITAL SPEN D IN G , AND
LEADING IN D IC A TO RS

After dropping in the previous month, the flow of new
orders received by durable goods manufacturers advanced
in October. Actually, the October gain would have been
bigger but for a fairly large decline in the bookings for
defense goods, a development unrelated to the current
state of business conditions. Excluding new defense book­
ings, the increase in new durables orders amounted to
$0.9 billion in October, which more than erased the dip
of the preceding m onth and which was a bit above the
average monthly gain recorded over the M arch-August
period. As shipments of durable manufactured goods also
rose in October and exceeded new orders, the backlog of
unfilled orders edged down further, continuing the pattern
of the past year. In contrast, at this stage of the recovery
during previous postwar upturns, the backlog of unfilled
durables orders had usually begun to rise.
While real business capital spending leveled off in the

C h a rt II

C O M P O S ITE IN D E X O F LEAD IN G IN D IC A T O R S
S e a s o n a lly a d ju s t e d ; 1 9 6 7 = 1 0 0
P ercent
1130

-

110

100

- 80

ill
63

64

65

66

ill
67

J_L
68

111

11
69

70

71

N o te: S h ad ed areas represent recession p erio d s , in d ic a te d by the N atio n a l Bureau of Economic Research (NBER) chronology. The latest recession
has not yet been dated by the NBER.
Source: United States D e p a rtm e n t of Commerce, Bureau of Economic A n alysis.




ILL LLL ILL

70

FEDERAL RESERVE BANK OF NEW YORK

third quarter following four quarters of declines, there
are no signs of any exuberance in this sector, where re­
covery typically lags behind that in other sectors. The
recent McGraw-Hill survey of planned capital outlays
points to a 9 percent rise for 1976 with an equal increase
in capital goods prices, thus implying no gain in real
spending levels. A similar projection was obtained by the
Commerce Department in its October-November survey
of planned plant and equipment spending; it was reported
that businesses expect to step up their capital outlays in
the first half of 1976 at a 10.6 percent annual rate, com­
pared with what they were planning to spend during the
second half of 1975. While the various surveys have gen­
erally tended to underestimate capital outlays in the first
years of recoveries, the lackluster outlook evidenced by
the surveys is corroborated by recent monthly data on
new orders for nondefense capital goods. Although new
orders rose in October, the most recent month for which
data are available, they were slightly below their July level.
An interesting barometer of economic activity is the
composite index of leading indicators, which is as­
sembled and published each month by the United States
Department of Commerce. The index is made up of a
dozen individual data series and is designed to provide
an advance reading on the direction of economic activity.
Several of the data series, such as net business formation,
building permits, new orders for consumer goods and ma­
terials, and contracts and orders for plant and equipment,
represent early indications of spending intentions. After
a while, these decisions show up as actual expenditures.
Other data series, such as the average workweek, the
layoff rates, changes in the wholesale prices of crude
materials, and vendor performance, reflect the decision
of managements in reaction to the perceived strength of
prospective demand. Also included in this index, but
harder to characterize, are common stock prices, the real
money stock, and changes in total liquid assets.
The revised composite index of leading indicators has
fallen in each of the past two months from 102.6 in
August to 102.0 in October (see Chart II). The ques­
tion arises whether this drop points to a downturn in eco­
nomic activity or to a slowdown in the rate of prowth.
An examination of past episodes where the index de­
clined in two successive months after increasing in previ­
ous months reveals that the most recent two-month de­
cline is the smallest in the postwar period. The two com­
ponents that declined for two straight months and ac­
counted for most of the drop in the index were the real
money supply and liquid assets. However, it appears that
the real money supply expanded strongly in November
following contractions in the two previous months. In addi­




283

tion, the rebound of the composite index of leading indi­
cators prior to the declines in the past two months had
been quite strong, compared with the upturn pattern in
past early recoveries. It should be noted that, as a reces­
sion predictor, the composite leading indicators series has
exhibited a number of false signals. For example, down­
turns in 1962, 1963, and 1968 were not followed by ma­
jor downturns in economic activity. However, the sluggish
pattern of the index in the past two months is consistent
with the pattern of slower growth exhibited by a number
of other monthly series and may be an indicator that the
pace of the recovery in the near term will remain con­
siderably below the extremely rapid third-quarter rate.
LABOR M ARKET DEVELOPM ENTS

The slackening pace of the economic recovery has car­
ried over to the labor market. In November, nonfarm
employment was essentially unchanged in both the house­
hold and payroll surveys. According to the payroll survey
of establishments, seasonally adjusted payroll employ­
ment edged up by a scant 41,000 workers following four
months of very hefty gains. Indeed, from June to October,
the increment in payroll employment amounted to more
than 1.2 million workers. In the separate survey of house­
holds, nonagricultural employment dipped by 33,000
workers and agricultural employment fell by 130,000
workers subsequent to a similar decline in the previous
month. However, the civilian labor force, which often
exhibits volatile movements on a monthly basis, fell by
a substantial 464,000 workers. Because of the propor­
tionately greater decline in the labor force, the seasonally
adjusted civilian unemployment rate fell 0.3 percentage
point to 8.3 percent of the labor force, bringing it back to
its September level.
While the average number of unemployed workers
has been substantially higher in 1975 than in the previous
year, there has also occurred a sharp increase in the propor­
tion of unemployed workers who are eligible for unem­
ployment insurance benefits (see Chart III). For those
who are eligible, these benefits act partially to replace the
income lost due to unemployment. By acting as a cushion
for lost wage and salary income, unemployment insurance
benefits also tend to stabilize aggregate consumer outlays
on goods and services. These benefits are a particularly
potent stabilizer since they are not subject to the personal
income tax or social security payments. Typically, the
fraction of unemployed workers eligible for benefits rises
during recessions. This partly reflects the greater numbers
of adult men and job losers among the ranks of the un­
employed; these groups have larger fractions who qualify

284

MONTHLY REVIEW, DECEMBER 1975

Chart III

INSURED UNEMPLOYMENT AS A PERCENTAGE
OF TOTAL UNEMPLOYMENT
Percent

S e a s o n a lly adju sted

percent
80

80

70 -

70

/ -

/

60 -

50 -

40 -

30

^

-

60

-

50

-

40

1 11 1 1 1 1 11 11 1 1 11 11 1 111 1 1 1 11 1
1967

1968

1969

1970

1971

1972

1973

1974

30

1975

Note: Q uarterly data on insured unemployment seasonally adjusted by
Federal Reserve Bank of New York.
Source: United States Department of Labor, Bureau of Laboi ’ Statistics and
M anpower Administration.

to receive unemployment insurance benefits. In the most
recent recession, new legislation which temporarily ex­
tended the benefit period has also had an impact in raising
the proportion of unemployed workers who receive ben­
efits. This proportion has in fact risen throughout 1975 to
70.9 percent in the third quarter, by comparison with a
figure of 51 percent for all of 1974.
Although the tempo of wage rate increases appears to
have picked up in the two most recent months, the
monthly wage data typically exhibit considerable vari­
ability, and the overall rate of wage inflation seems to be
about in line with that registered in the third quarter. In
the July-September interval, average hourly earnings in
the private nonfarm economy, adjusted for interindustry
shifts and overtime in manufacturing, advanced at an
8.4 percent seasonally adjusted annual rate. This was
identical to the gain in the first quarter of this year but
slightly above the second-quarter rate of advance. The
advances in adjusted average hourly earnings in October
and November brought the three-month growth in the
adjusted index to a seasonally adjusted annual rate of
& percent.
PRICES

Although there have been a number of flare-ups in both
wholesale and retail prices in recent months, it appears
that the typical pattern of moderating price increases in




early recovery phases is continuing in the current re­
covery. The twelve-month growth rate in the consumer
price index, which smooths out much of the monthly
volatility of retail prices, has fallen steadily over 1975.
In October, the twelve-month growth rate in consumer
prices stood at 7.6 percent, down substantially from a
figure of almost 12 percent with which the year began.
This slowdown reflects continuing moderation in recent
months in consumer nonfood commodity prices and ser­
vices prices (apart from higher New York City subway
fares in September). In addition, there is the encouraging
prospect that food price increases are likely to slow con­
siderably as the record 1975 crop comes to market.
On a seasonally adjusted basis, the wholesale price in­
dex in November was virtually unchanged from the level
of the previous month. This development reflected a sub­
stantial drop in the index for farm products and processed
foods and feeds, combined with a moderate increase in
wholesale prices of industrial commodities. Wholesale
prices of farm products and processed foods and feeds
fell at a seasonally adjusted rate of 1.2 percent (not
annualized) following very rapid gains in the previous two
months. While these prices have been advancing fairly
rapidly in the past six months, as of November they actu­
ally stood slightly below the level of a year ago. Prices of
industrial commodities rose at a 0.6 percent seasonally
adjusted rate in November, marking the first month since
April that the rate of increase in these prices did not
accelerate further. It should be pointed out, however, that
prices of nonagricultural intermediate materials and sup­
plies, which are an im portant input for nonfood com­
modities at the retail level, have advanced at a 7.5 percent
seasonally adjusted annual rate over the past three months.
In November, these prices stood 5.2 percent above the
year-ago level.
Consumer prices climbed at a 0.7 percent seasonally
adjusted rate in October, a somewhat faster rate of in­
crease than the moderate gains of the two previous months.
All the acceleration, however, was attributable to the
run-up in the volatile food prices component. Accord­
ing to the Departm ent of Agriculture, however, the growth
of retail food prices should moderate to a 4-5 percent
annual-rate range in the first half of 1976. Consumer
prices of nonfood commodities, which had risen at an
average annual rate of about 7 percent in the first three
quarters of the year, have averaged about a 5 percent an­
nual rate over the three most recent months. Increases in
the prices of services have remained moderate in recent
months, apart from the September spurt which largely
reflected higher subway fares in New York City.

FEDERAL RESERVE BANK OF NEW YORK

285

The Money and Bond Markets in November

Interest rates in the money and bond markets stabilized
in November after dropping sharply in the previous
month. Although slightly easier conditions prevailed in the
Federal funds market, reports of very large weekly in­
creases in the money stock produced doubts that the
monetary authorities would promote further declines in
interest rates in the near term. As a result, rate declines
early in the month were generally offset by subsequent
increases.
Substantial new corporate borrowing weighed heavily
on the bond market in November, as the calendar of new
issues for December increased. The Treasury continued to
borrow through large increases in the regular bill auctions
but not through coupon issues during the month. Govern­
ment agency financing activity was also heavy.
Yields on high-grade tax-exempt securities declined
modestly in November, but lower rated issues continued
to encounter market resistance. Throughout the period,
uncertainty revolved around the prospect of finding a
means of avoiding a New York City default. Optimism
was revived in midmonth when a three-year moratorium
on the payment of certain New York City notes, with the
option of exchanging them into long-term Municipal As­
sistance Corporation (M A C ) bonds, was passed by the
New York State legislature and enacted into law. The
moratorium, however, is being challenged in the courts.
By the end of November, the legislature had passed a
broad plan designed to help avert a default by New York
City, which included the raising of certain taxes. Subse­
quently, President Ford indicated that he would propose
Federal legislation to provide the city with up to $2.3
billion in short-term loans.
According to preliminary data, the narrowly defined
money stock ( M J rebounded strongly in November from
its decline in October. With consumer-type time deposits
continuing to advance, the more broadly defined money
stock (M l.) expanded rapidly as well. The bank credit
proxy also experienced relatively strong growth in com­
parison with previous months.




THE MONEY MARKET AND THE
MONETARY AGGREGATES

Interest rates on most money market instruments fluc­
tuated narrowly in November, after having fallen in the
previous month (see Chart I). The effective rate on Federal
funds averaged 5.22 percent during the month, down 60
basis points from October. With the rate of Federal funds
averaging over 3A percentage point below the discount
rate, member banks continued to make little use of the dis­
count window (see Table I) . Rates on 90- to 119-day
dealer-placed commercial paper closed the period at 5.75
percent, down Vs percentage point from the end of Octo­
ber, and rates on ninety-day bankers’ acceptances fell 5
basis points to 5.75 percent. At the month end, large
negotiable certificates of deposit (CDs) maturing in ninety
days were trading in the secondary market at 6.30 per­
cent, a decline of 10 basis points over the period.
Business demand for bank loans remained weak in No­
vember. Over the first four statement weeks of the month,
business loans at large commercial banks rose by $642
million; however, a portion of this reflects a rise in hold­
ings of bankers’ acceptances. Business loans excluding
bankers’ acceptances declined by $519 million. Over com­
parable periods in the preceding three years, these loans
showed an average increase of $877 million. One large
bank lowered its prime lending rate x/ i percentage point
in two steps to 7 percent. A few other money center banks
reduced their prime rates lA percentage point to IV a. per­
cent, and at the beginning of December this became the
prevailing rate at most money center banks.
Preliminary data indicate that, after experiencing slug­
gish growth over the previous four months, the monetary
aggregates grew at rapid rates in November. During the
four-week period ended November 26, seasonally adjusted
M ,— private demand deposits adjusted plus currency out­
side commercial banks— advanced at a 13.7 percent an­
nual rate from its average level during the preceding four
statement weeks. This rapid expansion raised the growth

286

MONTHLY REVIEW, DECEMBER 1975

C h a rt I

SELECTED INTEREST RATES
S e p t e m b e r - N o v e m b e r 1975
M O N E Y M A R K E T RATES

B O N D M A R K E T YIELDS

S e p te m b e r

N o te :

O c to b e r

P erc e n t

Novem ber

D a ta are shown for business days only.

M O N E Y MARKET RATES Q UOTED: Prime com m ercial loan rote a t most m ajor banks;
o ffe rin g rates (quoted in terms of rate of discount) on 90- to 119-day prime com m ercial
p a p e r q u oted by three of the five d ealers th at re p o rt th eir rates, or the m idpoint of
the ran g e q u o te d if no consensus is a v a ila b le ; the effective ra te on F ed eral funds
(the rate most representative of the transactions executed); closing bid rates (quoted
in term s of rate of discount) on newest o u tstan d in g three-m onth Treasury bills.
B O N D MARKET YIELDS QUOTED: Yields on new A a a -r a te d public utility bonds are based
on prices asked by u n d erw ritin g syndicates, adjusted to m ake them eq u iv a le n t to a

rate of M 1 over the past thirteen weeks to 3.3 percent (see
Chart II ). Consumer-type time and savings deposits at
commercial banks in November expanded at a relatively
strong rate. Consequently, M 2—
plus time deposits
other than large negotiable CDs— also registered a sizable
gain. During the first four statement weeks of the month,
these deposits advanced at a 12.8 percent annual rate
from their average during the four statement weeks ended
October 29. Over this same period, M 2 increased at a 13.2
percent annual rate. After rising at a rapid rate in the
preceding month, the average level of CDs declined slightly
in November. The adjusted bank credit proxy— total mem­
ber bank deposits subject to reserve requirements plus
certain nondeposit sources of funds— rose at a 12.8 per­
cent average rate.




stan d ard A a a -ra te d bond of a t least tw enty yea rs ' m aturity; d a ily av erag e s of
y ield s on seasoned A a a -ra te d corporate bonds; d a ily a v e ra g e s of yield s on
long -term G o vern m en t securities (bonds due or calla b le in ten yea rs or more)
and on G overn m en t securities due in three to five y ears, com puted on the basis
of closing bid prices; Thursday a v erag es of yield s on tw enty seasoned tw entyy ear ta x -e x e m p t bonds (carrying M o o d y ’s ratings of A a a , A a , A , an d Baa).
Sources: Federal Reserve Bank of N e w York, Board of G overnors of the F e d e ra l
Reserve System, M oody's Investors Service, Inc., and The Bond Buyer.

THE GOVERNM ENT SECURITIES M A RKET

Yields on most Government securities ended higher on
balance in November. The interest rate declines that
typified the previous month continued during the first
week of November. Easier conditions prevailed in the
Federal funds market, and increased investor preference
for safety supported demand. Toward the middle of the
month, however, investor preference for safety eased
somewhat with the appearance of progress in resolving
New York City’s fiscal crises. A t the same time, pub­
lished data indicating that the money stock measures had
expanded sharply during the first two statement weeks of
the month fostered m arket expectations that the recent
easing in monetary policy could halt and possibly reverse.

FEDERAL RESERVE BANK OF NEW YORK

Sizable increases in the wholesale and consumer price
index added to the concern of market participants, while
supplies of fixed income investments grew through en­
larged regular bill auctions and corporate debt financings.
Against this background, yields in all maturity ranges
moved higher.
Treasury bill rates declined modestly early in Novem­
ber in response to good investor demand and lower dealer
financing costs. At the second weekly auction of the
m onth on November 10, the average issuing rate on
three-m onth bills was 5.28 percent (see Table II ), 41
basis points below the average rate at the last weekly
auction in October. At the same time, the average yield
on six-month bills was 5.48 percent, 49 basis points lower
than two auctions previous. In the auction of 52-week
bills held on November 13, the average issuing rate was
6.01 percent, 59 basis points below the average yield
in the corresponding monthly auction in mid-October.
Around mid-November, however, considerable concern
emerged about the future course of monetary policy.
Dealer financing costs stabilized, and the substantial addi­
tions to the available supply of bills through increases in
the bill auctions began to weigh on the market. The Trea­
sury raised approximately $2.8 billion of new cash in
the four regular weekly auctions in November and about
$1 billion in the auction of 52-week bills. Following these
developments, the average yields on three- and six-month
bills at the weekly auction of November 24 rose to 5.52
percent and 5.93 percent, respectively.
At the end of the month, the Treasury announced
plans to raise $3.2 billion of new money in the Treasury
bill market. An auction of $2 billion of 139-day bills due
April 22, 1976, representing an addition to the outstand­
ing series, was scheduled for December 2. Auctions for
$600 million of ten-day bills due December 18 and $600
million of eighteen-day bills due December 26, both of
which represent additions to the outstanding series, were
scheduled for December 5. The terms of the financing
were generally in line with market expectations and had
little effect on bill rates. The average yield on the 139-day
bills auctioned on December 2 was 5.82 percent, and in
the auctions held on December 5 the average yield was
5.22 percent on the ten-day bills and 5.14 percent on the
eighteen-day bills. Over the month as a whole, bill rates
were about 2 basis points lower to about 40 basis points
higher.
Developments in the market for Government coupon
issues followed a similar pattern. November was the first
month in 1975 in which there was not an auction for new
cash borrowing through coupon issues by the Treasury.
While this was a positive factor, supply considerations




287
Table I

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

Net
changes

Factors
Nov.
5

Nov.
12

Nov.
19

Nov.
26

“ Market” factors
Member bank required reserves ................ +

303 +

Operating transactions (subtotal) .............. — 214
Federal Reserve f lo a t.................................. +
Treasury operations* ..................................

—

362 — 788 +

54

_

69

+3,419 —1,022 _2,680

— 497

457 +
10 + 587 — 577
591 +3,933 — 389 —1,677

+1,276

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

23 +

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

60 — 849 —1,104 — 215

15 —

42 +

38

+

—

477

12

—2,228

Other Federal Reserve liabilities
and capital ............ .................................... +
Total “ market” factors .......... ................

+

5 +
89

310 —

+3,781

76

—

250

—

11

—1,810 —2,62G

— 566

408 —4,582

+2,242

+2,997

+1,065

Treasury s e c u ritie s ...................................... — 962 —2,305

+2,016

+1,527

+

Direct Federal Reserve credit
transactions
Open market operations (subtotal) ............ +
Outright holdings:

Bankers' accep tan ces.................................. +

U

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

—
—

10 —

7 +

_

1

276

3

_

_

I

Repurchase agreements:

428 —4,572

+1,983

+2,053

+
+
+
—
—
—
+

517 — 791

+

+

—

—

27

+
+
+
+

10 —

16

_

Treasury securities .................................... +1,104
Bankers’ acceptances.................................. +
Federal agency obligations ................ .

+

Member bank b orrow ings.............................. —
Seasonal borrowingst .................. ............

—

Other Federal Reserve assets^ ....................

+
+
+

Excess reserves^ .............................................

—1,930

170 — 232
82 — 104
28

48

+

184 +1,232
44
5
19

+
+
+

118
117
15

1

37 — 278 — 359

173

27

590

100
100
21
27
552
492
74

Monthly
averages!

Daily average levels

Member bank:
Total reserves, including vault c a s h ? ........

34,943

33,790

34,751

34,724

34,552

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

34,140

33,778

34,566

34,512

34.249

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

803

12

185

212

303

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

67

40

59

74

60

Seasonal borrowingst ................................

43

27

26

26

31

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

34.876

33,750

34,692

34,650

34,492

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

160

267

36

88

138

N ote: Because of rounding, figures do not necessarily add to totals.
* Includes changes in Treasury currency and cash,
t Included in total member bank borrowings.
t Includes assets denominated in foreign currencies.
§ Average for four weeks ended November 26, 1975.
11 Not reflected in data above.

288

MONTHLY REVIEW, DECEMBER 1975

continued to be an issue as corporate and agency financ­
ing was sizable. The uncertain outlook for interest rates
and inflation encouraged trimming of dealer positions,
and some profit taking followed October’s rally. Over the
month as a whole, the index of yields on intermediate-term
Government securities rose 19 basis points to 7.62 per­
cent. The index of long-term bond yields rose 9 basis
points to 7.24 percent.
Yields on Government agency issues reflected the same
influences during November. Early in the month, the
Federal Home Loan Banks successfully sold $1.8 billion
of bonds. Rates of return on this three-part financing were
7.25 percent on $800 million of 27-month bonds, 7.75
percent on $600 million of five-year bonds, and 8.10
percent on $400 million of ten-year bonds. In concurrent
issues just before midmonth, refinancings by the Federal
Intermediate Credit Banks (FIC B ) and the Banks for
Cooperatives (BC) were well received, as the redeemed
securities totaled $232 million more than the two new
issues sold. The FICB sold $714 million of nine-month
bonds yielding 6.20 percent, and the BC sold $449 million
of six-month bonds yielding 6 percent. These returns were
70 and 75 basis points, respectively, below similar financ­
ings in October. In addition to the previously mentioned
factors depressing the market later in the month, the
Federal National Mortgage Association unexpectedly in­
cluded $600 million of new cash borrowing in an auction
on November 25. In that $1.4 billion financing, $450
million of 21-month debentures was sold at a !Y s per­
cent yield, $650 million of five-year debentures was sold
at an 8 percent yield, and $300 million of eight-year de­
bentures was sold at an 8.4 percent yield.

underwriters brought a substantial amount of new corpo­
rate issues to market in November and added more to the
schedule for December. This financing activity included
an appreciable new supply of medium-term notes as well
as long maturity issues.
Reflecting the improvement in m arket conditions, a
$50 million A-rated utility offering of thirty-year bonds
was priced in the first week of November to yield 9.75
percent, a full percentage point below a similar issue
offered two months earlier. However, after the market
retreated somewhat, a yield of 10 percent was set on $100
million of A-rated thirty-year utility bonds. In two 25-year
industrial financings, $250 million of Aa-rated debentures
was priced to yield 8% percent and $100 million of

C h a r t II

CHANGES IN MONETARY A N D CREDIT AGGREGATES
S e a s o n a l l y a d j u s t e d a n n u a l ra te s
Perce nt

Perce nt

OTHER SECURITIES M A RK ETS

Yields on corporate securities edged downward early
in November, but they reversed course following increased
concern about monetary policy, a very sizable influx of
new issues, and a growing calendar of scheduled financ­
ings for December. Large price declines were recorded
when dealers sought to reduce inventories by removing
price restrictions on issues in syndicate, and a number of
new offerings were postponed. In the market for state and
municipal obligations, yields on high-quality issues outside
New York State stabilized, while developments in Albany
and Washington were the primary influence on the prices
of debt instruments which carried low ratings or were
located in New York State.
Following the improvement in market tone of the previ­
ous month and anticipating sizable demand on the credit
markets by the United States Treasury in early 1976,




Note:

G r o w t h r at e s a r e c o m p u t e d on t h e b a s i s o f f o u r - w e e k a v e r a g e s o f d a i l y

f i g u r e s f o r p e r i o d s e n d e d in t he s t a t e m e n t w e e k p l o t t e d , 13 w e e k s e a r l i e r a n d
52 w e e k s e a r l i e r .

The l a s t e s t s t a t e m e n t w e e k p l o t t e d is N o v e m b e r 26, 1975:

M l - C u r r e n c y pl us a d j u s t e d d e m a n d d e p o s i t s h e l d b y t h e pu b li c .
M 2 = M l pl us c o m m e r c i a l b a n k s a v i n g s a n d t i me d e p o s i t s h e l d b y th e p u b l i c , l ess
n e g o t i a b l e c e r t i f i c a t e s o f d e p o s i t i ssue d in d e n o m i n a t i o n s o f $ 1 0 0 , 0 0 0 o r mor e.
A d j u s t e d b a n k c r e d i t p r o x y = Tot al m e m b e r b a n k d e p o s i t s s u b j e c t to r e s e rv e
r e q u i r e m e n t s pl us n o n d e p o s i t sou rces o f fu n ds , such as Euro d o l l a r
b o r r o w i n g s a n d the p r o c e e d s o f c o m m e r c i a l p a p e r i ss ue d b y b a n k h o l d i n g
c o m p a n i e s or o t he r af f i l i a t e s.
S o ur c e:

B o a r d o f G o v e r n o r s o f the F e d e r a l Re se rv e S yst em .

FEDERAL RESERVE BANK OF NEW YORK

Aa-rated debentures returned 9 Vs percent. M arket sen­
timent shifted while the larger issue was still in syndicate,
and the yield rose sharply when price restrictions on the
undistributed portion were lifted.
New issues of Aaa-rated state bonds were distributed at
lower interest rates in November. The State of Wisconsin
sold $102 million of bonds yielding from 3.50 percent in
1976 to 6.50 percent in 2005, while returns on $100 mil­
lion of State of Oregon bonds ranged from 5 percent
in 1981 to 6.15 percent in 1990. A similar Oregon issue
yielded 5.25 percent in 1981 to 6.70 percent in 1993
when offered at the beginning of October.
As in recent months, the financial problems of New
York City continued to dominate the market for lower
grade tax-exempt securities. Developments around midNovember rekindled optimism over the prospect of some
form of Federal aid to New York City, and prices on
MAC issues rose. Another municipality in New York
State as well as certain state agencies, however, experi­
enced financial difficulties. At midmonth the New York
State legislature averted default by Yonkers, the fourth
largest city in the state, and by the Housing Finance
Agency (H F A ). Yonkers was able to redeem $21 million
of maturing notes on schedule through a plan passed by
the legislature providing for the creation of an emergency
control board to oversee the city, similar to the one for
New York City. The legislature also appropriated $80
million as part of a package to prevent the HFA from
defaulting on its maturing notes. Although rated Aaa by
Moody’s and Aa by Standard & Poor’s, a $37 million
issue of Westchester County bonds was offered at yields
ranging from 4.5 percent in 1976 to 6.8 percent in 1990,
between 50 and 90 basis points higher than on a similar
issue of bonds by a municipality outside the state.
At the end of the month, prices of MAC issues rose
following the passage by the New York State legislature
of a plan designed to avoid a New York City default.
The legislature voted a $200 million increase in New
York City taxes, which includes increases in the personal
income tax, the bank tax, and the cigarette tax. The city
sales tax is to be extended to cover personal services, and




289
Table II

A VERAGE ISSU IN G RATES
A T R EGULAR TREASURY BILL AUCTIONS*
In p e rc e n t
Weekly auction dates— November 1975
Maturity
Nov.
3

Nov.
17

Nov.
24

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

5.602

5.279

5.471

5.520

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

5.792

5.483

5.790

5 .9,‘-)3

T h r ee-m o n th
S ix -m o n th

Nov.
10

Monthly auction dates— September-November 1975

F ifty - tw o w eeks

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

Sept.
17

Oct.
15

Nov.
13

7.338

6.601

6.010

* In ter est ra tes on b ills are q uoted in term s of a 3 6 0 -d a y year, w ith th e d isc o u n ts from
par as th e retu rn on th e fa c e am ou n t o f th e b ills p ay a b le a t m a tu r ity . B o n d y ie ld
eq u iv a le n ts, re la ted to th e am ou n t a c tu a lly in v e sted , w ou ld be s lig h tly lu sh er .

the minimum corporation tax is to be raised. In addition, an
estate tax is to be levied and a minimum personal income
tax is to be imposed. In a subsequent speech, President
Ford stated that he would propose legislation to provide
short-term loans to New York City to allow for adjust­
ments to the uneven cash flow pattern during the year.
The direct Federal loans, to be available through June 30,
1978, would not exceed $2.3 billion at any one time. To
qualify for new loans for the next fiscal year, the city
would be required to pay back all outstanding loans by
the end of each fiscal year. The loans would be admin­
istered by the Treasury and made at a rate of 1 percentage
point above the Treasury borrowing rate. If the city failed
to keep up its efforts to achieve a balanced budget, the
loans could be discontinued.
The Bond Buyer index of twenty bond yields on
twenty-year tax-exempt bonds rose 3 basis points from
the end of October to 7.39 percent on November 26. The
Blue List of dealers’ advertised inventories declined by
$53 million and closed the month at $631 million.

290

MONTHLY REVIEW, DECEMBER 1975

Treasury and Federal Reserve Foreign Exchange Operations
Interim Report: August-October 1975
By A l a n R. H o l m e s

and

Coming into August, the exchange markets were bullish
for the dollar. By that time, the United States trade account
had moved decisively into surplus. Growing signs of a
United States economic recovery also helped bolster con­
fidence in the dollar, while a firming of United States
interest rates beginning in late June had added to interest
differentials favoring short-term dollar placements. By
contrast, economic recovery abroad was still lagging, and
the market had come to expect additional stimulative
measures, including lower interest rates, in several foreign
countries. These considerations had gradually erased the
m arket’s previous extreme pessimism toward the dollar
and had prompted a ground swell of demand for dollars
in June and July, as earlier speculative positions against the
dollar were unwound, adverse leads and lags were reversed,
and arbitrage and investment funds were drawn into New
York and the Euro-dollar market. By end-July, the dollar
had climbed against the German mark by some 9% per­
cent from mid-May and by almost 11 V2 percent from the
lows of last February. As previously reported, the Federal
Reserve had taken advantage of this recovery to acquire
sufficient currencies to repay in full all remaining swap
debt incurred in market operations in late 1974-early 1975.
During August the immediate optimism for the dollar
waned somewhat, particularly after release of discour­
aging consumer and wholesale price figures for the United

*
M r. H olm es is the E xecutive V ice P resident in charge o f the
F oreign F u n c tio n o f the F ed eral R eserve Bank o f N ew Y ork and
M anager, System O pen M a rk et A ccount. M r. P ardee is V ice P resi­
dent in the F o reign F u n ctio n and D eputy M anager fo r Foreign
O perations of the System O pen M a rk et A ccount. T he B ank acts as
agent fo r b o th the T reasu ry and the F e d e ral R eserve System in the
conduct o f foreign exchange operations.




S c o t t E. P a r d e e *

States. Following the previous sharp run-up, profit taking
shaved some 1-2 percent from dollar exchange rates early
in the month. The undertone was nevertheless firm, and
over subsequent weeks the dollar continued to be bolstered
by the sizable United States trade surplus and by favorable
interest arbitrage differentials. In fact, the exchange m ar­
kets remained in rough balance through the rest of August
and early September.
Toward mid-September, bullish exchange market senti­
ment for the dollar resurfaced. While the economic picture
remained little changed abroad, the United States recovery
was, in the initial stages at least, progressing much more
strongly than previously expected. Consequently, a renewed
rise in some United States money market rates prompted
expectations of even further increases in dollar interest
rates. In response, traders resumed heavy bidding for
dollars in the exchanges and dollar rates advanced across
the board. To moderate the day-to-day rise, foreign cen­
tral banks sold sizable amounts of dollars in their respec­
tive markets. The Federal Reserve bought modest amounts
of German marks to add to working balances, accumu­
lating $59.3 million equivalent since early August.
Moreover, w'hen the Belgian franc dropped particularly
sharply, the System took the opportunity to purchase $6
million equivalent of francs to hold in balances. Demand
for the dollar crested on September 22-23, when dollar rates
reached some 4 to 5 percent above their late-July highs.
The mood of the market shifted abruptly in late Septem­
ber, however, as the long-brewing controversy over how
to resolve New York City’s fiscal difficulties began to influ­
ence the exchanges. By then, each new development was
receiving widespread attention in the world press and,
although very little of New York City debt is held abroad,
an increasing number of foreign businessmen and officials
were expressing concern over the broader implications of

291

FEDERAL RESERVE BANK OF NEW YORK

a possible default by the city. These concerns at first
prompted precautionary selling of dollars by some traders,
leading to a slippage of dollar rates. Then, in early October,
United States interest rates turned down once again and,
amidst scattered indications that the pace of the United
States economic recovery might have slowed, some dealers
shifted to expect further declines. Meanwhile, new fore­
casts of a near-term pickup of some European economies
raised the prospect of a hardening of interest rates abroad.
In this atmosphere of uncertainty, the dollar lost buoyancy
and dollar rates were pushed sharply lower in sporadic
bouts of selling pressure. In an effort to maintain order
and resist the decline, foreign central banks entered the
market as buyers of dollars, on some days in sizable
amounts. The New York market also turned unsettled on
several occasions in early October, and the Federal Reserve,
operating on four days between October 1 through 15, sold
a total of $50.1 million equivalent of marks from balances.
Thereafter, the dollar leveled off around 4-5 percent below
late-September highs. Exchange rates still fluctuated
widely, however, as the market reacted to each new twist

Table I
FEDERAL RESERVE SYSTEM D R A W IN G S A N D REPAYM ENTS
U N D E R RECIPROCAL CURRENCY ARRANG EM ENTS
In millions of dollars equivalent

Transactions with

System swap
commitments,
July 31, 1975

Drawings ( + ) or
System swap
repayments ( — )
commitments,
August 1 through
October
31, 1975
October 31, 1975

N ational Bank of Belgium

261.8

-0-

261.8

Swiss N ational B ank..................

371.2

-0-

371.2

Bank for In tern atio n al Settle­
m ents (Swiss fran cs).................

600.0

-0-

600.0

1,232.9

-0-

1,232.9

Total

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

N ote: D iscrepancies in totals are due to rounding.




Table II
DR A W IN G S A N D REPAYM ENTS BY FOREIGN CENTRAL BANKS
A N D THE BA NK FOR INTERNATIONAL SETTLEMENTS
U N D E R RECIPROCAL CURRENCY A R R ANG EM ENTS
In millions of dollars

Banks drawing on
Federal Reserve System

Drawings on
Drawings on
Drawings ( + ) or
Federal Reserve
Federal Reserve
repayments ( — )
System
System
August 1 through
outstanding
outstanding
October 31, 1975
October
31, 1975
July 31, 1975

-0-

+360.0

360.0

Bank for International Settle­
ments (against G erm an m arks)

-0-

+ 58.0]
— 58.Of

-0-

Total

-0-

+418.0)
- 58.0 S

360.0

Bank of M exico ...........................

and turn in the New York City fiscal situation. On bal­
ance, foreign central banks continued to buy dollars
through the month end. In New York, although the Fed­
eral Reserve remained prepared to intervene, the market
was generally quiet and there was no further need for
sales of foreign currencies. During periods of dollar buoy­
ancy in October, the System purchased $36 million equiv­
alent of marks for future contingencies.
In sum, during the period August-Octobcr the Federal
Reserve purchased in the market and from correspondents
a total of $95.3 million of German marks and $6 million
of Belgian francs. Sales of currencies in the market which
occurred in early October amounted to $50.1 million
equivalent of marks. There were no new swap drawings
by the Federal Reserve.
On August 29 the swap line between the Federal Reserve
and the Bank of Mexico was increased by $180 million to
$360 million. The full amount was subsequently drawn by
the Bank of Mexico, in late September-early October, to
meet temporary needs, and these drawings remained out­
standing at the end of the period.