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FEDERAL RESERVE
BANK
OF NEW YORK

MONTHLY REVIEW
FEBRUARY 1960

Contents
The Business Situation ...............................
Money Market in January.........................
International Developments.......................
Comments on Employment, Growth, and
Price Levels: A Letter by William
McChesney Martin, Jr............................
Growth and Price Stability: The German
Experience .............................................

Volume 42




18
22
25

27
29

No. 2

MONTHLY REVIEW, FEBRUARY 1960

18

The B u siness Situation
Economic activity continued strongly upward in the first
month of the new year, as industry sought to satisfy the
pent-up demand for steel and to increase the output of
business equipment and durable consumer goods. New
production records were posted in several fields, including
steel, while automobile assemblies approached the previous high of November 1955. Investment expenditures,
dampened during the steel strike, were on the rise; and
outlays for consumer goods, supported by an advancing
level of personal income and a further growth in consumer
credit, were apparently pushing ahead to fresh heights,
Yet, despite the strengthening in all sectors, there was a
noticeable quieting of the tempo of increasing demand,
compared with the preceding two months, and earlier
fears of an imminent outbreak of fresh inflationary devel­
opments were not realized.

were slightly less than a year ago and more than 100,000
units below the 1955 and 1957 December levels. During
January, however, stocks of cars moved up substantially,
to an estimated 800,000.
A general increase in inventories could of course occur
only after current demands for final goods by consumers,
business, and government had been satisfied. The rise in
stocks thus depended upon a rise in production beyond
recent levels. Such a rise was evidenced by the new index
of industrial production (described in more detail below),
which bounced back from 103 in November (1957=100)
to 109 in December, a level just 1 point short of the
June peak (see Chart I). The principal element in this
advance was the output of durables, which jumped 11 per

T H E C O N T IN U E D A D V A N C E

The need to rebuild business inventories depleted dur­
ing the strike was a basic force in the upward momentum.
By the end of November, the book value of total inven­
tories had dropped $1.5 billion below the July level, sea­
sonally adjusted, and the ratio of inventories to sales was
just slightly above the unusually low levels that had pre­
vailed during the spring of 1959. In many lines, stocks
were apparently run down further by excellent sales rec­
ords during the year-end holiday season. The rebuilding of
steel and automobile inventories, begun late in the year,
went on apace during January. Although steel mills were
operating at over 95 per cent of the 1960-rated capacity
(established at 148.6 million tons as against 1959’s 147.6
million), industry sources estimated that current consump­
tion of steel was equal to only about 80 per cent of
capacity tonnage, with the balance being added to stock­
piles held by steel users and warehouses. Some part of
this heavy inventory demand may have stemmed from
anticipations of steel price increases following recent wage
settlements. But inventory shortages were obviously wide­
spread. Steel warehouses, for instance, which are the main
supply source for smaller users, and normally carry about
20 per cent of the country’s steel inventories, reported
that they thought it would be April before they would be
reasonably well stocked, and August before they would
have adequate inventories in all products. Automobile
dealers’ inventories were also still low at the end of
December. With only 575,000 cars on hand, their stocks




Chart I

SOME ECONOMIC INDICATORS
Seasonally adjusted

Billions of dollars
' 390

B illions of dollars
390
380 __

380
Personal income
Annual rates

370

— 370
360

360
350
1■ 1 1
1
Billions of dollars
150
140

i l l

_

1 I t 1 ... 1..1 L
...
.

_T*rr*i

N ondurable retail sales
,
A nnual rates

1

i

i

l.i

v

i

L

i

140

i

130
M illions of persons
------------------- 153
52

s

51

50
Per cent
128

i l l

Nonfarm employment^

-V

51

1. 1 ..L
.,
I__ 350
Billions of dollars
150

A

130
i— j— — l
M illions of persons
5 3 -------------------52

1. I

■
L..-L

I

W H O LESALE PRICES
1947- 49=100

50
cent
128

~

Industrial commodities
126

i i 1i i

I
1958

126

1959

^ Reflects payment of retroactive salary increases to Federal Government
employees.
U n ite d

States Bureau of Labor Statistics series.

Sources: Board of Governors of the Federal Reserve System, United States
Bureau of Labor Statistics, and United States Department of Commerce.

FEDERAL RESERVE BANK OF NEW YORK

19

cent, reflecting particularly a sharp expansion of iron and Gains occurred in all three components of construction—
steel and automobiles but also substantial increases in the residential, the nonresidential, and the public sectors.
Prices, meanwhile, have remained relatively stable. The
fabricated metal products and electrical machinery. The
three other major components of the index—nondurables, wholesale price index was unchanged in December, at
mining, and utilities — rose too, but by much smaller 118.9 (1947-49), just fractionally under the year-ago
amounts. The continuing high level of operations in many figure and 1 per cent below the year’s April high. How­
important fields suggests that the level of production for ever, the wholesale prices of industrial commodities (that
January will move beyond the record set last June.
is, all commodities other than farm products and processed
The rise in December in industrial activity led to a fur­ foods) continued to edge up in December (see Chart I);
ther advance in nonfarm employment The number at still, they ended the year only 1 per cent above December
work rose to 52.5 million (seasonally adjusted), only 1958. The consumer price index slipped 1/10 of a point
73,000 below the July record level. As in November, in December, the first drop since August. Over the year
the ratio of unemployment to the total civilian labor force as a whole, the consumer price index moved up 1.5 per
again moved down, dropping to 5.2 per cent after seasonal cent, mostly because of increases in the prices of services.
adjustment, compared with the 6.0 per cent reached in
October as a result of the steel strike.
T H E N E W I N D U S T R I A L P R O D U C T IO N I N D E X
The gain in employment contributed to an increase in
personal income that was almost as large as in November.
A much refined tool for the analysis of United States
On a seasonally adjusted basis, total income in December business conditions was unveiled at the end of December
was at a record level, 2 per cent above the pre-strike high with the publication by the Board of Governors of the
(see Chart I). Although most of the advance was in wages Federal Reserve System of a thoroughly revised industrial
and salaries, farm income also improved markedly; by production index. This is the third substantial revision of
December, farm income had recovered two thirds of the 25 the index since it first appeared in 1927, and covers the
per cent dip in level that had occurred during the first nine period from January 1947 on. The changes are, in sum­
months of the year. Indeed, the widespread gains through­ mary, as follows: (1) Electric and gas utility output has
out the economy following the resumption of steel-making been added to the index, supplementing the output of
operations early in November pushed up gross national manufacturing and mining industries. (2) The individual
product for the fourth quarter of 1959 to an estimated
annual rate of $482 billion (seasonally adjusted), $3.4
billion above the third-quarter level. In real terms, GNP
Chart II
was still lYz per cent below the high second-quarter rate
COMPARISON OF OLD AND NEW
INDUSTRIAL PRODUCTION INDEXES
but 2> z per cent above the 1958 fourth-quarter rate.
V
Seasonally adjusted; 1947-49=100
Per cent
per c, nf
A drop in retail sales during the last two months of
1959, to a December level 4 per cent below October
(seasonally adjusted), was accounted for by a decline in
durables, attributable primarily to a shortage of automo­
biles. Demand for nondurables continued to move up in
December, as Chart I shows. While preliminary figures for
January department store sales do not suggest the same
degree of strength in the demand for nondurables as in
December, larger and more diversified stocks of automo­
biles are expected to stimulate auto buying and help
increase total durables sales.
Continued strength in the economy was also indicated by
the level of construction activity. On a seasonally adjusted
basis, total construction outlays were up almost 6 per cent
in January. However, the Census Bureau, which makes
these estimates, believes that the December estimate of
government spending on highways was too low, and that
Note: Last date for old index is November 1959.
therefore the December-to-January increase in total ex­
Source: Board of Governors of the Federal Reserve System.
penditures was actually somewhat less than indicated.




20

MONTHLY REVIEW, FEBRUARY 1960

production series, formerly grouped only by “industry”
(for example, primary metals and transportation equip­
ment), are now grouped also according to “market”—
the three most comprehensive categories being consumer
goods, equipment (business and defense), and materials.
(3) The series have been adjusted to take into account
new data that show the production of individual items
more accurately; these “bench-mark” figures have been
obtained primarily from the detailed 1954 Census of Man­
ufactures. (4) The estimating procedures have been re­
fined for those series that, for lack of current physical
output data, are based on man-hour data. (5) Some new
monthly series have been added. (6) All seasonal adjust­
ments have been revised. (7) The industry groupings
have been reclassified to accord with the Bureau of the
Budget’s 19S7 Standard Industrial Classification. (8) The
weights for the combining of individual series into groups
continue to be derived from 1947 “value added” relation­
ships for the years 1947-52, but, for the years beginning
with 1953, 1957 relationships are used. (9) The “com­
parison base” for all series is now 1957 rather than 194749, and the regularly published figures will have this base
(i.e., 1957=100) pending general adoption of a new (me
by other Federal agencies. (However, the total index as
well as major groupings will continue to be published for
an indefinite period on a 1947-49 base also.)1
The effects of the revisions on the total industrial pro­

duction index are shown in Chart II for the years 1953
through 1959. (Prior to 1953, when the new value-added
relationships were incorporated, the differences between
the old and the new indexes were not so substantial as
later on.) To facilitate comparisons, all three series in
the chart are given on a 1947-49 base. The series are:
(a) the old index, which covered only manufacturing and
mining; (b) the revised index of manufacturing and mining
only, which will no longer be compiled by the Board as a
separate index, and (c) the new index, which covers
manufacturing, mining, and utilities. It will be noted that
in 1959 the new index reached a pre-strike peak of 166
in May and June, while the old index at its June peak
was only 155. About two thirds of this gap between the
two is attributable, as the chart shows, to changes in the
old manufacturing and mining series, and about one third
to the inclusion of electric and gas utilities.
From the new index it now appears that production in
the United States since 1947 has risen at an average annual
rate of 4.1 per cent, significantly faster than the previously
assumed rate of 3.8 per cent. These rates of course lump
1The December 1959 Federal Reserve Bulletin presents the new
leries of total and summary groupings back to January 1947 on both
a 1957 and a 1947-49 base. More detailed historical series will be
presented by the Board of Governors in a separate publication. While
current figures for the total index and for the major industry and
market groupings will be available in current issues of die Bulletin, die
only published source of all the individual series will henceforth be the
Board’s midmonthly Business Indexes release.

Chart III

RELATIVE IMPORTANCE OF MAJOR GROUPINGS IN THE REVISED INDUSTRIAL PRODUCTION INDEX




Industry groupings

M arke t groupings

PRODUCTS ..
' ✓ rio ji'

21

FEDERAL RESERVE BANK OF NEW YORK

together years of rapid growth and years of slower growth
and conceal the important swings that reflect cyclical
variations in economic activity.
The revised figures show slightly greater fluctuations
in recent years than was indicated by the old index.
The upswing from 1954 to 1957 is 1 per cent more in the
revised manufacturing-mining index than in the old index;
the 1957-58 dip is 2 per cent more; and the rise from the
spring of 1958 to the months just before the recent steel
strike is almost 4 per cent more. When utilities are added,
the fluctuations are similarly greater than before. The
principal reason for these wider fluctuations is the shift
from 1947 to 1957 value-added relationships, which gives
greater weight to items whose prices rose relative to others
between 1947 and 1957. And prominent among these
were automobiles, steel, and machinery, all of which are
especially sensitive to cyclical fluctuations.
The inclusion of utilities output in the total index, in
order to have a better representation of fuel and power
production, has naturally reduced somewhat the weight of
manufacturing and mining. Previously, manufacturing ac­
counted for 90 per cent, and mining for the remainder;
now, manufacturing accounts for 86V2 per cent, and
mining for 8V2 per cent, while utilities are assigned 5 per
cent (see Chart III). Even more important have been the
changes within the manufacturing sector itself. In the old
index, nondurables and durables were given almost exactly
the same weights. Now, however, durables account for
50 per cent of the total as against 37 per cent for non­
durables. The gain of durables over nondurables reflects
largely the growing importance of aircraft manufacturing,
and the growth in metals and industrial and commercial
machinery—items whose prices, as indicated earlier, rose
substantially more than average. The change in weight
for these products has pushed up the “machinery and re­
lated products group” from 51 per cent of the total dura­
bles group to 58 per cent, i.e., to 29 per cent of the total
new index.
Before the index was reconstructed, the only “market”
index published by the Federal Reserve Board was a
limited, special “consumer durables goods” index. Now,
however, all the series included in the industrial production
index are classified according to market. The major cate­
gories may be seen in Chart III. Hie “final products”
sector consists of (a) consumer goods and (b) business
and defense equipment, and accounts for somewhat less
than one half of the total new index (47 per cent), with
consumer goods about twice as important as equipment.
The other 53 per cent of the total new index is made up
of “materials” and is divided almost equally between non­
durables and durables. The individual series of the con­




sumer goods sector are also being compiled in two alterna­
tive groups, different from those shown on the chart. One
group includes the cyclically sensitive automotive products
and home goods—appliances, furniture, and other dur­
ables-—(7.75 per cent), and the other the less sensitive
apparel and staple goods (23.38 per cent). Aside from
these last two groups, the market breakdowns distinguish
among a total of forty-seven major groups and subgroups.
With this amount of detail, important and sometimes
critical economic developments can probably be spotted
somewhat earlier than was heretofore feasible, and an­
alyzed in greater depth. For instance, inventory movements
of the sort mentioned earlier, in the discussion of current
developments, can be a significant cyclical factor. The mar­
ket groupings may facilitate an evaluation of movements
in materials inventories by permitting fluctuations in mate­
rials output to be measured against fluctuations in the out­
put of consumer goods and equipment; and a sharper rise
in the former than in the latter could suggest that materials
inventories are being accumulated. However, some esti­
mate would have to be made of leakages into, for instance,
exports and construction. The accumulation (or liquida­
tion) of specific categories of materials inventories could
perhaps be similarly examined by utilizing subgroups. The
market groupings also permit growth patterns in different
types of goods to be explored.
Comparison of the fluctuations in the consumer goods,

Chart IV

INDUSTRIAL PRODUCTION BY MARKET GROUPINGS
Seasonally adjusted; 1957=100
Per cent
115

Per cent

110

105

100

95

90

85

80
1957

1958

1959

Source: Board of Governors o f the Federal Reserve System.

22

MONTHLY REVIEW, FEBRUARY 1960

equipment, and materials indexes during the past three
years shows that, over the period, the consumer goods
index rose the most and that during the 1957-58 reces­
sion it fell the least (see Chart IV, in which 1957=100).
The 1957-59 rise reflects primarily the secular increase
in population, as well as the growth, over the period as
a whole, in disposable income. The dip during the reces­
sion was less than in the other sectors, largely because
the consumer goods index is heavily weighted by food,
other consumer staples, and apparel, all of which are less
sensitive to short-run changes in income than are consumer
durables and the equipment and materials sectors. As
regards the other two indexes, the equipment index shows
only a slightly sharper dip than materials in 1957-58, but
a substantially less sharp rise than materials in 1958-59.

The latter relationship is in part attributable to the usual
lag in demand for business equipment when a cyclical re­
covery begins. It also reflects, however, the rapid accumu­
lation of primary metals inventories during the first half
of 1959, undertaken in anticipation of the midyear steel
and copper strikes. The sharp impact of the strikes on
materials output is revealed in the steep drop of the ma­
terials index during the third quarter of 1959; and the
subsequent curtailment in output of consumer goods and
equipment that resulted from the ensuing materials short­
ages is also evident. The closing months of the year, on
the other hand, show the pickup in materials production
that followed the reopening of the steel mills in early
November, and the positive influence this had on the out­
put of final products in December.

M oney M arket in Jan u ary
The money market continued tight during January,
although seasonal repayment of bank loans and large flows
of nonbank funds into the market relieved the severe
pressure on short-term interest rates that had character­
ized the closing weeks of 1959. Reserve positions of
member banks remained under pressure, as large seasonal
reserve gains were offset by System open market opera­
tions. The effective rate on Federal funds held firmly at
4 per cent on most days of the period, and rates on new
and renewal loans to Government securities dealers at
the New York City banks rose from a flat 5 per cent at
the end of December to 5V4-5Vi per cent at midmonth,
before declining to a uniform 5 per cent in the closing days
of the period.
As often happens at this season of the year, yields
declined during January in the Government and other
securities markets. Treasury bill rates moved markedly
lower over the month, as strong demand from nonbank
investors encountered an increasing scarcity in the market
supply of most issues of bills despite sizable sales and
redemptions of these obligations by the System. The de­
cline in rates, which was also evident in the market for
Treasury notes and bonds, may also have reflected a
number of loosely related background factors—reaction
to the sharp rise in yields of the previous two months,
the forecast of a sizable budget surplus for fiscal 1961,
and the emergence of a feeling in the market that, con­
trary to earlier expectations, interest rates might not move
further upward in the period ahead. There also were re­




ports that the market for notes and bonds was strengthened
by some movement of funds out of equities, which in turn
may have been related to the sharp decline in stock prices
during the month.
The Treasury announced on January 28 that it would
offer 4% per cent one-year certificates to mature February
15, 1961 and 4% per cent four-year nine-month notes
to mature November 15, 1964, in exchange for $11,363
million of 33 per cent certificates maturing February 15,
A
1960 and $198 million of IV2 per cent notes maturing
April 1, 1960. The certificate will be offered at par, while
the new 4% per cent note is to be offered at 99.75 per
cent of face value, making the effective yield about 4.93
per cent. The subscription books for the exchange will be
open from February 1 to February 3.
M EM BER

BANK R ESER V ES

Net borrowed reserves of all member banks averaged
$416 million for the four statement weeks in January,
little changed from the $444 million average for the five
statement weeks ended in December. Average excess re­
serves were virtually unchanged at $487 million, and
average borrowings at the Federal Reserve declined by
$26 million to $903 million. The relative stability of the
average level of net borrowed reserves, however, con­
cealed large movements in the individual factors affecting
reserves. The major source of reserves was the usual
January return of currency to the banking system follow­
ing the large increase in circulation during the Christ­

FEDERAL RESERVE BANK OF NEW YORK

mas shopping season. The total return flow in January
amounted to $1.2 billion, a volume somewhat greater
than the net increase in currency in circulation during the
entire second half of 1959. In addition, average required
reserves declined, also seasonally, by $407 million over the
period. On a week-to-week basis, fluctuations in float
were an important factor, absorbing reserves during all
but the third week, when a substantial amount of reserves
was provided by float.
Member banks also gained reserves in January as a
result of the interest payment to the Treasury on Federal
Reserve notes—statistically reflected in a decline in Fed­
eral Reserve capital and surplus accounts which are in­
cluded in the item “other deposits, etc.” shown in the
table. The fact that the payment was larger than usual
reflected a System decision to close out certain reserves
for contingencies, to reduce the surplus accounts of the
Federal Reserve Banks to 100 per cent of subscribed
capital, and to pay the Treasury 100 per cent of net earn­
ings. In effecting this new policy, the Reserve Banks
transferred to the Treasury all the surplus in excess of
subscribed capital as of December 31, 1959. Heretofore,
Changes in Factors Tending to Increase or Decrease Member
Bank Reserves, January I960
(In millions of dollars; ( + ) denotes increase,
(—) decrease in excess reserves)
Daily averages—week ended
Net
changes

Factor
Jan.
6

Jan.
13

Jan.
20

Jan.
27

64
- 202
+ 374
+ 39
+ 132

+ 67
- 317
+ 237
+ 39
+ 224

+ 12
+ 244
+ 372
+ 77
+ 10

26
- 410
- f 260
+ 13
6

11
685
+ 1,243
+
168
+
360

+ 280

4- 250

+ 714

-

169

+ 1,075

-

- 268
+ 21

-

719
54

-

170
2

-

1,337
42

-

102
1

+

3

-

141
1

-

155
2

3

-

2
34

Operating transactions

Treasury operations*....................................
Federal Reserve float...................................
Currency in circulation................................
Gold and foreign account............................
Other deposits, etc........................................

Direct Federal Reserve credit transactions

180
7

+
00

Government securities:
Direct market purchases or sales...........
Held under repurchase agreements........
Loans, discounts, and advances:
Member bank borrowings........................
O ther..........................................................
Bankers’ acceptances:

—

_

—

-

5

-

19

+
-

1
10

-

Under repurchase agreements.................
T otal.......................................................

-

109

-

368

-

779

-

318

-

1 574

65
29

-

487
22

-

499
100

—

Member bank reserves

With Federal Reserve Banks......................
Cash allowed as reserves..............................

+ 171
55

- 118
+
6

-

Effect of change in required reserves f ..........

+ 116
92

- 112
+ 171

94
+ 102

- 509
+ 226

+

599
407

Excess reserves!..............................................

+

+

+

-

-

192

Daily average level of member bank:
Borrowings from Reserve Banks................
Excess reserves t ............................................
Net borrowed reserves f ...............................

24
1,013
509
504

59
911
568
343

Note: Because of rounding, figures do not necessarily add to totals.
* Includes changes in Treasury currency and cash,
f Th«se figures are estimated,
t Average for four weeks ended January 27, 1960.




8
914
576
338

283
773
293
480

9031
4 87|
416J

23

the practice had been to add approximately 10 per cent of
the annual net earnings of the Federal Reserve Banks
to the surplus accounts and to pay 90 per cent of the
annual net earnings to the Treasury.
System open market operations during the month were
employed to offset the gains through regular market fac­
tors. Reserves were absorbed in each week of the month,
with the absorption reaching a peak in the third week
when the midmonth increase in float combined with move­
ments in other market factors to provide an unusually large
amount of reserves. System open market activity tapered
off in the final statement week, however, as the release
of reserves through market factors abated somewhat.
System holdings of Government securities were reduced
by about $1.3 billion from December 30 through Janu­
ary 27, as a result of $1.3 billion of net sales and redemp­
tions from the System Open Market Account and a $30
million decline in securities held under repurchase agree­
ments. The reduction in System holdings was at record
proportions for this period, falling only slightly short of
the postwar peak for January set in 1957.
G O V E R N M E N T S E C U R IT IE S M A R K E T

A sharp decline in Treasury bill rates and a parallel,
if somewhat less pronounced, decline in note and bond
yields were the striking features of the Government securi­
ties market during most of January. The rally, which
began to gather momentum late in the first week of the
month, seems in part to have represented a reaction to the
pronounced rise in rates and decline in prices of the pre­
vious two months, which in many cases had carried yields
to postwar highs and prices to postwar lows. While the
market generally expected further economic expansion and
strong demands for credit, there apparently was some feel­
ing that these developments might not exert further strong
upward pressures on yields, at least over the short rim.
The market, moreover, was buoyed by the President’s
statements in the State of the Union Message, and re­
emphasized in the Budget Message, concerning the expec­
tation of a large budget surplus in fiscal 1961.
Against this background, the appearance of a broad
and sustained seasonal reinvestment demand for Treasury
bills on the part of corporations, public funds, Government
agencies, and other nonbank investors had a pronounced
impact on market rates of interest. The market not only
readily absorbed the sizable reduction in System and com­
mercial bank bill holdings during this period, but the mar­
ket supply of most issues rapidly diminished. Over the
month, rates on most issues declined by 30 to 60 basis
points, thereby erasing much of the increase of the previ­
ous two months.

24

MONTHLY REVIEW, FEBRUARY 1960

The improvement in the Treasury bill market was also
evident in the success of the Treasury’s financing opera­
tions in January. The first phase of the operation, the
auction on January 5 of an additional $2 billion of June 22
tax anticipation bills, brought out strong bidding by the
commercial banks, which could make payment for the
bills through credits to Tax and Loan Accounts. The aver­
age issuing rate for these bills was 4.726 per cent, a rate
considerably below the market, which reflected the advan­
tage to commercial banks of being able to pay for the bills
through credits to Treasury deposits on their books. The
bills began to trade on the secondary market at 5.12 per
cent bid, but by the end of the month the market rate
had declined to 4.48 per cent.
The second phase of the financing — the auction on
Tuesday, January 12, of $1.5 billion 366-day Treasury
bills to replace the major part of the $2.0 billion of matur­
ing January 15 bills— elicited considerable enthusiasm
from the market generally, and in some areas from small
investors in particular whose interest had been stimulated
by press comments over the week end. The average issuing
rate of 5.067 was well below the 5.25 per cent or higher
that many market observers had expected only a few
days earlier. A good demand for these bills subsequendy
developed, and the market rate moved down to 4.74 per
cent by the end of the month. The stronger tone of the
market was also evident in the last three regular weekly
bill auctions. Average issuing rates declined in each of
these auctions, with the rate in the January 25 auction at
4.116 per cent for 91-day bills, or 55 basis points less
than the record rate established in the December 21 auc­
tion, and at 4.608 per cent for 182-day bills, or 49 basis
points below the record 5.099 rate in the January 4 auc­
tion. At the end of the month, the three-month bills were
trading in the market at 3.99 per cent, and the six-month
bills at 4.46 per cent.
Prices of Treasury notes and bonds moved irregularly
upward through most of January, with the rise over the
month generally ranging from X to VA for notes and
A
short-term bonds, and from Vi to 2Va for longer term
issues. By the close of the period, the average yield on
long-term bonds had declined to 4.34 per cent, compared
with 4.39 per cent at the end of December, while the
average yield on issues due in three to five years had
dropped to 4.77 per cent, about the level prevailing in
mid-November. The market was favorably affected by the
sharp decline in stock prices that occurred after the first
week of the month, and which apparently reflected in part
some shifts of funds from the stock market. In addition,
press reports of discussions in Congress of possible action
that would permit advance refunding of outstanding bond




issues also tended to strengthen the 2 Vi per cent “tap”
bonds, issues frequently mentioned as candidates for ad­
vance refunding, without depressing longer term issues.
Demand for the most part remained limited, however,
originating principally with small investors and with pro­
fessionals for the purpose of covering short positions, and
the volume of trading generally remained small.
O TH ER S E C U R IT IE S M A R K E T S

A moderate upward trend developed in prices of sea­
soned corporate and, especially, in tax-exempt securities
during January, reflecting the same underlying factors that
affected the Government securities market. The average
yield on Moody’s Aaa corporate bonds held at 4.61 per
cent throughout most of the period, but the similarly
rated tax-exempts declined to 3.47 per cent at the month
end, 2 basis points below the end-of-December level.
During January, the flotation of new corporate bonds
and tax-exempt securities rose substantially above the
seasonally low December levels. New tax-exempt flota­
tions aggregated $625 million, an increase over both the
December amount of $394 million and the January 1959
total of $547 million. The new issues met with recep­
tions ranging from fair to excellent. Among these issues
was an offering by a State power authority of $96 million
of 4¥a per cent term bonds due in 2006 and priced at
par, and a companion issue of $24 million of 4 per
cent and 334 per cent serial bonds due 1965-79. The
term bonds were sold at a net interest cost of 4.388
per cent, with the serial bonds reoffered at yields ranging
from 3.50 to 4.00 per cent. Another State issue of $100
million (Aa-rated) bonds was sold at a net interest cost of
4.02 per cent and was reoffered to yield from 3 to 4 per
cent. This issue was originally scheduled to be sold in
December but had been postponed. New corporate issues
marketed during the month totaled $324 million, an in­
crease over the $258 million in December but slightly less
than the January 1959 figure of $376 million. Most cor­
porate issues were accorded fairly good receptions. The
market for United States Government agency obligations
was also firm over most of the period. New issues, which
aggregated a sizable $651 million, were very well received,
generally at slightly lower offering rates than in the latter
part of 1959.
Rates on several short-term money market instruments
were adjusted upward early in the month but most were
subsequently lowered in the latter part of the period. On
January 6 and 7, the New York banks raised the rates on
call and time loans secured by customers’ stock exchange
collateral to 5Vi per cent from 5 per cent. On January 8,
sales finance company rates on directly placed paper were

FEDERAL RESERVE BANK OF NEW YORK

raised by Vi to % of a percentage point, with 60- to
89-day paper Vs per cent higher at 4% per cent. How­
ever, these companies cut rates by V\ to Vi per cent on
January 27 and at the same time combined the 30- to
59-day and 60- to 89-day maturities into a 30- to 89-day
maturity with a rate of 4V4 per cent. Rates on commercial
paper, which were advanced Vs per cent on January 11
to bring the offered rate on prime 4- to 6-month paper to
5 per cent, were reduced by the same amount on both

25

January 22 and January 27, thus lowering the rate to 4%
per cent. Dealers in bankers’ acceptances increased all
rates by Ys per cent on January 7 and 8, making the new
bid rate on 90-day unindorsed paper 5 per cent. But on
January 21, one dealer lowered the rates on all paper by
Vs per cent with the 90-day maturity at 4% per cent. On
January 29, four acceptance dealers reduced rates on all
maturities by Va per cent and one dealer by Vs per cent,
with the 90-day maturity at 43 per cent bid.
A

International Developm ents
N E W M O V E S IN I N T E R N A T I O N A L
E C O N O M IC C O O P E R A T IO N

The recent establishment of the Inter-American Devel­
opment Bank and the moves now under way to broaden
the Organization for European Economic Cooperation are
significant steps toward greater cooperation in seeking
solutions for international economic problems. Although
many formal and informal regional economic groupings
have emerged since the end of the war, the two arrange­
ments now being launched are the first of their kind in
which the United States would be a full participant.
THE INTER-AMERICAN DEVELOPMENT BANK, which be­
came a legal entity on January 1, climaxes more than
half a century of attempts to establish an inter-American
financial institution. In recent years, with the drive for
economic development and for the creation of a regional
market gaining momentum in Latin America, the idea
received general acceptance and, in November 1958, a
special committee of the Organization of American States
began formulating a draft charter. In April 1959 this
charter was signed, and by the end of the year it had
been ratified by eighteen of the twenty-one signatories,
including the United States.
The objectives of the new institution are to promote
the general economic development of Latin America and
its economic integration, to provide technical assistance to
member countries in the formulation of development pro­
grams and the establishment of project priorities, and to
encourage the flow of private capital to the area. The
institution will have total capital resources of $1 billion,
of which the United States contribution will be $450 mil­
lion. These resources will be supplemented with funds
obtained by the flotation of the institution’s own securities.
The Inter-American Development Bank will consist of the




bank proper and a fund for “special operations”. The
bank will conduct “ordinary operations”, on the basis of
member capital subscriptions totaling $850 million. These
operations will consist of loans for specific projects repay­
able in the currency in which they are made. The loans
may be extended to cover both the foreign exchange and
the local currency requirements of the investment projects.
The bank will not necessarily require a government guar­
antee on loans extended to nongovernmental entities. The
special fund, financed with resources derived from addi­
tional member contributions ($150 million, of which the
United States will contribute $100 million), will extend
loans partially or wholly repayable in the currency of the
country in which the project is located. These loans are
intended to finance undertakings that may not contribute
directly to the borrower’s foreign exchange earning capac­
ity, presumably “social overhead” projects, such as health
and research centers, schools, and similar facilities.
Although the institution’s $1 billion capital stock is a
sizable sum, only a part will be available for lending when
actual operations begin. On the basis of full membership,
the bank’s paid-in capital for ordinary operations will
total $400 million, the unpaid capital of $450 million
serving as a guarantee fund for the flotation of the bank’s
own securities. Of the paid-in capital, 20 per cent is to
be paid immediately, together with 50 per cent of the
separate contributions to the fund for special operations.
The remainder of the payments to both the bank and the
fund will be made over a period of two to three years.
The statutes further specify that only half of each instal­
ment is to be paid in gold or dollars, the rest being payable
in the members’ own currencies.
The structure and organization of the bank closely
resemble those of the International Bank for Reconstruc­
tion and Development. Formulation of policy rests with

26

MONTHLY REVIEW, FEBRUARY 1960

a board of governors, on which each member country
has representation. A seven-man board of executive direc­
tors, including one designated by the United States,
constitutes the bank’s highest executive organ. Administra­
tion of the bank’s operations is under the authority of a
president, elected by the governors. The election of the
president and the setting-up of the two governing bodies
is scheduled for the bank’s organizational meeting in
El Salvador this month. Policy decisions by the governors
and by the executive directors will be made on the basis
of votes weighted according to size of capital subscrip­
tions, and will be by simple majority of the total votes cast.
The Inter-American Development Bank is intended to
supplement, rather than to replace, existing sources of
development finance in Latin America. Hence, effective
coordination of its lending activities with those of other
agencies is regarded as vital to the institution’s success.
At least initially, a sizable part of the bank’s operations
is expected to take the form of participation in, or guaran­
tees of, loans extended by other lenders. For the longer
run, there is general agreement that the bank’s capacity
to meet the rising financial requirements of the region will
hinge on its ability to tap the world’s private capital mar­
kets. This of course requires that the bank’s ordinary
operations be conducted on the basis of sound banking
principles and in a manner that will inspire confidence
among prospective investors. With regard to the bank’s
special operations, concern has been expressed that the
granting of loans repayable in the borrower’s currency
may result in sizable holdings of national currencies with
limited international usefulness. It is hoped, however, that
the strengthening of the Latin American economies will
gradually reduce the need for loans from the special fund,
while the growth of intraregional trade will at the same
time steadily widen the scope for employing national
currencies.
PROPOSAL FOR A NORTH A TLA N TIC COM M UNITY.
While
United States participation in the Inter-American Devel­
opment Bank reflects this country’s concern with economic
growth in this hemisphere, the recent proposal by the
United States to broaden economic cooperation within the
North Atlantic community would forge an important new
link with Western Europe. The need for such a link arises
from several factors. First, the formation of the European
Common Market and the European Free Trade Associa­
tion threatens to split the area in two distinct trading
zones, which may inhibit effective economic cooperation
in Western Europe. Second, the United States balance-of-




payments deficit during the past two years has emphasized
the need for a more active role by the United States in
promoting freer trade and safeguarding the recent advances
in the direction of multilateralism. And, third, the restora­
tion of Western Europe’s economic strength has opened
the way for a cooperative approach to the channeling of
aid to the economically underdeveloped regions.
Against the background of these considerations, the
United States proposed on January 12 that the eighteennation Organization for European Economic Coopera­
tion be broadened into an economic body in which the
United States and Canada would participate as full mem­
bers. Representatives of the twenty governments con­
cerned are to meet in Paris on April 19 to consider
arrangements for achieving this objective. A committee
of four has been named to study the problem in the
meantime, and to submit a report which will facilitate
the work of the April 19 meeting. In addition, eight
countries (the United States, Canada, Britain, France, West
Germany, Belgium, Italy, and Portugal) have set up an
informal body for the purpose of exploring techniques to
facilitate the flow of long-term funds to underdeveloped
areas.
The proposal for the establishment of an economic
organization capable of dealing effectively with North
Atlantic community trade problems and with the question
of sharing the development-aid burden raises many issues
that cannot be solved quickly. Nevertheless, within the
Atlantic community, just as within the Western Hemis­
phere, important steps have now been taken to estab­
lish a new basis for international economic cooperation
adapted to the changing positions of the various countries
and regions in the world economy.
EXCH AN GE R A T E S

Spot and forward sterling quotations tended to ease
slightly in the first half of January in a quiet market.
Following the announcement of the increase in the Bank
of England’s discount rate from 4 to 5 per cent on Janu­
ary 21, the spot quotation firmed to $2.8028, while the
forward quotations, which had commanded rather sub­
stantial premiums, abruptly dropped to par with the spot
rate. At the end of January spot sterling was $2.8027,
while three and six months’ forwards had moved to
discounts of 2 and 4 points, respectively. The Canadian
dollar moved somewhat erratically between $1.042%2
and $1.051%4, and was quoted at $1.05 at the month end.

FEDERAL RESERVE BANK OF NEW YORK

27

Com m ents on Em ploym ent, Growth, and P rice Levels
B y W illia m M c C h e s n e y M a r t i n , J r .*
Chairman, Board of Governors of the Federal Reserve System

We have been most impressed with the fine work that
the Joint Economic Committee and its staff have been
doing, during the course of the Study of Employment,
Growth, and Price Levels, in bringing together the think­
ing of qualified persons, in formulating questions to be
addressed to us and to other agencies, and in the studies
thus far published.
In reading over the material that has been presented
to the Committee, it occurs to me that there are two
aspects of the problems under study that may deserve
more explicit consideration than has been given to them
so far.
The first point that I have in mind relates to imperfec­
tions in our price system—variously referred to as costpushes, ratchet effects, and administered prices—and per­
haps it can best be phrased in the form of a question.
Granting that there are these imperfections as regards the
behavior of individual prices and that they create inflation­
ary pressures or biases in economic processes that cannot
be effectively dealt with by monetary policy, does it follow
from this that monetary policy should be less (or more)
restrictive than if such phenomena did not exist? I am
sure that all serious students of economic policy are con­
cerned with this question and, to some extent, their views
are implied in their responses to other questions. I know
this is true, for example, in the case of much of the
material which the Federal Reserve has furnished to the
Committee.
As I understand it, the argument presented by those
who advocate acceptance of creeping inflation is that insti­
tutional factors which are not dealt with directly by
Government action are likely to cause money wages and
administered money prices in certain basic industries to
increase more rapidly than is consistent with full employ­
ment of the labor force and the growth of other productive
resources. Therefore, unless these wages and prices are,
in effect, reduced by inflating the price of everything else,
we will suffer from chronic underemployment. In other
words, these advocates suggest that monetary and, indeed,
fiscal policy as well, should be used openly to frustrate the

bargaining efforts of organized labor and the pricing poli­
cies of certain industries. Only in this way, they imply,
can a workable equilibrium be achieved between the mar­
ginal productivity of labor and real wages and between the
relative prices of competitively marketed and administered
price goods.
The objections to a policy of deliberately engineered
creeping inflation seem to me to be manifold. I hope the
problems generated by such a policy, with respect to the
whole process of saving and investment and for the balance
of payments, have been adequately treated in my re­
sponses, and those of others, to the questions asked by
the Committee. If this is the case, all that needs to be
said here is that these problems would be greatly intensi­
fied by any effort to absorb wage increases and adminis­
tered prices through calculated inflation.
Beyond this, I think there is a very serious question as
to whether such a policy could possibly succeed in the
accomplishment of its primary objective. Would those
who are in a position to administer prices or extract wage
settlements in excess of productivity gains be content to
maintain the same pace when they discovered that their
efforts to capture a larger share of the real income stream
were being frustrated by calculated inflation? Would they
not increase their demands further to improve their rela­
tive position?
Thus, it seems probable that, far from encouraging a
high level of employment and growth in the economy,
a policy of calculated creeping inflation would not make
any contribution—and certainly not a lasting one—toward
the correction of the difficulties toward which it was
directed. On the contrary, it would involve all of the
social injustices that economists universally agree accom­
pany inflation, and it would also disrupt the saving and
investment process, which must function efficiently if
vigorous growth and high level employment are to be
sustained.
If we reject a policy of deliberate inflation, what should
be the role of monetary policy in a situation in which the
over-all price level or average of prices is being pushed
up by administered costs and prices? Increases in the
* Substance of a letter sent to Senator Douglas, Chairman of the
Joint Economic Committee of the Congress, by Chairman Martin on general level of prices, and the expectation of further in­
creases, regardless of their origin, diminish the incentive to
December 9, 1959-




28

MONTHLY REVIEW, FEBRUARY 1960

save and increase the incentive to borrow. Hence, unless
credit expansion is limited to a rate of growth consonant
with the increase in the physical output of goods and
services a cost-push inflation will automatically become
a demand-pull inflation as well. This point is spelled out
in one of the papers I referred to in my replies to the
Committee, but I would like to quote it in this context.
“It is the fact of rising prices or anticipation of rising
prices that provides the incentive to borrow to finance
overaccumulation of inventories and the construction of
plant capacity in advance of need. It is the fact of rising
prices or the anticipation of rising prices that leads to
misallocations of investment and miscalculation of invest­
ment decisions. It is rising prices or the anticipation of
rising prices that diverts savings into equities, and that
dissipates their ability to finance growth, in short, that
diminishes the supply of loanable funds and accentuates
the demand in such a way as to force high and rising inter­
est rates. Finally, it is the fact that a country’s prices have
risen above those of its competitors that prices a country
out of world markets and initiates a deficit in the balance
of payments. All of these reactions, which place great
strains on the monetary and fiscal mechanism, ensue irre­
spective of whether an inflation may be described as costpush or demand-pull.
“In the credit market, these situations increase the
profitability of operating on borrowed funds even at very
high interest costs. They increase, therefore, the demand
for borrowed funds far above the amounts made available
by savings and unless they are resisted by appropriate
fiscal and monetary policies, i.e., by balanced budgets and
by restraints on the availability of reserves, they result
inevitably in an expansion of bank-created money.
“Because borrowing to anticipate inflation appears very
profitable, the pressure of customers on their banks to
borrow is very heavy and this in turn brings pressure on
the Federal Reserve Banks to expand reserves. If this
pressure is resisted, interest rates may have to rise quite
sharply before the force toward overexpansion is con­
tained. If the pressure is not contained and bank-created
money is used to finance these hedges against inflation, the
inflation, even if it started as a cost-push type, will by
that very fact be converted into one of the demand-pull
variety.”
This indicates how the pressure of cost-pushes on price
levels leads to conditions in which monetary policy tends
to be forced into a more restrictive position than would
otherwise be the case and the level of interest rates tends
to be higher than would otherwise be required to maintain
the balance between savings and investment. On the one
hand, it gives strong support to the desirability of direct




and vigorous attack on cost-push elements themselves. On
the other hand, it suggests to me that the adoption of a
“stable plus cost-push” goal for prices could not lead to
anything but trouble. It would both encourage the pro­
liferation of cost-pushes and, at the same time, provide the
demand-pull to match them. We come back to what
appears to me the inescapable conclusion that deviation
from the objective of reasonable price stability for all arms
of public economic policy would multiply our difficulties,
not reduce them.
The second, and related question which I think deserves
more examination anil probing, might be stated as follows:
Does the demand for credit from consumers and for pri­
vate investment sometimes converge on the market with
such vigor that it defies any reasonable application of gen­
eral monetary and fiscal measures, producing either uncontainable inflationary forces or the impoverishment of
certain socially desirable programs which are unable to
compete for loanable funds, and perhaps having both
effects? If this happens, should an attempt be made to
expand bank credit sufficiently to satisfy all credit-worthy
borrowers at a lower rate of interest than the demand and
supply relationship between real savings and investment
would establish? This sort of surge in the demand for
credit in the private sector, it is argued, presents a problem
not unlike that to be faced should the Federal Government
be required to expand its expenditures and borrowing
rapidly in a defense emergency. The implication is that
bank credit expansion—a form of forced saving through
inflation—is the only way to meet this problem so as to
prevent socially undesirable distortions in the economic
system.
To me, this line of reasoning is indefensible, on both
moral and economic grounds. To the extent that such a
program could succeed, even temporarily, it could do so
only because the public was deceived as to the nature of
the policy and its effects. The moral objection to any
national policy based on public deception seems to me
overwhelming. On economic grounds, this kind of mone­
tary policy could not possibly succeed for more than a very
short period. Even before the economic effects became
fully apparent, they would be anticipated by those who
would seek to protect themselves from the ravages of infla­
tion, or to profit from it. The inevitable result would be
a rapid decline in the volume of savings and an even more
rapid rise in the rate of interest than would otherwise have
occurred.
Rather than inflation, the first approach to a solution
to this problem lies in a sound general monetary and fiscal
policy. Of equal importance is the elimination of those
imperfections in the operation of the price and wage mech­

FEDERAL RESERVE BANK OF NEW YORK

anism mentioned in connection with my first point. If we
do these things I believe there is a strong likelihood that
we will avoid the kind of surges of credit demand that
are postulated. If they still occur then we should certainly
consider the application of selective controls on credit use
by consumers and businesses. I would like to hope that
these can be avoided because I am sure that they are
bound to interfere with the process by which resources are
directed to their most efficient uses in a free enterprise
economy. When one weighs the alternatives, it seems clear
that such controls would be preferable to either calculated
or uncontrolled inflation, but we should recognize that they
involve a degree of regimentation never before accepted in
this country except in time of war.
I have addressed myself to these questions at some
length because I think there may have been some real
misunderstanding of my position. My interest in a mone­
tary policy directed toward a dollar of stable value is not
based on the feeling that price stability is a more important
national objective than either maximum sustainable growth
or a high level of employment, but rather on the reasoned
conclusion that the objective of price stability is an essen­
tial prerequisite to their achievement.
I want to emphasize that I am most concerned with the

19

preservation of freely competitive markets and the correc­
tion of any institutional imperfections which exist in the
working of the price mechanism. While such imperfections
cannot be corrected simply by a sound monetary and fiscal
policy, they surely cannot be corrected by an unsound
financial policy.
Nor does a sound general monetary policy necessarily,
in itself, accomplish the optimum distribution of loanable
funds among various sectors of the economy. It is not only
the right but the duty of Government to assure that socially
necessary programs are adequately financed. But, again,
this objective can never be well served by unsound general
monetary or fiscal policies. If, as a matter of public policy,
the financing of school construction, for example, should
have an overriding priority in the allocation of resources,
this can be accomplished in a number of ways, but we can
be sure that it would not be accomplished by the general
expansion of bank credit and money.
I trust that these additional comments will be helpful
to the Committee in its work of clarifying for the Congress
and the nation the basic issues involved in attaining and
maintaining optimum levels of employment and vigorous
growth, as well as a structure and level of prices conducive
to both.

Growth and P rice Stability: The Germ an Experience
The postwar recovery of the West German economy and there are perhaps two principal lessons to be learned from
the country’s return to a place among the great industrial the German experience.1 The first is that currency stability
nations have constituted one of the most impressive per­ can be achieved and preserved even under adverse circum­
formances of the postwar economic scene. Despite heavy stances. The second lesson—and to him a more significant
wartime destruction and the burdens of partition, plant one—is that a monetary policy firmly committed to cur­
dismantling, and refugees, Germany regained prewar rency stability not only does not conflict with rapid and
production levels within five years of the end of the war sustained economic growth but indeed is essential to its
and had become a pacesetter among Europe’s most pros­ achievement. The present article—the fifth in a series
perous countries. Equally striking has been the great dealing with the problems of growth and inflation in vari­
strengthening of the country’s international economic posi­ ous economic environments2
—undertakes to examine the
tion, which has turned the German mark into one of the German experience since the 1948 currency reform.
world’s hardest currencies. These achievements—to which
massive United States aid of course contributed—were at
F A C T S A N D F A C T O R S IN G E R M A N Y 'S
least partly the result of the early restoration of a free
E C O N O M IC R E C O V E R Y
market mechanism by which effort and resources could be
Following the end of hostilities in May 1945, the Ger­
channeled into their most useful employment. The early
adoption of a vigorous monetary policy, which helped to man economy was in almost complete collapse, due both
contain inflationary pressures at home and thus to ensure
Wilhelm Vocke, "The
Germany’s ability to compete in world markets, helped to 1 See Dr. Review, June 1959- Future of the Dollar”, supplement
Monthly
provide the orderly financial setting necessary for rapid
2Cf. Monthly Review: "Creeping Inflation”, June 1959; "Growth
Without Inflation in Britain”, July 1959; "Inflation and Economic
economic recovery.
Development”, August 1959; and "The French Stabilization Program”,
As one of the architects of this policy has pointed out, January I960.




30

MONTHLY REVIEW, FEBRUARY 1960

to physical destruction and to the complete disorganization
of the country’s economic life and political institutions.
Industrial production was at a virtual standstill. Imports
had ceased completely, except for food supplies brought
in by the United States and the United Kingdom. More­
over, money had largely lost its usual functions. Labor
and other income recipients insisted on being paid partly
in kind, bartering the commodities they received against
others that they needed. Most people had little inducement
to earn more money than they required for buying their
rations, the prices of which remained generally fixed at the
prewar level. Even by early 1948, West German indus­
trial production was still only 50 per cent of the 1936 level.
The monetary reform of mid-1948, which in introducing
the Deutsche mark canceled approximately 90 per cent of
the money supply, supplied the necessary condition for
awakening the country’s economy from this stagnation.
Black-market and barter transactions disappeared over­
night, and a genuine price system re-emerged. Most im­
portant, the cancellation of a large proportion of the excess
money supply that had resulted from the war years re­
stored incentives to work and save.
While the first three years following the monetary re­
form constituted the most spectacular phase of Germany’s
postwar recovery, it was during this period that the eco­
nomic and financial policies, discussed below, faced their
most crucial test. The ultimate success of the currency
reform was not assured until after about six months, during
which time the authorities had to struggle against sharp
inflationary pressures, despite rapid advances in output.
This was followed by a period, lasting until the spring
of 1950, during which the advance slowed somewhat,
prices fell, and unemployment rose rapidly. As a result of
the Korean war, after mid-1950 the German authorities
found themselves confronted with a period of rising prices
for the second time in two years. This time, however, it
was not domestic inflation that had to be controlled. It
was the external deficit, generated by panicky purchases
of raw materials at rising prices and financed through
European Payments Union credit, that threatened to wreck
Germany’s precariously maintained balance. However, the
problems of these early years were overcome successfully,
and economic activity thereafter continued to advance
along more normal lines.
Despite the difficulties of the first few years following
the monetary reform, in 1949-50 gross national product
(GNP) increased by about 16 per cent per annum (at con­
stant prices) and by the end of 1950 had regained its 1938
level. With the immediate needs of reconstruction met, the
rate of growth slackened, but in the first half of the 1950’s
GNP still recorded annual increases of between 7 and 12




per cent. For the 1951-59 period as a whole, the average
annual rate of increase of 9 Vi per cent was the highest for
any country in Western Europe and North America; even
in per capita terms, the annual increase in real GNP
averaged about 8 per cent—a rate surpassed only by
Austria. Industrial production registered even sharper
gains, with an average annual increase of nearly 14 per
cent for the 1951-59 period.
The extremely rapid advance in total production was
based in part upon an exceptionally rapid increase in the
labor force. In the first five years after the currency re­
form, the large-scale influx of refugees and the belated
repatriation of prisoners of war swelled the total labor
force by 21 per cent and created a serious unemployment
problem. But by 1955 unemployment had been reduced
to 5 per cent of the labor force and in 1959 to less than 2
per cent. Indeed, the average annual increase in em­
ployment over the whole 1949-59 period amounted to
4Vi per cent.
The rapid expansion in total output also reflected a
marked rise in productivity (see Chart I). During 194951, when the German industrial machine swung into high
gear, output per man-hour in manufacturing rose by an
average of over 10 per cent per year; in 1952-59, the ad­
vance still averaged 7 per cent. The particularly sharp pro­
ductivity rise in the earliest years after the monetary reform
reflected the simple fact that productive activity was being
resumed in an economy that until then had been totally
disorganized. More fundamental over the long pull was
the high proportion of available resources channeled into
investment. Throughout most of the postwar period the
ratio of gross investment to GNP remained well above 20
per cent, substantially higher than for most Western Euro­
pean economies; this ratio has even risen somewhat fur­
ther in the most recent years as a result of a marked rise
in fixed investment. Germany was able in this manner to
obtain a large increase in productivity in a short time.
The process was helped further by the initial concen­
tration of investment on projects of low capital intensity,
and hence relatively quick returns, and on the replacement
of destroyed or dismantled factories with the most up-todate plant and equipment. The massive investment was
facilitated by the relatively small share of GNP absorbed
by the public sector thanks largely to the absence in the
earlier years of a domestic defense establishment. It was
also aided by fiscal measures that encouraged accelerated
depreciation and ploughing-back of profits. Consumer
spending, moreover, remained relatively low, in part ap­
parently reflecting the desire of individuals to rebuild
their assets.
Although the influx of refugees added to the demands

FEDERAL RESERVE BANK OF NEW YORK

Chart 1

WEST GERMAN PRODUCTION AND PRICES
1953=100
Per c«nt

Per cent

160

160
M anufacturing production
W a g e s / ''" ,

140

140

/

120

"* ■ * * * * *

60 ~

120

P rod uctivity

~

Cost of living

--- 100

I

1

100

80

-

I

/

—

80

60

40

40
1

1

1

1

1....

1

1

1948 1949 1950 1951 1952 1953 1954 1955

1

I

I .......

1956 1957 1958 1959

Note: Productivity (output per man-hour) and wages are for manufacturing
industries. 1948 data are for second half of year. 1959 data are
partly estimated.
Source: Organization for European Economic Cooperation.

for resources, particularly for housing and related social
capital, it undoubtedly served to moderate the pressure for
wage increases. Labor’s cooperative attitude also con­
tributed to the process of rapid capital rebuilding by its
restrained wage policy. The unions’ relative emphasis on
job security rather than on higher wages permitted wage
increases to lag behind the rise in profits, and thus enabled
business to utilize retained earnings for investmentfinancing on a large scale. The unions’ sense of responsi­
bility in assisting reconstruction and growth, buttressed by
labor participation in management deliberations, was of
course a major factor behind the relative stability of the
Deutsche mark and helped to keep German exports com­
petitive in world markets.
Labor’s restraint did not mean that wage rates did not
move up rapidly—the average annual wage increase in
manufacturing amounted to almost 10 per cent during
1949-59. But the wage rise was not far out of line with
the average increase in productivity (see Chart I). Partly
as a result, the rise in the German price level has been
one of the smallest in Western Europe—an average 1 per
cent per year in 1949-59—and “real” wages advanced
almost as rapidly as money wages.




31

An equally conspicuous facet of Germany’s postwar
economic recovery has been the sustained growth in Ger­
man exports; Germany rapidly regained her prewar share
of total world exports. During the past ten to twelve years,
the generally high level of economic activity throughout
the world and, for much of the period, the inflationary
pressures in other countries have created a sellers’ market
for such German products as machinery, cars, and other
highly specialized finished products. Moreover, most coun­
tries until fairly recently continued to discriminate against
dollar imports and thus had to look for other sources of
supply for many products. Germany offered such a source,
especially as regards capital equipment. This factor was
of considerable importance after Korea, when Germany’s
major trade partners started rearming, since Germany did
not have to devote resources to the support of a defense
establishment of her own and remained free, moreover,
of economic and defense commitments toward overseas
areas. German industry’s aggressive export promotion, in­
cluding active participation in international trade fairs,
and great flexibility in adjusting its products to foreign
requirements were also of course an important element
in Germany’s export performance.
T H E P O L IC Y FR A M E W O R K

The encouragement of free enterprise in a free market
has been the most widely publicized among the policies
adopted by the German authorities to spur the country’s
recovery. While this policy never envisaged an economic
system wholly free of government intervention (or, for
that matter, of monopolistic practices), it did provide
ample incentives to businesses and consumers alike. For
the former, the absence of the detailed government regu­
lation of the economy that characterized many other coun­
tries intensified both the opportunities and the pressures to
improve industrial efficiency. Expansion of production
was also facilitated by tax concessions which, as noted,
were designed to stimulate private capital formation. In
particular, tax benefits encouraged the self-financing of
business through the use of profits and depreciation allow­
ances; such funds financed as much as two thirds of new
investment in the early part of the period. Tax incentives,
as well as a system of government export credit insurance,
also helped to spur exports. As regards the consumer, the
free market policy assured him of the right to select freely
among alternative products within the limits imposed by
his earnings (after relatively low income taxes)—a fairly
unique phenomenon in early postwar Europe. As a stimu­
lus to personal effort, there was no attempt to discourage
“conspicuous consumption” of luxury products by such

32

MONTHLY REVIEW, FEBRUARY I960

measures as high sales taxes or import restrictions. None­
theless the rate of private savings was continuously high.
The policy of active competition and market freedom,
which was applied domestically with such success, was
also extended to foreign trade. Except in a few protected
sectors like agriculture, from the immediate postwar years
onward, increasing emphasis was placed on trade and pay­
ments liberalization. As a result, Germany was able at a
relatively early stage to participate intensively in interna­
tional trade (see Chart II), and to reap the benefits of
international specialization. The absence of major trade
restrictions probably would not have been possible, how­
ever, without the relative stability of the domestic price
level. Indeed, the movement toward free markets and the
policy of successively wider decontrol could have occurred
only under conditions of relative price stability, which
bolstered confidence in the mark. At the same time, of
course, the climate of competition that was fostered by
a minimum of government interference helped keep prices
down.
While fiscal policy, through balanced budgets or budget
surpluses, has provided a strong anti-inflationary assist,
it was not used as a compensatory device for controlling
fluctuations in economic activity. Monetary policy has
been the principal official instrument for influencing over­
all demand. The measures employed have been directed
toward three general objectives. Price stability, in view of
Germany’s disastrous experiences with monetary inflation
after two world wars, has received the highest priority.
Next has been the provision of sufficient financing for the
expansion of production. Finally, there have been the inter­
national objectives of increasing Germany’s foreign trade
in the early years of the period under review and, in the
later years, of moderating the country’s external surpluses.
Within this framework monetary policy was conducted
along fairly restrictive lines, although on a year-to-year
basis the money supply was allowed to expand continu­
ously. However, at the faintest signal of danger to internal
price stability, the central bank was quick to apply its
weapons of restraint.3 The bank thus has resisted the
temptation to aim at constant and unvarying full employ­
ment at the risk of inflation. In the over-all setting, the
rapid growth of the German economy was sufficient to
generate high employment.
While West Germany has been successful in reconciling
rapid growth with a reasonable degree of price stability, it
has been plagued with a balance-of-payments problem dur3 The most recent example of this attitude was displayed last fall
when the bank, after a "warning shot” in the form of a discount rate
increase in early September, tightened its policy in order to keep the
investment boom from getting out of hand.




Chart II

WEST GERMAN FOREIGN TRADE
Billions of dollars

Billions of dollars

Source: International M onetary Fund.

ing recent years radically different from that faced by most
other European countries. Germany’s external surpluses
and the accumulation of vast reserves have proved far
more intractable than the temporary external deficit en­
gendered by the inventory boom in 1950-51, which had led
to energetic restrictive steps. And, although the central
bank’s policy in 1957-59 was directed toward low­
ering the over-all interest rate structure in order to pro­
mote, among other things, capital exports, this specific
objective was subordinated when it no longer coincided
with the need for some easing of credit at home. In once
more moving toward higher interest rates in the closing
months of 1959 the central bank, according to its presi­
dent, “deliberately accepted the possibility” that funds
might return from abroad and that waxing foreign exchange
surpluses might “again cause . . . headaches”.
Q U E S T IO N S FO R T H E F U T U R E

Germany’s external surpluses, which have already at­
tracted so much attention, seem likely to remain in the
forefront of discussion in the near future. German official
gold and net foreign exchange holdings4 rose from $1.1
billion equivalent at the end of 1952 to $6.2 billion at
the end of 1958 (see Chart III), the largest holdings
of any single Free World country after the United States.
Although in the first nine months of 1959 these holdings
* Including balances held under payments agreements, net claims on
the European Payments Union through 1958, and in 1939 net claims
under the European Monetary Agreement.

FEDERAL RESERVE BANK OF NEW YORK

declined to $5.2 billion—partly as a result of repayments
on foreign indebtedness, and partly because of rising
interest rates in the United States and Canada that stimu­
lated an outflow of capital from Germany—they were
back to $5.7 billion by the end of the year. The accumu­
lation of these sizable holdings, and the possibility of
continued gains, are obviously of paramount concern to
Germany’s trading partners, some of whom have ques­
tioned whether German domestic economic conditions
actually warranted actions that were bound to lead to a
further accumulation of reserves.
Domestic considerations, however, may well become
even more important, since a number of major structural
changes appear to be taking place in the German economy.
These changes may, before long, make it more difficult to
preserve price stability, although they may tend to reduce

Chari III

WEST GERMAN OFFICIAL GOLD AND
NET FOREIGN EXCHANGE RESERVES
Billions of dollars

Billions of dollars

-II_____________________________________1-1
1948

49

50

51

52

53

54

55

56

57 . 58

59

Note: No breakdown available for 1948-49. No breakdown of foreign
exchange reserves, as between United States and Canadian dollars
and “all other”, available for 1959. "All other” comprises net holdings
of nondollar currencies, balances under payments agreements, net
position in the European Payments Union(1950-58), and in 1959
net claims under the European Monetary Agreement.
Source: International Monetary Fund.




33

the magnitude of the external problem. In the public
sector, a new phase of budgetary deficits may be in the
making inasmuch as ordinary and defense expenditures
are rising and disbursements for social services and benefits
are being increased. At the same time, labor’s bargaining
position has grown stronger with the reduction in unem­
ployment to low levels and the slower rise in the labor
force. This circumstance may portend wage demands in
excess of productivity advances, creating the problems for
price stability that many other countries have faced.
Other changes that are currently taking place appear to
foreshadow a slowing-down in the rapid growth rate of the
past ten years. The quickened pace of private consumption
in 1959, if it continues, may well reduce the savings ratio.
The uptrend in consumption has been reflected in and
partially supported by the current spectacular rise in con­
sumer credit, and has fostered recent price increases. At
the same time, the period of quick returns from investment
outiays may be drawing to a close. The most obvious gaps
in plant and equipment have been filled, labor has become
scarce rather than ample, and investment is therefore
tending to be directed toward labor-saving and capitalintensive projects. Lower returns on capital may also
ensue as a greater share of the total is devoted to the
economy’s overhead facilities—including roads and com­
munications—which have not in all cases kept up with
the expansion of production.
Under these conditions, the monetary authorities may
find themselves confronted with a delicate dilemma. On
the one hand, they will of course wish both to offset any
additional liquidity generated by the public sector and
to contain price and wage pressures in general. On the
other hand, the authorities will wish to pursue their goal
of gradually lowering the over-all interest rate level, in
order both to help reduce the external surpluses through
short- and long-term capital exports and to encourage
an adequate level of domestic investment as profit margins
are squeezed by rising wages. The maintenance of mone­
tary stability thus will require much wisdom and financial
statesmanship in order that the gains achieved so far may
be preserved and continued. The success that Germany’s
postwar economic policies have had in reconciling growth
with relative price stability is reassuring evidence that
any future problems will be solved.

34

MONTHLY REVIEW, FEBRUARY 1960

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