Full text of Economic Policy Review (Federal Reserve Bank of New York) : February 1974, Vol. 56, No. 2

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FEDERAL RESERVE BANK OF NEW YORK

31

Central Banking in the Econom y To d a y
By A l fr e d H ayes
President, Federal Reserve Bank of New York

A n address before the forty-sixth annual midwinter meeting of the
New York State Bankers Association in New York City on January 21, 1974

I would like to talk today about the central bank and
the environment in which it must operate to affect the
course of the economy. While I will naturally focus on the
Federal Reserve, central banks in other countries face
similar challenges and are subject to similar constraints.
It may be particularly timely to review these matters in
view of the very uncertain economic outlook for 1974,
and the problems that this uncertainty poses for monetary
policy.
Painted with very broad strokes, the economic picture
of the last quarter century or so is quite satisfactory. Never
before had this country or other developed economies es­
caped serious depression for so long. The recessions that
were experienced were, historically, mild and short in dura­
tion. Until the past few years, our record of inflation was
also encouraging; from 1951 to 1965, for example, con­
sumer prices rose less than 1V2 percent a year on average.
For the past eight years, however, we have been grappling
with a stubborn and distressing rate of inflation; averaging
over 4 percent a year and exceeding 8 percent last year, it
has distorted spending and investing, borrowing and lend­
ing, decisions. This inflation is not easily stopped, as we
have learned from a mini-recession in 1967 and a year’s
recession in 1970.
Just as the record of expansion since W orld W ar II may
point up the capability of the Federal Reserve to con­
tribute to satisfactory economic performance, the experi­
ence with inflation since 1965 illustrates some of the
limitations of monetary policy. First, throughout most of
this period, private demand was strong and fiscal policy,
stimulative. In the fiscal years 1971 to 1973, for example,
the Federal budget deficit totaled $60.5 billion. As the




credit crunch of 1966 illustrated, in the absence of fiscal
restraint a restrictive monetary policy can be pushed only
so far before the financial system becomes seriously
strained. Second, once wages and prices rose, they were
validated by contract and price practices, and they resisted
decline, even when total demand slackened. Third, in
1973, the second of the dollar devaluations resulted in
increased foreign demand for our goods just as bottlenecks
in the expanding economy began to appear. Finally, in­
comes policy, which had contributed to stabilizing prices
in 1971 and 1972, became ineffective in the overheated
environment of 1973. Thus, appropriate fiscal and in­
comes policies are important conditions for monetary pol­
icy to be effective.
Now, I do not want you to think that I am commenting
on the difficulties that confront the Federal Reserve in
dealing with economic problems as a defense against criti­
cism of our mistakes, or to seek sympathy for those of us
with the responsibility for making policy. It is rather that
I believe that a better understanding of what a central
bank can and cannot do will guard against unrealistic ex­
pectations— and consequent disappointment. Moreover,
better understanding may well produce more useful criti­
cism that could help the Federal Reserve to improve its
performance.
To begin with, it’s obvious that any group— whether in
the Congress, the Administration, or the Federal Reserve
— required to make decisions that will affect the economy
in the future must formulate some idea of how the econo­
my is going to evolve in the months ahead. For the Fed­
eral Government’s budget, that time period is a year and
a half ahead or more. We have just had a timely reminder

32

MONTHLY REVIEW, FEBRUARY 1974

— at a recent meeting in this city, attended by some of the
country’s foremost economists— that the art of forecasting
is still an extremely difficult one and that nobody is willing
or able to claim adequate foresight. Although the art has
certainly made progress in recent decades as our economic
understanding has been enhanced, as strides have been
made in quantifying variables and constructing economet­
ric models, and as judgment has improved, it still has far
to go.
Nevertheless, economic policy makers must do their
best to forecast the conditions they hope to affect. At this
point, then, we can say that a central bank must make a
forecast taking into account all other government policies,
and of course it must review this forecast frequently and
adjust its policies as that may become desirable. The cen­
tral bank must then decide how to exert its influence on
money and credit, and how vigorously. For some students
of central banking policy this task does not seem to pose
any problem: just increase the money supply by, say, 6
percent a year or Vi percent a month. This seems to be an
appealingly simple solution. But, in my view, an effective
monetary policy cannot be achieved by such a simple—
and simplistic— formula. As you probably know, a large
majority in the Federal Reserve is very reluctant to accept
the notion that the rate of growth in bank credit, and total
credit, or volatile fluctuations in interest rates, or in veloc­
ity, can be safely disregarded in such a narrow focus on
any monetary aggregate. And, even if such an approach
were desirable, it presumes a much greater degree of sta­
tistical knowledge, and a greater ability to control the
monetary aggregates in the short run, than exists.
In this regard, I am very much concerned about the ad­
verse impact of the present system of reserve requirements
on our ability to control money and credit. In today’s en­
vironment, effective monetary control requires that the
reserves of all institutions offering payments services come
under the direct influence of the Federal Reserve. Until
this is accomplished, our monetary and credit control ef­
forts will be less precise than they can, or should, be.
Moreover, the present system imposes a heavier reserve
burden on Federal Reserve member banks than on non­
members, and fear of aggravating member banks’ com­
petitive disadvantage can inhibit the use of reserve re­
quirement changes for control purposes. Thus, I am con­
vinced that we face a continuing gradual weakening of our
ability to control money and bank credit so long as some
banks have the option of not holding their reserves in a
form that comes under the direct influence of the Federal
Reserve. These considerations have led me to the firm
conclusion that reserve requirements on demand deposits
should be similar for both member and nonmember banks.




Indeed, it is anomalous that the United States is the only
major country in which banks enjoy the option of choos­
ing not to adhere to the central bank’s reserve regulations.
With respect to nonmember banks, I should also note
that we need more comprehensive and timely deposit data
from these banks for monetary control purposes. Normally
we have gotten deposit figures from nonmember banks for
only two days a year; that is, for the June and December
call dates. In addition, these figures are available only with
a very long lag. Thus, we have no current information on
nonmember bank deposits to feed into the monetarypolicy process. This has been a serious limitation in recent
years when nonmember bank deposits have been growing
more rapidly than expected. The June 1972 call report,
for example, indicated that nonmember bank demand de­
posits were $1.8 billion higher than expected, which was
the largest such revision on record. Unfortunately, we
were not aware of the size of this revision until the end of
the year. We are still not sure what changes will be made
in 1973’s numbers, but, in any case, it seems clear that
better nonmember-bank deposit data are needed to en­
hance overall monetary control.
Apart from the statistical and other limits on our ability
to control the monetary aggregates within narrow limits of
tolerance in short periods of time, the very attempt to do
so would in all likelihood result in wide fluctuations in in­
terest rates. Gyrations in interest rates and in prices of
fixed-income securities disrupt financial markets and the
decision-making process of market participants. Yet it is
in and through these financial markets that the central
bank must carry out policy decisions. The basic operating
premise of the central bank’s open m arket operations is
that they must be conducted in effective, viable financial
markets. The need for vigorous markets, capable of ab­
sorbing and transmitting the effects of expected and unex­
pected developments, does not mean the central bank
must protect, much less promote the interest of, the
participating institutions. It does, however, mean that
those committing their capital in the m arket must be
confident that they will not be exposed to unduly violent
fluctuations caused by actions of the central bank. M ore­
over, any suspicion of erratic conduct by the monetary
authorities would cause an apprehensive withdrawal of
savers and investors that would make it difficult for pri­
vate and governmental borrowers to conduct financing
operations.
Any such interruption of financial flows to the business
or consumer sectors would have an adverse impact on
production and employment. But over and above such
financial effects, uncertainty about the central bank’s op­
erations and intentions, resulting from wide short-run

FEDERAL RESERVE BANK OF NEW YORK

fluctuations in interest rates, may well have a negative
effect on business confidence and spending. There is, in
short, a real cost to interest rate instability that we cannot
ignore in formulating and implementing policy.
Please do not misunderstand me; I am referring here
only to the wide gyrations in interest rates that are likely
to result from any attempt to maintain steady short-run
growth of the monetary aggregates. Longer run move­
ments in interest rates in response to policy changes and
developments in the private sector have, of course, impor­
tant equilibrating and allocative effects on the economy.
Such rate movements are obviously meaningful, and are
part of the process of transmitting monetary policy
changes to the economy. It would be just as bad to try to
pursue policies that avoid significant movements in inter­
est rates as to follow policies that lead to very sharp short­
term fluctuations in rates. In this respect, I am in full ac­
cord with the Federal Reserve move toward greater reli­
ance on interest rates in free markets than on direct con­
trols, such as certificate of deposit (C D ) ceiling rates, in
the monetary-control process.
Just as the central bank must earn and keep the con­
fidence of financial markets and institutions in its integrity,
its competence, and its awareness of present and impend­
ing developments, so it must also earn the confidence of
the Government, in our case principally the Treasury and
the Congressional committees concerned with banking and
with the economy. A former Governor of the Bank of
England, Lord Cobbold, reflecting on his service in that
position, concluded that “After its relationship with Gov­
ernment, which is fundamental,” the central bank’s
“most important concern” is with the banking and finan­
cial systems. “One of its first duties”, he said, “is to inter­
pret Government thinking to the financial markets and
market thinking to the Government. A central bank which
is out of touch with its own financial community and does
not enjoy their confidence can never be doing its job
properly.” He then noted that “confidence and praise are
two quite different things”.
There are clearly major differences between the role in
Government of the Federal Reserve and the Bank of Eng­
land. However, the Federal Reserve Bank of New York
— as the operating arm of the System in the domestic
money market and of the System and the Treasury in the
foreign exchange market— is, I believe, well situated to
serve as such an intermediary between the Government
and the financial community. We have sought to fulfill
this role, always recognizing, of course, that the indepen­
dence of the Federal Reserve within the Government and
from the financial community must not be compromised.
As for “confidence and praise”, I am certainly not going




33

to argue that central banks should get heaping portions
of praise at frequent intervals, any more than Lord Cobbold would. But a goodly measure of confidence is neces­
sary. Perhaps the chief reason for this is the authority
entrusted to the central bank to create and issue money,
including the high-powered variety called bank reserves
that provide the base for a multiple expansion of bank
credit and deposits. It is self-evident that the Congress,
the Treasury, and all participants in financial markets
have a crucial interest in how well the central bank exer­
cises this great authority. By the same token, all of them
will review most carefully the monetary authorities’ ac­
tions and the results, since those actions will affect incomes
and market values. For all these reasons, a central bank
must always stand ready to explain its objectives and
reasoning, and the use it has made of its instruments. This
is particularly true in our country with respect to the
Congress, which has delegated its constitutional monetary
power to the Federal Reserve.
In the past year we have been confronted with a new
problem for monetary policy as the shortages associated
with a cyclical peak have been aggravated by a worldwide
boom and the reduction in oil supplies. Even before the
cutback of oil output and the embargo on shipments to
the United States by several large producers in the M id­
dle East, it was becoming apparent that our economy
faced a year of much less growth than in 1972 or 1973,
when real output rose about 6 percent a year. During
1973 it became increasingly clear— as has often been the
case in the past— that we had reached effective capacity
for many materials; there were more and more widespread
shortages and delays in delivery, larger and larger back­
logs of unfilled orders. It was also clear that a good deal
of time was going to be required to develop additional
capacity.
This cyclical-capacity problem was exacerbated in 1973
by worldwide boom conditions. During most of the period
from the end of World War II to last year, the makers of
economic policy for the nation had to focus on how fiscal
and monetary policies should affect aggregate demand.
They could generally assume that an adequate supply of
goods and services would be forthcoming, perhaps in
response to a higher price, if not at home then from
abroad. But one can no longer make that assumption,
either knowingly or unconsciously. The coincidence of
excess demand, both at home and abroad, in 1973 was
unique in the postwar period and meant that we could
no longer rely on the rest of the world to fill the gap be­
tween supply and demand in this country. In this setting,
the devaluation of the dollar, and the encouragement it
gave to exports from this country, added to our supply

34

MONTHLY REVIEW, FEBRUARY 1974

problem. More recently, this problem has been further
aggravated by the oil embargo. Thus, we are facing condi­
tions today quite unlike any of the past quarter century,
not merely because of a shortage of petroleum whose
extent we cannot even now determine with any precision.
There is, in fact, little the central bank can do to ease
such supply problems in the short run; as Chairman
Burns pointed out, the problem is a shortage of oil, not
of money. The central bank can, however, seek to forestall
any cumulative downswing in the economy that might
result from the oil shortage.
To this point, I have tried to sketch what seem to me
some of the major elements shaping the capabilities and
limitations of central bank policy, drawing largely on our
experiences in the United States, but implying that similar
conditions exist in other developed countries. Clearly, I
would not wish to conclude without some reference to the
world monetary system and the flows of trade, investment,
and other international transactions that affect all central
banks.
On the international financial side, we have witnessed
over the last several years a breakdown of the Bretton
Woods system. World trade and investment have never­
theless continued to expand, and some would construe
this experience as a vindication of those who have long
advocated floating exchange rates and as a repudiation
of earlier fears by central bankers, such as myself, that
floating rates would not work. I would view the recent
experience quite differently.
During the past year it has become evident that no large
country is prepared to allow the external value of its cur­
rency to fluctuate without limit in response to market
forces. To do so is to invite speculative aberrations which
may carry exchange rates to levels that are inconsistent
with balance-of-payments equilibrium. Moreover, undue
variations in exchange rates can have harmful domestic
effects on the economic life of every country, large and
small. As we have seen in the United States this past
year, such rate changes unnecessarily exacerbate infla­
tionary pressures in countries whose currencies depreciate
well beyond longer run equilibrium levels. They can also
distort the allocation of real resources into a pattern not
warranted by underlying economic forces. Thus, for both
domestic and international reasons most governments
have found it desirable to limit exchange rate fluctuations
through periodic official intervention or through controls
on trade or payments.
In fact, we have not really had freely floating rates;
the world financial system has developed into a mixed
arrangement of fixed and managed rates, involving
exchange-market intervention by the major central banks




of about $30 billion equivalent since last M arch when the
markets were reopened. In this connection, I believe that
the resumption of Federal Reserve operations in the
foreign exchange markets since last July helped to create
conditions in which the improvement in our balance of
payments was able to be reflected in the subsequent recov­
ery of the dollar. Such operations will provide an essential
safeguard against unwarranted speculation in the future.
It is also evident that exchange rate changes are a mat­
ter of international concern, since any exchange rate
change inevitably entails variations in the exchange rates
of other countries and may introduce new problems in
the management of other economies. Thus, the determina­
tion of exchange rates under virtually any regime involves
a process of international negotiation and conciliation. The
Bretton Woods system provided a solution to this problem
for many years, but one that placed the United States in
a passive role. That role is no longer appropriate, and the
need for agreed-upon rules of international conduct is all
the more urgent.
The urgent need for close international cooperation is
underlined by all of the ramifications of the oil crisis. The
impact of the staggering increase in crude oil prices on
world trade and payments is of particular concern to cen­
tral bankers. The resulting jump in payments to the oilproducing countries by the rest of the world will be
enormous— some estimates place it in excess of $50
billion this year alone. The readjustment of the world
economy to such a major shift can properly take place
only on a cooperative basis. If we don’t work together we
shall all be the losers, the developed and developing
countries alike.
In conclusion, I am sure you understand that, despite
what I have said about the limits or constraints confront­
ing monetary policy, there is no doubt in my mind of the
important influence exerted on the economy by the central
bank. It’s just that I don’t think money is the only thing
that matters. You will probably agree that the problems
confronting central banks are unusually difficult today.
While, in our policy formulation, we can’t disregard the
possibility of a cumulative downturn that would increase
unemployment substantially, inflation has been, and con­
tinues to be, the major problem for policy makers. It is
difficult to remember a time when the economic outlook
was as uncertain as it is today. Supply constraints, not
only in petroleum but also in a wide range of basic indus­
trial materials, pose novel and, in the short run at least,
largely intractable problems for policy makers. However,
I am confident that in time these difficulties will be sur­
mounted, with your cooperation and with that of all of the
American people.

FEDERAL RESERVE BANK OF NEW YORK

35

Th e Business Situation
The most recent business statistics provide further evi­
dence of a slowing in the economy. During the past quar­
ter, real gross national product (G N P) edged up at a
seasonally adjusted annual rate of 1.3 percent, the slowest
pace in three years. In the last month of the quarter, indus­
trial production actually declined, following three months
of very small gains. Some of this recent braking clearly
reflects the impact of the embargo on oil shipments from
the Arab oil-producing nations, announced late last
October, with all of the December decline in industrial
production traceable to reductions in the output of
“energy” and automotive assemblies. Actual and antici­
pated fuel shortages contributed to a fairly broad-based
rise in unemployment from 4.8 percent in December to 5.2
percent in January.
Some slowing in the economy was generally expected
even before the petroleum situation moved to center stage,
and would almost certainly have taken place even if ample
supplies of oil had continued to be available. Shortages
were an im portant factor; these were widespread up to and
including the final quarter. Indicative of this was the
extraordinarily high level of capacity utilization in the
major materials industries during the last quarter. Despite
a slight decline from the third-quarter rate, the OctoberDecember figure was the second highest quarterly utiliza­
tion rate on record. Price controls contributed to the
shortages, since they led to changes in output patterns and
also induced producers to expand exports, which are not
subject to domestic price controls.
The price situation has gone from bad to worse in recent
months, with prices of fuel and power skyrocketing. The
rise in the GNP deflator continued to accelerate during the
fourth quarter and reached an annual rate of 7.9 percent,
the fastest climb since the Korean war. Wholesale prices
soared at a 26 percent annual rate in December, after reg­
istering a 21 percent increase in November. A broad-based
advance in all the components was evident, even though
fuel and power prices, which increased at the phenomenal
annual rate of 146 percent in December and 157 percent
over the last three months, had an overwhelming effect on
the index. For the entire year, wholesale prices rose by




18.2 percent, the highest rate since the end of World War II.
Although the upward march in consumer prices “slowed”
to an annual rate of 6 V2 percent in December, the rapid
run-up in wholesale prices has not yet been fully felt at the
retail level. During the past year, consumer prices climbed
8.8 percent, the fastest advance since price controls were
terminated after World W ar II.
Cost pressures during the final quarter of 1973 intensi­
fied, as rapidly rising wages and declining productivity
generated the largest unit labor cost increase in four years.
Prospects for a moderating of the pace of wage changes
are diminished by the fact that real wages declined over
much of 1973. Moreover, a heavy collective bargaining
schedule is anticipated for 1974.
GNP AND R E LA TE D D EVELO PM EN TS

The market value of the nation’s output of goods and
services rose $29.5 billion during the fourth quarter to a
seasonally adjusted annual rate of $1,334 billion, accord­
ing to the preliminary Commerce Departm ent estimates.
Measured in current dollars, GNP climbed at a 9.4 per­
cent annual rate, but nearly all of this advance reflected
higher prices; after adjustment for changes in the price
level, GNP expanded at a 1.3 percent rate, the slowest pace
in three years (see Chart I) .
Although the Arab oil embargo had some impact on real
growth during the fourth quarter, a slowing had become
apparent earlier in the year. During the two middle quar­
ters of 1973, real growth averaged about 3 percent per
year, after having risen 8 percent during the twelve months
ended March. A comparable deceleration in the growth of
the Federal Reserve B oard’s index of industrial produc­
tion, which measures the physical output of the nation’s
factories, mines, and utilities, has also occurred. Over the
four quarters ended last March, the expansion in industrial
production averaged close to 12 percent. It then slowed to
about 6 percent in each of the next two quarters and to less
than 1 percent in the final quarter. In December, industrial
production registered its sharpest decline in more than
two years. However, excluding the energy component,

36

MONTHLY REVIEW, FEBRUARY 1974

which encompasses such activities as the extraction and
processing of fuels as well as the generation of power, and
the motor vehicles and parts component, which has also
been strongly affected by the oil situation, industrial pro­
duction rose in December.
Inventory investment added $11.2 billion to the growth
of GNP during the fourth quarter (see Chart II). Accord­
ing to estimates based on incomplete data, the change in
business inventories soared from the small $4Vi billion
annual rate of accumulation averaged during the pre­
ceding three quarters to a huge $15.9 billion climb in
the October-December period. Final expenditures— GNP
net of inventory accumulation— rose only about half as fast
as in the earlier quarters of 1973, as spending on consumer
durables and residential construction declined sharply.
The abrupt rise in inventory investment represents the
outcome of a diverse set of factors. As in the preceding
quarter, there was a run-up of farm inventories ($1 bil­
lion, annual ra te ), with farmers probably increasing their
holdings in anticipation of higher prices. Many other busi­
nessmen were undoubtedly attempting to build up inven­

tories from the very low levels to which they had been
pushed by the exceptionally rapid growth of final demand
and the widespread supply shortages that have character­
ized much of the recent past. However, the most dramatic
development was the $4.5 billion surge in passenger car
inventories held by auto dealers (see table), while some of
this buildup was voluntary, in response to the depletion of
dealer stocks during the earlier part of the year, most of it
reflects the marked weakening toward the end of 1973 in
the demand for standard-size cars. As sales dropped,
dealer stocks of domestic-type cars went from the equiva­
lent of forty-two days of sales in September to sixty-nine
days in December. The present imbalance of auto inven­
tories is underscored by industry reports that supplies of
certain slow-selling large vehicles currently are equal to
several months of sales while for some of the muchsought-after subcompacts supplies are extremely short.
The pace of overall consumer spending slowed dramat­
ically during the fourth quarter. Current-dollar outlays
expanded by only $13 billion, compared with the $20.4
billion advance registered in the previous quarter and an

C h a rt I

PERCENTAGE CH A N G ES IN REAL GR O SS N ATIO N A L PRODUCT
From p re v io u s q u a rte r; s e a s o n a lly a d ju s te d a n n u a l ra te s

N ote:

S h ad ed areas represent recession periods, in d icated by the N atio n a l Bureau of Economic Research chronology.

The dates of the 1 9 69-70 recession are tentative.
Source

United States D epartm ent of Commerce, Bureau of Economic Analysis.




P ercent

37

FEDERAL RESERVE BANK OF NEW YORK

average increase of $19.1 billion per quarter over the year
ended in June. When stripped of the sharp price increases,
the recent sluggishness of consumer spending emerges even
more clearly, showing an actual decline in the fourth quar­
ter at a 2.6 percent annual rate. This was the first decline
since the final quarter of 1970, when the recession and a
lengthy strike at General Motors had combined to produce
an even larger drop.
Current-dollar spending on consumer durables, which
had shown a very sizable increase in the first quarter of
1973 and had remained essentially flat for the next six
months, declined in the fourth quarter by $6 billion. Ex­
penditures on passenger cars plummeted $7.1 billion (see
table), a decline comparable in both current dollar and
real terms to the drop that occurred during the auto strike
of three years ago. Although some slowing in the pace of
new car sales was widely anticipated well in advance of the
launching of the 1974 models, the magnitude of the decline
has surpassed most expectations. The Arab oil embargo
and accompanying uncertainties as to the availability and
cost of gasoline have taken their toll on the auto industry.
They have not only weakened the demand for new cars
beyond the amount of slippage that might otherwise have
occurred, but have also precipitated a strong shift toward
smaller vehicles. However, parts shortages and capacity
limitations have constrained the production of smaller
cars both at home and abroad and lengthened delivery
times. Consequently, sales of new passenger cars— domes­
tic types and imports combined— dropped from the record
annual rate of 12.6 million units reached this past March
to a seasonally adjusted annual rate of 9.6 million units in
December. In January, sales of new domestic cars, which
had been at a seasonally adjusted annual rate of 7.9 mil­
lion units in December, slipped to 7.7 million units. This
compares with a fourth-quarter average of 8.4 million,
and a peak rate of over 10 million reached during the
first quarter of the year.
Spending on nondurable goods also weakened during
the fourth quarter, with real outlays showing a decline. Al­
though current-dollar outlays for both food and gasoline
rose appreciably in the face of rapid price increases, real
consumption fell in both categories. The decline was es­
pecially acute with respect to gasoline and motor oil. Ex­
penditures for services, on the other hand, continued quite
strong— both before and after adjustment for price in­
creases.
Business fixed investment advanced by a comparatively
modest $3.1 billion. This was somewhat slower than in
the preceding two quarters and only about half as fast as
the rapid growth during the final quarter of 1972 and the
opening quarter of 1973. During October-December, busi­




RECENT CHANGES IN GROSS NATIONAL PRODUCT
AND ITS COMPONENTS
S easo n ally adjusted

^ C h a n g e fro m second q u a rte r

I C h a n g e from th ird q u a r te r

^ to th ird q u a rte r 1973

■ to fourth q u a rte r 1973

GROSS NATIONAL PRODUCT

In ven to ry investm ent

Fin al exp en d itu res

Consum er e x p e n d itu re s for
d u ra b le g oods
Consum er e x p e n d itu re s for
n o n d u ra b le goo ds
Co n su m er e x p e n d itu re s for
services

R e s id e n tia l construction

Business fix e d investm ent

F e d e ra l G o v e rn m e n t
purchases
S ta te and lo cal g o v e rn m e n t
p urchases
N e t exports o f goods
an d services
5

10

15

20

25

30

35

Billions of dollars

Source-. U n ited State s D e p a rtm e n t o f C o m m e rc e , B u rea u o f Econom ic A n aly sis.

ness purchases of passenger cars dropped by $1.2 billion
to the slowest pace in almost two years (see “producers’
durable equipment” in the table). The petroleum outlook,
including its implications for the resale price of larger-size
cars, was at least partly responsible for this decline.
The im portant role of automotive developments in the
evolution of fourth-quarter GNP is summarized in the
table. These data show those portions of GNP that arise
from expenditures on passenger cars. They comprise con­
sumer spending on passenger cars, the part of business
fixed investment that takes the form of passenger car pur­
chases by business, and the portion of the change in busi­
ness inventories that is accounted for by dealer holdings
of cars. The difference between auto exports and auto
imports (the latter including passenger cars assembled in
Canada for sale in the United States) also enters into the
calculation of gross auto product.
As the table shows, following the big drop in auto pro­

38

MONTHLY REVIEW, FEBRUARY 1974

appears quite strong. The latest Commerce Department
survey, which was conducted during November and
December— after the announcement of the Arab oil em­
bargo— indicated that businessmen are planning to
increase their capital spending 12 percent above 1973
levels. Of course, when adjusted for anticipated price
changes, the implied increase is substantially less. None­
theless, it is interesting that the planned rise showed no
significant decrease from projections made on the basis of
information gathered somewhat before the oil embargo
was instituted— namely, 12 percent in the Lionel D. Edie
survey and 14 percent in the McGraw-Hill survey. How­
ever, many of these intentions are still tentative and may
involve no firm commitment on the part of business firms.
Residential construction spending during OctoberDecember dropped $5 billion. This had been foreshadowed
by monthly data showing a decline in private housing
starts, which moved down from an average in the first
quarter of 1973 of 2.4 million units, seasonally adjusted
annual rate, to 1.6 million in the final quarter. The high
cost and limited availability of mortgage financing have
played an important role in reducing the volume of hous­
ing activity. However, other forces have also contributed
to the decline. Some slowing was inevitable from the fever­

duction during the General Motors strike near the end of
1970 and the sizable rebound immediately thereafter, auto
product remained virtually flat through the first half of
1972. This was followed by a period of dramatic growth,
with real auto product rising at an annual rate of more than
32 percent over the three quarters ended M arch 1973.
This compared with a rise of less than 8 percent in total
real GNP (see last line of table) over the same period.
Thus, the increase in gross auto product accounted for
fully 20 percent of the increase in real GNP. As 1973
wore on, however, gross auto product began to decline,
contributing significantly to the slowing in overall econom­
ic activity. During the middle two quarters of the year,
auto product growth was restrained by the fact that the
industry was operating at or close to maximum capacity,
and the third quarter was additionally plagued by a variety
of supply problems. The fourth-quarter decline, as indi­
cated above, was clearly related to the weakening in de­
mand for the larger new cars. Although a sharp rise in
dealers’ inventories offset much of this decline in final
demand, it is unlikely that this will continue, given the
substantial downward adjustment of domestic auto pro­
duction that is currently under way.
The demand for fixed investment goods as a whole still

GROSS AUTO PRODUCT AND ITS COMPONENTS
Seasonally adjusted annual rates
1971

1970

1972

1973

Groups
III

IV

1

II

IV

III

1

II

III

IV

1

II

III

IV

In billions of current dollars

Gross auto product ............................................

34.2

22.5

42.4

40.1

42.4

38.8

40.1

42.1

46.5

45.6

51.5

51.2

49.6

45.7

Personal consumption expenditures ...........

29.7

23.4

34.3

34.3

37.1

35.9

36.6

38.1

41.8

41.2

45.1

44.6

44.5

37.4

Producers’ durable equipment ....................

5.2

4.1

6.1

6.1

6.5

6.3

6.5

6.7

7.4

7.3

8.0

7.9

7.8

6.6

Change in dealers’ auto inventories ...........

0.3

—3.3

4.0

1.6

1.2

— 1.2

—0.4

—0.4

—0.8

—0.4

0.9

1.2

—0.5

4.5

Net exports ......................................................

—1.5

—2.1

—2.3

—2.3

—2.9

—2.8

—2.9

—2.8

—2.3

—2.9

—2.8

—2.9

—2.7

—3.3

In billions of 1958 dollars

Gross auto product ............................................

31.6

20.0

37.1

34.8

37.8

35.8

36.1

37.7

41.0

41.4

46.4

45.5

43.6

40.6

726.8

718.0

731.9

737.9

742.5

754.5

768.0

785.6

796.7

812.3

829.3

834.3

841.3

844.1

Addendum:
Gross national product ....................................

Note: The gross auto product totals include government purchases, which amounted to
Because of rounding, figures do not necessarily add to totals.
Source: United States Department of Commerce, Bureau of Economic Analysis.




billion annually during the periods shown.

FEDERAL RESERVE BANK OF NEW YORK

ish and unsustainable pace hit during 1972 and early last
year. In addition, rapid increases in housing prices have
probably reduced demand somewhat below where it might
otherwise be. More recently, the restricted availability and
increased cost of gasoline and other fuels, as well as the
general uncertainties associated with the Arab oil em­
bargo, have probably been further factors dampening hous­
ing activity. On the other hand, recent Government steps,
such as that providing for expanded use of the “tandem
plan”, could favorably affect the near-term outlook for
housing. The tandem plan allows the Government N a­
tional Mortgage Association to purchase at below market
interest rates up to $6.6 billion in unsubsidized Federal
Housing Administration and Veterans Administration
mortgages.
Spending by state and local governments rose $5.8
billion during the fourth quarter, up from the $4.7 billion
growth averaged during the earlier quarters of the year.
Federal spending increased $1 billion, compared with the
decline of $0.4 billion in the previous quarter and the large
gain of $2.3 billion averaged during the first half of the
year. A Federal pay raise that took effect on October 1
led to a $1.7 billion increase in fourth-quarter Federal
expenditures on wages and salaries. Excluding the pay
raise, nondefense spending was up $0.7 billion and de­
fense spending was down $1.5 billion. However, defense
spending was reduced $2.5 billion by the sale of arms to
Israel out of Government stocks, and net exports were
raised by the same amount. Excluding both the pay raise
and the arms shipment, defense spending was up $ 1 billion.

39

year-ago levels. The fuel and power component of the
wholesale price index soared in the final three months of
the year, rising at a 157 percent annual rate after climbing
at a 25 percent rate during the first nine months of the
year and 6 percent during 1972. Even excluding the two
foregoing index components, wholesale prices have risen
extremely rapidly— at a 12.3 percent rate during the last
three months of 1973, compared with an 8 percent rate
during the first nine months of 1973 and a total of 3 Vi
percent in 1972.
Consumer price increases “slowed” to a seasonally
adjusted annual rate of 6 V2 percent in December, com­
pared with the 9V^ to 10 percent range of the October
and November advances. For the entire year, prices soared
8.8 percent, more than twice as fast as during 1972 and
the highest annual burst in a quarter century. Food price
increases tapered off sharply during the final quarter of
the year, compared with the advance during JanuarySeptember; in those first nine months prices soared at a
23 percent rate, and in the last three months rose at a
9 percent rate. This deceleration, however, was dwarfed by
the explosion of energy prices that accompanied the Arab
embargo on petroleum shipments to the United States.
Prices for consumer power and fuel, i.e., gasoline, homeheating oil, and gas and electricity, which have a total
weight of about 6 Vi percent in the consumer price index,
rose at over 40 percent, annual rate, in the final three
months of 1973, compared with a rise of about 8 percent,
annual rate, during the first three quarters of the year.
WAGES, P R O D U C TIVITY, AND EM P LO YM EN T

PRICE DEVELOPM EN TS

Prices took a decided turn for the worse during the
fourth quarter. According to preliminary data, the implicit
GNP deflator rose at a 7.9 percent annual rate, almost a
full point above that recorded in the previous quarter. For
the entire year, the deflator climbed 7 percent. This was
more than twice the rate of increase experienced during
1972, lVi percentage points faster than the 1969-70 pe­
riod of rapid price inflation, and the strongest spurt since
the Korean war.
Partly as a result of numerous changes in the price con­
trols program, the month-to-month behavior of wholesale
prices has been exceedingly erratic. On balance, the move­
ment has been very sharply upward. Seasonally adjusted
prices of farm products, processed foods, and feeds rose
at a 17 percent annual rate in December, following the
astronomical leap of 232 percent, annual rate, in August
and large declines in each of the next three months. By
December, this component had risen 27 percent above




Recent data indicate a substantial intensification of infla­
tionary pressures during the fourth quarter, with wages
rising rapidly and productivity registering an outright de­
cline. Hourly compensation in the private economy in­
creased at a seasonally adjusted annual rate of 8 percent,
bringing the rise over the entire year to a very substantial
8.2 percent. The 1973 increase in this broad measure of
wage and fringe benefits was a full point higher than the
advance in 1972, and the largest since 1968. However,
because of the very rapid advance in the consumer price
index, real private compensation declined for the third
consecutive quarter. This erosion is almost certain to put
added pressure on wage demands during 1974.
Productivity, as measured by output per hour of work in
the private economy, fell at an annual rate of 1.3 percent
in the October-December period. Over the preceding two
quarters, productivity growth had been essentially un­
changed after having risen very rapidly during the previous
twelve months or so. The combination of rising hourly

40

MONTHLY REVIEW, FEBRUARY 1974

compensation and declining productivity caused private
sector unit labor costs to soar 9.3 percent in the fourth
quarter, the largest increase since 1969. For the entire
year, unit labor costs rose 7.2 percent or nearly three times
the 2.7 percent rise averaged over 1972.
According to the Bureau of Labor Statistics survey of
major collective bargaining agreements, contracts negoti­
ated during 1973 provided, on average, first-year wage
increases of 5.8 percent and life-of-contract gains of 5.2
percent. However, for wages and fringe benefits combined,
first-year settlements averaged 7.1 percent and life-ofcontract gains came to 6.1 percent. Moreover, the growth
in compensation that will finally emerge under many of
these contracts will undoubtedly be larger, since the Labor
Departm ent data do not include payments made under
escalator-clause provisions that are contingent on move­
ments in the consumer price index. Forty percent of the
workers under major contracts concluded in 1973 were
covered by cost-of-living escalator clauses.
A very heavy collective bargaining schedule is unfold­
ing for 1974. During the year, 5.2 million workers, repre­
senting about half the working population covered by
major collective bargaining agreements, will be involved
in negotiations. Bargaining activity will be concentrated in
the steel, canning, aluminum, construction, communica­
tions, electrical machinery, aerospace, longshore, railroad,
and mining industries. More than a million additional
workers come under contracts that, although not sched­
uled for negotiations this year, could be reopened in the
event of a “national emergency”.
The unemployment rate registered its third consecutive
monthly increase in January, according to the household
survey, rising to 5.2 percent on a seasonally adjusted basis.
This compared with the 3 ^ -year low of 4.6 percent
reached this past October and the 4.8 percent level regis­
tered in December. A sharp January rise of 370,000 in
the number of unemployed persons was the net result of
a very large growth of more than 500,000 persons in the
size of the civilian labor force and a very small increase
of 142,000 persons in the volume of employment as mea­
sured by the household survey. Although month-to-month




changes in the size of the labor force tend to be quite
volatile, the growth in the labor force has, on balance,
been rather vigorous. Over the year ended January, the
civilian labor force increased by 3.5 million persons or
close to 4 percent.
The January payroll survey recorded a second straight
monthly decline in the number of persons employed by
nonagricultural establishments. Seasonally adjusted pay­
roll employment dropped by 260,000 persons to about the
level reached this past October, with the decline concen­
trated in construction and manufacturing. A t the same
time, the average workweek for production and nonsupervisory workers dropped sharply. The abrupt decline of 0.8
hours brought the seasonally adjusted factory workweek
to 39.9 hours, its lowest level in slightly more than two
years.
Although the household and payroll surveys tend to
give rather comparable employment readings over longenough time spans, they often diverge on a month-tomonth basis for a variety of reasons, including coverage,
sampling techniques, and seasonal adjustments. A substan­
tial portion of the January discrepancy between the house­
hold and payroll survey measures of employment is
removed when the two surveys are examined from the
vantage point of more comparable coverage. If the
150,000-person increase in agricultural employment is
excluded, the January household survey shows a small
employment decline.
Taken together, the direct and indirect effects of the
Arab oil embargo have undoubtedly accounted for a
considerable part of the January rise in unemployment,
but it is impossible to tell how much. About half of the
large January decline of 125,000 persons in manufacturing
employment was centered in transportation equipment,
where sizable layoffs have occurred among workers pro­
ducing passenger automobiles. Although the evidence is
preliminary, Labor Departm ent analysts feel that actual or
anticipated fuel shortages have been responsible for reduc­
ing employment in a variety of other areas also, such as
gasoline stations, air transportation, automobile selling,
and hotels and motels.

FEDERAL RESERVE BANK OF NEW YORK

41

M onetary and Financial Developments in the Fourth Quarter
During the fourth quarter of 1973, growth in the money
supply measures accelerated substantially. The narrowly
defined money supply (Mx)— as recently revised to reflect
new bench-mark data for nonmember bank deposits—
expanded at a seasonally adjusted annual rate of 7.5 per­
cent, after showing virtually no change in the third quar­
ter. The more broadly defined money supply (M2) also
rose more rapidly than in the previous quarter, although
the time deposit component advanced at only a slightly
faster pace. The outstanding volume of large negotiable
certificates of deposit (CDs) fell appreciably, on balance,
over the quarter. Consequently, growth in the bank credit
proxy was much lower than the gains experienced in the
first three quarters of the year.
Total bank credit advanced very slowly over the
October-December period as loan demand, particularly
from businesses, slackened. The weak demand for busi­
ness loans stemmed, in part, from a shift of corporate
borrowings to open market instruments, especially com­
mercial paper. This, in turn, reflected a lagged response
to the sharp declines in late September in short-term inter­
est rates relative to banks’ prime lending rates. During the
fourth quarter, most short-term interest rates fluctuated
over a broad range but showed no discernible trend. In
contrast, movements in intermediate-term and long-term
interest rates were mild. New corporate bond offerings,
however, were significantly higher in the fourth quarter
than in the first nine months of the year, and new issue
activity is increasing further in the early months of 1974.
Following a three-month period of restrained growth,
deposits at thrift institutions increased at a moderate rate
in the fourth quarter. Deposit inflows were stimulated by
the sharp September declines in rates on several competi­
tive market instruments as well as by changes in regula­
tions which allowed these institutions to increase their
issuance of long-term consumer-type certificates of deposit.
TH E M O N ETA R Y AGGREGATES

— private demand deposits adjusted plus currency
outside commercial banks— advanced in the fourth quarter
at a seasonally adjusted annual rate of 7.5 percent, follow­




ing a decline of 0.2 percent in the preceding three-month
period (see Chart I). Some of the fourth-quarter gain can
be explained by policy actions taken during the early
part of the period that were designed to step up the growth
in the money stock to a moderate pace. The strenghtening
of the dollar in foreign exchange markets contributed to
the advance, since it led to higher foreign central bank
balances at the Federal Reserve Banks and expanded
foreign bank demand deposit holdings at commercial
banks. An increase in precautionary demand for cash
balances, stimulated by uncertainties concerning the energy
situation and employment, may also have played a role.
For 1973 as a whole,
is now estimated to have
grown by 5.7 percent, compared with an increase of 8.7
percent in 1972. These data reflect the latest annual re­
visions of the money stock figures, which boosted the
growth in M x over what was previously reported by 0.4
percentage point in 1972 and 0.7 percentage point in
1973. The revisions included the annual reestimates of
seasonal adjustment factors and also incorporated data
from new monthly reports filed by internationally oriented
banking institutions. The principal changes, however, re­
sulted from upward adjustments of the estimates of
demand deposits at nonmember domestic banks. Because
deposits at such institutions are not available on a current
basis, they are estimated initially from data for “country”
member banks. Estimates are adjusted annually to incor­
porate figures reported by nonmember banks on call dates.
In the current revision, nonmember domestic bank esti­
mates were “benchmarked” to the M arch and October 1973
call reports in addition to the usual June and December
calls. This was the first year since the early 1960’s that
call report data appropriate for money supply bench marks
were available for the spring and fall call dates. The
Board of Governors of the Federal Reserve System noted
that the current revisions incorporating the largest non­
member bench-mark adjustments in the history of the
series point up the serious need for more timely and more
complete nonmember bank data.
Mo— defined as M T plus time deposits other than large
CDs— expanded in the fourth quarter at a seasonally
adjusted annual rate of 10.1 percent, substantially higher

42

MONTHLY REVIEW, FEBRUARY 1974

than the 5.2 percent rate of increase experienced in the
previous quarter. The acceleration was primarily attribut­
able to the sharp rise in currency and demand deposits;
the time deposit component advanced at only a slightly
faster pace than in the preceding three-month period.
According to the revised data, M 2 is estimated to have
increased 8.6 percent in 1973, up 0.7 percentage point
from the figure previously reported. New bench-mark
levels for nonmember banks led to upward revisions of the
time deposit component similar in magnitude to the corre­
sponding adjustments of the demand deposit component.
Contrary to the behavior of the money supply measures,
the adjusted bank credit proxy— member bank deposits
subject to reserve requirements plus certain nondeposit lia­
bilities— rose at a relatively slow pace in the fourth quarter.
After adjustments for seasonal variations, the proxy grew
at an annual rate of only 3.3 percent. For the year as a
whole, however, it increased 10.6 percent, 1 percentage
point below the growth experienced in 1972.
The slow growth of the proxy during the fourth quarter
reflected primarily a sharp decline in CDs. Earlier in the
year, CDs had risen very rapidly as banks aggressively

sought funds to finance a strong demand for business
loans. During the fourth quarter, however, business loan
demand was weak and banks tempered their CD sales
efforts. Moreover, CDs had become an increasingly ex­
pensive source of bank funds. Effective early in June, the
Board of Governors had imposed a supplemental reserve
requirement of 3 percent, in addition to the existing 5 per­
cent requirement, on CDs and certain other bank liabilities
above their mid-May base levels, and subsequently had
raised the new requirement an additional 3 percentage
points effective mid-September. These moves were in­
tended to help curb the rapid expansion of bank credit. D ur­
ing the fourth quarter, the growth of bank credit turned very
sluggish and, effective December 13, the supplemental re­
serve requirement was lowered back to 3 percent.
Reserves available to support private nonbank deposits
(RPD) grew very slowly in the fourth quarter in conform­
ity with the behavior of the credit proxy. After adjustments
for normal seasonal variations and the effects of changes
in reserve requirements, the annual rate of increase
amounted to only 1.4 percent. The volume of borrowed
reserves declined by $563 million over the quarter, as the
Federal Reserve supplied nonborrowed reserves more
readily in relation to deposit growth.
BANK CREDIT, IN TE R E S T RATES, AND
TH E C A P ITA L M ARKETS

C hart I

GROW TH IN MONETARY AGGREGATES
Seaso n ally ad ju s te d a n n u a l rates
Percent

Percent
15

10
5

0
20
15

10
5

0
15

10
5

0
1971

1972

1973

M l = Currency plus adjusted demand deposits held by the public.
M 2 = M l plus commercial bank savings and time deposits held by the public,
less negotiable certificates of deposit issued in denominations of $100,000
or more.
Adjusted bank credit proxy = Total member bank deposits subject to reserve
requirements plus nondeposit sources of funds, such as Euro-dollar
borrowings and the proceeds of commercial paper issued by bank holding
companies or other affiliates.
Source: Board of G overnors of the Federal Reserve System.




The rate of growth in total bank credit fell sharply during
the October-December period. When adjusted for net loan
sales to affiliates, bank credit increased at only a 4.4 per­
cent seasonally adjusted annual rate, compared with a
15.2 percent annual rate in the first nine months of the
year. Banks continued to make only modest additions to
their securities holdings. Total loans, however, which had
expanded rapidly during the first nine months of 1973,
advanced at the slowest rate in three years. Virtually all
the major loan components registered somewhat smaller
gains, or larger declines, than earlier in the year, but busi­
ness loans were particularly sluggish.
During the first three quarters of 1973, business loans
had increased very rapidly (see Chart II ). In part, this
reflected strong demands for funds brought on by the
heady economic expansion and the acceleration in the rate
of inflation. To some extent, however, the increase rep­
resented merely a redirection of business borrowings to
banks from other credit sources, particularly the commer­
cial paper market. Interest rates on commercial paper rose
sharply from January through August, along with other
short-term market rates. However, because banks were
restricted by the Committee on Interest and Dividends

FEDERAL RESERVE BANK OF NEW YORK

C h art II

SHORT-TERM BUSINESS BORROW INGS AND
RELATED INTEREST RATES
Percent

Percent

N o te : Business lo a n s a r e a d ju s te d fo r lo a n s sold to a ffilia te s . Y ield s on
fo u r - to six-m onth co m m e rc ia l p a p e r a r e m o n th ly a v e r a g e s o f d a ily fig u re s .
The p rim e ra te is th e in te re s t ra te p o sted b y m a jo r c o m m e rc ia l b an k s on
sh o rt-te rm lo ans to th e ir m ost cre d itw o rth y la rg e b usiness b o rro w e rs.
S o u rc es : B o ard o f G o v e rn o rs o f the F e d e ra l R es erv e S ystem a n d the
F e d e ra l R eserve B ank o f N e w Yo rk.

from raising their lending rates to large business borrowers
too rapidly, the prime rate did not keep pace. For ex­
ample, the rate on four- to six-month prime dealer-placed
commercial paper averaged about 30 basis points above
the prime rate during the February-August period (see
Chart II). This contrasted with the usual relationship dur­
ing recent years when the commercial paper rate had aver­
aged about 50 basis points below the prime rate. Conse­
quently, the volume of nonbank dealer-placed commercial
paper fell by $3.9 billion over the first quarter, and then
remained essentially flat through August. Meanwhile, the
volume of business loans at commercial banks surged,
spurting during the first quarter and continuing to rise
rapidly for the next five months. Over the January-August
period as a whole, business loans adjusted for loan sales
to affiliates rose at a seasonally adjusted annual rate of
28.7 percent.
In September, credit markets began to ease. Late that




43

month, rates on commercial paper started to fall, moving
below the prime rate for the first time since February. In
mid-October, most major banks reduced their prime lend­
ing rates from 10 percent to 93A percent, retaining that rate
for the remainder of the quarter, although several boosted
their rates back to 10 percent early in December. Over most
of the period from late September through December, the
more usual relationship between the prime rate and com­
mercial paper rate prevailed, and corporations returned to
the commercial paper market to finance their short-term
borrowing needs. Reflecting these developments, the vol­
ume of commercial paper rose $4.6 billion from the end of
August to the end of November. In December, however,
there was a small decline, presumably indicating that most
of the switch back to commercial paper had been com­
pleted in the prior month. During these last four months
of the year, business loans at commercial banks increased
at a seasonally adjusted annual rate of only 4.6 percent.
Several other major loan components of bank credit,
including consumer loans and real estate loans, also grew
less rapidly in the fourth quarter than earlier in the year.
Securities loans fell sharply, continuing the trend set in the
preceding three quarters. Decreased loans to brokers, re­
flecting the rundown in their margin stock accounts, un­
doubtedly played a major part in the year-long slump in
securities loans. Total margin credit to customers, which
is financed in part by bank loans to brokers, declined about
30 percent in 1973. In recognition of the sharp reduction
in stock market credit, the Board of Governors lowered its
margin requirements for purchasing or carrying stocks from
65 percent to 50 percent, effective January 3, 1974.
Most short-term interest rates moved irregularly over
the fourth quarter, after falling dramatically in the last
half of September. The Federal funds rate, however, de­
clined about 75 basis points to 10 percent in mid-October,
and then hovered around that level for the remainder of
the period (see Chart II I). Intermediate-term and long­
term interest rates fluctuated in a very narrow range
throughout the quarter, despite a sharp increase in new
bond offerings. In the corporate market, public and pri­
vate placements, seasonally adjusted, totaled $7.1 billion,
considerably above the January-September quarterly aver­
age of $5.1 billion. New corporate bond issues in January
amounted to one of the largest monthly totals in nearly
three years, and the calendar of issues scheduled for Feb­
ruary is about as heavy. State and local government bond
issues also increased in the fourth quarter of 1973, to $6.2
billion, seasonally adjusted, up from an average volume of
$5.6 billion during the first three quarters. Federal agency
offerings, on the other hand, declined slightly over the
quarter, reflecting the improved financial position of thrift

44

MONTHLY REVIEW, FEBRUARY 1974

C hart III

SELECTED INTEREST RATES
Percent
11

N o te : R ates fo r F e d e ra l funds (e ffe c tiv e ra te ) a n d th re e -m o n th T re a s u ry b ills
(m a rk e t y ie ld ) a r e m o n thly a v e r a g e s o f d a ily fig u re s . Y ie ld s on A a a -r a t e d

intense competition. The situation became acute in Sep­
tember when many thrift institutions— particularly mutual
savings banks— reached the legal limits on the amounts
of these deposits that they could offer (5 percent of total
deposit liabilities at insured commercial banks, savings
banks, and savings and loan associations, with an addi­
tional 5 percent allowed at savings and loan associations
for certificates issued by September 7 and subse­
quently renewed). New regulations, effective November 1,
removed all restrictions on the volume of these consumertype certificates that may be issued and imposed interest
rate ceilings on such certificates of 7.50 percent for thrift
institutions and 7.25 percent for commercial banks.
Reflecting the improved performance of deposit flows
in the fourth quarter, thrift institutions increased their
liquid asset holdings and sharply reduced their rate of
borrowing. Net Federal Home Loan Bank Board advances
to savings and loan associations, for example, rose $841
million during the October-December period as compared
with an increase of about $3 billion in the preceding quar­
ter. The growth in mortgages held by thrift institutions,
however, as well as commitments by these institutions to
make new mortgage loans, continued to slacken.

c o rp o ra te a n d t w e n ty -y e a r t a x -e x e m p t b o n ds a re m o n th ly a v e r a g e s of
w e e k ly fig u re s .
Sources: B o a rd o f G o v e rn o rs o f th e F e d e ra l R eserve S ystem , M o o d y 's In vestors
S e rv ic e , In c., a n d The Bond B uyer.

institutions. Nevertheless, the $5.9 billion total of new
Federal agency issues was about $2Vi billion greater than
in the final quarter of 1972.

GROW TH IN THRIFT INSTITUTION DEPOSITS
AND M O RTGAGE LOANS, AND
OUTSTANDING M ORTGAGE COMMITMENTS
P ercent

Billions of dollars

T H R IF T IN S TITU TIO N S

Deposit flows into thrift institutions showed a marked
recovery in the fourth quarter of 1973 (see Chart IV ).
Combined deposits at savings and loan associations and
mutual savings banks advanced at a seasonally adjusted
annual rate of 8 percent, following a gain of only 3
percent during the preceding three-month period. The
increased thrift deposit inflows reflected, in part, a delayed
response to the declines in late September in interest rates
on competing market instruments, particularly Treasury
bills. Moreover, thrift institutions benefited from changes
in the regulations on consumer-type certificates of deposit
with maturities of four years or more. The previous modi­
fication of regulations in July 1973, which had permitted
the introduction of no-interest-rate-ceiling “wild card”
deposits by banks and thrift institutions, had resulted in




N o te : G ro w th in th rift in s titu tio n d e p o s its a n d h o m e m o rtg a g e lo a n s a re
e x p re s s e d a t s e a s o n a lly a d ju s te d a n n u a l ra te s.
Sources:

F e d e r a l H o m e Loan B an k B o a rd a n d N a t io n a l A s s o c ia tio n o f

M u tu a l S a v in g s B an ks.

FEDERAL RESERVE BANK OF NEW YORK

45

Th e M oney and Bond Markets in January
A rally late in January pushed most interest rates down
sharply from their midmonth levels. Treasury bill rates
had backed up earlier in the month in response to a heavy
volume of sales by foreign central banks. However, when
the Federal funds market showed signs of easing in the
final week of January, this was interpreted by participants
as indicative of a less restrictive monetary policy and
touched off the rally. Rates on money market instruments
had begun to move downward early in the month, and the
declines accelerated in the wake of the rally. By the end of
the month, rates on commercial paper were as much as a
full percentage point lower while other rates posted more
modest declines. In addition, toward the end of the month,
most major commercial banks reduced their prime lending
rate to large borrowers by V* percentage point to 9 Vi
percent.
End-of-the-month declines in yields on Treasury coupon
issues were more modest than those on bills, and most
rates closed above their levels at the end of December. The
rising yields in the United States Government securities
m arket resulted from a number of factors. The selling
of foreign holdings occurred because of the strength of the
dollar relative to certain other currencies and the conse­
quent attempt of foreign central banks to support these
currencies. Dealers were also concerned with the high
cost of financing inventories in view of the relatively
weak investor demand and prospects of additional supplies
that would be forthcoming from the Treasury’s February
refunding. The termination on January 29 of United States
restrictions on foreign investments by United States resi­
dents contributed to an improved tone in the securities
market at the close, since the move was expected to reduce
some of the pressure on foreign currencies.
Faced with the largest monthly calendar in two and
one-half years, the corporate bond market posted rates
on new issues in January at the highest levels since
last summer. The yield on new Aaa-rated utility bonds,
as measured by the Board of Governors of the Federal
Reserve System, climbed to 8.27 percent from the 7.98
percent registered late in December, before declining to
8.13 percent at the close of January. (On one utility issue




the yield dropped back to 7.98 percent.) Rates on munici­
pal bonds also rose, as dealers began the period with heavy
inventories and the prospects of a sizable supply of new
issues.
Preliminary data indicate that the narrow money sup­
ply (MO— private demand deposits adjusted plus currency
outside banks— declined on average for the four weeks
ended January 23, following a large increase during the
preceding four-week period. There was further expansion
both in M 2, which includes time and savings deposits
other than large negotiable certificates of deposit (C D s),
and in the adjusted bank credit proxy, which consists of
daily average member bank deposits subject to reserve re­
quirements plus certain nondeposit liabilities.
On January 25, the Board of Governors of the Federal
Reserve System sent to the Congress draft legislation to
implement its recommendations for uniform reserve re­
quirements. The proposals were drawn in such a way as to
achieve more precision in monetary control and more
equity in competition without altering the diversified bank­
ing and financial structure that now serves the country.
The basic underlying principle is that equivalent cash re­
serve requirements should apply to all deposits that effec­
tively serve as a part of the public’s money balances, regard­
less of the type of institution in which the balances are
held. Thus, there would be reserve requirements against
demand deposits at nonmember commercial banks and at
foreign-owned banking institutions located in the United
States as well as against those interest-bearing deposits at
savings and loan associations and m utual savings banks
from which withdrawals by negotiable instrument are per­
mitted in some states. The proposal would provide a fouryear transition period and no reserves would be required
against the first $2 million of deposits.
BANK RESERVES AND TH E M ONEY M ARKET

Interest rates on most money m arket instruments de­
clined in January and by larger amounts than had oc­
curred in the preceding month (see chart). All categories
of dealer-placed commercial paper registered decreases;

46

MONTHLY REVIEW, FEBRUARY 1974

SELECTED INTEREST RATES
N ovem b er 1973 - J an u a ry 1 97 4
P e rc e n t

M O N E Y M A R K E T RATES

N ovem ber

Decem ber
1973

N o te:

B O N D M A R K E T YIELDS

J a n u a ry
1974

Novem ber

Decem ber
1973

P erc e n t

J a n u a ry
1974

D a ta are shown for business days only.

M O N E Y MARKET RATES QUOTED:

Bid rates for three-m onth Euro-dollars in London; offering

standard A a a -ra te d bond of a t least twenty years' m aturity; d a ily averag e s of

rates (quoted in terms of rate of discount) on 90- to 119-day prim e com m ercial p ap er

yields on seasoned A a a -ra te d corpo rate bonds; da ily avera g e s of yields on lo n g ­

q uoted by three of the five d ealers that report their rates, or the mid point of the range

term G overnm ent securities (bonds due or c allab le in ten years or more) and

quoted if no consensus is availab le; the effective rate on Federal funds (the rate most

on G overnm ent securities due in three to five y e a rs , com puted on the basis of

rep resen tative of the transactions executed); closing bid rates (quoted in terms of rate of

closing bid prices; Thursday averages of yields on tw enty seasoned tw en ty-y e ar

discount) on newest ou tstanding three-m onth Treasury b ills.
B O ND MARKET YIELDS QUOTED: Yields on new A a a -ra te d public utility bonds are based
on prices asked by un derw riting syndicates, adjusted to m ake them e q u ivalen t to o

these ranged from % percentage point on paper maturing
in ninety days or more to 1 percentage point on paper due in
less than ninety days. Bid rates on bankers’ acceptances were
lowered by % percentage point. The effective rate on Fed­
eral funds averaged 9.65 percent in January, 30 basis
points less than in December when the rate also fell. For
the fifth consecutive month, member banks reduced their
reliance on the discount window. Consequently, the aver­
age level of borrowings fell $251 million in January to
$1,076 million (see Table I).
The secondary market yield on large negotiable CDs
also moved lower in January. The rate on CDs of three
months’ maturity closed the month at 8.87 percent, down
36 basis points over the period. At the same time, the vol­




tax-exem pt bonds (carrying M oody's ratings of A a a , A a , A , and Baa).
Sources: Federal Reserve Bank of New York, Board of G o vern o rs of the F ed e ra l
Reserve System, M o ody's Investors Service, Inc., and The Bond Buyer.

ume of CDs outstanding increased by about $2.5 billion
in this, the first month following the reduction in the
marginal reserve requirement on large CDs and certain other
commercial bank liabilities.* The reduction had been
made in recognition of the slowing of bank credit growth
during October and November, a pattern which had con­
tinued in December. In line with the deceleration of credit
growth and the decline in short-term rates, several com­
mercial banks reduced their prime lending rate Va per­

* For details concerning this change in reserve requirements,
see this Review (January 1974), pages 7-8.

FEDERAL RESERVE BANK OF NEW YORK

cent age point to 9 V2 percent effective late in January.
Following the pattern of the last several years, M x ap­
pears to have been weak in January after rapid growth in
December. Preliminary data indicate a decline in season­
ally adjusted
for the four weeks ended January 23.
(The money supply series have been revised to reflect
bench-mark adjustments for nonmember banks and new
seasonal adjustment factors.) From its average for the four
weeks ended thirteen weeks earlier to its average for the
four weeks ended January 23, M x rose at a seasonally
adjusted annual rate of 5.1 percent. The increase from the
average for the four weeks ended fifty-two weeks earlier
was also at a 5.1 percent rate.
The growth of commercial bank time and savings de­
posits other than large CDs remained strong in January,
and as a result the advance in the broad money supply
(M 2) slowed very little from its December pace. M 2
expanded at an 8.5 percent annual rate between its fourweek average thirteen weeks earlier and its average for the
four weeks ended January 23.
The adjusted bank credit proxy grew strongly during
the four weeks ended January 23, continuing the pickup
which had begun in December. The rise in the proxy
during this most recent period was at a seasonally adjusted
annual rate of 6 percent, compared with the four-week
average ended thirteen weeks earlier. Substantial growth in
CDs, as well as in other time and savings deposits, and a
large increase in United States Government deposits were
the major factors in the proxy’s expansion following two
months of contraction. Reserves available to support pri­
vate nonbank deposits also increased in January, though
more moderately than their average growth in 1973.

Table I
FACTORS TENDING TO INCREASE OR DECREASE
MEMBER BANK RESERVES, JANUARY 1974
In millions of dollars; (+ ) denotes increase
and (—) decrease in excess reserves

Changes in daily averages—
week ended

Rates on Treasury bills were pushed steadily higher
during the first half of January, when this sector of the
market experienced heavy sales by foreign central banks.
Investor demand was modest, and Government securities
dealers were generally reluctant to incur the high cost of
financing inventories in the absence of signs of a Federal
Reserve move to a less restrictive monetary policy. Rates
began to drift lower in the third week, and sentiment
improved dramatically as the month closed. A decline
in the Federal funds rate during the final week was inter­
preted as a sign of a relaxed policy stance, and rates fell
sharply. By the end of the month, shorter rates were
only a touch above their end-of-December levels while
rates on bills maturing in more than three months were
6 to 24 basis points lower on balance.
Early in the period, the market had responded favor-




Net
changes

Factors
Jan.
2

Jan.
9

Jan.
16

Jan.
23

Jan.
30

“ Market” factors
Member bank required
—

316 — 924 —1,129

800

— 923

859 —1,330
— 418 —1,028
— 162 — 741
— 80 — 96
94 + 571
-

—2,641
— 842
4- 37

4- 646 +

Operating transactions
741 +
Federal Reserve float ................ — 723 +
Treasury operations* .................. — 27 Gold and foreign account ........ + 200 —
4 +
Currency outside banks ............ +

983
202
73
213
571

Other Federal Reserve
liabilities and capital ................ _

196 +

496 _

81

—

10*5 —

L,057 +

59 +

289

-

213 -

23

—

158

— 458

879 +
9 —
117 +

428 +
4 __

21

486

195

338

95

+

48 —
66 —
434 +
12 +
7 -

39
42

—

Total “ m arket" f a c to r s ..............

+1.418
— 674
+ 161
+ 226
-fl,786

37

— 529

4-2,838
4-

77

530

—1,452

+

803

4- 869

+

498
3

4-1,340

Direct Federal Reserve credit
transactions

Open market operations
+
Outright holdings:
Treasury se c u ritie s ...................... +
B ankers’ acceptances ................ +
Federal agency obligations ---- +
Repurchase agreements:
Treasury s e c u ritie s ..........................
Bankers’ acceptances ................... —
Federal agency obligations . . . . —
Member bank bo rro w in g s.............. +
Seasonal borrowings-}1 ................ —
Other Federal Reserve assetsf . . . . +
Total

TH E GOVERNMENT SECURITIES M ARKET

47

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

Excess reserves^

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

+
-

705

—

68
37

—

172
4

—

—

5

—

1
2

+
2 +

—

28 +
5 +
7 +

21

+
4- 193 +
7 +
—
+ 62 +

-

449 +

34

202

88 -

390 +

323

—

92 +
969

213
1

13
226

7

+
4- 131
—

374

21
42

139
— 96

39

- f 183
— 18

4
58

—

-f

198

+

900

-fl,2 5 2

~ 415 +

370

—

-

200

M onthly
averages§

Daily average levels

Member bank:

Total reserves, including
Required reserves ............................
Excess reserves ................................
Total borrowings ............................
Seasonal borrowingsf ................
Nonborrowed reserves ....................
Net carry-over, excess or
deficit (—)|| ....................................

35,656 36,190
35,268 36,192
388 —
2
1,210
776
31
19

37,642
37,321

36,581
36,675

321

— 94

36,151
35,875
276

989

1,182

1,221

20

13

17

20

34,446

35,414

36,653

35,399

34,930

35,368

229

152

64

171

Note: 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 five weeks ended January 30, 1974.
II Not reflected in data above.

—

31

36,444
36,266
178
1,076

117

48

MONTHLY REVIEW, FEBRUARY 1974

ably to a move by several major banks to reduce the prime
rate to 93A percent. However, in the cautious atmosphere
that prevailed at that time, the improvement was short­
lived. When rates approached the 8 percent level around
midmonth, some participants felt investors would be
attracted, and bidding at the regular auction on January 14
was stronger than anticipated. Investor demand did
emerge and rates moved lower over the rest of the week.
At the auction on January 21, bidding was once again
strong; the rate on the new six-month bill was down 5
basis points from the week before, while the three-month
bill was only 1 basis point higher (see Table II ). Sales
by the Federal Reserve for customer accounts depressed
the market soon after that, but a firm tone developed dur­
ing the final week of January in response to the additional
lA percentage point reduction in the prime rate to 9Vi
percent by most major banks. When the Federal Reserve
executed repurchase agreements shortly before the weekly
auction on January 28, bill rates plummeted and the aver­
age issuing rates were down about lA percentage point
from the previous week’s auction rates. The removal of
restrictions on investments abroad helped buoy sentiment
causing rates to continue falling over the final days of the
month.
Yields on Treasury coupon issues also rose over the first
half of January, and the rate on long-term securities held
steady at that level during the rest of the period. The rate
on three- to five-year issues, however, continued its in­
crease over the next week, and then declined. For the
month as a whole, the rate on intermediate-term issues rose
7 basis points and that on long-term issues 5 basis points.
The coupon market was also influenced by many of the
factors which operated in the bill market during the first
half of the month. In addition, there was concern over
continued inflation and the dim prospects for sustained
long-term rate declines. In the face of relatively limited
demand, dealers became increasingly anxious about the
addition to supply that would result from the Treasury’s
February refunding, and a cautious tone prevailed as partic­
ipants awaited the Treasury’s January 30 announcement.
At the beginning of the final week, the coupon market re­
acted favorably to the reductions in short-term rates and a
firmer tone developed despite the impending Treasury sale.
In its February refunding, the Treasury will provide
funds for retiring the $4.5 billion of publicly held notes
and bonds maturing on February 15 by auctioning three
issues to the public. These consist of up to $2lA billion
of 3 lA -year notes, up to $lV i billion of seven-year notes,
and up to $300 million of 1 9 ^ -year bonds. The last is an
addition to an issue of 1 V2 percent bonds initially offered
last August. Coupon rates on the 3 1/4- and seven-year




Table II
AVERAGE ISSUING RATES
AT REGULAR TREASURY BILL AUCTIONS*
In percent
Weekly auction dates— January 1974
Maturity

Three-month ........................................

Jan.
7

Jan.
14

Jan.
21

Jan.
28

7.615

7.983

7.995

7.778

7.560

7.867

7.819

7.516

Monthly auction dates— November 1973-January 1974

Fifty-two w eek s....................................

Nov.
14

Dec.
12

Jan.
9

7.708

6.881

6.948

* Interest rates on bills are quoted in terms of a 360-day year, with the discounts from
par as the return on the face amount of the bills payable at m aturity. Bond yield
equivalents, related to the am ount actually invested, would be slightly higher.

notes were set at 6% percent and 7 percent, respec­
tively. M arket reaction to the terms of the refunding was
generally quite favorable.
Yields on Federal agency securities also increased on
balance. There were large offerings by each of the three
major farm agencies during January. The first of these
was a two-part sale by the Federal Land Banks that in­
cluded $360 million of thirty-month bonds yielding 7.05
percent and $300 million of five-year bonds yielding 7.10
percent. Later in the month the Banks for Cooperatives
and the Federal Intermediate Credit Banks also marketed
two bond issues, both of which were priced at par. The
former consisted of $556 million of 8.15 percent bonds
due August 1, 1974, while the latter comprised $753.5
million of 8 percent bonds maturing November 4, 1974.
All of these issues were well received.
O TH ER SECURITIES M ARKETS

Yields on corporate and municipal securities moved
somewhat higher during January, when more than $3
billion in new securities was marketed. The corporate
calendar of more than $2 billion represented the heaviest
monthly volume in two and one-half years. In view of the
large supply, investors were quite selective and rates
moved steadily higher until late in the month, when they
declined.
At the start of the month, prior to the marketing of any
new offerings, syndicates were terminated on the unsold
portions of several recent corporate issues, resulting in

FEDERAL RESERVE BANK OF NEW YORK

upward yield adjustments of as much as 21 basis points.
Investors gave a rather cool reception to the year’s first
large new issue, $75 million of power company bonds
offered on January 7. Utility bonds were in plentiful sup­
ply, and several offerings had recently encountered in­
vestor resistance. On the following day, however, investors
responded with strong interest to two attractively priced
offerings. The larger of these issues, $100 million of Singer
Company A-rated debentures, was almost completely sold
by the close of the first day, a result of its 8.1 percent yield
and the relative scarcity of new industrial bonds. Although
the smaller issue was again a utility issue (Oklahoma Gas
and Electric Com pany), it was priced to yield SV4 percent,
the highest return on Aa-rated utility bonds in about six
months, and sold rapidly.
Investor response to new offerings of bonds from
industrial corporations remained favorable through­
out the month. Shortly after the Singer Company sale,
two other industrial issues totaling $150 million were suc­
cessfully m arketed in one day. The largest offering of the
month, a $160 million package from Ford M otor Com­
pany on January 16, was also in good demand. This ne­
gotiated package included $100 million of six-year notes
and $60 million of twenty-year debentures, yielding 7.40
percent and 7.85 percent, respectively. Investor response
to new utility bonds, on the other hand, remained, as at
the beginning of the month, quite mixed. The year’s first
Bell System issue, $100 million of Aaa-rated Wisconsin
Telephone Company bonds priced to yield 8.05 percent,
was given a good reception, and a $125 million Aa-rated
offering by the Florida Power and Light Company was a
first-day sellout on January 17 at a yield of 8.44 percent.
Several other large issues, however, met with investor
resistance, and one syndicate disbanded after two days.




49

In addition to attractiveness of price, a factor cited by
some observers in determining the reception to new utility
issues was the impact that investors thought possible
fuel shortages would have on the companies selling the
bonds. A t the close of the month, two issues— one of
industrial debentures and the other of utility bonds— were
successfully m arketed at yields just under 8 percent.
While the January calendar of new state and local gov­
ernment bonds was somewhat smaller than the corporate
calendar, dealers began the month with heavy inventories,
and rates moved higher in this market as well. The Bond
Buyer index of yields on twenty tax-exempt bonds climbed
10 basis points over the first three and one-half weeks to
5.26 percent and then eased back to 5.20 percent on Jan­
uary 31 for a net gain of 4 basis points over the month.
The largest issue sold during the month was $349.1 mil­
lion of New York City bonds, the city’s first offering since
being restored to an A rating by both bond-rating houses.
The city was able to sell the bonds at an average interest
cost several basis points below The Bond Buyer index, in
contrast to its previous sale when the average cost was
higher than the index. The bonds, which are exempt from
New York City, New York State, and Federal taxes, were
well received, with a balance of only $25 million remain­
ing after the first day. Another large offering during the
month was a $302 million package of New Jersey Sports
and Exposition Authority Baa-rated bonds. This consisted
of $218.2 million of term bonds yielding 7.5 percent and
$83.8 million of serial bonds with rates from 5Va percent
to 7 percent. The term bonds sold well, but the others
moved more slowly. By the end of the month, dealers
had made some progress in reducing their inventories and
the Blue List of stocks on hand had declined $97 million
to $1,034 million.