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Inflation in a Sluggish Economy— Trouble for
Monetary Policy: An Address by Alfred Hayes


The Business Situation ...................................................
The Money and Bond Markets in December..........


Index for the Year 1970 ................................................

Volume 53



No. 1




Inflation in a S luggish Econom y — Trou ble fo r M on etary Policy*
By A l f r e d H a y e s
President, Federal Reserve Bank of New York

I am very glad to have the opportunity to address this
important gathering of the nation’s savings bankers. Not
surprisingly, my banking contacts tend to be primarily
with the commercial banks of this District, since most
of them are member banks of the Federal Reserve System.
The System exercises a direct and powerful influence over
their reserves for the purpose of carrying out national
monetary policy. But while our relationship with your
institutions is not as direct, we recognize that you play
an important role in the national economy, especially
where mortgage credit is concerned. We also recognize
that the System’s supervisory role and regulatory powers
with respect to state member banks often take us into
areas of direct interest to savings banks. So I welcome this
chance to share with you a few thoughts on significant
monetary problems that we face today. Before dealing
with monetary policy as such, I would like to touch on
a few questions bearing on your own industry.
I am sure you know that, while the first impact of
monetary policy is felt by the commercial banks, savings
institutions have also proven to be very vulnerable to
tight credit restraint. The last five years have provided
two significant testing periods: first, during the 1966
“credit crunch” and, more recently, during the even more
severe restraint of 1969 and early 1970. During the 1966
episode, you may remember, the Federal Reserve System
was prepared to use its emergency powers in order to
insure a flow of credit to the thrift institutions. We were
similarly prepared last summer had the need arisen.
These experiences involving drastic curtailments of de­
posit inflows and the consequent strains on savings bank

* An address before the annual midyear meeting of the Na­
tional Association of Mutual Savings Banks, New York City,
December 8, 1970.

liquidity led to widespread suggestions that only funda­
mental changes in the way savings banks do business
could rescue them from a situation that was not only
unpleasant for them but which also created unnecessary
handicaps for the smooth execution of monetary policy.
Even without fundamental changes, however, thrift
institutions have shown remarkable ability in negotiating
the difficulties of the past two years. They had the fore­
sight to provide larger liquid reserves than had been cus­
tomary in the past. In addition, during much of 1970
they have been able to realize a sizable increase in de­
posits despite the fact that competing investments have
been yielding far higher rates than savings institutions
are permitted to pay on deposits. Admittedly, mutual
savings banks, located as they are near the eastern finan­
cial markets, felt most keenly the competition of market
instruments and did not fare so well as other thrift insti­
tutions in this regard. Nevertheless, in recent months,
deposit flows to mutual savings banks have also strength­
ened considerably. In any event, the recent deposit experi­
ence speaks well for the public’s confidence in the safety
of funds entrusted to the savings institutions and for
their handling of customer relationships. Their success
has borne fruit in the form of larger flows of mortgage
funds and a better pickup in housing construction than
credit conditions themselves might have suggested. I
might add, however, that recent generous flows of savings
to the thrift institutions are probably due in part to a
temporary desire for safe harbor by consumers as they
try to evaluate the uncertainties of world developments
and the dilemma posed by the persistently rapid rate of
inflation despite a sluggish economy and rising unem­
In any case, the fact remains that your organizations
are highly dependent on one type of long-term asset
which is none too well matched with your principal form
of liability. It is thus no wonder that savings bankers have



been turning their attention to possible ways of diversify­
ing both assets and liabilities through a wider variety of
customer services. The fact remains, too, that because
of the enormous social significance and political influence
of the housing industry, your activities have been the
object of much attention on the part of various legislative
bodies and regulatory authorities. Artificial ceilings on
deposit interest rates have never struck me as consistent
with a free enterprise system, but a major argument in
their favor has of course involved the desire to protect
the thrift institutions from some of the consequences
of tight money that have followed from your specializa­
tion in mortgage financing while holding essentially short­
term liabilities.
I would hope that basic changes in your industry might
in time obviate the need for such artificial protection. One
of the most fundamental of these, variable interest rate
mortgages, has made very little headway—though I
would add that it seems to offer some promise. Perhaps
the propitious time for experimentation is now, when con­
tinuing high interest rates might give the proposal con­
siderable public appeal.
Recent efforts to expand your activities—notably by
adding checking deposits and the making of personal
loans—have captured the interest and support of thrift
institutions. A significant first step is the recent authoriza­
tion granted to Federal savings and loan associations to
make certain third-party transfers. I would agree that
such moves carry considerable appeal from the stand­
point of public convenience and need. On the other hand,
I would stress that piecemeal modifications of the savings
institutions’ present rights and privileges probably do not
give adequate consideration to questions of competitive
equality among financial institutions (including evenhanded tax treatment) or to questions of monetary
policy. In the latter connection I should like to point out
that, if the savings banks are to become a new source
of demand deposits and hence to perform a full-fledged
money-creating function, they must accept the likelihood
that in due course they will become subject to the reserve
requirements of the Federal Reserve if we are to avoid
an undesirable weakening of the effectiveness of monetary
policy instruments.
The type of difficult questions I have touched on so
briefly will be solved only if all concerned will devote
their best efforts to solving them. I have no doubt you
yourselves will be in the forefront of this movement, and
I can assure you that the subject is receiving much thought
in the Federal Reserve; we also can hope for constructive
suggestions from the Presidential Commission on Finan­
cial Structure.

Let’s turn now to the part that monetary and fiscal policy
have tried to play in promoting the nation’s major eco­
nomic goals: sustainable economic growth, high employ­
ment, reasonable price stability, and equilibrium in our
international payments. Nearly two years ago I referred
in a speech to a severe testing period through which mone­
tary and fiscal policy would have to perform, to determine
whether these broad impersonal methods of economic
control could bring a halt to the inflationary spiral without
subjecting the country to a serious recession. The testing
continues and the answer is not yet apparent. By the time
effective policies were marshaled against inflation in midand late 1968, inflationary psychology had become so
deeply embedded that it was very hard to dent it, much
less to dislodge it completely. Policy was successful in
bringing about a pronounced slowdown of business—in­
deed, culminating in two quarters of negative real growth
in the last quarter of 1969 and the first of 1970. Since
then the rate of positive growth has been very modest,
and unemployment has been climbing faster than most
economists had predicted. Whether all this has constituted
a recession is largely a matter of semantics; the essential
point is that we have reached a range of unemployment
which it would be socially undesirable and politically im­
practicable to exceed for any length of time. Yet on the
other side of the picture we see continuing inflation, now
almost entirely of the cost-push variety, with grossly ex­
cessive wage settlements the order of the day. These
settlements are far in excess of any conceivable produc­
tivity gains and hence bound to contribute to either lower
profits or higher prices, or both. Evidence of a slower
trend of cost-of-living increases is still too fragmentary
to be very convincing. And there is a constant danger
that, if business picks up too rapidly, we may again see
demand pressures reinforcing the cost-push in raising
prices further. The evidence of recent years raises serious
questions as to whether very low unemployment rates are
compatible with a reasonable degree of price stability—
particularly if such rates are approached through a rapid
upswing in economic activity. As for inflationary psy­
chology, it seems to me that most businessmen and most
consumers tend toward a fatalistic view that prices are
likely to go on rising substantially for a long time to come.
We should not lose sight of the fact that inflation not
only produces gross inequities in our domestic economy,
threatens sound economic expansion, and causes severe
social losses, but it is also the greatest threat to restora­
tion of a reasonable approximation to balance-of-payments
equilibrium, with all that that implies for the dollar’s inter­
national standing and world trade.
The Federal Reserve deserves high marks for its per­


formance during the period of severe financial stress that
developed in June and July. The System has shown that
it can and will act effectively to prevent financial panic
when this threatens as a result of tight money conditions
and deterioration in corporate liquidity and corporate
credit standards. The atmosphere of extreme uneasiness
in financial markets during the early summer clearly
called for decisive Federal Reserve action in an area that
the market tends to forget for years at a time, i.e., in our
function as lender of last resort. When the Penn Central
collapse threatened to dry up much of the commercial
paper market and thus to put great strains on major cor­
porate borrowers, the Federal Reserve System moved
promptly to assure the banks that reserves would be avail­
able at the discount window to enable them to fill the
gap by providing bank loans. I am especially proud
of the role played in this by my associate, William F.
Treiber, First Vice President. And at about the same
time the Board of Governors took the equally important
step of removing the Regulation Q interest rate ceiling
on certificates of deposit maturing in less than ninety days,
thus providing the banks with a more lasting source of
funds to serve the same purpose. The rest is now history.
The commercial banks jumped into the breach with speed
and effectiveness, and fears of some kind of general finan­
cial collapse soon vanished. Incidentally, the legacy of
this episode is by no means all bad. Credit standards in
the banks and investment markets are undoubtedly appre­
ciably sounder now than they were six months ago.
On the whole, fiscal policy has performed reasonably
well over the past two years or so. In fiscal 1969 and
1970, it contributed to the slowdown by eliminating the
large deficit which had been recorded in fiscal 1968. While
the present fiscal year’s deficit threatens to be quite large,
its size can be attributed in large part to a decline in rev­
enues caused by greater than expected business weakness
and consequent shortfalls in revenue estimates. To this
extent the deficit is tolerable and it may even be helpful.
What troubles me most about the Federal budget is not
the prospective deficit this fiscal year, but rather a feeling
of unease as to the probable direction and magnitude of
spending and revenues over the next several years. There
are real hazards in placing excessive emphasis on the fullemployment budget concept. Useful as that concept is,
there are two cautionary notes with respect to its use: (1)
the fact that a great many assumptions must be made
concerning what constitutes “full employment” and con­
cerning the course of real economic growth, prices, and
tax revenues, all of which leave an enormous margin for
error in the calculations of the full-employment surplus
and (2) the fact that, regardless of the state of the full-


employment budget at a given time, it is the actual budget
deficit that must be financed. The deficit can have severe
consequences both in terms of pressures in the financial
markets and for the orderly provision of credit by the
Federal Reserve.
As for the outlook for Federal spending, I am struck
by the magnitude of the rise in nondefense outlays in the
last year or two. It is only the sharp curtailment of de­
fense spending that has permitted a rather good showing
by total expenditures. With a number of important non­
defense programs still in their infancy, there is a real risk
of accelerating increases in these outlays over the coming
years, while at the same time we may soon have exhausted
the possibilities of large cuts in spending on defense. In
addition, while agency financing outside the budget seems
to be slackening this year as housing funds become more
available, there is a large volume of potential financing
by new as well as existing agencies on the more distant
horizon. All of this has a bearing on whether fiscal re­
straint will be readily forthcoming if it should be needed
again within the next year or two.
Meanwhile, what about monetary policy’s present role?
As I said earlier, some easing of credit conditions and
provision of adequate liquidity during the summer’s fi­
nancial troubles constituted one important feature of our
policy this year. But our overriding concern has been to
encourage moderate expansion of money and bank credit
to help the economy stage an orderly and gradual re­
covery. It is never possible to know exactly what rates
of increase for these aggregates are most likely to bring
the desired results, especially since the effects usually in­
volve an uncertain lag. With respect to the money supply,
some adjustment should be made for shifts in the public’s
desire to hold money balances—which is another way of
saying that money velocity is bound to show unforeseen
fluctuations from time to time. For example, the General
Motors strike doubtlessly lessened the demand for money
and credit and made it harder to induce a desired growth
of money with a given injection of reserves into the bank­
ing system or a given set of conditions in the money
market. I should also like to repeat a point that can
hardly be overemphasized, i.e., it is always dangerous to
set much store by short-term (say, month-to-month)
swings in rates of gain for money or credit. These series
are subject to so many unpredictable and uncontrollable
influences, or later revisions, that a longer perspective is
essential if valid conclusions are to be drawn from the
figures. Even quarterly data may be subject to temporary
distortions that should be discounted—not to mention the
fact that the data may be substantially revised after the
initial publication. The rather wholesale revision of the



money supply data released about ten days ago is a case
in point. Furthermore, the bank credit data must always
be viewed in the light of the factors encouraging or dis­
couraging intermediation of the banking system in the
savings-investment process. A very high rate of bank
credit growth was fully justified when withdrawal of buyers
from the commercial paper market forced borrowers back
into the banks. But fortunately a much slower rate of
growth has reappeared since the commercial paper situa­
tion has pretty well stabilized.
I would not like to give the impression that the System
is concerned only with the rates of growth of the money
and credit aggregates. Early this year there was a change
of emphasis in this direction, but no more than that, and
we continue to regard credit conditions and interest rates
as important considerations in the setting of policy. Of
course, interest rates are influenced primarily by the size
of investment demands and the volume of available sav­
ings; our ability to affect rates, especially long-term rates,
is decidedly limited. For some time now, short-term in­
terest rates have been moving sharply lower in response
to slackened business activity and reduced loan demand
along with an accommodative Federal Reserve policy.
But until recently long-term rates, despite the sluggishness
of business, were slow to respond under the influence of
an enormous flow of new issues in the capital markets.
The widening spread between short- and long-term rates
appeared to be a natural result of supply and demand
forces, and I have seen no need for special actions to
push long rates lower. Within the last few weeks, in any
case, long-term rates have also turned sharply lower.
While it has seemed reasonable and, indeed, essential for
monetary policy to encourage moderate business ex­
pansion, there is no assurance that a policy of this type
either will be consistent with checking the deeply em­
bedded inflation or will keep unemployment within politi­
cally tolerable limits. We are not yet visibly winning in the
test of monetary and fiscal policy—so it is in no way
surprising that calls for further Government efforts to
exert direct influence on wages and prices are heard in
an ever-increasing crescendo. I was encouraged to note
the Administration’s recent initiative with respect to al­
lowable oil production and import quotas, and the defeat
of a protectionist trade bill would be an important step
from an anti-inflation point of view. It is certainly true that
past experiments with incomes policies, both here and

abroad, have not been startling successes. Yet we really
have little alternative but to keep on experimenting in
this area hoping to find some reasonably acceptable and
effective approach, not as a substitute for proper fiscal
and monetary policies but as an additional support for
them. A simple call for wage and price controls does
not offer a practical solution. Those who advocate such
an approach are often prone to forget the elaborate ad­
ministrative trappings needed to make them work. More­
over, short of a wartime emergency, elaborate and rigid
controls would probably not command sufficient public
understanding and support. Yet I am hopeful that our
ingenuity can devise some sort of workable incomes
policy, whether backed by jawbone or some more tangible
carrot or stick, that would command reasonable public
support and would permit speedier progress against both
unemployment and inflation. There may also be a need
for a greater effort to reduce the social hardships asso­
ciated with any given degree of unemployment, in order
to reduce the seductive appeal of treatment by sharply
accelerated increases in overall demand. I would like to
emphasize that in any case I can see a great need for
cautious fiscal and monetary policy as long as inflation
remains the challenge that it is today. As savings bankers,
you have as great a stake as anyone in the solution of
this exasperatingly stubborn problem.

P E R S P E C T IV E '7 0

Each January this Bank publishes Perspective, a
brief review of the performance of the economy
during the preceding year. This booklet is a layman’s
guide to the economic highlights of the year. A
more comprehensive treatment is presented in our
Annual Report, available in March.
Perspective ’70 is available without charge from
the Public Information Department, Federal Reserve
Bank of New York, 33 Liberty Street, New York,
N. Y. 10045. A copy is being mailed to Monthly
Review subscribers.


The B usiness Situation
Though obscured somewhat by the effects of the Gen­
eral Motors strike, recent business indicators suggest con­
tinued sluggishness in most sectors of the economy. In
November, industrial production declined, personal in­
come posted only a small increase, and retail sales con­
tinued to put on a lackluster performance. Continuing the
trends which began in earlier months, businesses accu­
mulated inventories at a relatively rapid pace while their
sales generally fell; as a result, some areas of the economy
—particularly the wholesale and manufacturing sectors—
have a surfeit of inventory stocks. Although the automo­
tive strike was partly responsible, the slackening in the
economy seems to go beyond the direct and indirect effects
of the work stoppage. In sharp contrast to much of the
rest of the economy, residential construction activity has
continued to gain upward momentum. With the resump­
tion of production at GM, the stepped-up activity in the
automobile and related industries should provide a sub­
stantial impetus to production and employment in the
months immediately ahead.
Despite the pervasive slack within the economy, con­
sumer prices have continued their steep ascent. There
has been some moderation in the rate of advance of the
overall consumer price index as a result of a marked
slowing in the pace of food price increases. However, this
development has obscured somewhat the extremely rapid
rise in prices of nonfood consumer commodities and con­
sumer services. At the same time, the rate of advance of
wholesale industrial prices does appear to have moderated
somewhat during 1970, affording some encouragement
that prices of consumer nonfood commodities may soon
respond similarly. Thus far, however, there have not been
any clear signs of abatement in the rate of consumer price

Industrial production continued its downtrend in No­
vember, contracting by 0.6 percent on a seasonally ad­
justed basis (see Chart I). Unlike the preceding two
months when the fall in production was partially attribut­
able to the strike at GM, the indirect effects of this work

stoppage appear to have added little downward impetus
to the overall index. The November drop centered in
the business and defense equipment and the materials
components. At its November level of 161.4 percent of
the 1957-59 base, the Federal Reserve Board’s index of
industrial production was 7.6 percent below the peak at­
tained in July 1969. Thus, measured in terms of this index,
the current business slowdown is comparable in magnitude
to the 7.3 percent fall during the 1960-61 contraction but
is considerably milder than the 14 percent decline recorded
in the 1957-58 recession. With the resumption of produc­
tion at GM in late November, the index will probably
show considerable gains in the near term as the effects of
the ten-week strike unwind themselves.
Output of consumer goods was virtually unchanged
despite the fact that the production of automobiles actually
edged upward. Consumer goods output exclusive of auto­
mobiles was sluggish throughout the year; for the first
eleven months of 1970 the index has risen by only 0.9
percent. Moreover, among selected consumer goods cate­
gories, such as furniture and apparel, output actually
decreased in 1970. The November declines in defense and
business equipment output were further extensions of down­
ward trends which have been under way for some time.
Defense goods production has been on the downslide since
August 1968, while business equipment production has
declined 11.9 percent from the October 1969 peak.
Following three consecutive—and at least partly strikerelated—monthly declines, new orders for durable goods
advanced by 1.9 percent in November on a seasonally ad­
justed basis. However, at $29.0 billion, orders in No­
vember were still 5.2 percent below the monthly average
in 1969. The principal factors underlying the November
increase in durables orders were the sharp spurts in orders
for nonautomotive consumer durables and producers’ cap­
ital goods. Having jumped 5.8 percent to $6.9 billion,
orders for producers’ capital goods reached the high­
est level since September 1969. Capital goods orders
appear to have strengthened somewhat in the last three
months, although the monthly average for the first eleven
months of 1970 was still below the average for 1969.
In view of the general lack of growth in planned plant and



continued to outrun sales, and the inventory-sales ratio rose
to its highest level in a decade. Manufacturers’ inventories
swelled by $0.8 billion in October, more than double the
average increase in earlier months of 1970. This inventory
accumulation coupled with a $1.5 billion fall in sales
pushed up the inventory-sales ratio, with the imbalance
problem concentrated in the durables sector. Because
much of the October decline in durables sales was strike
related, it appears that the inventory-sales ratio for du­
rables manufacturing somewhat overstates the extent of
any inventory-imbalance problem in this sector. However,
November data— which are available for manufacturing
only—indicate that the problem of excess stocks in the
manufacturing sector was exacerbated in that month.
Durables manufacturers accumulated another $0.4 billion
of inventories in November, while their sales dropped by
$0.6 billion. Unlike that in the previous month, the Novem­
ber fall in sales was widely distributed and was not pri­
marily associated with the automotive strike. Indeed, even
the large decline in the sales of transportation equipment
was accounted for by reductions in the shipments of the
aerospace industry.

C h art I

Seaso n ally adjusted; 1 9 5 7 -5 9 = 1 0 0

1 5 9 .2

1 5 2 .7





Note: Indexes for defense equipment and nonautomotive consumer goods
were calculated at the Federal Reserve Bank of New York from data
published by the Board of Governors of the Federal Reserve System.
Indexes are not plotted in rank order. Data for latest four months are
subject to revision.
Source: Board of Governors of the Federal Reserve System.

equipment expenditures projected by recent surveys, it
is uncertain whether this uptrend in orders is indicative
of some future strengthening in investment spending.
While orders for durables increased in November, du­
rables shipments continued to edge down to the lowest
level since December 1968, marking the fourth successive
monthly decline.
There apparently continue to be some areas in the
economy where inventory stocks are a bit high relative
to the volume of sales, though the extent of the imbalances
has been clouded by the automotive strike. Large ac­
cumulations of inventories in October at wholesale outlets,
retail stores, and manufacturing firms more than offset a
$1.0 billion contraction of retail automobile dealers’ stocks,
so that total business inventories rose by only a small
amount. Within the trade category, the inventory-sales
ratio for nonautomotive retailers actually dipped slightly.
At wholesale outlets, however, accumulations of stocks


After having bottomed out in the first quarter, residen­
tial construction activity has progressively strengthened
throughout the third quarter. This trend continued in
November when total private housing starts expanded by
122,000 units to a seasonally adjusted annual rate of
about 1.7 million units. This represented the largest num­
ber of starts initiated in any one month since January
1969 and exceeded the average number of starts recorded
in the first quarter of 1970 by 35 percent. About 60
percent of the November surge in starts occurred in the
multifamily category. However, starts of single-family
structures, which typically have a higher value per unit,
also rose by about 50,000 in November to the highest
level since December 1968. Because construction activity
is spread out for several months after new units are be­
gun, residential housing expenditures tend to lag the series
on housing starts. Thus, following the trend in housing
starts, outlays for nonfarm residential buildings have also
accelerated sharply in recent months. Since June, when
outlays fell to a recent low of $28.1 billion on a seasonally
adjusted annual rate basis, spending on housing has
expanded at an annual rate of 20.4 percent through
November. Moreover, the November surge in starts would
suggest some further gains in outlays in the months imme­
diately ahead. In a similar vein, the recent strength in



building permits also suggests some further strength in consumer price index advanced at a seasonally adjusted
this sector. Marking the fourth consecutive monthly annual rate of 3.7 percent, down considerably from the
increase, new permits advanced slightly in November to 6.4 percent average increase of the preceding two months.
a record high 126.0 percent of the 1957-59 base.
In view of the seesaw monthly movements in the rates of
Residential construction activity continues to be favor­ change in this index throughout the year, it is too soon to
ably influenced by the large deposit flows to the nation’s hail November’s slowdown as the beginning of a down­
mutual savings banks and savings and loan associations, trend. Moreover, part of the improvement in Novem­
the major suppliers of mortgage credit. While these ber was the result of the decline in food prices, whereas
flows have, of course, expanded the availability of mort­ the rise in nonfood commodities prices actually ex­
gage credit, there is some evidence that the increased ceeded the average gain in these prices for the first half
supply of funds is beginning to produce some easing in of 1970.
During the past two years, the price rises originating
the terms under which mortgages are granted. Mortgage
interest rates, which tend to be quite sticky, have edged in various sectors have contributed disproportionately
down slightly. Between July and October, the interest to the gains in the overall consumer price index (see
rate on thirty-year Federal Housing Administration mort­ Chart II). While in 1969 rising food prices pulled up
gages fell by 14 basis points and that on conventional the overall index, they have tended to dampen the ad­
mortgages declined by 10 basis points. The latest data vances in the consumer price index during 1970, par­
show an increase in the loan-price ratio for conventional ticularly in the closing months of the year. On the other
mortgages on new homes, suggesting a reduction in down­ hand, nonfood commodities prices continue to surge ahead.
payment requirements. This easing in mortgage market Adjusted for seasonal variation, these prices increased 4.8
conditions bodes well for an extension of the strength in percent in November, following rises of 6.8 percent in Octo­
residential construction activity into 1971.
ber and 6.8 percent in September. As shown in Chart II,
While construction activity in the residential sector there has been no abatement in the rate at which nonfood
has gained upward momentum throughout most of 1970,
the opposite trend has emerged in the private nonresidential construction sector. Indeed, for the three months ended
in November, the value of new commercial and industrial
construction put in place was 10.6 percent below the firstChart II
quarter annual rate average of $17.6 billion. Similarly, the
F. W. Dodge data on construction contract awards for
commercial and industrial structures have been character­
ized by a distinct downward trend in 1970, and spending
on nonresidential structures as measured in the gross
national product (GNP) accounts showed absolute de­
clines in both the second and third quarters of 1970.
The weakness of new construction activity in the indus­
trial and commercial sector is, of course, in line with the
paring-down in business planned capital spending which
has characterized 1970. In real terms, outlays on struc­
tures have fallen off more sharply than have outlays on
producers’ capital equipment. This suggests that business
firms have attempted to economize on their investment
costs by expanding and modernizing productive facilities
within existing structures.

Inflation continues to be a more deeply rooted problem
than most observers had originally thought; despite the
slowdown in economic activity, the pace of inflation does
not appear to have noticeably abated. In November, the


.............................................................. ............................... 1

W / \ 1965

E H 1966


[jgg| D e c 6 9 - M a y 7 0

] 969

m i 1967

R T fl 1 9 6 8

M a y 7 0 -N o v 7 0

Note: Seasonally adjusted except for services.
Source: United States Department of Labor, Bureau of Labor Statistics.



commodities prices have been advancing. The failure of
these prices to respond to the economic slowdown is one
of the most perplexing aspects of the present inflation.
Similarly, services prices accelerated in November, grow­
ing at a rate of 7.6 percent. (Services include such things
as medical care, various modes of public transportation,
and insurance.) Price rises in this sector have been the
primary source of increases in the consumer price index.
Though constituting only about one fourth of the overall
index, services prices have contributed a shade more than
half the past year’s rise. Like those for nonfood commodi­
ties, these price rises have also stubbornly persisted.
There has lately been some easing in the rate at which
wholesale industrial prices have been advancing. In
December, according to preliminary seasonally adjusted
estimates, these prices rose at an annual rate of 2.8 per­
cent, reflecting primarily the higher prices of fuels and
electrical power. During the second half of 1970, indus­
trial wholesale prices posted a 3.2 percent annual rate
gain, compared with the 3.8 percent growth in the first
half of 1970 and the 4.2 percent growth in the second
half of 1969. It may be that the failure of consumer com­
modities prices to reflect the slowing in the pace of whole­
sale industrial prices is in part a consequence of the
rapidly rising shipping costs. Wholesale agricultural prices
fell 7.2 percent on a seasonally adjusted annual rate basis
in December, marking the third successive monthly de­
cline. This decline entirely offset the advance in industrial
commodities prices so that the seasonally adjusted overall
wholesale price index was unchanged in December.

Personal income posted a relatively small increase of
$2.4 billion in November, less than half the average
monthly increase registered in 1969. This gain was de­
pressed somewhat by a roughly $1 billion nonrecurring
payment to retired railroad workers in October, which had

buoyed the level of personal income in that month, while
the removal of the retroactive payment from the November
data depressed the level of personal income in that month.
Even allowing for this factor, however, the rise in personal
income in November was of a relatively small magnitude.
The growth in personal income principally reflected a $1.8
billion gain in wage and salary disbursements; in turn, this
increase in disbursements centered in the government and
services sectors which posted expansions in payroll em­
ployment in November. In the manufacturing sector, wage
and salary disbursements declined slightly, mirroring the
November contractions in overtime hours and employment.
According to preliminary estimates, there was a small
decline during November in durables retail sales which
more than offset the gain in nondurables sales, so that
total retail sales on a seasonally adjusted basis edged
down 0.5 percent. While consumer spending has been
sluggish all year, the purchases of durable goods have
been particularly lethargic. Dealer sales of domestically
produced new cars during the first eight months of the
year were off 8.2 percent from the corresponding average
for the last year; during the September-November period
when the GM strike was in effect, dealer sales of new
cars produced by the other automotive companies con­
tracted further on a seasonally adjusted basis. In addi­
tion, retail sales of nonautomotive durables have failed
to register any growth during the year; for the first ten
months, nonautomotive durables sales in current dol­
lars were virtually unchanged relative to the same period
in 1969. Concurrent with the sluggishness in retail sales—
and in consumer demand generally—have been large in­
creases in disposable income, which is equal roughly to
personal income less personal taxes. As a result, then, the
personal savings rate has been abnormally high all year.
The large store of savings accumulated in recent quarters
may provide the fuel for future step-up in the pace of
consumer spending, though its timing and magnitude are
still uncertain.



T he M oney and Bond M ark ets in D ecem ber
Interest rates continued to decline on a broad front
until about mid-December, and then generally leveled
off or rose somewhat over the latter half of the month.
On balance, most interest rates were little changed for the
month, following the sharp declines of November (see
Chart I). Over the fourth quarter as a whole, however,
both short- and long-term rates declined considerably and
in several instances fell to their lowest levels in a year
and a half or more. Thus, the average issuing rates on
new three- and six-month bills reached their lowest point
since late 1967, while The Weekly Bond Buyer*s index
of yields on twenty municipal bonds fell to its May 1969
level by the close of 1970.
Both the money supply and the adjusted bank credit
proxy1 rebounded in December following two months of
relatively slow growth. Over the fourth quarter as a whole,
the money supply apparently grew at about a 3Vi percent
annual rate and the adjusted credit proxy at about an
8 percent rate. Over the year 1970 the money supply in­
creased by about 5 V2 percent, compared with 3 percent
during 1969. The adjusted bank credit proxy grew by
about 8 V4 percent over 1970 after virtually no growth
during the previous year.

Conditions in the money market eased further during
December, when the effective rate on Federal funds aver­
aged 4.90 percent, some 50 basis points lower than in
the preceding month. Reflecting in part the substantial
provision of reserves by System open market operations,
as well as continued sluggishness of loan demand, mem­
ber bank borrowings from the Federal Reserve Banks
declined further in December. Such borrowings averaged
$348 million for the month (see table), down $61 million

1 A measure of bank liabilities, which includes deposits subject
to reserve requirements and nondeposit items such as Euro-dollar
liabilities and bank-related commercial paper.

from the November average and the lowest monthly level
since January 1968.
Business loan demand at weekly reporting banks con­
tinued in the sluggish pattern which began in midSeptember. During the week containing the December 15
corporate tax payment date, business loans (adjusted for
sales to affiliates) grew by only $1.2 billion, compared
with an increase of $1.6 billion in the same period last year
when bank reserve positions were under considerably more
pressure. Moreover, for the fourth quarter as a whole,
repayments of business loans exceeded new borrowing at
weekly reporting banks. Consequently, outstanding loans
fell by $1.4 billion, whereas during the comparable periods
of 1968 and 1969 they rose by $4.4 billion and $3.1
billion, respectively. In response to the contraseasonal
slackening of loan demand, commercial banks had re­
duced their prime lending rate by V2 percentage point in
two steps during November. Then, following the midDecember corporate tax date experience, major banks
lowered their prime rate an additional V\ percentage
point to 6% percent, compared with the high of 8 V2
percent earlier in the year. The prime rate was again re­
duced by Va percentage point to 6 V2 percent in early
Preliminary data indicate that the money supply grew
at about a 6 percent annual rate during December follow­
ing gains of only 1.1 percent and 2.8 percent in October
and November when economic activity was depressed by
the strike in the automotive industry. Over the three
months as a whole, the money supply grew at about a
3 V2 percent rate. The adjusted bank credit proxy showed
an even greater rise in December, growing at an annual
rate of about 15 percent compared with increases of 1.1
percent and 7.0 percent in the preceding two months. This
brought the growth rate of the adjusted proxy over the
fourth quarter to about 8 percent. Continued heavy in­
flows of time deposits (see Chart II), particularly large
certificates of deposit, were the primary factor in the
substantial rise in the proxy. Large CD’s at weekly reporting
banks climbed to $26.1 billion at the end of December,
surpassing the late-1968 peak by $1.8 billion.



O c to b e r-D e c e m b e r 1 9 7 0
P e rc e n t



P erce n t

N ote: D ata a re shown for business days only.
M O N E Y MARKET RATES QUOTED: Bid rates for three-month Euro-dollars in London; offering
rates for; directly placed finance com pany paper; the effective rate on Federal funds (the
rate most representative of the transactions executed); closing bid rates (quoted in terms
of rate of discount) on newest outstanding three-m onth and o ne-year Treasury bills.
B O N D MARKET YIELDS QUOTED: Yields on new A a a - and A a -ra te d public utility bonds
(arrows point from underw riting syndicate reoffering yield on a given issue to m arket
yield on the same issue im m ediately a fter it has been released from syndicate restrictions);

Nondeposit liabilities of banks declined further during
the month, however. Since Euro-dollar rates far exceeded
domestic interest rates, banks reduced their Euro-dollar
liabilities by an additional $1.1 billion. Outstanding Euro­
dollar liabilities of weekly reporting banks totaled $7.7
billion on December 30, just one half of their October
1969 high. Bank-related commercial paper—the other
major nondeposit component of the adjusted credit
proxy—also declined in December, continuing a trend
which has been evident since the late-August announce­
ment of the imposition of reserve requirements on these
liabilities. As a result of the accompanying reduction of
the reserve requirement on large time deposits to the same
level as that on commercial paper, CD’s and bank-related
paper were placed on a more nearly equal basis. Since

d a ily averages of yields on seasoned A a a -ra te d corporate bonds,- d aily averag es of
yields on lo n g -term Governm ent securities (bonds due or c a lla b le in ten years or more)
and on G overnm ent securities due in three to five years, computed on the basis of closing
bid prices; Thursday averages of yields on tw enty seasoned tw enty-y e a r ta x -e x e m p t bonds
(carrying M o o d y’s ratings of A a a , A a , A, and Baa).
Sources: Federal Reserve Bank of N ew York, Board of Governors of the F e d era l Reserve System,
M o o d y’s Investors Service, and The W e e k ly Bond Buyer.

both banks and their customers tend to prefer deposits
to commercial paper, the volume of bank-related paper
outstanding was reduced to $2.4 billion at the end
of the year, down from a high of $7.8 billion at the end
of July.

The market for United States Treasury issues continued
to advance over the first half of December, and yields on
all maturities registered additional declines. The rally
faltered after midmonth, however, and prices generally
declined thereafter, particularly in the coupon sector. As
a result of the consolidation in the coupon market, yields
on most longer dated securities were higher at the close


of December than they were at the start of the month.
Yields on intermediate-term issues generally rose 3 to 27
basis points, while those on most long-term coupon issues
ranged between 3 and 20 basis points higher.
The month-long rally in the bond market was sustained
in the first week of December by the reduction in the dis­
count rate on November 30, System purchases of coupon
issues on the following day, and active investor demand.
Some profit taking then emerged, as participants reflected
upon the sizable rise in prices which already had occurred,
but after a few days the coupon market resumed its
advance. The gains at this time were triggered in large
part by the expectation of further reductions in interest
rates, particularly in the prime rate in view of the contraseasonal sluggishness of business loan demand at commer­
cial banks. Increased demand for Treasury securities on
the part of both investors and professionals was an addi­
tional factor in the renewed advance, and over the
December 1-14 period yields on most coupon issues
showed net declines of 8 to 24 basis points.
The better tone was short-lived, however, and yields on
Treasury notes and bonds began to rise on December 15
in reaction to the unenthusiastic response given by inves­
tors to a large, aggressively priced new corporate bond
issue. On several succeeding days coupon yields continued
to rise, as investors and dealers attempted to reduce their
holdings. Increasingly as the month progressed there was
discussion of the forthcoming Treasury refunding in Febru­
ary, the terms of which will probably be made known
late in January, and a reluctance on the part of dealers
to add to their already large inventories in the face of the
imminent refunding.
An additional factor which weighed upon the coupon
market in the latter half of December was the possibility
that, after the turn of the year, insurance coverage on
Treasury and Federal agency bearer securities held by
banks, dealers, and brokers might be drastically curtailed.
The Federal Reserve Bank of New York, in cooperation
with the financial community, formulated contingency
plans to ensure the continued functioning of the market
in the event that one or more major banks or dealers
curtailed its securities operations. Late in the month,
the major insurer in this field made known its intention
of extending coverage with respect to banks through the
first three months of 1971, thereby removing for the time
being the threat of disruption of trading in the Govern­
ment securities market. Meanwhile, the Federal Reserve
Bank is pressing ahead with plans for the further expan­
sion of its Government securities clearing arrangement
and of the book-entry procedure for Government securi­
ties, as a means of minimizing the physical handling of


bearer Government securities by market participants.
Unlike yields on most Government coupon issues,
Treasury bill rates declined on balance during December.
The bill market was buoyed early in the month by some
of the same factors that led to an improvement in coupon
issues. At midmonth, when the rally in the capital markets
faltered, the bill market performed quite well in the
absence of the usual selling pressure in connection with
the corporate tax date. In addition, there was steady
investor demand for bills much of the time and yields
continued working down. As the holidays approached,
however, apprehension over the uncertain insurance situa­
tion and a slackening of investor interest were felt in this
sector as well, and yields edged somewhat higher. Never­
theless, rates on most issues declined by a net of 7 to 19
basis points over the month.

C h a rt II

Seasonally a d ju sted w e e k ly a v e ra g e s
Sep tem b er-D ecem b er 19 7 0
Billions of dollars


Billions of d ollars

Ratio scale

* Total member bank deposits subject to reserve requirements plus nondeposit
liabilities, including Euro-dollar borrowings and commercial paper issued by
bank holding companies or other affiliates,
t At all commercial banks.





In the corporate and municipal bond markets, yields
on both new and seasoned issues showed further decreases
in the early part of the month, but then some investor
resistance developed in the market for tax exempts. Profit
taking and investor unwillingness to pay higher prices later
extended to the corporate bond market, and by midDecember the approximately six-week-long rally had
faltered in both sectors.
Rates on new and seasoned corporate bonds moved
lower as the month opened, and on December 3 a long­
term Aa-rated utility issue was priced to yield 7.85 per­
cent, the first instance in sixteen months that the return
on such a new issue was less than 8 percent. The recep­
tion to these bonds was quite favorable, despite the fact
that the return was 37 basis points lower than that on a
similar issue sold three days earlier, and over the next
several days additional Aa-rated offerings were marketed
at this same yield. The response of the market was some­
what cooler, however, and these later issues were initially
only partially sold. When on December 10 another utility
bond was even more aggressively priced to provide in­
vestors with a return of only ! 3 percent, however, the
remaining 7.85 percent bonds were snapped up. The
last large corporate issue to be sold in 1970 was a $200
million offering of New York Telephone Company bonds,
which was marketed on December 14. Priced to yield
7.60 percent—56 basis points below the yield offered on
the most recent comparable issue on November 23—the
bonds moved slowly and the bulk of them remained in the
underwriting syndicate’s inventory at the end of the year.
Prices of municipal bonds continued to rise during the
first week of December, but the rally began to falter dur­
ing the next week when the market faced one of the
heaviest calendars on record. Indicative of the improve­
ment during the rally is the fact that for almost two years
the state of Texas had been unable to sell certain bonds
because of a 4.5 percent interest ceiling but finally mar­
keted them on December 7 at a net cost of 4.07 percent.
On the following day, however, more than $400 million in
new tax-exempt securities was offered, and investor inter­
est was decidedly restrained. Yields were raised somewhat
on succeeding new offerings, but dealer inventories con­
tinued to rise as an unusually heavy December calendar
was marketed. The Blue List of advertised inventories
climbed to more than $1 billion during the December
10-14 period. Finally in the third week of December,
underwriters began pricing new issues more attractively
to investors, and several bond offerings were quickly sold
out. In the face of such sizable inventories and the suc-

In millions of dollars; (+) denotes increase
(—) decrease in excess reserves
Changes in daily averages —
week ended on







— 168

— 109

— 344

— 156

— 331


— 410


4- 300
+ 152
- f 103
— 8
— 81

— 419
— 103
— 107
4- 3
— 260

+ 395
+ 905


— 8
— 665

+ 507
— 376
— 19
+ 232

+ 173
— 345
— 27
— 780

— 65

4 - 47

+ 161

— 70

— 53



— 763

+ 239

+ 176

— 935

— 138

4-5 8 8

— 48

— 88


+ 32
4- 4

4- 328
4- 6

+ 286



+ 19

— 177
4 - 33
— 30
- 163

— 28
4- 24

— 321
— 14
— 7
— 75



“ Market’" factors

Member bank required
Operating transactions
Federal Reserve float ........... 1 — 317
Treasury operations* ........... | - f 34
Gold and foreign account. .. ; + e
— 6
Currency outside b a n k s ........
Other Federal Reserve
— 126
liabilities and capital .........
Total “market" factors---- ! — 578



Direct Federal Reserve
credit transactions

Open market operations
+ 967

Outright holdings:
Government securities ___ ; + 6 1 6
Bankers’ acceptances ........
Repurchase agreements:
Government securities . . . .
+ 337
Bankers' acceptances ........
+ 42
Federal agency obligations. + 78
Member bank borrowings ___
+ 18
Other Federal Reserve



— 61

4- 26

4- 28





+ 924



4- 724



— 96

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

4- 341


— 37

+ 159





— 166




+ 262


Daily average levels
Member bank:

Total reserves,
including vault cash .................
Required reserves......................
Excess reserves ........................







— 38

— 154

— 300

— 66


— 98*







Free, or net borrowed (—),
Nonborrowed reserves .............
Net carry-over, excess or
deficit (—)§ ..............................

Note: Because of rounding, figures do not necessarily add to totals.
* Includes changes in Treasury currency and cash,
t Includes assets denominated in foreign currencies.
t Average for five weeks ended on December 30.
§ Not reflected in data above.

cess of these new, lower priced bonds, a number of out­
standing issues were released from syndicate price restric­
tions with upward yield adjustments of 20 to 40 basis
points. Dealer inventories were reduced, but the Blue List


was still at a very high $937 million on December 31.
An interesting development in the tax-exempt market
during December was the sale of some $46 million in
bonds by the Vermont Municipal Bond Bank, which in
turn will purchase the bonds of several small Vermont

communities and school districts that individually would
not have ready access to nationwide capital markets. The
Aa-rated bonds of the bank were well received and may
set a pattern for other states which are considering ways
to raise additional funds for financing local governments.

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m o n e y : m a s t e r o r s e r v a n t ? (1970) by Thomas O. Waage. 48 pages. A comprehensive discussion
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is and how it works in a dynamic economy. (15 cents each in excess of 100 copies)
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e s s a y s i n d o m e s t i c a n d i n t e r n a t i o n a l f i n a n c e (1969) 86 pages. A collection of nine articles
dealing with a few important past episodes in United States central banking, several facets of the relationship
between financial variables and business activity, and various aspects of domestic and international finan­
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e s s a y s i n m o n e y a n d c r e d i t (1964) 76 pages. A collection of eleven articles on selected subjects
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c e n t r a l b a n k c o o p e r a t i o n : 1924-31 (1967) by Stephen V. O. Clarke. 234 pages. A documented
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