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98

MONTHLY REVIEW, MAY 1965

The Business Situation
The business situation continues to show a great deal of
strength. Most important monthly indicators surged fur­
ther in March, and the total volume of goods and services
produced in the first quarter as a whole showed the largest
increase in three years. Part of the first-quarter buoyancy,
of course, reflected a catching-up of output and sales lost
during the automobile strikes last fall as well as inventory
building due to the threatened steel strike. Nevertheless,
there are few, if any, signs of an appreciable falloff in activ­
ity in any major sector. Indeed, a very recent survey sug­
gests that business capital spending plans for 1965 may
have further strengthened in the last several months. The
extension of the deadline for a steel settlement for another
four months has removed the threat of a strike during the
current quarter and, while automobile assemblies did de­
cline in April, current production schedules for the second
quarter as a whole nearly match the pace reached in the
first quarter. Retail sales were apparently about unchanged
in April and consumer demand, buoyed by a high degree of
consumer confidence, remains strong.
Activity in a number of sectors has clearly been mov­
ing closer to full utilization of capacity— difficult as this
type of measurement is to make. Furthermore, the un­
employment rate averaged 4.8 per cent in the first four
months of this year, the first extended period during this
business expansion in which the average was below 5 per
cent. The April figure was 4.9 per cent. Signs of pro­
duction bottlenecks that might put strong upward pres­
sure on prices are still largely absent, and there are
only isolated instances of labor costs outrunning pro­
ductivity gains. Nevertheless, current specific price an­
nouncements are heavily weighted on the upside and
there continues to be a need for very close surveil­
lance of the price situation. The present period is marked
by a round of current and upcoming labor contract nego­
tiations in a number of key industries, including not only
steel but also aluminum, paper, shipbuilding, ordnance,
and aircraft. The terms of the settlements that will emerge




from these negotiations will individually, and even more in
the aggregate, have an important bearing on future cost
stability. In addition, significant upward price pressures
have developed in the world markets for certain raw ma­
terials, while the high level of domestic demand for many
goods has led to numerous probings of markets for their
degree of resistance to price increases.
As regards the immediate price situation, industrial
wholesale prices apparently advanced once more in April.
Such prices (seasonally adjusted) rose by 0.7 per cent in
the second half of last year and are now about 1.8 per cent
above the level reached in April 1963 (a month that marked
the end of a general downtrend during the early phase of
the current expansion). Consumer prices edged up once
more in March, following a pause in February when the
index was unchanged. In most recent months, however, the
year-to-year increase in the consumer price index has re­
mained slightly lower than in the preceding two years.
PRODUCTION, ORDERS, AND EMPLOYMENT

Industrial output advanced on a broad front in March,
and the Federal Reserve Board’s seasonally adjusted index
rose by 1.2 percentage points to 140.1 per cent of the
1957-59 average. The increase was paced by a very large
gain in automobile assemblies and received additional
strength from another rise in iron and steel production.
Outside these two industries, however, production gains
were also larger in March than in February. Prospects for
further near-term strength in production were bolstered
by the further advance in March of new orders received by
durable goods manufacturers. New orders booked by steel
producers fell a bit in March, following the bulge in orders
earlier in the year— many of which were for delivery sev­
eral months in the future. On the other hand, the over­
all volume of orders in other durable goods industries in­
creased. Data at hand for April show that auto produc­
tion slipped back from the extraordinary 10 million unit

FEDERAL RESERVE BANK OF NEW YORK

Chart I

EMPLOYMENT AND HOURS IN MANUFACTURING
OVER THREE CYCLES
Quarterly averages of seasonally adjusted monthly data

99

tries, lengthened the average workweek of all manufactur­
ing production workers to 41.5 hours, a postwar record.
RECENT PATTERNS OF DEMAND

The strength of the economy in March capped off a
first quarter that, as had been widely expected, showed an
exceptionally large gain in over-all activity. According to
the Commerce Department’s preliminary estimates, gross
national product rose to a seasonally adjusted annual rate
of $649 billion in the first three months of 1965, up by
$14.4 billion from the preceding quarter when strikes in
the automobile industry had curtailed output. To be sure,
some of the first-quarter surge reflected a recovery of the
losses suffered during the auto strikes last fall. One way
of making a rough allowance for this special circumstance
is to focus on the average increase in GNP in the past two
quarters combined. Such a calculation shows that the

Note: Shaded are as represent recession periods, according to National Bureau of
Economic Research chronology.
Source: United States Bureau of Labor Statistics.

Chart II

RECENT CHANGES IN GROSS NATIONAL PRODUCT
AND ITS COMPONENTS
S ea so n ally adjusted annual rates
A verag e quarterly change, second
quarter 1964 and third quarter 1964

annual rate reached in March. For the second quarter as
a whole, however, current schedules call for a seasonally
adjusted assembly rate of around 9.4 million units, virtu­
ally the same as that turned in during the first quarter.
According to trade reports, producers foresee the con­
tinuation of extra shifts and six-day weeks well into the
summer. In the steel industry, ingot production (season­
ally adjusted) rose once again in April.
Nonfarm payroll employment also scored another siz­
able advance in March, with virtually all sectors sharing
in the expansion. Reflecting the continued growth of fac­
tory output, especially in the metal-producing and metalusing industries, the number of persons at work in
manufacturing reached the highest monthly reading since
early 1944. On a quarterly basis, manufacturing employ­
ment over the first three months of 1965 was very nearly
equal to the postwar quarterly record reached twelve years
earlier (see Chart I). Over-the-year gains in such em­
ployment in early 1965 have amounted to some 600,000
persons, in contrast to the over-the-year gains of only
about 200,000 persons in early 1964. Extensive use of
overtime in March, especially in the durable goods indus­




-2

■■ A verag e quarterly change, fourth
quarter 1964 and first quarter 1965

0

2

4

6

Billions of dollars
Source: United States Departm ent of Com merce.

8

10

12

100

MONTHLY REVIEW, MAY 1965

average increase in the annual rate of GNP in the two confidence in the January-March period had risen to a
most recent quarters — i.e., 1964-IV and 1965-1 — very high level, and that the proportion of families plan­
amounted to $10.3 billion, compared with $9.8 billion in ning to purchase new cars was larger than a year and two
the second quarter and again in the third quarter of 1964 years earlier.
(see Chart II). It is noteworthy that, even on this
Outlays for residential construction in the initial quarter
smoothed-out basis, the average GNP gain over the past of 1965 were up for the first time in a year, and the new
two quarters has exceeded the increases registered in all level was about maintained in April. While this level re­
but one of the quarters since the pace of expansion mains below the year-earlier reading, a number of ob­
servers have expressed the view that the recent weaken­
speeded up in mid-1963.
The most notable added boost to over-all demand in the ing may well have bottomed out. Contributing to this
latest six-month period, compared with the preceding six more optimistic appraisal is the rebound in March in the
months, came from business decisions to build up inven­ number of housing units started as well as in the number
tories. After a very modest accumulation through most of of new building permits issued, following considerable de­
1964, stock building (at an annual rate) jumped by clines in February. Moreover, the value of residential
$2.9 billion in the fourth quarter and by an additional construction contract awards also registered a substantial
$0.8 billion in the first quarter of 1965. To a consider­ increase in March.
able extent, of course, the fourth-quarter spurt reflected
Business outlays for new plant and equipment also ex­
the onset of widespread steel stockpiling. It is estimated panded in the first quarter, with the large size of the gain
that manufacturers and wholesalers laid in 2.9 million tons to some extent reflecting the effects of delayed business
of finished steel during the fourth quarter of last year, an spending for automobiles and trucks. Future spending
accumulation rate almost five times as large as in the pre­ plans, moreover, continue to show strength. Thus,
ceding three months. Steel stockpiling continued in the first McGraw-Hill’s latest survey of business spending plans
quarter of this year, though at the reduced rate of 2.1 for 1965, taken in March and early April, points to total
million tons, while auto dealers were at the same time add­ outlays this year of $51.7 billion, or 15 per cent more than
ing heavily to their strike-depleted stocks in an effort to in 1964. As has been generally true in other years of
meet the booming demand for new cars. While there are over-all economic expansion, this year’s McGraw-Hill
obvious potential dangers associated with a rapid rate of spring surrey suggests a larger rise in capital spending
inventory building, it should be noted that, even with than the 12 per cent increase indicated in the survey taken
the recent run-up in stocks, inventory-sales ratios in most in February by the Commerce Department and the Securi­
lines of business have risen little, if at all, in recent ties and Exchange Commission. In part, the difference be­
months. Moreover, despite the near-record number of tween the results of the two surveys may reflect the greater
automobiles in dealer stockpiles, some fast-selling models concentration of large firms in the McGraw-Hill sample.
In the past several years, such firms have tended to show
reportedly continue to be in short supply.
Although consumer spending showed significantly more above-average percentage gains in capital spending. Yet,
strength in the first quarter of 1965 than in the preceding the fact that the size of the over-all differential between the
three months, the average gain in the two quarters com­ two surveys is somewhat larger this year than in the past
bined was about the same as in the previous two quarters. several years suggests that some businessmen probably
The main factor in the first-quarter surge was, of course, have upgraded their spending plans, as sentiment regarding
the boom in auto sales, following their strike-caused slow­ the business outlook has become more optimistic.
down late in 1964, but spending on nondurables also
Government purchases of goods and services have re­
showed a sizable gain. Auto sales in March and again cently given little push to over-all GNP. Indeed, the
in April moved down from the extremely high level of total volume of such purchases by all levels of govern­
the first two months of the year but, at an annual rate of ment was unchanged in the first quarter, following a
8.2 million units in April, remained well above the pace very small rise in the final quarter last year. Federal out­
of 7% million units set during the first nine months of 1964. lays declined in both quarters, while the rate of increase
In recent months, consumers have also been heavy buyers in state and local government purchases slowed somewhat
of color television sets and demand for nondurable goods from the pace set earlier in 1964. It is interesting to note
has picked up new vigor. Total retail sales were apparently that state and local government outlays for goods and
unchanged in April, following the slight dip in March. services in the first quarter of 1965 exceeded those of
Prospects for further gains remain strong. Michigan Uni­ the Federal Government for the first time since mid-1950,
versity’s Survey Research Center reported that consumer when defense spending began to accelerate after the out­




FEDERAL RESERVE BANK OF NEW YORK

break of the Korean conflict. Total government spending,
of course, also includes sizable outlays for social welfare,
interest on the debt, etc. Since these government “trans­
fer” expenditures are not purchases of goods or services,
they are not counted directly in GNP. (They do, of
course, affect GNP indirectly since they constitute income
for the recipients of the transfers, who are then able to pur­
chase goods and services.) Such expenditures, which have
been growing more rapidly than government purchases of
goods and services, make up a considerably larger propor­
tion of total Federal spending than of total spending at the
non-Federal level. As regards government purchases of

101

goods and services alone, the total at all levels of govern­
ment accounted for about 14 per cent of GNP in 1950, with
outlays at the state and local level very slightly larger than
those of the Federal Government. By the end of 1953
Federal purchases had grown to more than twice the size
of state and local purchases, and combined government de­
mand accounted for some 23 per cent of GNP. Since that
time, the share in GNP of outlays for goods and services
by all levels of government combined has been nearly con­
stant at about 20 per cent, but such spending has grown
more rapidly at the state and local than at the Federal
level.

The Money and Bond Markets in April
The slightly firmer tone which had developed in the
money market during the latter part of March generally
also prevailed in April. Nationwide net reserve availabil­
ity fluctuated about the lower levels reached in late
March, and reserve positions at banks in the major money
centers remained under pressure. A number of these
banks raised their interest rates on brokers’ call loans
secured by stock exchange collateral, while some other
short-term interest rates also rose during the month. De­
spite this general firmness in the money market, Treasury
bills continued to be in strong demand. Bill rates were
little changed during the first two thirds of the month and
moved slightly lower in the latter part of April.
Prices of Treasury notes and bonds receded at the be­
ginning of the month in quiet trading, as the market
evaluated the continued rapid advance of the domestic
economy and awaited disclosure of the new British budget.
This budget, presented on April 6, was well received. Sub­
sequently, investment demand for coupon issues expanded
moderately, and a steadier atmosphere emerged. Over the
remainder of the month, prices of intermediate- and long­
term Government securities fluctuated narrowly as market
attention focused upon the Treasury’s approaching May
refinancing operation. Prices of corporate and tax-exempt
bonds were little changed in early April, receded tempo­
rarily around midmonth, and held generally steady during
the remainder of the month.




THE MONEY MARKET AND BANK RESERVES

With nationwide net reserve availability remaining at
the lower levels reached toward the end of March, the
money market was steadily firm in April. Federal funds
traded predominantly in a 4 to 4Vs per cent range during
the month, and member bank borrowings from the Federal
Reserve averaged somewhat higher in April than in the pre­
ceding month. Rates posted by the major New York City
banks on call loans to Government securities dealers were
generally quoted in a 4Vs to 4V2 per cent range during the
month. Offering rates for new time certificates of deposit
issued by leading New York City banks and the range of
rates at which such certificates traded in the secondary
market edged higher in April. New York banks expanded
their volume of outstanding negotiable certificates of de­
posit substantially during the month, and they accounted
for the bulk of nationwide growth in such certificates. Early
in the month, three dealers in bankers’ acceptances tem­
porarily rescinded a Vs of a per cent increase in rates that
they had posted in late March. However, dealer holdings
remained heavy, and on April 23 all five dealers raised their
rates by Vs of a per cent, quoting ninety-day unendorsed
bills at 4% per cent bid, 4V4 per cent offered.
In the early part of the month, market factors absorbed
an unexpectedly large volume of reserves, particularly re­
flecting a substantial rise in required reserves and an in­

102

MONTHLY REVIEW, MAY 1965

crease in currency outside banks. System open market
operations offset a part of these reserve drains, primarily
through repurchase agreements with Government securi­
ties dealers, but reserve positions of banks in the major
money centers remained under considerable pressure.
These banks were strong bidders for Federal funds, gen­
erally at a 4Vs per cent rate, but with only a limited sup­
ply of funds coming into the market, a substantial portion
of their reserve needs had to be obtained through borrow­
ing from the Reserve Banks. Money market banks con­
tinued to incur basic reserve deficiencies in the statement
period ended April 14. Federal funds still traded pri­
marily at a 4Vs per cent rate, but the availability of such
funds improved as “country” banks released some of their
reserve surpluses accumulated the week before. Borrow­
ings from the Reserve Banks thus declined somewhat.
After mid-April, reserve distribution again favored the

Table 1
CHANGES IN FACTORS TENDING TO INCREASE OR DECREASE
MEMBER BANK RESERVES, APRIL 1965
In millions of dollars; (+ ) denotes increase,
(—) decrease in excess reserves

April
7

April

April

April

Gold and foreign accou n t....................
Currency outside banks* ......................
Other Federal Reserve
accounts (net)$ ......................................

— 130
— 249
-f- 33
4 - 188
— 29
— 455

14

21

— 236
+ 551
+ 469
+ 11
— 127
+ 138

+ 82
+ 176
— 189
— 25
+ 13
+ 386

+
—
+
—
—
—
+

119
156
78
183
26
60
36

+

58

9

+ 99

— 37

+ 315

+ 258

+ 157

+ 95
+ 3
+ 211

+ 127

— 137
— 1

— 143
+
1

— 58

3

— 150
— 11
+ 175
+
2

— 90
— 32
— 227
— 2

— 87
— 142

1

+ 29
— 37
— 173
—
1
— 58

— 122

— 493

— 287

+

7

— 95

+ 193

— 235

— 130

21,503
21,130
373
570
— 197
20,933

21,289
21,011
278
397
— 119
20,892

21,718
21,247
471
572
— 101
21,146

21,401
21,165
236
345
— 109
21,056

21,4788
21,1388
340§
471 §
— 1318
21,0078

H

—

— 165
+ 322
+ 391
— 9
— 169
+ 9

— 379

+

Direct Federal Reserve credit

transactions
Open market instruments
Outright holdings:
Repurchase agreements:
Bankers* acceptances ........................
Other loans, discounts, and advances...

Excess reserves* ..............................................

— 7
4 - 83

+

—

Daily average levels of member bank:

Total reserves, including vault ca sh * ...
Required reserves*......................................
Excess reserves* ..........................................
Borrowings ..................................................
Free reserves* ..............................................
Nonborrowed reserves*..............................

Note: Because of rounding, figures do not necessarily add to totals.
* These figures are estimated,
t Includes changes in Treasury currency and cash.
t Includes assets denominated in foreign currencies.
§ Average for four weeks ended April 28, 1965.




April
7

April
14

Average of
four weeks
ended
April 28*

April
21

April
28*

Reserve excess or deficiency(—) t ...
13
14
9
Less borrowings from Reserve Banks..
125
54
133
Less net interbank Federal funds
purchases or sales (—) .........................
455
705
726
Gross purchases .................................
895 1,168 1,255
Gross sales ........................................
440
463
530
Equals net basic reserve surplus
or deficit (—) ......................................... - 5 6 7 - 7 4 4 - 8 4 9
Net loans to Government
securities dealers ...................................
534
459
670

12
3

12
79

173
924
751

515
1,061
546

Eight banks In New York City

-1 6 4

-5 8 1

639

576

Reserve excess or deficiency (—) f .......
1
13
2 — 17
Less borrowings from Reserve Banks..
173
92
190
54
Less net interbank Federal funds
purchases or sales (—) .........................
306
339
364
248
Gross purchases ................................
904 1,062
989 1,054
Gross sales ........................................
650
598
697
805
Equals net basic reserve surplus
or deficit(—) ......................................... - 4 7 8 - 4 4 3 - 5 2 8 - 3 1 9
Net loans to Government
securities dealers ...................................
431
304
333
373

314
1,002
688

Thirty-eight banks outside New York City

127

-4 4 2
360

28

4-386

Total “market" fa c to r s....................

Daily averages—week ended
Factors affecting basic reserve positions

Net
changes

“ Market’* factors

Operating transactions (subtotal) ........

In millions of dollars

* Estimated reserve figures have not been adjusted for so-called “as of” debits
and credits. These items are taken into account in final data,
t Reserves held after all adjustments applicable to the reporting period less
required reserves and carry-over reserve deficiencies.

Daily averages— week ended
Factor

Table n
RESERVE POSITIONS OF MAJOR RESERVE CITY BANKS
APRIL 1965

country banks, and the reserve positions of banks in the
major money centers came under heightened pressure in
the wake of increased bank lending over the April 15 in­
come tax date. Toward the end of the month, pressures on
the central money market abated, in good part reflecting the
fact that heavy Treasury tax receipts were temporarily re­
deposited with major money market banks. As a result,
Federal funds traded more frequently at 4 per cent than at
4Vs per cent in the final days of the month.
After having absorbed a substantial volume of reserves
during the first half of April, market factors released a
larger amount of reserves in the final two statement periods
of the month. Over the month as a whole, market factors
provided $157 million of reserves partly as a result of a sea­
sonally large rise in float, while System open market opera­
tions absorbed $145 million. The weekly average of System
outright holdings of Government securities decreased by
$58 million from the final statement week in March through
the last week in April, and average System holdings of
Government securities under repurchase agreements were
unchanged on balance. Average net System holdings of
bankers’ acceptances, both outright and under repurchase

FEDERAL RESERVE BANK OF NEW YORK

agreements, declined by $87 million during the period.
From Wednesday, March 31, through Wednesday, April 28,
System holdings of Government securities maturing in less
than one year fell by $231 million, while holdings of
issues maturing in more than one year remained unchanged.
THE GOVERNMENT SECURITIES MARKET

The market for Treasury notes and bonds took on a
cautious atmosphere at the beginning of April. On the
domestic scene, attention focused on the continuing surge
in bank lending to business, the moderate contraction in
nationwide reserve availability, and reports that the un­
employment rate had declined in March to the lowest level
since 1957, while the market also awaited the details of
the forthcoming British budget for 1965-66. Prices of
notes and bonds drifted lower amid light trading. A small
net investment demand did remain in evidence, however,
and in the absence of significant selling pressures dealers
gradually reduced their inventories. As the technical posi­
tion of the market progressively strengthened, a somewhat
more confident tone developed. The new British budget
announced in the House of Commons on April 6 was
generally accepted as a constructive effort to help deal
with the British balance of payments problem and to
strengthen international confidence in the pound sterling;
a subsequent reduction in the French bank rate was also
favorably received by the market. Against this background,
a fairly good demand emerged, particularly for lowcoupon issues in the intermediate-term maturity area, and
prices of Government notes and bonds tended to move
higher from April 6 through April 14.
Around midmonth, offerings increased somewhat and
prices briefly declined when the market learned that sev­
eral large money market banks were raising their interest
rates on brokers’ call loans secured by stock exchange col­
lateral. Activity tapered off in the latter part of the month,
as the market geared itself for the terms of the Treasury’s
May refinancing operation, but a moderate investment
demand persisted and was augmented at times by some
professional interest. As a result, prices edged irregularly
upward from April 20 through Wednesday, April 28. After
the close of business on the latter day, the Treasury an­
nounced the refunding terms. Holders of $1.8 billion of
4% per cent notes and $6.6 billion of 3% per cent notes
coming due on May 15 were given the opportunity to ex­
change the maturing securities either for the reopened 4
per cent notes of August 1966 (offered at a discount to
yield about 4.12 per cent) or for the reopened 4X per
A
cent bonds of May 1974 (offered at a premium price to
yield about 4.22 per cent). Subscription books were




103

open from May 3 through May 5, with the payment and
delivery date for the Treasury’s offerings scheduled for
May 17. The market reacted mildly to the terms of the re­
funding, and the Treasury’s announcement had little impact
on prices of outstanding coupon issues., Prices of the “rights”
issues— the maturing securities eligible for exchange—
which had advanced prior to the Treasury’s announcement,
receded slightly in the closing days of the month, while
prices of other outstanding notes and bonds were narrowly
mixed.
In the Treasury bill sector, the supply of securities in the
market generally increased during the month. In the early
days of the period, the usual portfolio adjustments follow­
ing the April 1 Cook County, Illinois, personal property tax
date triggered expanded offerings, and the Treasury en­
larged the first two regular weekly auctions of the month by
a total of $300 million over the amounts maturing. In addi­
tion, some commercial bank selling developed as a con­
sequence of the prevailing firm money market atmosphere,
while relatively high dealer financing costs made dealers
more willing to trim their inventories. These enlarged offer­
ings were readily absorbed, however, by considerable de­
mand from public funds and, to a lesser extent, from cor­
porations. As a result, bill rates fluctuated narrowly through
April 20. Subsequently, rates receded slightly in response
to professional and investment demand, which arose par­
tially in connection with the Treasury’s refunding operation.
At the last regular weekly auction of the month, held
on April 26, average issuing rates were 3.916 per cent
for the new three-month issue and 3.977 per cent for the
new six-month bill— about 1 and 2 basis points lower,
respectively, than the average rates at the final weekly
auction in March. The April 23 auction of $1 billion of
new one-year bills produced an average issuing rate of
3.996 per cent, as against 3.987 per cent on the com­
parable issue sold a month earlier. The newest outstand­
ing three- and six-month bills closed the month at bid
rates of 3.91 per cent and 3.97 per cent, respectively.
OTHER SECURITIES MARKETS

Prices of corporate and tax-exempt bonds were little
changed in sluggish activity during the first half of April,
as investors continued to focus their attention upon equi­
ties. Investment demand for new bond flotations was
selective, and dealers made little progress in reducing
their inventories of recently marketed issues and seasoned
bonds. Over the midmonth period, prices eased slightly
in both sectors, largely in reaction to news of the in­
crease in broker loan rates. In the latter part of April,
prices of corporate and tax-exempt bonds held generally

104

MONTHLY REVIEW, MAY 1965

steady as the Treasury’s impending refunding and a buildup
in the calendar of scheduled flotations tended to restrain
activity. Over the month as a whole, the average yield on
Moody’s seasoned Aaa-rated corporate bonds rose by 2
basis points to 4.44 per cent while the average yield on
similarly rated tax-exempt bonds was unchanged at 3.09
per cent. (These indexes are based on only a limited num­
ber of issues and therefore do not necessarily reflect market
movements fully.)
The volume of new corporate bonds publicly floated in
April amounted to an estimated $395 million, compared
with $570 million in March 1965 and $375 million in
April 1964. The largest publicly offered new corporate
bond issue of the month consisted of $65 million of 4 per

cent convertible debentures maturing in 1985. The deben­
tures, which were unrated by Moody’s, were offered at par
and were quickly sold. New tax-exempt flotations in April
totaled about $920 million as against $950 million in
March 1965 and $1,125 million in April 1964. The Blue
List of tax-exempt securities advertised for sale closed the
month at $821 million, compared with $750 million at the
end of March. The largest new tax-exempt bond flotation
during the month consisted of $125 million of A-rated
municipal various-purpose bonds. Reoffered to yield from
2.35 per cent in 1966 to 3.40 per cent in 1995, the bonds
were accorded a fair investor reception. Other new cor­
porate and tax-exempt bonds publicly offered during the
period were accorded fair to good investor receptions.

Recent Banking and Monetary Developments
Commercial bank credit increased rapidly in the first
quarter, both reflecting and facilitating the substantial rise
in economic activity during the period. Business loans at
commercial banks grew in the quarter at a rate more than
twice as fast as during all of 1964. Bank credit may well
have risen more rapidly than credit at other types of fi­
nancial institutions since banks were able to attract an
increased share of the public’s deposits following the
liberalization of Regulation Q in late November 1964.
Nevertheless, total nonbank liquidity expanded at an
accelerated pace in the first quarter, and over the past six
months has in fact grown more rapidly than over-all
economic activity. A large amount of the reserves needed
to support the credit-deposit expansion at commercial
banks was supplied through Federal Reserve open market
operations. However, part of the increased reserve needs
accompanying the surge in deposits had to be met by
heavier borrowing at the “discount window”, and member
banks also drew down their excess reserve positions dur­
ing the period. Toward the end of the quarter the banking
system was operating consistently with net borrowed re­
serves.
BANK CREDIT IN THE FIRST QUARTER

Total bank credit at all commercial banks rose by $8.5
billion, seasonally adjusted, in the first quarter, or at an




annual rate of 12.8 per cent (see Chart I). This was the
largest absolute and percentage increase in bank credit
in any three-month period since the second quarter of
1958, and more than half again as large as the 8 per cent
growth rate that has characterized most of the current
business expansion of more than four years’ duration.
This surge in bank credit in the first quarter undoubtedly
reflected to a large extent the increased credit demands
generated by the rapidly growing economy. But a part of
the rise in bank credit was at the expense of competitive
sources of funds. Interest rates on borrowing from non­
bank sources generally rose during the quarter whereas
bank loan charges apparently did not. (For example, the
rate of discount on directly placed six-month prime com­
mercial paper rose from 4 per cent to 4V4 per cent over
the quarter.) Prime borrowers — who have access both to
the commercial paper market and to the banks for their
credit needs — thus had an increased incentive to tap
banks for funds rather than to issue commercial paper.
Partly as a result, the seasonally adjusted volume of total
commercial paper outstanding declined sharply in the
first quarter after having increased by 24 per cent in 1964.
It might also be noted that the latest quarterly survey of
bank interest rates — which covered rates charged during
the first fifteen days of March — showed a sharp rise
since early December in the proportion of new loans made
at the unchanged prime rate.

105

FEDERAL RESERVE BANK OF NEW YORK

C h art!

GROWTH OF BANK CREDIT AND SELECTED COMPONENTS
Sea so n ally adjusted annual rates

I December 19631 December 1964

December 1964March 1965

finance inventories of goods awaiting shipment abroad; and
business loans to foreigners (and possibly also to Ameri­
can companies operating abroad), in the early weeks of
the year, were sought and made prior to the official steps
taken in February to restrain foreign lending of banks as
part of President Johnson’s balance of payments program.
Loans to nonbank financial institutions apparently also
grew substantially over the quarter, particularly in Feb­
ruary and March as rates on commercial paper edged
higher, making bank borrowing a relatively more attrac­
tive source of funds for such borrowers. Toward the end
of the quarter, commercial bank loans for the purpose of
carrying securities rose sharply, reflecting to some extent
sales to the public of two large recent stock offerings and
reductions in loans to securities dealers by New York
agencies of foreign banks.
TIME DEPOSITS, MONEY SUPPLY, AND
TOTAL LIQUID ASSETS

As a counterpart of the sharp rise in bank credit in the
first quarter, total deposits held by the banking system
Per cent
Source: Board of Gove mors of the Federal Reserve System.

Chart II

GROWTH OF MONEY SUPPLY, TIME DEPOSITS,
AND NONBANK LIQUID ASSETS

Nearly all categories of bank loans showed an accelerated
growth in the first quarter, the only notable exceptions be­
ing real estate and agricultural loans. Partly to help meet
this loan demand, banks reduced their holdings of Govern­
ment securities during the quarter. Nevertheless, their total
investments declined only slightly as the rate of acquisition
of other securities, such as municipals, actually increased.
The rearrangement of portfolios in favor of loans led to a
further rise in loan-deposit ratios over the quarter, with
the ratio for all commercial banks as a group reaching a
postwar record of 60.3 per cent in March.
Business loan demand was especially strong during the
quarter. The total of such loans grew by $4.0 billion
(seasonally adjusted), or at an annual rate of 27.8 per
cent — much larger than the 1964 expansion of 10.8
per cent. The data relating to member banks reporting
weekly suggest that demands were widespread among the
different industrial groupings, though part of the over-all
expansion undoubtedly was attributable to the effects of
three temporary special factors. Steel-using industries
financed some of their strike-hedge stockpiling of inven­
tories through bank loans; the East and Gulf Coast dock
strike early in the year necessitated bank borrowing to




Per cent

Seasonally adjusted

Note: The money supply and time deposits are monthly averages of daily figures.
Nonbank liquid assets are end-of-the-month observations.
Source: Board of Governors of the Federal Reserve System.

Per cent

106

MONTHLY REVIEW, MAY 1965

C h art III

GROWTH OF MEMBER BANK RESERVES
B illio n s of d o lla r s

PERCENTAGE CHANGES
S e a s o n a l ly a d ju s t e d a n n u a l r a t e

^■Total reserves
vC Required reserves
yy. Nonborrowed reserves

Fe b 1961J uI 1 96 3
Note: A ll reserve d ata a re ad ju sted for changes in required reserve ratios. The difference between total reserves and nonborrowed reserves is
member bank borrowings from the Federal Reserve Banks. Free reserves, usually defined as excess reserves less borrow ings, may also be
represented as the difference between nonborrowed reserves and required reserves. W hen required reserves are larg er than nonborrowed
reserves, the difference is termed net borrowed reserves. The shaded bands covering months in 1953-54,1957-58,and 1960-61 represent
recession periods, according to National Bureau of Economic Research chronology.
Source: Board of G overnors of the Federal ReserveSystem .

also expanded substantially. The bulk of the growth
occurred in time deposits. Banks had raised the rates paid
on time deposits late in 1964, shortly after the change in
Regulation Q effective November 24. These higher rates
made banks more effective competitors in the market for
liquid savings, especially after the start of a new quarterly
interest period in January. As a result, bank time deposits
surged in January and February of this year (see Chart II),
with the annual rate of growth over the first quarter
as a whole amounting to 18.7 per cent. (During 1964,
time deposits grew by 12.6 per cent.) Deposits and shares
at mutual savings banks and savings and loan associations,
in contrast, grew less rapidly than earlier — the increase
in the first quarter amounted to 7.4 per cent at an annual
rate, compared with a rise of 10.8 per cent in 1964.
The rapid growth in time deposits early in the year




was probably also to some extent at the expense of growth
in demand deposits. Demand deposits, as well as the daily
average money supply1 actually showed a net decline
over the first two months of the year, after adjustment
for normal seasonal influences. The money supply picked
up in March, but the growth for the quarter as a whole —
at an annual rate of 1 per cent — was well below the 4
per cent per annum growth rate that had characterized the
preceding two years. Interestingly, a temporary surge in
time deposits and a slowing in the growth of the money
supply also developed in the months following the July

1 Defined to include demand deposits at commercial banks other
than those of the United States Treasury (and certain other adjust­
ments) plus currency held by the nonbank public.

FEDERAL RESERVE BANK OF NEW YORK

1963 and January 1962 changes in Regulation Q. In these
previous periods, it should be noted, the growth of the
money supply subsequently accelerated while growth in
time deposits slowed down to rates more nearly com­
parable to those prevailing before the Regulation Q
changes. Developments in March and April suggest that a
similar pattern is being repeated this year.
Since part of the more rapid growth in time deposits
in the first quarter thus came at the expense of growth in
other forms of liquid assets, total liquid asset holdings of
the nonbank public2 did not advance as fast as those of
time deposits alone. Nevertheless, total nonbank liquidity
did increase at a seasonally adjusted annual rate of 8.6
per cent over the quarter, or somewhat more rapidly than
during 1964 when the advance was 6.9 per cent. More­
over, the ratio of nonbank liquid assets to gross national
product has increased by 0.5 percentage point since the
third quarter of 1964, to 82.4 per cent for the first quarter
of 1965, showing that the growth in such liquidity over
the past six months has outpaced the growth in over-all
economic activity. This contrasts with developments dur­
ing the period from mid-1963 through mid-1964 when

2 Total nonbank liquid assets include demand deposits and time
deposits (adjusted) at all commercial banks, currency outside
banks, deposits at mutual savings banks, savings and loan shares,
postal savings, United States Government savings bonds, and the
public’s holdings of United States Government securities maturing
within one year.




107

nonbank liquidity and over-all economic activity appeared
to be growing at roughly the same rate.
BANK RESERVES

The accelerated growth in commercial bank deposits
in the first quarter placed pressure on bank reserve posi­
tions. Total member bank reserves, of course, have grown
throughout the current business expansion, in contrast
to the experience of the two preceding business upswings,
and the growth in reserves actually speeded up in the
first quarter (see Chart III). There was less growth than
previously, however, in that portion of total reserves
which banks obtained through the net effects of Federal
Reserve open market operations. Nonborrowed reserves
(seasonally adjusted) grew at an annual rate of 3.4 per cent
in the quarter, compared with a 4.7 per cent increase in
1964. In order to meet the expanded total reserve needs,
member banks as a group therefore had increasing need to
resort to the Federal Reserve discount window, and mem­
ber bank borrowings for the quarter as a whole averaged
$372 million, compared with $327 million in the preced­
ing three-month period. During the first six weeks of the
quarter, the banking system operated on average with
free reserves of just under $100 million. But with continued
strong credit expansion and a more restricted growth of
nonborrowed reserves, banks operated with net borrowed
reserves averaging just under $40 million for the remain­
ing seven weeks.

108

MONTHLY REVIEW, MAY 1965

The Puerto Rican Economy in Transition*
Since the inauguration of a well-conceived develop­
ment program in the late forties, Puerto Rico has under­
gone a dramatic transformation from a stagnant,
predominantly agricultural area to a more fully diversi­
fied and rapidly growing economy. Despite the island’s
limited resource availabilities and high population density,
the rate of economic growth in Puerto Rico has been sub­
stantially higher than growth rates typically encountered
in developing countries and, during recent years, has ex­
ceeded those of a number of industrially advanced coun­
tries as well. Between 1947 and 1963 gross insular
product in real terms increased at an average annual rate
of 6.3 per cent, and in 1964 advanced by 8.5 per cent.1
Over the same period, real yearly income per capita— a
measure that allows for the effect of population growth—
increased at an average annual compound rate of 5.5 per
cent and by 1964 amounted to $706 (at 1954 prices),
about two-and-one-half times its level in the early postwar
period.2 (In terms of current prices, annual per capita in­
come amounted to $830 in 1964, compared with $253 in
1947.) The growth in per capita income in Puerto Rico
has to some extent been aided by a high rate of emigration
from the island. But, with the rapid growth in income and
employment opportunities on the island, emigration has
dwindled in recent years.
The island’s extraordinary growth has derived much of
its momentum from a sustained increase in the level and
rate of investment in industries oriented largely toward
export markets. And with the increase in the pace of de­

* Martin Barrett had primary responsibility for the preparation
of this article.
1 Unless otherwise noted all annual data are for the fiscal year
ended June 30.
2 The growth of per capita income is, of course, only an im­
perfect indicator of possible advances in the “standard of life”,
a measurement of which should also allow for such factors as life
expectancy and degree of literacy. Since 1940, life expectancy on
the island has increased from 46 to 70 years and the death rate has
declined from 18.4 to less than 7 per thousand. With a rapid in­
crease in school enrollment, literacy increased from 68.5 per cent
in 1940 to 83 per cent in the early 1960’s.




velopment the economy’s center of gravity has shifted
from the production and export of sugar toward industry.
Indeed, the Commonwealth Government’s development
program— known familiarly as Operation Bootstrap— has
been based primarily on the promotion of nonresident di­
rect investment in industrial activities. While industriali­
zation has played a leading role in the transformation of
the whole economic structure, it is only one element,
though an important one, of the broader problem of lift­
ing the level of productivity and achieving better utiliza­
tion of the labor force. The high rate of industrial invest­
ment has directly or indirectly facilitated the transfer of
workers newly entering the labor force from rural areas,
where there appears to have been substantial “under­
employment”, into industrial activities in which produc­
tivity is appreciably higher and has thus helped to raise
output per employed worker for the economy as a whole.
And the increasing diversification of production and the
resulting reallocation of labor have substantially reduced
the island’s vulnerability to the wide seasonal and cyclical
swings in employment and income that had resulted from
its extreme dependence on sugar.
THE CRUCIAL ROLE OF CAPITAL FORMATION

Both the increase in the over-all rate of Puerto Rican
growth and the expansion of industrial activities reflect to
a large extent a substantial increase in investment. Of
course, a host of other factors— the availability of a grow­
ing labor force with appropriate training and skills, the
emergence of a managerial group, and the efficiency with
which both labor and capital are utilized—have also ex­
erted an important influence upon the growth of income
and output. Even though capital formation alone by no
means adequately explains the success of the Puerto Rican
development effort, the very acceleration of investment
has tended to call forth many of the technological, struc­
tural, and other influences required to overcome the iner­
tia of underdevelopment and propel the economy for­
ward. The extensive mechanization of agriculture and
industry has resulted in substantial increases in the pro­
ductivity of labor by increasing the volume of capital

FEDERAL RESERVE BANK OF NEW YORK

equipment per worker, thus increasing output directly or
releasing labor for use elsewhere in the economy. More­
over, the introduction of more up-to-date and efficient
equipment, which is virtually inseparable from the level
of investment, has helped to raise the level of manual,
technical, and managerial skills on the island.
Except for a brief pause in 1950 and again in 1953
gross real investment—including both private and public
investment—has increased steadily throughout the post­
war period, not only in absolute terms but also in relation
to gross insular product. Throughout the postwar span
gross investment rose at an average annual rate of almost
11 per cent, and during the early sixties the growth in
fixed investment in Puerto Rico was faster than in many
developed countries. Moreover, investment rose more
rapidly than any other component of demand and, in the
past three years, has amounted to about 25 per cent of
gross insular product as compared with 16 per cent in the
early postwar period (see Table I ) .
Private investment has increased more rapidly than
public investment. Nevertheless, the Commonwealth Gov­
ernment has played an important role in the promotion
of private investment by providing the basic transporta­
tion and power facilities, which were an essential pre­
requisite for the effective participation of private capital
in the development process. Thus public policy was bas­
ically designed to provide a general framework in which
private investment could be fostered.

Table I
GROWTH AND COMPOSITION OF REAL GROSS INSULAR PRODUCT
Annual average
As percentage of
gross insular
product

Rate of growth

Gross insular product
and its components

1948-64 1948-52 1953-58 1959-64 1947-49 1962-64
Private consumption ...........

6.0

5.3

4.7

8.0

90.2

84.9

Government current
expenditure ...........................

7.6

6.1

7.7

8.8

12.5

14.1

Gross investment
(public and private) .........

10.6

14.2

6.6

11.5

16.0

25.3

Exports of goods and
services ...................................

8.1

8.6

7.0

8.7

40.7

8.2

6.2

7.9

10.3

-5 9 .4

-7 9 .5

Gross insular product .........

6.4

7.6

4.3

7.6

100.0

100.0

In the early stages of the industrialization program the
government went beyond the provision of social overhead
capital and established and operated a number of manu­
facturing plants. However, it soon became clear that the
Commonwealth authorities had neither the financial nor
the managerial resources to launch the many industries re­
quired for a sustained expansion of industrial activity.
Moreover, while the provision of social overhead capital
was a crucial factor in stimulating private investment, it
was not in itself sufficient to assure a higher level of pri­
vate investment. Accordingly, the emphasis in policy
shifted in the late forties toward the adoption of more
specific measures designed to promote private investment.
In 1948 Puerto Rico began to exempt almost all new
manufacturing firms from all insular income and property
taxes for periods up to ten years. However, since the
period of exemption provided in the 1948 law was fixed
to expire fully in 1962, its effectiveness as an incentive
declined as the remaining period for exemption grew
shorter. To deal with this situation, the Industrial Incen­
tive Act of 1954 provided that the ten-year exemption
period for new firms would begin when the firm started the
operation. Furthermore, under a 1963 amendment, tax
exemption is now available for periods of as much as
seventeen years, depending on the location of the new
plant.3 These extended tax holidays resulted in a sub­
stantial increase in net profits and thereby sharply reduced
the payback period and thus the initial risk inherent in the
investment.4 At the same time tax incentives focused at­
tention on investment opportunities in Puerto Rico that
might otherwise have gone unnoticed and also aided in
the internal financing of the expansion of the exempt
enterprises.
Apart from the provision of certain strategic facilities
and the adoption of tax and other incentive measures by the
Commonwealth Government, perhaps the most important
influence on the level of investment is the Puerto Rican
investment climate— that elusive constellation of factors
which makes the island an attractive area for investment.
External as well as local private capital is welcome to
engage in any legitimate business activity. No special
spheres are reserved for local capital, and the only field
that the government has dominated is electric power.

55.2

Less: Imports of goods
and services* ......................

109

Note: Because of rounding, figures do not necessarily add to totals.
* Goods and services produced abroad and imported must, of course, be de­
ducted from total expenditure in order to arrive at a measure of produc­
tion within Puerto Rico.
Source: Puerto Rico Planning Board.




3 Essentially, the less industrialized the zone of establishment of
a new manufacturing facility, the longer the available tax-exemption
period.
4 For a discussion of the tax-exemption program and other meas­
ures designed to promote investment, see “Private Investment and
the Industrialization of Puerto Rico”, this Review, April 1960,
pages 68-74.

110

MONTHLY REVIEW, MAY 1965

Moreover, the commitment of the Commonwealth Gov­
ernment to rapid industrialization along with the island’s
political stability undoubtedly provided a significant im­
petus to private investment.
Following the introduction of the tax-incentive program
there was a sharp increase in the rate, as well as a change
in the composition, of total investment. In 1947-49 pub­
lic investment accounted for about 44 per cent of gross
fixed investment, but that proportion has declined to less
than one third in recent years. The decline in the relative
importance of public investment has its counterpart, of
course, in a sharp increase in the level of fixed private
investment, which (in current dollar terms) rose from $97
million in 1954 to $410 million in 1964— equivalent to
an average annual increase of almost 16 per cent. The
greater part of the increase in private investment in plant
and equipment undoubtedly represents investment by pub­
licly “promoted” plants, most of which are subsidiaries
of mainland firms engaged in manufacturing operations.
Since tax exemption has been one of the principal fac­
tors in the rapid expansion of new industrial investment,
the question arises how permanent such industries may be
once a specific firm’s exemption period expires, as it
eventually will for all and already has for some.5 Al­
though many plants may indeed have originally been at­
tracted by tax exemption, pre-tax profits of new firms in
Puerto Rico have been twice as high in relation to equity
investment as for companies in the same asset-size classes
on the mainland. Moreover, Puerto Rican corporate in­
come taxes are on the average only slightly more than
half the Federal corporate tax. As an added incentive,
Puerto Rico allows taxpayers to depreciate fixed assets at
their own discretion so that, as a firm’s income becomes
taxable, depreciation accruals can be materially increased
and taxable income reduced. Although a few firms have
begun to retrench in their operations on Puerto Rico, this
tendency has been counteracted by the successful drive to
attract new plants. In 1964 alone, some 175 new factories
were established.

largely toward the mainland market. One indication of
the export orientation of Puerto Rican development has
been an Increase in the relative importance of exports,
which rose from 41 per cent of gross insular product in
the early postwar period to an annual average of 55 per
cent in 1962-64. To a large extent the growth in com­
modity exports reflected substantial increases in exports
of textiles and apparel, electrical equipment, processed
foods, and petroleum products, as well as a wide range of
other manufactured goods. Exports of sugar and sugarrelated products, such as rum and molasses, which ac­
counted for more than half of total export receipts as
recently as 1950, now represent less than 15 per cent.
The growth in exports of manufactured products has
also exerted an important influence on the level of invest­
ment and the over-all rate of growth by helping to finance
the increasing import requirements generated by rising in­
dustrial activity. Whether new production is oriented pri­
marily to the mainland market or to the internal market,
the realization of a rising volume of investment has called
for an increased flow of resources, a large part of which
must be imported since the island produces few industrial
raw materials and, in the virtual absence of local capital
goods industries, heavy reliance must also be placed on
imports of capital equipment from the mainland. The
very growth of manufacturing activities has led to some
substitution of local production for imported goods—
notably furniture, fuel oils, and certain processed foods.
On balance, however, the spread of industrial activities
has intensified the demand for imports— particularly capi­
tal goods, raw materials, and other intermediate goods. As
a result the trade deficit has risen, and the ratio of mer­
chandise imports to gross insular product has advanced
from 53 per cent in the late forties to about 70 per cent
in recent years.
THE FINANCING OF INVESTMENT

In Puerto Rico, as in most economically less developed
areas, the rate of capital formation required to launch a
rapid and lasting increase in income has been substan­
TRADE AND INVESTMENT
tially higher than the local capacity to mobilize domestic
Since Puerto Rican exports have duty-free access to resources either through voluntary savings or through in­
the United States market and since the internal market is creased taxes. In view of the close financial links between
relatively small, new investments have been oriented Puerto Rico and the mainland, the Commonwealth has
been able to have recourse to the mainland capital market
and to promote successfully direct nonresident investment.
Capital inflows have enabled the Puerto Rican economy
5 A total of 1,100 plants have been established in Puerto Rico to realize a higher rate of growth than would otherwise
since the adoption of tax exemptions, and such plants account for have been possible and to avoid the resource bottlenecks
an estimated 60 per cent of income generated in the manufacturing
and inflationary pressures that frequently accompany pro­
sector.




FEDERAL RESERVE BANK OF NEW YORK

grams of rapid industrialization.
The net inflow of external capital—whether in the form
of direct investments or of an increase in financial claims
on Puerto Rico— has been reflected in, and has been ac­
companied by, increased imports and current account def­
icits in the island’s balance of payments. In 1947-49, the
net use of external capital funds—as measured roughly by
the current account deficit plus unilateral transfers from
abroad— amounted to an annual average of $67 million,
equivalent to almost 65 per cent of gross investment dur­
ing the period (see Table II). The use of outside funds
dropped considerably in the early fifties, but during the
later years of the past decade there was a steady increase
in both the amount and proportion of investment financed

Table II
INVESTMENT AND ITS FINANCING IN PUERTO RICO

Item

1947-49
(annual
average)

1960

1961

1962

1963

1964

Millions of dollars
Gross capital formation:
Inventories ........................
Fixed private investment..
Fixed public investment....

12.7
51.6
41.1

39.4
220.7
129.8

37.2
241.5
132.0

72.7
305.3
139.9

79.4
342.2
139.8

62.5
409.6
171.8

Total ................................... 105.5

390.0

410.7

517.9

561.4

643.9

63.5
131.3

56.6
144.5

59.3
160.9

85.9
181.9

111.6
199.8

Financing:
Public sector surpluses .... 19.0
Depreciation allowances .. 26.9
Other corporate and
private savings ................. - 7 .3
Current account and uni­
lateral transfer deficit ..... 66.9
Total .................................. 105.5

- 0 .4

39.3

30.7

68.4

- 9 .5

195.6

170.3

267.0

225.2

342.0

390.0

410.7

517.9

561.4

643.9

Percentage of total
Gross capital formation:
Inventories .........................
Fixed private investment..
Fixed public investment....

111

externally as nonresidents responded to the tax and other
incentives provided by the Commonwealth Government.
However, with the growth of Puerto Rican income, do­
mestically generated savings have also increased substan­
tially, and in the process Puerto Rico has stabilized the
extent of its reliance on external sources of capital.6 Since
1959, the proportion of total investment financed directly
or indirectly by nonresidents has leveled off at about 50
per cent— substantially below its level in the early post­
war period.
Among the internal sources of savings, there has been
some decline in the relative importance of savings gen­
erated by the public sector—the combined budgetary
surpluses of the Commonwealth and municipal govern­
ments and the net revenues of public corporations. Sav­
ings at all levels of government, including those made
possible by direct grants-in-aid from the United States
Government, almost tripled since the end of the war to as
much as $112 million in 1964, despite the increasing de­
mands for public services generated by rapid urbaniza­
tion. Yet as a proportion of total investment, government
savings declined from an annual average of about 19 per
cent during 1947-49 to less than 15 per cent in 1962-64.
On the other hand, internally generated private funds—
which include depreciation allowances, retained corporate
earnings and other private savings— have increased from
about 16 per cent of total savings in 1947-49 to an an­
nual average of 38 per cent during 1960-64. Deprecia­
tion allowances showed a large absolute increase— rising
from an annual average of $26.9 million in 1947-49 to
almost $200 million in 1964— but, as a proportion of
gross capital formation, increased only from 26 per cent
to 31 per cent during the same period. Corporate savings
(other than depreciation allowances) and other private
savings— which has been assisted by Federal transfers—
have tended to rise more rapidly; in 1947-49 these two
components combined were negative, as they were again
in 1964. Nevertheless, during the past five years they
have averaged about $26 million, or about 5 per cent of
gross investment.

13.5
48.2
38.3

10.1
56.6
33.3

9.1
58.8
32.1

14.0
58.9
27.0

14.1
61.0
24.9

9.7
63.6
26.7

Total ................................... 100.0

100.0

100.0

100.0

100.0

100.0

COMPOSITION OF OUTPUT

16.3
33.7

13.8
35.2

11.4
31.1

15.3
32.4

17.3
31.0

The progressive increase in aggregate output and the
changing pattern of final demand have been accompanied
by a major increase in the size of the industrial sector

Financing:
Public sector surpluses .... 19.1
Depreciation allowances .. 25.5
Other corporate and
private savings ................. - 9 .4
Current account and uni­
lateral transfer deficit ..... 64.7
Total .................................. 100.0

- 0 .1

9.6

5.9

12.2

- 1 .5

50.2

41.5

51.6

40.1

53.1

100.0

100.0

100.0

100.0

100.0

Note: Because of rounding, figures do not necessarily add to totals.
Source: Puerto Rico Planning Board.




6 For a discussion of the role of the Puerto Rican banking system
in mobilizing domestic savings, see “Financing Economic Develop­
ment in Puerto Rico”, this Review, May 1961, pages 78-83.

112

MONTHLY REVIEW, MAY 1965
Table

in

INDUSTRIAL ORIGIN OF GROSS DOMESTIC PRODUCT
Amounts in millions of dollars at 1954 prices
Sector

1947
1955
1963
Per cent
Per cent
Per cent
Amount of total Amount of total Amount of total

Agriculture ...........................

125.8

20.1

152.1

14.8

191.5

9.9

Industry .................................
Manufacturing .................
Contract construction ....
Transportation and
public utilities .................

173.2
112.7
13.2

27.6
18.0
2.1

342.2
202.0
49.3

33.2
19.6
4.8

749.4
439.7
134.5

38.8
22.7
7.0

47.3

7.5

90.9

8.8

175.2

9.1

Services .................................
Commerce ........................
Finance, insurance, and
real estate.........................
Other services
(including tourism) .........
Government of Puerto
Rico ...................................

328.0
150.9

52.3
24.1

534.0
222.4

51.9
21.6

992.3
379.7

51.3
19.6

67.9

10.8

125.5

12.2

237.7

12.3

41.6

6.6

70.9

6.9

161.8

8.4

67.6

10.8

115.2

11.2

213.1

11.0

100.0 1,933.2

100.0

Total gross domestic
product ...................................

627.0

100.0 1,028.3

Note: Because of rounding, figures do not necessarily add to totals.
Source: Government Development Bank for Puerto Rico.

relative to agriculture. One measure of the change in the
composition of output is provided by the relative con­
tributions of each sector to gross domestic product at
constant (1954) prices (see Table III). While agricul­
tural output has continued to increase, its share in total
product has receded from about 20 per cent in 1947 to
less than 10 per cent in 1963— only slightly higher than
in the United States. Incomes generated in the industrial
sector—here defined to include transportation and public
utilities as well as construction and manufacturing pro­
duction proper— rose so much faster that this sector ac­
counted for almost 39 per cent of total output in 1963,
compared with roughly 28 per cent in 1947. The share of
income generated by service activities— wholesale and re­
tail trade, financial enterprises, as well as health, educa­
tion, and other public services— has remained virtually
unchanged and still accounts for about half of gross do­
mestic product.
The changing structure of the island’s economy has also
been accompanied by changes in the composition of out­
put within sectors. In the agricultural sector, the pro­
duction of sugar and tobacco—Puerto Rico’s traditional
export products—has declined in both absolute and relative
terms, while production of other agricultural foodstuffs,
notably meat and dairy products, has increased substan­
tially. There have also been considerable changes within
the service sector. While income derived from wholesale




and retail trade has increased in recent years, the propor­
tion of income derived from such activities has declined
somewhat since 1947. On the other hand— and partly as
a result of vigorous efforts by the Commonwealth authori­
ties to promote tourism— income from “other services”
rose at a faster than average rate.
The process of industrial development has also en­
tailed significant shifts within the manufacturing sector.
As industrialization gained momentum, there has been a
progression from relatively simple types of manufacturing
—textiles,, clothing, and food processing—to more com­
plicated types of consumer durables and producer goods,
such as electronic equipment, chemical products, and cer­
tain household appliances. In the most recent years, the
whole constellation of industries that fall under the gen­
eral heading of engineering and chemicals has been the
most dynamic.
But it is not only in the pattern of output that indus­
trialization now differs from its early development. At
first, the types of plants established depended little on
other plants or industries for either materials or markets.
Raw materials were derived largely from the agricultural
sector, and products were sold directly to final consumers
or exported to the mainland. More recently, the inter­
relation among plants has become more complex. Such
industries as metals, petroleum, and machinery and trans­
port equipment tend to depend on a varied supply of com­
ponents from other plants and industries. Although a
large proportion of these components are still imported,
the emergence of heavy industries has also led to ancillary
activities such as synthetics and plastics within Puerto
Rico. Thus, the character of industrial growth has shifted
toward the organic development of whole complexes of
interdependent plants.
Both the shift in output from agricultural to nonagricultural activities and the changing composition of industrial
output itself reflect in part the changing pattern of final
demand in response to increases in real incomes. Thus,
the decline in the share of the agricultural sector is related
to the fact that the demand for foodstuffs tends to increase
less than proportionately to increases in per capita in­
come. Moreover, consumer demand tends to shift from
relatively simple fabricated nondurables to more highly
fabricated durable and nondurable goods. Therefore,
changing Commonwealth consumption patterns may have
contributed to the relatively rapid growth of the chemical,
metal, machinery, and transport industries. However, the
relationship between changes in the structure of manu­
facturing production and the growth in insular demand is
certainly a loose one: a considerable part of the increase
in manufacturing activities has consisted of the expansion

FEDERAL RESERVE BANK OF NEW YORK

113

worker in each sector of activity but also on the effects
of faster expansion in some branches than in others— i.e.,
on changes in the structure of the economy. Although out­
put per worker in agriculture has increased considerably
since the late forties, largely as a result of the extensive
mechanization of farm production and the shift in output to
dairy, meat, and other year-round products, both the level
and the rate of increase in such output were lower in agri­
culture than in industrial activities. The continuous trans­
fer of labor out of agriculture has thus contributed to the
growth of the economy as a whole. Even though output
per worker in service activities has grown less rapidly
than in the agricultural sector, output per worker in serv­
ice activities was considerably higher than in agriculture
prior to the start of the transformation of the Puerto
Rican economy. Therefore, the continuing reallocation of
employment toward service activities has also had a favor­
able effect on the over-all increase in labor productivity.
As industrialization has lifted the level of labor pro­
ductivity, wage and salary income has increased as a pro­
portion of total net internal income. Thus the share of
wages and salaries rose from 56 per cent in 1940 to almost
70 per cent in 1964. Since incomes generated in the form
of payments to employed labor is a much lower share of
total factor payments in the agricultural sector, the in­
crease in the ratio of wage and salary income to total
income reflects to some extent a decline in the importance
of the agricultural sector. Moreover, some of the increased
share of labor income may simply be a reflection of
the reduced importance of income from self-employment
(classified as nonwage income), which may well be re­
lated to the relative decline of the agricultural sector where
self-employment was relatively high. Furthermore, a part
of the increase in labor’s share of income received within
Puerto Rico reflects the fact that payments received from
abroad— including those made by the United States Gov­
ernment— consist largely of wages and salaries. Payments
to the rest of the world, on the other hand, include a large
component of property income, and, in addition, have
7 Both the spread and the changing character of industrial activity been rising more rapidly than receipts. Since these pay­
also reflect the nature of the island’s resource availabilities. Al­
though natural resources are relatively scarce, there is an abundant ments are of course not income received within Puerto
supply of skilled and unskilled labor. Indeed, absorption into pro­ Rico, the relative importance of nonwage income on the
ductive activity of the large numbers of unemployed or underem­
ployed persons was and remains a major objective of Operation island itself is correspondingly reduced.
Bootstrap. In the initial stages of the industrialization program,
One of the most encouraging aspects of Puerto Rico’s
many plants established were concentrated in industries such as
cotton textiles, which require large amounts of relatively unskilled growth has been a substantial and sustained decline in
labor. By now, the very process of industrialization has lifted the unemployment. Although the current rate of unemploy­
level of skills and technical expertise and generally improved the
quality and efficiency of productive resources throughout the econ­ ment in Puerto Rico— at about 11 per cent of the labor
omy. This factor has undoubtedly contributed to the development force— remains high, it is nevertheless lower than it was
of the electronics industry, which calls for a high degree of technical
and professional expertise. The increasing availability of skilled in the early fifties, and a decrease in the number of un­
personnel, together with Puerto Rico’s close proximity to Vene­ deremployed (those who are nominally employed but con­
zuelan oil, has facilitated the emergence of the petroleum and petro­
tribute very little to output) has no doubt also taken place.
chemical industries.

of production for the mainland market.7
Between the late forties and the early sixties the shifts
in the industrial origin of income were broadly paralleled
by similar changes in the occupational pattern of employ­
ment, but there are nevertheless significant differences. The
proportion of the employed labor force engaged in agri­
cultural activities is substantially greater than that sector’s
contribution to output. In the construction industry,
which is also relatively labor-intensive, the percentage of
income generated was generally less than the proportion
of manpower absorbed, while in the capital-intensive
transport and public utilities sectors the absorption of la­
bor was considerably less than the share of income gen­
erated. In the manufacturing sector, the relationship be­
tween the share of income generated and the percentage
of labor absorbed has changed with the shift in the com­
position of manufacturing output and with the extensive
mechanization of certain traditional branches of manu­
facturing production. The home needlework industry, for
example, which at one time employed thousands of wom­
en has virtually disappeared. Moreover, the emergence of
capital-intensive industries has tended to reduce the over­
all ratio of employment to income generated in the manu­
facturing sector. The manufacturing sector’s share of
income has thus become substantially greater than its
relative absorption of labor.
These differences between the industrial origin of in­
come and the occupational pattern of employment reflect,
of course, underlying differences in output per employed
worker, which in turn have their roots in differences in
labor productivity, in the amount of capital per worker,
and in the efficiency of utilization of both labor and capi­
tal. Given the differences in output per worker between
sectors, the rate of growth of productivity for the econ­
omy as a whole depends not only on the rise in output per




MONTHLY REVIEW, MAY 1965

114

Moreover, the average duration of unemployment is rela­
tively short. In recent years about 90 per cent of the
unemployed have been without work for less than fifteen
weeks a year and about 60 per cent for less than five
weeks. Thus, a considerable part of the unemployment is
short term in nature. This fact, in all likelihood, largely
reflects the individually temporary, but continuing, dis­
locations caused by the steady movement of the popula­
tion from rural to urban areas and by the shifts within
the labor force from unskilled to more skilled work.
CONCLUDING REMARKS

Puerto Rico’s Operation Bootstrap owes much of its
extraordinary success to the island’s status as an integral
part of the mainland economy— a position which has re­
moved many of the risks ordinarily associated with foreign
investment and thereby facilitated the flow of external capi­
tal to the island. Puerto Rican government obligations
are traded in the United States on the same tax-free basis
as the obligations of state and local authorities, and private
Commonwealth borrowers may enter the United States
market for long-term funds on the same basis as mainland
borrowers. In addition, the high rate of net emigration
from Puerto Rico mitigated the island’s unemployment
problem, especially during the early stages of industriali­
zation. Moreover, since the island shares a common cur­




rency with the mainland, Puerto Rican trade with the
United States is entirely free of foreign exchange prob­
lems. However, most nonresident direct investment is
export oriented. As a result the Puerto Rican economy
is vulnerable to changes in business conditions on the
mainland, with respect to both the demand for Puerto
Rican exports and the supply of nonresident investment.
Each of the postwar recessions in the United States was
reflected in a more or less concurrent slowdown in the
growth of investment and income in Puerto Rico.
Puerto Rico’s experience thus provides neither a pan­
acea nor a blueprint for other developing areas. Never­
theless, that experience is by no means irrelevant. The
island’s unique status hardly explains the success of its
postwar development drive. Puerto Rico’s progress clearly
owes much to the energy, imagination, and the success with
which the island’s government and public authorities have
tackled the problems of raising the level of education,
providing basic public facilities, and making the island
attractive for the effective participation of private main­
land capital in economic development. Planned capital
inflows continue to play an important part in the govern­
ment’s development strategy. However, the very process
of growth has enabled the island to reduce the extent of
its reliance on external sources of capital, and in this and
many other respects Puerto Rico appears to be making
the transition to fully self-sustained economic growth.

FEDERAL RESERVE BANK OF NEW YORK

Publications of the Federal Reserve Bank of New York
The following is a selected list of publications available free (except where a charge is indicated)
from the Public Information Department, Federal Reserve Bank of New York, New York, N. Y. 10045.
Copies of charge publications are available at half price to educational institutions.
1.

F E D E R A L RESERVE

O P E R A T IO N S IN

THE

M ONEY

AND

G O V E R N M E N T S E C U R IT IE S M A R K E T S

(1956) by Robert V. Roosa. A 105-page booklet describing how Federal Reserve operations are con­
ducted through the Trading Desk in execution of the directions of the Federal Open Market Committee.
Discusses the interrelation of short-term technical and long-range policy factors in day-to-day operations.
Has sections on the role of the national money market, its instruments and institutions, trading procedures in
the Government securities market, what the Trading Desk does, the use of projections and the “feel” of
the market, and operating liaison with the Federal Open Market Committee.
2. t h e m o n e y s i d e o f “ t h e s t r e e t ” (1959) by Carl H. Madden. A 104-page booklet giving
a layman’s account of the workings of the New York money market and seeking to convey an under­
standing of the functions and usefulness of the short-term wholesale money market and of its role in the
operations of the Federal Reserve. 70 cents per copy.
3. d e p o s i t v e l o c i t y a n d i t s s i g n i f i c a n c e (1959) by George Garvy. An 88-page booklet dis­
cussing the behavior of deposit velocity, over the business cycle and over long periods, with emphasis on
the institutional and structural forces determining its behavior. 60 cents per copy.
4.
M O N E T A R Y P O L IC Y U N D E R T H E I N T E R N A T I O N A L GOLD S T A N D A R D , 1 8 8 0 -1 9 1 4 (1959) by
Arthur I. Bloomfield. A 62-page booklet analyzing, in the light of current monetary and banking theory,
the performance and policies of central banks within the framework of the pre-1914 gold standard.
50 cents per copy.
5. o p e n m a r k e t o p e r a t i o n s (1963) by Paul Meek. A 43-page booklet describing for the inter­
ested layman or undergraduate student how open market operations in United States Government securities
are used to cope with monetary stresses and promote a healthy economy.
6. e s s a y s i n m o n e y a n d c r e d i t (1964). A 76-page booklet containing eleven essays on tech­
nical problems of monetary policy, Treasury debt and cash operations, and the Federal Reserve’s daily
work. It also contains several analyses of money and securities market instruments and of banking prob­
lems and policies. 40 cents per copy.
7.

TREASURY A N D FED ER A L RESERVE FOREIGN EXC H A NG E O PER A TIO N S: M ARCH 1 9 6 1 -AUGUST

1964 (1964) by Charles A. Coombs. A 47-page consolidated reprint of five reports on the title subject

that appeared earlier in the Federal Reserve Bulletin and the Monthly Review. 50 cents per copy.
8. t h e n e w y o r k f o r e i g n e x c h a n g e m a r k e t (1965) by Alan R. Holmes and Francis H.
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