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FEDERAL RESERVE BANK OF NEW YORK
103
The Business Situation
The economy continues to push ahead into new high
ground with undiminished vigor. While the physical vol
ume of goods and services produced and consumed has
expanded—and will no doubt continue to expand—this
expansion has been accompanied increasingly by price
advances, as pressures on the economy’s resources have
mounted. Thus the exceptionally large dollar increase
during the first quarter in gross national product (GNP)
reflected not only the continued vigor of growth in real
output but also a rather substantial rise in the prices of
the goods and services produced.
Chart I-
UNEMPLOYMENT RATES
Quarterly averages of seasonally adjusted monthly data
Per cent
Per cent
Prices normally come under increasing pressure in an
economy where mounting demands are pressing against
a productive apparatus in which little slack remains. The
over-all unemployment rate is down to the lowest level in
many years, and even the particularly troublesome teen
age rate has been sharply reduced (see Chart I ). More
over, rates of industrial capacity utilization have edged
higher and higher and, against this background, prices of
a broad range of goods have risen. The wholesale indus
trial price index increased at an annual rate of 3 per cent
during the first three months of the year, compared
with a rise of not quite IV2 per cent during 1965, and it
appears that such prices continued to move up in April.
The over-all wholesale price index, however, was un
changed in March and perhaps also in April as a result
of declines in agricultural prices. At the consumer level,
March witnessed another appreciable rise in the over-all
price index, reflecting increases for a number of nonfood
commodities as well as for foods and services.
Under present conditions, restraint on aggregate de
mand to keep it in balance with supply possibilities is
clearly desirable. With respect to capital spending, there
appear to be several factors at work tending to influence
businessmen to postpone some of the outlays originally
planned for this year. Among these factors, of course, is
the President’s direct request that businessmen try to cut
back on spending wherever feasible. Moreover 1966
capital outlays may be constrained to some degree by the
reduced availability and higher cost of credit and, on the
supply side, by actual and prospective shortages of capital
goods and skilled labor. Nevertheless, while any decisions to
postpone some of this year’s planned spending will surely
be helpful, it remains to be seen how quantitatively impor
tant such postponements will prove to be in aggregate.
G R O S S N A T IO N A L P R O D U C T
IN T H E F I R S T Q U A R T E R
Note: Shaded areas represent recession periods, according to National Bureau of
Economic Research chronology.
Source: United States Bureau of LaborStatistics.
The Commerce Department’s preliminary estimates put
GNP at a seasonally adjusted annual rate of $714.1
billion in the first quarter, up by $16.9 billion from the
preceding three-month period (see Chart II ). This large
104
MONTHLY REVIEW, MAY 1966
Chart II
RECENT CHANGES IN GROSS NATIONAL PRODUCT
AND ITS COMPONENTS
Seasonally adjusted annual rates
j Quarterly change, third quarter
* to fourth quarter 1965
Quarterly change, fourth quarter
■
1965 to first quarter 1966
GROSS NATIONAL PRODUCT
Inventory investment
Final expenditures
Consumer expenditures for
durable goods
Consumer expenditures for
nondurable goods
Consumer expenditures for services
Residential construction
Business fixed investment
Federal Government purchases
State and local government purchases
Net exports of goods and services
0
5
10
15
Billions of dollars
Source: United States Department of Commerce.
advance represented an annual growth rate of 10 per cent,
close to the highest rate of gain experienced during any
quarter of the current business expansion. In real terms,
the nation’s aggregate output of goods and services grew
at an annual rate of slightly more than 6 per cent in the first
quarter, somewhat better even than last year’s strong rate
of expansion. The average price of output rose at an an
nual rate of around 3V2 per cent, however, the sharpest
increase in more than eight years and significantly ahead
of last year’s advance of about 2 per cent. A large firstquarter rise in food prices was an important factor con
tributing to this step-up in the over-all rate of price
increase.
Most of the major components of aggregate demand
contributed to the first-quarter GNP increase. Net exports,
however, posted their third consecutive quarterly decline,
as spending on imported goods and services increased
more than did exports of goods and services produced in
the domestic economy. The downtrend in net exports is
disappointing in view of the important part played by
our trade balance in the effort to achieve equilibrium in
the over-all balance of payments. Nevertheless, a fall
in net exports is by no means unusual in a setting of high
and rising levels of production, resource utilization, and
income. In addition, a rising domestic price level of course
tends to stimulate imports and dampen exports.
The estimated rate of inventory accumulation also
slowed down a bit in the first quarter, following a sizable
fourth-quarter advance that had pushed the annual rate
of accumulation up to an exceptionally high $10.1 bil
lion. While the $8.3 billion first-quarter rate was quite
large relative to the experience of recent years, it was
associated with an exceptionally strong expansion of
final demand. Viewed in this context, the accumulation
rate does not appear to have been excessive. Neverthe
less, a desire to build protection against possible future
shortages or price increases may be having an influence
on business decisions regarding inventories.
Increased spending for goods and services by all levels
of government contributed substantially to over-all de
mand expansion in the first quarter. State and local gov
ernment outlays rose by $1.3 billion, right in line with the
average gain recorded last year. Federal purchases, how
ever, registered the largest quarterly advance since the
Korean war, and this jump followed a significant rise in
the fourth quarter of 1965. The recent speedup in Federal
spending reflected the expansion of the armed forces and
of military procurement, as Federal nondefense purchases
continued to rise at about last year’s average rate. Al
though uncertainty over the future course of events in Viet
nam makes forecasting difficult, current estimates never
theless imply that the push given by defense spending to the
expansion of aggregate demand will become more modest
in the latter part of 1966.
Consumer spending showed an exceptionally large
increase in the first quarter even though the growth of dis
posable income was slowed by the rise in social security
taxes effective January 1. Thus there was a considerable
decline in the proportion of disposable income saved,
reflecting the fact that it usually takes a while for con
sumers to adjust their spending habits to changes in dis
posable income caused by tax changes (including social
security deductions). The dip in the saving ratio stemming
from the rise in such withholdings may therefore prove
to be short-lived. Sharply higher food prices were one
factor contributing to the strong rise in consumption
spending, and the growth in outlays for nondurables was
well ahead of the average pace recorded last year. Spend
ing for durable goods also showed a substantial increase in
the first quarter, attributable in good part to very strong
FEDERAL RESERVE BANK OF NEW YORK
105
to cut back on the pace of spending this year. Statements
by a number of large corporations during the past month
suggest that, because of the President’s request and also
because of delivery delays, some reductions may in fact
take place.
The McGraw-Hill survey indicates that manufacturers
are devoting an increased proportion of their capital
spending to the expansion of productive capacity. During
the first four years of the current business expansion, man
ufacturers’ capital investment was heavily oriented toward
cost reduction, and capacity growth averaged somewhat
less than 4 per cent yearly. As utilization rates moved
upward, however, there was a marked shift toward spend
ing for expansion. Thus capacity grew by about 7 per
cent last year, and this year’s planned gain amounts to 8
per cent.
Reflecting the sustained advance of capital spending,
output of business equipment has been growing at a rapid
rate for some time and has been an important factor in
the over-all expansion of industrial production. Business
equipment production increased again in March, as did
all the other major categories of industrial output. The
Federal Reserve Board’s seasonally adjusted production
C A PITAL IN V E ST M E N T A N D
index rose by a substantial 1.5 percentage points to reach
IN D U S T R IA L P R O D U C T IO N
152.9 per cent of the 1957-59 average. The March show
The rate of growth in spending for business fixed invest ing rounded out a very strong quarter. Indeed, industrial
ment continued to exceed the rate of increase in over output increased during the first quarter at an annual rate
all GNP in the first quarter. As a result, the ratio of of more than 11 per cent, one of the highest growth rates
such investment spending to total GNP edged up fur recorded for any quarter of the current business expansion.
ther to reach 10.6 per cent, equal to the highest rates
Scattered data suggest that the over-all pace of output
recorded during the investment boom of 1956-57. In growth may have slowed a bit in April. A strike at one
dollar terms, business fixed investment spending grew at company cut steel output somewhat, though total ingot
an annual rate of $2.4 billion in the first quarter, about production (seasonally adjusted) was up for the fifth
equal to last year’s average quarterly increase. The latest consecutive month. Auto assembly operations early in the
survey of business plans, moreover, clearly supports earlier month were hampered by a railroad strike, and the re
indications that the remainder of this year will see further sulting production losses were a factor in the decline in
strong advances in outlays for new plant and equipment. the assembly rate—to about 9.1 million units, in annual
According to this survey, taken by McGraw-Hill in March, terms, compared with 9.4 million in March. More
planned 1966 outlays add up to a 19 per cent rise over over, April output in the mining sector was significantly
1965—an even larger gain than the 16 per cent reported dampened by the widespread strike of coal miners. On the
by a Government survey taken in late January and early other hand, new orders for durable goods moved sharply
February. The McGraw-Hill survey, however, was largely higher in March and the backlog of unfilled orders reg
completed prior to the President’s appeal to businessmen istered a very substantial further increase.
sales of new domestically built cars. Sales for the quarter
as a whole were at a seasonally adjusted annual rate of
9V4 million units, equal to the high set in last year’s first
quarter—when the industry was making up sales lost during
strikes late in 1964—and substantially above the fourth
quarter’s 82 million units. Following the strong firstA
quarter showing, however, sales dropped sharply in April to
a seasonally adjusted annual rate below 8 million units.
Spending on residential construction increased in the
first quarter by $0.9 billion (annual rate), and thus re
couped the declines of the two preceding quarters. The
rate of spending nevertheless remained somewhat below
the peak attained two years ago. The upturn in the first
quarter reflected improvement late last year in the rate of
new housing starts, as well as some further rise in
construction costs. The starts rate, however, is highly
volatile, fluctuating sharply from month to month. Thus,
despite the March recovery of starts from the sharply
reduced February level, there has apparently been no real
breakout from the sideways movement that has char
acterized this sector over the past two years.
106
MONTHLY REVIEW, MAY 1966
Banking and Monetary Developments in the First Quarter of 1 9 6 6
The banking system came under increased pressure
during the first quarter. Demand for bank loans con
tinued very strong, while the reserves needed to support
further deposit and credit expansion by the banks were
not so readily available as in earlier months. Thus bank
reserve positions tightened somewhat.
Banks responded to these pressures in several ways. In
some cases customers did not get the loans they requested
or received smaller amounts than they had sought, as a
number of banks adopted somewhat more selective lend
ing policies. Then, in early March, major banks around
the country raised the interest rate charged prime business
borrowers from 5 per cent to 5 Vi per cent, a move which
discouraged some potential loan applicants. Despite these
moves, the volume of loans actually extended rose sub
stantially during the quarter, and banks found it necessary
to liquidate sizable blocks of Government securities in
order to finance them. As loans were added and invest
ments liquidated, bank loan-deposit ratios rose further. By
the end of March, the aggregate ratio for the banking
system as a whole stood above 64 per cent, 1 percentage
point above the level prevailing three months earlier.
In seeking funds needed to permit the expansion of
loan portfolios, many banks continued to bid aggressively
in the market for time deposits. By the end of the quarter
several banks were posting the maximum permissible rate
of 5 Vi per cent on negotiable time certificates of deposit
(C /D ’s) maturing in nine months or more, and rates paid
on shorter term certificates were not far below the ceiling.
While the actual flow of new funds into C/D’s was rather
small during the first two months of the year, it began to
pick up during March. For the quarter as a whole, how
ever, total time deposits at all commercial banks increased
at a much slower rate than in preceding months. Private
demand deposits, on the other hand, increased substan
tially over the period, contributing to a growth in the
money supply that was only slightly less rapid than the
fast pace set in 1965.
The first-quarter growth rate in total liquid assets held
by the nonbank public was in line with that of the pre
ceding quarter. Within this total, however, there appeared
to be a substantially diminished flow of liquid savings, not
only to commercial bank interest-bearing accounts, but to
mutual savings banks and, to a somewhat lesser extent, to
savings and loan associations as well. In contrast, the
nonbank public’s holdings of United States Government
securities maturing within one year showed a sizable in
crease in the first quarter of this year.
B A N K C R E D IT
Total loans and investments at all commercial banks
rose at an 8.0 per cent seasonally adjusted annual rate in
the first quarter of this year, a bit below the 10.9 per cent
pace in the preceding quarter. Indeed, the first-quarter
growth rate in total bank credit was more in line with the
8.4 per cent annual average recorded in the 1961-64 pe
riod than with the somewhat more rapid 10.0 per cent
pace that was experienced over the last year as a whole.
Banks reduced their holdings of United States Govern
ment securities by a substantial $2.0 billion (seasonally
adjusted) over the first quarter (see Chart I ) and, by the
end of March, bank holdings of these instruments stood
at their lowest level since March 1960. The decline in
holdings of United States Government obligations swamped
a $0.4 billion first-quarter increase in holdings of other
securities, the smallest quarterly rise in the current expan
sion. In March, bank holdings of these securities actually
declined by $300 million on a seasonally adjusted basis, the
first appreciable decline in this series since 1960.
The strong 15.6 per cent annual rate of increase during
the first quarter in total loans at commercial banks was
paced by a sharp increase in business loans. While the
expansion in loans to business borrowers was considerably
below the extraordinary first-quarter advance of last year,
it was about in line with the growth rate for 1965 as a
whole. Underlying the business loan strength have been
tighter corporate liquidity positions and a high rate of
capital spending and inventory accumulation. Stepped-up
corporate tax payments, expectations of continued high
rates of investment expenditure, and projections of a slower
growth rate in profits this year relative to last year all
FEDERAL RESERVE BANK OF NEW YORK
107
BAN K D E P O SIT S, R E SE R V E S, A N D
T O T A L LIQ U ID A S S E T S
point to continued strength in business loan demand. On
the other hand, despite net increases in most open market
rates during the quarter, the relative costliness to business
borrowers of bank financing had risen by the end of the
period. The main factor in this development was the in
crease in the prime rate from 5 per cent to 5Vi per cent
on March 10.
The sharp advance of loans during the first quarter was
accompanied by continued pressure on bank liquidity po
sitions, as evidenced by a further sharp advance in loandeposit ratios. During the January-March period, the
loan-deposit ratio for all commercial banks climbed a full
percentage point to 64.1 per cent. Even more striking
was the rise of 2 percentage points in the loan-deposit
ratio at weekly reporting banks over the quarter to 69.8
per cent by the end of March. Similarly, the loan-deposit
ratio at New York City reporting banks had advanced to
72.4 per cent by the end of the quarter, up markedly from
69.9 per cent at the end of December.
The daily average money supply grew at a 4.3 per cent
seasonally adjusted annual rate from December 1965 to
March 1966, considerably below the 7.5 per cent pace in
the final quarter of last year but not greatly different from
the 4.8 per cent growth rate over 1965 as a whole. Monthto-month movements in the money supply reflected in part
the frequently observed inverse relationship between shortrun changes in its demand deposit component and shortrun changes in United States Government deposits. Thus,
in February, private demand deposits declined by some
$0.6 billion on a daily average seasonally adjusted basis,
while Government deposits, measured on this same basis,
rose by roughly the same amount. Despite midmonth tax
payments, a reverse flow from Government deposits to
private demand deposits occurred over the month of
March as a whole, with private demand deposits growing
by $1.1 billion and Government deposits falling again by
an approximately offsetting amount.
Commercial bank time deposits (seasonally adjusted)
rose at a 7.1 per cent annual rate over the first quarter,
markedly less than the rapid 16.1 per cent pace for last
year as a whole (see Chart II). Largely because of the
sluggish advance in these deposits, the money supply and
time deposits combined grew at an annual rate of only 5.6
per cent during the first quarter, as against a 9.8 per cent
rise in 1965. Data for weekly reporting member banks
suggest that the primary factor in the reduced first-quarter
growth in time deposits was the diminished public interest
in passbook savings accounts. Funds in these accounts at
weekly reporting banks actually declined by some $251
million over the quarter, compared with a $1.6 billion
rise over the comparable period last year. Moreover,
there was some evidence of a diminished flow of new
funds into C/D’s during the quarter. Despite the sharply
higher rates paid on these instruments, C/D’s at all weekly
reporting banks expanded by only about $700 million
from the beginning of this year to the week just preceding
the mid-March dividend and tax dates, as against a $1.6
billion gain in the comparable period of 1965. Weekly re
porting banks— and especially the New York City reporting
banks—were, however, considerably more successful than
many had expected in attracting additional C/D ’s during
the last two statement weeks in March, with the net gain
amounting to $807 million.
Despite the reduced over-all flow of funds into com
mercial bank interest-bearing accounts—and into other
deposit-type institutions as well—there appears to be some
evidence that savings certificates issued by commercial
108
MONTHLY REVIEW, MAY 1966
banks, generally in relatively small denominations, have
been growing at a stepped-up pace. This development
reflects an increase in the number of banks offering such
certificates, some advances in the rates paid on them, and
more extensive advertising by issuing banks. Probably a
good part of this money represents funds that would other
wise have been lodged in other savings-type accounts,
whether outside the commercial banking system or in pass
book savings accounts at commercial banks, including
passbook accounts of the issuing banks themselves.
In order to help meet the reserve needs occasioned by
the over-all expansion in their demand and time deposit
liabilities, banks ran down their excess reserves from an
average of $358 million in January to a $303 million aver
age in March. At the same time, their borrowings from
the Federal Reserve Banks rose from an average level of
$402 million in January to $551 million in March. On a
seasonally adjusted basis, member bank nonborrowed re-
Chart III
MEMBER BANK RESERVES
Seasonally adjusted
Billions of dollars
• Billions of dollars
1965
Chart II
QUARTERLY CHANGES IN LIQUIDITY INDICATORS
End of quarter to end of quarter
Per cent
Season ally adjusted annual rates
per cenj
1966
Note: The difference between total reserves and non borrow ed reserves is member bank
borrow ings from the Federal Reserve Banks. Free reserves, usually defined as excess
reserves less borrowings, may also be represented as the difference between
nonborrow ed reserves and required reserves. When required reserves are larger
than nonborrowed reserves, the difference is termed net borrowed reserves.
Source: Board of Governors of the Federal Reserve System.
serves expanded at a relatively slow 1.5 per cent annual
rate in the first quarter (see Chart III). Over 1965 as a
whole, the rate of growth had been 4.2 per cent.
The nonbank public’s liquid assets1 expanded at a sea
sonally adjusted annual rate of 8.5 per cent in the first
quarter, closely in line with the rise in the fourth quarter
of last year. As already suggested, however, the growth
rate in the time deposit and share components of total
liquid assets—commercial bank time and savings deposits,
deposits at mutual savings banks, and savings and loan
shares—dropped markedly below that for last year as a
whole. Savings flows to all three types of institutions may
have been adversely affected by the rising attractiveness
I
1965
1966
* Daily average figures.
Includes commercial bank time and savings deposits, measured on a last-Wednesdayof-the-month basis, and deposits at mutual savings banks and savings and loan
shares, measured on an end-of-the-month basis.
Source: Board of Governors of the Federal Reserve System.
1 Total liquid assets are defined to include demand deposits and
time deposits (adjusted) at all commercial banks and currency out
side banks— all measured on a last-Wednesday-of-the-month basis;
also, deposits at mutual savings banks, savings and loan shares,
postal savings deposits, United States Government savings bonds,
and the public’s holdings of United States Government securities
maturing within one year— all measured on an end-of-the-month
basis.
FEDERAL RESERVE BANK OF NEW YORK
of yields on open market instruments, such as state and
municipal bonds, and by the fact that individuals ap
parently saved a considerably smaller proportion of their
disposable income in the first quarter than in the preceding
quarter. Reflecting in part the heavy bank liquidation of
Governments, the nonbank public’s holdings of such securi
ties maturing within one year rose by a substantial $3.3
billion in the first quarter following a modest decline in the
109
preceding quarter. The ratio of total liquid assets held by
the nonbank public to gross national product fell by 0.4
percentage point in the first quarter to 80.9 per cent. Con
trary to the experience of earlier business expansions, this
ratio rose through much of the current upswing. Since
early 1964, however, its movement has been somewhat
irregular, and the current position of the ratio is about
equal to the level prevailing in the third quarter of 1963.
The Money and Bond Markets in April
The money market became firmer in April, and interest
rates on many short- and long-term instruments moved
irregularly upward. Bank reserve positions were under
pressure during the month, as a continuing strong demand
for credit pressed against a somewhat lower average level
of nationwide net reserve availability. Reserve needs of
the money center banks in particular expanded sharply
during the first three weeks of April, which included the
midmonth Federal income tax date. As a result, Federal
funds were widely sought at rates generally above the
discount rate and member bank borrowings from the Fed
eral Reserve increased. For the first time, a significant
amount of trading in Federal funds took place at 4% per
cent, % of a per cent above the discount rate. Toward
the end of April, reserve distribution shifted in favor of
the money center banks and market conditions became a
little less taut.
Treasury bill rates, which had already begun to back
away from their March lows in the final week of that
month, continued to adjust upward on balance during
April. A fairly good demand for bills persisted during the
month, but dealers were willing sellers through most of the
period as they hesitated to allow positions to build up in
the face of high financing costs.
In the bond markets, prices retreated in April from the
higher levels to which they had climbed in March. Market
participants reacted to the continued heavy flow of financ
ing in the capital markets, including the market for Gov
ernment agency issues, as well as to uncertainties over the
possibility of a tax increase and the future course of inter
est rates. Trading activity in Treasury notes and bonds
was quite light on most days of the month. By the end
of the period, the upward drift in yields had erased a
good part of the March decline. The Treasury’s announce
ment in late April of the terms of its May refunding was
in line with expectations and thus had little effect on over
all market sentiment, although investor response to the
offering was quite restrained.
THE M ONEY M ARKET AN D BANK RESERVES
A noticeably firmer tone emerged in the money market
during April. While the level of nationwide net borrowed
reserves fluctuated somewhat on a week-to-week basis, the
average for the month as a whole— $281 million (see
Table I ) —was higher than the $209 million (revised)
average in March. Member bank borrowings from the
Federal Reserve also expanded during April—rising by
$93 million on average—as banks with reserve deficits
turned increasingly to the “discount window” to fill resid
ual reserve needs which had gone unsatisfied in the Fed
eral funds market.
Against the background of a contraction in nationwide
reserve availability, there was a pronounced tightening in
MONTHLY REVIEW, MAY 1966
110
Table I
Table II
FACTORS TENDING TO INCREASE OR DECREASE
MEMBER BANK RESERVES, APRIL 1966
RESERVE POSITIONS OF MAJOR RESERVE CITY BANKS
APRIL 1966
In millions of dollars; (+ ) denotes increase,
(—) decrease in excess reserves
In millions of dollars
Daily averages— week ended
Changes in daily averages—
week ended
Net
changes
Factors
April
6
April
13
27
20
— 191
4 - 651
- f 307
— 132
reserves*............. — 137
(subtotal) ......... — 332
............................. — 104
............................. + 257
— 37
— 441
Other Federal Reserve
— 8
— 17
4 -170
4 - 232
- f 194
4 - 15
— 312
41
4-
99
— 469
4 - 153
4-
460
+
+
4-
n
367
—
—
—
—
4-
5
157
188
191
13
4-211
— 350
4 -3 3 2
4 -2 4 7
4 -128
+
2
— 175
4
4 -128
— 162
— 18
—
Open market instrum ents
O utright holdings:
+ 274
Bankers' acceptances .........................
Repurchase agreements:
Government s e c u ritie s.........................
Bankers’ acceptances .........................
Member bank b orrow ings...........................
Other loans, discounts, and advances...
Total ........................................................
Excess reserves* ...........................................
1
—
+ 145
— 21
-f- 115
—
+
4-
8
1
— in
— 4
— 20
—
486
—
—
—
4-
34
4-1 4 5
—
—
—
4-
82
— 43
4-1 3 4
1
3
+
+ 513
— 126
—
445
+ 149
+
4 - 27
+
15
13
44
— 89
—
4- 43
6
+
April
13
April
20
April
27*
Eight banks In New York City
Direct Federal Reserve credit
transactions
—
April
6
Average
of four
weeks
ended
April 27*
April
April
“ Market" factors
Member hank required
Operating transactions
Federal Reserve float
Treasury operations!
Factors affecting
basic reserve positions
37
28
8
157
863
75
113
822
334
34
88
532
1,377
514
1,310
488
981
647
1,158
626
— 854
-970
-372
-586
1,067
1,002
840
892
8
59
23
147
Thirty-eight banks outside New York City
Reserve excess or deficiency(—) f ......
Less borrowings from Reserve Banks..
Less net interbank Federal funds
purchases or sales ( —) .......................
Gross purchases ..............................
Gross sales .....................................
Equals net basic reserve surplus
or deficit (—) .......................................
Net loans to Government
securities dealers ................................
16
203
445
46
164
21
160
338
406
239
357
1,357
912
1,390
1,052
1,359
954
1,289
1,050
1,349
992
-633
— 456
-544
— 290
— 481
268
353
489
472
396
12
+ *
+ ®1
-f
Reserve excess or deficiency ( —) t
15
Less borrowings from Reserve Banks..
54
Less net interbank Federal funds
purchases or sales ( —) .......................
107
964
Gross purchases ..............................
856
Gross sales .....................................
Equals net basic reserve surplus
or deficit ( —) ....................................... - 146
Net loans to Government
securities dealers ................................
658
Note: Because of rounding, figures do not necessarily add to totals.
* 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 re
quired reserves and carry-over reserve deficiencies.
73
Daily average levels
Table III
AVERAGE ISSUING RATES*
AT REGULAR TREASURY BILL AUCTIONS
Member bank:
Total reserves. Including vault ca sh *. . .
Required reserves* .......................................
Excess reserves* ...........................................
22,358
22.025
333
623
F ree reserves* ................................................ — 290
Nonborrowed reserves* ............................... 21,735
22,402
22,042
360
603
— 243
21,799
22,608
22,233
375
685
— 310
21,923
22,600
22,238
362
642
— 280
21,958
22,492§
22,135§
357§
6385
— 2815
21,8545
In per cent
Weekly auction dates— April 1966
m aturities
April
18
April
25
4.618
4.664
4.630
4.763
4.754
4.730
April
11
4.531
4.719
Three-month ..............................
Changes in Wednesday levels
Monthly auction dates— February-April 1966
System Account holdings of Government
securities maturing in:
— 124
—
— 1,084
—
—
4-7 4 6
4 - 24
4 -1 9 3
4 - 24
4 655
Less th a n one year .....................................
More than one y e a r .....................................
April
4
4 - 655
— 124
— 1,084
4-7 7 0
4 -217
March
24
April
26
4.945
Note: Because of rounding, figures do not necessarily add to totals.
* These figures are estimated,
t Includes changes in Treasury currency and cash.
X Includes assets denominated In foreign currencies.
S Average for four weeks ended April 27.
February
23
4.739
4.773
* Interest rates on bills are quoted in terms of a 360-day year, with the dis
counts from par as the return on the face amount of the bills payable at
maturity. Bond yield equivalents, related to the amount actually invested,
would be slightly higher.
FEDERAL RESERVE BANK OF NEW YORK
the reserve positions of banks in the central money market
during the first three weeks of April (see Table I I). City
banks experienced a substantial increase in their total
loans and investments during this period. In part, this
reflected an increase in bank holdings of securities and a
sharp rise in securities loans, as dealers—including dealer
banks—expanded their inventories. In addition, the de
posits initially created at the money center banks as the
counterpart of loans made for the settlement of earlymonth business needs subsequently became widely dis
persed throughout the banking system.
In order to cover their mounting reserve deficiencies,
the money market banks bid aggressively for Federal
funds. Reflecting both the strong demand and reduced sup
ply, the bulk of transactions in this market was completed
at a 4% per cent rate during the month, Vs of a per cent
above the rate which had predominated in March. Early in
the month and for a few days following the midmonth tax
date, a substantial volume of funds was transferred at
4% per cent, marking the first period in which Federal
funds had traded at a % of a per cent “premium” over the
Federal Reserve discount rate.
Money market pressures became particularly strong
shortly after midmonth. The April 15 tax date itself passed
smoothly as banks in the central money market benefited
from an inflow of corporate deposits accumulated to cover
tax checks written on that day. Following the tax date,
however, reserve needs began to intensify in the money
center banks. The Treasury initially used part of the tax
checks it received drawn on the commercial banks to
build up its deposits at the Federal Reserve Banks since
these balances had fallen to abnormally low levels. As
a result, Treasury redeposits of tax receipts in commercial
bank Tax and Loan Accounts lagged behind the pace ex
pected in the market. Meanwhile, bank loans continued
to remain at a high level, particularly loans to nonbank
financial institutions and to securities dealers needing
alternative sources of financing to replace corporate re
purchase agreements that had matured. With banks unable
to cover all their needs in the Federal funds market, bor
rowings from the Reserve Banks on the final day of the
April 20 statement week swelled to $1,587 million.
In the final statement period of the month, the tautness
of the money market relaxed somewhat. The money
market banks, managing their reserves very cautiously in
the wake of the extreme pressures which had existed at
the end of the preceding week, borrowed heavily early in
the period both in the Federal funds market and from the
Federal Reserve. Following the April 23-24 weekend, the
excess reserves accumulated by the city banks in this way,
together with a supply of excess reserves from “country”
111
banks, piled up in the money market. As a result, the
effective rate on Federal funds declined from 4% per cent
at the beginning of the statement period to 3 per cent at
the close when funds were offered at rates as low as Va
per cent.
Although the money market banks experienced sub
stantial reserve pressures during much of the month, they
were quite successful in replacing the large volume of time
certificates of deposit reaching maturity at rates that were
little changed from March. Indeed, the volume of such
certificates outstanding at the weekly reporting member
banks actually climbed in April. There were reports that
a considerably broader list of customers was entering the
C/D market than in earlier months, with public funds
in particular playing a growing role.
THE G O V E R N M E N T SE C U R IT IE S M ARK ET
Following the strong March recovery in the bond mar
kets during which prices of Treasury coupon issues had
advanced sharply, prices of intermediate- and long-term
coupon issues fell back irregularly in April. (The righthand panel of the chart on page 112 illustrates the rise in
yields which accompanied this decline in prices.) Activity
was generally quite light and was dominated by profes
sional participants. Although a cautious atmosphere de
veloped at a number of points during the period, price
changes on most days were relatively modest and the
market showed signs of resistance to any pronounced
downward price movement.
In the early days of the month, Government bond
traders were encouraged by the fairly good tone then
prevailing in the corporate sector, as well as by comments
from the Secretary of the Treasury that any potentially
unhealthy aspects of bank credit growth might better be
remedied by judicious bank lending policies than by fur
ther increases in interest rates. Subsequently, a note of
hesitancy appeared in the coupon sector when participants
increasingly focused on the heavy calendar of Government
agency offerings, the softening tone in the corporate sec
tor, and the uncertain political situation in Vietnam. In
addition, the market was affected by the announcement
on April 12 that the Federal Housing Administration
was increasing from 5Vi per cent to 5% per cent the
maximum interest rate permitted on mortgages it insures.
(The Veterans Administration also made the same rate
change on mortgages it guarantees.) Against this back
ground, professional offerings of coupon issues were
augmented by limited investment selling, including bank
offerings, and prices of notes and bonds generally edged
lower from April 6 through midmonth.
112
MONTHLY REVIEW, MAY 1966
SELECTED INTEREST RATES*
Feb ru ary-A p ril 1966
M ONEY MARKET RATES
February
March
April
BOND MARKET YIELDS
February
March
April
Note: Data are shown for business days only.
* MONEY MARKET RATES QUOTED: Daily range of rates posted by major New York City banks
on new call loans (in Federal funds) secured by United States Government securities (a point
indicates the absence of any range); offering rates for directly placed finance company 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- and six-month
' Treasury bills.
BOND MARKET YIELDS QUOTED: Yields on new Aaa- and Aa-rated public utility bonds are plotted
around a line showing daily average yields on seasoned Aaa-rated corporote bonds (arrows
Over the following few days, reports of a large rise in
gross national product during the first quarter of 1966
apparently led some professional traders to feel that the
chances for a Federal tax increase to combat inflationary
pressures might be strengthening. Investor interest in
coupon issues remained light, however, and prices con
tinued to drift irregularly lower. In the final statement
period of the month, prices fluctuated narrowly and activ
ity was quite light. Considerable uncertainty developed
over the prospects for a tax increase, and participants
awaited news of the terms of the Treasury’s May re
funding.
After the close of business on April 27, the Treasury
announced that it would offer holders of $9.3 billion of
notes and bonds maturing on May 15 the right to ex
point from underwriting syndicate reoffering yield on a given issue to market yield on the
same issue immediately after it has been released from syndicate restrictions); daily
averages of yields on long -tarm Government securities (bonds due or callable in ten years
or more) and of Government securities due in three to five years, computed on the basis of
closing bid prices; Thursday averages of yields on twenty seasoned twenty-yeqr tax-exempt
bonds (carrying Moody’s ratings of Aaa, Aa, and Baa).
Sources: Federal Reserve Bank of New York, Board of Governors of the Federal Reserve System,
Moody’s Investors Service, and The Weekly Bond Buyer.
change them for new eighteen-month AVs per cent notes
dated May 15, 1966 and maturing on November 15, 1967.
The new notes were priced at 99.85 to yield about 4.98
per cent. Subscription books were open from May 2
through May 4, with payments and deliveries scheduled
for May 16. Market participants viewed the exchange as
routine. With initial interest in the offering restrained,
trading in the refunding issues was quite moderate on the
final two business days of the month. During the same
period, prices of outstanding issues edged lower.
In the market for Treasury bills, the basically firm un
dertone which had been evident in March generally carried
over into the first part of April when a fairly strong de
mand persisted. Rates on the very short-dated bills did
move up in the opening days of the month, however, as
FEDERAL RESERVE BANK OF NEW YORK
dealers anticipated a heavy expansion in the available
market supply of bills following the March 31 quarterly
commercial bank statement date and the April 1 Cook
County, Illinois, personal property tax date. However,
offerings expanded less than expected and were readily
absorbed. At the same time, a good demand for longer
bill maturities emerged from a broad spectrum of in
vestors, and rates on most of these issues edged lower
through April 5 (see the left-hand panel of the chart).
A more cautious atmosphere developed in the bill
sector during the following week. Increased dealer offer
ings were prompted by the emerging higher level of in
ventory financing costs and by expectations that market
pressures would heighten over the April 15 corporate tax
date. In this setting, bill rates moved higher from April
6 through April 13. Subsequently, the rather moderate bill
sales from corporations raising funds for their midmonth tax
payments and from other sources were absorbed without
strain, and dealer offerings tapered off. A fairly strong
demand for bills reemerged after midmonth, including
large purchases by state and local government funds. At
the same time, traders began to anticipate the appearance
of some reinvestment demand for bills from sellers of
“rights” to the Treasury’s May refunding. Against this
background, bill rates edged irregularly lower from April
14 through April 28. Bill rates rose again at the close of
the month, however, when reinvestment demand con
nected with the refunding proved disappointing and dealer
offerings expanded. Over the month as a whole, bill rates
were generally 4 to 25 basis points higher, with the largest
increases reported in the shortest maturities.
A substantial volume of new securities was sold in
April by agencies of the United States Government, in
cluding the Federal Intermediate Credit Bank, the Fed
eral Home Loan Banks, and the Federal Land Banks.
Agency offerings totaled approximately $1.9 billion, of
which a substantial $660 million represented new money.
Yields on the agency issues were generally attractive,
compared with rates on competing market instruments.
However, in anticipation of a heavy future calendar of
such issues, investors tended to proceed with caution be
fore committing their funds. While the offerings eventu
ally found buyers, dealer inventories of agency issues
bulged quite substantially at times.
113
O THER SE C U R IT IE S M A R K E T S
In the market for corporate bonds, prices were gen
erally steady to slightly higher during the first statement
week in April. Dealer inventories remained at relatively
low levels during this period and, as a result, underwriter
bidding for new corporate offerings was quite aggressive.
At the lower reoffering yields, however, investor demand
became selective. Subsequently, additions to the calen
dar of scheduled offerings were made and the volume
of current corporate bond flotations expanded. Against
this background, the new offerings encountered consider
able investor resistance. Syndicate price restrictions were
removed fairly quickly on most of the recent corporate
issues, after which yields were adjusted higher by as much
as 10 to 15 basis points before attracting some investor
demand. (The right-hand panel of the chart illustrates this
rise in yields.)
In the tax-exempt sector, prices held generally steady
through midmonth. New issues were accorded mixed in
vestor receptions. Later in the period, however, the vol
ume of new offerings and the calendar of scheduled
tax-exempt flotations expanded, and investors became
more reluctant to commit their funds at the prevailing
price levels. As a result, dealers in tax-exempt bonds
made little headway in reducing their unsold balances of
recent issues—even after making price concessions. By
the end of April, the Blue List of dealers’ advertised in
ventories of tax-exempt issues had risen by $190 million
to $523 million. The largest new tax-exempt flotation of
the month, a huge $242 million New York City offering
of various-purpose bonds, reached the market on April
28. Reoffered to yield from 3.60 per cent in 1967 to
4.16 per cent in 1996, the issue was accorded a good in
vestor reception.
Over the month as a whole, the average yield on
Moody’s seasoned Aaa-rated corporate bonds declined by
4 basis points to 4.95 per cent, while The Weekly Bond
Buyer’s series for twenty seasoned tax-exempt issues (car
rying ratings ranging from Aaa to Baa) rose by 3 basis
points to 3.62 per cent (see the right-hand panel of the
chart). These indexes are, however, based on only a
limited number of issues and do not necessarily reflect
market movements fully.
114
MONTHLY REVIEW, MAY 1966
Second District "Country” Member Banks and the
Federal Funds Market*
The national market for commercial bank balances at
the Federal Reserve Banks—better known as “the Federal
funds market”—has grown steadily in the past decade.1
Available data suggest that the typical daily volume of sales
in the market has more than tripled since late 1956, to per
haps as much as $3 billion in early 1966. Until the last two
or three years, the bulk of market activity was accounted
for by relatively few large banks. Since then, however, an
increasing number of smaller banks appear to have en
tered the market. Inasmuch as these institutions hold the
greater part of the banking system’s excess reserves, their
role has been most often as sellers, although to some extent
they have also acted as purchasers. An over-all indication of
the broadening participation in the Federal funds market by
smaller banks— at least on the selling side—is suggested by
the increase in the net sale of funds to the forty-six large
banks included in the Federal Reserve Board’s Federal
funds series by the rest of the commercial banking system.
On a daily average basis, these sales rose from about $250
million in late 1959 to some $500 million in 1962 and to
* William G. Colby, Jr., Economist, Statistics Department, and
Robert B. Platt, Economist, Bank Examinations Department, had
primary responsibility for the preparation of this article.
1 A distinguishing feature of Federal funds— and one which has
largely accounted for their increasing use as a medium for settling
financial transactions— is their immediate availability. That is to
say, in contrast to clearing house funds which are credited to mem
ber banks’ accounts at a Reserve Bank only after one business day,
banks acquiring Federal funds from other banks receive an imme
diate credit. Transactions in the Federal funds market in effect con
sist of the borrowing or lending of these balances, for one business
day, at a specified rate of interest. In market terminology, however,
such transactions are generally referred to as “purchases” or “sales”
of Federal funds. For detailed accounts of the structure and work
ings of the Federal funds market, see The Federal Funds Market,
Board of Governors of the Federal Reserve System (M ay 1959);
Dorothy M. Nichols, Trading in Federal Funds, Board of Gover
nors of the Federal Reserve System (September 1 965); and Parker
B. Willis, The Federal Funds Market, Federal Reserve Bank of
Boston (October 1 9 6 4 ).
over $1 billion in early 1966.2 In addition, specific evidence
of wider “country” bank participation in the Federal funds
market can be found in studies and reports by several Fed
eral Reserve Banks.3
A survey of country banks in the Second Federal Re
serve District taken recently by this Bank indicates that
the nationwide trend toward more widespread country
bank participation has also been evident among banks in
this District. This article summarizes the main findings of
the survey.
IN C R E A SE D E N T R Y OF C O U N T R Y B A N K S
IN T O T H E F E D E R A L F U N D S M A R K E T
In November 1965, the Federal Reserve Bank of New
York sent questionnaires to each of the nearly 400 country
member banks in the Second Federal Reserve District re
questing information on the extent of their participation in
the Federal funds market, the trading channels used, the
size of the trading unit, and the effects of participation on
these banks’ reserve adjustment practices. Responses were
received from about 98 per cent of the District’s country
banks. In addition, interviews were held with officers
responsible for managing the reserve positions in twenty
respondent banks, selected at random.
2 Net sales as used here are calculated as the differences between
gross purchases and gross sales reported by the forty-six banks.
The resulting amount represents funds that the reporting banks
on balance obtained from the nonreporting banks. Data on these
transactions are published regularly in the Federal Reserve Bulletin.
For a detailed discussion of the series, see “New Series on Federal
Funds”, Federal Reserve Bulletin (August 1 9 6 4 ).
3 For example, see Jack C. Roth well, “Federal Funds and the
Profits Squeeze— A New Awareness at Country Banks”, Business
Review, Federal Reserve Bank of Philadelphia (March 1 9 6 5 ), pp.
3-11, and Dorothy M. Nichols, “Marketing Money: How ‘Smaller’
Banks Buy and Sell Federal Funds”, Business Conditions, Federal
Reserve Bank of Chicago (August 1 9 6 5 ), pp. 8-12.
115
FEDERAL RESERVE BANK OF NEW YORK
The survey clearly points to a substantial amount of
participation in the Federal funds market by Second Dis
trict country member banks, with nearly half of these
banks reporting at least occasional trading in Federal funds
as of late 1965 (see Table I ).
As might be expected, the proportion of participating
banks was much higher in the larger deposit size-groups.
All responding banks in the $100 million and over deposit
category participated in the market, as did four fifths of
banks in the $25 million to $100 million category. Never
theless, over 30 per cent of the respondent banks with
deposits under $25 million reported some trading activity.
Moreover—and perhaps most significantly—the entry of
smaller banks into the market appears to have begun
fairly recently and to be spreading rapidly (see Table II).
While only three of the respondent banks which currently
have less than $25 million in total deposits were participat
ing in the market in 1960, the number reached seventynine by 1965, with the greatest part of the increase
occurring in the last two years. All the participating banks
with less than $5 million in deposits first traded Federal
funds during 1965, and nearly all the institutions in the
$5 million to $10 million deposit size-group entered the
market in either 1964 or 1965. In contrast, three quarters
of the participating banks presently in the over $100 mil
lion deposit group had participated in the market prior to
1960.
Second District country member banks as a group en
tered the Federal funds market more often as sellers than
as buyers—a characteristic that is in accord with the fact
that country banks are known to hold relatively high levels
of excess reserves. Indeed, most of the participating banks
in this District with less than $10 million in total deposits
entered the market only as sellers (see Table III). The
number of participating banks in the intermediate-size
range, $10 million to $25 million in deposits, was divided
fairly evenly between banks that just sold funds and banks
that acted both as buyers and sellers, while most banks with
deposits of $25 million or more traded at various times
on both sides of the market. Even among the banks that
both sold and purchased funds, however, the frequency
of transactions on the selling side generally was substan
tially greater than on the purchasing side. On average,
all participating banks sold funds nine days a month dur
ing 1965, and purchased funds only three days per month.
The banks were asked to indicate in which months of the
year their most frequent participation in the market oc
curred. The replies tended to divide about equally among
the twelve months. A few banks reported shifts from
periods of daily funds sales to periods of continuous pur
chases, and vice versa.
Table I
DISTRIBUTION OF RESPONDENT BANKS BY SIZE AND
PARTICIPATION IN THE FEDERAL FUNDS MARKET, 1965
Deposit size
Respondent banks
Number
Millions of dollars
Percentage of
total
Under 5 ......................................
Banks participating in
the market
Number
Percentage of
respondents
84
22
14
17
5 to under 1 0 ..........................
78
20
19
24
46
10 to under 25 ..........................
99
26
46
25 to under 1 0 0 ...........................
74
19
59
80
100 and over ................................
51
13
51
100
Total ...................................
386
100
189
49
Table n
NUMBER OF BANKS PARTICIPATING IN
THE FEDERAL FUNDS MARKET*
Years
Deposit size
Prior to
1960
Millions of dollars
Under 5 .....................
5 to under
10........
1960
1961
1962
—
—
—
—
—
—
—
1963
—
_ _
1964
14
—
1
1965
7
19
10 to under 25........
2
3
7
10
19
35
46
25 to under 100........
18
22
30
38
43
50
59
100 and over...............
39
43
44
48
50
50
51
Total ...................
59
68
81
96
113
142
189
* Banks are included in the above table in the year of their initial entry into the
market and for all subsequent years, whether or not they have participated
in each of those years. Almost all banks, however, participated in every
year following their initial entry.
Table HI
DISTRIBUTION OF PARTICIPATING
BANKS BY SIDE OF MARKET, 1965
Deposit size
Millions of dollars
Sellers only
Buyers only
Number Percent Number Percent
Both
buyers and sellers
Number Percent
Under 5 ..............................
9
64
2
14
3
5 to under 1 0 .................
15
79
1
5
3
16
10 to under 2 5 .................
22
48
4
9
20
43
3
25 to under 1 0 0 .................
14
24
100 and o v e r ........................
2
4
Total .............................
62
33
21
10
5
42
71
—
49
96
5
117
62
Note: Because of rounding, percentages may not add across to 100 per cent.
MONTHLY REVIEW, MAY 1966
116
TH E ROLE OF
C O R R E SP O N D E N T R E L A T IO N SH IPS
The forces underlying the increased participation by
smaller banks in the Federal funds market have been
present for some time. Perhaps most significant among
these has been the generally rising trend of short-term
interest rates over much of the postwar period. This de
velopment—combined with increasing banking costs—has
prompted banks to keep noneaming excess reserves at a
minimum, while at the same time inducing many of the
larger city banks to increase borrowing in the funds mar
ket to facilitate the maintenance of positions in relatively
high-yielding assets.
Until recently, however, these influences had only a
limited impact on the smaller country banks’ activity in
the market. In many instances, insufficient knowledge of
the opportunities presented by the Federal funds market
inhibited their participation. Moreover, the magnitude of
the usual unit of transaction— $1 million—largely pre
cluded entrance into the market by the smaller banks. This
is a larger amount than most of these banks would have
available for sale in the market or, on the other hand,
would require for temporary reserve adjustment. Some
trading at times took place in lesser amounts but, until
quite recently, the large money center banks and brokers
in Federal funds that form the nucleus of the Federal
funds market were not particularly anxious to deal in such
amounts, and indeed seldom bothered with transactions
of less than $500,000.4
In the more recent past, these impediments to country
bank participation in the Federal funds market have been
reduced by the efforts of the larger city banks to tap the
excess reserves of these smaller institutions. With this
end in view, the city banks—operating through their cor
respondent relationships—have spread information about
the Federal funds market and enhanced the attractiveness
of participation by providing the smaller banks with a
convenient and relatively certain outlet or source for the
sale and purchase of funds. Moreover, in order to accom
modate their correspondents, they have been willing to
trade funds in smaller units than in earlier years.
The part played by the larger banks in introducing their
correspondents to the market emerged clearly in the inter
views with the country bankers. According to these bank
ers, once a country bank began to trade in the market,
individual funds transactions were almost invariably
initiated by that bank; nevertheless, the first entry in the
market was often the result of advice and encouragement
on the part of a city correspondent.
TR A D IN G C H A N N E L S A N D U N IT SIZ E
OF T R A N SA C TIO N S
The continuing role of the correspondent relationship
was reflected both in the channels of trading used by
Second District country banks and in the unit size of trad
ing. The survey revealed that most of Second District
country bank transactions in the Federal funds market—
both on the sale and the purchase side—were conducted
with their city correspondents (see Table IV ). Inter
viewed bankers based their preference for trading with
correspondents partly on the rapport existing between the
country bank and its correspondent, resulting from years
of satisfactory relations, as well as on the familiarity of
the city bank with the smaller institution’s financial re
sources and needs. The convenience to country banks,
particularly the smallest institutions, of trading with cor
respondents appeared to be significantly enhanced by the
willingness of the larger city banks to accommodate them
on either the selling or buying side of the market as re
quired, and without regard to the current reserve needs
of the larger institutions themselves.
This desire on the part of the city correspondent banks
to accommodate the trading needs of the country banks
has also been reflected in the significant number of trans
actions that now take place in units involving less than
Table IV
DISTRIBUTION OF PARTICIPATING BANKS
BY FEDERAL FUNDS TRADING CHANNELS, 1965
Trading channels*
Deposit size
Number of Correspondents
banks
Brokers
Others
Per cent
Millions of dollars
Under 5 ............................
14
86
5 to under 10 .............
19
95
14
5
10 to under 25 .............
46
100
2
25 to under 100 .............
59
97
8
2
2
100 and o v e r ....................
51
92
35
10
A ll participating banks ...
189
95
13
5
4 See Howard D. Crosse, Management Policies for Commercial * Since some respondents used more than one type of intermediary, the totals
across may exceed 100 per cent.
Banks (Englewood Cliffs: Prentice Hall Inc., 1 9 6 2 ), p. 128.
FEDERAL RESERVE BANK OF NEW YORK
$1 million (see Table V ). Federal funds brokers, it may be
noted, still prefer to deal in units of $1 million or more.
Most transactions in the funds market nevertheless do
involve units of $200,000 or more. Some of the smaller
banks are often able to sell such relatively large units
at one time only by accumulating excess reserves up to
the closing days of their biweekly reserve averaging pe
riod, and then drawing down the reserve balances, some
times below their reserve requirements, with the resulting
modest deficiency offsetting the previously accumulated
excess. While this practice permits the profitable employ
ment of potentially idle resources, it is subject to some
constraint. Notably, a member bank is not permitted to
overdraw its reserve balances at its Federal Reserve Bank,
and should not deliberately incur large daily deficits.
117
Table VI
EFFECTS OF FEDERAL FUNDS ACTIVITY ON
RESERVE ADJUSTMENT PRACTICES
Number of participating banks according to
their ranking of effects*
Type of effect
First
Second
Third
Fourth
Fifth
Reduction in excess reserves......
116
42
10
2
0
Reduction in the use of Treasury
bills and other short-term in
struments ..................................
33
85
26
8
0
Reduction in borrowings from the
Federal Reserve .......................
28
27
38
8
0
Reduction in borrowings from
other banks (other than Federal
funds transactions) .................
1
6
19
16
0
Other ............................................
11
5
6
3
1
* Columns and rows may not add to 189, the total number of participating
banks, since many banks ranked fewer than five effects.
EFFECTS ON
RESERVE ADJUSTM ENT PRO CEDURES
Nearly all the surveyed banks participating in the mar
ket reported that their trading activity in Federal funds
has been accompanied by a reduction in their average
holdings of excess reserves—although the bankers that
were interviewed generally could not estimate the mag
nitude of the decline traceable to participation in the
market. One hundred and sixteen banks (over 60 per
cent of the total participating) specified that a reduction
in excess reserves has been the single most important
effect of their activity in the Federal funds market on their
reserve management practices (see Table V I). A majority
of banks also indicated that trading in funds has reduced
Table V
SIZE OF FEDERAL FUNDS TRANSACTIONS*
Sales
Purchases
Deposit size
Median
Millions of dollars
Under 5 .......................................
5 to under
10 ........................
Range
Median
Range
Thousands of dollars
225
50-
400
225
150-
300
50- 1,100
675
their reliance on purchases or sales of Treasury bills and
other money market instruments as a means of reserve
adjustment. Seventeen per cent of the respondent banks
singled out this development as the most important result
of their participation.5
In elaborating on the changes in reserve adjustment
practices resulting from their Federal funds activity, most
of the country bankers interviewed felt that purchases and
sales of Treasury bills and similar instruments were in
appropriate for putting idle resources to work for short
periods—such as within the two-week settlement period
—or for making up temporary reserve deficiencies. The
reluctance to purchase or sell bills for short-term reserve
adjustments was based primarily on the inconvenience to
country banks of trading these instruments. Some concern
was also expressed, however, over transfer costs and pos
sible losses resulting from declines in market prices. Ac
cording to several bankers, the reluctance to keep liquid
reserves in the form of Treasury bills had previously led
them to maintain excess reserves at a higher level than
they have found desirable since they began to use the
Federal funds market as a convenient and flexible outlet
350- 1,000
750
10 to under 25 ........................
600
60- 4,000
500
150- 1,000
25 to under 100 ........................
1,000
300- 5,000
1,000
400- 3,000
100 and over ................................
3,000
500-20,000
3,000
300-15,000
All participating b an k s...............
1,000
50-20,000
1,250
150-15,000
* The respondent banks reported their average-transactions size during 1965.
This table presents the medians and the ranges of these reported averages.
5 Among other effects of Federal funds activity noted by respon
dent banks were reduced borrowings from the Federal Reserve and
borrowings from banks other than through the Federal funds mar
ket. These results, however, were generally considered by the banks
to be o f substantially less importance than the reduction in excess
reserves or the use of Treasury bills.
118
MONTHLY REVIEW, MAY 1966
for idle funds. Similarly, banks that did employ Treasury
bills and other short-term instruments as secondary re
serves have tended to substitute Federal funds sales for
such short-term investments since their entry into this
market.
The country banks thus clearly prefer Federal funds
sales to holdings of Treasury bills as a short-term invest
ment. This is particularly true for the smaller banks, which
often indicated during the interviews that “moderate”
differentials in interest rates in favor of Treasury bills
would not induce them to substitute such instruments for
Federal funds sales. Larger country banks also were re
luctant to substitute bills for funds, although they ex
pressed a greater sensitivity to rate differentials in
choosing among short-term investment outlets.
CO NC LUDING C O M M E N T S
The Federal funds market has filled an important gap
in the array of money market instruments available for
the investment of idle reserve balances. Its development
reflects the increasing attention being given throughout
the economy to the efficient utilization of financial re
sources—even for very short periods of time—resulting
in good part from the relatively large loss of interest earn
ings involved in holding idle balances. For country banks
in particular, access to the Federal funds market has
enabled these banks to put otherwise idle funds to profit
able use. It has also brought the country banks into closer
touch with the centers of financial activity, thereby pro
moting a more integrated financial system.
