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FEDERAL RESERVE BANK OF NEW YORK

99

Banking Supervision and Monetary Policy
By A l f r e d H a y e s
President, Federal Reserve Bank of New York

An address before the seventy-second annual convention of the
New Jersey Bankers Association in Bermuda on April 22, 1 9 7 5

It is a real pleasure to join our Philadelphia colleagues
in this traditional luncheon meeting with our many good
friends of the N ew Jersey Bankers Association— and it is
especially pleasant to do so in this lovely setting of Ber­
muda. A s Mr. Eastburn has said, this is the last occasion
I will have to address you in my capacity as President of
the Federal Reserve Bank of N ew York. I have valued
your friendship and your support in our many joint efforts
looking toward better banking and better central banking
over the years.
Since I saw you a year ago we have all been through
a trying and difficult period, as the economy has ex­
perienced not only the deepest recession of the post­
war years but also a period of virulent inflation coupled
with peak interest rate levels. The worst of the inflation
now seems to be behind us, and it is my hope and belief
that business will be well on the road to recovery before
many months have passed. But, while the severity of the
recession and its financial ramifications are still very
much on our minds, it may be well to reflect briefly on
some of the lessons that have been pointed up more
sharply than they had been in more stable and prosperous
times. And I would like to dwell particularly on the rela­
tionships between the commercial banking system and the
Federal Reserve in the latter’s functions as the nation’s
monetary authority and as one of its principal bank su­
pervision agencies.
At the outset, let me stress the mutuality of our interest
in a healthy growing economy and a healthy growing
banking system. As far as the Federal Reserve is con­
cerned, our overall objectives are spelled out in broad
terms in the Federal Reserve A ct and in the Employment
Act of 1946, and they are objectives to which I am con­
fident all of you would subscribe— sustainable economic




growth, full employment, stable purchasing power, provi­
sion of an elastic currency, provision of the functions of
the lender of last resort, and maintenance of a sound
banking system. By tradition and widespread agreement,
the maintenance of reasonable balance-of-payments equi­
librium has also been added to these objectives. Of course
it is not always easy to serve all of these objectives at
once. There must be a constant weighing of values— and
all of us face serious dilemmas from time to time— but this
is inevitable, and it underlines the vital importance of
judgment, whether one is a commercial banker or a cen­
tral banker. Judgment can never be satisfactorily replaced
by easy automatic formulas, tempting though it may be
to seek such simplistic guides.
As you well know, monetary policy operates through
the banking and financial systems to ensure that the flow
of money and credit is sufficient to foster sustainable
growth of economic activity, but not so abundant as to
foster excess demand and inflation; and of course the com ­
mercial banking system is affected most directly by our
policies. It is essential that our banking and financial insti­
tutions remain strong and effective, since a weak and
inefficient financial system would constrain or blunt the
impact of monetary policy and would also impede the
nation’s economic progress. It follows that the Federal
Reserve must take a keen interest in the soundness and
efficiency of individual banking institutions and their
ability not only to withstand the impact of adverse eco­
nomic and financial developments but also to continue
to meet the credit and deposit needs of the public.
Since ours is essentially a market economy, the chan­
neling of money and credit rests primarily in the hands of
bankers and other private lenders, who compete with one
another as they determine the relative creditworthiness of

100

MONTHLY REVIEW, MAY 1975

various borrowing needs. Whatever influence the Federal
Reserve exercises is focused on overall monetary and
credit conditions rather than on the channeling or alloca­
tion of funds. In my view, it is hard enough for the
central bank to determine and achieve desirable total flows
of money and credit without becoming involved in credit
allocation. N ot only would such allocation complicate
enormously an already very demanding assignment, but
it would also place the Federal Reserve in a position of
deciding social priorities that are better left to political
bodies such as the Congress. It also seems to me that
credit-allocation devices are seldom effective for very
long, in part because the credit markets are so highly
interdependent. Attempts to increase the supply of credit
for any one sector set in motion market forces, such as
interest rate changes, and a search for new financing
instruments and techniques, which over time tend to
negate allocative efforts. I recognize that voices have been
raised in various circles favoring an activist role for the
Federal Reserve in this area, but I remain decidedly
unconvinced.
Since this credit-channeling function is now performed
primarily by private financial markets, you bankers have
a heavy responsibility to see that your portion of these
credit flows contributes to a vigorous and healthy econ­
omy. And now that business recovery is so essential, you
have every reason to assist in this recovery by meeting
the legitimate credit needs of business firms and other
borrowers. In this connection, some of my banker friends
have recently indicated some uncertainty as to the rela­
tionship between an accommodative overall monetary
policy, such as the Federal Reserve has been pursuing for
some months, and the earlier admonitions from the central
bank urging greater attention to liquidity, asset condition,
and capital adequacy. Actually I see no real conflict be­
tween these forces. The banking system must play a major
part in financing recovery, but there will inevitably be
differences in the ability of individual banks to do so in
the light of their own financial condition.
Bankers have an obligation to appraise the impact of
their credit operations and liability management practices
on the financial strength of their organizations and on
their ability to withstand the temporary, but often severe,
adjustments that can occur in a changing economic envi­
ronment. Certainly the current recession has carried further,
and financial strains have been greater, than most observ­
ers would have predicted a year or so ago. But the wiser
bankers had provided themselves with a comfortable
margin of safety to tide them over the economic and
financial strains of the past year.
It is also true, however, that in attempting to satisfy




the inflated credit demands of the early seventies some
banks allowed their liabilities and assets to expand much
more rapidy than their capital. In too many of these banks,
I fear that this reflected overemphasis on a “go-go” philos­
ophy, which placed too much emphasis on the “bottom
line” and not enough on building basic strength as a bul­
wark to withstand a deteriorating economic environment.
Adequate capitalization is essential to banks in the perfor­
mance of their function as the nation’s principal suppliers
of money and credit. And, if capital deficiencies show up,
action to remedy them is called for.
I realize that the very conditions that have caused
awareness of capital deficiencies have also made it difficult
for banks and bank holding companies to acquire new
capital. I am also aware that the disclosure requirements
of the Securities and Exchange Commission (S E C ), as
now applied to banking organizations, are making it quite
difficult for them to raise funds in the capital markets.
While no one questions the need for sufficient disclosure
to provide adequate protection for investors in the securi­
ties of banking organizations, it also seems clear that
the same standards cannot be applied indiscriminately to
banking organizations and industrial companies. The bank­
ing system has the unique function of creating deposits
and money— a function which has long been recognized
as so essential to the country’s well-being as to require
special legislative and regulatory treatment. The principal
goal of banking legislation and regulation has been to
insure the integrity of the nation’s money supply and
financial system, with special emphasis in this regard on
depositor protection. Thus, I think there is a need for
greater cooperation between bank supervisors and the
SEC in an effort to develop standards pertaining to the
securities issues of banking organizations that are realistic
and equitable to all concerned.
I believe that these problems can and will be resolved
and that banks and bank holding companies will find
opportunities for raising new capital through the sale of
debt and equity instruments in periods in which pressures
in the nation’s capital markets have eased. At the same
time, banks should take a hard look at their dividend
policies from the point of determining the best balance
between internal and external sources of funds to meet
their needs. For example, as bank profits have improved,
a number of banks have been able to pare payout ratios
without reducing dividends. In addition, banking organi­
zations should not be deterred from raising equity capital
merely because current market prices are below book
values. Perhaps bankers should take a cue from those
public utilities which have recently raised new equity
capital through successful common stock offerings. Some

FEDERAL RESERVE BANK OF NEW YORK

dilution of the existing equity interest may be a price well
worth paying, for a strong equity base deserves a high
priority in the thinking of banks’ senior management and
is surely in the long-run interest of the shareholders.
The dilution of equity can of course be avoided if banks
build equity capital out of earnings. Banks should intensify
their efforts toward increasing earnings by trimming oper­
ating expenses and curtailing marginally profitable activ­
ities, but more especially by pricing their products
realistically. I have in mind the fact that banks have
for many years been liberal in establishing lines of credit
without fees and have charged too little in fees for loan
commitments. The banks, like the proverbial grasshopper,
found to their regret that fees paid for commitments con­
tracted in the “summer” conditions of 1971 and 1972
represented bargain prices for access to credit in the
“winter” conditions of 1973 and 1974. I was pleased to
see the trend toward higher commitment fees which began
last year. I might also add that there are many in the Sys­
tem— and I include myself among them— who would, over
time, favor some easing of the reserve requirement burden
borne by Federal Reserve member banks as an aid to
improving their capital positions.
Needless to say, a bank’s capital needs as viewed by
the regulators are importantly affected by the quality of
the bank’s assets and the nature of its liabilities. Both
bankers and regulators share a common interest in seeing
that the quality of bank assets is maintained at high levels.
Of course there are certain factors bearing on asset quality
that are not under the immediate control of individual
banking organizations. The percentage of loans involving
delinquency by the borrowers typically rises in periods
of economic strain and recession, and the present episode
is no exception. To the extent that banks’ asset quality
has suffered as a result of the general softening of the
economy, there should be a marked overall improvement
once the national economy begins to recover. Meanwhile,
bank regulators must “call the shots as they see them”
and cannot lower their standards because the recession
has spread a certain degree of loan weakness fairly widely
throughout the banking community.
I should emphasize that, despite these loan troubles,
I believe the nation’s banking system is sound and in a
good position to meet the changing economic and financial
needs of the country. In this regard, the recent substantial
increase in deposit insurance has helped to assure the
public of the continued strength of the banking system.
While some problems still remain, I think the worst is
behind us. For example, the latest report of the Federal
Deposit Insurance Corporation indicated that 183 banks
required “close supervision” at year-end 1974, but these




101

banks represented only 1.3 percent of all insured banks
and about 1 percent of total deposits. We expect that the
problems of these banks will not result in disruption of
banking services to the public, or have any adverse impact
on the overall strength of our banking system.
We have all been impressed with the international na­
ture of some banking problems, and banking authorities
in other countries are also interested in ensuring the
strength of their own banking systems. Since the foreign
exchange losses experienced last year, banks all over the
world have taken a more cautious view of foreign ex­
change operations. In this country, authorities are
strengthening examination techniques relating to foreign
exchange operations, and are monitoring positions for indi­
cations of any tendencies toward undue exposure. The
Federal Reserve System is also cooperating with other
central banks in an attempt to develop an early warning
system for banking problems that might have significant
international effects. The Federal Reserve Bank of New
York’s action last summer in purchasing the foreign ex­
change book of the Franklin National Bank was motivated
in part by a desire to prevent the international difficulties
that might have stemmed from the Franklin National
Bank’s inability to deliver the foreign exchange for which
it held forward contracts.
Let me say a word about the Federal Reserve’s role as
“lender of last resort”. The System has demonstrated in
a number of recent instances, notably in the case of the
Franklin National Bank, its ability to cope effectively with
severe liquidity problems in troubled banks, and the
System’s very effectiveness in such efforts has tended to
cause a number of nonfinancial corporations and political
entities to look to the System for help when they have
found themselves in difficulties. However, the Federal
Reserve is by its very nature better equipped to handle
the problems of financial institutions than those of non­
financial firms or political bodies. Moreover, it is worth
pointing out that Federal Reserve credit is not available
on a long-term basis to any institution, financial or non­
financial. Rather, it serves to provide needed liquidity
to creditworthy borrowers in temporary emergencies until
more permanent financing can be arranged, and only if
the failure of the borrower would have broad financial
conscquences. There are strict statutory limitations on the
Federal Reserve’s power to make emergency credit avail­
able, not least because Federal Reserve credit serves as
the base for the creation of money and bank credit.
The financial difficulties encountered by various organi­
zations in the past few years have led to a good deal of
thinking about the possible need for a new Government
agency, modeled perhaps along the lines of the Recon­

102

MONTHLY REVIEW, MAY 1975

struction Finance Corporation, to provide intermediateor long-term credit to important elements of our national
economy having financial difficulties and finding them­
selves unable to obtain needed credit from existing private
or public sources. There has been wide disagreement, how­
ever, as to the desirability of such an agency, with the
opponents citing the danger of political abuse of such
credit facilities and possible squandering of public funds
on enterprises that might better be left to sink or swim
on the basis of their degree of access to normal market
funds. I recognize the risk of abuse, but on balance I find
that the advantages of having such an emergency lender
in the wings probably outweigh the disadvantages. I
would emphasize, however, that I am expressing a purely
personal view.
One question that has been receiving a great deal of
attention recently is whether some change would be appro­
priate in the structure of the Federal bank regulatory
framework in the interest of greater efficiency. Certainly
a good case can be made for less dispersion of authority,
but it is certainly not easy to find a solution that will
meet all needs. The suggestion that the Federal regulatory
and supervisory authority be centered in the Federal
Reserve has encountered much opposition on the ground
that combining all Federal supervisory authority with the
responsibility of conducting monetary policy would con­
stitute too great a concentration of power. On the other
hand, I have been impressed, especially in the last few
years, by the very close relationship between bank regu­
lation and the exercise of monetary policy. The central
bank has a direct interest in seeing that supervision is
such as to provide a sound and efficient financial environ­
ment in which monetary policy can operate effectively.
Moreover, the close familiarity with banking problems
acquired through our bank supervision certainly permits
a more intelligent implementation of monetary policy
than would be possible if we were operating in more of an
“ivory tower” atmosphere. N o matter what solution is
found, the Federal Reserve should have a major part to
play in any more unified Federal supervisory structure.
As for the general economic outlook, I can see real
grounds for optimism. The recession would appear to be
following a customary cyclical pattern, with some con­
structive forces already at work in the form of diminished
inflation, some strengthening of consumer buying, progress
in achievement of a better inventory balance, and easier
credit conditions that should bring gains in many eco­
nomic sectors, including housing. On the other hand, now
that the Congress has passed and the President has signed
a bill to provide fiscal stimulus, there remains a serious
risk that the Federal deficit may ultimately grow so large




as to interfere with the financing of private credit demands
and to rekindle inflationary fears. Obviously, this situa­
tion calls for a high degree of caution in keeping Federal
spending under control.
On the international front, I am heartened by what I
take to be an increasing awareness that the dollar’s posi­
tion in exchange markets deserves the close and solicitous
attention of United States financial authorities. While the
sudden emergence of huge current-account surpluses in
oil-producing countries and huge deficits in oil-importing
countries is still causing very real economic and financial
difficulties for many countries, at least the magnitude of
the problem is less than was feared only a few months
ago, primarily because the world has learned to economize
considerably in its use of petroleum and the oil-producing
countries have been able to step up their imports and
investments much more rapidly than most observers
thought possible. Furthermore, the oil-producing nations
have shown a willingness to grant sizable amounts of aid
to less developed countries.
I might add that many people have been unduly pessi­
mistic regarding the United States balance-of-payments
position. I believe that the weakness of the dollar has
been exaggerated in recent months, and the foreign ex­
change markets have tended to overlook a major improve­
ment in the United States trade balance, reflecting a
greater competitiveness of United States exports. In part,
the dollar’s weakness during the winter months was at­
tributable to a temporary cyclical widening of the spread
between interest rates here and abroad, which has tended
to mask the underlying improvement in our payments
position. I have been confident that a more realistic as­
sessment of the United States balance of payments would
soon come to the fore, and I have been gratified by the
buoyant trend of the dollar rate in recent weeks.
We still face some danger that disruptive financial events
here at home or abroad might interrupt the prospective
improvement of the economy. The coming months will call
for a prudent balance between policies of expansion and
policies of consolidation, and nowhere will this need for
balance be more marked than in the banking business. All
of us— bankers and central bankers alike— have been
through a profoundly sobering experience in the past few
years. I trust that we shall make the most of that experi­
ence in coping with the economic developments that lie
ahead. Indeed, the years ahead will not be easy ones.
Taming the inflation which has plagued us for the past
decade will require a long period of disciplined and sus­
tained effort. I am confident, however, that my colleagues
at the Bank, in the System, and in the banking community
will measure up to tomorrow’s problems and challenges.

FEDERAL RESERVE BANK OF NEW YORK

103

The Business Situation
Economic activity has continued to decline, extending
the duration of this most severe of the postwar recessions.
In recent months the contraction has been primarily the
result of a massive turnaround from inventory building to
inventory liquidation, as firms have attempted to bring
stocks into line with sales. The inventory correction cur­
rently under way is an essential element in setting the stage
for future recovery. While the timing of the recession’s end
remains uncertain, a few encouraging signs have begun to
appear in the economy. Consumption spending in recent
months has shown tentative signs of renewed strength.
While post-rebate car sales have been disappointing, the
freewheeling fall in automotive sales appears to have bot­
tomed out. Moreover, consumers have actually stepped up
their purchases of other goods and services. N o doubt fur­
ther impetus to consumption spending will come from the
recently passed tax reductions, which will add about $20
billion to disposable income. In addition, the substantial
recovery in the stock market, amounting to more than 40
percent since early December, will probably also contribute
to some pickup in consumer spending.
In the first quarter, reai gross national product (G N P)
dropped at a 10.4 percent annual rate, the steepest quar­
terly decline on record, to a level 7.5 percent below the
peak attained at the end of 1973. While reductions in busi­
ness fixed investment and residential construction contrib­
uted to the first-quarter fall, substantial inventory disinvest­
ment was the major factor. Although inventory liquidation
will probably persist for some time, it is unlikely to exert
such a large drag on overall activity again. Conditions in
the labor market deteriorated somewhat further in April
as the unemployment rate rose from 8.7 percent to 8.9
percent. However, total employment increased for the first
time in seven months.
In recent months, there has been noticeable improve­
ment in the price situation. The implicit price deflator for
GNP rose at an 8 percent annual rate in the first quarter,
the slowest advance since the second quarter of 1973.
Much of this deceleration reflected the sharp plunge in
farm prices. The implicit price deflator for the private




nonfarm business sector increased at an 11.8 percent an­
nual rate in the first three months of the year, down only
modestly from the 13.2 percent rate of inflation recorded
in the last quarter of 1974. Wholesale prices of industrial
commodities have lately shown significant improvement,
however. During the first quarter, these prices increased
at a 5 percent annual rate, on average, well below the
7.9 percent advance of the previous quarter. In contrast,
the slowdown in the rise of retail prices was much less
pronounced. In all likelihood, however, the full impact
of the moderation in nonfood wholesale .prices has not yet
been registered at the consumer level.

G R O SS NATIONAL P R O DUCT A N D
RELATED DEVELOPM ENTS

According to preliminary data released by the Depart­
ment of Commerce, the market value of the nation’s
output of goods and services declined by $11.7 billion
during the first quarter to a seasonally adjusted annual
rate of $1,419.2 billion. This amounted to a 3.2 percent
annual-rate decline and was the first drop in nominal GNP
in over fourteen years. Moreover, after correcting for
changes in the price level, real GNP fell at a 10.4 percent
annual rate, the fifth consecutive quarterly decline in real
output and the sharpest quarterly reduction on record.
(Quarterly GNP data extend back to 1946.) Thus far,
real output has fallen 7.5 percent below the peak attained
at the end of 1973.
The sizable liquidation of inventories was the most
important factor affecting GNP in the first quarter (see
Chart I ). According to preliminary estimates based on
partial data, total business inventories were pared at an
$18 billion annual rate, creating a huge $35.8 billion
swing from the rate of investment in the previous quarter.
In contrast, current-dollar final expenditures— GNP ex­
cluding inventory investment— actually rose by $24 bil­
lion in the first quarter, compared with an increase of
only $5.5 billion in the fourth quarter of 1974.
The liquidation of excess stocks was spread across all

104

MONTHLY REVIEW, MAY 1975

for the nonfarm sector climbed to the highest level since
1952 (see Chart II). Moreover, according to the March
RECENT CHANGES IN GROSS N A T IO N A L PRODUCT
survey
of the National Association of Purchasing Man­
A N D ITS C O M PO N E N TS
S eason ally adjusted
agement, about 50 percent of the respondents reported
that they expected to continue working off excess stocks in
C h a n g e fro m th ird to
■ ■ ■ C h a n g e from fo u rth q u a rte r 1974
fo u rth q u a r te r 1974
to first q u a rte r 197 5
coming months. While this suggests that further inventory
liquidation is in prospect, there is a basis for believing that
the worst has passed and that inventory investment will be
a less severe drag on the economy in the months ahead.
Indeed, disinvestment in the first quarter was so large that
inventories would have to be reduced at three times the
$ 18 billion annual rate of the first quarter to exert an equal
drag on GNP.
Personal consumption spending exhibited renewed
growth in the first quarter, rising by $20.5 billion. While
in real terms the increase amounted to a modest $4.1
billion, this was still a vast improvement over the huge
$19 billion plunge that occurred in the previous quarter.
To a large extent, this pattern reflected the movements
in consumers’ purchases of durable goods, particularly
automotive goods. However, even excluding autos, con­
sumer durables spending managed to post a modest
advance in the first quarter. The anticipation of the
income tax rebates, as well as the publicity given to wide­
spread price rebate programs, was probably influential in
boosting consumption. Moreover, these factors may also
have contributed to some recent improvement in consumer
-4 0 -3 5 -3 0 -2 5 -2 0 -1 5 -1 0 -5
0
5
10 15 2 0 2 5
Billions of d ollars
attitudes. For instance, The Conference Board survey
conducted
during January and February pointed to a rise
S o u rc e : U n ite d State s D e p a rtm e n t o f C o m m e rc e , B u re a u o f E conom ic A n alysis.
in consumer sentiment of 11 percentage points. In coming
months, consumption spending should receive additional
impetus from the recently passed tax reductions. In all,
about $20 billion will be added to disposable income in
1975, of which $8 billion will be derived from the income
the major sectors. Stocks of durable and nondurable tax rebates. While consumers initially may choose to save
manufactured goods were reduced $11.2 billion and $6.8
this increment or use it to repay debt, it may eventually
billion, respectively, while farm inventories fell $1.6 be used to purchase goods and services that they might
billion at an annual rate. All the rundown in durables not otherwise have purchased. Consumption spending will
stocks occurred in the automotive sector. Last November, no doubt be a key element determining both the timing
faced with a sales slump and a record 102 days’ supply and vigor of the prospective economic recovery.
of automobiles, domestic manufacturers drastically cut
Residential construction spending declined by $5.2
production. However, little dent was made in the overhang billion in the first quarter, leaving expenditures on new
of unsold automobiles until the price rebates on new cars housing about 40 percent below the peak reached in the
were instituted in January. Sales then perked up in re­ second quarter of 1973. Much of the decline, however, is
sponse to the lower effective prices, and car inventories
attributable to the sharp slide in housing starts that oc­
were gradually drawn down, easing to 68 days of sales by curred throughout the second half of 1974. New housing
the end of March. Despite this correction, the stock of non­ starts leveled off during the first quarter at an average
farm inventories, including unsold automobiles, still ap­ annual rate of 988,000 units. This is well above the de­
pears to be on the high side, and some further paring will pressed December figure of 880,000 units and suggests
undoubtedly take place in coming months. In the first that the bottom of the current housing slide may have
quarter, based on GNP data, the real inventory-sales ratio been reached. With a sizable volume of funds flowing




C h art I

FEDERAL RESERVE BANK OF NEW YORK

into thrift institutions, housing should receive some
stimulus in coming months. In the first quarter the
nation’s thrift institutions are estimated to have gained
deposits at a rate more than double that averaged over
the last half of 1974. Despite these inflows, an outright
advance in new home construction has not yet developed.
Before the long-awaited recovery can begin, thrift
institutions will have to rebuild their liquidity positions
and the large backlog of unsold new homes will have to
be reduced. Building permits continued to fall during the
January-March period, declining to the lowest level on
record.
Business fixed investment fell by $3.8 billion in the
January-March period, the first outright decline since a
strike in the automobile industry depressed business in­
vestment in the last quarter of 1970. In real terms, the
drop was even greater, as constant-dollar expenditures on
structures fell by $0.8 billion, while spending on equipment




105

declined by $4.3 billion. Businesses have apparently re­
duced their capital spending plans as well. According to
the most recent Commerce Department survey, taken dur­
ing January and February, spending on new plant and
equipment is expected to rise 3.3 percent in 1975. Not
only is this less than the 4.6 percent rise projected in the
preceding Commerce survey but, after allowing for
expected increases in capital goods prices, it also repre­
sents an 8.5 percent decline in real business outlays. The
latest McGraw-Hill survey also projects that real capital
spending will fall in 1975 but only by 5 percent. In
current dollars, business spending reportedly will rise by
5 percent over the 1974 level with more than half the
total amount allocated toward modernization and replace­
ment of plant and equipment rather than expansion. This
reluctance to add to capacity is not surprising since a
great deal of idle capacity currently exists. In the first
quarter, manufacturers were producing at only 68.3 per­

106

MONTHLY REVIEW, MAY 1975

cent of capacity and, in the sensitive major materials
industries, plant utilization fell to 70.7 percent, the lowest
level since the second quarter of 1958. In any event, the
rise in the investment tax credit included in the tax-cut
legislation might provide some stimulus to investment later
in the year.
Government purchases of goods and services rose by
$9 billion in the first quarter, compared with $11.5 bil­
lion in the previous quarter. Federal outlays advanced by
$3.2 billion, or less than half the increase posted in the
fourth quarter, while state and local outlays rose by
$5.8 billion. In real terms, outlays at each level advanced
by $ 1 billion.
Finally, net exports rose by $3.5 billion in the JanuaryMarch period despite the fact that both exports and im­
ports declined. A $4 billion reduction in exports was due
entirely to a drop in exports of services. Agricultural ex­
ports increased sharply during the first quarter, while
exports of other goods remained strong. Meanwhile, im­
ports fell by $7.6 billion, the second consecutive quarter
in which imports have declined. With the exception of
capital goods, imports of all goods and services were
weaker. Petroleum imports, which fell by 12 percent
during the January-March period, registered the sharpest
drop. If anything, the overall improvement in net exports
suggests that the recession has been more severe in the
United States than it has been abroad.
PRICE D E V E L O P M E N T S

Inflationary pressure showed further signs of easing in
the first quarter. As measured by the implicit GNP de­
flator, prices of goods and services rose at an 8 percent
seasonally adjusted annual rate. Although this remains
intolerably high, it was sharply below the 14.4 percent
advance of the previous quarter and was the slowest
rate of advance since the second quarter of 1973.
However, this improvement was distorted somewhat by
the dramatic fall in farm prices. Thus, the implicit price
deflator for the private nonfarm economy rose at an 11.8
percent annual rate in the January-March period, a mild
improvement over the 13.2 percent increase recorded in
the final quarter of 1974 (see Chart III). The fixedweight GNP price index, which is unaffected by changes
in the composition of output, rose at a 7.1 percent sea­
sonally adjusted annual rate, compared with a 12.4 per­
cent gain in the previous quarter.
Consumer prices rose at a 6.4 percent seasonally ad­
justed annual rate in the first quarter, down substantially
from the 9.8 percent advance recorded in the previous
quarter. The slowdown was mainly attributable to a mild




C hart III

THE IMPLICIT A N D PRIVATE N O N FA R M G NP DEFLATORS
Changes from previous q u a rte r at s e a so n ally adjusted a n n u a l rates
Percent

S ource:

Percent

U n ited State s D e p a rtm e n t o f C o m m erce , B u reau o f Econom ic A n a ly s is .

3.7 percent annual-rate rise in consumer prices during
March, the smallest monthly advance since July 1973
when a partial price freeze was in effect. Responding to
earlier declines at the wholesale level, retail food prices
fell at a 6.3 percent annual rate in March. In addition,
nonfood commodity prices rose at a 7.4 percent annual
rate during the month, well below the 11.3 percent ad­
vance recorded in the last half of 1974. Finally, prices of
consumer services increased at a 4.4 percent annual rate
in March, compared with the 9.4 percent advance posted
over the last six months. The moderation was due largely
to a decline in mortgage interest rates.
Wholesale prices fell at a 6.8 percent seasonally ad­
justed annual rate in the first quarter, in sharp contrast
to the 12.7 percent advance posted in the previous quar­
ter. While the decline was centered in agricultural prices,
which fell at a 33 percent annual rate during the JanuaryMarch period, there was also a noticeable moderation in
price increases for industrial commodities. During the first
quarter, wholesale industrial prices rose at a 5 percent
annual rate, well below the 7.9 percent advance that oc­
curred in the fourth quarter of 1974. With prices of crude
materials excluding food and feed declining at a 7.7 per­
cent annual rate in the first quarter, further moderation in
industrial prices appears likely. Moreover, the fact that
wholesale prices of consumer finished goods rose at only a
4.9 percent annual rate in the first quarter suggests that
there will be further relief at the retail level as well.

FEDERAL RESERVE BANK OF NEW YORK

PRODUCTIVITY, W AGES, A N D E M P L O Y M E N T

Despite the economic slump, cost pressures apparently
mounted during the first quarter, as compensation per
hour worked in the private economy rose at a 10.4 per­
cent seasonally adjusted annual rate. This sizable increase,
when adjusted for the slowdown in consumer prices,
enabled real hourly compensation to rise modestly after
two consecutive quarterly declines. Output per hour
worked, which typically begins rising during the latter
stages of economic contractions, edged up at a 0.6 percent
annual rate in the January-March period. However, this
was due to a sharp increase in farm productivity, which
more than offset a further decline in productivity in the
nonfarm sector. As a consequence of these changes in
compensation and output per hour worked, unit labor
costs rose at a 9.7 percent annual rate in the first quarter.
According to a separate survey of collective bargaining
agreements covering 5,000 or more workers, agreements
reached in the first quarter provided for a 13 percent
annual rise in wages and benefits in the first year of the
contract and a 7.5 percent gain over the life of the con­
tract. Evidently, unions are still striving to make up for
previous losses in real earnings as a result of inflation. For
wages alone, first-year increases amounted to 12.5 percent
while life-of-contract settlements provided for a 7.7 per­
cent annual increase. The most lucrative settlements were
negotiated in nonmanufacturing, but contract settlements
in manufacturing, where unemployment has been espe­
cially severe, also were quite liberal. Settlements in the
construction industry were modest, partly because of the
small number of contracts that were signed during the
period. Effective wages— which include gains arising from
current settlements, deferred increases negotiated in earlier
years, and additional gains resulting from escalator clauses




107

— increased at a 6.1 percent annual rate during the first
quarter, after rising 9.4 percent in all of 1974. Only 2
percent of the first quarter’s advance was attributable to
current decisions as opposed to 4.8 percent in 1974. Pre­
vious settlements accounted for another 2.4 percent, while
only 1.6 percent resulted from escalator provisions.
Labor market conditions deteriorated somewhat further
in April, although there was a gain in total employment.
According to the household survey, the civilian labor
force rose sharply by 433,000 persons in April after grow­
ing very little over the previous six months. Apparently,
many workers had either dropped out of the labor force
or delayed their entry because of the dismal job situation.
Meanwhile, the number of persons employed rose by
237,000 in April, the first such increase since last Septem­
ber. This rise was less than the growth in the labor force,
however, so that the seasonally adjusted unemployment
rate rose by 0.2 percentage point to 8.9 percent in April.
A ll labor force groups shared in this rise in joblessness.
At 5.6 percent, the jobless rate for married men was the
highest since August 1958. The nonwhite unemployment
rate climbed to 14.6 percent in April, while the white
jobless rate rose 0.1 percentage point to 8.1 percent.
According to the payroll survey of establishments, sea­
sonally adjusted nonfarm payroll employment dropped
slightly in April. Of course, the household and payroll
surveys often diverge in a particular month because of
sampling and coverage differences; however, over longer
periods they tend to show comparable changes. Manu­
facturing employment fell by 96,000 workers in April,
but the decline was much smaller than it had been in
previous months. The stepped-up pace of automobile
production in April led to some reduction in layoffs in
this industry. Employment fell slightly in the construc­
tion and public utilities industries in April, while jobs in
government, trade, and services increased.

108

MONTHLY REVIEW, MAY 1975

Monetary and Financial Developments in the First Quarter
Private demands for short-term credit remained sluggish
in the first quarter of 1975, while credit availability became
more plentiful. As a result, short-term interest rates fell
sharply through most of the quarter, although the declines
moderated as the period drew to a close. In addition, the
monetary authority’s restrictions on the banking system
eased considerably, and the average effective rate on Fed­
eral funds dropped from 8.53 percent in December to 5.54
percent in March, the lowest monthly level since December
1972. Similar declines were registered in rates on commer­
cial paper, bankers’ acceptanccs, large-denomination certif­
icates of deposit (C D s), and on most other money market
instruments as well. On three separate occasions during the
quarter, the Board of Governors of the Federal Reserve
System approved reductions of J/2 percentage point in the
discount rates charged at the twelve Federal Reserve
Banks, and by mid-March the discount rate had reached
6X
A percent. During the quarter the Board also reduced
reserve requirements on net demand deposits at member
banks by between Vi and 1 percentage point.
In the long-term debt markets, yields fell initially but
turned around in late February and by the end of the
period were at levels approximately equal to those in early
January. Long-term yields were strongly affected by both
huge Treasury borrowing during the quarter and the pros­
pects of even heavier borrowing over the remainder of the
year. This development encouraged many corporations to
advance their financing plans so as to fulfill their foresee­
able needs for funds at prevailing interest rate levels. The
result was a record quarterly volume of corporate borrow­
ing on top of an unusually heavy Treasury schedule. In
the municipal sector, the volume of new borrowing was
moderate, but developments in other long-term debt mar­
kets put upward pressure on yields over the second half
of the quarter. In addition, yields on some tax-exempt
securities were affected by the financial difficulties of the
New York State Urban Development Corporation and by
concern over the financial position of New York City.
The overall growth of the narrowly defined money stock
(M O remained about as sluggish in the first quarter as it




had been in the final quarter of 1974. However, in the
last two months of the period, M, rose at a relatively rapid
pace after declining sharply in January. The further drop
in short-term-market interest rates induced substantial in­
creases in consumer-type time deposits at commercial
banks during the quarter. Consequently, the more broadly
defined money stock (M -) continued to expand at a faster
pace than M,. Lower market interest rates also resulted
in a dramatic increase in deposit flows into thrift institu­
tions during the first quarter. These, however, failed to be
reflected fully in mortgage lending, as the growth in both
mortgage holdings and commitments outstanding remained
modest.
THE M ONETARY AGGREGATES

Over the first quarter as a whole,
— private demand
deposits adjusted plus currency outside commercial banks
— advanced at a seasonally adjusted annual rate of 3.5
percent, down slightly from the 4.6 percent gain registered
during the preceding three-month period. Growth in M a
was erratic over the quarter, as it often is over brief
periods. In January,
fell at a seasonally adjusted an­
nual rate of 8.9 percent. This was followed by rates of
expansion of 6.8 percent in February and 12.7 percent
in March. The erratic behavior of Mi during the quarter
mainly reflected sharp changes in the growth of its demand
deposit component. The monthly fluctuations in the pub­
lic’s currency holdings followed a pattern similar to that
of demand deposits, although the changes were less
pronounced.
The growth in consumer-type time deposits at commer­
cial banks accelerated further in the first quarter, as inter­
est rates on competing market instruments continued to
decline. Time deposits less large negotiable CDs rose at a
seasonally adjusted annual rate of 12.7 percent, up from the
9 percent gain registered in the final quarter of 1974. As a
result, the growth in M .— which includes these deposits
plus M ,— also accelerated over the period and remained
considerably above the rate of expansion in M 1.

FEDERAL RESERVE BANK OF NEW YORK

During the quarter, the Board of Governors modified
slightly its M;i measure of money and also added two new
money stock concepts to its list of regularly published
monetary statistics. The M 3 measure— previously defined
as Mo plus deposits at mutual savings banks and shares at
savings and loan associations— now also includes credit
union shares. These, however, constitute only a small frac­
tion of the M ;l measure, so that its growth pattern was
only slightly affected by the change. For example, in
January 1974, the public held credit union shares of
$27.9 billion, or 2.8 percent of M ;1. The Board also began
computing two additional money concepts which include
large negotiable CDs. M L
> plus CDs now constitute the
Board’s M 4 measure of money, while M ;< plus CDs now
comprise M f).
Abstracting from differences in their long-term trends,
movements in the Board’s five money stock measures in
the past several years have been generally similar (see
Chart I ) . All five measures, for example, advanced at a
relatively rapid pace in 1972, but subsequently grew more
modestly in both 1973 and 1974. The decline in the rate
of expansion of M x over these last two years, however,
was proportionately greater than that of the broader mone­
tary aggregates.

C hart I

GROW TH OF SELECTED MONETARY AGGREGATES

109

The adjusted bank credit proxy increased relatively
slowly in the first quarter of 1975, continuing its perfor­
mance of the previous three months. This measure, which
includes total member bank deposits subject to reserve
requirements plus certain nondeposit sources of funds, rose
at an annual rate of 3 percent in the January-March inter­
val, following a gain of only 4.2 percent in the preceding
three-month period. By way of contrast, during the first
nine months of 1974, the proxy rose at an annual rate of
more than 10 percent.
A contributing factor to the slow rate of expansion in
the credit proxy during the first quarter was the sharp
deceleration in the growth of large negotiable CDs. From
a seasonally adjusted annual rate of growth of 25.9 per­
cent in the fourth quarter of last year, the volume of CDs
outstanding actually declined at a rate of 2.2 percent
in the first quarter of 1975. During much of 1974, heavy
loan demands on the banking system encouraged banks
to bid aggressively for deposit funds and the outstanding
volume of CDs rose sharply. With sluggish loan demand
in the first quarter of this year, however, banks chose to
allow some runoff in CDs by offering relatively low rates
on such deposits. Member banks also repayed a con­
siderable amount of borrowing from the Federal Reserve
System during the quarter. Such borrowings dropped from
$801 million in December to an average of $113 million
in March.

BA N K CREDIT, IN T E R E ST RATES, A N D
T H E CAPITAL. M A R K E T S

S e a s o n a lly a d ju s te d a n n u a l rates
Percent

N o te:

Percent

See tex t for d e fin itio n s o f M l, M 2 , M 3 , M 4 , an d M 5 .

S o u rc e:

B o a rd o f G o v e rn o rs o f the F e d e ra l R eserve S ystem .




Seasonally adjusted total bank credit, including loans
sold to affiliates, resumed positive growth in the first
quarter after declining in the fourth quarter of last year
(see Chart II). The increase, 5.8 percent at an annual
rate, was almost entirely attributable to a dramatic in­
crease in investments and to a rise in securities loans.
Banks were particularly heavy purchasers of United States
Treasury obligations during the first quarter, as they found
reserve positions becoming more comfortable and overall
loan demand diminishing.
Almost every loan category decreased in the JanuaryMarch period, and overall loan demand was weak for the
second quarter in a row. Business loans at all commercial
banks, for instance, fell at a rate of 3.7 percent in the first
quarter, in comparison with a decline of 0.7 percent in the
fourth quarter of last year. This accelerating decline in
business loan volume coincided with the deepening eco­
nomic slump. Indeed, the only loan category to register a
substantial gain was securities loans. As the volume of
Treasury borrowing picked up during the quarter and as

MONTHLY REVIEW, MAY 1975

110

business loan demand fell off, securities dealers found
banks more willing to accommodate their increased credit
needs.
With few exceptions, short-term interest rates fell steeply
through almost the entire first quarter before leveling off
at the end (see Chart III). The rate on 90-day CDs, for
example, fell about 3 percentage points over the quarter
to close at 6.1 percent. Similar decreases were recorded
on many other instruments. However, some rates began
to back up around the middle of the quarter, partly as a
result of heavy Treasury borrowing. Such a pattern was
evident in Treasury bill rates. After falling 136 basis
points from the end of December to mid-February, the
rate on one-year bills subsequently proceeded to rise by

Chart III

SELECTED INTEREST RATES
P ercent
13

C hart II

CHANGES IN BANK CREDIT A N D ITS C O M P O N E N TS
Seasonally adju sted a n n u a l rates

Note-.

R ates for F e d e ra l funds (effe ctiv e ra te ) a n d th re e -m o n th T rea su ry bills

(m ark et yie ld ) a r e m o n th ly a v e r a g e s o f d a ily fig u res. Y ie ld s on re c e n tly
o ffe r e d A a a -r a t e d utility bo n ds an d fo u r- to s ix -m o n th co m m e rc ia l p a p e r
a re m o n thly a v e r a g e s o f w e e k ly fig u res .
S o u rce:

30

20

Finn

10

jm

m 0
-1 0
82 .0 £ ^ p
30

U N ITED STATES G O V E R N M E N T SECURITIES

20

Em

10

J3ZL

nr

0
-10

1
li U
i

id id

-2 0
-3 0
-4 0
30

O THER SECURITIES

20
10

Am

.E S H
1972

1 973

1974

* A d ju s te d for lo a n s sold to a ffilia te s .
Source:

B o ard o f G o v e rn o rs o f th e F e d e ra l R es erv e System .




0

B o a rd o f G o v e rn o rs o f th e F e d e ra l R eserve S ystem .

51 basis points to close the quarter at 5.89 percent. A
similar but less pronounced end-of-quarter rise was exhib­
ited by shorter term bill rates.
Reductions in commercial bank prime lending rates dur­
ing the first quarter followed the decline in other money
market rates with a substantial lag. As a result, unusually
large spreads developed between the prime rates and other
short-term rates. By the end of January, for example, the
prime rates being quoted by most of the major banks ex­
ceeded the rates on commercial paper by almost 3 per­
centage points, very high by historical standards. This gap,
which narrowed somewhat to around 1 % percentage
points by the end of the quarter, induced a considerable
degree of switching of corporate borrowing from banks to
the commercial paper market. By the end of the quarter,
most major banks were quoting prime rates of between
l lA percent and 1 3A percent, down from the range of
10V4 to IOV2 percent at the close of 1974. By way of
comparison, the rate on 90- to 119-day commercial paper
fell steadily from 9¥s percent at the end of December to
6 Vs percent at the end of March.

111

FEDERAL RESERVE BANK OF NEW YORK

Intermediate- and long-term interest rates fell during
the first half of the quarter before moving upward sharply
in March. A contributing factor to this reversal was new
Treasury borrowing during the quarter of $11.2 billion in
coupon issues. In addition, the continued reevaluation
during the quarter of Treasury borrowing needs over the
course of the year was a source of concern. Investor
apprehension about the size of these needs coupled with
a heavy corporate calendar, as firms rushed to float new
debt issues at attractive yields, contributed to the rise in
long-term interest rates. The index of yields on three- to
five-year Treasury securities, for example, fell about 60
basis points from the end of December to late February
and then rose 57 basis points, closing the quarter at 7.25
percent. A similar pattern was evident in yields on longer
term obligations as well. In the corporate market the esti­
mated total of* public and private placements, seasonally
adjusted, was around $14 billion in the first quarter, a new
record. N ew corporate bond issues in January amounted
to the highest monthly total in almost four years. V ol­
ume records were set despite a significant number of post­
ponements late in the quarter resulting from the rapid rise
in long-term yields. The volume of Federal agency offer­
ings declined somewhat over the first quarter, reflecting
the improved financial position of thrift institutions. The
$3.6 billion of new Federal agency issues was well below
the quarterly average volume of $6.2 billion in 1974.
The market for municipals was buffeted by two signif­
icant developments during the quarter. In February the
New York State Urban Development Corporation (U D C )
was unable to redeem $104.5 million in maturing short­
term notes. The failure to carry out its financial respon­
sibilities with regard to these issues generated substantial
doubt in the market concerning the status of “moral
obligation” bonds. Moral obligation bonds are basically
revenue bonds that carry a tacit assurance by a political
subdivision that the issuing authority’s obligations to the
bondholders will be met. This event precipitated an in­
crease in yields on outstanding moral obligation issues as
investors became somewhat more wary of such issues.
New flotations of moral obligation bonds were made more
difficult by the increased investor apprehension. In addi­
tion, the continuing budget problems of New York City
were another source of concern in the municipal market.
The UDC difficulties could not help but focus renewed
investor attention on the city’s problems as the city con­
tinued to approach the market with sizable short-term
offerings. By March the city was forced to pay a rate of
8.69 percent for $537 million of bond anticipation notes,
the highest rate ever paid by the city for such borrowing.
Later in the quarter, however, the city announced a reduced




short-term borrowing schedule, which in turn contributed
to a more constructive market atmosphere.
The volume of tax-exempt bond offerings in the first
quarter rose to $6.5 billion, up from the quarterly average
volume of $5.7 billion in 1974. Yields in this market be­
haved much like those in the other long-term markets, as
The Bond Buyer index fell 81 basis points in the first half
of the quarter before rising 68 basis points to end the
quarter at 6.95 percent.
THRIFT INSTITUTIONS A N D THE
MORTGAGE MARKET

Deposit flows into thrift institutions increased sharply
in the first quarter (see Chart IV ). Combined deposits at
savings and loan associations and at mutual savings banks
advanced at a seasonally adjusted annual rate of 14.9
percent, more than double the fourth-quarter growth and
the most rapid expansion since November 1972. The
increased thrift deposit inflows at least partially reflected
the increased attractiveness of such deposits, as rates on
competing short-term instruments declined sharply over
the quarter. Thrift institutions, on the other hand, actively
encouraged deposit inflows by maintaining the rates paid
on their deposits at the highest levels permitted by law.
The sharply increased inflow of deposits to thrift insti­

C h a r t IV

DEPOSITS A N D MORTGAGES AT THRIFT INSTITUTIONS
A N D OUTSTANDING MORTGAGE COM M ITM ENTS

Note-. T h r i f t i n s t i t u t i o n d e p o s i t a n d m o r t g a g e l o a n g r o w t h s a r e e x p r e s s e d a t
s e a s o n a l l y a d j u s t e d a n n u a l r at es . M o r t g a g e c o m m i t m e n t s a r e t h e sum o f the
s e a s o n a l l y a d j u s t e d l ev e ls o f m o r t g a g e c o m m i t m e n t s a t a l l s a v i n g s a n d l o a n
a s s o c i a t i o n s a n d a t al l m u t u a l s a v i n g s b a n k s in N e w Y o r k St ate. M o r t g a g e s
f o r t he f ir st q u a r t e r a r e b a s e d on d a t a a v a i l a b l e t h r o u g h F eb r u a r y .
S o ur c es : F e d e r a l H o m e L o an B a n k B o a r d , N a t i o n a l A s s o c i a t i o n o f M u t u a l
S a v i n g s B a nk s, a n d S a v i n g s B a n k A s s o c i a t i o n o f N e w Y o r k St ate.

112

MONTHLY REVIEW, MAY 1975

tutions did not result in a similar increase in mortgage
holdings in the first quarter. Over the two-month period
ended in February, mortgage holdings grew at a 7 per­
cent rate, somewhat above the 3.3 percent rate of growth
of the previous three months but only slightly above
the 6.5 percent expansion over all of 1974, a year of slow
mortgage growth. Similarly, commitments for new home
mortgages failed to reflect fully the improved thrift deposit
situation. Although the seasonally adjusted volume of out­
standing mortgage commitments did rise over the first quar­
ter by $800 million, it still remained more than $10 billion
below the peak level recorded in early 1973.
The general easing in interest rates was reflected in
mortgage yields as well. In the secondary mortgage mar­




ket, the average yield set at the last Federal National
Mortgage Association auction in March was 8.85 percent,
62 basis points below the average yield at the last auction
in December. Most of this decline took place early in the
quarter, when yields in both the short- and long-term
markets were declining. In the primary market, a similar
situation existed, with the Federal Home Loan Bank
(FH L B ) Board series on effective rates on new-home
mortgages falling 29 basis points over the quarter to 9.08
percent. Since deposits were more plentiful, thrift institu­
tions reduced their level of borrowing. The volume of out­
standing FHLB advances to member savings and loan
associations fell by $3.6 billion over the first quarter to
$17.9 billion.

FEDERAL RESERVE BANK OF NEW YORK

113

The Money and Bond Markets in April
The money market in April was dominated by heavy
Treasury borrowing. While most short-term interest rates
changed little, rates on some longer term Treasury bills
rose over the month. Overall, the Treasury raised about
$9 billion in new cash in April, the bulk of it through
the sale of new notes and additions to the weekly bill
auctions. Tn the face of this substantial borrowing, in­
vestors revealed a preference for short-term maturities,
and the yield curve for Treasury bills grew increasingly
steep. An initial difference of roughly 40 basis points be­
tween three- and twelve-month Treasury bill rates widened
to about 80 basis points by the month end.
Yields rose, in some cases substantially, in the long­
term markets. The expectation that heavy Treasury
borrowing would continue through fiscal year 1976 and
the attempts to distribute the large issues of Treasury
coupon securities auctioned recently placed great pressure
on the market for United States Government securities
despite a brief respite from Treasury financing after mid­
month. Some of these pressures were reflected in the
corporate bond market where rates generally increased,
although cancellations and postponements of issues helped
reduce the calendar to more manageable proportions. In­
vestors’ preferences for intermediate-term maturities con­
tinued to provide borrowers with the incentive to include
intermediate-term issues in their debt financing. Despite
a manageable calendar in the municipal bond market,
rates moved up there as well, as the lack of sizable de­
mand from banks continued to be a stumbling block. On
May 1, the Treasury lowered the projections of its new
cash needs over the May-June period and the bond mar­
ket rallied strongly the next day, with the prices of some
long-term Treasury bonds rising as much as 1% points.
According to preliminary data, the growth of
—
private demand deposits adjusted plus currency outside
commercial banks— moderated in April from the very rapid
pace experienced in March. Time deposits other than large
certificates of deposit (C D s) continued to rise sharply, and
thus the slowing in the growth of M ,— which combines
M, with these time deposits— was less pronounced. With




business loans remaining sluggish and consumer time de­
posits growing rapidly, large commercial banks were less
aggressive in selling CDs and the amount outstand­
ing declined.
Long-term monetary growth rate targets were disclosed
by Federal Reserve Board Chairman Arthur F. Burns on
May 1. The target rate of growth for M , from March
1975 to March 1976 is a range from 5 to IV i percent. In
comparison, M, grew at a seasonally adjusted rate of 4.7
percent in 1974 and at a 3.5 percent annual rate in the
first quarter of 1975.

THE MONEY MARKET, BANK RESERVES, AND
THE MONETARY AGGREGATES

Money market rates leveled off in April (see Chart I ),
bringing to a halt— at least temporarily— the rather steady
decline of the previous seven months. Most rates moved
up early in the month, then declined somewhat in response
to a rally in the Treasury bill market, and finished the
period about unchanged. For the month as a whole, the
Federal funds rate averaged 5.49 percent, down only
5 basis points from the March average. The rate on 90to 119-day dealer-placed prime commercial paper re­
mained at 6V% percent for most of April and closed the
period at 6 percent. Similarly, rates on CDs in the
secondary market and rates on bankers’ acceptances fluc­
tuated in a narrow range and finished the month relatively
unchanged. Meanwhile, most major commercial banks
kept their prime lending rate at IV 2 percent for the month,
although one major bank was quoting IVa percent.
Weakness was still quite evident in business demand for
short-term credit. Commercial and industrial loans at large
commercial banks declined by $529 million in the first
four statement weeks of April, and the amount of nonfinancial commercial paper outstanding was basically un­
changed. The combined total of these two series generally
increases sharply in April, owing in part to business
borrowing over the April tax date.
Preliminary data indicate that
grew in April at

114

MONTHLY REVIEW, MAY 1975

Chart I

SELECTED INTEREST RATES
February - April 1975
Percent

M O N E Y MARKET RATES

F e b ru a ry

N o te :

M a rch

B O N D MARKET YIELDS

April

F e b ru a ry

M a rch

Percent

April

D a ta a re shown for business days only.

M O N E Y MARKET RATES Q UO TED: Prime com m ercial loan rate a t most m ajo r banks;
o ffe rin g ra te s (quoted in terms of rate of discount) on 9 0 - to 119-day prim e com m ercial
p a p e r q u o te d by th ree of the five dealers th a t re p o rt th e ir rates, or the m idpoint of
the ra n g e q u o te d if no consensus is a v a ila b le ; the e ffective ra te on F e d e ra l funds
(the rate most re p resen tative of the transactions execu ted ); closing bid rates (quoted
in term s of ra te of discount) on newest o u ts ta n d in g three-m onth Treasury bills.
B O N D MARKET YIELDS Q U O TED: Yields on new A a a -r a te d p u blic utility bonds are based
on prices as ked by u n d erw ritin g syndicates, adjusted to m ake them e q u iv a le n t to a

less than half its March rate. M 1 increased at a 5.4 per­
cent seasonally adjusted annual rate in the four-week
period ended April 23 from its average level of the four
weeks ended March 26. Three months of fairly rapid ex­
pansion in M 1 have brought its growth in the first four
statement weeks of April from its average level in the
corresponding period thirteen weeks earlier to a 7.2 per­
cent rate (see Chart I I ). M 2 grew at an 8.1 percent an­
nual rate from the four weeks ended March 26 to the four
weeks ended April 23, as other time deposits rose at an
11.1 percent rate. The adjusted bank credit proxy— total
member bank deposits subject to reserve requirements
plus certain nondeposit sources of funds— grew at roughly
a 6 percent rate in the same period even though outstand­




stan d ard A a a -ra te d bond of a t least tw enty yea rs ' m aturity; d a ily a ve ra g e s o f
y ield s on seasoned A a a -ra te d corporate bonds; d a ily a v e ra g e s of y ie ld s on
long -term G o v e rn m e n t securities (bonds due or c a lla b le in ten years o r more)
and on G o vern m en t securities due in three to five ye a rs , com puted on the basis
of closing bid prices; Thursday avera g e s o f yield s on tw enty seasoned tw en tyye a r ta x -e x e m p t bonds (carrying M oody's ratings of A a a , A a , A , a n d B aa).
Sources: Federal Reserve Bank of N e w York, Board of G overnors of the F e d e ra l
Reserve System, M o o d y's Investors S ervice, Inc., and The Bond Buyer.

ing CDs declined. There was little pressure on member
bank reserves in April, and member bank borrowings
from the discount window averaged $102 million for the
five statement weeks ended April 30 (see Table I ) .
On April 9, the Board of Governors of the Federal
Reserve System announced that it had lowered the reserve
requirement on Euro-dollar borrowings from 8 percent to
4 percent. The reduction will initially affect reserves that
must be maintained against Euro-dollar borrowings in the
four-week period beginning May 22. The actual reserves
held during that period will be based on the level of bor­
rowings in the period April 10 through May 7. The move
will reduce required reserves of member banks by ap­
proximately $65 million and will also release about $15

FEDERAL RESERVE BANK OF NEW YORK

million of reserves maintained voluntarily by foreignowned banking institutions. In commenting on its action,
the Board noted that the move will bring reserve require­
ments against Euro-dollar borrowings into better align­
ment with reserve requirements against time deposits and
that it may strengthen the position of the dollar in foreign
exchange markets. During the first week in which the new,
lower reserve requirements were in effect, N ew York City
banks began substituting Euro-dollar borrowings for pur­
chases of Federal funds, and their liabilities to foreign
branches increased by about $450 million in the state­
ment week ended April 16.

Table I
FACTORS TENDING TO INCREASE OR DECREASE
MEMBER BANK RESERVES, APRIL 1975
In millions of dollars; (-}-) denotes increase
and (—) decrease in excess reserves

Changes in daily averages—
week ended

Yields on most Treasury securities rose in April, as the
market for Treasury obligations was buffeted by the Trea­
sury’s heavy borrowing requirements. The scope of the
Treasury’s near-term needs became clearer when the taxreduction bill was enacted at the end of March. The
Treasury announced on March 31 that it expected to
borrow an additional $17.5 billion in the April-June
period, raising total borrowing for the first half of 1975
to $41 billion. In comparison, early in the year, private
forecasts had estimated that the Treasury’s new cash
needs in the first half of 1975 would be close to $20
billion, while at the end of February the Treasury said it
expected to raise $28 billion to $38 billion in the first
half. For the month of April the Treasury concentrated its
borrowing in the short maturity area, raising approxi­
mately $6 billion in new cash through the bill market and
another $3 billion with twenty-month and two-year notes.
The market for Treasury securities improved after May 1,
in the wake of the Treasury’s announcement that its net
financing in the first half of 1975 had been reduced to
$36 billion.
Treasury bill rates rose sharply in the first few days of
April in response to heavy new supplies. The Treasury
raised $800 million of new cash at the regular weekly
bill auction on March 31, $400 million at the regular
monthly auction on April 2, $800 million at the weekly
auction on April 7, and $1.5 billion at a special auction
on April 8. At April’s first regular weekly auction,
the three-month bill was sold in cautious bidding at an
average rate of 6.02 percent, 46 basis points above the rate
at the previous auction, while the rate on the six-month bill
was 57 basis points higher at 6.35 percent (see Table II).
By the next day, however, it appeared that rates had moved
up sufficiently to encourage investor demand and the
special auction of 292-day bills drew good interest, with
the average issuing rate set at 6.56 percent. Investor de-




Net
changes

Factors
April
9

April
2

April
16

April
23

April
30

“ M a r k e t” facto rs

M em ber b an k req u ired reserves . .

THE G O V ERNM ENT SECURITIES M ARKET

115

—

137

+

261

— 521

—

81

—

140

—

024

O perating tra n sa ctio n s
............................................ +

083

+ 1 ,5 6 6

— 108

— 2,029

—3,891

F e d e ra l R eserve f l o a t .................... +
T reasu ry operations* .................... +

057

+

124

— 634

-f

—

G04

+

914

+ 951

— 2,539

— 4,400

Gold a n d foreign a c c o u n t ...........

100

+

118

22

+

10

+

97

—

192

+ 91
— 379

—

90

— 159

+

887

+

247

lia b ilitie s a n d c a p ita l ...............

2G8 - f

602

— 137

—

+

10

T o tal “ m ark e t” facto rs .............

846

-{-1,827

— 629

—2,710

— 4,037

— 4,703

493

— 2,016

- f 619

+ 2 ,3 8 3

+ 4 ,0 9 6

+ 4 ,5 8 9

455

— 2,009

- f 197

+ 1 ,9 7 7

+ 1 ,7 8 5

+ 2 ,4 0 5

—

6

—

+

+

+

20

—

1

+

208

(su b to tal)

Currency ou tsid e banks ............. +
O ther F e d e ra l Reserve

+

209

119 —

200

02

— 4,079
+

90

— 4,530

D ire c t F e d e ra l Reserve c re d it
tra n s a c tio n s

Open m ark e t o p eratien s
(su b to tal)

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

O u trig h t ho ld in g s:
...................... +

T reasu ry securities

B a n k ers' acceptances

.................. +
F ed eral agency obligations . . . . +

15
209

R epurchase agreem ents:
T reasu ry securities

838

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

159

F e d e ra l agency obligations . . . .

175

M ember ban k borrow ings ................

104

B a n k e rs’ acceptances

_

114

T otal

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

Excess reserves $ ....................................

+

4

23

__

+ 345

+

328

+ 1 ,9 3 6

+ 1 .7 7 1

+

23

+

127

+

25

—

+
+

+

51

+

225

+

100

— 11

+

144

+

76

+

SO

—

+
+

1
190 -

19

S easonal borrow ings! ..................
O ther F e d e ra l Reserve asse ts! . . . -

16

+

2

+

34
59
2
89

711

— 2,033

+ 647

+ 2 ,7 1 7

1M

— 206

+

+

18

—
37

+ 4 ,1 3 4

7 +

97

+

1
80

+ 4 .7 5 4
+

51

Monthly
averages§

Daily average levels

M em ber b an k :

T otal reserves, in clu d in g
R equired reserves
Excess reserves
T otal borrow ings

25 nno

34,674

35,213

35,301

35,544

35,166

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

34,817

34,556

35,077

35,158

35,304

34,982

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

279

118

136

143

240

183

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

51

32

21

165

241

102

Seasonal borrow ings! ..................

7

7

5

0

6

6

045

34,642

35,192

25,130

35,303

35,004

49

129

55

95

46

75

N et carry-over, excess or
deficit (

) || .......................................

N o te: B ecause of ro u n d in g , figures do n o t necessarily a d d to to tals.
* In clu d es changes in T reasury currency and cash,
t In clu d e d in to ta l m em ber ban k borrow ings.
t In clu d es assets d en o m in ated in foreign currencies.
§ Average for five weeks ended A pril 30, 1975.
|| N ot reflected in d a ta above.

116

MONTHLY REVIEW, MAY 1975

mand remained strong and bill rates retraced their early
April increases, spurred by Federal Reserve purchases
for foreign customer accounts. While interest in the second
weekly auction was routine at prevailing rate levels,
sizable declines had already occurred and the average
issuing rates were about 50 basis points lower. Bill rates
fluctuated within a narrow range for the rest of the month,
and the average issuing rates at the auctions moved up
slightly. For the month as a whole, bill rates were generally
12 basis points lower to 52 basis points higher.
The market for Treasury coupon securities labored
under the effort of distributing the Treasury’s notes and
bonds marketed in March (about $7 billion) and early
April (another $3 billion). The price declines which had
occurred at the end of March meant that underwriters
and investors had sustained losses on recently issued
Treasury securities. As a result, they became more defen­
sive in their bidding at the first auction of coupon securi­
ties in April. The auction on April 1 of $1.5 billion of
twenty-month notes attracted $3.8 billion in tenders, but
at yields well above those prevailing on similar outstand­
ing maturities. The average issuing yield was 7.15 percent,
and a 7 Vs percent coupon was placed on the issue. Yields
continued to rise, but by mid-April rates had leveled off,
partly in response to the improvement in the bill market,
and most participants felt that the market had established
a sustainable trading range. The auction on April 15 of
$1.5 billion of two-year notes attracted broad demand
near the prevailing yield levels. A sizable $4.1 billion in
tenders was received; the average issuing yield was 7.43
percent, and the coupon was established at 7% percent.
The market’s confidence proved fragile, however, and
toward the end of the month rates moved up in advance
of the May refunding announcement. For the month as
a whole, the index of yields on three- to five-year Treasury
coupon securities rose 64 basis points to 7.89 percent,
while the index for long-term Government securities rose
by 26 basis points to 7.10 percent.
On May 1, the Treasury announced its plans to refi­
nance $3.8 billion of publicly held debt maturing on
May 15 and to raise $1.2 billion in new cash. The $5 bil­
lion of securities will be sold in three separate auctions:
$2.75 billion of 3 1/4-year notes on Tuesday, May 6;
$1.5 billion of seven-year notes on May 7; and $750 mil­
lion of thirty-year bonds on May 8. The coupon rates will
be determined after the tenders are allotted. The 3 Vx -year
notes will be sold in minimum denominations of $5,000,
while the other two issues will have minimum denomina­
tions of $1,000.
N ew offerings of Federal agency securities were well
received in April at interest rates that were generally




C h art II

CHANGES IN M ONETARY A N D CREDIT AGGREGATES
S e a s o n a lly a d ju s te d a n n u a l rates
Percent

Percent
15

Ml
1
/ \

\\

J

From 5 2
w eeks e a rlie r

/ \

^

From 13

10
t

A

5

-

0

w eeks e a rlie r
1

1

1

1 1

1

1

1

1

1

1 1

I I

I I I

i

1 j

j

-5

i

"15
M2

|

From 5 2

5 ^

^
\

w eeks e a rlie r

-10

i

__

^

x

From 13

/

___

w eeks e a rlie r
1

1

1

1

1

1

I I

1

1973

1

1

1

1

1

1

1

I

1

1

197 4

1

1

1

1975

N o te : G ro w th ra te s a r e c o m p u te d on th e b as is o f fo u r-w e e k a v e r a g e s o f d a ily
fig u re s fo r p e rio d s e n d e d in th e s ta te m e n t w e e k p lo tte d , 13 w e e k s e a r lie r an d
5 2 w e ek s e a r lie r . The la te s t s ta te m e n t w e e k p lo tte d is A p ril 2 3 , 1975.
M l - C u rre n c y plus a d ju s te d d e m a n d d ep o s its h eld by th e p u b lic .
M 2 = M l plus c o m m e rc ia l b a n k sa vin gs a n d tim e d ep o s its h eld by the p u b lic , less
n e g o tia b le c e rtific a te s o f d e p o s it issued in d e n o m in a tio n s o f $ 1 0 0 ,0 0 0 or m o re.
A d ju s te d b a n k c re d it p ro x y = T o ta l m e m b e r b a n k d e p o s its s u b je c t to re se rve
re q u ire m e n ts plus n o n d e p o s it so u rc es o f funds, such as E u ro -d o lla r
b o rro w in g s a n d th e p ro ce ed s of c o m m erc ial p a p e r issued by b a n k h o ld in g
co m p a n ies o r o th e r a ffilia te s .
Source-.

B o a rd o f G o v e rn o rs of the F e d e ra l R es erv e S ystem .

higher than those paid on recent issues. In the first week
the Federal Land Banks raised $550.1 million in new
money through the sale of two issues: $750.1 million of
21-month notes priced to yield 7.45 percent and $300
million of seven-year bonds priced to yield 8.15 percent.
In January the Federal Land Banks had sold seven-year
bonds priced to yield 7.80 percent. On April 15 the Gov­
ernment National Mortgage Association auctioned $245.9
million of mortgage-backed securities which were reoffered
to yield 8.60 percent. The next day the Farm Credit
Administration sold two issues totaling $1,231.5 million:
$322.5 million of Banks for Cooperatives (B C ) six-month
bonds priced to yield 6.15 percent and $909 million of
Federal Intermediate Credit Banks (F IC B ) nine-month
notes priced to yield 6.60 percent. In March, comparable
BC bonds were priced to yield 5.85 percent and FICB
bonds were priced to yield 6.05 percent.

FEDERAL RESERVE BANK OF NEW YORK

THE OTHER SECURITIES M ARK ETS

The pressures encountered in the corporate and munic­
ipal bond markets at the end of March continued into
April. In the face of rising yields early in the month, many
offerings were postponed (among them a $300 million
Aaa-rated corporate issue) and many underwriters sched­
uled a large amount of new issues on a day-to-day basis
rather than set a firm sale date. Dealers reduced their in­
ventories by releasing several recent offerings from syndi­
cate restrictions and the prices of these issues declined,
some dramatically. At midmonth, the long-term markets
were bolstered by the reductions in the supply of new issues
and dealers’ inventories as well as by the respite from the
Treasury’s borrowing in the latter half of April. At the
month end, however, yields were again rising in response
to weakness in the Government sector.
Investors remained cautious and continued to prefer
shorter maturities. Borrowers responded by presenting of­
ferings containing intermediate- as well as long-term com­
ponents. In the second week of the month, the Aaa-rated
issues of $75 million of ten-year notes and $75 million of
25-year debentures of Warner-Lambert Company were
reoffered to yield 8.30 percent and 8.925 percent, respec­
tively. This yield differential of about 63 basis points was
comparable to the spreads of roughly 65 basis points
which occurred on several large industrial offerings in
March. During the next week, a spread of 85 basis points
occurred on an A-rated $200 million offering by United
Aircraft Corporation. The company’s ten-year notes in the
amount of $100 million were reoffered to yield 9.10 per­
cent, and its 25-year debentures were reoffered to yield
9.95 percent. In an Aaa-rated issue during the same
week, South Central Bell Telephone Company sold $100
million of eight-year notes, which were priced to yield
8.20 percent, and $200 million of 35-year debentures,
which were priced to yield 9.20 percent. This differential
was only slightly smaller than the 106 basis point spread
on a comparable Bell issue in March.
Yields on new issues of tax-exempt securities continued
their upward trend, begun in February, into early April.
As a consequence of the escalation in costs and statutory
limitations on interest payments, several local authorities
postponed borrowing. Pressure on the market was eased
somewhat at the end of the first week when New York
City, which had been meeting investor resistance, received
an advance payment of funds from N ew York State and
was thus able to cancel a planned $450 million note offer­
ing slated for the middle of April. N ew York State, in
turn, sold $400 million of 414 percent two-month tax
anticipation notes, roughly half the rate paid by New York




117

City on a short-term issue in March.
In the longer term municipal market, several issues met
resistance in the uncertain atmosphere prevailing in the first
week of the month. A $75 million offering of State of
California Aaa-rated bonds sold slowly when priced to
yield from 5.10 percent in 1982 to 6.50 percent in 2000,
and price concessions were eventually made to move them
out of inventory. The market improved somewhat during
the second week, and a New Jersey offering of $75 million
of Aaa-rated bonds sold out when priced to yield from
4.75 percent in 1979 to 6.30 percent in 1995— yields that
were 5 to 20 basis points above those on comparable
maturities of the California issue. Late in the month the
Commonwealth of Massachusetts successfully brought to
market April’s largest municipal offering, a $150 million
issue of bonds rated A a by M oody’s and A A A by Stan­
dard & Poor’s. The bonds were priced to yield from
4.25 percent in 1976 to 6.70 percent in 1996-2005, be­
tween 40 and 65 basis points higher than a similar issue
sold in February.
A high yield premium paid by a New York State agency
illustrated, in part, the continuing impact on the municipal
bond market of the problems surrounding the New York
State Urban Development Corporation (U D C ). Late in
the month the N ew York State Medical Care Facilities
Finance Agency sold $62 million of A -l-rated moral ob­
ligation bonds. The bonds sold out when priced to yield
from 7.00 percent in 1977 to as high as 9.59 percent in
2006. These yields were roughly IV 2 percentage points
higher than yields on comparably rated issues sold at

Table II
AVERAGE ISSUING RATES
AT REGULAR TREASURY BILL AUCTIONS*
In percent
Weekly auction dates— April 1975
Maturity

1
T h ree-m o n th

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

April
7

April
14

April
21

April
28

6.021

5.538

5.653

5.716

6.351

5.843

6.067

6.158

Monthly auction dates-—February-April 1975

Fifty -tw o weeks ......................................

February
5

March
5

April
2

April
30

5.313

5.637

6.475

6.400

* In te re s t ra te s on b ills are q u oted in term s of a 360-day year, w ith th e discounts from
p a r as th e re tu rn on th e face a m o u n t of th e bills payable a t m atu rity . B ond yield
eq u iv alen ts, re la te d to th e am o u n t a c tu a lly invested, w ould be slightly higher.

118

MONTHLY REVIEW, MAY 1975

about the same time. During the same week, Boston sold
$40 million of A-rated bonds priced to yield between 5
percent in 1976 to 7.70 percent in 1993-1995, while one
week earlier the Salt River Project Agricultural Improve­
ment and Power District had sold A - 1-rated bonds priced
to yield between 5.80 percent in 1983 to 7.60 percent in
2015. Both issues sold slowly, however, and the Salt River




bonds were released to the resale market at price con­
cessions.
On May 1 The Bond Buyer index of twenty municipal
bond yields was 6.95 percent, unchanged from the end of
March. The Blue List of dealers’ advertised inventories
finished the month at $463 million. It declined by $76
million for the month.