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258 MONTHLY REVIEW, NOVEMBER 1975 New Y o rk C ity’s Economy — Some Longer Te rm Issues By R i c h a r d A. D e b s First Vice President and Chief Administrative Officer Federal Reserve Bank of New Y ork Rem arks at a panel discussion sponsored by Bernard M. Baruch College, M acy’s, and The Committee on the Public Interest in New Y ork City on Novem ber 7,1975 As you know, this conference was organized sometime ago, and the general topic then was “challenges and opportunities of doing business in New York City” . At the time I accepted the invitation to participate, I had in m ind— as I’m sure most of us did— discussing the longer term problems and prospects for the basic economic health of our city. Although there were many pressing short-term problems brewing at that time, I had hoped that at least the more critical ones would have been settled by now so that we could by this time focus on the longer term. Unfortunately, that hasn’t happened. Our short-term problems are obviously still very much with us, and they become even more critical with every passing week. Be cause these problems have been most demanding of our time and energy, none of us have had very much time to think about the longer term. Nevertheless, I would like to take these few minutes to do just that— to focus on the longer term to see what we might hope for in the years ahead, but also perhaps to put into a better perspective some of our more pressing short-term problems. In talking about the city’s financial and economic problems, I find it useful to separate them into three different, but related dimensions, somewhat parallel to the three principal types of financial statements. To begin with, the most immediate, most acute, and shortest term problem the city faces is a problem of financ ing— a funding problem. This is a question of where and how the city can fund itself over the next few months. Given the levels of its short-term expenditures and income — over which there can be relatively little control within the short period we are talking about— the problem is one of cash flow. The next dimension of the city’s financial and economic problem centers on the budget and the need to balance it. Obviously, the budget problem is inextricably linked with the cash flow problem, but is quite distinct from it, just as the annual profit and loss statement is linked to, but is distinguishable from, a flow-of-funds statement. For our purposes, they must be distinguished because they require different kinds of solutions. There is no doubt that the chal lenge of balancing the budget is an immediate challenge and, in that sense, an immediate problem, but it cannot have an immediate solution. It is clear that the city needs time to achieve a balanced budget, although major steps have already been taken in that direction. The story of how we arrived at our present position on the budget is compli cated but basically well known to all of us here. Without indulging in recriminations or trying to assign responsi bilities, the im portant point is that we need to focus on how we can balance the budget as fast as possible. And we must recognize that it cannot be done overnight. The third dimension of the city’s financial problem, as I see it, is related to its longer term, basic economic situation. Again this is distinct both from the immediate cash flow problem and from the budget or “profit and loss” problem. It is, instead, analogous to a balance-sheet problem in that it involves analysis of the city’s tangible and intangible longer run economic assets and liabilities. And it is this longer run situation that I ’d like to talk about for a few minutes. FEDERAL RESERVE BANK OF NEW YORK First of all, I think it’s useful to emphasize the fact that — quite apart from the greatly publicized recent problems of an unbalanced budget and the cash flow crisis— the city has for some years now suffered from an underlying eco nomic problem. In several ways, New York shares this problem with other older cities generally, many of which have experienced a deterioration in their basic economic health over recent years. This deterioration can be mea sured by declines in jobs and in population, either abso lutely or in relative terms. It is also reflected in various measures, some very intangible, of the “quality of life” . The reasons for this general tendency— which really has to do with what I would call “natural” forces— are to be found simply in the evolution of the economic structure of our society. For example, the further development of transportation and telecommunications facilities has di minished the value of being located physically within large cities such as New York. Moreover, as the scale of cities has grown with growth in the general population, there have been increasing costs of congestion within the large cities. Over the years, there has also been a rising propor tion of old and deteriorating physical plant, both publicly and privately owned. Such forces, by themselves, could be expected to cause problems for large cities in terms of economic growth over time. However, with good planning, such forces should be manageable and do not fully account for the acute crisis in which this city now finds itself. In many ways, these natural forces of change seem to have been reinforced by governmental policies that have set in motion flows of businesses, jobs, and people that have tended to weaken the underlying economic strength of the city. For example, many Federal and state road construction programs have, in effect, subsidized the sub urban areas by facilitating transportation and encouraging the emigration of businesses and families to the suburbs. At the same time, the relatively high levels of welfare benefits and public services have led to what, in effect, has been a subsidized in-migration of poor rural families, many of whom have only limited skills for coping productively with urban life. This pattern of population movement simultaneously increased the cost of social services in the city, and it also reduced— at least in the short run— the average economic productivity of its work force. No doubt the urbanization of this largely rural population will in the long run greatly benefit the nation. In the meanwhile, how ever, its costs have been borne disproportionately by New York and other similar cities. These costs have been re flected in disproportionately high tax rates, and these in turn— by driving out businesses, jobs, and relatively well-off taxpayers— have served to erode further the city’s economic base. And, at the same time, of course, this has 259 aggravated the more immediate problem of the city’s budget. W hat are the solutions to these kinds of problems— problems that are caused by government policies? Obvi ously, we can look for the answers in the government policies themselves. W ithout in any way trying to be ex haustive, it’s easy to point to a few areas for obvious consideration. In the first place, at the level of the Federal Govern ment, the first thing that comes to mind is the possible federalization of our welfare system. In a nation whose population enjoys a high degree of mobility, a welfare system that permits disparate rates of support, and exerts an uneven burden on taxpayers, is bound to create severe problems and inequities in particular localities— and that has been the case in New York City. A nother area that needs some rethinking is the pos sible regionalization of some governmental services that are now paid for primarily by the city. Of course our problem in New York is complicated by the fact that our local region crosses state lines. But there is already a precedent for regional approaches— such as the M TA— and transportation obviously comes to mind as a pos sibility. Another possibility deserving exploration is the assump tion by the state of functions now paid for by the city that are treated as state functions in other parts of the country. F or example, there has been mention of the court system and the penal system. The fourth area that comes to mind relates to the pol icies of the city itself. To what extent have public policies of the city had the net effect of eroding its economic base? One policy that is often mentioned in this connection is the controversial subject of rent control. There are many sides to this question, but it certainly deserves further close analysis and study from an economic point of view. There are many other public policies that need reexamination, and indeed many of them are being looked at anew. One of the very basic questions, of course, relates to tax policy, and here, as with many of these other issues, we are faced with a dilemma. On the one hand, it is clear that a burden some level of taxes will encourage the movement of busi nesses and population from the city. At the same time, tax revenues are an essential ingredient in coping with the city’s immediate budgetary problems. This is a most im portant issue. One of the challenges we face is that some solutions to the city’s narrow budgetary problems may well prove inconsistent with solutions to its longer term problems. If at all possible, we should try to avoid short-term budgetary solutions that would worsen the longer term economic situation. And of course, in the longer run, any measure that weakens the city’s economic 260 MONTHLY REVIEW, NOVEMBER 1975 base will ultimately feed back on the budgetary position adversely. It is not difficult to imagine a vicious cycle of budgetary changes that could in the end worsen budgetary problems even further. And this is especially relevant when we consider the capital budget, which is clearly an invest ment in the future. Seen in this longer term prospective, it will not be easy to find satisfactory solutions to the immediate budgetary problems that the city faces. Simply increasing revenues by raising taxes, or simply cutting expenditures by reducing services, if nothing else is done, will have a long-range adverse effect. The real trick, and the real solution, to the budget problem as well as the long-term problem is to m aintain the services— and the capital expenditures— that are essential to the city’s longer term economic health but at a reduced cost. We should not let ourselves be de luded that the only way to reduce costs is to reduce output. Our aim should be to lower costs by increased produc tivity, increased efficiency, and the use of operations im provement methods. If we are able to do that in the shorter term, we should be able to preserve our economic base from further deterioration in the future. A t the same time, of course, we urgently need to go to work on some of the longer term problems— problems that require changes in governmental policy— to strengthen further our economic base over the longer run and put us back on the path of long-term economic growth. There is no doubt that the city has the potential for the needed growth. O ur basic assets are strong. While there has been some deterioration, it has been from a very high base. There is still much underlying strength in the city and, given the chance, that strength can show itself once again in the years ahead. FEDERAL RESERVE BANK OF NEW YORK 261 Th e Business Situation Economic activity has advanced sharply in recent months, but the upward impetus is still rather narrowly based. In the third quarter, the increment in gross national product (G N P) in real terms was the largest in twenty years. Over half of this gain, however, was attributable to the marked slowdown in the rate of inventory liquidation. Ex pansion in consumption spending, especially on durable goods, accounted for the rest of the increase. Elsewhere, there was barely any movement, as the small increases and decreases recorded for the other components of real aggre gate demand were largely offsetting. Nor are there any clear-cut signals of developing strength in these other spending components. Looking ahead, once the inventory imbalance has been eliminated, it appears that the pace of the economic recovery will for a time be keyed closely to the growth in consumption spending. While there continues to be a good deal of variability in the monthly price data, the overall rate of inflation was about 7 percent at an annual rate in the third quarter. This is a bit higher than the rate of inflation in the previous quarter but is still a substantial improvement over the double-digit increases recorded last year. However, the acceleration of wholesale industrial commodity prices in the past six months, together with the flare-up of these prices in October, is a worrisome development which sug gests that the prospects for a significant slowdown in the near term are anything but certain. Whereas the huge overhang of inventories had fostered some moderation in price increases earlier in the year, this imbalance has been largely eliminated. Moreover, after having tapered off a bit, the rate of growth of wages appears to have quickened somewhat in recent months, and fuel and energy prices have been rising at a slightly faster pace. GNP AND R ELA TE D DEVELOPM ENTS According to preliminary estimates compiled by the Department of Commerce, the market value of the na tion’s output of goods and services (G N P) rose in the third quarter at a 16.8 percent annual rate of increase. Measured in terms of 1958 prices to correct for changes in the price level, the increment in real GNP amounted to a hefty 11.2 percent rate, up from the 1.9 percent rise of the previous quarter and the biggest quarterly gain in twenty years. Nevertheless, real GNP was still almost 5 percent below the peak recorded at the end of 1973. Contributing most to the third-quarter surge in GNP was the sharp slowdown in the pace of inventory liquida tion (see Chart I). Indeed, the slower runoff of business inventories accounted for more than half of the total gain in real GNP. In fact, the monthly data on the book value of business inventories (which are, however, measured differ ently than in the national income accounts) showed a sizable accumulation occurring in August for the first time since last January. Moreover, the August increase was broadly distributed throughout the trade and manufacturing sectors, the only exception being in the durables manufac turing industries. This pattern suggests that much of the inventory overhang has now been eliminated. Further cor roborating evidence can be gleaned from the recent behavior of the ratio of real nonfarm business inventories to real final sales of the business sector. This ratio jumped to a record peak at the end of 1974; since then, it has declined steadily to about the level of the first half of last year. While imbal ances still exist within certain segments of the economy, notably the durables manufacturing sector, it does look as though the inventory liquidation process will have run its course in the next few months. Once the inventory correc tion has been completed, the speed of the economic re covery will then be paced by the strength in real final sales. In the third quarter, final expenditures— equal to GNP less the change in business inventories— moved ahead at a 4.4 percent annual rate in real terms, just about equal to the growth of the previous quarter. The sizable advance in con sumption spending more than accounted for the increase in real final sales. Among the other components of aggregate demand, there were small increases and decreases which were largely offsetting, on balance. Buoyed by the vigorous economic recovery, the one-shot 1974 tax rebates, the special payments to recipients of social security, and the 1975 tax reductions, disposable personal income has staged a fairly strong comeback since MONTHLY REVIEW, NOVEMBER 1975 262 sumer price index since 1973 (see Chart II, but note that these are annual observations recorded as of May in each R E C E N T C H A N G E S IN G R O S S N A T I O N A L P R O D U C T year). In large part, however, the erosion in this measure of A N D ITS C O M P O N E N T S S e a s o n a lly a d ju s te d the real wage has stemmed from compositional changes y - r-r r — . C h a n g e fro m first q u a rte r to C h a n g e from second q u a rte r to within the employed work force. First, while there had [ /'''V , 1 s e c o n d q u a r te r 197 5 th ird q u a r te r 197 5 long been an uptrend in the proportion of part-time to total employment, the recently ended recession exacerbated this trend greatly, as many formerly full-time workers had to settle for part-time employment along with a sharp cutback in their weekly earnings. Second, for many years including the last few, the full-time work force has been composed of proportionately more women and young workers, both of whom tend to earn less than their adult male counterparts. Adjusted for changes in the age-sex composition, it turns out that the average weekly earnings of full-time workers, after accounting for the effect of inflation, fell only 4 per cent between 1973 and 1975 (see Chart II). This was about half of the decline experienced by average weekly earnings in real terms, as measured by the establishment survey. It should be mentioned, however, that these esti mates of weekly earnings are measured on a before-tax basis and, therefore, do not take into account the effect of inflation on workers’ aftertax earnings. That is, even if consumer prices and before-tax wages do grow at the same rate, the progressivity of the personal income tax structure implies that workers will still experience a reduction in -1 5 - 1 0 - 5 0 5 10 15 2 0 2 5 3 0 3 5 4 0 4 5 5 0 5 5 6 0 their real aftertax earnings. To some extent, of course, the B illio n s of d o lla rs legislated decreases in the 1975 personal income tax rates S o u rc e-. U n ite d S t a t e s D e p a r tm e n t o f C o m m e r c e , B u r e a u o f E c o n o m ic A n a ly s t s . have partly offset this effect. Spurred by the continuation of the recent gains in dis posable income, real consumption spending advanced at a 7 percent annual rate in the third quarter, a shade higher than that of the preceding quarter. Consumption outlays have been the dominant factor in the current economic the beginning of the year in real terms. As of the first quar recovery. Since the opening quarter of the year, the expan ter, real disposable income had fallen 4.1 percent below the sion in real consumption expenditures has accounted for peak attained at the end of 1973, by far the largest post over two thirds of the total increment in real GNP. Even war cyclical decline on record. Since then, real disposable more importantly, the pickup in consumption has facilitated income has rebounded sharply, though only half the real the liquidation of the huge overhang of inventories. Consumer outlays on durables advanced briskly in the loss has been recouped. In retrospect, the decline in real disposable income over third quarter. Historically, no doubt because these pur the last two years appears to have been distributed unevenly chases are postponable and often involve replacements, among workers. Much of the decline can be attributed to real consumption spending on durables has tended to the effects of the recession on employment, including the move in a pronounced procyclical fashion (see Chart III). unusually sharp rise in the proportion of part-time to total In recessions, the largest cutbacks in consumption spending employment, rather than a drop in the real wages of those occur in purchases of durable goods. In turn, during the en full-time workers who have remained employed. Indeed, suing recoveries, real durables outlays snap back vigorously. there has been some confusion over this point. Compound Indeed, in the four previous cyclical recoveries, the ex ing the confusion is the fact that, according to data collected pansion in real consumption durables sales has averaged by the Bureau of Labor Statistics in its payroll survey, aver a bit more than 20 percent in the four quarters after the age weekly earnings have risen at a slower rate than the con cyclical trough. The official date of the trough of the C h a rt I FEDERAL RESERVE BANK OF NEW YORK most recent recession has not yet been posted by the N a tional Bureau of Economic Research, but it will probably be located in the second quarter since that is when indus trial production bottomed out. Hence, given this tentative dating, the current resurgence in real consumer durables spending has to date surpassed those experienced in all previous postwar upturns, except for the 1970-71 recov ery which was bolstered by the aftermath of the General M otors strike during the last quarter of 1970. W hether this rapid pace will be sustained in the months to come remains to be seen. Indeed, although the average level of domestic automobile sales in the third quarter was well above that of the preceding three months, the monthly sales pattern has been fairly flat from July to October. In real terms, residential construction outlays posted a healthy advance in the third quarter, following a minuscule rise in the previous quarter and the precipitous two-year slide before that. The third-quarter increase in real residen tial construction outlays reflected a higher level of housing starts, compared with the level of the previous quarter. C h a rt II A L T E R N A T I V E M E A S U R E S O F G R O S S W E E K L Y E A R N IN G S 1967 = 100 Notes: Data are for M ay o f each year shown and are not seasonally adjusted. The 1968 d a ta points fo r the two household series are in te rp o la tio n s of the preceding and fo llo w ing years. The w e ig h te d index measure uses fixed 1967 relative em ploym ent w eights fo r the earnings of d iffe re n t age-sex groups. Sources: U nited States D epartm ent of Labor, Bureau of Labor Statistics. The w eighted index was calculated by the s ta ff o f the Federal Reserve Bank o f New York. 263 Housing starts were running at a 1.25 million unit annual rate in the July-September period, up from the 1 million unit rate averaged in the first half of the year. However, housing starts in September, the most recent month for which data are available, were essentially unchanged from the July level. In the third quarter, mortgage interest rates, which had been at very high levels by historical standards, edged up further. The average yield on Federal National Mortgage Association home-mortgage commitments rose about 80 basis points from the end of June to the end of September, although it declined about 20 basis points in October. While the high rates currently prevailing on home mortgages make them an attractive investment from the viewpoint of thrift institutions, they do tend to discourage potential home buyers from undertaking such long-range commitments. In addition to high mortgage costs, pro spective homeowners may be concerned about the rapid run-up in the prices of fuels and utilities. In the third quarter, business fixed investment spend ing was virtually unchanged in real terms from what it had been in the April-June period. This leveling off marks the end of a steep year-long contraction in real outlays on plant and equipment, which left these expenditures about 17 percent below what they had been a year pre viously. It is interesting to note that, in past cyclical re coveries, a turnabout in real outlays on plant and equip ment has occurred either in the same quarter or one quarter after the business-cycle trough. It remains to be seen, however, whether the pattern of real capital spending in the current recovery will turn out to be consistent with historical experience. To some extent, businesses may lately have boosted their capital spending in response to the temporary increase in the investment tax credit. This increase is due to lapse at the end of the year. Even if extended, however, the higher investment tax credit is not likely to exert much addi tional stimulus to capital spending, unless business condi tions continue to improve in other respects. Indeed, capi tal spending within the key manufacturing sector remains weak, judging by the recent behavior of net new capital appropriations by the nation’s 1,000 largest manufac turers. On a seasonally adjusted basis, net new appropri ations have declined steadily from the peak of $15.9 bil lion recorded in the third quarter of 1974 to $8.8 billion in the second quarter of this year, the latest period for which data are available. In view of the significant lags separating appropriations, orders, and actual expendi tures, the recent drop in net new appropriations has prob ably not yet had its full depressive effect on manufac turers’ actual outlays on plant and equipment. Neverthe less, there seems to be a rather large backlog of unspent 264 MONTHLY REVIEW, NOVEMBER 1975 C h a rt III R E A L C O N S U M E R D U R A B L E S S P E N D IN G IN FIV E P O S T W A R R EC E S S IO N S P erc e n t S pending as a p e rc e n ta g e o f tro u g h - q u a r te r l e v e l * + For each reference cycle the tro u g h -q u a rte r level equals 100 percent. N ote: The N a tio n a l Bureau of Economic Research-dated recession occur in second quarter 1954, second q u a rte r 1958, first quarter fourth q u a rte r 1970. The trough quarter for the latest recession yet been dated by the NBER. Industrial production bottom ed out second quarter, which is used as the trough quarter in the chart. troughs 1961, and has not in the Source: U nited States Departm ent of Commerce. appropriations, suggesting that firms have lately been post poning projects rather than canceling them. Hence, if there were a pickup in the pace of real final sales, this would be an incentive for businesses to decide to go ahead with their postponed projects. The rundown in the backlog of unspent appropriations would impart added momentum to investment spending but probably not before the end of the year. Net exports declined in the third quarter in both nomi nal and real terms, as imports of goods and services posted a larger advance than exports. Modest increases in this spending component in three previous quarters had acted as a stabilizing influence, albeit a minor one, just as it has in most postwar recessions. PRICE SITUATION Although erratic monthly movements in the recent price data have made their interpretation difficult, it nevertheless appears that the overall annual rate of infla tion in the third quarter was about 7 percent. As measured by the GNP implicit deflator, prices of goods and services advanced at a 5 percent annual rate. However, the fixed-weight GNP price index, which is unaffected by compositional shifts in output, rose at a 7.2 percent sea sonally adjusted annual rate, compared with 5.5 percent in the second quarter. In the previous postwar recoveries, price increases generally continued to moderate in the period immediately following the trough in industrial pro duction. Hence, at this early point in the recovery, a sig nificant acceleration in inflation would be an unusual and unlikely occurrence. Yet any further slowdown in the rate of inflation will be severely constrained by the underlying pressure from wages and materials costs. Consumer prices rose at an 8.2 percent seasonally ad justed annual rate in the third quarter, up from the 5.8 percent advance in the previous quarter. Food prices increased at an 11.8 percent annual rate, mostly because of the large spurt in July. Similarly, nonfood commodity prices climbed at a 7.2 percent annual rate, also reflecting a July spurt and much more moderate advances in the last two months of the quarter. Prices of services exhibited modest gains through the months of the third quarter ex cept in September when the large gain posted was primarily the result of the subway fare increase in New York City. Thus, while the third quarter’s rate of price inflation was higher than the previous quarter, price gains tended to be moderate in the last two months of the quarter. In part, the m idsum m er flare-up in nonfood prices may have re flected an unsustainable slowing of price increases in the last months of the second quarter as firms were attempting to get out from under the very substantial inventory over hang. At the wholesale level, there was a resurgence in infla tion in October, following the very moderate advance in the previous month. The October run-up in wholesale in dustrial prices amounted to a rapid 14.4 percent annual rate and was paced by large price increases for milled steel products, new passenger cars, textiles and apparels, and lumber and wood products. Including the October spurt, wholesale industrial prices have steadily accelerated over the past six months. While this pattern probably in part reflects the unsustainably low price increases recorded in the second quarter, when so many firms were doggedly trying to get out from under the massive overhang of in ventories, the prolonged upward thrust in the rate of infla tion in wholesale prices is a rather worrisome development. Also, the wholesale prices of farm products and of pro cessed foods and feeds posted a rather big increase in October, moving ahead at about a 20 percent annual rate. FEDERAL RESERVE BANK OF NEW YORK WAGES, PR O D U C TIVITY, AND E M P LO YM EN T Recent data indicate that the pace of wage increases quickened somewhat in the third quarter. Compensation per hour worked in the private nonfarm economy rose at an 8.5 percent seasonally adjusted annual rate, up 1 per centage point from the rate of growth over the first half of this year but below the quarterly increases posted in 1974. O utput per hour worked, which typically exhibits the largest advances in the early part of the recovery period, moved ahead at a 9.4 percent seasonally adjusted annual rate. As a result of these changes, unit labor costs edged downward at a 0.8 percent annual rate in the third quarter. According to data gathered by the Labor Departm ent on major collective bargaining settlements, the average effective wage of approximately 10 million unionized workers has risen at a 9.6 percent annual rate over the first nine months of the year, about the same as the 9.4 percent increase recorded in 1974. The average effective wage adjustment reflects first-year increases negotiated in the current quarter, deferred increases under earlier contracts, and cost-of-living raises accumulating under current and previous contracts. There was a sharp run-up in the effective wage rate in the third quarter, due to a substantial increase in cost-of-living adjustments as well as to larger deferred increases. For the entire private nonfarm economy, average hourly earnings— which are conceptually similar to the effective wage adjustments in the unionized sector— advanced at a seasonally adjusted annual rate of 7.1 percent, above the rate of increase in 265 the first two quarters of the year. A better indicator of the level of wage rates in the private nonfarm economy, how ever, is the adjusted average hourly earnings series, since it abstracts from fluctuations in average hourly earnings which are attributable to interindustry shifts in employment and variations in overtime hours in manufacturing. In terms of quarterly averages, the adjusted average hourly earnings series posted a seasonally adjusted annual rate of growth of 8.3 percent in the July-September period, up slightly from the 7.8 percent increase during the first half of the year but below the 9 percent rise in 1974. Nonfarm employment posted increases in both the household and payroll surveys in the month of October. However, a substantial increase in the labor force com bined with a large reduction in agricultural employment resulted in a 0.3 percentage point increase in the civilian unemployment rate. According to the payroll survey of establishments, seasonally adjusted payroll employment increased by 217,000 workers in October, marking the fourth consecutive month of healthy payroll gains. As in previous months, manufacturing payrolls played an impor tant role in the rise, accounting for about half of the Octo ber increase. The remainder of the rise was distributed between the services and government sectors. In the sepa rate survey of households, nonagricultural employment moved ahead by 147,000 workers. However, agricultural employment fell by 124,000 workers in the month so that civilian employment was little changed on balance. At the same time, the labor force posted a substantial gain of 252,000 workers, and the seasonally adjusted civilian un employment rate rose by 0.3 percentage point to 8.6 per cent of the civilian labor force. 266 MONTHLY REVIEW, NOVEMBER 1975 Th e Money and Bond Markets in October Interest rates in the money and bond markets declined sharply during October. The broad-based rally was pre cipitated by substantially easier conditions in the Federal funds market which emerged early in the month. Besides the lower trading range for Federal funds, market sentiment was affected favorably by a reduction in reserve require ments on longer term time deposits. Also adding to the improved tone of the markets were continued slow growth in the monetary aggregates and indications that the re maining Treasury debt financing for the year would be easily manageable. Virtually all sectors of the money and capital markets participated in the rally, including the market for highgrade state and local government obligations. The demand for lesser quality municipal securities, however, continued to be adversely affected by New York City’s fiscal crisis. The city narrowly escaped default at midmonth, but con siderable apprehension remained over whether default could be avoided by early December or perhaps even in mid-November. At the end of October, amidst Congres sional debate over providing Federal aid or loan guarantees to the city, President Ford announced his intention to veto Congressional legislation that would aid New York City prior to a default. In response to his announcement, large negotiable certificates of deposit of commercial banks (CDs) and high-quality municipal securities gave up some of the gains posted earlier in the month and yields on Trea sury bills experienced additional moderate declines. According to preliminary data, the narrow money stock (MO declined in October, following modest gains in the previous three months. Growth of the more broadly defined money stock (M .) was sluggish, although the expansion of consumer-type time and savings deposits accelerated slightly. The bank credit proxy experienced moderate growth in October for the second consecutive month, with a substantial increase in the average level of large negoti able CDs outstanding. TH E M ONEY M ARKET AND TH E M O N ETA R Y AGGREGATES Interest rates on Federal funds and other short-term financial instruments moved sharply lower in October (see Chart I ) , while member bank reserve positions eased somewhat (see Table I). The effective rate on Federal funds averaged 5.82 percent during the month, down 42 basis points from September’s average. Rates on 90- to 119-day dealer-placed commercial paper fell by about 1 percentage point to close the month at 5.93 percent, and rates on ninety-day bankers’ acceptances declined 1 per centage point to 5.8 percent. Large negotiable CDs m atur ing in ninety days traded in the secondary market at 6.16 percent at the end of the month. This rate was 87 basis points below the rate at the end of September though slightly above the rate in the period immediately preceding the President’s announcement about aid to New York City. Business demand for short-term credit continued weak in October. Commercial and industrial loans at large com mercial banks, after adjustment for normal seasonal vari ation, grew at a moderate rate during the month. In spite of this growth, the volume of loans remained almost $10 bil lion or about 7 percent below the level of one year earlier. Following declines in other market rates and reflecting the continued sluggishness of loan demand, most money center banks lowered their prime lending rate by percentage point to 7% percent. A further move to IV 2 percent was initiated as the month ended. The latest available data indicate that the growth in the monetary aggregates has continued to be unusually slug gish. Indeed, during the four-week period ended October 29, seasonally adjusted — private demand deposits adjusted plus currency outside commercial banks— declined by 3.1 percent at an annual rate from its average level during the four previous statement weeks. This brought the annual growth rate in M 1 over the past thirteen weeks to less than FEDERAL RESERVE BANK OF NEW YORK 1 percent (see Chart II ). Because of a moderate expansion in consumer-type time and savings deposits at commercial banks in October, M 2— M t plus time deposits other than large negotiable CDs— posted a modest gain. During the first four statement weeks of the month, ML averaged 4 percent at an annual rate above its average during the four statement weeks ended September 24 and 4.6 percent above its average during the four weeks ended thirteen weeks earlier. The adjusted bank credit proxy— total mem ber bank deposits subject to reserve requirements plus certain nondeposit sources of funds— also experienced modest growth in October. The proxy advanced 4.6 per cent at an annual rate in the first four statement weeks of 267 the month from its average level over the four previous statement weeks. On October 15, the Federal Reserve announced a re duction in reserve requirements on member bank time deposits with maturities of four years or more from 3 percent to 1 percent. The new reserve requirement is sub ject to the condition that the average of reserves on time and savings deposits at any individual bank must not be less than 3 percent, the minimum specified by law. The reserve ratio applies to deposits in the week beginning October 16 and will affect required reserves in the state ment week beginning October 30. About $550 million of reserves is expected to be released by this action. S E L E C T E D IN T E R E S T R A T E S A u g u s t-O c to b e r 1975 P e rc e n t M O N E Y M A R K E T RATES A ugust Note-. S e p te m b e r B O N D M A R K E T YIELDS O c to b e r A ugust S e p te m b e r P e rc e n t O c to b e r D a ta a re s how n fo r business d a ys o n ly. M O N E Y MARKET RATES Q U O TED: P rim e c o m m e rc ia l loan rate a t m ost m a jo r ban ks; o ffe r in g ra te s (q u o te d in term s o f ra te o f d is c o u n t) on 90- to 1 19-day prim e c o m m e rc ia l p a p e r q u o te d b y th re e o f the five d e a le rs th a t r e p o r t th e ir ra te s , o r the m id p o in t o f the ra n g e q u o te d if no consensus is a v a ila b le ; the e ffe c tiv e ra te on F e d e ra l fu n d s (the ra te m ost re p re s e n ta tiv e o f th e tra n s a c tio n s e x e c u te d ); clo sin g b id ra te s (q u o te d in te rm s o f ra te o f discount) on n ew est o u ts ta n d in g th re e -m o n th T re a su ry b ills. B O N D MARKET YIELDS Q U OTED: Y ie ld s on new A a a - r a te d p u b lic u tility b o n d s a re ba se d on p ric e s a s k e d b y u n d e r w ritin g s y n d ic a te s , a d ju s te d to m ake th e m e q u iv a le n t to a s ta n d a rd A a a - ra te d b o n d o f a t le a s t tw e n ty y e a rs ' m a tu rity ; d a ily a v e ra g e s o f y ie ld s on se a so n e d A a a -r a te d c o rp o ra te b o n d s ; d a ily a v e ra g e s o f y ie ld s on lo n g -term G o v e rn m e n t s e c u ritie s (b o n d s d u e o r c a lla b le in ten y e a rs o r m ore) a n d on G o v e rn m e n t s e c u ritie s d u e in th re e to fiv e y e a rs , co m p u te d on the b a s is o f c lo s in g b id p ric e s ; T h u rsd a y a v e ra g e s o f y ie ld s on tw e n ty s e a so n e d tw e n tyy e a r ta x -e x e m p t b o n d s (c a rry in g M o o d y 's ra tin g s o f A a a , A a , A , a n d Baa). Sources: F e d e ra l Reserve B a n k o f N e w Y o rk, B o a rd o f G o v e rn o rs o f the F e d e ra l Reserve System , M o o d y 's In ve sto rs S e rvice , Inc., a n d The B ond B uyer. 268 MONTHLY REVIEW, NOVEMBER 1975 Table I TH E GOVERNMENT SECURITIES M ARKET FACTORS TENDING TO INCREASE OR DECREASE MEMBER BANK RESERVES, OCTOBER 1975 In millions of dollars; (+ ) denotes increase and (—) decrease in excess reserves Changes in daily averages— week ended Net changes Factors Oct. Oct. 1 8 “ Market” factors Member bank required reserves . — 402 + Oct. 22 Oct. 15 646 — Oct. 29 67 — 167 + 133 + 143 Operating transactions —2,244 +1,807 +2,261 95 + 365 — 405 + —2,373 +1,588 +2,788 42 — 105 Gold and foreign account ___ + 8 + + 665 — 417 — 693 — 1,239 —2,245 + 79 — 349 — 470 —2,567 + 95 — 20 — 773 + 851 —1,660 — 215 —1,034 + 20 — 367 Other Federal Reserve — 140 + 499 — Total “market" factors .......... —2,646 +2,453 94 — 169 — 160 — —1,406 —2,112 —1,517 +2,418 +1,453 +2,194 64 Direct Federal Reserve credit transactions Open market operations (subtotal) ........................................ +2,798 Outright holdings: Treasury securities .................... + 826 Bankers' acceptances ................ + 16 Federal agency ob ligations----- -f- 113 Repurchase agreements: Treasury securities .................... +1,618 Bankers’ acceptances ................ + 120 Federal agency ob ligation s___ + 105 Member bank borrowings ............ + 186 Seasonal borrowings! ................ + Other Federal Reserve assets} .. + —2,764 —1,934 + 935 — 201 — 610 + + 12 — 5 + + 281 167 +1,484 689 + 569 — 698 44 « + 36 + 16 60 — 138 3 — 2 — 8 — 88 203 + 104 + 126 + — 90 _ 149 — 300 — 3 + 604 X —1,069 + — 150 _ 100 + — 65 + Total .............................................. +3,067 —2,904 —1,895 Excess reservest ...................... + 46 678 21 284 —2,505 — 145 _ 206 — 343 io 83 + +1,666 + + 2 + + 421 — 451 + 299 +1,121 +2,369 +1,758 — 285 + + 257 241 Monthly averages! Daily average levels Member bank: Total reserves, including vault cashj ...................................... 35,454 34,357 34,723 34,605 34,729 34,774 Required reserves .......................... 34,342 581 74 15 238 34,552 222 Total borrowings ............................ Seasonal borrowings! ................ 34,409 314 173 34,576 Excess reserves .............................. 34,988 466 Nonborrowed reserves .................... 34,873 74 34,119 7 196 29 34,443 286 95 264 66 34,550 233 63 34,372 61 34,634 68 34,510 32 106 3 69 Net carry-over, excess or deficit ( )|] .................................... Note: Because of rounding, figures do not necessarily add to totals. * Includes changes in Treasury currency and cash, t Included in total member bank borrowings. %Includes assets denominated in foreign currencies. § Average for five weeks ended October 29, 1975. || Not reflected in data above. Yields on all maturities of Government obligations de clined dramatically during October in direct response to an apparent easing in the Federal Reserve’s stance with re spect to interest rates. With an increased availability of Federal funds, inventory financing costs for dealers de clined and bill rates adjusted sharply downward. Continued slow growth in the monetary aggregates was viewed as pro viding additional latitude for the Federal Reserve in pursu ing its longer range targets, and some market participants interpreted the reduction in reserve requirements as a further sign of easing. Against this background, prices on coupon-bearing Treasury obligations were bid up substan tially. Demand for Treasury issues was augmented by in creased investor preferences for high-quality securities and by moderate financing needs of businesses. On October 22, the Treasury announced its borrowing needs for the remainder of 1975. The Treasury indicated that it expected to raise between $8 billion and $11 bil lion of additional cash before the year-end, with $1.1 billion obtained in auctions of notes and bonds late in October. Only $500 million to $1.5 billion of the re mainder would be financed by the sale of additional coupon issues later in the quarter, with the rest to be raised as additional amounts in Treasury bill auctions. Despite the substantial supply of new Treasury bills forthcoming, bill rates, which had declined throughout the month, continued their decline as a result of generally optimistic market senti ment. At the end of the month, the President’s announce ment about New York City apparently led buyers of CDs and municipal securities to place relatively more of their funds in Treasury bills and other high-quality assets, and this may have enlarged the decline in bill rates. Moreover, the Treasury did not offer a short-term issue in the refund ing of the November 15 issues on October 29 and, with rates already on a downward trend, many holders of the November 15 issues may have reinvested in short-term securities in advance. The average yield at the monthly auction of 52-week bills on October 15 was 6.60 percent, 74 basis points less than the average yield at the corresponding auction in September (see Table II). At the weekly auction on Octo ber 24, the average yields on three- and six-month bills were 5.69 and 5.97 percent, down 86 and 101 basis points respectively from the last auction in September. Over the month as a whole, yields on most bills fell 95 to 160 basis points. Yields on Treasury coupon securities, reflecting the improvement in market conditions, fell sharply during October. Early in the month, $2.5 billion of 38-month 269 FEDERAL RESERVE BANK OF NEW YORK notes was auctioned with an average yield of 8.14 per cent. At midmonth, $3 billion of two-year notes was auc tioned with an average yield of 7.55 percent. This was 89 basis points lower than the yield at an auction of $3 bil lion of two-year notes on September 16. A $2.5 billion auction of seven-year notes on October 29 resulted in a yield of 7.92 percent, while on the following day $1 bil lion of 25-year bonds was auctioned to return 8.25 percent. Over the month as a whole, the index of yields on intermediate-term Government securities fell 85 basis points to 7.43 percent. The yield on the 8 Vi percent Trea sury bond of 1994-99 fell to 8.18 percent at the end of October, down 46 basis points from its level at the end of September. In the major agency financing of the month, the Fed eral Land Banks issued $650 million of 42-month bonds with a yield of 8.55 percent and $435 million of ten-year bonds with a yield of 8.8 percent. The issue was very well received. Over the month, yields on agency securities dropped in concert with yields on Treasury issues, and prices on the Federal Land Bank bonds moved to sub stantial premiums. At the end of the month, yields on short-term agency securities declined further in response to the President’s announcement. OTHER SECURITIES MARKETS C h a rt II C H A N G E S IN M O N E T A R Y A N D C R ED IT A G G R E G A T E S S e a s o n a lly a d ju s te d a n n u a l rates P e rce n t P erce n t Note-. G row th rates are com puted on the basis of four-w eek averages of d a ily figures fo r periods ended in the statem ent w eek p lo tte d , 13 weeks e a rlie r and 52 weeks e a rlie r. The lastest statem ent week p lotted is O cto b e r 29, 1975. M l - Currency plus adjusted dem and deposits held by the public. The tone of the corporate bond market improved con siderably during October, primarily reflecting the indi cations of some easing in monetary policy. With few new financings and with the upcoming calendar of bond flota tions light relative to the first half of 1975, yields declined steadily over the month. This pattern was reflected in three recently marketed Aaa-rated telephone issues. At the end of October, a $100 million financing of 37-year deben tures was priced to yield 9.06 percent. This yield was appre ciably below those of two earlier issues, a 9.60 percent yield offered on a $200 million issue of 33-year debentures at the beginning of October and a 9.70 percent yield on $125 million of forty-year bonds in September. At midmonth, a $300 million issue of Aaa-rated industrial debentures due in twenty-five years was priced to yield 8.90 percent and was sold quickly. Several Aa- and A-rated securities also sold well, with yields 50 to 75 basis points below those of comparably rated issues brought to market one month earlier. In the market for tax-exempt securities, high-quality issues followed the general move toward lower yields while some lower grade securities responded directly to devel opments surrounding the effort of New York City to avoid default. On October 17, a default by the city was averted M2 = M l plus com m ercial bank savings and time deposits held by the p u blic, less nego tia b le certificates of deposit issued in denom inations of $100,000 or more. A djusted bank cre d it p ro xy - Total member bank deposits subject to reserve requirem ents plus nondeposit sources of funds, such as Euro-dollar b orrow ings and the proceeds of com m ercial pap e r issued by bank ho lding com panies or other affilia te s. Source: Board of G overnors of the Federal Reserve System. only after a last-minute agreement by a union of munic ipal employees to purchase $150 million of Municipal Assistance Corporation obligations with pension funds. Later in the month, attention centered on Washington, where Congressional proposals for Federal assistance for the city met mixed reviews. At the end of the month, Pres ident Ford announced that he would veto any Congres sional proposal that would provide Federal aid to the city to avert a default. As an alternative, the President pro posed legislation modifying Federal bankruptcy laws to give the courts sufficient authority, if necessary, to pre side over an orderly reorganization of the city’s financial affairs. Significant concern also emerged over New York State’s extensive involvement in the city’s financial problems. 270 MONTHLY REVIEW, NOVEMBER 1975 Amidst these developments, yields on the general obliga tion bonds of the state traded in the secondary market several percentage points above yields on comparably rated obligations of other tax-exempt borrowers. In addi tion, the ratings of a number of the issues of New Y ork State agencies were lowered by the major investor services, and these agencies became unable to market additional securi ties. In other evidence of investor concern for quality, the Massachusetts Housing Finance Agency was required to reduce the size of a planned $31.1 million issue of bonds to $12.4 million. In a negotiated underwriting of these bonds, which carry only the state’s moral obligation, $1.5 million of the issue was priced to yield from 6 per cent in 1978 to 8.50 percent in 1995 and the remaining $10.9 million was priced to return 9 percent in thirtyseven years. Following the downward movement in yields for govern m ent and corporate debt, returns on A aa-rated issues of state and local governments moved sharply lower over the month. This improvement is reflected in the terms on the m onth’s two major Aaa-rated tax-exempt issues. On Oc tober 1, the State of Oregon m arketed $125 million of bonds, with yields ranging from 5.25 percent on the 1981 issues to 6.70 percent on the 1993 issues; these are some of the highest yields ever paid on tax-exempt obligations with an A aa rating. Three weeks later, the State of M ary land sold $85.9 million in bonds, with yields ranging from 4.20 percent in 1978 to 5.70 percent in 1990 or about 1 percentage point less than the yields on the Oregon Table II AVERAGE ISSUING RATES AT REGULAR TREASURY BILL AUCTIONS* In percent Weekly auction dates— October 1975 Maturity Oct. 6 Oct. 10 Oct. 20 Oct. 24 6.239 6.045 5.887 5.685 6.571 6.243 6.156 5.974 Monthly auction dates— August-October 1975 Fifty-two weeks ................................ Aug. 20 Sept. 17 Oct. 15 7.331 7.338 6.601 * Interest rates on bills are quoted in terms of a 360-day year, with the discounts from par as the return on the face amount of the bills payable at maturity. Bond yield equivalents, related to the amount actually invested, would be slightly higher. securities. After the President’s announcement, prices on Aaa-rated municipal securities gave up about one third of their previous gains for October. The Bond Buyer index of twenty bond yields on twenty-year tax-exempt bonds fell to 7.36 percent on October 29 from its record level of 7.67 percent on October 1. The Blue List of dealers’ advertised inventories rose by $49 million and closed the month at $684 million.
@FedFRASER