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MONTHLY REVIEW O f Credit and Business Conditions F E D E R A L V o lu m e R E S E R V E 38 B A N K OCT O BER OF N E W Y O R K 19 56 No. 10 MONEY M ARKET IN SEPTEMBER Pressures in the money market remained relatively registered net advances. Recurrent rumors of a reduction steady during September. On a statistical basis there was actually some easing of bank reserve positions, associated in member bank reserve requirements and the announce ment on September 2 0 of an easing of mortgage credit by with an unusually large midmonth expansion of float and Government agencies contributed to a shift in psychology, the Treasury’s cash redemption of Government securities and prices advanced, in quiet trading, largely on profes maturing on September 1 5 in advance of the collection of income tax checks in volume. Although the over-all re sional markups. Nonetheless, the market continued to be characterized by an underlying uncertainty, as inflationary serve position of member banks fluctuated widely over the tendencies still pointed to the maintenance of strong de month, the reserves available on balance were apparently mands for credit and capital, which it was feared might adequate to provide for a seasonal growth of business loans mean higher rates of interest and lower prices for Govern comparable to that of a year ago. ment securities. Reserve positions of T o w ard the end of the month, prices N ew Y o rk and Chicago central reserve city banks con tinued tight most of the month, and the Federal funds rate declined somewhat but did not reach earlier lows, appar remained almost steadily at 3 per cent, except for brief Federal Reserve were aimed at accommodating necessary declines at the end of each statement week. seasonal requirements, including those of the Treasury. A further reflection of the relatively tight conditions in N ew Y o rk was the maintenance of the rates charged by N e w Y o rk banks on call loans to Governm ent securities dealers gen erally at 3 Vi per cent, after advances early in the month. ently because of a growing view that the actions of the Treasury bill rates, after declining early in the month, rose to record highs for the postwar period on Septem ber 2 5 . The increases were brought about, to some extent, by the sizable sales which corporations made in order to Federal Reserve System open market operations during meet tax and dividend disbursements, by the sales of the the four weeks ended September 2 6 alternately injected Federal Reserve System, and by the influence of market and withdrew reserves in order to mitigate the fluctuations expectations that the Treasury would soon be borrowing additional amounts for cash in the very short-term area. Tow ard the end of the month, however, rates declined somewhat as demand revived and offerings tapered off. in reserve positions and adjust to seasonal requirements. Before the Lab o r D a y week end, when the usual sharp increase of currency in circulation w as reducing reserves, substantial outright purchases were undertaken. Together with purchases made toward the end of August, these aggregated 4 1 1 million dollars. Subsequently, however, as the expansion of float and the return flow of currency from circulation, along with a sharp decline in Treasury The atmosphere in the markets for corporate and mu nicipal bonds improved during September, as yields on CONTENTS balances at Federal Reserve Banks, added to reserves, Money Market in September.......................... 137 System holdings of Government securities declined by 2 7 6 International Monetary Developments............ 141 million dollars. Repurchase agreements with Government securities dealers were written from time to time when tem porary strains appeared in the market, and the volume outstanding reached a peak of 8 5 million dollars on one day; total repurchase agreements outstanding at the close of the period amounted to 4 0 million dollars. The prices of most Government notes and bonds leveled off early in September and, over the month as a whole, Business Inventories and Economic Fluctuations ................................................... 143 Monetary Control in a Rapidly Developing Economy: the New Zealand Royal Commis sion R eport...................................................... 147 Selected Economic Indicators.......................... 152 MONTHLY REVIEW, OCTOBER 1956 138 credit for seasonal needs would be available, resulted in exceeded their borrowings from the Federal R eserve Banks on a daily average basis for the first time in over a year. Aside from this temporary and unusual easing, net bor a generally good response to the heavy volume of flota tions, and dealers were able to make reductions in inven August. new issues advanced to levels that were attractive to inves tors. The higher yields, and the growing expectation that tories of unsold issues. rowed reserves remained close to the levels recorded in E a rly in the month, banks lost reserves chiefly from the Com m ercial paper dealers raised their rates Vs per cent sharp seasonal increase in currency in circulation as de on September 4, and a further Vs per cent increase was positors withdrew cash for the L a b o r D a y week end, while announced on September 2 8 , bringing the rate on prime the average level of float continued to decline. These losses four-to-six months5 paper to 35 per cent. /s were more than offset, however, by a continuation of On Septem ber 2 7 and 2 8 , four large finance companies announced an sizable outright purchases of Governm ent securities by advance in their rates on directly placed commercial paper the System, amounting to 1 3 3 million dollars during the by week ended September 5 . to % of 1 per cent, effective on September 2 8 and October 1 ; the new rate on the 3 0 to 89-d ay paper of these companies is 3V4 per cent. Federal Reserve funds were also supplied through the extension of repurchase agree ments with Governm ent securities dealers, although the in crease was actually very moderate since dealers generally M em ber B ank R eserve P o s it io n s found funds available elsewhere to meet their financing M em ber bank borrowings from the Federal Reserve Banks were somewhat lower during the four weeks ended September 2 6 , averaging 7 9 2 million dollars as compared with 9 2 3 million in the previous four weeks. M oreover, the margin of borrowings over excess reserves shrank from 3 4 4 million dollars in the four weeks of August to 1 7 9 million dollars in the recent period. M ost of the decline was accounted for by the easing during the week ended September 1 9 when the excess reserves of member banks Table I In the two subsequent weeks, an unusually early and sharp midmonth rise in float and Treasury operations tended to reduce net borrowed reserves. A feature of the period was the cash redemption of the 9 8 2 million dollars of 23 per cent Governm ent bonds of 1 9 5 6 - 5 9 , A called for September 1 5 . These and other Treasury dis bursements were only partly offset by Treasury calls, espe cially on Class C banks, so that Treasury balances at F e d eral Reserve Banks declined sharply. Furthermore, delays in the processing of checks, as the volume of checks flowing Changes in Factors Tending to Increase or Decrease Member Bank Reserves, September 1956 into Reserve Banks from all sources rose sharply, caused a large increase in float. In addition, a return flow of cur (In m illions of d o lla rs; ( + ) denotes increase, (— ) decrease in excess reserves) Daily averages— week ended Net changes Factor requirements. rency began during the week ended September 1 2 and continued in the next week, thus adding to reserves. These factors converged in the third statement week of the month with the result that, despite a decrease of more than 2 4 0 Sept. 5 Sept. 12 Sept. 19 Sept. 26 Treasury operations*.............................. Federal Reserve float.............................. Currency in circulation.......................... Gold and foreign account...................... Other deposits, e tc ................................... + 60 - 42 -1 6 9 - 57 + 32 - 90 +2o8 -1 2 3 + 20 + 1 + 65 +444 +100 + 36 + 13 -2 0 0 — 95 + 96 + 15 + 10 -1 6 5 +565 - 96 + 14 + 56 million dollars in System holdings of Governm ent securi ties, member bank borrowings declined sharply while ex T o ta l............................................ -1 7 5 + 66 +658 -1 7 6 +373 reserves was, however, concentrated in country banks, and +226 + 1 + - 11 2 — 156 - 11 -1 1 8 + 3 - Operating transactions Direct Federal Reserve credit trarisactions Government securities: Direct market purchases or sales. . Held under repurchase agreements. Loans, discounts, and advances: Member bank borrowings................. Other.......................................................... Bankers’ acceptances: Bought outright.................................... Under repurchase agreements......... the central reserve city banks continued to be under pres -1 3 9 — +216 — __ 2 37 9 -3 5 8 — + 51 — -2 3 0 — - 1 — - 1 — - 63 -2 7 5 1 — + + 1 2 To ta l............................................ + 92 +222 — 526 - Total reserves.................................................... Effect of change in required reserves^ . . . . + 83 33 +288 - 20 + 132 -1 1 4 — 23S + 55 + - 98 46 - 50 +268 + 18 -1 8 4 + 52 796 449 1,012 717 654 735 705 551 Daily average level of member bank: Borrowings from Reserve B anks. . . . cess reserves were relatively large. Th e bulk of the excess - sure. Part of the difference in the incidence of ease or pressure was related to shifts in the distribution of Treasury cash balances, notably as the result of a heavy call that was made on Class C depositaries on September 1 7 . In the final statement week, as bank reserve positions moved back to a net dependence upon borrowed reserves, money market pressures were virtually unchanged. C on tributing to the shift in reserve positions w7 a sharp con as traction in float. In addition, Treasury balances at Reserve 7921 6131 Banks increased as the result of heavy collections of tax checks, the rise being only partly offset by redeposits at Note: Because of rounding, figures do not necessarily add to totals. * Includes changes in Treasury currency and cash, f These figures are estimated, j Average for four weeks ended September 26. the Class C banks— which had been subject to large calls the previous week. FEDERAL RESERVE BANK OF NEW YORK G o v e r n m e n t S e c u r it ie s M arket Th e prices of Government notes and bonds, which had exhibited a downward trend since m id-June, leveled off in early September and then staged a sharp advance, only to decline again toward the close of the month. Despite the advance in prices, which by September 2 0 carried the longer 2 V i’s up to as much as IV s points above the end-of-August levels, the market was characterized by an underlying uncertainty as to the future course of interest rates. M an y observers looked for a continued strong de mand for credit and for inflationary tendencies that might result in the maintenance, or even intensification, of tight credit conditions. On the other hand, persistent rumors of a reduction in member bank reserve requirements, the measures taken by several Government agencies to increase the availability of and ease the terms on mortgage credit, and a growing feeling that the Federal Reserve would pro vide the funds necessary for essential seasonal credit needs gave rise to more sanguine expectations in some quarters. 139 Tow ard the end of the month rates declined somewhat, but at the close the longest outstanding bills were bid at 2 .9 1 per cent, up 2 5 basis-points for the month as a whole. O ther Se c u r it ie s M arkets The corporate and municipal bond markets showed an improved tone in September, as higher yields, combined with expectations that the likelihood of further advances had diminished, led to a favorable response from investors to a heavy volume of new issues. In line with the advance in yields on new issues, prices of outstanding corporate bonds declined on balance, despite advances at the close of the month. A verage market yields on seasoned corpo rate issues, as reflected in M o o d y’s A aa-rated corporate bond index, rose by 7 basis-points to 3 .5 8 per cent on September 2 4 , but dipped to 3 . 5 7 on September 2 8 . Yields on similarly rated municipal bonds rose by 1 basispoint to 2 .6 3 per cent in midmonth, but dropped back to 2 .6 2 as the month ended. Trading activity in the Governm ent bond market was light through most of the month, as switching for tax pur The estimated volume of public offerings of corporate bonds for new capital in September rose, in part sea sonally, to 4 8 0 million dollars, com pared with a revised poses contracted and outright demand remained small. estimate of 2 4 0 million dollars for August. The advance in prices took place on a small volume of out yields were sharply higher than earlier in the year, and right trading and largely reflected professional markups and interdealer trading. A t the same time, sales of the most new issues met with a good reception. Thus a 2 0 million dollar flotation of A -rated utility bonds met with Reoffering two longest bonds b y investors switching into corporate a good response from investors when reoffered just before bonds held down price increases for these two issues. Tow ard the end of the month, prices of almost all issues midmonth at a yield of 4 .4 1 per cent, 4 1 basis-points higher than a similar issue at the end of Ju ly. Similarly, were marked down. O ver the month as a whole, however, most issues maturing after 1 9 6 1 showed net increases of several A a-rated issues were successfully reoffered at yields close to 4 .2 0 per cent, in contrast to offerings at about 3 .7 0 between 12/22 and 1(>32 of a point. The 3 per cent bonds of 1 9 9 5 rose in price by % 2. per cent in late Ju ly which encountered investor resistance; late in September, however, another A a-rated issue met Treasury bill rates, after declining toward the end of with a good response when priced to yield 4 .0 1 per cent. August, turned up on September 1 0 and subsequently ad vanced to record highs for the postwar period. E a rly in the month demand from nonbank investors tended to push A symptom of the better atmosphere was the successful offering of 7 5 million dollar issues by two sales finance rates down. In the September 1 0 auction, however, the average issuing rate rose slightly from 2 .7 3 6 per cent in the auction held prior to the La b o r D a y week end to 2 .7 7 0 per cent, as diverse considerations including uncertainty companies, one of which had twice postponed issues sched uled in June and August because of unsatisfactory market conditions. Publicly announced postponements or cancel lations in September were moderate, amounting to an esti mated 60 million dollars. over the impact of the September 1 5 tax date made dealers Th e market for new municipal securities also showed cautious. Subsequently, bill rates moved still higher under a better tone, despite a rise in estimated public offerings the influence of sales by corporations for tax and dividend to 3 0 0 million dollars from 16 0 million in August, and disbursement purposes, System sales to offset some of the underwriters were able to reduce their inventories of un accruals to bank reserves, and growing market expectations sold issues. M unicipal issues were received somewhat less that the Treasury would soon be borrowing additional enthusiastically than corporate offerings but in general funds in the short-term area. met with a good response from investors when reoffered In the succeeding auction, the average issuing rate for the bills dated September 2 0 at attractive yields. Illustrative of the better tone was the moved to 2 .9 0 8 per cent, a new postwar high. Rates on outstanding Treasury bills continued to advance, and in rapid sale and premium bid on a 2 5 million dollar flotation of A -rated Port of N e w Y o rk Authority bonds, which were the final auction of the month for the bills dated Septem reoffered at 3 .4 5 per cent as compared with a 3.0 0 per ber 2 7 , the average issuing rate rose to 2 .9 8 5 per cent. cent yield on a similar issue by the same agency in M ay. 140 MONTHLY REVIEW, OCTOBER 1956 M em ber B ank C largely seasonal, increase also took place in loans to food, r e d it Total loans and investments at all weekly reporting liquor, and tobacco firms. member banks declined 1 4 million dollars during the four Reporting banks reduced their investment portfolios on weeks ended September 1 9 , as a 3 7 2 million dollar increase balance during the four weeks ended September 1 9 , in in total loans was offset by a 3 8 6 million dollar decline contrast to the preceding four weeks when investments in investments. increased largely as the result of acquisition of the new tax anticipation certificates. In the current period, hold The expansion of total loans was somewhat larger than in the preceding four weeks, but fell below the rate of ings of Government securities other than bills dropped by increase recorded a year ago largely because of the con 6 1 0 million dollars, as the tax anticipation certificates were tinued sharp contraction in security loans. R eal estate distributed to nonbank investors and as the Treasury bonds loans advanced at about the same pace as in previous called for September 1 5 were redeemed for cash. H old months, while consumer loans recorded a very small Th e bulk of the expansion continued to be ings of Treasury bills rose by 1 3 4 million dollars, and port folios of non-Governm ent securities by 90 million dollars, accounted for by business loans (including agricultural the latter increase being presumably attributable in part loans), which rose by 5 1 2 million dollars, about the same to the attractive yields on new offerings. net decline. amount as in the similar 1 9 5 5 period. M ost categories of F o r the year thus far, total loans at weekly reporting business loans showed increases during the current period, banks have risen 3 .2 billion dollars, com pared with an although almost 3 5 per cent of the rise was accounted for increase of 4 .3 billion in the comparable period last year, by net borrowings of 1 7 4 million dollars by firms in the while total investments declined by 4 .1 billion dollars as petroleum, coal, chemical, and rubber classification; this against a 6 .3 billion decrease in the comparable period last substantial increase was reportedly attributable in con siderable part to one large oil company. A sizable, though year (see ch art). The advance in loans so far this year is largely accounted for by a 3 .0 billion dollar increase Table II half of the total loan increase w as due to business loans. in outstanding business loans, whereas last year only about Weekly Changes in Principal Assets and Liabilities of the Weekly Reporting Member Banks (In millions of dollars) Statement weeks ended Item Aug. 29 Sept. 5 Sept. 12 Sept. 19 A striking difference between the two years was the much Change from Dec. 28, 1955 to Sept. 19, 1956 period. In addition, the growth in real estate loans has been only about 60 per cent as large, and in consumer loans only half as large, as last year. Assets Loans and investments: Loans: Commercial and industrial loans........................................ Agricultural loans................... Security loans.......................... Real estate loans..................... A ll oth e r lo a n s (la rg e ly consumer)............................. sharper decline in security loans, which have so far fallen by 7 8 4 million dollars more than in the com parable 1 9 5 5 -1 2 9 + 1 + 45 9 +190 + 9 - 51 + 28 + 34 + 30 - 12 - - - 13 1 + 183 + 4 +136 + + 4S 23 + 988 651 70 + CHANGES IN LOANS AND INVESTMENTS WEEKLY REPORTING MEMBER BANKS 684 + 4 + 2 ,9 8 7 Total loans adjusted*. . -1 0 7 + 175 +162 +142 + 3 ,2 0 9 Investments: U. S. Government securities: Treasury bills................. Other.................................. - 78 -2 0 5 — 85 +112 - 68 +185 -3 4 7 775 - 2 ,9 6 4 -2 8 3 + 74 + 75 43 + 44 -1 6 2 Billions of dollars -3 ,7 3 9 363 - 4 ,1 0 2 T o t a l ... . . . Other securities. + 10 - 22 Total investments. -2 0 9 32 + 22 -1 6 7 T o ta l loans and investm ents adjusted*................................... -3 1 6 +143 +184 - - 893 Loans to banks. 90 +142 +143 - 21 + 320 Loans adjusted* and “ other’ securities....................................... 33 +218 +140 +137 + 2 ,8 4 6 25 Liabilities Demand deposits adjusted. . Time deposits except Government........................... U. S. Government deposits.. Interbank demand deposits: Domestic................................. Foreign..................................... +374 -4 8 1 +857 + 131 + 35 -4 0 5 - 28 -4 4 1 +100 -9 1 0 - 37 +398 — 95 - 37 +791 + 42 +464 - 28 -1 9 5 + 44 - 2 ,9 7 4 + + 348 431 55 119 * Exclusive of loans to banks and after deduction of valuation reserves; figures for the individual loan classifications are shown gross and may not, therefore, add to the total shown. Septem ber 19, 1956. 1 9 5 5 -5 6 * Billions of dollars 141 FEDERAL RESERVE BANK OF NEW YORK INTERNATIONAL MONETARY DEVELOPMENTS M onetary T rends and P o l ic ie s Effective September 6 the W est Germ an discount rate was lowered to 5 per cent from SVi\ this action followed three successive increases between August 1 9 5 5 and last M a y (see chart). It has been officially stated that the latest move is not the result of a reversal in the Bank deutscher Land er’s estimate of the basic economic trends in Germ any, sional” borrowers reduced their bank indebtedness, while the engineering, shipping and shipbuilding, and chemical industries increased their borrowing. Loans to hire- purchase finance companies were reduced further during the quarter, and the total amount of hire-purchase debt outstanding fell during Ju ly as in every previous month this year and is now 1 3 per cent below Decem ber 1 9 5 5 . but rather is a response to an easing in the economic situation. It is also hoped that the discount rate reduc tion m ay help alleviate the current stringency in the capital market. INTEREST RATES IN SELECTED F O R E IG N C O U N T R IE S The slackening of the Germ an boom is ...............Long-term government bond yield (GB) *■ «*“ Treasury bill rate(TB) “ am m Day-to-day money (DM) m ttm ---- ----- --Discount rate (DR) reflected in the 7 per cent decrease in industrial production during June and Ju ly, the slower expansion of demand Percent UNITED KJMGDOM WEST GERMANY Furthermore, bank credit declined in Ju ly and, while y this was partly seasonal, the drop was much larger than H r ( , .B * last year and apparently continued through August. The / * . ; serves resulting from the heavy foreign exchange inflow A . . % *« * in Ju ly and A ugust for the purpose of reducing their indebt s commercial banks used part of the increase in their re * ** V dm edness to the central bank (another part of this inflow hav ! 1 J J. 1 1 .. 1 ..L i .j . j ing been offset by substantial open market sales by the central b a n k ). Nonetheless, bank liquidity increased, and short-term interest rates m oved downward from the Ju ly peak. Lo w er interest rates m ay well make Germ any less attractive for foreign short-term capital; actually, the influx of foreign exchange fell off sharply in August. However, the underlying expansionary forces in the Germ an econ om y remain strong, and the authorities have stated that they stand ready to meet with tightened credit restraints any renewed surge of demand such as might be set off by the prospective reduction in taxes, further wage increases in excess of the growth of productivity, or the impending expansion of defense expenditures. In the United Kingdom, the latest quarterly statement of the British Bankers’ Association reveals a further slight increase in loans to the public sector, which more than Per ce ...............................................................................................................................................................................................................................! . ................................ " N and new orders, and the stability of prices since M arch. 1 offset the continued decline in advances to private bor rowers. Although advances had also increased during the preceding quarter, the total of advances outstanding in midA ugust was still almost 1 0 per cent less than a year earlier and seems to have been further reduced in the following five weeks. In the three months to m id-August the public utilities and local authorities increased their borrowing by 48 million pounds; in the private sector, where net borrow ing declined by some 3 1 million, the food, drink, and tobacco industries, retail trade, and “ personal and profes 19 5 4 1955 1956 1954 1955 1956 Note: September figures based on incomplete data. X West Germany: IB covers 8 per cent industrial bonds. Australia: GBS covers short-term (two-year basis) government bonds. Sources: National statistics; International Monetary Fund, International Financial Statistics. 142 MONTHLY REVIEW, OCTOBER 1956 The London money market continued tight during Sep tember and, although there reportedly were official pur chases of bills, the discount houses were on several occa sions obliged to borrow directly from the Ban k of E n g land. Th e reduction in the London Clearing B an ks’ hold ings of government bonds, which had been interrupted ments of which are tied to Paris stock and bond prices; the rate for day-to-day money in Fran ce has shown no clear trend this year. The yields on both short and long term Australian Government bonds rose sharply in M arch, after the central bank withdrew its support from the m ar ket, and stood at postwar peak levels in June. in Ju ly, was resumed in the four weeks ended in midAugust when the banks’ investments fell by roughly 7 5 million pounds— one of the largest declines ever recorded for a single month. T h e banks, however, made large pur chases of Treasury bills, and as a result their liquidity ratio rose to 3 5 .6 per cent. Y ield s on gilt-edged securities have continued their slow upward trend; the return on 2 Vi per cent Consols reached 4 .9 0 per cent on September 1 8 — the E xchange R ates Am erican-account sterling fluctuated during September between $ 2 . 7 8 x and $ 2 . 7 8 1% 2, with quotations generally /4 on the lower side but occasionally tending to be firm. Sea sonal pressures, along with concern over developments related to the Suez Canal situation and the wage demands of British unions, continued to be the principal forces m ak highest level in more than twenty years— but closed at 4 .8 4 ing for weakness; in the final days of September, however, on September 2 8 . A s the accom panying chart shows, the the Israel-Jordan border difficulties were also of some im average tender rate for three months’ Treasury bills has portance. moved upward, reaching 5 . 1 7 per cent at the third Septem was somewhat stronger in the last half of the month. ber tender but declining to 5 .0 9 at the fourth tender. A m o n g commercial concerns, oil interests were important Com m ercial demand w as generally light, but Elsewhere, too, interest rates have continued to rise. both as buyers and as sellers o f sterling at various times In Canada, government bond yields were generally higher, and at the fourth tender in September the average rate for during September; fairly large offerings of dollars in three months’ Treasury bills reached a new high of 3 . 1 6 per cent. Effective September 1 5 , Canadian banks raised the interest rate on personal savings accounts to 2 Vi per cent from 2 V*\ this was the second increase in six weeks, the 2 V4 rate having been in effect only since A ugust 1. Business loans by the chartered banks stood virtually un changed during the first two statement weeks in September, and during the third week dipped slightly; on September 19 business loans outstanding were 2 1 . 7 per cent above a year ago against 2 4 .8 per cent at the end of August. The liquidity position of the chartered banks has been easier for the past eight weeks; September was the first month in more than a year in which there was no reduction in the banks’ holdings of government bonds, and there has been no borrowing at the Ban k of Canada since the middle of August. The increase in interest rates in the Netherlands, where the discount rate w as raised twice this year, has been London and demand for sterling in N ew Y o rk by oil com panies were m ajor factors in setting the highest quotation on September 1 1 . Th e general weakness of sterling was also evident in other rates. Thus, the discounts on sterling for three and six months’ delivery rose from 1 % 6 and 2 17/S2 cents to 1 1 % 2 and 3 % 2 at the month’s end, with somewhat higher discounts at the midmonth that largely reflected offerings in the London market. Transferable sterling also declined, falling to $ 2 . 7 5 0 5 — the lowest quotation since February 1 9 5 5 — on September 1 4 , at which time official interven tion reportedly eased the pressure. Subsequently, however, strong bidding from the Continent, representing purchases for covering short positions in the market, improved the rate, and on September 2 8 the quotation stood at $ 2 . 7 6 1 5 . Securities sterling fluctuated between $ 2 .6 0 and $ 2 . 6 4 % , being generally easy but with occasional demand on the part of stock houses. Th e Canadian dollar met with very good demand dur especially notable; the market rate for Treasury bills with ing the first part of September. three months to maturity rose in A ugust to a peak postwar Canadian dollars of the proceeds of new Canadian bond T h e conversion into level of 3 per cent from 1 .3 8 in January, and government issues floated in the N e w Y o rk market, a strong investment bond yields have reached the highest level since early 1 9 5 2 . demand from London, and fair commercial purchases, Swiss bond yields, after slumping during the winter, re especially by grain interests, were major factors in moving covered to last fall’s peaks during the second quarter of the rate to $ 1 . 0 2 4% 4 on September 1 4 ; this quotation was this year, and in the third quarter attained a new seven- the highest since February 1 9 5 5 . In the latter part of the year record. Th e rate of return on government bonds in month, however, activity declined somewhat and rates were Fran ce lias fluctuated around a slightly rising trend, the noticeably easier at about $ 1 . 0 2 % 6 until September 2 8 , rise in September possibly reflecting selling for reinvest when the Canadian dollar rose to $ 1 . 0 2 3 % 4 at the m ar ment in the new government loan, the redemption p ay ket’s close. 143 F E D ER AL R ESER VE B A N K OF N E W Y O R K BUSINESS INVENTORIES AND ECONOMIC FLUCTUATIONS Business outlays for inventories constitute the most vola tile type of spending in the economy. R apid and sizable shifts between inventory accumulation and liquidation inventory movements in periods of general business con traction in the two postwar recessions apparently has been even greater than during the interwar years. In the 1 9 4 9 have, in fact, been so characteristic of shorter business downturn, a shift from inventory accumulation at an annual rate of 3 V2 billion dollars to liquidation at a rate of 5 billion represented virtually the entire contraction in cycles that these fluctuations in over-all activity are fre quently referred to as “ inventory cycles” . W hile such swings in inventory accumulation tend to reflect, rather national output,2 while a similar shift accounted for about than cause, more fundamental changes in underlying eco three quarters of the decline which occurred in 1 9 5 3 - 5 4 . nomic conditions, most economists agree that the rate of A steep fall in the rate of inventory growth also accom investment in stocks is one of the most significant “ triggers” of turning points in economic activity and is also an impor tant determinant of the extent of the swings in production panied the marked slackening in the rate of growth of G N P in 1 9 5 1 - 5 2 , although G N P did not actually decline at that time. Th e relative significance of inventory build and employment. Th e outlook for inventories is of par ups in periods of rising G N P , on the other hand, has con ticular interest at the present moment, in view of the pro longed expansion in aggregate stocks since the beginning siderably diminished in the postwar period, although such build-ups have continued to be of considerable importance of 1 9 5 5 and its possible implications for the continuation in the earlier stages of recovery, as at the beginning of of the current business expansion. 1 9 5 0 and of 1 9 5 5 . T he Im portance of In v e n t o r y C hanges in B u s in e s s C y c l e s E x p l a n a t io n s of I n v e n t o r y B e h a v io r A study by the National Bureau of Econom ic Research The behavior of business inventories m ay be explained principally by reference to two m ajor factors: ( 1 ) the ratio has concluded that in most of the business cycles that of inventories to sales (or output) which businessmen occurred during the two interwar decades ( 1 9 1 9 - 3 8 ) , the amount of inventory investment— i.e., the rate at which businessmen were adding to or drawing on their stocks— exhibited greater fluctuations than any other major cate gory of expenditures.1 A lm ost a third of the total cyclical fluctuation in “ real” gross national product ( G N P adjusted attempt to maintain; and ( 2 ) their success in maintaining this ratio. Inventory objectives and the degree of precision with which they can be realized m ay, of course, vary widely from industry to industry, from commodity to com 2 Or about two thirds of the decline, if the end of the contraction is placed before rather than after the steel strike of October 1949- to exclude the effects of price changes) over these twenty years was found to have reflected alternating shifts between inventory accumulation and liquidation. A further impor tant finding was that the role of inventory changes, although significant during both expansions and contrac tions, was relatively much greater in contractions. During the expansions, the stepping-up of the pace of inventory building amounted, on the average, to less than a quarter of the total gains in output from cyclical troughs to peaks; but in recessions the shift from accumulation to liquida tion represented nearly half of the declines. While data that would permit a comparable analysis of FEDERAL RESERVE OPERATIONS IN THE MONEY AND GOVERNMENT SECURITIES MARKETS Th e publication of the booklet, Federal Reserve Operations in the Money and Government Securities Markets, which w as announced in last month’s Review, has met somewhat greater demand than had been anticipated. T h e original printing is now virtu ally exhausted. Additional copies will be available for bulk distribution, free of charge, early in N ovem ber. Requests for copies will be filled as promptly the postwar period have not been published, the available as possible. figures do seem to indicate that inventory behavior since which operations are conducted through the B an k ’s This booklet discusses the manner in W orld W ar II has in most respects conformed to a similar Trading Desk pattern, notwithstanding the distortions in the course of the Federal Open business activity introduced by the K orean w ar and by the should be addressed to the Publications Division, steel strikes in 1 9 4 9 , 1 9 5 2 , and 1 9 5 6 . Th e importance of Federal R eserve B an k of N ew Y o rk , N ew Y o rk 4 5 , N ew Y o rk . 1 Moses Abramovitz, Inventories and Business Cycles, National Bureau of Economic Research, 1950. in carrying out the directions of M arket Committee. Inquiries 144 MONTHLY REVIEW, OCTOBER 1956 by making certain assumptions about the nature of inven tions regarding the prices and availabilities of raw mate rials. E a rly this year, for example, m any producers of tory goals and the extent to which they can be achieved, consumer durables were building up their steel inventories a considerable measure of understanding of inventory be havior m ay be gained. in expectation of a price rise and possible strike, although they were at the same time reducing their output of modity, and from one period to the next. Nevertheless, Probably the simplest such assumption is that business finished goods. In some industries where goods m ay be men desire and are in fact able to maintain stocks in some stored for long periods between one processing stage and constant proportion to sales (or o u tp u t). O n this assump the next (e.g., tanning), even stocks of goods under fabrica tion, inventory behavior will be governed by what is tech tion m ay vary quite independently of output.4 Despite nically termed the ‘ ‘acceleration” effect, first applied to inventories by J . M . C lark in 1 9 1 7 . 3 Th e acceleration these influences, however, it seems likely that changes in the rate of output still are most often the major deter principle asserts that the extent to which businesses add minant of changes in raw materials and in-process inven to (o r draw on) their stocks is determined by the amount tories, so that for these stocks the acceleration effect would be expected to apply without major modification. that sales increase (or decrease) in successive periods. (In the case of stocks that a firm does not intend to sell but uses in production— i.e., purchased materials or goods in However, for much of the two thirds of total inventories that consists of stocks of goods for sale, the assump process— the relevant relationship is between inventories tion that the stock/sales ratio can be held constant is and output rather than sales.) Thus, when sales advance by a larger amount in one month than in the preceding unrealistic. W ith the exception of items for which there are specific and guaranteed orders from particular cus tomers, the rate of purchasing on the part of retailers and wholesalers, and of output by manufacturers, must neces one, business firms will also increase the rate of inventory accumulation, accentuating the business upturn. W hen sales are falling more rapidly over a given interval than sarily depend on their anticipations as to what customers during the previous one, the rate of inventory liquidation will want to buy. Th e inherent uncertainty of predictions of demand makes it virtually inevitable, however, that m any if not most of these forecasts and judgments will be somewhat wide of the mark. Alm ost unavoidably, therefore, inventories of goods for sale are rarely at the will also be speeded up, accentuating the business decline. A striking corollary of the acceleration effect is that, when gains in sales become smaller— although total sales con tinue to rise— firms will make smaller additions to inven tory, and as a result even total ordering (or production) m ay turn down. Conversely, when sales are falling, a slackening in the amount of decline— though sales are still on the downtrend— will lessen the need to reduce inven tories and will contribute to an upturn in total ordering. Consequently, if not offset by other factors, a decline in the rate at which aggregate sales are growing m ay touch off a general contraction in production, while a decline in the rate at which sales are falling m ay lead to a general recovery. Th e assumption that business firms maintain a fairly constant stock/output ratio seems to describe fairly accu rately the w ay in which manufacturers manage inventories o f materials to be processed in their own plants (although unforeseen changes in output and other factors m ay give rise to intermittent departures from stock/output objec tives). Such stocks currently amount to more than a third of total inventories. O f course, while businessmen m ay tend to maintain their holdings of raw materials and goods in process close to target levels, they do at times revise target ratio which businessmen had sought and would con sider most desirable. W hen the possibility of these involuntary departures from inventory goals is taken into account, it can be shown, by a detailed economic analysis beyond the scope of this article, that the corrective reactions of business firms in stepping up or curtailing output in response to such influences m ay, through their repercussions on em ployment and incomes, be sufficient to bring about cyclical fluctuations affecting the entire econom y.5 Th e experience of the automobile industry with the 1 9 5 5 and 1 9 5 6 models illustrates in some respects the w a y in which largely unavoidable errors in sales forecasts become reflected first in unforeseen inventory changes and then in production adjustments that react on economic activity at large. Th e new 1 9 5 5 models, introduced at a time when the economy was just emerging from a mild recession, were accorded an unexpectedly favorable reception. Produc tion was immediately stepped up in response, spurring on 4 Ruth P. Mack, Consumption and Business Fluctuations: A Case Study of the Shoe, Leather, Hide Sequence, National Bureau of level of stocks in relation to output. F o r the most part, Economic Research, 1956, provides a detailed study of the differing determinants of inventory behavior in industries with diverse produc these shifts probably are caused by revisions in expectation and marketing patterns. 5 Lloyd Metzler, "The Nature and Stability of Inventory Cycles” , 3 "Business Acceleration and the Law of Demand: A Technical Review of Economic Statistics, August 1941. Factor in Economic Cycles” , Journal of Political Economy, March 1917. their view as to what constitutes a necessary or desirable FEDERAL RESERVE BANK OF NEW YORK 145 the general economic recovery; but the pace of automobile sales also quickened more than seasonally so that, despite capacity output, inventories remained unintentionally low in relation to sales until well into the spring of 1 9 5 5 . A fte r the usual seasonal swings in output and inventories result ing from the annual model change-over, the industry re A s indicated earlier, involuntary or undesired changes in inventories would be expected to occur principally, although by no means exclusively, in holdings of finished goods. This is true particularly of holdings of finished durables, since purchases of such goods, being to a large extent postponable, fluctuate more capriciously than other sumed peak assembly rates in the fourth quarter of 1 9 5 5 , apparently on the assumption that sales of the 1 9 5 6 models buying. If analyzed in combination with indicators of out put and sales, the behavior of some types of finished goods would follow the pattern of the previous year. However, sales instead fell sharply behind the 1 9 5 5 rate, bringing inventories held in manufacturing and trade often permits about an unintended and undesired build-up in new car stocks. A s a result, production had to be drastically cur tailed to a rate substantially below sales for the rest of the 1 9 5 6 model run, compelling sizable layoffs of workers in the automobile industry and among its suppliers. Thus, by and large, apart from sheer excesses of specu lation, the instability of inventories as a factor in triggering cyclical turns, or in accentuating cyclical swings, arises in a diagnosis as to whether current movements are largely intended or unintended. F o r example, if sales and output are expanding but finished goods inventories are declin ing, involuntary liquidation m ay be in progress. If inven tories are growing in the face of declining sales and output, on the other hand, the accumulation of stocks m ay be unwanted. Because of these involuntary fluctuations in finished goods stocks, it is to be expected that turning points in two principal ways. First, there is the so-called accelera the level of such inventories would tend to lag behind tion relationship which applies most clearly to the one third of all inventories that vary rather directly with output turning points in sales. or sales. Second, there is the effect of attempting to cor rect for involuntary changes in inventories, a possibility Stocks continue to accumulate (involuntarily) for some time after sales have turned down, and are liquidated (involuntarily) for some time after sales have turned up. Turning points in inventories of other than that is dominant through the two thirds of business in ventories that consists of the finished goods of m anufac finished goods, in which involuntary fluctuations are likely turers and the stocks of the wholesale and retail trades. cide more closely with those in sales. The effects on aggregate activity of these built-in tenden study cited earlier has verified to the extent permitted by cies toward fluctuation are, of course, mitigated by the vast variety of the nation’s product m ix which much of the the limited data that these relationships did in fact prevail time provides several adjustments in one direction to offset those occurring elsewhere in the opposite direction. It is the problem of observing and appraising the patterns, of judging the likelihood of balancing offsets or of a cumu to be smaller and less frequent, would be expected to coin Th e Abram ovitz during the interwar period. Furthermore, as m ay be seen in the chart, which plots sales of durable goods against inventories of durable finished goods at all levels of dis tribution, the lag between sales and inventories of such goods has apparently continued to operate in the postwar lative spiral, that must occupy much of the attention of those who attempt to visualize the “ business outlook” . SALES AND INVENTORIES OF FINISHED DURABLES St a t is t ic a l E v id e n c e Quarterly averages of monthly figures, 1948-56 Billions of dollars Billions of dollars While statistics alone can never distinguish between voluntary and involuntary inventory changes, breakdowns of the aggregate inventory figures have been developed that do provide some guidance in this regard. Th e Department o f Com m erce publishes monthly estimates of the book value of inventories held by manufacturers, wholesalers, and retailers, showing breakdowns for durables and non durables, as well as by several industry classifications. F o r manufacturers, furthermore, the inventory total is re fined into three additional subcategories: purchased mate rials, goods in process, and finished goods ready for sale. (N o such further breakdown is needed for wholesalers and retailers; virtually all their stocks are presumed to consist of goods ready for sale.) # Data for 1948-50 are not exactly comparable to later figures. Source: United States Department of Commerce. MONTHLY REVIEW, OCTOBER 1956 146 period. Alm ost every turning point in durable goods sales over the 8 V2 industrial production— a time when most other important years covered by the chart has preceded by categories of stocks (as well as stocks in the aggregate) one or more quarters a similar turnabout in finished goods were still decreasing. Retail inventories began to advance inventories. The evidence concerning the timing of turns at the turn of the year, but the rise initially reflected almost entirely the build-up in new car stocks as the automobile in inventories of finished nondurables and of other-thanfinished goods during the postwar period is less clear-cut, industry attempted to bring inventories into line with the but seems in general also to accord with theoretical unexpectedly high rate of sales. T h e broad inventory up expectations. swing did not begin until A p ril 1 9 5 5 , when manufacturers’ holdings of purchased materials, wholesalers’ stocks, and R ecent I n v e n t o r y B e h a v io r nonautomotive retail holdings also turned upward. M anu Th e recent period of business expansion has been accom facturers’ holdings of finished goods, in accord with pre panied by a substantial growth in inventories, with sea vious experience, were the last m ajor category of inven sonally adjusted book values increasing in every month tories to rise; these stocks did not expand significantly until the third quarter of 1 9 5 5 . since the beginning of 1 9 5 5 . Th e total addition to book value over the period amounted to 9 billion dollars, or more than 1 0 per cent. Th e major part of the increase resulted from physical addition of goods to stockpiles, while about a third reflected higher replacement costs. In broad terms, the variations in growth rates of aggre Th e subsequent record is more difficult to interpret, since a large and growing proportion of the expansion in inventory values after the summer of 1 9 5 5 has reflected higher prices rather than increases in physical quantities. It would appear, however, that between the latter part of gate stocks as well as of their m ajor constituents appear 1 9 5 5 and m id-1 9 5 6 the growth of stocks of finished dura to have conformed fairly closely to the patterns outlined bles held by both producers and distributors has slowed above. considerably or been replaced b y liquidation; this is true even if retail automobile stocks are excluded. The expan A s in previous business expansions, the rise in stocks did not begin until several months after the upturn Once the expansion in stocks had sion in the volume of goods in process probably also has begun, at the beginning of 1 9 5 5 , it proceeded at first less slackened somewhat, in real terms, reflecting the levelingoff in factory output. On the other hand, nondurable finished in aggregate output. rapidly than the advance in business sales. Th e inventory growth soon accelerated, however, and by the fall of 1 9 5 5 goods— such as textiles, petroleum, paper, and possibly was already outpacing the sales advance. W hen total sales subsequently leveled off in late 1 9 5 5 and early 1 9 5 6 , the chemicals— v/ere piling up much more rapidly, while stocks of raw materials increased swiftly in the months preceding the steel strike. inventory accumulation continued and in fact temporarily speeded up, reflecting in part the “ involuntary” growth of stocks of such items as automobiles and appliances. Since M arch 1 9 5 6 , however, the rise in book value of inventories has slackened and in Ju ly was brought almost to a halt by the steel strike. During these months, inventories appeared to be undergoing a “ rolling readjustment” . Out put in industries with overextended inventory positions, notably the automobile industry, was curtailed, and accu A s noted above, the rate of inventory accumulation has slowed substantially in the past few months; indeed, it would not have been possible for the rapid rate of accu mulation since early 1 9 5 5 to have been sustained indefi nitely. M ost recently, there m ay in fact have been actual liquidation in the physical volume of stocks, due to the interruption of steel production, the further reduction of retail automobile inventories (which had built up to record mulation turned to liquidation. T h e effects of such liqui heights early this y e a r), and scattered output curtailments dation were moderated, however, by the more rapid expan in other lines, such as textiles. H ow ever, in m any of the sion of stocks in other lines. In some of these industries, industries where stocks had earlier become overextended, notably in capital goods, producers still were attempting they are now reported to have been reduced almost to the to catch up with rising demand, while in others, such as desired levels. textiles, some firms m ay have experienced involuntary aggregate inventories is therefore a distinct possibility. accumulations. A resumption of more rapid growth in Prior to the steel strike, the widespread H o w long renewed growth could continue depends in stockpiling of steel also provided a major offset to the large measure on whether such growth would be balanced liquidation of other types of holdings. Th e types of goods that were being added to inventories changed considerably as the business upswing progressed. and in line with sales, rather than being motivated by expectations of higher prices. Since such expectations are often subject to sudden reversal, particularly abrupt Inventories of goods in process, for example, started to shifts from accumulation of inventories to liquidation m ay expand in the fall of 1 9 5 4 — coincident with the upturn in occur when accumulation has depended to an important 14? F E D E R A L R E SE R V E B A N K OF N E W Y O R K extent on speculative motives. These shifts, in turn, are prone to touch off cumulative forces leading to recession in the economy at large. A t the same time, however, it should be recognized that some moderate growth in inven tories over the long run is to be expected and is, in fact, in moderating rapid shifts in the rate and direction of inven tory investment and in combating their unsettling conse quences. T o the extent that policy succeeds in averting or cushioning wide and too rapid fluctuations in incomes and employment, and hence the accom panying swings in essential to a growing economy. demand and prices, the sudden and sharp reversals in inven tory movements that have aggravated cyclical turns in the I n v e n t o r ie s and E c o n o m i c P o l ic y past also are likely to be moderated. A t the same time, Fluctuations in inventories are unavoidable in our com monetary policy m ay also help to restrain excessive inven plex economy in which business production and purchasing tory expansions which stimulate economic activity to unsus decisions must seek to anticipate frequent variations in tainable peaks, and can be effectively used to prevent prices and demand, which at best can be only imperfectly foreseen. Nevertheless, economic policy can play a part credit stringencies that might provoke distress liquidation of inventories in recession. MONETARY CONTROL IN A RAPIDLY DEVELOPING ECONOMY: THE NEW ZEALAND ROYAL COMMISSION REPORT A broad-scale public inquiry into the monetary problems ployment of labour, ensuring the healthy development of of a rapidly developing economy has recently been con natural resources, and promoting generally the economic, financial, and social welfare of the people of N e w Zealand” . cluded in N ew Zealand. A s is traditional in the British C om monwealth countries, the inquiry was conducted by a R o yal Commission appointed by the government on a nonpolitical Accordingly, it was to investigate and report on: “ (a) any monetary, banking, and credit proposals that m ay be sug comparable in m any respects to the reports of similar gested as suitable for application in N ew Zealand; (b) the present monetary, banking, and credit system in N ew commissions in the past, such as those which in Canada Zealand and the advisability or otherwise of any changes in 1 9 3 3 dealt with the question of establishing a central in that system; and (c) any associated matters which should bank, in N ew Zealand in 1 9 3 4 and A ustralia in 1 9 3 6 - 3 7 with the improvement of the monetary framework and be deemed . . . to be relevant to the general objects of the inquiry” . instruments, and in Britain in 1 9 3 1 (the M acm illan C om The commission itself was composed of six distinguished N ew Zealanders selected from various parts of the country basis. The commission’s report1 is an important document, mittee) with the broader problem of fostering domestic adjustments to fundamental changes in the world economy. and from various professions. Th e chairman was a judge These earlier reports analyzed the economic and financial issues of the day, recommended policies for dealing with of the labor Arbitration Court; the other members included a barrister, a public accountant, the managing director of the Farm ers’ Co-operative Organization Society, the gen eral manager of a business firm, and the managing editor of a daily newspaper. Heading the commission’s staff were the chief of the economic research branch of the N ew Zealand Treasury and a senior lecturer in economics from them, and contributed greatly to a better understanding by the public of the com plex problems facing the monetary authorities. Lik e its forerunners, the report of the N ew Zealand R o yal Commission m ay well exert a profound influence on the evolution of central banking and monetary policy in N ew Zealand. Victoria University College, Wellington. Hearings were held over a five-month period in 1 9 5 5 in Wellington and T he R oyal C o m m is s io n other principal cities of N ew Zealand. cluded individuals who The R o yal Commission on M onetary, Banking, and Witnesses in appeared at the commission’s request (m ainly government officials and representatives Credit Systems was established by the N ew Zealand G o v of banks and insurance com panies), as well as others ernment on M arch 16 , 1 9 5 5 . Its terms of reference were whose testimony was given on their own initiative, while broad since it was to concern itself with “ fostering a written statements were also received from both official greater degree of stability in prices, maintaining full em 1 Report of the Royal Commission on Monetary, Banking, and Credit Systems, Wellington, New Zealand, 1956. and private sources. Little more than a year after it had been established, the commission submitted its 500-p age final report, signed by all its members without reservations. MONTHLY REVIEW, OCTOBER 1956 148 T he M onetary Problem in N e w Z ealand over the substantial changes in incomes of producers and exporters that are induced by wide fluctuations in overseas In keeping with its objectives, the commission devoted considerable attention to the analysis of inflation in N ew prices. Zealand. M oreover, the problem of monetary control is Th e commission’s report attributes these infla greatly complicated when— as has been too frequently the tionary strains mainly to the country’s rapid population case in N e w Zealand since the w ar— “ the governments increase, a rise in overseas prices for its exports and imports, an excess of capital expenditures over voluntary savings, have permitted, and through tax reductions have even encouraged, unduly high domestic spending” . heavy government expenditures during W orld W ar II for military purposes and subsequently for social security Additional limitations lie in the structure of the banking system. Th e system itself is relatively simple, consisting of and other programs “ com m only associated with the W el fare State” , wage and salary increases, and finally the only five commercial banks with branches throughout the expansion of the money supply resulting from greatly central bank difficult. Th e operations of one of the five com increased bank lending. The inflationary pressures thus created have brought years has handled 4 0 per cent of the country’s banking busi about balance-of-paym ents difficulties which, the report ness and is government owned— have not always been notes, had led to the imposition of import and exchange controls as early as Decem ber 1 9 3 8 . These controls were Reserve Ban k of N ew Zealand. O f the other banks, three country; but certain of its features render control by the mercial banks— the Ban k of N e w Zealand, wiiich in recent closely coordinated with the policy of the central bank, the tightened after the beginning of the w ar and were bolstered by an anti-inflationary fiscal policy and other measures have their head offices in other sterling countries, thus m ak that did much to curb the upward pressure on prices. M an y of these measures remained in force in the early postwar the absence of a money market in N ew Zealand and the years, with the result that “ compared with other countries of open market operations as an instrument of control. In N ew Zealand was very successful in restraining price in these circumstances, according to the commission, “ the creases between 1 9 3 9 and 1 9 4 8 ” . Thereafter, however, most that can be expected from the monetary, banking, and prices began to rise more steeply as the incomes of N ew Zealand wool growers were swollen by high overseas prices, private investment outran voluntary savings, and the w ar credit systems is that they should certainly not aggravate” these economic, financial, and institutional difficulties, and that “ they should be capable of being used to assist in the time stabilization programs were discontinued. W ith the economic adjustments which are necessary to enable society ending of the commodity boom that followed the Korean to reap the benefits, while countering any drawbacks, of outbreak, these inflationary strains declined perceptibly, technical and economic changes” . only to rise again in 1 9 5 5 . Summing up N ew Zealan d’s eco nomic position in 1 9 5 5 , the commission pointed out that exporters’ incomes were buoyant, capital investment was at a high level, vacancies in industry exceeded the number of persons seeking work, and there was “ confidence in future prospects” . Since the mid-thirties, in short, the coun try’s outlook had “ changed from depression to prosperity, from severe unemployment to overfull employment, and ing for easy access to overseas money markets. M oreover, thinness of the capital market make impracticable the use Within these limitations, the commission found that the N ew Zealand monetary authorities are on the whole ade quately equipped to perform their task. The Reserve B an k of N e w Zealand possesses the rediscount, open market, and reserve requirement instruments for credit control. There is no ceiling on the level to which reserve require ments m ay be increased, but they m ay not be reduced be low 7 per cent of demand deposits and 3 per cent of time from deflation to inflation” . deposits; all changes require the consent of the M inister of T he F ram ew o rk M and onetary In str u m e n ts of P o l ic y Finance. Other controls are exercised directly by the gov ernment, which has for m any years restricted to a low level Th e central questions to which the commission ad the commercial banks’ holdings of government securities; dressed itself were whether the authorities possessed ade in addition, the overdraft rates have long been controlled quate monetary control instruments, whether the existing by instruments had been used as effectively as possible, and mercial banks. whether any changes in these instruments or in their use ownership of the Ban k o f N ew Zealand could, in the opin were desirable. A t the outset, the commission recognized ion of the commission, “ reinforce its general policy as certain limitations under which the monetary authorities regards bank lending, and influence bank charges b y spe had to operate. N o matter how refined their monetary in cific instructions” to that institution. Equipped with these struments, the authorities, in an econom y as dependent on various powers, the monetary authorities accordingly have foreign trade as N ew Zealand’s, can exercise little control “ far reaching powers to curb unwanted bank lending” . agreement between the government and the com M oreover, the government through its FEDERAL RESERVE BANK OF NEW YORK Indeed, the Reserve B an k ’s powers unaided could “ be used . . . to make an unwanted expansion of advances com pletely unprofitable to the banks and to provide them with a direct financial inducement to keep advances within desired limits” . R ecent M onetary P o l ic y 149 Requirements were raised in several steps, from the 7 and 3 per cent minima, until in M a y 1 9 5 3 they stood at 2 0 per cent against demand deposits and 1 0 per cent against time deposits. Nevertheless, commercial bank balances at the R eserve Bank, augmented by substantial surpluses in the balance of payments, remained well above the required ratios, averaging no less than 3 9 per cent of total bank deposits during 1 9 5 3 . “ Y e t despite the large amounts o f Th e conclusion that the authorities possessed adequate instruments for monetary control led to the further ques minimum reserve ratios were not raised again until the tion whether these instruments had been effectively used. end of M a y 1 9 5 4 ” , while the discount rate remained un In answering this question the commission reviewed N ew Zealand’s recent monetary experience, dividing it into four periods that coincided with the m ajor changes in the Reserve B an k ’s credit policy. Th e first period included roughly the three years ended in M arch 1 9 5 2 . This was a period of sharp inflationary pressures, during which commercial bank advances more than doubled. W hile this expansion was partly attributable to factors beyond official free cash in the hands of the banks” , the report states, “ the changed at IV2 per cent. Th e money supply accordingly continued to expand, domestic prices rose despite de clining import prices, and the labor market remained tight. Summing up its findings in regard to this period, the com mission stated that “ in our opinion, a firmer policy should have been adopted in the latter part of 1 9 5 3 , e.g., by reducing the margin of free cash available to the banks to a very low level and indicating that the reserve ratios control, the commission found that it was also partly due and the interest rate for borrowing from the R eserve B ank “ to the failure of the monetary authorities to make use of would be raised speedily and considerably if advances the reserve ratio[s]” , which remained at their legal minima increased to any significant extent” . until after the end of the period. M oreover, the Reserve B an k ’s discount rate had remained unchanged at the IV2 1 9 5 5 , inflationary pressures again increased. The Reserve per cent level at which it had been set in Ju ly 1 9 4 1 . B ank accordingly tightened its monetary policy further by Indeed, the Reserve Bank, according to the commission, squeezing the banks’ “ free cash” and also by raising the cost of borrowing at the central bank. Th e R eserve B an k’s did not “ appear to have recognized the need for imposing restraint” until the autumn of 1 9 5 0 , and even then it In the third period, covering the year ended M arch merely asked the commercial banks “ to adopt a cautious discount rate w as raised by 2 per cent to in Ap ril 1 9 5 4 , and to 4 per cent in Novem ber 1 9 5 4 . A t the same attitude to all requests for increased accommodation” . time, reserve requirements were so adjusted during the This request was subsequently bolstered by other restraint winter of 1 9 5 4 - 5 5 that the “ free cash” balances of the four measures under the so-called selective advance-control private commercial banks were “ substantially reduced” . M oreover, the government-owned B ank of N ew Zealand policy, in accordance with which certain priorities have been set by the government for the granting of bank credit. However, as the commission noted, it was not until Decem ber 1 9 5 1 that the banks were advised that the reserve ratios were to be raised, and the first increase was not made until August 1 9 5 2 . Assessing the government’s policy in this period, the commission commented that “ the monetary was in debt at the Reserve Bank during most of the year ended M arch 1 9 5 5 , although for special reasons part of its borrowings was interest free. Nevertheless, the expansion of bank credit continued, and this occurred despite the fact that, in the opinion of the commission, “ external authorities were slow to appreciate the need of restraining factors were not exerting an inflationary influence” . The banks’ advances rose 1 5 per cent between M a y and bank advances” . M oreover, the authorities were “ unwise” to rely on the policy of selective advance control because October 1 9 5 4 , and after a brief period of stabilization began to expand again in M arch 1 9 5 5 . Summing up, the the commercial banks had “ substantial excess cash reserves commission found that “ the narrowing of the margin of [and] were confronted with a very strong demand for free cash and the raising of the Reserve B an k ’s lending advances from credit-worthy borrowers for purposes which rate in the second quarter of 1 9 5 4 did not have any were not (at least until the end of 1 9 5 1 ) inconsistent” restraining effect on lending by the trading banks” . with the selective controls. Th e persistence of inflationary strains during the nine In the second period— roughly the two years ended months ended Decem ber 1 9 5 5 — the final period analyzed M arch 1 9 5 4 , during which external inflationary pressures by the commission— prompted a further tightening of the on the N ew Zealand economy were subsiding— the Reserve Reserve B an k’s monetary policy. Reserve ratios were ad Bank brought the reserve requirements into play in order justed so as to force the commercial banks as a whole to to place itself in a better position to control bank credit. borrow at the central bank in order to maintain the re MONTHLY REVIEW, OCTOBER 1956 150 quired level of reserves. A statement of the governor of additional income made by the banks on their higher the Reserve Bank in October 1 9 5 5 , when the reserve advances . . . E v e n allowing for any consequential in requirements for demand deposits were raised to 2 4 per creases in administration expenses, and loss of income due cent, indicated that the authorities’ aim was to keep the to sales of sterling, the banks’ additional earnings obviously banks as a whole “ in the red” to the extent of about 1 2 greatly exceeded the interest payments made to the Reserve B an k.” Th e Reserve B an k ’s policy, in the opinion of the million pounds, equivalent to about one fifth of their re quired reserves at that time. A t the same time, the Reserve commission, would have had a restraining influence only Ban k raised its discount rate in three steps to 7 per cent in the exceptional case in which a single bank that was in October 1 9 5 5 from the 4 per cent rate established the just meeting its minimum reserve requirements was ex previous Novem ber. These measures were accompanied by rather notable panding its lending while the lending of other banks was changes in monetary trends. Apparently with the aim of “ would certainly be penalized” . However, the commission not increased. In these circumstances the expanding bank reducing their indebtedness at the Reserve Bank, the com apparently felt that this was not the situation in Newr mercial banks sold an exceptionally large amount of ster ling to that bank. “ Though they thus escaped payments Zealand where the relatively few, big banks more or less kept pace with each other in the general expansion of of interest to the Reserve B an k ” , the commission found lending. that the commercial banks “ had to forego the interest cluded, “ the banks are not automatically penalized if they In these circumstances, the commission con which might otherwise have been earned on short-term are forced to borrow from the R eserve B an k to maintain investments overseas” and were thus indirectly penalized their statutory reserve requirements as a result of an ex by the stringent reserve requirements. F o r the same rea pansion of their advances. This is so even if the minimum son, some of the commercial banks also borrowed over reserve ratios are fairly high and the rate of interest seas, although the amount, in the opinion of the commis charged to the banks by the Reserve Ban k is higher than sion, did not seem “ abnormally high in comparison with the rate of interest which the banks can obtain on their previous years” . accompanied the Reserve B an k ’s stringent measures was advances.” W hile critical of the conduct of the official monetary the 7 per cent decline in commercial bank advances during policy and dubious about its effectiveness in recent years, the nine-month period, the reduction being achieved, as the commission found that “ inadequate support from other the commission noted, “ in the face of strong pressure for policies has been an important element in the lack of suc accom m odation” . cess in controlling advances . . . Inflation cannot be effec tively fought on one front alone.” In particular, support A Pr o blem s more important development that of M o netary C ontrol While the commission regarded this reduction of com mercial bank advances as gratifying, it expressed some doubts about the extent to which this change could be attributed to the Reserve B an k ’s policy of putting the trad ing banks “ in the red” . These doubts stemmed partly from the special position of the B an k of N ew Zealand which, because it handles certain government business in various parts of the country, was permitted a specified amount of interest-free borrowing at the central bank. Although it was not given by the government’s fiscal policy. Although the use of budgetary policy to restrain inflationary pressure had been recognized in successive issues of the official Economic Survey, the government “ has not in fact made sufficient use of its power to restrain private expenditure in an inflationary period by collecting more from the pub lic, by taxation and borrowing, than it pays out. Govern ments have, throughout the postwar period, been too ready to grant taxation concessions which economically were in all the circumstances inadvisable.” M oreover, insufficient held relatively large amounts of overseas funds, the B ank attention had been paid, in the opinion of the commission, of N ew Zealand nevertheless borrowed continuously “ quite to the inflationary effects of some types of nonbank credit, large amounts from the Reserve B an k ” , which in the opin especially as regards housing. In this field, the program of ion of the commission “ had the rather anomalous effect of the authorities had “ tended to frustrate the government’s preventing the intended measure of restraint on lending anti-inflationary policies, either by reducing the overall from operating with full force on the other [commercial] budget surplus achieved, or at times by necessitating re banks. Thus the policy of the State-controlled bank oper course by the government or by the State A dvances C o r ated, in the circumstances, to shield the private banks.” poration to the banking system for finance” . Furthermore, the commission noted that, although the amount of borrowing by the commercial banks from the T he C o m m is s io n ’s R e c o m m e n d a t io n s Reserve Bank was relatively large, “ the actual interest In the field of monetary policy, the commission’s prin paid by the banks has been small in relation to the cipal recommendations were that the authorities, in con FED ER AL RESERVE B A N K OF N E W Y O R K 151 sultation with the trading banks, should periodically assess the grounds that the proceeds are to be used to reduce or the level of bank credit appropriate for the short-term repay bank overdrafts, that direct controls over capital future and, while allowing scope for competition between transfers overseas be maintained, that the government the banks, should give them “ a direct financial incentive to avoid frequent variations of exchange rates as a method of cooperate” in the achievement of the official target. The balance-of-payments adjustment, and that N ew Zealand banks, said the commission, would: “ be informed that, for seek membership in the International M onetary Fund and every £ 1 million by which advances exceeded the target the International Bank. level fixed for a particular date, the ratios would be raised to put the banks into debt at the Reserve B ank to the extent of £ 1 million. To avoid unduly conservative lending C o n c l u d in g R em arks policies by the banks, it might be desirable to fix two The commission’s recommendations have not failed to rates of interest for borrowing from the Reserve Bank. provoke debate in N e w Zealand. In particular, the question One would apply to extensions of credit slightly above has been raised whether the proposal for a target level of the desired level and would be fixed at such a figure that advances goes to the root of the country’s monetary diffn the banks made neither profit nor loss by expanding culties, and whether the inquiry has not neglected some credit to that extent. The other, a penal rate, would be factors that have contributed to the banking system’s slow applied after this margin of tolerance had been exceeded.” response to monetary policy. M ore specifically, it is ques In accordance with this suggestion, the commission recom tioned whether sufficient emphasis has been placed on: (1) mended that the authorities be prepared to vary reserve the elasticity of the commercial banks’ cash balances, which requirements “ quickly and resolutely in order to make can be augmented by loans from head and other offices them effective” , and that no ceiling be placed on the level overseas; (2) the fact that the volume of bank loans depends However, if on the borrowers’ initiative so long as overdraft limits the requirements were “ fixed at very high levels, it might exceed actual advances; and (3) the difficulties of branch to which the requirements could be raised. sometimes be equitable to allow the banks’ interest on part managers in making quick readjustments in thousands of o f the balance which they are required to keep at the overdraft limits, especially as regards important customers. Reserve Bank, or to permit them to take up Treasury bills Finally, the report, having cast doubts on the efficacy of held by the R eserve B an k ” . In addition, the commission monetary policy in bringing about the decline in advances recommended increased use of the commercial banks’ over during 1 9 5 5 , offers no alternative explanation for the draft rates, especially in order to strengthen the selective change in monetary trends. advance-control policy. “ Th e banks should be permitted It is clear, however, that the N e w Zealand inquiry has to fix rates of interest on overdrafts within a fairly wide served many useful purposes. range, on the understanding that the average rate of inter has gathered a large amount of valuable information Th e commission’s report est charged will be at a level deemed desirable by the not heretofore available about the N e w Zealand economy. authorities.” It also recommended that, if an effective sys Its hearings and report have stimulated public interest in tem for controlling the aggregate of the banks’ assets were the country’s difficult monetary problems. Th e commission adopted, “ the banks should be allowed to invest in Govern itself, moreover, has made many thought-provoking recom ment securities” and that a “ short-term money market . . . mendations for dealing with the persistent inflationary be established” . Finally, noting that successful monetary pressures that have cut in half the purchasing power of policy depends on the skill and judgment of the authorities, N ew Zealan d’s currency during the past twenty years. the commission emphasized that recurring disturbances M ore generally, the commission has highlighted the extra from both internal and external factors make flexibility ordinary insensitivity of N ew Zealand commercial bank essential and that “ a change of monetary policy is not a lending to wide variations in bank liquidity, and has raised sign of weakness, but a sign of increased knowledge and some important questions about the extent to which mone alert appreciation of changing conditions” . tary control can be exercised through traditional instru In other fields also, the commission made a number ments in economies like N e w Zealand’s. The R o yal C om of recommendations, including the proposals that local- mission’s report m ay thus mark the beginning of a fresh authority borrowing rates be kept in line with those at approach to N ew Zealand’s monetary problems, and m ay which the central government borrows in the capital m ar also offer constructive guidance to other primary-producing ket, that the Capital Issues Committee should not refuse countries faced with the need for reconciling rapid eco permission to companies to enter the market merely on nomic growth with reasonable financial stability. MONTHLY REVIEW, OCTOBER 1956 152 SELECTED ECONOMIC INDICATORS United States and Second Federal Reserve District Percentage change 1956 Item 1955 Unit August July June August Latest month Latest month from year from previous month earlier U N IT E D ST A T E S Production and trade Industrial production*............................................................................. Ton-miles of railway freight*................................................................ Manufacturers’ sales*............................................................................... Manufacturers’ inventories*.................................................................. Manufacturers’ new orders, total*...................................................... Manufacturers’ new orders, durable goods*................................... Retail sales*................................................................................................. Nonresidential construction contracts*............................................ 1947-49 = 1947-49 = 1947 -49 = billions of billions of billions of billions of billions of 1947 -49 = 1947 -49 = 100 100 100 $ $ $ $ $ 100 100 1947-49 = 1947 -49 = 1947 -49 = billions of 1947-49 = thousands thousands hours thousands 100 100 100 $ 100 141p 220 — 2 7 . 5p 49. 4p 2 8 .9p 15 .1 p 2Q5p 253 p 136 219 97p 2 6 .2 4 9 .2 2 7 .0 13 .5 16. Op 265 249 141 221 106 2 7 .7 4 9 .1 2 7 .9 1 4 .2 1 6 .0 269 248 140 208 102 2 7 .2 4 4 .3 2 8 .7 1 5 .1 1 5 .7 278 246 8 8 .6 114.0 117.0 3 2 4 .5p 149 p 5 1 ,022p 16,467p 4 0 .0 2 ,8 3 3 8 8 .3 1 14.2 116.2 32 4 .9 149 51,600 16,877 4 0 .2 2 ,9 2 7 8 9 .5 110.9 1 1 4 .5 3 0 8 .7 142 5 0,3 1 5 16,677 4 0 .6 2 ,2 3 7 7 2 , 150p 8 7 , 250v 105,340p 3 0,782 7 8 ,3 2 3 141.9 2 9,103 72,750® 87,720p 105,080p 3 0 ,7 2 0 76 ,4 8 8 135.0 2 8,890 7 9 ,3 4 0 7 7 ,3 4 0 103,880 30 ,3 8 0 74,741r 1 32.5 2 6 ,1 5 5 3,7 0 1 5 ,6 0 3 3 ,8 2 2 12,192 6 ,8 9 8 3 ,5 0 5 6 ,3 3 3 7 ,2 5 6 3 ,7 7 7 Prices, wages, and employment Basic commodity pricesf........................................................................ Consumer pricesf....................................................................................... Personal income (annual rate) *^[........................................................ Composite index of wages and salaries*........................................... Nonagricultural employment*.............................................................. Manufacturing employment*............................. .................................. Average hours worked per week, manufacturingf....................... Unemployment............................................................................................ 9 0 .6 1 1 4 .6p 1 16.8 — — 5 1 ,621p 1 6 ,840p 40. 3p 2 ,1 9 5 + 4 # 9 5 # + 7 +12 # # + 2 + 1 + 6 - 9 + 1 +12 + 1 # + 3 — o + 3 + + + + + + + + + _ + + + + -2 2 1 # # # 1 2 1 3 1 3 2 5 5 3 1 1 O Banking and finance Total investments of all commercial banks..................................... Total loans of all commercial banks................................................... Total demand deposits adjusted.......................................................... Currency outside the Treasury and Federal Reserve B a n k s*.. Bank debits (337 centers)*.................................................................... Velocity of demand deposits (337 centers)*................................... Consumer instalment credit outstanding!............. ......................... millions of $ millions of $ millions of $ millions of $ millions of $ 1 9 47 -49 = 100 millions of $ 73,240p 87,570p 1 0 4 ,550p 3 0 ,742p 80,756 1 4 1 .3p — United States Government finance (other than borrowing) Cash outgo.................................................................................................... National defense expenditures.............................................................. millions of $ millions of $ millions of $ 6,5 7 9 6 ,8 5 5 3 ,5 4 5 + + + 2 # 1 3 # 1 - S + 13 + 1 + 1 + 8 + 7 +14 +78 +22 - 7 + - 4 6 6 + 3 -1 4 - 2 # # + 1 +14 # + 9 + 1 # — — + + 2 x< 3 2 2 1 S E C O N D F E D E R A L R E S E R V E D IS T R IC T Electric power output (New York and New Jersey)*..................... Residential construction contracts*........................................................ Nonresidential construction contracts*................................................. Consumer prices (New York C it y ) f ....................................................... Nonagricultural employment*................................................................... Manufacturing employment*.................................................................... Bank debits (New York C ity )* ................................................................ Bank debits (Second District excluding New York C it y )* .......... Velocity of demand deposits (New York C it y )* ............................... Department store sales*............................................................................... Department store stocks*............................................................................ 1947 -49 = 100 1947 -49 = 100 1947-49 = 100 1947 -49 = 100 thousands thousands millions of $ millions of $ 1 947 -49 = 100 1947-49 = 100 1947 -49 = 100 Note: Latest data available as of noon, October 1, 1956. p Preliminary. r Revised. * Adjusted for seasonal variation. Source: A description of these series and their sources is available from 155 — — 114.4 7 ,7 2 7 .3 p 2 ,6 7 4 .2 p 77,3 3 2 5,1 3 5 1 95.8 117 127 150 205p 279p 114.6 7 ,6 9 2 .6 2 ,6 4 8 .5 6 7 ,9 1 0 5,1 5 7 1 79.8 116 127 158 237 285 113.8 7 ,7 5 2 .2 2 ,7 0 5 .6 6 5 ,4 9 4 4 ,9 0 1 1 66.0 115 126 158 201 254 111.9 7 , 6 2 7 .5r 2 ,6 6 9 .3 r 67 ,7 9 3 4 ,7 9 7 168.7 106 117 f Seasonal variations believed to be minor; no adjustment made, # Change of less than 0.5 per cent. % Revised series. Back data available from U. S. Department of Commerce. the Domestic Research Division, Federal Reserve Bank of New York, on request. $ +14 + 7 + 16 +10 + 9