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The Business Situation
Recent developments suggest that economic expansion
continues to be constrained by shortages and capacity limi­
tations arising under the pressures of strong aggregate de­
mand. Industrial production declined in August because of
a sharp drop in the output of automobiles and trucks,
in part resulting from materials shortages. With backlogs
of unfilled orders still rising rapidly and the inventory-sales
ratio for manufacturing continuing low, it is apparent that
demand is straining productive capabilities. The latest
Government survey indicates that businesses now anticipate
even larger increases in expenditures on plant and equip­
ment for the final quarters of 1973 than were previously
reported. Retail sales remained high in August, as rapid
increases in personal income helped to bolster consumer
demand. Some buying, however, seemed to be related
to attempts to beat expected post-freeze price increases.
Only the housing sector has shown clear signs that a con­
siderable slackening in activity is under way. While the
unemployment rate held steady in September, the high
level of job vacancies and increasing complaints that cer­
tain types of labor are in short supply suggest a tight
labor market.
Soaring inflation in recent months has been marked by
especially rapid increases in food prices. In August, the
consumer price index rose at its most rapid rate in over
twenty-five years, with food prices exploding at a 74 per­
cent annual rate. At the wholesale level, prices dropped in
September, as sharp declines in the prices of certain agri­
cultural commodities led to a drop in the overall index
at an 18.3 percent seasonally adjusted annual rate. Never­
theless, over the three months ended in September, whole­
sale prices rose at a 12.6 percent annual rate because of
the overwhelming increase in prices of farm products,
processed foods, and feeds. There are also indications that
wholesale industrial prices have begun to rise rapidly
again, especially in areas where demand is pressing strong­
ly against capacity. At this point, the effects of rapidly
rising wholesale food and other prices in earlier months are

probably not fully reflected at the retail level. Moreover,
while wage increases appear modest by comparison with
the acceleration in prices, there are some tentative signs
that the size of wage changes may be picking up.

During August, the Federal Reserve Board’s index of
industrial production edged down at a seasonally adjusted
annual rate of 2.8 percent, registering its first decline since
October 1971. This downturn was primarily the result of
a substantial fall in the output of motor vehicles and
parts. Such production, which accounts for about 5 per­
cent of the total index, dropped 12 percent in August, the
sharpest one-month decline since the 1970 automobile
strike (see Chart I). Originally scheduled to exceed 10
million units at an annual rate, actual August output of
domestic-type autos turned out to be at a much slower 8
million unit rate. The shortfall reflected the simultaneous
occurrence of several unusual developments. Intensely
hot weather covered much of the United States during
portions of the month and hampered production by
prompting scattered layoffs and plant shutdowns. The
Canadian rail strike had an adverse impact on the output
of domestic-type passenger cars, since there is a substan­
tial amount of integration of auto production facilities
between the United States and Canada. However, the
major portion of the August setback resulted from short­
ages of a wide variety of automotive parts. Although
production was proceeding at a brisk clip in early Sep­
tember, the seven-day strike at Chrysler held total Septem­
ber output to a 9 million unit annual rate, compared with
rates of production averaging around 10 million units dur­
ing the first half of 1973.
Excluding motor vehicles and parts, industrial produc­
tion advanced at a 5.7 percent seasonally adjusted annual
rate in August. Over the past six months, nonautomotive
industrial production has advanced much more slowly


C h a rt I

S e a s o n a lly a d ju s te d ; 1967 = 1 0 0

S ource: Board o f G o ve rn o rs o f the Federal Reserve System.

than during the previous half year. Some of this modera­
tion probably represents the impact of capacity constraints
and supply bottlenecks in many important sectors of the
economy. In any event, output of intermediate products
rose sharply in August and output of business equipment
increased modestly despite a decline in truck production.
Firms are planning to increase their plant and equip­
ment spending in 1973 by 13.2 percent according to the
Commerce Department survey taken during July and
August (see Chart II). This was the same increase as
reported in the April-May survey. Since actual outlays
fell more than %IV2 billion short of anticipated levels in
the second quarter— at least partly as a result of supply
problems— the most recent findings imply a substantial
step-up in spending during the second half of this year.
The April-May survey projected a 10 percent annual rate
of growth over the last two quarters but the more recent
estimates envision a 14 percent climb. If realized, the 13.2
percent rise in plant and equipment spending would make
this the largest increase since 1966, when outlays surged
16.7 percent. Spending in nonmanufacturing industries is
slated to rise by 9.9 percent, compared with the rapid
19.4 percent increase expected for manufacturing. A num­
ber of the industries that are facing capacity constraints,
such as primary metals, textiles, and paper, have revised


their plant and equipment spending plans upward.
Orders placed with manufacturers of durable goods fell
by $0.4 billion (seasonally adjusted) in August, marking
the second consecutive monthly decline. In July the cut­
back was centered in orders for defense goods, but book­
ings for these products rebounded substantially in August.
A sizable increase in bookings for primary metals helped
offset declines in other areas. Most of the August slowing
in new orders occurred in nondefense capital goods in­
dustries, where bookings were unchanged from June to
July. Over the first six months of 1973, orders for capital
goods increased rapidly, however. The backlog for non­
defense capital goods rose considerably in August and
accounted for over 25 percent of the large advance in un­
filled orders. More than 30 percent of the total existing
backlog is centered in the primary metals industries where
supply problems have persisted, nearly doubling the back­
log during 1973. In August, shipments of durable goods
declined following a rather large July increase, so that the
ratio of unfilled orders to shipments increased to a new
1973 high of 2.61 months.
An indicator of broader coverage, the book value of
seasonally adjusted business inventories, including all
manufacturing and trade, increased $1.4 billion in July.
In comparison, the average monthly increment in total
business inventories was $1.9 billion over the first half

C h a rt II

S e a s o n a lly a d ju s te d a n n u a l rate
B illio n s o f d o lla rs

B illio n s o f d o lla rs

Note: Figures shown fo r the th ird and fourth quarters o f 1973 are estim ates
o f intended spending from the Ju ly-A ugust survey.
Source: United States D epartm ent o f Com m erce, Bureau o f Economic Analysis.



of 1973. The magnitude of these changes has been
affected, of course, by the sharp intensification of inflation
over the past seven months, and it appears that the physical
volume of inventories has increased little. For example,
during the first half of this year, the monthly book value
increase in business inventories was well above the $1.2
billion increase averaged in the second half of 1972. How­
ever, the physical or real increase in inventories for the
first half of 1973, as recorded in the national income ac­
counts, was about half that of the earlier period.
Another aspect of the current inventory situation which
stands out is the persistently low level of the inventorysales ratio by historic standards. Business sales advanced
strongly during July, and the ratio of inventory to sales
fell to 1.410, the lowest level since the early days of the
Korean war.
Preliminary data indicate that manufacturing inventories
rose by nearly $1 billion in August, a slightly larger in­
crease than those registered on average over the first
seven months of the year. At the same time, manufactur­
ers’ shipments dropped, in part because of the problems
that plagued automobile producers in August, so that the
inventory-sales ratio for manufacturing increased modestly.

Consumer spending has remained strong in recent
months, with demand fueled in part by relatively large
increases in personal income. Personal income rose $8.5
billion in July and $10.6 billion in August after registering
average monthly gains of just over $7 billion during the
first half of the year. While wage and salary disbursements
have continued to advance strongly, farm proprietors’
income increased by an unusual $0.8 billion in both July
and August because of higher farm prices. In addition,
transfer payments spurted in August in part through a
cost-of-living adjustment applied to pensions of retired
Federal civilian employees.
Retail sales rose by a very sharp 3.7 percent in July
to $42.7 billion, following a decline between March and
June, and remained at the high July level in August ac­
cording to the advance report. In perspective, retail sales
during August were 3.2 percent above the average of
the second quarter, which had in turn shown virtually no
increase from the January-March average. In August,
sales of nondurable goods remained at the high July pace.
Recent strong demand for home food freezers, undoubt­
edly connected with food stockpiling, has helped to boost
sales in the furniture and appliances category which
spurted sharply upward in August. Sales of new domestic-

type autos slowed to a 9.7 million unit annual rate in
August but rebounded to a very strong 10.6 million unit
rate in September. Over the first nine months of the year,
sales of domestic cars have been at a 10.1 million unit
pace. The strong September pickup in sales is of note in
view of the fact that dealer inventories were quite low,
according to industry observers, with supplies of the popu­
lar small models especially tight. Sales of imported autos
moderated to 1.7 million units (seasonally adjusted annual
rate) in August and 1.5 million units in September, down
from the previous two months and well under the historic
high of 2 million units attained during February and
March of this year.
Retail purchases have been facilitated, in part, by con­
tinued sizable expansion in consumer credit. In August,
consumer credit outstanding rose by $2 billion, somewhat
less than advances averaged over the first seven months
of the year but still substantially above the average month­
ly increases of 1972. Increases in nonautomotive instal­
ment credit and in automobile paper have been large in
recent months, while the growth of noninstalment credit
has moderated relative to its performance earlier this year.
The pace of housing activity continues to slacken.
Housing starts dipped ,to 2 million units at a seasonally
adjusted annual rate in August, off sharply from the his­
toric peak of 2.5 million units achieved this past January.
The August decline, which reduced starts to their slowest
pace in almost two years, was concentrated primarily in
single-family units. Newly issued building permits fell in
August to an annual rate of 1.7 million, well below the
December 1972 peak of 2.4 million. This marked the sev­
enth decline in new building permits issued in the past
eight months. Sales of mobile homes, which had been a
rapidly growing component of the housing stock, have
fallen for four consecutive months with seasonally ad­
justed July shipments of 569,000 at an annual rate, the
lowest since last October. July sales of new one-family
homes dropped well below the June pace, while inventories
of unsold singe-family, homes rose sharply to a record
8.8 months of sales.
All of these data were gathered before the Administra­
tion’s mid-September announcements of proposed changes
in national housing and home financing programs. Some
of these proposals, such as lifting the interest rate ceilings
on Federal Housing Administration (FHA) mortgages
and instituting a tax credit for financial institutions on
mortgage lending, require Congressional approval and
thus are not likely to have an impact on housing in the
very near term. However, the two major initiatives which
can be implemented without further legislation— the ex­
pansion of the Government National Mortgage Associ­


ation’s capacity to purchase FHA-insured mortgages and
the establishment of a $2 Vi billion program of forward
commitments to savings and loan associations by the Fed­
eral Home Loan Bank Board—might help bolster housing
activity in the future.

The economy continues to feel the effects of the price
advances originating in the agricultural sector. Consumer
prices rose at a seasonally adjusted annual rate of 23.1
percent in August, the fastest increase in more than
twenty-five years. Over the year ended in August, the
consumer price index jumped 7.5 percent. This is much
faster than the most rapid twelve-month increase recorded
during the late 1960’s and early 1970’s— the rise of
6.4 percent over the year ended in February 1970. The
index for food consumed at home exploded at a 92 per­
cent annual pace in August, lifting such prices to a level
23.3 percent above that of a year earlier. Increases regis­
tered for poultry, eggs, and pork contributed substantially
to the August advance. Even prices of fresh fruits and
vegetables, items now in season, rose considerably on a
seasonally adjusted basis, although they declined on an
unadjusted basis.
A substantial rise in consumer food prices had been
widely anticipated in light of previously announced in­
creases at the wholesale level, but the August behavior of
prices of nonfood consumer items, while less dramatic, is
probably more surprising and complicated to assess. Non­
food commodity prices increased at a rapid 5.8 percent
annual rate on a seasonally adjusted basis but only a 2.9
percent annual rate before seasonal adjustment. In view
of the many changes in the Economic Stabilization Pro­
gram over the past two years, it is possible that some
usual seasonal patterns have been disturbed so that the
unadjusted data should also be closely watched. Prices of
services, which the Department of Labor does not adjust
for seasonal fluctuation, rose at a rapid 7.8 percent an­
nual rate in August, the sharpest advance since April 1970.
An increase in mortgage interest costs accounted for a
substantial portion of the upswing. Nevertheless, prices of
other services, such as rents, medical costs, and telephone
charges, also contributed to the increase in this measure.
Extraordinary variations in the wholesale price index
have resulted over the past several months in part in re­
sponse to changes in the controls program. Following a
decline of about 17 percent in July, wholesale prices sky­
rocketed in August at a record 75 percent annual rate and
then plummeted 18 percent in September, the largest an­
nual rate of decline for any month since March 1946.


The amazing August increase was propelled by the more
than 200 percent (annual rate) rise in wholesale prices of
farm products, processed foods, and feeds. Declines in
prices of major foodstuffs such as grains and livestock
caused the September index to reverse direction and
plunge at a record 62 percent annual rate. While the
September decline may ease the severity of some price
advances faced by the consumer, substantial retail food
price pressures undoubtedly still exist. Despite the declines
in July and September, prices of farm products, processed
foods, and feeds have climbed at an annual rate of 32
percent since June to a level almost 40 percent higher
than a year ago.
Wholesale industrial prices were essentially unchanged
in July as a result of the freeze. They then rose at a 4.7
percent seasonally adjusted annual rate in August, and
this was followed by a 7.9 percent jump in September.
(Data unadjusted for seasonal variation show much the
same pattern.) September’s large advance brought the rise
over the past year to nearly 8 percent. The hike in whole­
sale industrial prices in both August and September re­
flected increases in prices of metals, textiles, and lumber
and wood products—industries in which supply constraints
have been reported.
Wages have shown a comparatively modest response to
the protracted acceleration in consumer price changes.
However, there are some tentative signs that the size
of wage increases is beginning to pick up. The index of
average hourly earnings for private nonfarm workers is
probably the closest approximation to basic wage rates
available because it eliminates the effects of interindustry
employment shifts and manufacturing overtime hours.
Although the index is very volatile on a month-to-month
basis, an examination of changes over the most recent six
months shows that hourly earnings have increased at an
annual rate of 7.4 percent, compared with a slower rise of
5.7 percent during the previous half year.

Conditions in the labor market remain basically strong
although, as is often the case with monthly statistics,
some of the most recent evidence has been mixed. Ac­
cording to the survey of households, the civilian labor
force and employment registered very large increases in
September on a seasonally adjusted basis after contracting
slightly in both July and August. Because data based on
samples— even one as large as the household survey which
encompasses some 50,000 households— can move some­
what erratically on a month-to-month basis, comparisons
over longer time spans often help to give a clearer picture



of the underlying situation. Over the year ended in Sep­
tember, the civilian labor force expanded by a very rapid
2.7 percent, while the total civilian population of working
age increased by a considerably smaller 1.8 percent. The
overall unemployment rate edged up from 4.7 percent in
July to 4.8 percent in August, and this rate was main­
tained in September. However, the decline in the unem­
ployment rate from the 5.5 percent level prevailing a year

C h a rt Itl

S e a s o n a lly a d ju s te d

Source: The C onference Board, Inc.

ago in the face of very rapid labor-force growth is signifi­
cant both from the narrow technical standpoint and from
the broader vantage point of assessing underlying econom­
ic developments.
The separate survey of establishments revealed that the
number of persons on nonagricultural payrolls rose by
about 200,000 workers in both August and September
following a small decline in July. This brought the ad­
vance over the past year to 2.6 million jobs. During the
third quarter, employment growth in the major industries
was particularly strong in services. Manufacturing employ­
ment, however, was essentially unchanged over the quarter
after having increased by more than 900,000 over the pre­
ceding twelve months.
According to the Labor Department, the number of
seasonally adjusted unfilled job vacancies in manufactur­
ing was 191,000 in August, up sharply from 170,000 at
the start of this year and 131,000 a year ago. This is con­
sistent with reports of shortages of certain types of skilled
labor developing in recent months. Over the past year the
number of long-term job vacancies— those which have
gone unfilled for a month or more— has risen 64 percent,
compared with the 39 percent increase in shorter term
vacancies over the same period. The Conference Board’s
index of the volume of newspaper help-wanted advertising
is the closest available approximation to an all-industry
gauge of job vacancies. In July the index jumped to a rec­
ord 131 percent of the 1967 base and, while it slipped
to 127 in August, it remained well above rates posted
earlier in 1973 or in previous years (see Chart III). The
ratio of this index to the number of unemployed persons,
also indexed on a 1967 base, may be more suitable for
comparisons spanning several or more years as it adjusts
for labor-force growth. Since its trough in the first half
of 1971, this ratio has risen rather steadily. Although the
August ratio fell off somewhat from its July peak, it is
higher than it has been in recent years but substantially
below levels reached in the late 1960’s.



The Money and Bond Markets in September
After edging up early in the month, interest rates gen­
erally declined dramatically during the second half of
September as market pressures cooled and evidence
mounted that the growth of the monetary aggregates was
slowing. During the final two weeks of the period, partic­
ipants became convinced that monetary policy was turning
toward a less restrictive stance and, against this back­
ground, rates on most money market instruments moved
lower. Rates on most maturities of commercial paper de­
creased by
to % percentage point over the month and
rates on large-denomination certificates of deposit (CDs)
fell significantly toward the end of the period. The aver­
age effective rate on Federal funds remained about un­
changed from the previous month. Earlier in the month,
the Federal Reserve raised marginal reserve requirements
on large CDs, bank-related commercial paper, and finance
bills in a further step to control the rapid expansion of
bank credit. This measure increased the cost of such funds
to banks and was followed by a boost in the prime lending
rate to large business borrowers to 10 percent from 93
The rally in the United States Government securities
market which began in the middle of August continued
throughout September, except for one brief but sharp
downturn in conjunction with the announcement of the
increase in reserve requirements. Treasury bill rates de­
clined sharply over the second half of the month to
levels that had last prevailed in June. Prices of Treasury
coupon securities advanced considerably over most of the
month. Inventories were light, and reactions to shifting
expectations were dramatic. Prices of Federal agency
securities also increased during September despite a con­
tinued heavy calendar of new issues. New issue activity
in the corporate and municipal bond markets was modest,
and prices of older outstanding corporate and tax-exempt
securities also rose over much of the month.
In September, the narrow money supply (M i)— demand
deposits adjusted plus currency outside banks— contracted
for the second consecutive month. M2, which includes time
and savings deposits other than large CDs, expanded con­
siderably less rapidly in September than it had in August.

The slowing in the growth of these deposits together with
a slackening in the rise of large CDs contributed to the
moderation in the growth of the adjusted bank credit
proxy compared with its growth over the past few months.

Short-term interest rates generally held steady during
the first three weeks of September, but dropped rapidly
late in the month (see Chart I). The rate on 90- to 119day commercial paper fell % percentage point to close
the month at 95 percent. Rates on bankers’ acceptances
also moved lower in September, falling 3 percentage
point over the month. The average effective rate on Fed­
eral funds was fairly steady throughout September. In the
statement week ended September 26, the effective rate on
Federal funds averaged 10.84 percent in comparison with
the 10.79 percent average of the August 29 statement
week. However, member bank borrowings from the Fed­
eral Reserve, although still sizable, declined from the very
high $2.14 billion averaged in August to $1.94 billion in
September (see Table I).
With corporate cash needs seasonally high in Septem­
ber, reflecting tax and dividend payment dates, the de­
mand for bank credit continued strong. A large volume
of CDs held by corporations matured on or before Sep­
tember 15, providing some of the necessary liquidity.
Rates on large CDs remained high over the first half
of the month but declined thereafter. At the month’s
end, three-month CD rates in the secondary market were
around 9Vi percent, down about IV 2 percentage points
over the month. However, the effective cost to commer­
cial banks of acquiring funds through CDs was increased
as a result of a boost in marginal reserve requirements
applicable to such deposits. In a further effort to curb
the rapid expansion of bank credit, the Board of Gov­
ernors of the Federal Reserve System on September 7
announced an increase in the marginal reserve require­
ments on large-denomination CDs, bank-related com­
mercial paper, and finance bills. The action raised the
reserve requirement on increases in the level of these



liabilities since the week ended May 16 from 8 percent
to 11 percent, effective September 20. Member banks are
required to maintain the additional reserves in the state­
ment week beginning October 4. A 5 percent reserve
requirement continues to be applied to CDs and com­
mercial paper up to the quantity outstanding in the state­
ment week ended May 16. The 11 percent marginal
reserve requirement does not apply to banks with a com­
bined total of less than $10 million of CDs and bankrelated commercial paper outstanding. This is the second
time this year that the Federal Reserve has resorted to in­
creasing the marginal reserve requirements on these lia­

Commercial banks increased their prime lending rate
for large business borrowers by lA percentage point to
10 percent in the statement week ended September 19.
With the gap between the prime rate and commercial
paper rates slowly narrowing, corporations began to find
the commercial paper market a more attractive source of
funds. The volume of dealer-placed nonbank-related com­
mercial paper outstanding, after declining steadily over
the year to a low of $7.5 billion in mid-August, rose
modestly throughout September.
The latest data confirm that the growth of most of the
monetary aggregates has slackened considerably in recent
months after a prolonged period of rapid expansion. Pre-

C h art I



July - S e p te m b e r 1973

N o te :




D a ta a r e s h o w n f o r b u s in e s s d a y s o n ly .


B id ra te s fo r th r e e - m o n th E u r o - d o lla r s in L o n d o n ; o f fe r in g

s ta n d a r d A a a - r a t e d b o n d o f a t le a s t tw e n ty y e a r s ’ m a t u r i t y ; d a ily a v e r a g e s o f

r a te s ( q u o te d in te rm s o f r a te o f d is c o u n t^ o n 9 0 - to 1 1 9 - d a y p r im e c o m m e r c ia l p a p e r

y ie ld s o n s e a s o n e d A a a - r a t e d c o r p o r a te b o n d s ; d a i l y a v e r a g e s o f y ie ld s o n lo n g ­

q u o t e d b y th r e e o f th e fiv e d e a le r s t h a t r e p o r t th e ir ra te s , o r th e m id p o i n t o f th e r a n g e

te rm G o v e r n m e n t s e c u r itie s ( b o n d s d u e o r c a l la b le in te n y e a r s o r m o re ) a n d

q u o t e d if n o c o n s e n s u s is a v a ila b l e ; th e e f f e c t iv e r a te o n F e d e r a l fu n d s (th e r a te m o s t

o n G o v e r n m e n t s e c u r itie s d u e in th re e to fiv e y e a r s , c o m p u te d o n th e b a s is o f

r e p r e s e n t a t iv e o f th e tr a n s a c tio n s e x e c u t e d ) ; c lo s in g b id r a te s ( q u o te d in te rm s o f r a te o f

c lo s in g b id p r ic e s ; T h u r s d a y a v e r a g e s o f y ie ld s on tw e n ty s e a s o n e d tw e n t y - y e a r

d is c o u n t) o n n e w e s t o u t s t a n d in g th re e - m o n th T r e a s u r y b ills .
B O N D M A R K E T YIELD S Q U O T E D : Y ie ld s o n n e w A a a - r a t e d p u b l ic u t i l i t y b o n d s a r e b a s e d
o n p r ic e s a s k e d b y u n d e r w r it i n g s y n d ic a te s , a d ju s t e d to m a k e th e m e q u i v a le n t to a

ta x - e x e m p t b o n d s ( c a r ry in g M o o d y 's r a tin g s o f A a a , A a , A , a n d B a a).
S o u rc e s :

F e d e r a l R e s e rv e B a n k o f N e w Y o rk , B o a r d o f G o v e r n o r s o f th e F e d e r a l

R e s e rv e S yste m , M o o d y ’ s In v e s to r s S e rv ic e , In c ., a n d T h e B o n d B u y e r.


liminary estimates indicate that M ± declined in September
for the second consecutive month. During the past three
months, Mx has shown virtually no growth (see Chart II).
Over the twelve months ended in September, Mx increased
by 5Va percent. The growth of time deposits other than
large negotiable CDs slowed in September, after hav­
ing been buoyed in August by the increase in interest rate
ceilings on consumer time and savings deposits and the
abandonment of ceiling restrictions on deposits of maturi­
ties of four years or more. The combined effect of the
expansion of these time deposits and the decline in Mx
resulted in an advance of the broad money supply (M2)
at an annual rate of about 2 V2 percent in September. This
is well under the pace of expansion experienced over the
twelve months ended in September.
The adjusted bank credit proxy— which consists of
daily average member bank deposits subject to reserve
requirements and certain nondeposit liabilities— expanded
at an estimated 5V2 percent seasonally adjusted annual
rate in September. This is considerably slower growth
than the 13 percent advance over the last twelve months.
The growth of large CDs decelerated markedly in Sep­
tember, as such deposits increased at a rate of less than 4
percent. In comparison, over the first eight months of
1973 large CDs expanded at an explosive 82.6 percent
annual rate. Reserves available to support private non­
bank deposits advanced at an annual rate of about 13 Vi
percent in September.

Table I

In millions of dollars; (+ ) denotes increase
(—) decrease in excess reserves

Changes in daily averages—
week ended







“ M arket” fa c to rs

Member bank required reserves ..................


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

— 34



— 305



— 395

4 2 ,9 1 3

— 300

— 1,703

+ 876
+ 525


Federal Reserve float ...................................

— 282


+ 414

— 1,259

Treasury operations* ......................................

+ 570

+ 1 ,1 0 2

— 343

— 978

+ 351

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






— 87

Currency outside banks ...............................

— 204


— 14



— 211


— 144


Other Federal Reserve liabilities
and capital .......................................................

— 133



— 199


Total “ market” factors ...............................



+ 3,1 4 4

— 605





— 2,683

+ 356

+ 1,4 3 8

— 359

Treasury securities ..........................................



— 2,345

+ 494

+ 1,339

— 212

Bankers' a c c ep ta n c e s......................................



+ 101

D irect F ederal R eserve cred it
tr a n sa c tio n s

Open market operations (subtotal) .............
Outright holdings:

2 —







Federal agency o b lig a tio n s ..........................















— 40


Repurchase agreements:
Treasury securities ........................................

4- 162







Bankers’ a c c e p ta n c e s ...................................................











Federal agency o b lig a tio n s ...........................











Member bank b o rro w in g s .............................................


Seasonal borrowings!


Other Federal Reserve a s s e t s j .................................

Treasury bill rates declined over much of September,
and fell dramatically in the latter days of the month.
Throughout the period, the market was very sensitive
to actions of the Federal Reserve. Early in the month,
market sentiment was jolted by the Federal Reserve’s
announcement of an increase in reserve requirements on
large CDs, bank-related commercial paper, and finance
bills. Rates rose sharply and, in fact, new interest rate
peaks for some issues were established. The rise in yields
was short-lived, however, as a much firmer tone developed
around midmonth. Shortly thereafter, the rally gained
momentum when market participants interpreted a pur­
chase of bills by the Federal Reserve for both customer
and System accounts as an indication that monetary policy
was becoming less restrictive. In a flurry of spirited activ­
ity, the rate on three-month bills declined by about 177
basis points over the second half of the month. For the
month as a whole, secondary market rates on most Trea­
sury bills were about 76 to 170 basis points below their
opening levels. These sharp declines contrast with the



E xcess reserves!


— 876




+ 219




















+ 192

4 366


4 361



— 367

+ 642

+ 1.960










Daily average levels

M ember bank :

Total reserves, including vault cash! . . . .






Required reserves ................................................






Excess reserves§ ................................................
Total borrowings ................................................











Seasonal borrowings! ...................................





Nonborrowed reserves ........................................











Net carry-over, excess or deficit ( — ) J


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.
t Includes assets denom inated in foreign currencies.
§ Adjusted to include $112 m illion of certain reserve deficiencies on which penalties can
be waived for a transition period in connection with bank adaptation to Regulation J
as amended effective November 9, 1972. The adjustm ent amounted to $450 m illion
from November 9 through December 27, 1972, $279 m illion from December 28, 1972
through March 28, 1973, and $172 m illion from March 29 through June 27. 1973.
I Average for four weeks ended September 26.
# Not reflected in data above.



more modest reductions in some other short-term rates in
After a record yield was established for the three-month
bill in the September 10 weekly auction, rates declined
sharply (see Table II). In the September 24 auction, aver­
age issuing rates on the three- and six-month issues were
145 and 107 basis points lower, respectively, than the
rates set in the auction of August 31. The yield on 52week bills in the monthly auction held September 19 was
8.06 percent, about 33 basis points below the rate estab­
lished at the previous month’s auction.
Prices of Treasury coupon securities advanced during
much of September. Good technical position and im­
proved investor demand served to support the longer
term market. The evident slowing in the growth of the
monetary aggregates led to expectations that monetary
policy would become less restrictive and consequently
that interest rates were at or near their peaks. The im­
provement in the United States balance of payments and
the dollar’s better performance in the exchange markets
contributed to the firm market atmosphere. Over the
month, yields on most three- to five-year issues declined
by an average of 58 basis points, while yields on longer
term issues generally fell by about 36 basis points.
Prices of Federal agency securities rose appreciably
during September despite a substantial volume of new
issues. Investor demand was strong in this sector, in part
because the positive spread between yields on agency
and Treasury issues has widened. Federal agency financ­
ing, particularly from the housing support agencies, has
been heavy throughout 1973. During the first eight months
of the year, agency financings were 87 percent above the
level of the comparable period a year earlier. In Septem­
ber, the market for agency issues benefited from the good
overall technical position of the capital markets and from
the sentiment that interest rates had peaked. Early in the
month, the Federal Home Loan Bank Board announced
an offering consisting of $500 million each of fourmonth, seventeen-month, and 56-month securities. The
three maturities were priced to yield 9.38 percent, 8.70
percent, and 7.60 percent, respectively. These securities,
which raised $1.5 billion of new money, experienced good
initial investor demand but subsequently traded at dis­
counts during the weakening market of the second week
of the month. Also during the second week, the farm
credit agencies announced a $1.5 billion financing, con­
sisting of $306 million of five-month bonds, $302 million
of six-month bonds, $200 million of 42-month deben­
tures, and $699 million of nine-month bonds. These
issues, priced to yield 9.90 percent, 9.85 percent, 7.70
percent, and 9.75 percent, respectively, quickly rose to

C h a rt II

S e a s o n a lly a d ju s te d a n n u a l rate s
P e rce n t

P e rc e n t

0 1 I I 1 I 1 1 I I 1 I I 1 I I 1 I I 1 I I 1 1 I 1 11 I I I 1 I I . J o


1 1 1,1.

L -i-jJ—

1 1 1 I 1 11

I 1 I

1 I 1 1 I I I IJ 0


197 3

N o te : D ata fo r September 1973 are p re lim in a ry.
M l = C urrency plus adjusted dem and deposits held by the public.
M2 = M l plus com m ercial bank savings and tim e deposits held by the p ub lic,
less neg o tia b le certificates of deposit issued in denom inations o f $100,000
o r more.
A djusted bank c re d it pro xy = Total m em ber bank deposits subject to reserve
requirem ents plus nondeposit sources o f funds, such as E uro -d o lla r
borrow ings and the proceeds of com m ercial p a p e r issued by bank h o ld in g
com panies or other a ffilia te s .
Sources: Board o f G overnors of the Federal Reserve System and the
F ederal Reserve Bank of New York.

premiums. Later in the month, the Federal National
Mortgage Association marketed $500 million of fiftymonth debentures priced to yield 7.55 percent and $400
million of 83-month bonds priced to yield 7.50 percent.
These issues met a favorable reception.

Prices of corporate and municipal securities increased
on balance during September. The advance was inter­
rupted briefly by the additional measures instituted by the
Federal Reserve to curb the expansion in bank credit.
Thereafter, the corporate bond market was aided by the
strength of the Treasury coupon sector, and prices moved
higher. The technical condition of the corporate sector
was excellent, and the price increases in this sector un­
doubtedly stemmed, in part, from the prolonged scarcity
of new issues. Thus far in 1973 there has been about a 40


percent reduction in the volume of new corporate securi­
ties offered publicly by comparison with the 1972 level.
Most new issues marketed in September carried yields
well below similar securities offered in August. On Sep­
tember 5, $25 million of A-rated public service bonds
priced to yield 8.13 percent sold out quickly. The same
day, however, an A-rated power company issue attracted
only modest interest when aggressively priced to return
8.10 percent. This yield was 70 basis points less than that
of a similar issue marketed one-month earlier. On Sep­
tember 11, $150 million of forty-year Aaa-rated Bell
System debentures encountered a lukewarm reception.
The issue was originally priced to yield 7.85 percent,

Table II
In percent
Weekly auction dates— September 1973
Three-month ........................................






Monthly auction dates— July-September 1973
Fifty-two weeks ..................................






* 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.


35 basis points lower than a similar issue marketed three
weeks earlier; however, when syndicate price restrictions
were removed, the yield rose 17 basis points. In sub­
sequent trading later in the month, the issue recovered
virtually all of this price loss. During the middle of the
month $75 million of Aaa-rated first mortgage bonds,
priced to yield 8.02 percent in thirty years, was initially
afforded only a fair reception, but subsequently the bonds
were swept up in the rally which pervaded the capital
markets. Several aggressively priced smaller issues mar­
keted later in the month experienced heavy investor de­
Prices of tax-exempt securities also moved higher dur­
ing the month. The stable tone experienced throughout
the period was attributed, in part, to a relatively light sup­
ply of new issues. Of course, this market also reacted to
changes in the participants’ views of Federal Reserve pol­
icy. Prior to the increase in reserve requirements, a $75
million issue of Aa-rated bonds attracted excellent de­
mand when priced to return from 4.50 percent in 1977
to 4.65 percent in 1984. The buoyant atmosphere which
developed in the capital markets during the final two
weeks of September helped to generate good demand for
several high-quality issues. On September 26, $292.7
million of Aaa-rated bonds was reoffered to yield from
4.20 percent in 1974 to 5.15 percent in 2014— about 15
to 20 basis points below the returns provided by the
same borrower in June. On the same day, a power author­
ity offered $110 million of A -l rated debentures scaled
to yield from 4.85 percent in 1986 to 5.44 percent in
2010. These issues were quickly sold. The Bond Buyer
index of twenty tax-exempt bond yields fell from 5.34
percent on August 30 to 5.00 percent on September 27.
The Blue List of dealers’ advertised inventories rose
$226.5 million over the month to $711.5 million.



Reserve Requirements Abroad
By G eo r g e G arvy
Economic Adviser, Federal Reserve Bank of New York

The United States is the only important country in which
not even all commercial banks are subject to reserve regu­
lation by one central monetary authority. For members of
the Federal Reserve System, significant changes were in­
troduced last year (through amendments to Regulation D
that became effective in November 1972) to formalize the
break with the inherited geographic basis. However, the
basic ingredients of the system of reserve requirements
have remained, in fact, unchanged for almost forty years,
in spite of deep and manifold changes in banking and in
the structure of the demand for credit, credit instruments,
and their uses. In this article, the use of reserve ratios in
leading industrial countries is surveyed and an attempt is
made to extract from this experience some general con­
clusions regarding their place as a routine tool of mone­
tary control. Other uses, such as the control of undesirable
inflows of foreign funds, are also noted.1 In some instances,
it seemed desirable to refer to the policies and practices
of some less developed countries as well. A review of
foreign experience with fractional reserve ratios is timely
because, even after the recent changes in the structure
and average level of reserve requirements in the United
States, further improvements in the system of variable
reserve requirements remain on the agenda and continue
to be discussed within as well as outside the Federal
Reserve System.2

1 An appendix in which the uses of reserve requirements in
eleven individual major industrial countries are reviewed is avail­
able on request.
2 See, for instance, Deane Carson, “Should Reserve Requirements
Be Abolished?” The Bankers Magazine (Winter 1973), the Report
of the President’s Commission on Financial Structure and Regu­
lation (Hunt Commission Report, December 1971), and “The
Structure of Reserve Requirements”, an address by Arthur F.
Burns, Chairman of the Board of Governors of the Federal Re­
serve System, before the Governing Council Spring Meeting of the
American Bankers Association, April 26, 1973 (Federal Reserve
Bulletin, May 1973, pages 339-43).


To be sure, in each country the specific aspects of frac­
tional reserve ratios and the role which these requirements
play within the range of tools actually used by the mone­
tary authorities depend on a number of historical and
traditional factors. Preferences of the central bank and,
possibly, political constraints are other relevant influences.
As with so many other monetary tools, the use of reserve
ratios as a means of implementing policy objectives varies
from country to country and, within each country, over
The effectiveness of the regulation of the deposit mul­
tiplier depends basically on the ability of the monetary
authorities to control the supply of reserves and the differ­
entiation of deposits into separate categories to which dif­
ferent ratios apply. Adjustments in the supply of bank
credit can be achieved either by modifying the credit mul­
tiplier (the relationship between a given reserve base—
primary reserves— and the credit superstructure) or by
providing a fulcrum against which other policy tools de­
signed to control the availability of reserves can be ap­
plied. The effects of changes in reserve ratios on the
structure of bank costs and profits are important elements
in monetary control. However, the creation of domestic
reserve assets (through monetization of domestic public
and/or private debt) may be the result of public policy
decisions not directly related to monetary policy. Also,
changes in reserves of foreign origin may result from ex­
change flows that are triggered by speculation rather than
rooted in trade or service transactions or in international
migration of capital. Thus, regulation of the monetary
system through the manipulation of reserve ratios might
be complicated by limitations affecting a central bank’s
ability to control the availability of reserve assets.
The introduction in the United States in 1935 of vari­
able reserve ratios on a regular and permanent basis was
followed by many foreign countries which passed similar


legislation or provided for such requirements when under­
taking a general revision of banking laws. Peter Fousek
found that by October 1957 thirty-three foreign countries
had adopted variable reserve requirements, usually for
time as well as for demand deposits.3 In the sixteen years
following 1957, the use made of this new tool has varied
widely among individual countries, as has its coordination
with other tools of monetary policy, such as open market
operations and liquidity ratios. These variations bring
into relief the considerable differences in banking systems
and banking policies throughout the world.
Since World War II, reserve requirements have been a
preferred tool of monetary control in most industrially ad­
vanced countries, even those which, for historical or
other reasons, had hesitated for a long time to introduce
such requirements on a statutory basis. In several leading
industrial countries where reserve requirements were intro­
duced relatively recently,4 they have been integrated with
the existing fairly complex systems of monetary control,
notably liquidity ratios.5
Liquidity ratios, prescribing the holding of a specified
amount of cash and liquid assets related to total or selected
bank liabilities, have not altogether disappeared as a means
of controlling bank credit expansion. In most countries
they have been relegated to, or maintained in, the role of
a safeguard for depositors, and in that case are usually
administered (as in Switzerland) by a separate authority
in charge of bank supervision rather than monetary policy.
Variable reserve requirements now play a key role
in implementing monetary policy in the three main
countries of Western Europe— the United Kingdom,
France, and West Germany— and also in Canada. In West
Germany, reserve requirements became the main tool of
monetary control following the reconstruction of its bank­
ing system after World War II. The system of reserve
ratios was subsequently refined and modified to achieve
additional objectives, such as controlling undesirable short­
term capital flows. In the United Kingdom and in France,
reserve ratios are reinforced by related liquidity ratios,
and in recent years they have been used decisively to cope
with mounting inflationary pressures.

3 Peter G. Fousek, Foreign Central Banking: The Instruments of
M onetary Policy (Federal Reserve Bank of New York, 1957).
4 France in 1967 and Sweden in 1962.
5 While regulation of reserves is primarily a tool of quantitative
control over the cash base of the banking system, in some countries
it is also used as a qualitative instrument.



The way in which reserve requirements have been folded
into the existing framework of monetary control differs
from country to country. The usefulness of reserve re­
quirements as a control tool depends to a certain extent
on the alternative control mechanisms they replace or
supplement. To the extent that generalizations can be
made, in those industrially advanced countries in which
reserve requirements have been introduced only recently,
their attractiveness was in providing a fulcrum for con­
trolling total multiple deposit creation as well as in pro­
viding a more powerful means for achieving specific pol­
icy goals. Such goals range from selective control— “di­
rection” in the terminology of some foreign countries—
to dealing with undesirable inflows of foreign short-term
capital. In some instances, reserve requirements have been
introduced or revitalized as a result of disenchantment with
direct controls, or because the political parties that favored
such controls lost power. Indeed, by and large, reserve
requirements have now come to be widely regarded abroad
as an alternative to the system of quantitative controls
which set absolute or formula ceilings for total or specified
categories of loans or bank assets.
Introduction and variation of reserve requirements
usually pose difficult questions of policy and equity. The
first encompasses questions such as the proper differentia­
tion of deposit liabilities, the differential treatment of
deposits of nonresidents, exemption of certain deposit
liabilities, and compliance procedures. Problems of equity
frequently arise because not all banks acquire reserves in
the same manner and at comparable rates, especially when
the balance of payments is the main source of additional
reserves. Usually some banks have less difficulty than others
in complying with any change in the level and structure
of reserve ratios. Increases in reserve ratios must fre­
quently be cushioned by other central bank actions to
facilitate adjustment to the new levels, sometimes by
lengthening the time available for portfolio adjustments
beyond the effective date of the new provisions or by
other means.
Bank reserves are now normally stipulated by law or
regulation. Prior to the 1930’s, they were usually main­
tained to satisfy a bank’s liquidity needs under standards
set by custom or determined by each institution in the
light of its business experience. The detailed definition of
categories of institutions and liabilities (or assets) subject
to reserves may be stipulated in the law or left to the de­
termination of the monetary authorities. Setting and modi­
fication of reserve ratios within legal limits is usually
delegated to the central bank or, where it exists, to a



monetary authority which establishes broad policy guide­
lines for the central bank, or to the Minister of Finance.
In countries in which legal authority to impose reserve
requirements was lacking, central banks found it sometimes
necessary to obtain the cooperation of commercial banks
(in some cases, by indicating that, if it were not forth­
coming, binding legislation would be sought) to observe
“voluntarily” agreed-upon reserve ratios, either in cash
(as in Sweden and Switzerland) or in cash and/or specified
assets (as in the United Kingdom). Several central banks
preferred to continue operating for some time on the basis
of such agreements even after obtaining legal powers to
impose reserve requirements (Canada prior to 1967,
Sweden prior to 1969); the Bank of England, which has
been in a position to set obligatory reserve ratios since
1971 and, as a matter of fact, even as far back as 1946,
continues to seek voluntary cooperation.
Reserve requirements normally apply to various cate­
gories of deposit liabilities (in a few cases, other than
interbank deposits) as they are differentiated by maturity.
The degree of any further differentiation in reserve re­
quirements depends on a variety of factors, such as the
institutional structure of an individual country’s financial
sector and the nature and importance of foreign currency
deposits. Only a few countries differentiate ratios by geo­
graphic location or size of bank. In countries in which
nationwide branch banking systems predominate, there
is little, if any, room for differentiation of reserve require­
ments by either size or location.
In industrially advanced countries, with the exception
of the United Kingdom, reserves are normally held in the
form of deposits with the central bank, with allowance
for including vault cash up to a certain limit. In the less
advanced countries, specific provisions range from the
requirement that all reserves be held in the form of cash
deposits with the central bank to complex formulas in
which a specified part of the reserves may, or even must,
be held in the form of a variety of stipulated assets. The
range of assets qualifying as reserves depends on whether
they have been issued to achieve certain qualitative objec­
tives and/or are used to finance the government or some
specific institutions created or controlled by it. When
reserve requirements do double duty as a tool of mone­
tary control and as a means of achieving specific aims of
economic policy, such as stimulating growth of selected
economic activities or achieving socially desirable goals,
their average level is typically high.
In the less developed countries, the experience with
reserve ratios has been quite varied. During most of the
time since World War II, many of these countries have
been experiencing pressures on their balance of payments,

resulting in chronic shortages of international reserves.
Some of these countries— frequently following the advice
of experts from the United States or other advanced coun­
tries or international organizations— have introduced or
revised banking laws to include authority for sophisti­
cated versions of monetary tools. The use of these tools
was usually limited by the undeveloped character of the
countries’ financial structure and markets. Reserve ratios
were frequently vitiated by attempts to combine their use
as tools of monetary control with efforts to foster economic
development, typically by using them as a means of selec­
tive credit controls.
Reserve requirements in several countries of Latin
America offer some of the most extreme examples of
qualitative control use. In several countries, a prescribed
proportion of reserves must be held in the form of specified
obligations, including mortgages and/or loans to specified
categories of borrowers, or for stipulated purposes. Such
provisions lighten the reserve burden by reducing the share
of reserves which yield no income. At times, it becomes
difficult to determine whether reserve requirements are
used primarily as a means of controlling monetary expan­
sion or to influence the composition of bank portfolios.
The latter is clearly the case when a reduction in reserve
ratios is conditioned on using the funds released to make
loans that would foster production (Bolivia) or benefit
small- and medium-size industry (Brazil). A more frequent
provision requires or permits holding of specified govern­
ment securities. In some countries, interbank deposits
qualify as reserves (up to a stipulated percentage), but
in some instances only government-owned commercial
banks qualify as reserve depositories.
The experience of less developed countries also under­
lines the basic fact that the effectiveness of variable
reserve requirements as a monetary control tool hinges
importantly on the scarcity character of primary reserves
and the ability of the authorities to preserve this quality
by closely controlling the creation of reserves of domestic
origin. More broadly, it illustrates the proposition that the
transfer of any control technique to a country with a
different economic, financial, and social structure and po­
litical climate is fraught with many difficulties.
In several countries, one or more “central institutions”
exercise supervisory power over specialized credit institu­
tions and/or provide certain services to them, such as
lending or rediscounting. Transactions between these cen­
tral institutions and their members are frequent and
sizable, and the latter tend to hold the bulk of their
redundant funds with these central institutions. In some
instances, as in Italy and Sweden, the affiliated credit
institutions (such as credit cooperatives) may keep part

In percent

Demand deposits*

Savings and other time deposits*

Austria! ................


6.5-9 for time and savings deposits of up
to one year; 6.5-8 for time and savings
deposits of over one yearj

Belgium .................



Canada ..................



Francell .................


10 for savings deposits; 20 for other
time deposits
7.75-9.25 for savings deposits; 9-13.55
for time deposits#

Italyf .....................

22 Vi


Japan ....................

2 0 tt


15 I I


or all of the required reserves with their respective central
institutions. Since the latter must redeposit an equivalent
amount with the central bank, this arrangement amounts
to a two-tier system in which specialized institutions act
as a conduit for adjustments required of their members
to fulfill reserve requirements. Similarly, in some coun­
tries certain categories of credit institutions are permitted
to keep all or part of their legal reserves with Giro offices
or similar organizations, which in some countries perform
a key role in operating the national payments mechanism.


Germanyf .............


Netherlands §§
Sweden §§ ...............





0-5 for savings deposits; 0-30 for time
3.5 for savings deposits and bank bonds
maturing within five years




K ingdom ftt .........

Note: For some countries, not all of the ratios applying to specific institutions
and/or situations are mentioned in the following footnotes.
* The first line indicates the legal maximum, the second line the reserve
requirements in force on July 1, 1973.
f Some form of marginal requirements also in effect.
$ Lower ratios apply to institutions with liabilities of under 40 million schil­
§ Deposits with a maturity of one month or less.
I Higher reserve ratios apply to demand and time deposits held by non­
residents. Also, a separate reserve ratio on assets applied concurrently.
# Depending on location and other criteria.
** Applies to the excess of deposits over capital funds; a specified portion
may be held in income-yielding assets, other than deposits at the central
bank which earn interest. Different reserve ratios apply to various
deposit-accepting institutions other than commercial banks.
f t But 50 percent for free yen accounts held by nonresidents.
tt Depending on bank’s total deposits.
§§ Authority to set legal requirements was not used; ratios shown are based
on agreements concluded with the banks.
I II Applies to deposits in excess of 15 million guilders, or about $5.7 million
at the exchange rate in effect on June 29, 1973.
# # Depending on size and type of bank: 30 percent for the five largest com­
mercial banks, 24 percent for other commercial banks, 27 percent for
the Post Office Banks, and 20 percent for savings banks and rural credit
*** Indicated ratios apply to growth in deposit liabilities to residents above
July 31, 1971 levels. Lacking legal power, the Swiss National Bank ne­
gotiated in 1969 a gentleman’s agreement with the Bankers’ Association.
In December 1972, it obtained, for a three-year period, powers to
impose both average and marginal requirements on liabilities to both
banks and nonbank financial institutions and higher ratios against liabili­
ties to nonresidents. In addition, special cash deposits may be required
against the excessive growth of certain assets.
f t t The United Kingdom has a fixed reserve assets ratio, of which a small part
is held as balances with the Bank of England by London clearing banks
only; other reserve assets are various public debt securities, call money
placed with discount houses, and a limited amount of commercial
paper. Different reserve requirements apply to discount houses and
finance houses. At times, special deposits in the form of interest-earning
deposits must be held with the Bank of England. On July 1, 1973 special
deposits amounted to 3 percent.


The scope of application of reserve requirements has
tended to be widened as the range of near moneys has
grown and as the effectiveness of reserve requirements as
a monetary tool tended to become impaired because of the
significant changes which have taken place in the financial
structure as well as in banking procedures and processes.
In some countries, the scope of reserve requirements was
widened primarily in order to tighten selective credit con­
Indeed, since World War II, in most of the advanced
countries compartmentalization of financial services has
tended to be reduced by greater competition, mainly from
institutions which until quite recently had no legal author­
ity to engage in activities directly competing with those of
commercial banks. Banks have developed new ways of
raising funds to supplement deposit liabilities to which frac­
tional reserve requirements originally applied. The amounts
of such nondepository funds have increased rapidly and, in
some countries, more rapidly than deposits of commer­
cial banks. Furthermore, since reserve requirements raise
the cost of funds to (and therefore total expenses of)
banks, in some countries competing institutions have been
able to offer services (including loans) at lower rates. To
meet competition, commercial banks in some countries
have sponsored, or made greater use of, institutions able
to take over some of their business on a basis that would
reduce the reserve costs and yet permit them to
recapture the revenue (or profits) on business so trans­
ferred. At the same time, changes in savings, payments,
and money management patterns have tended to blur, and
even extinguish, what originally was— or appeared to be—
a clear demarcation between money and near money. All
advanced countries have experienced such developments
in various degrees.
Most advanced industrial countries have endeavored to
meet the problem of ever-growing proliferation of financial
institutions and the significant changes in the scope of their
activities by subjecting a widening range of financial insti­



tutions to reserve requirements which originally had been
applicable to commercial banks only.6 The tendency is
quite general to make reserve requirements applicable to
additional types of institutions which begin to accept de­
posits or that have become important factors in the short­
term credit market. Where, in the absence of statutory re­
quirements, cash balances with the central bank are held
in stipulated amounts as a result of gentleman’s agree­
ments, such agreements now usually encompass (as in
the Netherlands) various deposit-accepting and creditgranting institutions other than commercial banks.
There are, of course, many smaller and less developed
countries which, because their institutional framework still
consists essentially of commercial banks only or because
the volume of near money is very small, have not needed
to extend the range of institutions subject to reserve re­
quirements. As a matter of fact, in some of these countries,
currency rather than deposits constitutes the bulk of the
money supply, so that control of the volume of deposit
money is less significant than in the advanced countries.
Some countries have been searching for a more direct
means of influencing the distribution of bank credit than
making selected categories of assets eligible—within the
stipulated limits— as reserve assets, or giving such assets
preferential treatment at the discount window. Differen­
tiated reserve requirements on assets offer such an alterna­
tive. The imposition of separate reserve requirements
against assets rather than, or in addition to, reserves on
liabilities is a relatively new technique (first applied in
France in 1971). It is designed to give monetary authori­
ties a measure of control over the portfolios of financial
institutions by stimulating (or deterring) holding of cer­
tain types of assets. It is thought that reserve requirements
related to specific categories of assets can achieve policy
objectives more directly than similar requirements im­
posed on liabilities, or than reserve ratios on liabilities
differentiated by type of institution, on the assumption that
such variations can be related to institutional preferences
for specific categories of assets (such as mortgages, foreign
acceptances, etc.). Currently, credit institutions in France
subject to reserve requirements must comply with stipu­
lated ratios applicable to assets as well as to liabilities.
In some countries reserve ratios are used primarily as
a fulcrum. Relative tightness or, alternatively, ease in

monetary conditions is achieved by manipulating the avail­
ability of reserves— through open market operations or
other means, such as debt management—in relation to
aggregate reserves required by the applicable reserve ratio
structure. Since all growing economies must increase their
reserve base over the longer pull, the monetary authorities
can influence credit conditions without resorting to cyclical
changes in reserve ratios by regulating the availability of
additional reserves and the conditions under which they
are supplied. Reserve requirements may also be made
more or less stringent merely by varying the range of
eligible assets, by changing the mode of computation of
liabilities subject to reserves, or by a more rigid enforce­
ment of compliance rules. Thus, relative stability of reserve
ratios over protracted periods of time is not necessarily an
indication of a diminished role which fractional reserve
requirements play in a given country.
The use of reserve requirements as a fulcrum is subject
to serious limitations in situations where commercial banks
hold excess reserves in amounts above those deemed
desirable to protect their liquidity, or when banks (and,
in some cases, other financial institutions as well) dispose,
typically or occasionally, of large amounts of foreign
exchange that can be automatically converted into domes­
tic cash (as in the case of the Netherlands, for example).
A similar limitation arises in countries where a large
part— or even the bulk— of reserves is created by redis­
counting operations of the central bank and the additional
reserves needed to meet an increase in reserve ratios are
provided almost automatically. Indeed, in several Latin
American countries, for instance, the value of the reserve
tool—whether used as a fulcrum or a means of making
frequent changes in the monetary multiplier—is greatly
diminished, and in most instances neutralized, by cen­
tral bank policies which normally provide reserves almost
automatically to banks to meet increases in reserve ratios
(in particular when they are made primarily to affect the
composition of portfolios rather than the credit multiplier).
In such situations, compliance with minimum reserve re­
quirements has become a formality, which may involve
costs and inconvenience, but does not, in fact, prevent
banks from pursuing expansionary policies. Actually, in
some Latin American countries (and in other countries as
well) reserves provided at the discount window equal or
exceed the total amount of required reserves. Another
type of limitation has at times arisen in some less devel­
oped countries in which branches of foreign banks are an
important component of the banking structure. Branches
can usually offset the restraining effects of increased re­
6 In at least one country (Japan) reserve requirements have been serve ratios by obtaining additional funds from their
extended to funds held by trust departments of commercial banks.
head offices.
In a few countries, reserves must be maintained against overdrafts.



In a few countries, where alternative control techniques
such as open market operations are not available, fre­
quent changes in reserve requirements have been utilized
to offset seasonal fluctuations in reserve availability. One
conspicuous example is Colombia, where sales of its main
export product, coffee, used to result in seasonal bulges of
bank reserves. To cope with this situation, the reserve ra­
tios were frequently raised temporarily during end-ofyear periods, and subsequently were restored to the original
level. Another example is New Zealand, where massive
transfers from private accounts occur on several tax pay­
ment dates. Until recently no mechanism existed to cushion
the effect on the liquidity of banks, and for many years
reserve requirements had been changed often to offset the
impact on the New Zealand banking system of the pay­
ment of income taxes.7
On the other hand, some central banks have pursued a
policy of making only infrequent changes in reserve re­
quirements, in part to avoid undesirable “announcement
effects”. They have endeavored to mop up excess liquidity
by requiring commercial banks to acquire from the central
bank stipulated amounts of nonmarketable certificates of
deposit as an alternative to raising reserve requirements
(as in Austria). A similar technique is to require banks
and other specified deposit institutions to make temporary
deposits with the central bank. Interest may be paid on
such deposits. Such arrangements may rest on a statutory
basis (as in the United Kingdom) or be negotiated with
the banks and embodied in a “gentleman’s agreement” (as
in Belgium since July 1972).
In countries in which liquidity ratios serve monetary
control purposes (though in some countries, as in Austria
and until July 19 in the Netherlands, on a standby basis
only), they are used mainly to reinforce legal reserve re­
quirements by further reducing the monetary multiplier
but permitting the additional reserves to be held in
specified income-yielding liquid assets. The most conspicu­
ous examples are the United Kingdom and Canada. When
the United Kingdom authorities recently abandoned direct
credit ceilings and interest rate controls in favor of in­
creased reliance on liquidity ratios, the Bank of England
found it necessary to focus its regulatory concern beyond
the clearing banks (large institutions in the city of London,

A relatively new use of reserve requirements has been
to sterilize or reduce the effect on reserves of speculative
inflows of foreign short-term funds and to protect the
country from the effects of turbulence in the international
monetary field by imposing higher reserve requirements
on nonresident than on resident accounts. During the
period of international monetary unsettlement that has
existed since the floating of the pound in June 1972,
changes in reserve requirements have been used exten­
sively as part of moves by several European countries to
achieve monetary restraint and, more specifically, to mop
up liquidity resulting from central bank purchases of
foreign exchange.8

7 New Zealand and Colombia were identified by Fousek in 1957
as examples of frequent use of changes in reserve ratios (op. cit.,
pages 51-53). In New Zealand the reserve ratio was changed 251
times between November 1957 and November 1972. In Colombia,
27 changes were made between 1962 and 1969.

8 For example, the German Bundesbank raised, effective March 1,
1973, reserve ratios on demand and time deposits 15 percent
across the board, and by half this percentage on savings deposits
for residents; for nonresidents they were already 100 percent at
the margin.

but with nationwide branch networks). While the Scottish
banks and those in Northern Ireland were expected to
observe liquidity ratios comparable to those expected of
city banks, other financial institutions were not. Even
earlier, in July 1961, the Bank of England found it neces­
sary to address its informal requests, designed to achieve a
moderation of credit expansion, to an ever-widening range
of financial institutions, in addition to those that had al­
ready observed liquidity ratios. Subsequently, British over­
seas banks, branches of foreign banks, merchant banks,
acceptance houses, finance houses (which specialize in
consumer finance), and discount houses were all added to
the list of institutions required to observe stipulated re­
serve ratios, although not necessarily as high as those ap­
plying to the core of the financial system— the city banks.
Canada alters the liquidity ratio from time to time
mainly to complement debt management operations and
to support open market operations by forcing the banks
to liquidate assets other than Treasury bills when squeezed
for cash, thus spreading the effect of open market opera­
tions more quickly to other financial sectors. Other coun­
tries, such as Belgium, apply the ratio occasionally to
neutralize excess liquidity. However, France, the country
which after World War II had placed liquidity ratios in
the center of its monetary policy, has been phasing them
out since 1967 in favor of reserve ratios and other tools
of monetary control.



When separate or additional reserve ratios on deposits
by nonresidents are used to control the inflow of short­
term funds, usually marginal requirements are applied.
In such cases, typically some historical base period rather
than a uniform absolute amount is used to determine the
exempt base. Foreign experience also includes examples
of the temporary imposition of supplementary require­
ments in a form different from the normal reserve ratios
authorized by permanent legislation. Such requirements
may apply to borrowers rather than to lenders, as in the
case of Germany and Australia which established cash
deposit requirements for long-term borrowing abroad as
emergency measures in 1972 and 1973, respectively.

Among the major industrial countries, the United States
remains unique in that the responsibility for setting re­
serve requirements for commercial banks is split between
the Federal Reserve System and the fifty state banking au­
thorities, which define independently the assets that qualify
to satisfy these requirements. The United States is the only
major country in which the central bank does not have the
power to regulate reserves of depository institutions other
than commercial banks, even though the bulk of savings
and other time deposits is kept with such institutions.
Also, in no other country is the effectiveness of the cen­
tral bank limited by making membership, and thus com­
pliance with its reserve regulations, voluntary for a sig­
nificant segment of commercial banks.
In most of the advanced countries, central banks have
at their disposal a number of policy tools which can be
used either simultaneously or as substitutes. Skillful use
by some central banks of variable reserve requirements
has induced several other leading countries in recent years
to add this tool to those already available to their mone­
tary authorities. In countries in which the legal basis has
been lacking, informal agreements with bankers’ organiza­
tions were used to provide for holding specified cash
reserves. The flexibility of the reserve tool and the useful­

ness of marginal requirements has been demonstrated in
several situations, including the current period of inter­
national monetary tensions.
The mere existence of reserve requirements as well as
extension of the range of financial institutions subject to
them is by no means, by itself, an indication that the re­
serve tool is continuously and skillfully used, or even that
it is indispensable as a monetary control tool in a given
country. In some less advanced countries, the richness of
monetary instrumentation borders on unnecessary gadgetry
which, in effect, disguises unwillingness or inability to use
the simpler available mechanisms.
One important lesson of foreign experience is the
observable widening of controls through reserve ratios.
The need for this widening has arisen from changes in fi­
nancial structure, in the money market, and in the chan­
nels through which credit flows, as well as in the scope of
activities of the various credit-granting institutions. In
most advanced countries, it has resulted in successive ex­
tensions in the range of institutions subject to reserve
requirements and, in some cases, in the range of liabilities
as well. This, in turn, has led to greater differentiation of
requirements. In countries which typically gain nonresident
deposits in times of international monetary turbulence, it
has been found useful to impose higher reserve ratios—
frequently in the form of marginal requirements— on de­
posits of nonresidents (together with other measures to
neutralize their effect on the domestic reserve base).
Another important conclusion is that periodic changes
in reserve ratios must be coordinated with open market
and discount operations. Such coordination is required to
avoid situations in which the intended restraining or stimu­
lative influence on the money supply (or on a specified
collection of deposit liabilities) fails to materialize because
reserves are provided (or absorbed) through other policy
actions, thus permitting banks to avoid portfolio adjust­
ments. On the other hand, coordinated use of other tools
for a limited period might be required to facilitate individ­
ual bank adjustments to changes in the level and struc­
ture of applicable ratios.