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130
MONTHLY REVIEW, SEPTEMBER 1959
The Business Situation
The strikes in the metal industries, which began in midJuly in steel and spread to copper and some other metals
in August, introduced a number of crosscurrents into an
otherwise strongly advancing economy. The most imme
diately apparent effects have been on employment in the
strike-bound industries themselves and in closely allied
mining and transportation activities. The impact of the
shutdowns on metal-using industries, and on the economy
as a whole, was still relatively minor at the end of August,
although reports of actual and immediately prospective
cutbacks were becoming more frequent.
E F F E C T S O F T H E ST R IK E
The fourteen-month climb in industrial output, which
by June had pushed the Federal Reserve production index
Chart I
INDUSTRIAL PRODUCTION AND SELECTED COMPONENTS
S e a so n a lly a d ju ste d , percentage change
Per cent
Per cent
Change, June to July 1959
2
1
H
0
-2
-4
-6
Average monthly change, first half of 1959
4.
w w H
23 per cent above the April 1958 cyclical low, was re
versed in July as a result of the steel strike (see Chart I).
For the month as a whole, the index declined about 1 per
cent (seasonally adjusted), dipping from 155 to 153 per
cent of the 1947-49 average. The principal factor was,
of course, steel output, which in July was only one half
of the previous month’s level, bringing total output of
metals down by one fourth. In August, steel output in
the plants unaffected by the strike was about 12 per cent
of the industry’s capacity, while the strikes that began
in August cut the output of copper by an estimated 75
per cent and also curtailed sharply the production of lead
and zinc. Among activities that support the steelmaking
process, the shutdown had already had an effect in July
on coal and iron ore production. Coal output fell by 24
per cent, metal mining by about 30 per cent, and total
minerals production by 5 per cent. Also reflecting the
strike was a substantial decline in freight carloadings,
which continued into August.
As a consequence of the steel strike, wage and salary
payments, which had risen uninterruptedly from last
October’s seasonally adjusted annual rate of $242 billion
to $262 billion in June, fell back by $500 million in July.
This was almost entirely attributable to employment de
clines in the steel industry itself and in fields connected
with the production and distribution of steel. At the end
of July an estimated 500,000 persons were on strike in
the steel industry, in iron mines, and on ore boats that ply
the Great Lakes. Another 100,000 persons, it was esti
mated, had been laid off in other industries directly
affected by the strike, including coal and railroads, and
from construction projects in the steel industry. The
strikes in the copper industry idled approximately 30,000
more persons during August.
Average monthly change, second half of 1958
THE ECONOMY AS A W HOLE
jS
'V
s
v»
. o'
m
J>
6
Source: Board of G o v ern o rs of the Federal Reserve System .
S>
The latest figures available for the broader statistical
series show that the economy was performing sufficiently
well through July to be able largely to offset the impact
of the strikes. Strength was particularly pronounced in
durable manufacturing production, reflecting increases in
fixed investment outlays by business and growing con
sumer demand. As can be seen in Chart I, machinery,
131
FEDERAL RESERVE BANK OF NEW YORK
transportation equipment, and glass-clay-lumber products
were three industrial groupings where further gains in July
continued the strong increases registered during the past
year. The widespread advances in durables output were
supported by new orders, which, the latest statistics show,
had turned up strongly in June, following a dip the previ
ous month. Production of finished durable goods was
hardly hampered by the steel strike, since most users
reportedly had accumulated sufficient inventories to carry
them into September or beyond. Output also advanced
appreciably in July in a number of nondurable manu
facturing lines—among them rubber and leather products
and textiles and apparel.
kPersonal income continued its forward movement in
July (see Chart II), although the seasonally adjusted an
nual rate of increase of $300 million was the smallest for
any month this year. The reduced payrolls in the steel,
mining, and transportation industries were partially offset
by increased wage and salary payments in other industries.
And advances in proprietors’ income and in interest and
dividend receipts helped push total personal income be
yond that of June. The latest employment figures show
that the week the steel strike began, seasonally adjusted
nonfarm employment (Bureau of Labor Statistics) had risen
to an all-time high of 52.6 million persons. This was
about 160,000 more than in June and a rise of 2.2 million
from a year earlier. Total employment (Bureau of Census
figures) had also reached a record high in mid-July of 67.6
million persons, or 2.4 million more than a year ago.
However, the 250,000 rise from June was somewhat less
than seasonal, partly because of bad weather that cut farm
employment in the South, and unemployment as a per
centage of the civilian labor force rose slightly (seasonally
adjusted) to 5.1 per cent from 4.9 per cent a month
earlier. Long-term unemployment (fifteen weeks or more)
declined by mid-July to 820,000, less than half that a year
earlier, although it was still 320,000 higher than in July
1957, at the height of the previous prosperity period.
Consumer spending also continued to show strength.
Retail sales in July were at a record annual rate (sea
sonally adjusted) of $219 billion (see Chart II), up slightly
from May and June. Department store sales in July were
also at an all-time peak, rising 3.5 per cent above the
June level; the latest figures suggest a further increase
during the first half of August this year. Data for early
August also indicate a rise in new car sales over the
July level.
In contrast, outlays for new construction moved slightly
downward in July and August on a seasonally adjusted
basis, reaching a level 2 per cent below the April-May
record but still 13 per cent ahead of a year previous.
Chart II
SOME ECONOMIC INDICATORS
Se aso n ally adjusted
B illio ns of d o lla rs
_________ ________________________
380 “
^ ________ B illio n s of dollars
Personaf i n
c o
m
e
A n n u a l rates
370 -
— 330
-
360 -
370
H 360
\ I I I 1 I
350 1 1 1
B illio n s of d ollars
350
B illio n s of dollars
220
220
M illions of person!
M illio ns of persons
53
---------------- 53
52
S Nonfarm employment^
\1 iS«.«»r"'i 1 1 I 1 1
1957
•-
1958
51
50
1959
^ R e flects paym ent of re tro a c tiv e s a la ry increases to Federal G o vernm ent
em p loyees.
^ U nited States Bureau of Labor S ta tistics series.
Sources: United States D epartm ent of Commerce and U nited States
Bureau of Labor Statistics.
The decline was almost wholly a result of a decrease in
residential construction.
Prices, meanwhile, continued the general trends of the
last few months. The consumer price index, which had
been virtually stable between mid-1958 and March 1959,
moved up in July for the fourth straight month, rising
by %o of a point to 124.9 per cent of the 1947-49 aver
age. The increase was due partly to a seasonal rise in
food prices, but other broad groups of goods and services
also showed increases. Outstanding among the latter were
recreation, medical, and transportation costs (including
used cars). Average wholesale prices, on the other hand,
declined slightly in July for the third consecutive month,
primarily as the result of a further decrease, of 1.6 per
cent, in prices of farm products and of a smaller decrease
in processed foods. Average wholesale prices of other
goods rose slightly following a small decline in June,
reaching again the record high of 128.4 first touched in
May. The divergence in the trends for food prices at the
wholesale and consumer price levels, which is not unusual
over a short period, is probably attributable to differences
in the relative importance of particular items in the two
indexes and to the timing of the surveys.
132
MONTHLY REVIEW, SEPTEMBER 1959
Money Market in August
The money market remained tight throughout August,
as member bank reserve positions continued under steady
pressures. These pressures were particularly marked in
the case of the New York City banks, which purchased
large amounts of Federal funds and increased their bor
rowings from the Federal Reserve Bank. Average borrow
ings from the Federal Reserve by all banks rose further to
$1.0 billion, the highest level since August 1957. The
effective rate for Federal funds remained firmly at the 3 V2
per cent ceiling throughout most of the month, while
dealer loan rates posted by the major New York City
banks rose to AVa per cent from 3%-4 per cent during the
previous month. On September 1, the leading New York
City banks announced an increase in their prime rate to
5 per cent from AV2 per cent, and certain other short-term
market rates immediately moved upward.
The Government securities market‘maintained a firm
tone in the early part of the month in the wake of the
recent highly successful Treasury refunding operation.
Market optimism subsequently gave way, however, to a con
siderably more cautious attitude as statistical indicators
underscored the brisk pace of business activity, and gave
rise to expectations of a further strong economic expan
sion after settlement of the steel strike, with consequent
upward pressures on interest rates. Moreover, commercial
bank liquidation of securities apparently accelerated dur
ing the latter part of the month. Market yields on Gov
ernment securities, which had declined steadily throughout
all sectors since early July, increased sharply after midAugust, and in some cases closed the period at new post
war peaks. The yield increases were particularly marked
in the short-term area, partly reflecting the additional sup
ply of Treasury bills resulting from the Treasury’s August
cash financing.
MEMBER
BANK RESERV ES
Net borrowed reserves of all member banks, on a
weekly average basis, remained within a $475-610 mil
lion range during the four statement weeks ended in
August, averaging $532 million for the period as a whole,
virtually unchanged from the $550 million (revised)
average for the five statement weeks ended in July. Aver
age excess reserves rose $66 million to $466 million, while
average borrowings from the Federal Reserve Banks rose
$50 million to $998 million.
On balance, regular market factors absorbed reserves
during the month, as a decline in average required reserves
was more than offset by a seasonal increase in currency
in circulation and other factors. Float produced the largest
week-to-week variations in reserve availability, withdraw
ing on average more than $200 million in the first state
ment week and then adding nearly $300 million in the
third week. The sharp midmonth float expansion in the
third week was partly offset, however, by an unexpectedly
large increase in Treasury deposits at the Reserve Banks.
System securities operations during August were
relatively moderate in scale and roughly offset the net
reserve effect of other factors. Average System securities
holdings rose by $114 million from the last week in July
to the last week in August, as outright holdings of Treasury
bills rose by $110 million and repurchase agreements by
$4 million.
Changes in Factors Tending to Increase or Decrease
Member Bank Reserves, August 1959
(In m illions of dollars; (-{-) denotes increase,
(—) decrease in ex cess r eserv es)
Daily averages—week ended
Factor
Operating transactions
Treasury operations*.....................................
Federal Reserve float....................................
Currency in circulation.................................
Gold and foreign account.............................
Other deposits, etc.........................................
Total...............................................
Aug.
5
>>set
changes
Aug.
12
Aug.
19
50
208
35
16
29
+ 27
- 19
- 146
+ 13
- 40
- 159
+ 294
+ 20
- 17
- 49
+
-f-
77
115
100
2
20
- 239
- 167
+
92
+
39
+ 157
- 101
-
72
2
7
-j- 49
+ no
4
+
+
- 128
—
+
5
1
4- 50
1
-r
-
-
1
—
~b
-
Direct Federal Reserve credit transactions
Government securities:
Direct market purchases or sales.............. + 32
Held under repurchase agreements........... + 58
Loans, discounts, and advances:
Member bank borrowings......................... + 144
—
Bankers’ acceptances:
2
Bought outright......................................... Under repurchase agreements...................
—
39
—
-
1
—
2
Aug.
26
—
—
—
—
—
5
48
61
22
138
-
275
6
—
+ 233
+
93
- 205
+
38
+ 159
Effect of change in required reserves f ............
+
6
55
- 74
+ 181
- 113
+ 16
4- 77
- 53
_ 116
+ 199
Excess reserves f ..............................................
+
49
+ 107
-
+
+
1,034
428
606
1,073
535
538
Total...............................................
Daily average level of member bank:
Borrowings from Reserve Banks..................
Excess reserves!............................................
Net borrowed reserves f ................................
Note: Because of rounding, figures do not necessarily add to totals.
* Includes changes in Treasury currency and cash,
t These figures are estimated,
t Average for four weeks ended August 26,1959.
97
945
438
507
24
940
462
478
83
998 J
4661
532 X
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 A R K E T
The Treasury announced on August 5 that it would
raise $1.7 billion cash through the sale of an additional
$1 billion of the tax anticipation bills maturing March 22,
1960 and through the addition of $700 million to the
weekly issues of Treasury bills. The latter amount was sub
sequently reduced to $600 million. In an auction held on
August 13, the tax anticipation bills were awarded at an
average issuing rate of 3.719 per cent, compared with
the 4.075 per cent rate established in the July 1 auction
for the original $3 billion of that issue. The payment date
was August 19, and commercial banks were permitted to
pay in full through credits to Treasury Tax and Loan
Accounts. In each of three consecutive weekly auctions
beginning August 10, the Treasury offered $1.2 billion of
91-day Treasury bills, $200 million in excess of the
amount maturing.
Although the size of the cash financing was somewhat
larger than had generally been expected after the success
of the earlier refunding operation, the announcement
itself produced only limited initial reaction in the Treasury
bill market. Nevertheless, the addition of $200 million
91-day bills introduced some caution in the regular weekly
auctions and reinforced previous doubts regarding the
existing level of short-term yields. (The 91-day bill rate,
for example, had fallen in preceding weeks to about 3 per
cent, a full Vi percentage point below the discount rate
and more than 60 basis points lower than the yield on the
six-month issue.) In reflection of a more cautious ap
proach, the three-month bills were awarded at steadily
increasing average issuing rates in the regular weekly auc
tions, reaching 3.889 per cent on August 31 compared
with 3.047 per cent on July 27. The average issuing rate
on the six-month bills declined in the first two auctions of
August to 3.737 per cent and 3.690 per cent, respectively,
from 3.860 per cent on July 27, but then rose successively
to 3.782 per cent, 4.152 per cent, and 4.468 per cent in
subsequent auctions. The spread between market bid rates
on the issues nearest three months and six months to
maturity narrowed from a recent peak of 81 basis points in
late July to 30 basis points on August 20, but widened
again to 55 basis points by the close of the month.
Led by the new 4% per cent note of 1964, prices of
intermediate- and long-term Government securities ad
vanced in the early part of the month, with the bid price
on the 1964 issue reaching a peak of 1011%2 by mid
month. Prices dropped sharply thereafter, however, as
the market reappraised underlying economic developments
and as commercial bank offerings increased under the
133
impact of the continued pressure on reserve positions. Bid
quotations on the 43A per cent note of 1964 declined by as
much as 11%2 to par bid by the close of the period. Over
the month the average yield on long-term Treasury bonds
rose to 4.15 per cent from 4.10 per cent at the end of July.
O T H E R S E C U R IT IE S M A R K E T S
The corporate and municipal bond markets maintained
a steady tone through mid-August, with yields on seasoned
issues tending to decline slightly. Subsequently, however,
a note of hesitancy was injected into the markets by an
increase in the calendar of new offerings and by the same
influences that contributed to the weakening of the
Government securities markets in the latter half of the
month. In consequence, yields moved generally upward
toward the end of the period and showed a moderate net
rise over the month.
Corporate bond flotations totaled an estimated $410
million in August, representing a substantial increase over
both the July total of $170 million and the August 1958
total of $205 million. The volume of municipal financing
also increased, although less sharply, with new offerings
totaling $455 million in August, compared with $370 mil
lion in July and $315 million in August 1958. Most
of the month’s corporate offerings were received without
enthusiasm by the market. Toward the end of the period,
the syndicates on three sizable offerings broke up with
out completing distribution. Also, in the last week of
August, a $65 million Aa-rated bond issue, reoffered
to yield 5 per cent, was accorded a poor reception by
the market, although a $125 million issue of debentures,
also reoffered to yield 5 per cent, was fairly well received.
Municipal flotations during August were accorded widely
varying receptions. Many of the month’s smaller offerings
performed poorly, but, in contrast, the largest offerings
of the month—a $125 million State veteran bond issue
and a $50 million issue of both term and serial bonds by
a State highway authority—sold out rapidly.
Rates on several short-term debt instruments were
raised during the month. Commercial paper dealers lifted
their rates on August 18 and again on August 25 for a
total increase of Va of a per cent, bringing the offering rate
on prime four- to six-month commercial paper to 4 Vs per
cent. On August 18 and 19 dealers in bankers’ accept
ances announced a Vs of a per cent increase, bringing the
offered rate on 90-day unindorsed acceptances to 3% per
cent. The large finance companies announced on August
25 the lifting of the rates which they pay on their own
paper placed directly with investors; effective August 26
the new rate on 30- to 89-day paper became 3% per cent.
134
MONTHLY REVIEW, SEPTEMBER 1959
International Developments
B U S IN E S S T R E N D S A BRO A D
A brisk economic upswing is now under way in the
major industrial countries abroad. This expansion has
been gathering force since the start of the year and is
pushing most business indicators beyond previous peaks.
It follows a downturn in economic activity in these coun
tries that had generally been briefer and milder than that
experienced in the United States. The current upswing,
unlike some in the past, is proceeding both with a high
degree of price stability and against a background of
ample and rising foreign exchange reserves.
By mid-1959 industrial production had not only fully
Chart I
INDUSTRIAL PRODUCTION IN SELECTED COUNTRIES
S e a s o n a lly adjusted, 1953=100
Per cent
Sources: O rganization for European Economic Cooperation,
G e n e ra l S ta tistic s ; n a tio n a l statistics.
Per cent
recouped previous losses but in all countries under review
had attained levels above those recorded a year earlier
(see Chart I). The rise in production over the year ended
June 1959 ranged widely from 4 per cent in France to
a high of 26 per cent in Japan. The timing of the revival
also differed from country to country. In Japan and the
Netherlands industrial production began to move upward
as early as the second quarter of 1958, while in Canada,
the United Kingdom, the Federal Republic of Germany,
and Italy the rise got under way only during the second
half of the year. In France and Belgium, however, the
upturn in industrial output was delayed until the first
quarter of 1959.
The upswing in industrial production has been paced
by consumer durables and by the heavy industries, notably
metals, machinery, and chemicals. Automobile output in
the United Kingdom, for example, reached an all-time
peak in May and in France in June of this year. By
midyear steel production, too, was rapidly moving toward
record levels in France and Germany; in the United King
dom, steel output, after lagging in 1958, picked up
strongly in the second quarter of 1959. The rise in the
production of chemicals has been particularly rapid in
Italy and France. Even the textile industry, which had
been in the midst of deep-seated structural difficulties,
has recently begun to show signs of strength, notably in
Belgium and Italy. On the other hand, a revival in coal
output has been checked by the existence of large excess
stocks. Building activity has been vigorous in all coun
tries, especially in Germany, where it has furnished a
major stimulus to the current boom.
Employment, which had lagged in the early stages of
the revival—partly because of productivity gains—is now
also expanding rapidly in many industrial countries. In
deed, in Germany and the Netherlands labor shortages are
already appearing in some industries. In the United King
dom, unemployment declined further in June to a level
slightly below a year earlier, although it remains somewhat
above previous boom years. In Canada the number of
jobless, while still rather sizable, in June was down 25 per
cent from mid-1958. In Belgium, however, where the
stagnation of the coal industry has been impeding the gen
eral pickup in business activity, employment has been
rising only slowly and unemployment continues at rela
tively high levels.
FEDERAL RESERVE BANK OF NEW YORK
C hari It
WHOLESALE PRICES IN SELECTED COUNTRIES
Sources: O rg an izatio n fo r European Economic Cooperation,
G e n e ra l S tatistics; n a tio n a l sta tistic s.
The price stability achieved in the major industrial
countries abroad in the recent past has been maintained to
a remarkable degree this year (see Chart II). This stability
reflects, besides lower raw material prices and the exist
ence of some unused capacity, a general easing of wage
demands. In part it is also attributable to monetary poli
cies designed to promote expansion without sparking re
newed inflation. Even in France, where the December
devaluation of the franc had been expected to result in
substantial price advances, wholesale prices rose only 2.8
per cent during the first half of this year.
The buoyancy of consumer demand, which had already
helped to cushion the slackening of economic activity last
year, continued this year to furnish a major stimulus to
the expansion. Since the start of the year retail sales have
been rising everywhere—but most markedly in Canada
and Japan where they have been running 7 to 10 per cent
above 1958. A notably large upsurge in retail sales has
135
also occurred in the United Kingdom, reflecting partly
the end last year of consumer credit controls and this
year’s tax relief measures.
Exports have provided the other principal impetus to
the present economic upswing. French exports, in par
ticular, climbed to an all-time peak during the first half
of 1959, increasing 24 per cent over the first half of 1958.
Exports also advanced markedly in the Netherlands, Italy,
and Japan, while their rise was somewhat more subdued
in the United Kingdom and Canada. Belgian exports, in
contrast, have remained sluggish. The general export in
crease has covered the entire range of commodities, but
has been especially pronounced in machinery, electrical
equipment, and automobiles. In part, the increase has
reflected the economic expansion in the United States and
the heavier penetration of foreign products in the United
States market.
The revival of consumer and export demand and the
resultant recovery of manufacturers’ orders during the first
half of 1959 have already reversed last year’s decline in
inventories. With order books filling once again, stocks
are being replenished at a rapid pace in many industrial
countries abroad, especially in Canada and Germany.
In view of the continued existence of unused capacity,
however, no marked upsurge in fixed investment outlays
has so far taken place. Nevertheless, as business prospects
have turned increasingly auspicious, private capital spend
ing plans have been revised upward. Even in France,
where the outlook for private capital investment had been
rather clouded earlier this year, an official survey now
suggests that 1959 business investment will top last year’s
outlays by about 7 per cent. Belgium seems to be the
one country among those reviewed where private invest
ment activity continues to lag, but a government program
just introduced is expected to promote capital expendi
tures and to hasten the modernization of the country’s
industries.
With investment outlays expected to reinforce expand
ing consumer and export demand, significant gains in the
aggregate output of goods and services are generally antici
pated in the major industrial countries abroad this year.
For Western Europe as a whole, the United Nations Eco
nomic Commission for Europe had already earlier this year
forecast an advance of more than 3 per cent, with in
creases substantially above this figure expected in several
countries, notably Germany and the Netherlands. In
Canada, where the business upswing has been especially
strong, official Canadian estimates have placed the aggre
gate output of goods and services for this year at a level
7 per cent above that of 1958.
13*
MONTHLY REVIEW, SEPTExWBER 1959
C hart III
M O N E TA R Y T R E N D S AN D PO L IC IE S
As economic expansion gathered momentum, most in
dustrial countries abroad abandoned or modified the poli
cies of monetary ease actively pursued during 1958 and
early 1959. This is not to say that all these countries have
again reverted to credit restraint, although concern over
economic overexpansion has been voiced in several.
Rather, in many foreign industrial countries the monetary
authorities in recent months have simply ceased feeding
the revival of economic activity. In general, interest rates
have mirrored economic trends and the resulting changes
in monetary policies. In Western Europe, the decline in
rates that had characterized most of 1958 and early 1959
was halted or even reversed in recent months, while in
Canada rates have risen steeply since the summer of 1958
(see Chart III).
In most industrial countries abroad, the current expan
sion in economic activity has been accompanied by a
substantial increase in commercial bank lending. In
Europe, much of this increase has reflected the growth of
consumer instalment credit and the introduction of personal
loan facilities by commercial banks. An especially large
rise in commercial bank credit generally and in instalment
credit has taken place in the United Kingdom. In the
twelve months following the ending of the “credit squeeze”
in July 1958, advances of the London clearing banks in
creased by over 30 per cent. During the same period, total
instalment debt rose by over 50 per cent, with two thirds
of this increase attributed to car financing.1
A sharp expansion of commercial bank credit has also
occurred in Canada as economic recovery has accelerated.
However, the rapid expansion of the money supply in 1958
and the recent vigor of the Canadian boom led the Bank of
Canada to restrain any further growth of the money supply.
With the central bank keeping a tight rein on reserves, the
chartered banks were forced early this year to run down
their liquid assets. By April their liquid-assets ratio had
dropped to 15.6 per cent of deposits (the lowest level since
the 15 per cent minimum came into effect in mid-1956)
from 17.2 per cent in January. Moreover, during April
the banks also began selling government bonds in order
to meet their loan commitments. In mid-May, the banks
agreed among themselves that, until the money supply was
permitted to expand further, there should be no significant
increase in the over-all loan total. While total loan expan
sion slackened briefly following this announcement, pri
marily because of a sharp cutback in loans to finance
1 It should be noted, however, that consumer instalment credit in the
United Kingdom (as elsewhere in Western Europe) still is much less
widespread than in the United States.
INTEREST RATES IN SELECTED COUNTRIES
THREE-MONTH TREASURY BILLS
I H k i r . TCD kA
r .n V / C D M U F M T
Per cent
R H K in C
— I'"
Canada
I I 1I 1 1I I
1957
N ote:
II
1958
I 1I I
II
I 1I I 1 1 I
1959
August 1959 d ata p a rtia lly estim ated.
Rates on mortgage bonds.
Sources: In te rn a tio n a l M o n e ta ry Fund, In ternational F in a n c ia l Statistics;
natio nal sta tistics.
companies, general business loans nevertheless continued
to rise at an undiminished rate during June and July, with
the entire expansion having to be financed by sales of gov
ernment securities; by the end of July, business loans had
risen 22 per cent over the end of 1958. At the same
time, money market rates advanced sharply, with the aver
age tender rate on three months’ Treasury bills rising
from 5.01 per cent on July 2 to a record 6.16 per cent
on August 13. At that point, the banks—whose maximum
lending rate is legally set at 6 per cent—declared that
this development had deprived them of the ability to grant
new loans or permit increases in existing credit lines. The
bill rate declined, however, to 6.04 per cent on August 20,
as the Treasury accepted only $91.5 million of the regular
$115 million of bids submitted on 91-day bills and $12
million of the $20 million submitted on 182-day bills.
The rate dropped further to 5.33 per cent on August 27,
FEDERAL RESERVE BANK OF NEW YORK
as the Treasury reduced its offering of 91-day bills to $95
million and offered no 182-day bills at all. A less-thannormal amount of both types of bills was also scheduled
to be offered on September 3.
In order to moderate the current boom, the Swedish
Riksbank on July 1 raised the commercial banks’ required
liquidity reserves (which are in the form of cash and gov
ernment securities) to a 30-40 per cent range, depending
on the size of the institution, from the previous 15-33 per
cent range. The central bank pointed out, however, that
this change would not force the banks to reduce the
volume of loans outstanding at this time, but was in
tended, by adjusting reserve requirements to prevailing
high liquidity conditions, to facilitate control of any future
credit expansion.
In only two industrial countries—Belgium and France
—did the authorities reduce the cost of credit further in
attempts to encourage lagging private investment. The
Belgian Treasury is providing grants to banks to enable
them to reduce interest rates by as much as 2 per cent on
loans to finance the establishment, extension, or moderni
zation of industrial enterprises and to provide working
capital. The Bank of France, continuing its policy of credit
relaxation, on July 9 lowered its rate on advances against
securities to 5 Vi per cent from 6 per cent, and also re
duced the penalty rates applicable to borrowing in excess
of an individual bank’s discount ceiling. (The basic dis
count rate remained unchanged at the 4 per cent level
set on April 23.) The reduced cost of central bank credit
may not, however, become immediately effective, since
the high liquidity of the banking system, reflecting recent
foreign exchange gains, has made large-scale recourse to
the central bank at penalty rates unnecessary in recent
months. In July, also, the authorities lowered the com
mercial banks’ minimum lending rate, as well as various
commission charges, and raised from 500 million francs
($1.02 million) to 1 billion ($2.04 million) the ceiling on
individual commercial bank credits that may be extended
without prior Bank of France approval. In addition, con
trols over a wide range of consumer durable goods were
relaxed by lowering the minimum downpayments and ex
tending the maximum repayment periods.
The continuing re-examination by monetary authorities
everywhere of existing monetary techniques and institu
tions, in an effort to improve their functioning, has re
sulted in a number of new developments in recent months.
In the United Kingdom, the Committee on the Working
of the Monetary System, appointed by the government in
May 1957 and headed by Lord Radcliffe, published its
report on August 19. In general, the report recommends
the continuation of existing institutions and policies but
137
suggests, among other things, that the authorities place
increased reliance on changes in longer term interest rates
as a means of achieving the government’s debt-policy ob
jectives and of thereby controlling the economy’s liquidity.
The report also recommends various steps to formalize
the integration of monetary policy with the govern
ment’s over-all economic policies, and the adoption of
certain policy instruments designed to handle possible
emergency situations.
The Belgian authorities in June enlarged both the re
sources and the scope of the Fonds des Rentes, a public
institution established in 1945 to regulate government
bond prices, in order to enable the Fonds to engage ac
tively in open market operations—the central bank itself
does not operate in the government securities market. In
West Germany, the Central Bank Council revised the
commercial banks’ minimum reserve requirements, effec
tive August 1, in order to reduce the requirements for
small banks and thus make allowance for the fact that
banks in towns without a branch of the central bank have
to carry larger cash balances than those elsewhere. The
change establishes four reserve classifications based on the
size of total deposit liabilities, including savings deposits,
in place of the previous six classifications that had been
based on the size of deposits, excluding savings de
posits. And in Japan, steps are being taken to facilitate
the formal establishment of minimum reserve requirements
for commercial banks, under legislation enacted in 1957
authorizing the central bank, with the consent of the
finance minister, to impose such requirements up to 10
per cent of demand deposits.
EXCHANGE RATES
In the New York foreign exchange market spot sterling
declined during August from $2.8121 to as low as
$2.8052; on the other hand, three and six months’ de
liveries advanced to close the month at 12 and 16 points
premium, the highest since January 1955. These move
ments primarily reflected switching from sterling to dollar
securities in order to take advantage of higher interest
rates in the New York market. At the month end the
spot pound was quoted at $2.8054.
A sharp increase in Canadian bill rates, combined with
short Canadian dollar positions, resulted in rising quota
tions for the Canadian dollar which reached $1.05%2 at
midmonth, the highest since August 1957; at the month
end the rate was $1.05%2- Quotations for Continental
currencies, particularly the Netherlands guilder, tended to
decline in terms of the dollar.
138
MONTHLY REVIEW, SEPTEMBER 1959
Borrowing from the Fed
The economic recovery and expansion of the past year
has been accompanied by growing demands upon com
mercial banks for credit accommodation. The pressure
of these demands, in turn, has caused an increasing num
ber of banks to turn to the discount facilities at their
Federal Reserve Banks. Most of these borrowings by
member banks have been for short periods and have
been in the nature of temporary assistance while the banks
worked out orderly adjustments in their portfolios. As
seasonal credit needs increase further during the latter
half of 1959, it is possible, perhaps likely, that a growing
number of member banks will consider turning to the
“discount window” at the Reserve Banks to borrow the
funds needed to cover temporary shortages in their reserves.
This article examines the circumstances under which
member banks might appropriately exercise their privilege
to borrow from the Reserve Banks and also attempts to
place the administration of the discount window in per
spective against the monetary policy objectives pursued
by the Federal Reserve System.
The circumstances that might lead a member bank to
turn to the discount window for accommodation are
varied, but the most important general type of circum
stance is an unanticipated—or larger than anticipated—
loss of reserves through the clearings process. As indi
viduals, business concerns, and governments at various
levels receive and make payments for the broad range
of goods and services our economy produces, money is
in constant motion from depositor to depositor, from
bank to bank, and from region to region. It is to be ex
pected that these flows will not be perfectly offsetting in
any brief period of time as they affect any one bank, and
it is to be expected, therefore, that individual banks will,
from day to day or week to week, gain or lose reserves
as they receive payments or make payments for the checks
that pass through clearings.
Many of these gains or losses of reserves will be off
setting for a bank within a short period of time, perhaps
within the weekly reserve computation period for reserve
city and central reserve city banks, or within the semi
monthly reserve averaging period of country banks. Some
of the gains and losses, however, may not be offsetting
for periods of weeks or even months, following a broad
seasonal pattern that reflects the business or agricultural
activities of the customers whom the bank services. Even
in the case of these broad seasonal movements, the ap
proximate size of the gain or loss is often predictable.
The bank is accordingly able to make provision for such
changes by accumulating highly liquid investments, such
as Treasury bills, during the seasons when customer credit
requirements are lowest.
The source of funds to which a member bank turns
when it finds itself in need of reserves will depend upon
the expected duration of the need for reserves, the avail
ability of liquid short-term investment assets in portfolio,
and the money management practices of the bank. Reserve
shortages that are expected to be of some duration may
be covered by liquidating Treasury bills or other second
ary reserve assets, if these are available in sufficient
amount in the bank’s portfolio. Where the bank does not
have an adequate supply of highly liquid money market
securities in its secondary reserve, it may be necessary to
sell longer term portfolio investments, perhaps at a con
siderable loss, or to retrench in lending activity in order
to conserve reserves. Very brief reserve shortages, on the
other hand, may be provided for by drawing down a corre
spondent balance, by buying Federal funds, or by tem
porarily borrowing funds through some other means.
When the reserve need is expected to be of only a few
days’ or, at most, a very few weeks’ duration, a member
commercial bank may properly borrow from its Federal
Reserve Bank.
As some member banks have learned, however, access
to the discount window is not an automatic right that
goes with membership in the Federal Reserve System. The
Board of Governors of the Federal Reserve System has
established regulations, under authority of the Federal
Reserve Act, which outline the general circumstances
under which a member bank may properly borrow. Dis
count administration is intended to assist member banks
temporarily in need of reserves, but to do so without
impairing the ability of the Federal Reserve System to
discharge its principal responsibility, the regulation of the
supply of money and credit. The criteria for appropriate
borrowing apply uniformly and objectively to all member
banks; they do not attempt to make distinctions, for
example, between the needs of very active banks in fastgrowing communities and those of less active banks
located in communities that are not growing so rapidly.
Nor are the criteria changed from one month to the next
FEDERAL RESERVE BANK OF NEW YORK
or over the various phases of the business cycle. It is
important, therefore, that member banks understand the
general circumstances under which they may appropriately
turn to their Federal Reserve Bank for an advance when
they have a temporary need for reserves.
T H E O B JE C T IV E S O F FE D E R A L R E S E R V E PO LIC Y
In order to place the regulation of member bank bor
rowing in proper perspective, it would be helpful to re
view the broad objectives sought by the Federal Reserve
System through its policies. The ultimate objective, of
course, is to help to provide monetary and credit condi
tions conducive to sound, long-run growth in the economy,
free of both inflation and deflation. In pursuit of this
objective, the System exercises an influence upon the
credit-granting capacity of the commercial banking sys
tem. Member banks are required to maintain certain
minimum reserve balances on deposit with their Federal
Reserve Banks. To the extent that an individual bank,
or the banking system at large, holds larger reserves
than are needed to cover requirements against deposits,
it is in a position to grant new loans or to make new
investments.
There are many factors which influence the reserves
available to the banking system. For example, when the
public requires a larger supply of currency, perhaps due
to the shopping activity around the Christmas season,
commercial banks draw down their reserve balances as
they take currency out of the Reserve Banks to supply
their depositors. Similarly, the return flow of currency
after the seasonal need for the enlarged supply has passed
enables banks to build up their reserves. As gold flows
into or out of the United States in settlement of interna
tional balances, the settlements are reflected on the books
of the Federal Reserve Banks with a resulting effect upon
bank reserves. And there are many other influences upon
total banking reserves.
The net effect of these influences may, in any particular
time interval, either add to the supply of reserves in the
banks or reduce reserves. Sometimes the net changes can
be quite substantial. For example, the withdrawal of cur
rency from the banks during the last few months of each
year typically amounts to about a billion dollars, which is
equivalent to about 4 or 5 per cent of the total supply of
bank reserves. In order to hold to a minimum the dis
turbing impact that these sometimes random influences
might otherwise have upon the ability of commercial banks
to provide an orderly service to the community, the Fed
eral Reserve System employs open market operations in
Government securities to offset the greater part of their
139
net effect upon bank reserves. That is to say, when the
commercial banking system loses reserves each fall be
cause of the seasonal increase in currency needs, the
Federal Reserve System replaces these reserves by purchas
ing Government securities in the open market. There is,
of course, no way to assure that the reserve funds which
the System creates in buying Government securities will
be distributed among the member banks in exact propor
tion to the reserve losses which they are intended to
replace. The Federal Reserve System relies upon the
free flow of funds through the money market’s alloca
tion process to distribute the reserves to the areas of
greatest need.
Perhaps the most important influences upon bank re
serve positions over the longer run are changes in commer
cial bank credit. These do not affect the total of reserves
in the banking system but do change the total of reserves
that banks are required to hold. When banks as a
group make new loans or new investments, there is a
roughly equivalent increase in deposits in the banking
system, leading to larger required reserves. If the Federal
Reserve System automatically supplied new reserves to
replace those that have become tied up in required re
serves as bank credit expands and deposits increase,
there would be no limit upon the extent to which
the banking system could grant new loans or make new
investments. As the banks created new deposits in the
process of lending and investing, an endless supply of
reserves would be forthcoming to enable them to meet the
higher reserve requirements. To avoid this inflationary
outcome, the Federal Reserve System attempts to supply
new reserves for the purpose of supporting new deposit
growth only in amounts that are in pace with the money
requirements of a soundly growing economy.
A consequence of this policy is that bankers feel that
the supply of bank reserves is being limited—money is
being made “tight”—during periods of accelerating busi
ness activity, when rising payrolls, inventory financing,
and other uses for money cause the demand for bank loans
to swell. At such periods, it is possible that the credit
requirements of a bank’s “good customers” might exceed
the bank’s ability to expand loans out of available re
sources, necessitating the sale of marketable securities.
On the other hand, when business activity is not expand
ing, or is perhaps declining, loan requests ordinarily fall
off and the banker finds that he has more funds than he
needs to service his customers. Money is “easy”. To the
individual banker, it might well appear that the Federal
Reserve System’s policy with respect to growth in the
money supply is perverse in its effects. It creates a situa
tion where there is not enough money to service “good
MONTHLY REVIEW, SEPTEMBER 1959
140
loans”, when such loans are in demand, and there is more
than enough money to service all available loans when
“good customers” are not interested in borrowing.
The Federal Reserve System attempts to regulate the
money supply so as to achieve orderly monetary growth.
Each new loan, with its simultaneous creation of a new
deposit balance, represents an addition to the money that
is available for spending on the goods and services the
economy produces. However, the economy’s physical
capacity to expand the real quantity of its output in any
one year is limited. If the money available for spending
were allowed to increase at a faster rate than the econ
omy’s ability to increase real output, the net result would
be not an increase in real product but only an increase in
the prices paid for all goods and services. This is the
classical situation of too many dollars chasing too few
goods.
In other words, the Federal Reserve System cannot
supply the commercial banks with all of the reserves they
would need to service all of their loan requests when busi
ness is good without running the risk of inflationary money
and credit growth. “Tight money” at periods when loan
demands are piling up at a faster rate than reserves are
available to service them, and the resulting need to refuse
some loan demands, are the necessary conditions if infla
tion is to be resisted.
A D M IN IS T E R IN G T H E D IS C O U N T W IN D O W
Let us now return to the question of member bank bor
rowing from the Federal Reserve Banks. The preceding
description of the manner in which the Federal Reserve
System attempts to regulate banking reserves makes it
clear that the System could not permit unrestricted access
to the discount window by member banks. If it were
to do so, it might defeat its own policy objectives in
periods of rising business activity. It would be pointless
to attempt to regulate the rate of growth in the money
supply and in credit in use through open market opera
tions if, simultaneously, the discipline thus being exerted
upon the banking system were to be dissipated by a free
flow of reserves through the discount window. Therefore,
the Federal Reserve System must establish conditions for
regulating member bank access to advances from the
Reserve Banks. One method of influencing the amount of
member bank borrowing is through changes in Federal
Reserve discount rates; another is through discount ad
ministration at the Reserve Banks. This article discusses
only the latter method and does not appraise the role
of discount rates.
The Board of Governors of the Federal Reserve Sys
tem has defined in its Regulation A the circumstances in
which member banks may borrow. In the foreword to this
Regulation, the general principles governing appropriate
use of the discount window are presented, as follows:
Federal Reserve credit is generally extended
on a short-term basis to a member bank in
order to enable it to adjust its asset position
when necessary because of developments such
as a sudden withdrawal of deposits or seasonal
requirements for credit beyond those which can
reasonably be met by use of the bank’s own
resources. Federal Reserve credit is also avail
able for longer periods when necessary in order
to assist member banks in meeting unusual sit
uations, such as may result from national, re
gional, or local difficulties or from exceptional
circumstances involving only particular member
banks. Under ordinary conditions, the continu
ous use of Federal Reserve credit by a member
bank over a considerable period of time is not
regarded as appropriate.
In considering a request for credit accommo
dation, each Federal Reserve Bank gives due
regard to the purpose of the credit and to its
probable effects upon the maintenance of sound
credit conditions, both as to the individual insti
tution and the economy generally. It keeps
informed of and takes into account the general
character and amount of the loans and invest
ments of the member bank. It considers whether
the bank is borrowing principally for the pur
pose of obtaining a tax advantage or profiting
from rate differentials and whether the bank is
extending an undue amount of credit for the
speculative carrying of or trading in securities,
real estate, or commodities, or otherwise.
The wording in the preceding quotation is necessarily
general, although it is sufficiently precise to afford a help
ful guide to borrowers without attempting to establish
a fine line between appropriate and inappropriate borrow
ings. Each borrowing request—and the circumstances that
led to the request—differs in some respect from all other
requests; and the circumstances surrounding each request
must be appraised independently. At the same time, while
each request is sufficiently different as to make precise
definitions in a written regulation impossible, the types of
circumstances that lead to borrowing usually fall under
a few broad headings, and determination of the appro
priateness of the request may be made fairly and objec
tively within the intent of Regulation A.
Perhaps the most common circumstance leading to
member bank borrowing from its Federal Reserve Bank
is miscalculation in estimating the flow of funds into a
bank. As remarked earlier, customer deposits, and thus
bank reserves, are constantly flowing through the clearings
process, and it is completely understandable that a bank
FEDERAL RESERVE BANK OF NEW YORK
may, from time to time, misjudge the amount of reserves
that it will have at its disposal. Such borrowing would
fall under the wording in Regulation A that provides for
an adjustment made necessary
. . because of develop
ments such as a sudden withdrawal of deposits . .
It
should be added, however, that miscalculation of money
flows is not an acceptable reason for frequent or prolonged
borrowing. A bank that found it necessary to borrow
from the Federal Reserve Bank during one or more re
serve computation periods each month, at the points
during the month when total reserve balances were lowest,
would be relying upon the discount window to supply part
of a predictable need for reserves. It is equally clear that,
if a member bank requires access to the discount window
for several consecutive weeks, the reserve shortage is more
than temporary miscalculation and should be corrected
through portfolio adjustments. In this context, it should
be noted that continuous borrowing does not necessarily
imply borrowing on each day.
Another relatively frequent occasion for borrowing is
an unexpectedly large seasonal loss of reserves. Commer
cial banks in principally agricultural areas, resort areas,
or regions in which a single type of industrial business
predominates are likely to have fairly sizable gains or
losses of reserves from one season to the next. As a gen
eral principle, it is anticipated that a bank will attempt to
make preparations for seasonal reserve losses through its
cash position or its short-term investment portfolio. But
situations can and do arise when the seasonal reserve
loss is greater than the bank could realistically have been
expected to prepare for. In such circumstances, it is per
fectly proper for the bank to turn to its Federal Reserve
Bank for assistance until it has had an opportunity to
make other adjustments. However, such a bank should
not expect the Reserve Bank to continue to supply re
serve balances through the discount window until the
seasonal cycle has run its course and reserves again begin
to flow in. Borrowing from the Reserve Bank in such
circumstances is still a temporary expedient, to be used
while the bank makes the necessary decisions as to the
portfolio securities it will liquidate or the reduction in
lending it will adopt in order to correct its basic reserve
deficiency.
Continuous borrowing, which in effect means a member
bank is using Reserve Bank credit to supplement its own
capital resources, is inappropriate regardless of how meri
torious the loans made by the member bank may be. For
example, a situation which has occasionally led to in
appropriate borrowing requests originates in the attempt
of certain banks to provide financing for public projects,
such as new schools, pending the sale of bond issues. This
141
sort of loan demand can be foreseen long in advance, since
public works rarely are entered into on the spur of the
moment. There should be ample opportunity for the
arrangement on a suitable basis of such financing as the
school district or other public authority may require.
Unfortunately, however, some banks have become in
volved in the financing of public works in amounts out of
proportion to their resources and for periods of time which
have become burdensome.
Situations do arise, however, particularly when capital
markets are congested and interest rates are rising, when
public bodies find they are unable to sell the bonds they
have scheduled, at least at rates of interest they are willing
to pay. The local bank in this case may suddenly find itself
confronted with a request for a large construction loan that
may run for a period of years, until the bonds finally are
sold. What should the bank do? It does not have the
immediate resources to make the loan but, if it refuses,
the construction of a desperately needed school or other
public facility may be delayed. The answer must be de
termined, even in this case, by the bank’s own resources.
In such a situation, the Federal Reserve Bank might ex
tend temporary assistance while the bank arranged to
liquidate other assets or to participate the loan. But it
would be expected that such arrangements would be made
promptly so that the Reserve Bank would not, in effect,
become a participant in the loan. Similar circumstances
frequently arise when a bank is approached by a public
body to purchase tax anticipation notes.
Borrowing is also inappropriate in cases where a com
mercial bank, in responding to the loan demands arising
in its community, extends new loans at a faster rate
than it is able to provide for out of new deposits or
liquidation of other assets. Sometimes the member bank,
with some justification, feels that it has gotten into re
serve difficulties because it has provided a superior service
to its community. It may be hard for such a bank to
understand that it should not have ready access to re
serves “to make good loans to good customers”. A mo
ment’s reflection will show why the Federal Reserve Bank
cannot, in effect, become a partner with a bank so anxious
to serve its community. Obviously, all banks consider the
loans that they wish to make to be good loans or they
would not wish to make them. If each Federal Reserve
Bank in a sense “went into partnership” with each of its
member banks that had good loan requests in excess of
its ability to attract new deposit balances, by extending
virtually unlimited Federal Reserve credit for an unlimited
period, the entire structure of Federal Reserve efforts to
impose necessary limitations upon money and credit might
collapse.
142
MONTHLY REVIEW, SEPTEMBER 1959
In some cases, a bank that turns to the discount window
for the first time in a rather long while may prove to have
been borrowing funds steadily from other sources, either
in the Federal funds market or through other types of
loans. Such a bank, although it has not found it necessary
to borrow consistently from the Reserve Bank, nonetheless
has a basic reserve deficiency that it should adjust through
its portfolio rather than rely upon the Federal Reserve
Bank, even infrequently, to bail it out when it cannot find
the funds elsewhere to maintain its overloaned or overinvested position.
In still other cases, a bank that has developed a reserve
deficiency will not have made adequate provisions in its
portfolio of short-term securities to take care of such a
deficiency. The result might be that it would have to
liquidate longer term securities — perhaps at discounts
from book value that would substantially reduce bank
earnings—to raise the necessary reserves. Realizing the
member bank’s reluctance to suffer such a loss, the
Reserve Bank would nonetheless conclude in most cases
that the member bank should liquidate securities in order
that borrowing from the “Fed” might not become pro
longed or continuous.
In reviewing requests for accommodation, the Federal
Reserve Bank considers whether the need has, so to speak,
been created artificially. For example, many member banks
find participations in call loans, usually purchased through
their correspondents, a profitable outlet for surplus funds.
Such participations should not be retained except on a
most transitory basis, if the bank is at the same time find
ing it necessary to have recourse to the discount window.
Another example of such an artificial need is that of banks
which take on mortgage commitments outside their normal
business areas to increase their income. These should not
be carried by recourse to the discount window.
BN C O N C L U S I O N
This long list of “thou shalt nots” should not suggest
that the privilege of member banks to borrow from their
Reserve Bank is so limited as to be of little value. In
the Second Federal Reserve District alone, nearly one half
of all member banks borrowed at some time from the
Reserve Bank during the first six months of 1959. The
great value of the discount privilege is the assurance it
extends to each member bank that reserve funds are always
available to provide for the unexpected. Before the crea
tion of the Federal Reserve System, individual commercial
banks sometimes were the victims of national money
crises that subjected them to massive withdrawals of
money for which, individually, they were unable to com
pensate. The discount privilege assures the member bank
that it may always borrow for brief periods while it makes
other arrangements to offset the unexpected reserve loss
that made the borrowing necessary. Also, there are cir
cumstances in which a member bank may appropriately
borrow for longer periods. For example, a bank located
in a community that has been depressed for a long period
might be subject to a steady loss of deposits and other
adverse developments that would justify accommodation
by the Reserve Bank as it worked out its problem.
The circumstances leading to a borrowing request and
the relevant considerations surrounding that request are
infinitely varied. But of utmost importance in the deci
sion of the lending officer or discount committee at the
Federal Reserve Bank is the intent of the borrower, as
shown by his performance. So long as the member bank
is making every reasonable effort to operate its business
with its own resources, arrangements for temporary ac
commodation at the discount window can always be
worked out. It is only when the borrowing bank relies
upon the discount window of the Federal Reserve Bank
as a continuing source of funds for its own operation that
it is necessary for the Reserve Bank to discourage its use.
Finally, a common misconception with respect to
the procedures followed by the Federal Reserve Banks
in their lending operations should be corrected. The mis
conception is that lending standards become “tougher”,
that discount administration is tightened, when Federal
Reserve policy becomes restrictive. It is easy to under
stand why this misconception has arisen in some quarters,
since few banks find it necessary to borrow, and thus to
encounter the limitations imposed by Regulation A, when
money is easy. The fact is, however, that the standards
applied to borrowing requests from the Federal Reserve
Banks are consistent from year to year, when money is
easy and when it is tight.
Reprints of the foregoing article on “Borrowing
from the Fed” are available, and may be of par
ticular interest to member banks and educational
institutions. Requests should be directed to the
Publications Division, Federal Reserve Bank of New
York, New York 45, N. Y.
FEDERAL RESERVE BANK OF NEW YORK
143
Treasury Debt Management
Management of the public debt has attracted increas
ing attention in recent years as Treasury efforts to re
fund outstanding debt and borrow new money, in the
face of strong competing demands for funds at all maturi
ties, have been a frequent source of heavy pressure upon
the credit markets. Public debt management is a closely
circumscribed area of public policy, for it must operate
within the bounds of a Treasury surplus or deficit and
must take into account general business and capital
market conditions. Within these limits, however, debt
management decisions are of considerable importance,
since different approaches to managing the public debt
can have widely differing effects upon the nation’s
economy. This is true principally because of the size of
the debt—it accounts for about one third of total out
standing debt and is equivalent to about three fifths of
gross national product—and because of its key role in
the portfolios of so many private and institutional lenders.
Not all parts of the debt pose equal problems to
Treasury debt managers. Of the $285 billion in outstand
ing debt as of June 30, 1959, $55 billion was held in the
United States Government trust accounts (such as the OldAge and Survivors Insurance Fund) and $26 billion was
owned by the Federal Reserve System. Still another $51
billion was in the form of Savings bonds. Administration
of the Savings bond program, which is of considerable
importance in itself, can have a major effect on the
magnitude of other debt operations. The decisions
involved are of a special nature, however, and this body
of debt has been excluded from the discussion that follows.
It is upon the remaining $153 billion of publicly held debt,
of which all but $6 billion is in the form of marketable
securities, that the most difficult problems of Treasury
debt management center and through which the major
effects of debt operations reach the economy.
The magnitude of these problems, and the frequency
with which they arise, may be gauged from Chart I, which
shows the amount and maturity of each Treasury security
offering (exclusive of the regular bills rolled over in the
weekly bill auctions) since July 1, 1951, not long after the
Treasury-Federal Reserve accord. Treasury flotation of
marketable securities has averaged $52.0 billion a year
during this period— $13.5 billion a year in new cash bor
rowing and $38.5 billion a year in refundings. While some
new money borrowing is required nearly every year to
cover seasonal needs, the total of new borrowing has
varied from year to year with the size of the Treasury’s
cash deficit or surplus, with the attrition on refundings,
and with other debt operations. In fiscal 1959, for example,
when the budget deficit was $12.5 billion, new money
borrowing totaled $26.1 billion, almost twice as much as
the average for the period since 1951 and about three
times the $8.8 billion total of fiscal 1956. The volume of
Treasury exchange offerings has also varied considerably
from year to year, depending primarily upon the schedule
of maturing obligations. Thus, while the volume of mar
ketable securities issued in exchange for maturing issues
was $39.4 billion in fiscal 1959, it was as high as $57.3
billion in fiscal 1958 and as low as $29.0 billion in
fiscal 1956.
In order to avoid adding further to the short-term debt,
and thus to the refunding problem, the Treasury has
sought opportunities to sell debt of intermediate and
longer maturity. The sale of securities of longer term,
whenever economic and market conditions warrant such
action, is also necessary to avoid the inflationary potential
inherent in a steadily shortening maturity structure. How
ever, the Treasury has not found it possible to float many
large issues of longer maturity in the period since 1951
(see Chart I). With the passage of time moving the entire
body of the outstanding debt closer to maturity, therefore,
the maturity structure of the debt has shortened. The
portion of marketable debt maturing within five years rose
from 42.7 per cent in mid-1946 to 63.6 per cent in mid1951 and to 72.9 per cent on June 30, 1959, despite
efforts to avoid this debt shortening (see Chart II).
A related Treasury objective has been to minimize any
inflationary potential that might possibly arise from the
acquisition of its securities by certain classes of investors,
particularly commercial banks. In these efforts to influ
ence the ownership of the debt, some degree of success
has been achieved. As shown in Chart III, Govern
ment securities in the hands of commercial banks in
creased from $58 billion on June 30, 1951 to $61 billion
on June 30, 1959, but as a proportion of total publicly
held Treasury debt the amount held by commercial banks
was about 30 per cent at both the beginning and end of
this interval.
Numerous elements affect the Treasury’s efforts to con
trol the inflationary (or expansive) effects on economic
activity of its debt operations and to achieve an appro
priate maturity structure. The following sections develop
MONTHLY REVIEW, SEPTEMBER 1959
144
C h a rt 1
TREASURY OFFERINGS OF M ARKETABLE SECURITIES
J u ly 1951-August 1959
Sources: T re a su ry iss u e s:
T re a s u ry B u lle tin and recent T re a s u ry a n no unce m ents. In d u stria l p ro d u ctio n :
briefly the significance of these two broad objectives of
public economic policy and discuss the role of competitive
interest rates in achieving these objectives.
T R E A S U R Y FIN A N C IN G A N D
E C O N O M IC A C T IV IT Y
Because different methods of Treasury borrowing—and
repayment—can differ widely in their economic effects,
Treasury debt management may within limits either sup
plement or offset the economic effects of Government
fiscal policy. Thus, the expansive effects of a Government
deficit, or the constrictive effects of a Government surplus,
may—with a given Federal Reserve monetary policy—
have either much or little influence on economic activity,
depending upon the methods of debt management em
ployed. Since expansive effects may be desirable in certain
circumstances but inappropriate and inflationary in others,
the implications of various financing methods are of con
siderable importance in debt management deliberations.
Basically, Treasury borrowing is expansive or infla
tionary if the money borrowed to finance Treasury spend
ing is drawn from funds which otherwise would not be
B o ard of G o vern o rs of the Fed e ral R e se rve S ystem .
used—that is, if either the money supply or the velocity
of money is increased so that some other demand upon the
resources of the economy is not reduced and, as a result,
the total demand for goods and services is expanded. By
the same token, the policies followed in refunding existing
Treasury debt may have a net expansive or inflationary
effect, even during periods of balanced budgets or slight
surpluses. This will occur, for example, if the net effect
of these refunding policies is to shorten the maturity struc
ture. As the debt shortens, ownership tends to shift from
“savings-type” investors to investors who hold Govern
ments as a “money substitute”. Thus the Treasury, in
effect, borrows funds that would otherwise be idle and
releases longer term funds that flow into active use.1
In practice, therefore, Treasury financing may increase
or decrease the total demands upon the real resources of
the economy. Treasury borrowing may add to such de
mands, and at times to inflationary pressures, by relying
upon the creation of new bank credit, which would in
crease the supply of money. Alternatively, such an effect
1 The reverse of these conditions would, similarly, be deflationary.
FEDERAL RESERVE BANK OF NEW YORK
might be achieved through the activation of otherwise idle
cash balances, which would increase the velocity of money.
In immediate impact, increases in either the velocity or
supply of money tend to have expansive effects. Since,
however, an increase in velocity necessarily involves a
decline in liquidity, it is likely that debt management poli
cies which result in an increase in velocity are less expan
sive or inflationary than those which add to the money
supply. The likelihood of net expansive or inflationary
pressures from debt management operations is great when
a sizable deficit is to be financed and reliance is placed
principally upon funds borrowed from banks or raised by
the issue of short-term instruments which serve to activate
what would otherwise have been idle balances.
Treasury borrowing from these purchasers or in these
maturity ranges need not necessarily be expansive in
character. It would not be so, for example, if short-term
securities were purchased with bank reserves or deposits
that would otherwise be lent or expended for other active
uses. Similarly, sales of long-term securities by the Treas
ury might have an expansive or inflationary effect if they
were purchased, on balance, by banks employing reserves
supplied for the purpose by the Federal Reserve System or
with excess reserves or deposit balances that would other
wise be idle. Any resulting increase in the money supply or
velocity, of course, may or may not be consistent with the
objectives of monetary policy at any particular time, de
pending essentially on whether the chief current problem
is inflation or deflation.
In general, however, it may be assumed that reliance
Chart II
MATURITY STRUCTURE OF THE MARKETABLE DEBT
As of June 30
1946 1951
Source:
1952
1953 1954 1955 1956
U nited States Treasury.
1957 1958
1959
145
C hart III
OWNERSHIP OF THE PUBLIC DEBT
As of June 30
B illio n s of d ollars
B illio n s of d ollars
Note: In clud ing a ll United States Governm ent secu ritie s, direct
and fu lly g uaranteed .
* 1 9 5 9 d ata are as of M a y 31.
Source: United States T re a su ry.
upon new bank credit to absorb Treasury securities is the
most expansive (and potentially inflationary) method of
finance, and that reliance upon short-term issues, even
though they are purchased by nonbanks, is only marginally
less so in its effect upon the economy. Short-term securi
ties carry an inflationary potential even after their sale.
Unlike longer issues they can soon be turned in to the
Treasury for cash and thus provide a natural money sub
stitute for investors wishing to keep, in a near-cash form,
reserves or surplus funds that are not immediately needed.
To most investors in short-term Government securities,
these investments are considered virtually the equivalent
of cash, and the decision to purchase them does not take
the place of decisions to spend the money in other direc
tions. The purchase of longer term obligations, on the
other hand, usually represents a decision that these funds
will not be scheduled for other expenditure for an indefi
nite period ahead. Long-term securities may be “locked
in” the portfolios of their holders by any subsequent rise
in market interest rates because of the large capital losses
which their sale might entail. Shorter issues, because of
their early maturity, do not fluctuate so widely as longs in
capital value, and hence may generally be sold with rela
tively little capital loss if holders should require cash prior
to redemption.
M A T U R IT Y
Expansive or inflationary effects on total demands for
goods and services offer one guide line for the choice of
146
MONTHLY REVIEW, SEPTEMBER 1959
an appropriate maturity structure for the public debt, but
there are other important elements which must be taken
into account. One of these is the Treasury’s capacity to
repay and retire debt at maturity. If fiscal policy since
World War II had provided for gradual repayment of the
public debt out of an excess of current revenues, as it did
after previous wars, the most efficient policy would have
been to space out the maturity of the Treasury’s obliga
tions to fit its repayment capabilities. But recent Federal
budgets, at least since 1949, have not provided for regular
debt repayment, and the defense burden imposed by the
cold war probably will continue to make it difficult to
achieve a budgetary surplus.2
What then are the considerations—other than infla
tionary or expansive effects—which may guide the choice
of a maturity structure for Treasury issues? There are
several.
(1) Some Treasury borrowing is carried out to meet
strictly seasonal needs. These characteristically arise in
those months—usually during the first half of each fiscal
year—when the uneven flow of Treasury receipts cannot
cover the far more regular requirements of expenditures.
Since such borrowing—which has averaged about $6 bil
lion in recent years—can be repaid out of an excess of
Treasury receipts over current expenditures later in the
fiscal year, its maturity dates can be chosen to fit the
pattern of expected Treasury revenues.
(2) Because maturing Treasury issues other than those
covering seasonal needs will most likely not be repaid out
of current revenues, the Treasury must borrow new funds
from the market to replace the old issues when they come
due. The availability of intermediate and longer term
funds in the market at any one time is generally limited,
however, and too frequent maturities may mean, in effect,
that the Treasury has no alternative but to offer short-term
securities. This can best be avoided by an unbunched,
even spacing of maturities which takes into account the
market’s capacity to accumulate longer term funds.
(3) Frequent Treasury borrowing operations are also
undesirable for other reasons. For the credit and capital
markets, because the Treasury is such an important bor
rower, each Treasury financing operation occasions a
period of flux, uncertainty, and “churning”, as lenders
await first the terms of the new offering and then the
results of its reception. For the Federal Reserve System,
which gives recognition to Treasury financing problems,
frequent Treasury trips to market may mean some limita
2
Of course, to the extent that the Treasury enjoys a cash surplus—
even though it does not have a budget surplus— the net shift of debt
ownership from the public to the Treasury’s trust accounts does
represent a form of debt "retirement”.
tion upon independent policy decisions, and consequently
upon the effectiveness of monetary policy. For the Treas
ury itself, frequent operations may mean that the market
is kept off-balance and the difficulty of designing offerings
that will be well received is increased. For all of these
reasons, it is desirable to issue some part of the Treasury’s
borrowing in the form of intermediate and longer term
securities, which give rise to less rapid turnover of the
debt and fewer Treasury trips to the market. To the extent
that a substantial short-term debt is necessary to meet the
liquidity needs of the economy and must be refunded fre
quently, interference with the market and with both the
Treasury and Federal Reserve System may be held to a
minimum through a program for regularizing offerings of
short-term issues, thus reducing the market effects of
uncertainty as to what the Treasury will offer in exchange.
The Treasury has moved in this direction during the past
year with the institution of cycles of six-month and oneyear issues, in addition to the cycle of regular three-month
Treasury bills.
(4)
Treasury borrowing (or repayment) of funds in each
maturity range may be expected to have a significant im
pact upon the availability and cost of funds to other,
competing borrowers—such as mortgage borrowers, State
and local governments, and corporate borrowers in the
longer maturities, for example. While the supply of loan
able funds is not fully compartmentalized as to maturity,
and borrowers may also vary the maturity area in which
they borrow, the magnitudes of Treasury financings are
typically so large as to affect materially the supply of funds
of that maturity available to other borrowers. The Gov
ernment may wish, of course, for reasons of social or
economic policy, to encourage or discourage expanded
investment spending by such other borrowers.
It has been a shifting combination of all these elements
—as an examination of the magnitude, maturity, and
timing of each Treasury offering over the business cycle,
shown in Chart I, may indicate— that has determined
Treasury action over the past few years.
IN T E R E S T R A T E S
The most important, most obvious, and most often mis
understood fact of debt management is that, if the Treas
ury is to sell its securities in a market characterized by
the free decisions of lenders and borrowers, it must be
prepared to pay a competitive interest rate.
To be sure, it is theoretically within the Government’s
power to abridge the freedom of lenders’ and borrowers’
choice in order to sell its securities at less-than-competitive
interest costs. The Government, for example, might re
FEDERAL RESERVE BANK OF NEW YORK
quire that specified institutions—such as banks or pension
funds—hold additional prescribed reserves in the form of
Government securities. With this legislated addition to
the demand for its securities, it would appear that the
Treasury should be able to sell its obligations at lower
interest rates. Also, since this method would represent a
forced diversion of funds from other uses to the Treasury,
and would not require expansion of total credit, it would
seem that these lower rates could be achieved without
inflationary consequences. The immediately apparent diffi
culty with this schcme for reducing the Government’s
interest cost is that, unless the requirement tended to
freeze in all, or much the largest part of the publicly held
marketable debt, it would be largely ineffective. Prices are
set at the margin, and so long as there was a marginal
amount of Government debt that had to compete with
other demands for funds, the Government’s interest rate
would have to be competitive. The effective placement of
Government securities at artificially low interest rates
through administrative force would involve greater and
more extensive regimentation of the market than has been
seriously contemplated or, perhaps, than has been appre
ciated by those who propound such schemes.
Alternatively, the Government might attempt to lower
its interest costs through efforts to create a greater demand
for its securities by adding to the existing supply of money.
To channel funds into the purchase of new Treasury
issues, the Government might authorize or require the pur
chase of its securities with funds previously immobilized,
such as the required reserves of banks. Or, lower Treasury
interest costs might be achieved by setting for the Federal
Reserve System the task of purchasing Government securi
ties at fixed or variable support prices. For such support
to be effective, control over the money supply, and any
attempt to check inflation, would have to be sacrificed.
In effect, Treasury borrowing costs would have been re
duced by turning Treasury securities into interest-bearing
money. An expectation of continuing inflation would soon
be engendered, and other borrowers—e.g., individuals, cor
porations, and municipalities—would have to pay skyrock
eting interest rates to compensate investors for the antici
pated deterioration in the real value of their investment.
If the total supply of money is not to be expanded in
an inflationary manner, or if the freedom of lenders’
choice is not to be abridged by appropriating to the Treas
ury a larger share of loanable funds through administrative
force, there is no alternative but for the Treasury to sell its
securities by competing with other borrowers through
competitive interest rates. It may be possible for such
rates to be disguised, as through the offering of lower in
147
terest rate payments that are either partially or wholly
exempted from Federal income taxation, as was indeed
the case with Treasury securities before 1941. Such an
arrangement, of course, leaves part of the Government’s
actual interest payments to be paid by the Treasury in
sacrificed tax revenues.
Even without tax exemption or similar devices, the
Treasury can usually sell its securities in a free market
at costs that are somewhat lower than those which must
be paid by other borrowers. The qualities of credit risk
lessness and a broad secondary market that attach to
Treasury securities generally make them salable at interest
rates somewhat below those on competing issues of other
high-grade borrowers.
This differential has diminished considerably, however,
since World War II, perhaps chiefly as a result of actions
by the Government itself. Growing confidence in the
Government’s assumption of responsibility for high levels
of employment has, in the eyes of many investors, taken
much of the risk out of top-grade corporate obligations.
At the same time, various Government programs for the
insurance or guarantee of mortgages and other types of
debt instruments have brought these instruments to almost
the same level of safety, in investors’ eyes, as direct Treas
ury obligations. Long-term Government securities have
consequently come to enjoy a far smaller interest rate
differential relative to other high-grade securities. It should
also be noted that the rate of interest the Treasury
must pay and its relationship to other interest rates
reflect closely the demand and supply in the capital mar
ket, in which both current and expected Government bor
rowing needs play a very significant part. Thus, the
large supply of Government securities resulting from the
war and the frequent and large Treasury financing opera
tions in recent years have, themselves, tended to reduce
the competitive rate advantage of Government obligations.
In short, the Treasury has no realistic alternative but to
pay competitive market rates of interest in financing the
public debt. Efforts to avoid paying market rates must
involve inflation of the money supply or interference with
the freedom of investors’ decisions. And such devices as
tax exemption, in addition to having a perhaps unintended
income redistribution effect, do little but conceal the rate
of interest actually paid by the Treasury. Moreover, if the
Treasury is to prevent its management of the debt from
having inflationary consequences, it must resist the move
ment of the debt toward a shorter maturity structure by
regularly selling—at competitive rates of interest—inter
mediate and longer term obligations. These are the hard
facts of Treasury debt management.
@FedFRASER