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Federal Reserve Bank of NewYbrk Q u a r te r ly R e v ie w Winter 1976 1 13 21 24 31 33 Volume 1 The New York City Budget: Anatomy of a Fiscal Crisis Measuring Capacity Utilization in Manufacturing Jam es F. Ragan The business situation Current developments The changing composition of the labor force S haron P. S m ith The financial markets Current developments Interest rate behavior in the current economic recovery 40 Rona B. Stein John P. J u d d Treasury and Federal Reserve Foreign Exchange Operations A lan R. H olm es S c o tt E. Pardee The New York City Budget: Anatomy of a Fiscal Crisis by Rona B. Stein This article is designed to provide background infor mation on some of the key developments that underlie New York City’s recent budgetary difficulties. Its focus is threefold. In particular, the city budget is examined to identify those expenditure categories which are large and which have grown rapidly, especially in re cent years. Second, per capita spending by New York City is compared with that of other large municipalities in this country to gain perspective on the total package and costs of services provided by the city. Analysis of some of the major economic, demographic, and politi cal factors which have contributed to the budget im balance, and therefore to the city’s ongoing difficulties, constitutes the third principal area of focus. While much of the information presented in this article is available elsewhere, the objective here is to pull a wide variety of statistics into a coherent framework to facilitate informed discussion of the city’s difficulties. It should be emphasized at the outset that only some aspects of New York City’s complicated financial situation are analyzed here. The article does consider the budgetary impact both of demographic changes, which led to a relatively heavy concentration of the low-income aged in the city, and of nationwide reces sions and inflation. The fact that the city voluntarily assumed responsibility for supporting services that are not provided by most other municipal governments is also considered. On the other hand, while various municipal inefficiencies, including dubious accounting practices and poor budgetary control procedures, un doubtedly played a role in precipitating the crisis, this article does not delve into these topics. In the first section of the article, the expense budget is divided into its major components to identify areas of rapid growth and to suggest factors which may have contributed to this expansion. The second sec tion takes up the topic of “controllable” and “uncon trollable” spending, while the third examines city outlays relative to spending by other municipalities. Brief sections on the city’s revenue trends and on certain previously proposed remedies for some of the city’s fiscal ills follow, and concluding comments are contained in the final section. Composition of city spending To examine the expenditure patterns which existed at the onset of the fiscal crisis, it is necessary to analyze the budget prior to austerity measures taken either by the city administration alone or in conjunction with the Municipal Assistance Corporation (MAC) or the Emer gency Financial Control Board. For this reason the major expenditures outlined in Table 1 (and all other calculations unless otherwise indicated) are based on the authorized July 1975-June 1976 expense budget.1 The largest single area of expenditure, accounting for 22 percent of the total, is for the Department of 1 Th e authorized budget was used in this analysis because it contains detailed expenditure breakdowns for each departm ent or agency. However, since revenues and expenditures can never be forecast with perfect accuracy, budget figures change as the fiscal year progresses. In fiscal 1975-76, the authorized expense budget was alm ost $70 0 m illion less than actual outlays. A lthough such discrepan cies change the amounts of individual appropriations, they do not substantially affect the relative proportions of the various expense categories. FRBNY Quarterly Review/Winter 1976 1 T able I New York City’s Budgeted Expenditures Fiscal year 1975-76 M illions of dollars Percentage of total budget D epartm ent of Social Services . . . Board of Education ........................... Health Services A dm inistration . . . Police D e p a r tm e n t............................... Board of H igher Education ............ Environmental Protection ................. Payments to charitable institutions. Fire D e p a r tm e n t.................................... Hum an Resources P r o g r a m ............ D ebt s e r v ic e ........................................... O ther ......................................................... 2,937.5 2,468.0 1,165.3 943.7 597.9 495.1 586.3 410.5 164.9 1,885.6 1,577.7 22.2 18.7 8.8 7.1 4.5 3.7 4.4 3.1 1.2 14.2 11.9 Total e x p e n d itu re s ............................... Less: Capital budget and special funds used to finance operating e x p e n d itu re s ........................................... 13,232.5 100.0 Expense budget .................................... 12,087.5 Expenditure category 1,145.0 Note: Because of rounding, figures do not necessarily add to totals. S o u rc e : New York City Expense Budget, 1975-76. Social Services. Even this amount, however, does not cover the full extent of welfare costs. The separate allocation which is made for the Human Resources Program2 must be added to this sum, raising total wel fare expenditures in New York City to more than $3.1 billion, about three fourths of which are Federally or state funded. The second largest allotment is for total educational services, i.e., for the Board of Education as well as for the Board of Higher Education. More than $3 billion goes for education. The Health Services Administration, which includes the Health and Hospi tals Corporation, is the third major area of expendi ture, receiving 8.8 percent of budget funds. Together, welfare, education, and health services account for approximately 55 percent of New York’s budget. Over the long run, education and health services have each constituted a fairly constant share of the total budget, but the relative allotment for social ser vice expenditures has grown significantly. Expendi tures in this category are approximately fourteen times what they were in fiscal 1956, while the budget as a whole is about seven times larger. It is this area which has been responsible for the greatest part of the ex plosion in city spending. (The proportionate alloca 2 The Hum an Resources Program provides direction, budgeting, and coordination of city policy for com munity action, m anpow er and career developm ent, social and youth services, public assistance, and planning for and im plem entation of early childhood services. 2 FRASER FRBNY Quarterly Review/Winter 1976 Digitized for tions to social services, education, health services, pensions, and debt service are illustrated in the chart.) The actual allocations to the major budget areas in selected fiscal years are shown in Table 2. The extraordinary increases in social service and higher education expenditures stand in sharp contrast to the more moderate growth in other categories. The dra matic increase in the total welfare case load has been a major cause of the growth in social service expendi ture. The number of persons on public assistance rose from 339,000 in November 1961 to 998,000 in November 1975; in real terms, expenditures rose just as precip itously.3 In part, the exceedingly large social service alloca tions reflect demographic changes in the city’s popu lation. For example, services for the aged, a group which tends to have the lowest income, increase as the propor tion of the old in the population grows. By 1970, those aged 65 and over constituted 12 percent of all city resi dents, an increase of 4 percentage points since 1950. During this same twenty-year period, the nationwide increase was only 2 percentage points. Between 1970 and 1973, the proportion of the city’s older population continued to rise, reaching 13 percent. Moreover, in the three-year period ended in 1972, the real income of elderly households declined by 12.6 percent.4 As the number of young people has also been increasing, the proportion between 25 and 64 years of age, the bulk of the labor force, has fallen since 1960 and now constitutes less than half of the city’s population. Many of those presently receiving social service as sistance originally migrated to older industrial areas like New York because there was a traditionally high demand for unskilled labor in these urban manufactur ing centers.5 Lately however, the number of jobs in these areas has declined considerably. Indeed, 1975 3 The number of persons on public assistance declined sharply in N ovem ber 1974 because of the transfer of a significant number to the Federally funded Supplem entary Security Income Program (S S I). Under the SSI program, the Social Security Adm inistration assumed all adm inistrative and financial respon sibility for the Aid to the Disabled, Aid to the Aged, and Aid to the Blind programs. Although the basic SSI payments are uniform throughout the country, some states a n d /o r localities may supplem ent the minimum payment and make em ergency grants for loans to recipients, owing to differences in living costs. During 1975, New York City contributed about $58 million in SSI payments. 4 These are the latest available data. See New York City Office for the Aging [2 6 ]. 5 It has been suggested that the problems in urban areas actually associated with migration have been exaggerated. “ M igration to the cities and out of the South is not significant enough nor are m igrants’ income experiences different enough from their urban and Northern counterparts to warrant the considerable alarm the migration issue stimulates. The most im portant policy im plication of this is that programs to stem migration are not likely to have much im pact on city problem s.” See W ertheim er [42, page 61 ]. manufacturing employment in New York City was only 55 percent of its 1960 level. Yet, immigration to the older metropolitan centers did not completely halt. In fact, there is some evidence that New York City and other older industrial regions may have unintentionally encouraged the poor to move in by offering relatively generous levels of w elfare benefits. This can be seen in Table 3. In the eight largest industrial states, the average benefit distributed under the Aid to Families with Dependent Children (AFDC) program amounts to $270 per month. By comparison, in the eight states with the lowest benefits, the average monthly AFDC payment amounts to only $99. The problem is severe in New York, which pays the highest benefits and has the sec ond largest number of recipients, both in absolute and percentage terms. Given these differentials, there is an incentive for the poor to relocate to the older industrial regions, and the evidence in Table 4 suggests that such relo cation has taken place. As can be seen, the incidence of welfare-receiving mothers who were born out of state is considerably higher in the older industrial states than it is in the states that pay the lowest wel fare benefits.6 Moreover, in these industrial states, the proportion of the total population born out of state is less than half that of the welfare mothers, whereas in the other states, the figures are about equal. Yet it should be noted that, as available in New York, neither AFDC payments alone nor a more inclusive package of benefits— net cash, food, and public hous ing— appears to be out of line with those in some other large cities. A comparison of benefits available to two standard-size families in each of twelve cities is shown in Table 5. The major differences which arise are for the most part between the newer and older cities rather than between New York and the other cities. Nevertheless, the generous level of welfare payments must be included with such factors as the availability of low-cost rental housing and of cheap public transporta4 N either the birthplace nor the previous w elfare status of these welfare-receving mothers is known. Therefore, there is a possibility that these mothers, already dependent on w elfare in a high benefit state, m erely relocated to another area of sim ilarly generous benefits and did not m igrate from a low benefit area, as is suggested here. New York City: Major Budget Appropriations In selected fiscal years Millions of dollars 3 ,5 0 0 Social services 3 ,0 0 0 — $3,102 Millions of dollars 3 ,5 0 0 Education 2 ,5 0 0 - 2 ,0 0 0 - 2 ,0 0 0 - 1,500 - 1,500 - 1,000 — 1,000 $201 11% o 1 9 5 5 -5 6 $494 0 1975-76 $353 $330 19% | 195 5 -5 6 1 9 6 5 -6 6 1 1 9 6 5 -6 6 1975-76 1 9 5 5 -5 6 1 95 5 -5 6 I_1 1 9 6 5 -6 6 1975-76 1 9 6 5 -6 6 1975-76 Millions of dollars Millions of dollars Millions of dollars 1 9 5 5 -5 6 $1,165 _ 500 - |§ J 3 % J 196 5 -6 6 Millions of dollars 1,400 Health services 3 ,0 0 0 — 2 ,5 0 0 - c nn DUU $ 3 ,0 6 6 1 9 6 5 -6 6 197 5 -6 6 1 9 5 5 -5 6 Note: Base includes capital budget and special funds used to finance operating expenditures: 195 5 -5 6=$ 1 ,7 8 2 million, 1 9 6 5 -6 6 = $ 3 ,9 9 8 million, and 1 97 5-76=$13,233 million. Sources: C itizens Budget Commission, Pocket Summary of N ew York City Finances, s elected fiscal years, and New York City Expense Budget, 1975-76. FRBNY Quarterly Review/Winter 1976 3 eral report has stated that “ under Federal law the state determines eligibility requirements and benefit levels; therefore, the city already has virtually no control over its welfare budget although it must pay one fourth of the cost”.8 The state legislature, however, has a mea sure of control over local welfare expenditures, insofar as that body determines both the degree of local par ticipation in the funding of these expenses and the amount of benefit payments above the Federally man dated minimum. Since New York City and other locali ties must by law comply with the statutes established by the state legislature, welfare is probably “ uncontrol lable” in the short run. In the longer run, the city can try to bring about changes in the state law. In addition, the city does have discretionary control over the ad ministrative and personnel costs associated with the welfare program. While budgeted funds for the Depart ment of Social Services and the Human Resources Program exceed $3.1 billion, salary expenses con- 8 See C o n g re s s io n a l B u d g e t O ffice [9 , p ag e 2 7 ], nected with the welfare program total $287 million, or less than 10 percent. Of course, to the extent that personnel savings are achievable, this would represent a net gain to the city, assuming that efficiency is not adversely affected. It is important to note that, under state law, New York City is obligated to assume an inordinately large share of welfare costs relative to cities in other states. For example, localities in New York State must pay 25 per cent of total welfare costs, while those in California pay only 16 percent. Moreover, of the states that do not take full responsibility for the non-Federal share, New York State shifts the heaviest burden on to its localities.9 The states, in turn, receive varying contributions toward their welfare costs depending on the Federal Govern ment’s assessment of each state’s ability to pay. Thus, while Mississippi receives support for more than 70 percent of its welfare and Medicaid programs, New York State receives the minimum subsidy, i.e., 9 In N ew Y o rk S tate th e re is a ls o a n o n -F e d e ra lly b acke d h o m e -re lie f p ro g ra m s h a re d jo in tly by th e sta te a nd th e lo c a litie s . T a b le 3 Aid to Families with Dependent Children (AFDC) By state, J u ly 1975 G o v e rn m e n ta l u n it N um ber of re c ip ie n ts * P e rcen tag e o f to ta l A v e ra g e fa m ily m o n th ly p a y m e n t P e rc e n ta g e o f to ta l p o p u la tio n f T o ta l U n ite d S t a t e s ............................................................ 11,147,071 100 217.01 100 T o ta l, e ig h t la rg e s t in d u s tria l s t a t e s .......................... 54 270.26 45 C a lifo rn ia ............................................................................... I l l i n o i s ^ .................................................................................... M a s s a c h u s e tts ^ ................................................................... .......... M i c h i g a n ................................................................................. N ew J e r s e y ............................................................................. .......... N ew Y o rk ............................................................................... O h io ........................................................................................ P e n nsylva nia ......................; ............................................... 12 7 3 6 4 11 5 6 239.75 286.70 317.32 268.95 274.13 336.67 174.33 264.23 10 5 3 4 3 9 5 6 Total, e ig h t states w ith low e st b e n e f it s ...................... A la b a m a 354,313 443,201 1,929,802 16 98.62 18 234,169 185,919 135,408 2 03,626 393,951 1 2 3 2 '2 1 2 3 97.33 117.59 101.63 119.88 49.79 89.23 106.36 107.13 2 3 2 2 1 1 2 5 ................................................................................. G e o rg ia ................................................................................... L o u is ia n a . . . ....... ................................................................ .......... M is s is s ip p i .................................................. ................... .......... S outh C a r o lin a ..................................................................... .......... .......... * In c lu d e s th e c h ild re n a nd o n e o r b oth p a re n ts o r o ne c a re ta k e r re la tiv e o th e r th a n a p a re n t in w h ic h th e re q u ire m e n ts o f s u c h a d u lts w e re c o n s id e re d in d e te rm in in g th e a m o u n t o f a s s is ta n c e , f B ased o n 1970 C en su s a nd 1972 C en su s B u rea u e stim a te s, to ta l U n ite d S ta te s p o p u la tio n is e q u a l to 208,840,000. f E x c lu d e s d a ta on A F D C c h ild ca re. S o u rc e : S o c ia l S e c u rity B u lle tin (J u ly 1975) and B u rea u o f th e C e n s u s (1970), F o u rth C o u n t S u m m a ry Ta p e s, as re p o rte d in S e n a to r D o n a ld H a lp e rin , F e d e ra liz a tio n o f W elfa re (N o v e m b e r 1975). FRBNY Quarterly Review/Winter 1976 5 Table 2 Major Expenditures in the New York City Budget S elected fiscal years; in millions of dollars and percentage of total expenditures Category Departm ent of Social S e r v ic e s ........................ Board of E d u c a tio n ................. Health Services A d m in is tra tio n ........................... Police D epartm ent ................. Board of H igher Education .................................. Environmental Protection .................................. Fire D e p a r tm e n t...................... Pensions .................................... D ebt service ............................. O ther ........................................... 1 955-56 1960-61 1965-66 1970-71 1974-75 Expenditure Percent Expenditure Percent Expenditure Percent Expenditure Percent Expenditure Percent 201 303 11.3 17.0 246 440 10.5 18.8 494 768 12.4 19.2 1,712 1,535 21.0 18.9 2,438 2,127 19.4 16.9 121 122 6.8 6.8 151 168 6.4 7.2 353 272 8.8 6.8 723 477 8.9 5.9 1,096 739 8.7 5.9 27 1.5 45 1.9 84 2.1 298 3.7 533 4.2 * * 65 152 288 503 3.6 8.5 16.2 28.2 109 85 215 402 484 4.6 3.6 9.2 17.1 20.6 161 133 374 589 770 4.0 3.3 9.4 14.7 19.3 271 215 619 832 1,453 3.3 2.6 7.6 10.2 17.9 384 309 1,147 1,798 2,019 3.1 2.5 9.1 14.3 16.0 Total e x p e n d itu re s ................. Less: C apital budget and special funds used to finance operating e x p e n d itu re s ___ 1,782 100.0 2,345 100.0 3,998 100.0 8,135 100.0 12,590 100.0 46 — 123 426 1,486 Expense budget ...................... 1,736 2,345 3,875 7,709 11,104 * Not available. S o u rc e : Citizens Budget Com m ission, P o cke t S u m m a ry o f N ew York C ity F in a n ce s, selected fiscal years. tion in making New York a relatively attractive city for those with little income. From this perspective, the in flux and permanent settlement by the poor can be viewed as a rational response to economic incentives. Controllable vs. uncontrollable expenditures It is frequently noted that many of the city’s expendi tures are either mandated by state law or are under taken by so-called independent agencies, such as the Health and Hospitals Corporation. Such expenses are termed “uncontrollable” , at least in the short run. On the other hand, since the legislation which established the independent agencies and other programs can be changed over time, the distinction between “control lable” and “uncontrollable” tends to blur in the longer run. In Table 6, the city’s expenses for fiscal 1976 have been divided into those that the city closely controls and those that, at least in the short run, it does not. With regard first to the independent agencies— i.e., the Board of Education, the Board of Higher Education, and the Health and Hospitals Corporation— it should be noted that they were set up under state legislation at the city’s behest to circumvent local budgetary con trols which had supposedly hampered flexibility and innovative management. As initially conceived, each agency was governed by an independent board. The 4 FRASER FRBNY Quarterly Review/Winter 1976 Digitized for city made lump-sum allotments to each agency but had little control over how the funds were spent. The Mayor could reduce allocations to these agencies within limits prescribed by state law, but the actual distribution of funding cutbacks was up to the discre tion of the individual agency’s board. Besides legal restrictions, the M ayor’s control over agency finances was also circumscribed by the fact that, to receive state or Federal aid for the agencies, the city fre quently had to come up with minimum or matching amounts. Since the onset of the New York City financial crisis, the autonomy and independent authority of these agen cies has been altered somewhat by the Emergency Financial Control Board. Hence, their expenses are now more controllable than they w ere in the past, and presumably new state legislation could be sought if it were considered necessary to change the agency budgets. In fact, the persistent deficit in the budget of the Health and Hospitals Corporation recently prompted the Mayor to set up a new finance com mittee to see that the deficit is elim inated.7 W elfare expenditures are the largest item among the mandated “ uncontrollables” in Table 6. A recent Fed? See Sullivan [3 2, page 4 7 ], Table 4 Table 5 Aid to Families with Dependent Children (AFDC) Annual Public Welfare Benefits By place of birth of mother; in percent July 1972; in dollars G overnm ental unit Percentage born in sam e state Percentage born in another state or county A FDC mothers Total population United States t o t a l .......... 52.2 47.8 30.8 City New York City* .............. Total, industrial states . 25.0 45.1 66.2 54.9 13.4 25.0 C alifornia .......................... Illinois .................................. M assachusetts ................. M ic h ig a n ............................. New J e r s e y ........................ N ew York State .............. Ohio .................................... Pennsylvania ................... 32.5 36.7 63.3 48.8 35.2 34.1 47.5 62.8 67.5 63.3 36.7 51.2 64.8 65.9 52.5 37.2 47.4 23.5 17.8 23.6 32.7 17.8 24.3 12.7 Total, states with lowest b e n e f its ................. Baltim ore ................. . . . . . . Los Angeles .......... . New York C i t y ___ . P hiladelph ia .......... . San Francisco . . . . St. Louis ................. . W ashington, D.C. . . 75.6 24.3 23.5 A labam a ............................. Florida ............................... G e o r g i a ............................... Louisiana .......................... M ississippi ........................ South C arolina ............... Tennessee ........................ Texas .................................. 84.5 46.6 84.0 82.4 89.6 t 70.9 71.8 15.5 53.4 16.0 17.6 10.4 15.5 56.7 21.3 16.7 14.9 19.0 21.1 22.4 t 29.1 28.2 * Th e birthplace of approxim ately 8.8 percent of A FD C mothers in New York City is unknown. t Not available. S o u rc e s : D epartm ent of H ealth, Education, and W elfare, S o c ia l S e c u ritie s S ta tiis tic s (1971) and Division of Policy Research, D e partm ent of Hum an Resources (January 1975), as reported in Senator Donald Halperin, F e d e ra liz a tio n of W elfa re (N ovem ber 1975), and 1970 C en su s o f th e P o p u la tio n , T able 45, individual state volumes. 50 percent.10 The differences in funding among the eleven states which require local participation in the AFDC program are shown in Table 7. As a percentage of AFDC benefits, New York State receives 4 percent less Federal aid than the average of the other ten states and contributes 6 percent less to the welfare expenses of its localities. Hence, from New York City’s viewpoint, it must pay 10 percent more than do cities in these other states. Indeed, this inequality looms even larger when it is remembered that thirty-nine 10 Although New York State receives a com paratively low proportion of Federal assistance, it is among the most generous of the states in its overall level of w elfare payments. These differences in payment levels arise because most program s receive Federal funding and operate under Federal guidelines, but the states them selves retain responsibility for their actual im plem entation and adm inistration. Accordingly, the states retain a fair am ount of flexibility in apportioning local responsibility, setting paym ent levels, etc. See Joint Economic C om m ittee [2 0 ] and United States D epartm ent of H ealth, Education, and W elfare [4 0 ]. 6 FRASER FRBNY Quarterly Review/Winter 1976 Digitized for M other and three children Husband, wife, and two children AFDC* Maxim um benefit p a c k a g e *! AFDC* M axim um benefit p a c k a g e *f 2,400 4,121 3,251 2,820 3,792 1,776 3,360 3,996 3,612 3,360 1,560 2,862 4,248 6,136 5,021 4,789 5,001 4,0 7 0 5,304 5,292 5,127 5,646 3,945 5,164 2,400 4,075 3,179 2,904 3,792 0 3,360 3,996 3,612 3,360 0 2,759 4,095 5,972 5,081 4,738 5,074 2,737 5,133 5,121 4,965 5,493 1,389 5,056 * Represents m aximum benefits a vailable to fam ilies in which there is no incom e from either work or unem ploym ent insurance. t N et cash, food, and public housing. S o u rc e : Joint Economic Com m ittee, S tu d ie s in P u b lic W e lfa re: W elfare in th e 7 0 's : A N a tio n a l S tu d y o f B e n e fits A v a ila b le in 100 L o c a l A re as (July 2 2 ,1 9 7 4 ). states require no local contributions. Debt service and pension benefits account for the rest of the city’s mandated expenditures. The city is legally bound to meet its debt obligations, under the New York State constitution." Similarly, the city is under a legal obligation to maintain pension benefits and con tributions.12 The existing pension structure, at least insofar as it applies to current retirees and to those presently on the payrolls, is practically impregnable. Indeed, the state constitution forbids the reduction of public employee pension benefits once they have been extended. The one aspect of the city’s pension sys tem apparently subject to change is the “ increased take home pay” program (ITHP). Under this program, the city had been paying almost all of each em ployee’s pension contribution, thus making the system virtually noncontributory. Unlike other pension provisions, how11 In N ovem ber 1975, the state legislature enacted a three-year moratorium on the payment of city notes, with provision for an optional "s w a p ” of long-term bonds (which were issued by M A C). However, the New York State Court of Appeals, the highest court in the state, recently held the moratorium unconstitutional under the New York State constitution. 12 The classification of pension costs as either m andated or controllable depends upon the tim e horizon considered. Because fu tu re pension costs are negotiable, a report prepared by Arthur Anderson and Co. includes them with other controllable expenses. However, the report notes that "past pension service costs may not be reducible, and since the current city contribution to the pension funds is based on prior actual payroll lagged two years, there is no real opportunity for near-term reduction” . See Arthur Anderson and Co. [1 , page 31 ]. ever, ITHP was approved by the state legislature in the early 1960’s only on a temporary basis. Hence, it could be revised without changing or violating the constitution. Effective January 1, 1976, the legisla ture decreased the city’s annual obligation under this program by 50 percent. This share is now being picked up by the employees who were, however, granted a three-month grace period before beginning contribu tions. The Chief Actuary of New York City places cur rent annual ITHP costs at about half of the $170 million being spent prior to the change in legislation. However, this $85 million saving will not affect the city’s cash position until 1978. This is because pensions have historically been funded with a two-year lag, and so the city is presently paying for its 1974 obligations. In sum, while a good portion of the city’s expense budget may not be immediately controllable by city officials, in the long run the major “uncontrollables” seem to be debt service, pension benefits already granted to past and present employees, and welfare payments mandated by the state. It is, however, within the power of the state, though not the city, to reduce the welfare burden. Pensions, too, can be revised over time, even if it takes an amendment to the state constitution. Perspective on city spending To a large extent, the problems of New York City can be traced to the fact that, as an administrative and budget ary entity, it has taken on the responsibility of support ing a wider range of services than most other municipal governments. Although some of these “extra” responsi bilities are determined by the nature of the state-city relationship, others have been voluntarily assumed by the city. This drain on the city’s resources has been especially pronounced in the fields of education, wel fare, and medical care. As already indicated, New York City is required to shoulder a larger share of welfare costs than most other municipal governments. At the same time, it has had to provide direct funding for education. In most other cities, the educational system is supported by an independent school district which is endowed with separate taxing powers and which receives direct state support. These school districts are not necessarily coterminous with city boundaries and so may encompass a broader tax base than the city alone. For many years, New York City voluntarily pro vided its residents with tuition-free university educa tion, a program that the city had to abandon in its economy drive. Similarly, the city voluntarily established its extensive hospital system. In comparing the prevailing expenditure pattern in New York with those of other cities, it is necessary to examine both the range of services which are offered and the level of government which is responsible for the funding. In Table 8, the levels of expenditures and public employment in twelve major cities are compared for a common set of services for each of the munici palities listed in the table. In terms of total municipal services, New York had the highest per capita expen ditures in 1973 and the largest number of city em ployees in 1974. However, when the comparison is limited to those common services provided by all the cities, New York’s payroll and outlays are not out of line with those of other cities. In fact, on this basis, several other cities spend higher amounts and employ more workers per capita than does New York. Hence, the unusually broad range of services directly pro- Table 6 Composition of New York City Expense Budget Fiscal year 1975-76; in billions of dollars and percentage of contribution Budget expenses Federal Amount Percent State Am ount Percent City Am ount Percent Total expense M andated expenses: Debt s e r v ic e ............................................................................ W elfare (excluding salary and a d m in is tra tio n ).......... ___ P e n s io n s .................................................................................... . . . . Independent agency control: Board of E d u c a tio n .............................................................. Board of Higher E d u c a tio n ................................................ ____ Health and Hospitals C o rp o ra tio n ................................. 1.4 — 50 — 0.7 — 25 — 1.5 0.7 0.5 100 25 100 1.5 2.8 0.5 0.5 -— 0.3 19 — 33 1.6 0.2 0.1 62 40 11 0.5 0.3 0.5 19 60 56 2.6 0.5 0.9 Total not directly controllable ......................................... C ontrollable e x p e n s e s ......................................................... 2.2 0.2 — 6 2.6 — — — 4.0 3.1 — 94 8.8 3.3 Total expense b u d g e t ......................................................... 12.1 S o u rce : New York City Expense Budget, 1975-76. FRBNY Quarterly Review/Winter 1976 7 T able 8 T able 7 Per Capita Municipal Expenditures (Fiscal 1973) and Employment (1974) Government Funding of Costs of Aid to Families with Dependent Children In percentage of contribution Per capita expenditures Federal State Local ............ 50 34 16 .................................... ............ ...................................... ............ ............ 50 40 10 53 28 19 52 24 24 M o n t a n a ...................................... 59 27 14 N ew J e r s e y ............................... 50 38 13 North C a r o lin a .......................... .............. 64 18 18 North Dakota .......................... Ohio ............................................. 53 35 12 45 5 Wyoming .................................................. 57 22 22 A verage ten s t a t e s ............................... 54 31 15 New York State ................... .............. 50 25 25 N ew York d iffe r e n c e ............ ............... 4 6 10 States S tandard All present city city functions functions* City C olorado Indiana Note: Because of rounding, figures do not necessarily add to totals. S o u rc e s: Social and R ehabilitation Service, "State Assistance Expenditures” , F e d e ra l R e g is te r (Septem ber 13, 1974), p. 33020; Social and R ehabilitation Service, C h a ra c te ris tic s o t S tate P lan s fo r A id to F a m ilie s w ith D e p e n d e n t C h ild re n u n d e r the S o c ia l S e c u rity A c t Title IV -A (1974). vided by New York accounts, at least in part, for what is viewed in some quarters as an excessively large budget. To examine further the issue of whether New York directly provides more financial support for services than other localities, it would be helpful to have esti mates of the per capita cost of total services provided by the major municipalities— estimates, that is, of the total costs incurred at the local level regardless of the local government or local governmental agency pro viding the services. The available evidence suggests that per capita expenses in New York are above those of most other major cities, particularly in the areas of welfare, education, and health. Confidence in these comparisons is limited, however, by the fact that the data are not very good. It does appear, nevertheless, that New York City’s provision of “extra” services not paid for by many other municipal governments or, in some cases, not provided by any local governmental unit, has been a major cause of the recent series of expense-budget deficits. But, considering that the city has been supporting these services for many years, their costliness in recent years has been aggravated by changes in the demographic and economic makeup 8 FRASER FRBNY Quarterly Review/Winter 1976 Digitized for New York ___ C hicago ___ _ Los Angeles .. P hiladelph ia .. San Francisco New Orleans ., St. L o u i s ____ Baltim ore 1,224 858 267 692 242 415 751 241 310 473 806 357 435 441 383 449 408 395 488 260 360 375 470 396 City em ployees per 10,000 population All present city functions Standard city functions* 517.1 378.0 140.0 391.1 162.2 163.8 312.5 177.3 241.9 237.0 434.1 194.8 263.7 249.2 250.1 304.6 256.0 301.5 244.4 271.3 227.8 280.9 312.5 258.6 * Elem entary and secondary education, highways, police, fire, sanitation, parks, general and financial adm inistration. S o u rc e s : United States Bureau of the Census, C ity G o v e rn m e n t F in a n c e s in 1972-73 (1974), United States Bureau of the Census, L o c a l G o v e rn m e n t F in a n c e s in S e le c te d M e tro p o lita n A re a s a n d L a rg e C o u n tie s 1974 (1975), United States Bureau of the Census, L o c a l G o v e rn m e n t E m p lo y m e n t in S e le c te d M e tro p o lita n A re as a n d L a rg e C o u n tie s 1974 (1975), and unpublished United States C ensus Bureau data, as reported in Congressional B udget Office, N ew Y o rk's F is c a l P ro b le m s : Its O rig in s , P o te n tia l R e p e rc u s s io n s a n d S om e A lte rn a tiv e P o lic y R esp o n ses (W ashington, D.C.: O cto ber 10, 1975), page 16. of the city. Fueling the controversy over the appropriateness of supplying particular services are charges that excessive manpower costs have been incurred in their provision. Unfortunately, it is nearly impossible to examine ade quately the frequent contention that to ta l compensation of New York City employees, including fringe benefits and pensions, is excessive relative to that of other municipalities and to private industry. Data limitations preclude comparison of total compensation packages in which much confidence can be placed. It does ap pear, however, that at least some New York City office and clerical workers receive higher wages than their counterparts in private industry, as shown in Table 9. It would also seem likely that, if anything, differences in fringe benefits have exacerbated this gap. Revenues The responsibility for the provision of a comparatively wider range of services has forced New York City to strain its revenue-generating sources to a greater ex tent than have other central cities. New York City’s tax base has lately been shrinking. Property taxes are the city’s main local source of revenue. They provided about one half of 1975-76 locally raised revenues. Yet total tax arrearage for all properties (commercial, industrial, and residential) has been rising and presently amounts to more than $500 million.13 Hence, it is not surprising that the proportion of locally raised revenues derived from real estate tax receipts has been steadily declin ing. It can be seen in Table 10 that these receipts have dropped from 61 percent of local revenues in fiscal 1966 to 50 percent in fiscal 1976. The persistent declines in private sector employ ment in the city have also had an adverse effect on locally raised revenues. The decline in nonagricultural payroll employment amounted to about 500,000 jobs between June 1969 and July 1975. Each job lost dimin ishes total tax receipts, particularly from personal in come taxes and sales taxes. It has been estimated that each city-based job generated $820 in tax revenues for the city in 1970.14 Inflation has also had a deleterious effect on the city’s revenues. In the short run, expenditures respond quickly to the upward movement of prices, as do sales and in come tax receipts to some extent. Property reassess ments, however, cannot keep pace with price surges, in part because of the occurrence of unanticipated rates of inflation during the relatively long time periods be tween the setting of assessments and actual collection of taxes. This is not to say that New York alone among municipalities has suffered from the distorting effects of inflation. Although inflationary conditions lower the real burden of outstanding municipal debt, they also necessitate additional borrowing since, as noted, there is evidence that city expenditures in general have been more responsive to inflation than have its revenues. Proposed remedies The city’s ongoing financial problems have brought forth a number of suggestions for easing the budgetary squeeze. Some of these are economizing measures which aim at increased reliance on private enterprise to perform functions which have heretofore been pro vided by the city. Such measures, of course, involve reductions in personnel on the city payroll. In addition, a second set of proposals calls for transferring pro vision of certain services from the city to either the state or the Federal Government. On the revenue side, there are occasionally suggestions for higher taxes, but the tax burden on local residents is already so high u Th ere is evidence that the rent-control system has exacerbated the housing problem in New York City. Landlords, receiving lower returns in the face of rising costs, have neglected or, in the extrem e, entirely abandoned their housing units. This, in turn, has dim inished the city’s tax base and, thus, its revenue inflow. A ccording to one study, the elim ination of rent control could raise city revenues by as much as 6 percent. S ee Lowry, De Salvo, and Woodfill [2 2 ]. M See Bahl, Jum p, and Puryear [3 , page 8 ] . that the consensus is that any further tax increase is likely to be self-defeating. Of course, reform of the city’s accounting procedures— which is in progress— is an essential part of any plan for resolving the city’s problems. Among the suggestions for a greater role for private enterprise is the hiring of private haulage firms to re place, at least in part, the Municipal Sanitation Depart ment. It has been estimated that costs to the municipal department are 68 percent higher than to the average private contract firm to provide twice-a-week curbside collection service. The many contributing factors to this differential include higher employee absentee rates, larger crews, fewer households serviced per shift, more time per household, and smaller trucks, all characteristic of municipal service.15 Limited experi mentation along these lines is beginning within the Sanitation Department in the handling of garbage collection by a worker cooperative under an indepen dent contract with the city. The motivation for improving techniques is to be provided by the possibility of larger paychecks. As a more extreme suggestion, it has even been proposed that the responsibility for education be transferred to the private sector under a government subsidized voucher plan.16 The education benefits ex tended to eligible United States war veterans provide a successful precedent of this type of program. Those who were qualified were given a uniform sum to be spent in any institution which met minimum Govern ment standards. Many variations of these ideas are possible, all of which could have exceedingly complicated political and social, as well as economic, ramifications. Hence, it is not surprising that many of the more drastic inno vations have not been attempted. However, the city has achieved some budget economies through personnel cutbacks and other austerity measures. Besides cutbacks in expenditures, other proposals call for transferring various elements of the burden to some other level of government. Most recommenda tions of this type concentrate on the welfare system.17 The most common of these include (1) increasing the state and Federal proportions of the payments and consequently reducing the city’s share of the costs; (2) federalizing the welfare system altogether; (3) in stalling a Federally based negative income tax system which would replace welfare payments in their present form; and (4) increasing noncash benefits, such as food stamps, while reducing cash payments. 15 S ee Savas [2 9 , page V I] 14 S e e Friedm an [1 4 , pages 8 9 -9 0 ]. 17 In this regard, bear in mind that, since the city’s contribution to w elfare is 25 percent, savings here would am ount at most to about $700 m illion, excluding salary and adm inistration expenses. FRBNY Quarterly Review/Winter 1976 9 T able 9 New York City— Average Weekly Earnings of Men and Women Combined In dollars; April 197 3 -7 4-7 5 Em ploym ent classification April 1973: S enior stenographers .......... Typists— C lass B ................. Keypunch operators— Class B ....................................... C om puter systems analysts— April 1974: Senior stenographers .......... Typists— C lass B ................... Keypunch operators— Private industry M unicipal workers D ifference 1 49.00 114.00 165.00 131.25 + 16.00 + 17.25 126.50 145.75 + 19.25 335.50 343.50 + 160.50 119.50 175.75 134.00 + 15.25 + 14.50 138.00 147.75 + 360.50 347.25 -1 3 .2 5 172.00 133.50 191.75 148.00 + 19.75 + 14.50 147.00 163.25 + 1 6 .2 5 385.00 356.75 -2 8 .2 5 8.00 9.75 C om puter systems analysts— April 1975: S enior stenographers .......... Typists— C lass B ................... Keypunch operators— C lass B ....................................... C om puter systems analysts— C lass A ....................................... S o u rc e s : Bureau of Labor Statistics, A re a VJage S urvey, N ew York, N ew Y ork M e tro p o lita n A rea (annual). Bureau of Labor Statistics, W ages a n d B e n e fits o f N ew York C ity M u n ic ip a l G o v e rn m e n t W o rke rs (S eptem b er 1975). State and Federal takeover of services other than w elfare has also been suggested. The proposals include a Federal program to equalize energy costs; increased aid to education, mass transit, and hospitals; regionali zation of such services as transportation or environ mental protection; Federal assumption of the security costs incurred because of the United Nations and for eign consulates; and the conversion of city highways into interstate arteries which would, in effect, make them Federal responsibilities. In addition to the numerous methods for both stream lining and transferring expenditures, there are pro posals which attack the problem from the revenue side. Yet, due to the high level of taxes already paid by city businesses and residents, a n y further taxes may have detrimental rather than recuperative effects on the city’s faltering economy.18 For the past nine years, New ’» A pproxim ately $200 million by the A lbany legislature in corporate bond transfer tax has already been repealed. brokerage houses from the 10 in New York City taxes was approved N ovem ber 1975. However, the controversial passed by the legislature in August 1975 It is blam ed for the exodus of several city. See W a ll S tre e t J o u rn a l [41 ]. FRBNY Quarterly Review/Winter 1976 York State has led the nation in per capita state and local tax payments, exceeding the national average in fiscal 1973-74 by 54 percent and that of both New Jersey and Connecticut by almost 40 percent.19 This sizable tax differential is prominent among the reasons cited by m ajor firms for abandoning New York for locations in neighboring states in which it is felt that the tax burden on the corporation itself a n d /o r its employees would be smaller.20 When the tax burdens of individual cities are ex amined, it similarly appears that New York City is well up on the list. The government of the District of Colum bia compared the tax burden of a family of four at dif ferent income levels in the nation’s thirty largest cities. The “ burdens” include state and local income taxes, state and local sales taxes, automobile taxes, and resi dential property taxes adjusted for intercity differences in property values. A summary of these findings is shown in Table 11. At each income level, the combined state-local tax burden of New York City residents is either second or third highest. Summary Overall, the evidence marshaled here indicates that a broad array of factors, some of a fundamental eco nomic nature and some reflecting peculiarities specific to the city, combined to create the financial problem that emerged in 1975. The dramatic loss of jobs in the city, stemming in part from the two recessions experi enced over the 1969-75 period, was one factor. The virulent nationwide inflation with which city revenues, particularly from the property tax, were unable to keep pace was another. And demographic changes which led to a concentration of the low-income aged in the city and simultaneously reduced the proportion be tween the ages of 25 and 64, the primary labor force group, also contributed to the ongoing budgetary and financial strains. Beyond this, New York City’s distress can be attrib uted to a measurable extent to the fact that it has re sponsibility for supporting a broader range of services than are provided by most other municipal governments. There are really two aspects to this problem. First, New York City directly funds some services that are sup ported elsewhere by local instrumentalities other than the municipal government. W hile it is not clear how serious a problem this creates, it does suggest that New York supports certain services from a relatively narrow tax base compared with some other localities. i ’ United States Bureau of the Census [3 4 , Table 2 2 ], 20 High taxes have existed for m any years, but other favorable factors w hich once outw eighed the costs of locating in New York have now becom e less im portant. T able 10 New York City: Actual Receipts from Local Revenue Sources In m illions of dollars and percent 1 965-66 R evenue Percent R evenue sources R eal estate tax ................................................ ................. Sales tax ............................................................ ............... Personal incom e t a x ....................................... .............. Business incom e t a x ....................................... ............... Stock transfer tax ........................................... .............. C om m ercial occupancy t a x ........................ .............. Off-track betting .............................................. W ater c h a r g e s ................................................... Fines and fo r fe itu r e s ....................................... 1,432 .............. 2,202 31 — 214 94 72 1970-71 R evenue Percent 1974-75 Revenue P ercent 1 97 5 -7 6 R evenue Percent 158 39 55.2 13.9 1.4 5.6 7.1 7.3 3.9 — 4.4 1.1 2,619 791 90 4 66 444 185 191 67 191 66 5 1.3 15.5 1.8 9.1 8.7 3.6 3.7 1.3 3.7 1.3 2,8 9 8 825* 93 528 688 270 198 65 174 85 49.8 14.2 1.6 9.1 11.8 4.6 3.4 1.1 3.0 1.5 3,551 100.0 5,1 1 0 100.0 5,8 2 4 100.0 60.9 17.3 1.4 — 9.7 4.3 3.3 — 2.2 0.8 1,960 494 50 199 252 259 140 — 100.0 * Includes $65 5 m illion in funds earm arked for the M un icipal Assistance Corporation. S o u rc e : Citizens Budget C om m ission, P o cke t S u m m a ry o f N ew Y ork C ity F in a n c e s , selected fiscal years. Tab le 11 Estimated Burden of Major Taxes* for a Family of Four By adjusted gross incom e, 1974; in dollars and by rank City Atlanta .................................. Baltim ore ............................. Boston .................................. Chicago ............................... Detroit .................................. Houston ............................... Los Angeles ...................... New York C i t y ................... P h ila d e lp h ia ........................ San Francisco ................... W ashington, D .C ................. ............ Average for thirty cities . $5,000 Burden Rank 386 480 1,040 654 425 389 553 654 504 413 427 473 26 10 1 4 19 25 5 3 7 23 18 — $ 10,000 Burden Rank 745 1,051 1,965 1,114 829 610 1,061 1,267 1,062 833 853 879 $ 15,000 Burden Rank $20 ,00 0 Burden Rank $30,000 Burden Rank $40,000 Burden Rank 20 8 1 5 15 29 7 3 6 14 13 1,214 1,573 2,901 1,616 1,490 858 1,743 1,977 1,555 1,407 1,341 17 7 1 6 9 29 5 3 8 10 11 1,687 2,099 3,761 2,018 2,015 1,053 2,386 2,707 1,988 1,954 1,827 16 6 1 7 8 28 5 3 9 10 11 2,606 3,083 5,300 2,769 3,009 1,395 3,690 4,385 2,791 3,105 2,873 13 7 1 12 8 27 5 2 11 6 9 3,483 4,033 6,822 3,456 3,965 1,693 5,205 6,354 3,569 4,4 6 4 3,965 12 8 1 13 9 27 5 2 11 6 10 — 1,333 — 1,753 — 2,567 — 3,397 —- * Includes income, sales, auto, and real estate taxes. S o u rc e : D epartm ent of Finance and Revenue, Tax B u rd e n s in W a s h in g to n , D .C ., C o m p a re d W ith Those in th e N a tio n 's T h irty L a rg e s t C itie s (W ashington, D.C.: G overnm ent of the D istrict of C olum bia, 1974). FRBNY Quarterly Review/Winter 1976 11 Further, the city has attempted to provide more ser vices, in absolute terms, than are found in most other urban areas. This provision of extra services is par ticularly evident in education, medical care, and wel fare. While tuition-free university education for city residents has been dropped, vexing problems remain in these areas. Selected bibliography [ 1] Arthur Anderson and Co. Report for the Secretary of the Treasury Regarding Information Relating to the Financing Re quirements under the New York City Seasonal Financing Act of 1975 (December 29, 1975). [ 2] Bah I, Roy W.; Campbell, Alan K.; and Greytak, David. Taxes, Expenditures and the Economic Base (New York: 1974). [ 3] Bahl, Roy W.; Jump, Bernard; and Puryear, David. The Out look for State and Local Government Fiscal Performance. Testimony Prepared for the Joint Economic Committee (Janu ary 22, 1976). [ 4] Blanks, Vera J. Farm Population Estimates for 1974. United States Department of Agriculture, Economic Research Service, Agricultural Report, (No. 319) December 1975). [ 5] Bernstein, Blanche, and Bondarin, Arley. “ Income Distribution in New York City”. City Almanac (Center for New York City Affairs, New School for Social Research, April 1975). [ 6] Bernstein, Blanche, and Meezan, William. The Impact of Wel fare on Family Stability (Center for New York City Affairs, New School for Social Research, June 1975). [ 7] Citizens Budget Commission, Inc. Pocket Summary of New York City Finances (New York: selected years). [ 8] Citizens Budget Commission, Inc. The Scope of City Services: The Local Share of Public Assistance Payments (New York: November 1975). [ 9] Congressional Budget Office. New York City’s Fiscal Problem: Its Origins, Potential Repercussions, and Some Alternative Re sponses. Background Paper No. 1 (Washington, D.C.: United 6tates Government Printing Office, October 10, 1975). [10] Day, Richard H. “The Economics of Technological Change and the Demise of the Sharecropper”. American Economic Re view (June 1967). [11] Department of Finance and'Revenue. Tax Burdens in Wash ington, D.C., Compared with Those in the Nation’s Thirty Larg est Cities (Washington, D.C.: Government of the District of Columbia, 1974). [12] Fantus Company. The Manhattan Outlook: A Projection to 1985 of Operating Conditions in New York City for Office Employees (New York: December 10, 1975). [13] First National City Bank. Profile of a City (New York: 1972). [19] Joint Economic Committee. Studies in Public Welfare: Welfare in the 70’s: A National Study of Benefits Available In 100 Local Areas (July 22,1974). [20] Joint Economic Committee. Studies in Public Welfare. Nos. 1-4 (United States Congress, 1972). [21] Levitt, Arthur. Audit Report on Medicaid Eligibility and Oper ating Practices New York City Human Resources Administra tion (Report No. NYC 77-75, June 1976). [22] Lowry, Ira; De Salvo, Joseph; and Woodfill, Barbara. Rental Housing in New York City (Vol. II). “The Demand for Shelter” (New York City: Rand Institute, June 1971). [23] Meyer, Herbert E. “Why Corporations are on the Move”. Fortune (May 1976). [24] New York City Council on Economic Education. Challenges of the Changing Economy of New York City 1975 (New York: April 16, 1975). [25] New York City Expense Budget for Fiscal Year 1975-76. [26] New York City Office for the Aging. Recent Developments in the Economics of the Aging (June 1975). [27] New York State Department of Social Services. Social Statis tics (March 11, 1976). [28] Muller, Thomas. Growing and Declining Urban Areas: A Fiscal Comparison (Washington, D.C.: The Urban Institute, November 1975). [29] Savas, Charles S. Evaluating the Organization of Service De livery: Solid Waste Collection and Disposal (New York: Center for Government Studies, Graduate School of Business, Colum bia University, October 1975). [30] Shick, Allen. Central Budget Issues under the New York City Charter (New York: December 1973). [31] Social and Rehabilitation Service. Characteristics of State Plans tor Aid to Families with Dependent Children under the Social Security Act Title IV-A (1974). [32] Sullivan, Ronald. "Beame Takes over Fiscal Control of Hos pitals Agency to Force Cuts”. New York Times (November 4, 1976). [33] United States Bureau of the Census. City Government Fi nances in 1955-56, 1965-66, 1973-74 (Washington, D.C.: United States Government Printing Office, 1957, 1967, and 1975). [34] United States Bureau of the Census. Local Government Fi nances in 1973-74 (November 1975). [35] United States Bureau of the Census. Local Government Fi nances in Selected Metropolitan Areas and Large Countries 1973-74 (1976). [36] United States Bureau of the Census. Population Estimates and Projections (July 1976). [37] United States Bureau of Labor Statistics. New York City In Transition: Population, Jobs, Prices and Pay in a Decade of Change (1973). [14] Friedman, Milton. Capitalism and Freedom (Chicago: 1962). [38] United States Bureau of Labor Statistics. New York City: Tak ing Economic Stock: Eight Signs for the Eighties (April 1976). [15] Ginzberg, Eli, ed,. The Future of the Metropolis: People, Jobs, Income (Salt Lake City: 1974). [39] United States Department of Commerce. Revisions to National Income and Product Accounts, Table 6.7 (March 19, 1976). [16] Halperin, Senator Donald. Federalization of Welfare (Novem ber 1975). [40] United States Department of Health, Education, and Welfare. Health Education and Welfare Funds, State Data, and State Rankings (1967). [17] Hirsch, Werner Z.; Vincent, Phillip E.; Terrell, Henry S.; Shoup, Donald C.; and Rosett, Arthur. Fiscal Pressures on the Central City (New York: 1971). [18] Joint Economic Committee. New York City’s Financial Crisis (Washington, D.C.: United States Government Printing Office, November 3,1975). 12 FRBNY Quarterly Review/Winter 1976 [41] Wall Street Journal. “New York City Bond Tax on Transfers is Repealed” (March 3, 1976), p. 27. [42] Wertheimer II, Richard F. The Monetary Rewards of Migration within the United States (Washington, D.C.: The Urban insti tute, March 1970). Measuring Capacity Utilization in Manufacturing by James F. Ragan Capacity utilization rates play an important role in evaluating economic activity. They have been used, along with other factors, to explain the behavior of investment, inflation, productivity, profits, and output. In addition, information on capacity utilization can aid businessmen and economists in assessing current economic conditions and forecasting future activity. Unfortunately, alternative measures of capacity utili zation do not always tell the same story. There are frequent discrepancies between the levels of the vari ous series as well as discrepancies in their movements. The purpose of this article is twofold: (1) to examine how well alternative measures of capacity utilization seem to reflect the current availability of unused capi tal stock and (2) to assess the current capacity situa tion in manufacturing. There are four principal measures of capacity utili zation in manufacturing— those of the Wharton School, the Board of Governors of the Federal Reserve System (FRB), the Bureau of Economic Analysis (BEA), and McGraw-Hill.1 After a general discussion of the con cept of capacity, each of these measures is critically evaluated. All have flaws but, provided one is aware of their particular biases and shortcomings, valuable information can still be gleaned from them. While 1 For purposes of com parison, all four m easures reviewed here refer to m anufacturing utilization. Th e W harton School and M cG raw -H ill also publish utilization rates for a broader industrial classification, which includes m ining and utilities. In each instance, the criticism s raised at the m anufacturing level carry over to the industrial level. U tilization rates are available at more disaggregated levels as w ell. The FRB publishes utilization rates for both prim ary- and advanced-processing m anufacturing and also releases a separate index for the m aterials sector. Finally, W harton, M c G raw -H ill, and BEA utilization rates are available for individual m anufacturing industries. there is no one “best” measure for all purposes, over all the FRB utilization rate probably reflects current utilization of capital stock most accurately, provided that the statistical relationships on which it is based are kept up to date. Finally, based on present utiliza tion rates, the prospects for capacity problems in manufacturing over the next year or so appear remote. This is true for key manufacturing subsectors as well as for aggregate manufacturing. Capacity—an elusive concept Capacity refers to the quantity of output that can be produced in a fixed period of time, given the existing stock of capital. There are, however, a number of inter pretations for the expression “can be produced”. The engineering interpretation relates to the quantity of output that could be turned out if, apart from required maintenance, plants and equipment were operated around the clock seven days a week. Since most plants and equipment are operated only a fraction of that time, a more common interpretation of capacity refers to the maximum quantity of output producible under “normal conditions”. While the concept of nor mality is admittedly vague, it seems to be based on the notion of average or typical conditions. According to this interpretation, capacity describes the maximum producible output when plants and equipment are operated the average amount of time producing the normal mix of output.2 One difficulty with this approach is that the view of what is normal changes over time. 2 Specifying the output mix is im portant for any definition of capacity. Th e rate and duration of m achine breakdow ns frequently depend on w hat is being produced, and the longer a m achine is down the less that can be produced. FRBNY Quarterly Review/Winter 1976 13 As workers have gained shorter workweeks and greater vacation time, the “normal operating period” has apparently contracted. Furthermore, as discussed later, the concept of normal production seems to change over the business cycle. Capacity has also been defined from a cost perspec tive.3 Some view capacity as the level of output where average per unit cost is at a minimum, while others see it as the level beyond which the cost of producing additional ouput rises sharply. A practical problem with the cost approach is that few firms maintain suit able cost data. Furthermore, studies of the relationship between costs and output suggest that for some prod ucts there may be no unique level of output for which average cost is smallest. Instead, per unit costs may be about constant over wide ranges of production. And for some other products, unit costs do not show signs of rising even at very high levels of output.4 The McGraw-Hill and BEA measures of capacity are tied to “normal” conditions. Although capacity is not actually defined by McGraw-Hill and the BEA, most companies surveyed by them indicate that this is the concept they had in mind.5 Since the FRB utilization rate is constructed from that of McGraw-Hill, it too is linked to “normal” conditions. The Wharton utilization rate, in contrast, is based on an entirely different concept: observed production peaks. Capacity is assumed to equal output at production peaks, and between peaks capacity is estimated by linear inter polation. A second distinguishing feature of Wharton capacity is that it is a function of labor availability. Since pro duction depends on labor as well as capital, produc tion peaks are influenced by the supply of labor.6 The other three indexes of capacity are entirely capi tal oriented, i.e., they address the question of how much output can be produced with a given stock of capital, assuming labor, raw materials, and parts are all readily available. Thus, the Wharton measure of capacity is related to labor availability; the others are not. Because the concepts of capacity differ, as do the construction techniques, it is not meaningful to com pare values of alternative utilization measures. The Wharton utilization rate, for example, has always exceeded the McGraw-Hill rate, frequently by 8 per centage points or more (see the chart). Clearly then, a Wharton value of, say, 90 percent indicates lower * S e e d e Leeuw [ 2 ] and Edm onson [ 4 ] . capacity utilization than does a McGraw-Hill reading of 90 percent. Furthermore, a given value of utilization means very little per se. Only by comparing this value with past values of the same measure, especially those of previous troughs and peaks, is it possible to assess the degree of capacity utilization. Finally, since shortages and bottlenecks in key in dustries may effectively limit production, in spite of substantial unused capacity elsewhere, it is clear that conditions in the economy cannot be fully described without considering utilization rates in important sub sectors. For this reason, industry utilization rates will, in the final section, also be examined. International conditions are relevant as well. For one thing, produc tion in the United States is less likely to be constrained the more readily firms can import goods, materials, and energy from abroad. Aggregate utilization rates cannot, therefore, completely characterize an econ omy’s capacity situation; they are most valuable when supplemented with additional information. Bearing in mind these limitations, the principal measures of utili zation in manufacturing are reviewed in the following section. An analysis of four measures of manufacturing utilization7 The Wharton index of capacity is based on the “trendthrough-peaks” method.' Output, as measured by the Federal Reserve Board’s series on industrial produc tion, is plotted for each of the major manufacturing industries, e.g., primary metals, electrical machinery, and chemicals. Successive cyclical peaks are then joined together with straight line segments. The re sulting series of connected linear segments is the in dustry’s capacity measure. To obtain the industry’s utilization rate, output is simply divided by capacity. The utilization rate for all manufacturing is derived by summing the industry utilization rates, each weighted by the fraction of total national income contributed by the industry at full employment. Because of the computational method employed, an industry’s utilization rate equals 100 percent at all major production peaks.9 This is both a strength and a weakness of the Wharton technique. On the positive side, capacity values are attainable. At each of the 7 There exist several other m easures of capacity utilization, but none are more than a few years old. W ith so few observations, it is difficult to say m uch about these series. 8 See Klein and Sum m ers [ 9 ] , Klein and Preston [ 8 ] , and A dam s and Sum m ers [ 1 ] . * S ee W alters [ 1 7 ] . 5 See M atulis [1 3 ] and H ertzberg, Jacobs, and Trevathan [ 7 ] . * Furtherm ore, production functions containing labor as an input are som etim es used to adjust the W harton index. 14 FRASER FRBNY Quarterly Review/Winter 1976 Digitized for 9 Not all production peaks are associated with utilization rates of 100 percent. If a peak is judged to be "w e a k", i.e., associated with unused capacity, the cap acity line will lie above the peak, and capacity utilization w ill be less than 100 percent. 1953 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 Note: Shaded areas represent periods of recession as defined by the N ational Bureau of Economic R esearch e x c e p t for the latest recession, which is tentatively judged to have ended in M arch 1975. Sources: Wharton Econometric Forecasting Associates; Board of Governors of the Federal R eserve System; M cG raw -H ill Publications Company, D epartm ent of Economics; United States D epartm ent of C om m erce, Bureau of Economic Analysis (BEA). major peaks, the Wharton value of potential output is known to be producible; indeed, this is the level of output actually observed. Furthermore, output never exceeds Wharton capacity but may, and sometimes does, exceed alternative measures of capacity.10 Thus, a capacity value of 100 percent has special meaning for the Wharton index, and only for the Wharton index. Assigning a capacity value of 100 percent to the major peaks does, however, have a serious drawback: there is no way to determ ine intensity of production at different peaks. Instead, capacity utilization is assumed to be identical at every major peak, an assumption that is highly questionable. Another criti cism of the W harton technique is that it is not com pletely objective. W hether or not a production peak is one of full capacity is sometimes difficult to determine. In such situations, outside information, e.g., engineer ing data and industry surveys, is consulted. Still, the choice may not be obvious. The Wharton approach has also been faulted for its assumption that capacity growth between peaks can be represented by a straight line. Presumably, capacity 10 For exam ple, in 1973 production in the autom otive industry was running at 111.5 percent of capacity, according to the M c G raw -H ill index. growth is related to productive investment, which need not occur in equal increments each quarter. Better estimates of capacity could probably be derived by introducing investment data. The final and most serious shortcoming of the W har ton capacity measure is that, because the next pro duction peak is not known, the current rate of capacity growth can only be estimated. This is generally accom plished by extrapolating the capacity index at its cur rent slope. If the projected and actual growth rates differ, however, the error will accumulate over time. If projected capacity growth exceeds actual growth, the utilization rate will become increasingly down ward biased; if actual exceeds projected growth, an upward bias will develop. As the next major peak is approached, the error will be corrected, but the revi sion required may be substantial. For example, the aggregate industrial utilization rate for the first quarter of 1962 was estimated to be 94 percent in 1962-1, 92 percent in 1963-1, 85 percent in 1965-1, and 82.8 per cent in 1967-I.11 Thus, in five years the estimate of 11 See Sum m ers [ 1 6 , page 3 3 ]. The numbers cited are for the industrial sector, which includes mining and utilities as well as m anufacturing. S eparate num bers for the m anufacturing sector were not reported. FRBNY Quarterly Review/Winter 1976 15 capacity utilization was lowered by 11.2 percentage points. It is difficult to place much confidence in current Wharton estimates of capacity utilization, knowing they could be revised drastically in the future. The FRB’s index of capacity utilization overcomes most of the Wharton weaknesses but contains a flaw of its own. The actual method of constructing this index is quite complicated. Without elaborating on the Board’s technique,12 suffice it to say that the FRB index is derived from three series: (a) the December McGraw-Hill operating rate series (to be discussed later), (b) a separate and independent McGraw-Hill capacity series, computed from surveys of annual changes in capacity, and (c) a capital stock series based on census data deflated for price changes. The main criticism leveled at the FRB index is that it relies on "historic statistical relationships that are simple at best and that may change substantially”.13 Consequently, these relationships need to be con tinually reestimated. Otherwise, a bias is likely to develop. The recent FRB revisions make this clear.14 Based on the statistical relationships which the Board estimated in 1971, capacity utilization in 1976-111 was originally placed at 73.6 percent, which was low by historical standards. But, when the statistical relation ships for capacity were reestimated this year, sub stantially different results emerged. The Board now estimates capacity utilization for 1976-111 to be 80.9 percent, which is about midway between the historical high and historical low of the new series. Thus, the Board has revised considerably its assessment of cur rent capacity utilization. Perhaps the main reason for this change is that the Board does not distinguish between spending which augments capacity and spending which does not. In recent years an increasing proportion of capital spend ing has been for environmental and safety factors, ,J Construction of the FRB index is detailed b y d e Leeuw [ 3 ] , Enzler [ 5 ] , and R addock and Forest [ 1 5 ] . Briefly, the FRB D ecem ber value of output is divided by the M cG raw -H ill operating rate to generate a prelim inary estim ate of capacity output. This capacity output m easure is divided both by the annual M cG raw -H ill capacity series and by the capital stock series derived from census data. These two ratios are then each estim ated as a function of one or m ore tim e trends, and this process generates two separate estim ates of capacity. These two estim ates are averaged to provide a new and ‘‘sm oother" cap acity series, which is hopefully less subject to m easurem ent errors than the individual series. Next, the new capacity series is interpolated, yielding quarterly and monthly estim ates of capacity. This process is currently under taken at the industry level. (Prior to the recent FRB revisions, capacity had been com puted for only two sectors: prim ary processing and advanced processing.) C ap acity is then aggregated across industries, using valu e-ad d ed w eights. Finally, the FRB production index is divided by capacity to yield capacity utilization. w Perry [1 4 , page 7 0 7 ]. M For a discussion of these revisions, see Raddock and Forest [ 1 5 ] . 16 FRASER FRBNY Quarterly Review/Winter 1976 Digitized for which do not add to capacity.15 Consequently, in this decade, additions to capital stock increased capacity by a lesser amount on average than was true over the previous two decades. Therefore, using the pre-1971 relationship between capacity and capital stock re sulted in capacity being overstated in recent years and capacity utilization being understated. Prior to the recent revision, the FRB utilization rate had been drifting lower, away from the other three measures of capacity utilization. The Board’s revised numbers, on the other hand, have no discernible bias, which suggests that the FRB technique can provide reasonable estimates of utilization. It is essential, how ever, that a given statistical relationship not be extrap olated too far beyond the sample period. The final two measures of capacity utilization— the BEA and McGraw-Hill operating rates— are closely re lated. Both are based on company surveys, and both seem to measure the same concept of capacity.1* Each spring, McGraw-Hill asks companies: (1) what percent age of their capacity was used the previous December and (2) how much they expect to add to capacity in the current year. Additions to capacity are assumed to occur in equal monthly increments. Given the Decem ber operating rate, the projected monthly changes in capacity, and monthly output data (as recorded by the FRB production index), the operating rate can be esti mated for each month of the subsequent year.17 The operating rate series are “bench marked” an nually, which should prevent any measurement errors from piling up. Bench marking is accomplished by averaging the operating rate calculated in December 15 A ccording to M c G raw -H ill [1 0 ] and [ 1 2 ] , air and w ater pollution control as a percentage of m anufacturers’ capital spending rose steadily from 2.8 percent in 1967 to 9.1 percent in 1975. Expenditures for worker protection have also becom e substantial. In 1972, the first year for w hich M c G raw -H ill has data, they accounted for 3.0 percent of capital spending, and current projec tions indicate that in 1976 the percen tag e will reach 3.3 percent. A ccording to H ertzberg, Jacobs, and Trevathan [ 7 ] , both operating rates are based on the concept of "m axim um practical cap a city ” . This is defined to be the m aximum physical quantity of output that can be produced under "norm al conditions” , i.e., assum ing “ the usual num ber of hours per shift, shifts per day, days per w eek, overtim e, vacation, and dow ntim e for repair and m aintenance” . " T h i s technique is described in general term s by G ang [ 6 ] ; the com putational procedure is detailed by M c G raw -H ill [11 ]. M c G raw -H ill calculates the operating rate in a given month (O R 2) as a percen tag e of the previous m onth’s operating rate (O R J . They then link the change in operating rate to the form er m onth’s value but do so in an im precise m anner. In their exam ple, the operating rate in the initial month is 68.0 percent, and in the second month it is 1.0 percent higher, i.e., O R 2/O R ! = 1.010. O R 2 is then estim ated to be 68.0 percent 4- 1.0 percent = 6 9.0 percent. In reality, OR 2 = 1.010 X 6 8.0 percent = 68.6 8 percent or, rounding as M cG raw -H ill does to the nearest 0.5 percen tag e point, 68.5 percent. Thus, by acting as if percen tag e and percen tag e point changes were one and the sam e, M c G raw -H ill introduces a slight m easurem ent error. with the value actually reported in the subsequent spring survey. The series are also revised each year, to take into account recent information on actual as opposed to expected additions to capacity. Annual end-of-year operating rates are available from 1954, and monthly operating rates from September 1964. The all-manufacturing operating rate is obtained by weight ing industry operating rates with 1967 value-added weights. The BEA asks companies what percentage of their capacity was in use during the final month of the quarter.18 These surveys were conducted semiannually between 1965 and 1967 and then, in March 1968, switched to a quarterly basis. Operating rates are published for eleven manufacturing industries, for durables and nondurables, for primary and advanced processing, for asset size (three categories), and for all manufacturing. The all-manufacturing operating rate is obtained by weighting industry operating rates with 1969 capacity weights. Table 1 Magnitudes of Recent Cyclical Swings for Various Manufacturing Utilization Rates In percentage points Series W harton . FRB .......... M -H j .. M -H mo f • BEA 1 968-69 peak to 1970-71 trough 1970-71 trough to 1973 peak 1973 peak to 1975 trough Total movem ent 1968-75 11.5 11.1 9.5 9.0 6 13.1 11.5 10.2 9.0 7 20.1 16.9 15.2 16.0 11 44.7 39.5 34.9 34.0 24 * M -H 1/4 is the quarterly average ot m onthly M cG raw -H ill operat ing rates. t M -H mo. is the value of the M cG raw -H ill operating rate in the final month of the quarter. S o u rc e s : Wharton Econom etric Forecasting Associates; Board of Governors of the Federal Reserve System (FRB); M cG raw -H ill Publications Com pany, D epartm ent of Economics; United States D epartm ent of C om m erce, Bureau of Econom ic Analysis (BEA). Cyclical differences in capacity utilization rates The various measures of capacity utilization differ in their cyclical behavior. In particular, there is consider able disparity concerning the magnitude of cyclical swings— movements from peaks to troughs or from troughs to peaks. Table 1 compares recent cyclical movements of the various utilization rates. The W har ton and FRB measures capture average conditions throughout the quarter. So does the quarterly McGrawHill measure, which is the average of monthly operating rates. The BEA operating rate, on the other hand, reflects conditions in the final month of the quarter— March, June, September, or December. Hence, the timing of this operating rate differs somewhat from that of the other utilization measures. To see whether this timing difference is important, an end-of-quarter M cGraw-Hill operating rate was also constructed. The difference between the two McGraw-Hill operating rates is therefore a measure of the effect of timing. For all three time periods considered, the cyclical swings are smallest for the BEA operating rate. This cannot be attributed to a difference in timing since, for all three cyclical swings, the difference between M cGraw-Hill quarterly average and end-of-quarter operating rates is about 1 percentage point or less. Next to BEA, the McG raw-Hill operating rates exhibit the least amount of cyclical variation. The BEA and McGraw-Hill operating rates are both based on surveys of the percentage of capacity which firms report they are operating. One possible explana tion for these operating rates having smaller cyclical 18 The BEA technique is described by Hertzberg, Jacobs, and Trevathan [ 7 ] , swings is that survey respondents change their con cept of capacity over the cycle. When conditions are slack, firms may forget about, or at least fail to con sider explicitly, marginal plants and equipment. When conditions tighten and firms are pushed to increase production, they “ rediscover” these marginal facilities. Secondly, as conditions tighten, extra shifts may be added. If some firms calculate their operating rate on the basis of a single shift when only one shift is run but on the basis of two shifts when two shifts are run, production will vary over the cycle by a greater per centage than the reported operating rate. In either case, the reported cyclical swing will be more com pressed than the actual swing. Research by Perry in dicates that operating rates based on survey response do indeed contain such a cyclical bias.19 Because the BEA and M cGraw-Hill operating rates are derived from surveys, they are biased toward show ing too little cyclical variation. The magnitude of bias 19See Perry [1 4, page 7 1 1 ]. If the capital stock rem ains unchanged, an increase in output should have no im m ediate im pact on capacity. W hen the Wharton and FRB m easures of capacity were exam ined, there was in fact no relationship between changes in output and changes in capacity. If, on the other hand, survey respondents “ rediscover” capacity as output expands, there should exist a positive relationship between changes in output and changes in re p o rte d c a p a c ity . W hen the M cG raw -H ill m easure of capacity was used, a positive and statistically significant relationship did appear; each 10 percent increase in current output led to a 2.3 percent increase in reported capacity, even after the im pact of changes in capital stock was netted out. Thus, operating rates constructed from surveys apparently contain a cyclical bias; reported swings in capacity utilization are less than actual swings. FRBNY Quarterly Review/Winter 1976 17 cyclical bias than M cG raw -Hill.21 To summarize, none of the major indexes of capac ity utilization are without fault. Because the Wharton index is incapable of determining the current rate of capacity growth, its current estimates of capacity utili zation are unreliable; they may be drastically revised in the future. The FRB index appears to be reasonably reliable as long as the statistical relationships on which it is based are kept up to date. When a given statistical relationship is extrapolated very far, however, a bias is likely to emerge. The BEA operating rate contains a cyclical bias, causing it to vary much less over the cycle than the other measures of capacity utilization. Finally, the M cGraw-Hill operating rate contains two cyclical biases. These are partially offsetting, however, so that the McGraw-Hill cyclical bias is less severe than the BEA bias. W hile all four measures of capacity utilization contain flaws, the FRB measure is perhaps the best when it comes to estimating how much of the economy’s aggregate capital stock is currently being utilized. Unlike the McGraw-Hill and BEA rates, the FRB measure has no apparent cyclical bias. Further more, its current values seem more reliable than those of Wharton. differs, however. The McGraw-Hill cyclical swings are not very far below those of the FRB; the BEA cyclical swings are. Thus, the M cGraw-Hill operating rate apparently contains less of a cyclical bias than the BEA operating rate. One reason for this may be the difference in sampling techniques.20 Large firms are oversampled in the McGraw-Hill survey, and small firms are undersampled. The BEA, N on the other hand, has a somewhat more representa tive selection of firms. Thus, if the operating rate varies more over the cycle for large firms than for small firms, the McGraw-Hill operating rate should exhibit greater variation than the BEA operating rate. Does the operat ing rate vary more for large firms? Apparently it does, as Table 2 demonstrates. For total manufacturing, as well as for the durables and nondurables subsectors, there is a tendency for swings in capacity utilization to be greater in large companies. M cG raw -Hill’s oversampling of large firms therefore causes its operating rate to overstate the amplitude of cyclical swings, and this offsets a portion of the survey-response bias, which caused the amplitude of cyclical swings to be understated. In other words, M cG raw -Hill’s large-firm bias negates some of the bias arising from firms “ losing” capacity in recessions and “finding” it in recoveries. The BEA operating rate, in contrast, has less of a sampling bias with which to cancel its survey-response bias. As a result, the BEA has a larger The current situation Having discussed the various measures of capacity utilization, a final question remains: W hat is the cur rent capacity situation in manufacturing? Now that the 20 A nother reason for expecting som e divergence between M cG raw -H ill and BEA operating rates is that they do not rely on survey data to the sam e extent. The M cG raw -H ill value is derived from an annual survey of capacity utilization as well as from figures on industrial production; the BEA value com es exclusively from a quarterly survey. 21 From the perspective of current analysis, the M cG raw -H ill operating rate has another advantage over the BEA rate: its values are released much sooner. For exam ple, the BEA 1976-11 figures were not available until Septem ber 29, w hereas those of M cG raw Hill were released on July 23. Table 2 Magnitudes of Cyclical Swings in the BEA Operating Rate By firm size;* in percentage points Industry Total m anufacturing: Large f i r m s ................................................................................. Sm all f i r m s ................................................................................. Durables m anufacturing: Large f i r m s ................................................................................. Sm all f i r m s ................................................................................. Nondurables manufacturing: Large f i r m s ................................................................................. Small f i r m s ................................................................................. 1968-69 peak to 1970-71 trough 1970-71 trough to 1973 peak 1973 p e a k to 1975 trough 1975 trough to 1976-11 8 7 9 7 13 9 9 5 39 28 12 9 13 10 14 13 11 6 50 38 4 5 5 5 14 6 6 3 29 19 * Large firms: com pany assets of $100.0 million and over; small firms: com pany assets of under $10.0 million. S o u rc e : United States Departm ent of C om m erce, Bureau of Economic Analysis. 18 FRBNY Quarterly Review/Winter 1976 Total m ovem ent 1968-1976-11 FRB utilization numbers have been revised, there emerges something approaching a consensus among utilization measures. All four manufacturing series in dicate that approximately 40-60 percent of the decline in utilization over the 1973-75 period has been re couped (see Table 3). By historical standards as well, present capacity utilization appears to be somewhere around midrange. The current McGraw-Hill and FRB values indicate that capacity utilization is slightly closer to the historical lows than to the historical highs of their series; the current Wharton and BEA values indicate the reverse. On an aggregate level then, the manufacturing sector appears to possess ample unused capacity. But, as noted earlier, it is important to con sider utilization at more disaggregative levels as well. Capacity constraints could develop in certain sub sectors despite abundant capacity elsewhere. Disaggregation reveals that capacity is not a prob lem in either durables or nondurables manufacturing. The rebound in capacity utilization from the 1975 trough has been somewhat stronger percentagewise in the durables sector according to BEA, somewhat stronger in nondurables according to Wharton, and about equally strong in both sectors according to McGraw-Hill. But, while there is some discrepancy as to the relative rebound in the two sectors, one con clusion that does emerge is that neither sector is cur rently approaching capacity. The FRB utilization rates are not available for the durables and nondurables categories but are available along stage-of-processing lines. According to these numbers, considerable untapped capacity remains in both the primary-processing and advanced-processing sectors. Since 1975, utilization rates in both sectors have regained just over half of the decline registered between 1973 and 1975. The Board also publishes a separate series on utili zation in the materials sector because of “the strategic importance of materials capacity in limiting overall industrial production” .22 According to this index, mate rials capacity remains ample. As of 1976-111, just under 50 percent of the reduction in utilization between 1973 and 1975 had been regained (see Table 4). The in crease in utilization has been relatively stronger in the nondurables sector, but there still remains substan tial capacity there. Indeed, utilization in nondurables is lower now than it was last spring. The finding of substantial unused capacity in manu facturing seems to hold at the industry level as well. While the latest (1976-11) BEA readings suggested pos sible tightness in the automotive industry, recent data on automobile production and sales indicate that auto- T able 3 Past and Current Capacity Utilization Rates S eries* Historical high H istorical low Wharton ___ ____ 97.5 FRB ................. ........ 9 1.6 M cG raw -H ill . 89.5 B E A ................. ........ 86 Current value 1973 peak 1975 trough 88.0 80.9 77.7 82 97.5 87.8 86.5 86 77.4 70.9 71.3 75 74.7 70.9 71.3 75 * The W harton historical series runs from 1947-1 to 1976-111, the FRB series from 1948-1 to 1976-111, the M cG raw -H ill series from 1 96 4 -IV to 1976-111, and the BEA series from 1 9 6 7 -IV to 1976-11. Table 4 Past and Current Federal Reserve Board Capacity Utilization Rates for Industrial Materials Series run from 1967-1 to 1976-111 H istorical high low Sector Total ........................ 92.9 70.7 Durables ................. .....92.3 Basic m etals . . . 97.5 N o n d u r a b le s ...............94.0 Textiles ................... 93.9 P a p e r ................... .....99.5 C h e m ic a ls .............. 93.2 64.6 67.0 69.9 60.1 73.5 67.2 Current value 1973 peak 1975 trough 81.3 92.9 70.7 92.3 97.5 93.9 9 3.9 99.5 93.2 64.6 67.0 69.9 60.1 73.5 67.2 78.3 81.7 85.2 81.9 90.2 83.0 Table 5 Past and Current McGraw-Hill Capacity Utilization Rates Monthly series run from S eptem ber 1964 to O ctober 1976 Selected industries Historical Current high low value 1973 peak 1975 trough M a c h in e r y ........................ Electrical m achinery . . Fabricated m etals ___ C h e m ic a ls ........................ Paper ............................... Rubber and plastics . . . Petroleum r e f in e r y ____ Nonferrous m e t a ls ___ Textiles ............................. 94.5 93.5 91.0 85.5 95.0 103.5 98.0 101.5 98.0 86.0 82.5 81.5 85.5 94.5 9 7.0 97.5 90.5 91.5 71.0 60.5 68.0 68.5 70.5 66.5 85.5 60.0 62.0 71.0 60.5 67.5 68.5 70.5 66.5 85.5 60.0 62.0 74.5 71.0 76.5 77.5 82.5 93.5 88.0 83.0 79.5 22 Raddock and Forest [1 5, page 8 9 9 ], FRBNY Quarterly Review/Winter 1976 19 motive capacity should prove sufficient over the com ing year. According to McGraw-Hill, no industry faces impending capacity constraints. At first sight, the 88 percent utilization rate in petroleum refining might ap pear high, but utilization in this industry is always above the manufacturing average. The utilization rate for petroleum refining has never fallen below 85.5 per cent, and has reached 98 percent (see Table 5). Rubber and plastics is the only other manufacturing industry to have a McGraw-Hill operating rate above 83 percent in October, but its high current rate appears related to the recent rubber strike. As soon as the strike ended, companies sought to catch up on lost production, and the operating rate for the rubber and plastics industry shot up 11 percentage points. Once the backlog of orders is reduced to more normal levels, however, the operating rate is likely to decline. More over, its current value is still 10 points below its all-time high. Although capacity utilization in the nonferrous metals industry is not too far below its 1973 peak, it remains well below its historical high. Last spring some forecasts were made that capacity problems might soon develop in a number of key in dustries. Among the industries most frequently men tioned were paper, textiles, chemicals, and steel. Since that time, capacity in a majority of these industries has been expanding faster than production. According to monthly McGraw-Hill operating rates, capacity utiliza tion in the paper industry declined from 89.0 percent earlier this year to 82.5 percent in October. Capacity utilization in textiles fell from 84.5 percent to 79.5 percent, and capacity utilization in chemicals fell*from 80.5 percent to 77.5 percent. While capacity utilization in the steel industry generally increased over the first eight months of the year, it declined in September and again in October. With new orders for capital goods not picking up as expected, demand for structural steel remains soft. Only the market for sheet steel has been strong, and that is because of the pickup in automobile production. Yet even for sheet steel, no capacity prob lems are anticipated in the near future. Thus, since last spring the threat of impending capacity shortages seems to have dissipated. The conclusion to be drawn is that the manufacturing sector is operating considerably below its productive limits. How long before capacity will become a prob lem depends on future rates of production as well as on the rate at which capacity-augmenting investment is undertaken. But, at least for the near term, produc tion is unlikely to be hindered by capacity constraints. While not ruling out the possibility of bottlenecks in isolated product lines, capacity throughout the manu facturing sector should prove to be ample over the next year or so. 20 FRBNY Quarterly Review/Winter 1976 Literature cited [ 1] Adams, F. Gerard, and Summers, Robert. “The Wharton In dexes of Capacity Utilization: A Ten Year Perspective”. Pro ceedings of the Business and Economic Statistics Section of the American Statistical Association (1973), pp. 67-72. [ 2] de Leeuw, Frank. “The Concept of Capacity”. Proceedings of the Business and Economic Statistics Section of the Ameri can Statistical Association (1961), pp. 320-29. [ 3] de Leeuw, Frank. "A Revised Index of Manufacturing Capac ity”. Federal Reserve Bulletin (November 1966), pp. 1605-15. [ 4] Edmonson, Nathan. "Production Relations at High Levels of Capacity Utilization in the Steel Industry”. Proceedings of the Business and Economic Statistics Section of the American Statistical Association (1973), pp. 73-79. [ 5] Enzler, Jared. “The Federal Reserve Board Manufacturing Capacity Index: Comparisons with Other Sources of Capacity Information”. Proceedings of the Business and Economic Statistics Section of the American Statistical Association (1968), pp. 35-40. [ 6] Gang, Priscilla. “Another Look at the McGraw-Hill Measure of Industrial Operating Rates”. Proceedings of the Business and Economic Statistics Section of the American Statistical Association (1973), pp. 64-66. [ 7] Hertzberg, Marie; Jacobs, Alfred; and Trevathan, Jon. “The Utilization of Manufacturing Capacity, 1965-73”. Survey of Current Business (July 1974), pp. 47-57. [ 8] Klein, L. R., and Preston, R. S. “Some New Results in the Measurement of Capacity Utilization”. American Economic Review (March 1967), pp. 34-58. [ 9] Klein, L. R., and Summers, Robert. The Wharton Index of Capacity Utilization. (University of Pennsylvania: Economics Research Unit, 1966). [10] McGraw-Hill Publications Company. Historical Pollution Con trol Expenditures and Related Data (1975). [11] McGraw-Hill Publications Company. McGraw-Hill Measure of the Industrial Operating Rate (April 1976). [12] McGraw-Hill Publications Company. Ninth Annual McGrawHill Survey of Pollution Control Expenditures (May 1976). [13] Matulis, Margaret. “Capacity and Operating Rates”. Proceed ings of the Business and Economic Statistics Section of the American Statistical Association (1961), pp. 306-8. [14] Perry, George. “Capacity in Manufacturing”. Brookings Papers on Economic Activity (1973-111), pp. 701-42. [15] Raddock, Richard, and Forest, Lawrence. “ New Estimates of Capacity Utilization: Manufacturing and Materials”. Federal Reserve Bulletin (November 1976), pp. 892-905. [16] Summers, Robert. "Further Results in the Measurement of Capacity Utilization”, Proceedings of the Business and Eco nomic Statistics Section of the American Statistical Association (1968), pp. 25-34. [17] Walters, A. A. “Production and Cost Functions: An Econometric Survey”. Econometrica (January-April 1963), pp. 1-66. The business situation Current developments Chart 1 The Labor Market in Recession and Recovery Total employment * 1974-76 A verage of postw ar cycles I I I I I I J_L J_L Total civilian labor f o r c e * 104 1974-76 102 A verage of postw ar cycles I I I I I I I I I I -1 2 -1 0 -8 - 6 - 4 - 2 0 Months before trough 2 4 6 8 10 12 14 16 Months after trough 18 2 0 Note: R ecession troughs are dated according to National Bureau of R esearch chronology as occurring in May 1954, April 1958, February 1961, Novem ber 1970, and (tentatively) M arch 1975. * Indexed as a p e rcen tag e of the trough-month level for each respective cycle. Source: United S tates D epartm ent of Labor, Bureau of Labor Statistics. The prolonged “pause” in the rate of economic advance appeared to have continued into the fourth quarter. The economy’s resistance to the resumption of a more vig orous rate of expansion has necessarily increased un certainties over the outlook. Nevertheless, the danger of the economy moving into outright recession in the near future seems small. The current recovery is still relatively young by the standards of postwar business cycles and thus far has been marked by few of the stresses and strains that typically precipitate down turns. Indeed, the current episode of consolidation could lay the foundation for a prolonged period of gradually increasing prosperity. The pace of the recovery from the 1973-75 recession has not been abnormal, compared with other economic recoveries since the Korean war. Measured from the apparent trough in the first quarter of 1975, real gross national product (GNP) increased 7.3 percent during the first four quarters of recovery. This gain was slightly faster than the average increase of 7 percent during the first year of the four preceding cyclical recoveries— those beginning in 1954, 1958, 1961, and 1970. Even the much discussed “pause” in the rate of expansion dur ing the past two quarters was normal. The 4.1 percent annual rate of real GNP growth during the second and third quarters of 1976 was actually slightly faster than the 3.7 percent increase averaged during the sec ond year of the four preceding recoveries. Hence, an other quarter or two of slowdown in the rate of economic growth would not be at all unusual and would not necessarily presage an early end to the expansion. Only one of the four previous periods of expansion was as short as eight quarters; the average length was seven teen quarters. What is distinctive about the current recovery is the relatively low rate of resources utilization. The newly revised Federal Reserve Board index of manufacturing FRBNY Quarterly Review/Winter 1976 21 Chart 3 Chart 2 Retail Inventories Private Housing Starts Seasonally adjusted Seasonally adjusted annual rates M onths of sale 1.65 Millions of units 3.0 ________ inventory sales ratio 1.60- 11 1 1 111 I I 1 I I I I 1 1 11 1 1 11 1 1 1 111 1 I I 111 Billions of dollars 30 C hanges in book value of retail inventories 2 0 — Annual rate I nil —201I I I I I I I 1.1.U 1973 □ I I 1 1 1 1 M 1I I 1 TO i i I i i I 11 111 1974 1975 hW m 1.0 11 l I I l I l i.Ll J 197 ^6 Source: United States D epartm ent of Com merce, B ureau of Economic Analysis. capacity indicated a utilization rate of 79.8 percent in October, 8 percentage points below the recent peak in the third quarter of 1973. At a comparable stage of the four preceding cyclical recoveries, capacity utiliza tion in manufacturing averaged close to 84 percent according to this measure (see the article on pages 1320 of this R eview). Much more striking is the underutili zation of manpower. The unemployment rate was 8.1 percent in November, only 0.8 percentage point below the recent high reached in the spring of 1975. After twenty months of expansion in the four previous cycles, the unemployment rate averaged 5.1 percent, which represented an average decline of 1.6 percentage points from the respective cyclical peaks in the unem ployment rate (see the top panel of Chart 1). The persistence of high rates of unemployment has not resulted from unusually slow growth of employment during the current recovery. Indeed, as may be seen in the middle panel of Chart 1, total employment has increased somewhat more during the current recovery than on average during the four preceding recoveries. In large measure, the current high rate of unemploy ment reflects the severity of the last recession, which pushed the jobless rate to the highest level since World W ar II. It also reflects the unusually rapid growth of the labor force during much of the current expan sion. As can be seen in the bottom panel of Chart 1, the total civilian labor force increased 4.4 percent dur FRBNY Quarterly Review/Winter 1976 Digitized22 for FRASER c;ingle famil 1.5 Multifamily 01i i I u 1il1.il 1971 iii 1972 n iiin in 1973 iiiin i 1974 i 1975 11 ' 11 1 111 1n 11 1 1 1976 Source: United States Department of Commerce, Bureau of the Census. ing the first twenty months of the current recovery, which was much faster than the 2.7 percent average increase during the comparable period of the last four recoveries. Another influence contributing to the high overall rate of unemployment has been the con tinuing shift in composition of the work force toward groups that characteristically experience relatively high rates of unemployment (see the article on pages 24-30 of this Review). The stumbling of the economy early in the fourth quarter was exemplified by developments in industrial output. After advancing for seventeen consecutive quarters, industrial production, as measured by the Federal Reserve Board’s index, dipped slightly in Sep tem ber and then declined by a more pronounced 0.5 percent in October, according to preliminary data. W hile the Septem ber dip largely reflected the effects of the strike of the United Auto W orkers against the Ford Motor Company, the October decline was more generalized. Declines in production were common among materials and manufactured products, including business equipment and consumer goods. These pro duction cutbacks undoubtedly reflected attempts of firms to trim inventories, or to keep inventories from increasing, in the face of disappointing sales. A periodic data revision released in November indi cated that the level of retail inventories was about 3 1/2 percent higher than previously thought. While the Sep tember rise in stocks was not unusually large, sales slipped and the ratio of retail inventories to sales rose to the level of April 1975 when the economic recovery was just getting under way (see Chart 2). Inventory excesses in some lines are suggested by scattered indicators such as preseason sales of various con sumer goods and rebates on some subcompact auto mobiles. However, existing excesses appear neither widespread nor overwhelming. Most firms seem to feel they have their stocks under reasonable control, and the swiftness with which firms cut back orders when stocks appear to be getting out of line should help prevent inventory excesses from cumulating. If demand were to fall off drastically, however, the picture could turn around abruptly— as happened in late 1974. The likelihood of a sharp drop in demand appears slim. Indeed, while there are no conclusive signs of a rejuvenation of the economic expansion, a number of indicators point in that direction. Retail sales rebounded in October and November after several months of slug gishness. Nonfarm payroll employment posted a sizable increase in November, as did hours of overtime and the average workweek in manufacturing. Housing starts and permits rose sharply in September and held on to most of those gains in October. Especially impressive was the performance of single-family home building. Single family home starts in October were only a shade below the best months of 1972 and early 1973 (see Chart 3). Ample funds are available to finance increased homebuilding activity, as banks and thrift institutions con tinue to enjoy large inflows of savings attracted by deposit rates that are more generous than returns avail able on short-term market obligations such as Treasury bills (see article on pages 33-39 of this Review). Capital spending by business is another sector that may be poised for a significant advance. Several early private surveys indicate an increase in planned outlays for plant and equipment of about 6 to 7 percent in real terms in 1977. Continued sizable increases in new orders for capital goods appear to be consistent with these plans, although the Commerce Department’s survey of plant and equipment spending plans for the first half of 1977 suggests a smaller rate of advance. One development that could deal a severe blow to the nation’s economic expansion would be a resurgence of accelerating inflation, but it appears that such a resurgence can be avoided. The United States has made great strides during the past two years in reduc ing inflation. As measured by the consumer price index (CPI), for instance, the rate of inflation has been re duced from 12 percent in 1974 to 5Vz percent during the past year. To a considerable extent, however, this impressive record reflects the winding down of a com bination of extraordinary developments that pushed prices sharply higher in 1973 and 1974. Further prog ress in reducing inflation is likely to be much more gradual and more difficult to achieve. The 0.3 percent increase in the CPI in October probably understated the ongoing pace of inflation. The overall index was held down by stable food prices which translated into a very modest price rise after seasonal adjustment. Such stability in food prices cannot be expected to continue indefinitely, although the Department of Agri culture foresees only a moderate rise at least through mid-1977. The remainder of the CPI increased in October at an annual rate of 51/2 percent, the same as the growth rate of the overall index during the past four quarters. If the CPI numbers for October tended to understate the ongoing rate of inflation, the wholesale price index (WPI) for the past several months has almost certainly exaggerated the strength of inflationary forces in the marketplace. During the past three months, September through November, prices measured by the industrial wholesale price index have increased an average of 0.9 percent per month. It might be recalled that a sim ilar bulge at the same time last year was followed by several months of much more modest increases. There could be problems with the seasonal adjustment of these data, relating in part to the annual increases in new car and truck prices that accompanied the intro duction of the new models as well as other factors. Nearly half the increase in industrial wholesale prices in October and November was accounted for by power and fuel. In large measure, these increases reflected the effects on energy prices of regulatory changes— the increase by the Federal Power Commission in ceiling prices for natural gas sold across state lines beginning in late July and the decontrol in September by the Federal Energy Administration of crude oil from certain marginal wells. Due to the usual reporting lags, as well as continuing adjustments of prices to these regulatory changes, the effects of these events showed up in the WPI in October and November. Re ported prices of other industrial commodities rose an average of 0.5 percent per month, seasonally adjusted, during those two months. Because of the difficulties inherent in measuring actual transactions prices in periods of changing demand conditions, it is likely that the effective prices at which a number of industrial commodities actually traded— taking account of dis counts and special allowances— were somewhat weaker than indicated by the WPI. Moreover, it is not certain that recent increases in posted prices of some metals and fibers will withstand the test of the market. FRBNY Quarterly Review/Winter 1976 23 The changing composition of the labor force by Sharon P. Smith The persistence of relatively high unemployment rates through good times and bad in recent years raises the question of whether some structural change in labor supply may be adding to the unemployment created by recession. It does appear that the composition of the labor force1 has changed so that a larger proportion of it now is composed of demographic groups (in par ticular, women and teenagers) who tend to experience relatively higher rates of unemployment. The old image of a labor force largely composed of adult men has become increasingly inappropriate as differences in labor force participation rates of different demographic groups have narrowed. Thus, the labor force participa tion rates of females and teenagers have increased, and that of males has decreased. Moreover, this rapid rise of labor force participation among demographic groups traditionally regarded as sources of “second ary” workers has continued during a period in which high levels of cyclical unemployment might be ex pected to deter entrance into the labor force. The recent and apparently continuing changes in the com position of the labor force seemingly have tended to raise the average level of overall unemployment asso ciated with given cyclical conditions. A corollary ap pears to be that the level of unemployment associated with a state of ‘full employment”— whatever that some what elusive concept may mean— is now somewhat higher than in the earlier postwar period. This article focuses on the major changes that have occurred in the composition of labor force participants 1 Th e current definition of the total labor force is that it refers to all noninstitutionalized individuals 16 years of age and over who are at work, seeking work, or unem ployed. The labor force participation rate is the proportion of the noninstitutionalized population that is in the labor force; the participation rate can be determ ined separately for the population as a w hole or for any particular dem ographic group. FRBNY Quarterly Review/Winter 1976 Digitized24 for FRASER and the forces that have brought about these changes during the postwar period. Attention also is directed briefly to the impact of the changing patterns of labor force participation on the size and composition of unemployment. Growth and changing patterns of labor force participation The overall labor force participation rate for all demo graphic groups, 16 years of age and older, remained fairly stable from the late 1940’s through the early 1960’s, fluctuating between 57.0 percent and 58.3 per cent (see Chart 1). Since 1964, however, there has been a persistent rise in the participation rate. In 1969 it reached a record 58.6 percent, and by 1975 it had moved up further to 60.4 percent. Although these figures do indicate that a steadily rising proportion of the noninstitutional population is counted in the civilian labor force, the overall increase since 1947 has been a modest 3 percentage points.2 Nevertheless, this small overall increase masks changes of much larger magnitude in the labor force participa tion patterns of the major component demographic groups. The three groups exhibiting the most important changes are married women living with their husbands (“spouse present” in the language of the Census Bureau), older men, and teenagers. The changing role of women in the labor force The participation of women in the labor force has 2 It should be noted that during this period there w ere som e changes in definition so that the series are not always strictly com parable: prior to 1967 the percentage of the population in the labor force was reported for those 14 years of age and over, but beginning in 1967 this was reported for persons 16 years of age and over; beginning in 1972, data refer to the noninstitutional population. T a b le 1 Median Age at First Marriage Y ear 1940 1950 1960 1965 1970 1972 1973 1974 Fem ale M ale 21.5 20.3 20.3 20.6 20.8 20.9 21.0 21.1 24.3 22.8 22.8 22.8 23.2 23.3 23.2 23.1 .............................................................. .............................................................. .............................................................. .............................................................. .............................................................. .............................................................. .............................................................. .............................................................. Source: United States Departm ent A b s tra c t o f the U n ite d S tates 1975. of Com m erce, grown in recent years for all major groups regardless of marital status and the ages of their children. As might be expected, participation rates for married women tend to be lower than those of unmarried women, with rates for women who are married but not living with their husbands falling in between. Inter estingly, however, while the participation rates of all three groups have risen, the differences have nar rowed (see Chart 2). Thus, by far the largest increase has occurred for married women living with their hus bands. Their participation rate rose from 20 percent in early 1947 to 44.4 percent in early 1975. Just as important as marital status in influencing the probability of a wom an’s participation in the labor force are the number and ages of her children. In par ticular, the presence of small children is obviously an important deterrent to participation in the labor force. Chart 3 shows labor force participation rates for mar ried women living with their husbands by the ages of their children. The most important distinction here is between those women with children under 6 years of age and those with children over 6 years of age. As with the breakdown by marital status, there has been an increase in participation rates for all categories, and again the distinctions among the major categories generally have tended to shrink over the years. Thus, the observed rise in labor force participation is not concentrated among those who are childless. Nor has it occurred only for women with children over age 6. Rather, it appears that labor force participation of all married women living with their husbands has in creased. One possible explanation for this major rise in labor force participation among married women is that the younger generation has a significantly different out look toward market work (in contrast to housework) than earlier generations. However, an examination of changes in labor force participation rates by sex and age, shown in Chart 4, indicates that these patterns are consistent across the two younger age groups and are not the result of unusual behavior of a particular group as it ages. Among females, labor force participation rates in creased enormously for each age category except those 65 and over. The largest increase occurred among women between 25 and 34 years old. Although females between the ages of 20 and 24 remain the group with the highest labor force participation rate, the differences between the age groups generally have narrowed between 1955 and 1976.3Therefore, it appears that the increase in female labor force participation is S ta tis tic a l 3 The only exception is the widened difference between the labor force participation rate for the 55 to 64 age group and that for the 65 and over age group. FRBNY Quarterly Review/Winter 1976 25 a consequence of factors that affect all age groups and not just one particular generation or one particular age group. Before considering some of the factors that have brought about these changes in the participation of women in the labor force, it is worthwhile to look at the equally striking but quite different changes in the labor force participation of men. First, there has been a decre ase between 1955 and 1975 in the participation rates of all age categories of adult men— i.e., other than male teenagers. While the amount of the decrease for those categories under age 55 has been fairly slight, the decreases in the two oldest categories have been quite large. The total labor force participation rate for men 55 to 64 years old fell from 87.9 percent in 1955 to 75.8 percent in 1975, while that for men 65 and over fell from 39.6 percent in 1955 to 21.7 percent in 1975. Why female labor force participation has increased Several factors have been influential in the rise in fem ale labor force participation. The increased willing ness of married women (with spouse present) to con tinue working can be attributed in part to a trend toward later marriages and a decrease in the birth C hart 2 Labor Force Participation Rates By sex and m arital status, 1947-75 P ercent Source: Employment and Training Report of the President, (1976). 26 FRBNY Quarterly Review/Winter 1976 Table 2 Birth Rate 1940-73 Per 1,000 population Y ear Birth rate 1940 ............................................................. ............19.4 1950 ............................................................. ............24.1 1960 ............................................................. ............23.7 1965 ............19.4 1970 ............18.4 1971 ............17.2 1972 ........... 15.6 1973 ........... 14.9 Source: United States D epartm ent A b s tra c t o f th e U n ite d S ta te s 1975. of C om m erce, S ta tis tic a l rate (see Tables 1 and 2). With later marriages, it is more likely that women will have obtained skills and training that increase their expected wage and thus the attractiveness of having a job. Similarly, the de crease in the birth rate reduces the probability of the presence of young children to act as a deterrent to married women’s labor force participation. Although the median age of 21.5 at first marriage was quite high in 1940, this was probably a consequence of the de pression. In 1950 the median age had dropped to 20.3 and remained at that level in 1960. The median mar riage age began to rise again in the 1960’s and by 1974 had reached 21.1. Meanwhile, the birth rate was declining from a high of 24.1 (per 1,000 population) in 1950 to 14.9 in 1973. Another factor tending to raise fem ale participation rates was the rise in education levels. Actually, educa tion rates rose for both men and women during the period and the increase was greater for men (see Table 3). There is good reason to expect increased education to result in rising labor force participation. The reason is simply that education tends to increase attainable earnings levels and therefore increases the attractiveness of holding a job relative to homemaking and other nonmarket activities. These three factors— an increase in age at first mar riage, a decline in the birth rate, and increased edu cational attainment— alone would have increased fe male labor force participation. In addition, however, clearly there has been a marked change in social atti tudes and expectations toward women working. Thus, for any given set of circumstances (particular marital status, number and age of children, education level), the probability that a woman is in the labor force is greater today than it was twenty, or even ten, years ago. Chart 4 Labor Force Participation Rates* Chart 3 Labor Force Participation Rates of Married Women, Husband Present By age and sex, 1 950-75 Percent 110" M a le s By p resen ce and age of children, 1 9 4 8 -7 5 100- 2 5 -5 4 90- I I I i I I I I II 1948 50 55 I I I I I I I II 60 65 II 70 75 Source: Employment and Training R eport of the President (1976). Adult males and teenagers The decline in the male labor force participation rate already mentioned reflects a rise in age at first mar riage, an increasing trend to earlier retirements, and an increase in disability. The last two factors are im portant in explaining why the fall in male labor force participation rates has been concentrated in the older age categories. Years in retirement appear to be in creasing in part because of a rise in longevity. In addi tion, there has been a decrease in male labor force participation due to better pension plans, to more liberal social security payments and other Government benefits, and to the increase in working wives. It has been estimated that, between 1960 and 1970, male life expectancy rose from 66.8 to 67.1 years while “work expectancy” fell from 41.1 to 40.1 years.4 It is not clear to what extent the rise in disability might reflect an increase in debilitating illnesses and to what extent it has resulted from the liberalization of Government benefits. Amendments to the social 4 See Fullerton and Byrne [4 , page 3 2 ], 1950 1955 1960 * Includes arm ed forces. Source: Employment and Training Report of the P resident (1976). security law in 1956 and 1960 extended disability benefits to individuals under 50 years of age. More over, the definition of disability was changed in a 1965 amendment from an anticipated “ perm anent” or “long term ” disability to a disability with “expected duration of at least 12 months” . As many as 78.3 percent of the newly eligible recipients of disability benefits between the ages of 25 and 50 may be in this category because of these revisions in disability benefits (and not because of an increase in the incidence of disability).5 A third major change in the pattern of labor force participation has been the rapid rise in teenager par ticipation. Participation rates have risen for both sexes, though the increase has been sharper for females. The total labor force participation rate for males aged 16 to 19 actually fell between 1960 and 1970 (from 58.6 per cent to 57.5 percent) but then rose to 60.9 percent in 1975. The labor force participation rate for teenage females, on the other hand, grew irregularly from 39.1 percent in 1960 to 49.3 percent in 1975. This overall 5 See Gastwirth [5 , page 4 5 ], FRBNY Quarterly Review/Winter 1976 27 growth in teenage labor force participation rates be tween 1960 and 1975 probably reflects, in part, the recent drop in college enrollments. Beyond this, part of the very recent rise in the labor force participation of both married women and teen agers (of both sexes) may be due to the fact that un employment in the most recent recession has been concentrated in the predominately male industries (principally manufacturing) while the predominately fe male industries (principally service) continue to experi ence employment growth. The entrance of secondary workers into the labor force under these circumstances may reflect an effort to maintain the household’s cus tomary standard of living when the household head has become unemployed.6 Overall, the changing rates of labor force participa tion for adult females, adult males, and teenagers have occurred in the wake of higher market wage rates, later marriages, lower birth rates, increased pension and disability benefits, and the other changes discussed earlier. In addition, however, the fact that the largest increases in labor force participation have occurred for the secondary workers (married women living with their husbands and teenagers) suggests the possibility of increased household preference for the pecuniary rewards of market work (in place of the nonpecuniary rewards to such activities as work in the home or leisure). Such a shift in preferences wCtild be very difficult to document, however. Table 3 Median Years of School Completed Y e a r* Fem ale M ale 1952 .......................................................................... 12.0 1957 .......................................................................... 12.1 1959 .......................................................................... 12.2 1962 .......................................................................... 12.2 1964 ......... 12.3 1965 ......... 12.3 1966 ......... 12.3 1967 ......... 12.3 1968 ......... 12.4 ......... 12.4 1969 1970 ......... 12.4 1971 ......... 12.5 19 7 2 f .............................................................. ......... 12.4 1973 ......... 12.5 1974 ......... 12.5 10.4 11.1 11.5 12.0 12.1 12.2 12.2 12.2 12.3 12.3 12.4 12.4 12.4 12.4 12.5 * O ctober survey for 1952 and M arch surveys for all other years, t Beginning 1972, data refer to persons 16 years of a ge and over, other years are aged 18 and over. Source: United States D epartm ent of Labor, H a n d b o o k o l L a b o r S ta tis tic s 1975— R e fe re n c e E d itio n . Table 4 Composition of the Civilian Labor Force Changing composition of the labor force and unemployment The result of these different patterns of labor force participation of older men, married women, and teen agers has been continuing change in the composition of the civilian labor force during the last twenty-five years. Males, 16 years and older, constitute a steadily decreasing proportion of the civilian labor force, fall ing from 70.4 percent in 1950 to 60.1 percent in 1975, and females, 16 years and older, a correspondingly increasing proportion, rising from 29.6 percent in 1950 to 39.9 percent in 1975 (see Table 4). Teenagers of both sexes, of course, have become a larger propor tion of the labor force over this period. Moreover, the Bureau of Labor Statistics projects a continuation of 6 The incom e earned by working wives constitutes a significant proportion of total fam ily income, so that "secondary worker" may be a som ew hat m isleading label. The exact percentage varies with the w ife ’s work experience and status (full or part-tim e worker). It has been estimated that in 1974 when the wife worked full tim e for fifty to fifty-two weeks during the year, the m edian fam ily incom e was $17,500, and the m edian proportion the wife contributed to that income was 38 percent. Even where the wife worked part time or full tim e for one to twenty-six weeks during the year, she con tributed 12 percent to a m edian fam ily income of $13,500. See Hayghe [6 , page 1 7 ]. 28 FRBNY Quarterly Review/Winter 1976 Actual percentage distribution Sex and age group 1950 1960 1970 1975 Total men, 16 years and over . . . . 70.4 66.6 61.9 60.1 16 to 24 years .................................... 16 to 19 y e a r s .................................. 20 to 24 y e a r s .................................. 25 to 54 y e a r s ...................................... 55 years and o v e r ............................... 55 to 64 y e a r s .................................. 65 years and o v e r ........................... 11.5 4.0 7.4 45.7 13.3 9.3 3.9 9.9 4.0 5.9 44.2 12.5 9.2 3.3 11.7 4.8 6.9 38.9 11.2 8.6 2.6 13.1 5.1 8.0 37.3 9.6 7.5 2.1 Total wom en, 16 years and over . . . 29.6 33.4 38.1 39.9 16 to 24 y e a r s ....................................... 16 to 19 y e a r s .................................. 20 to 24 y e a r s .................................. 25 to 54 y e a r s ....................................... . 55 years and o v e r ............................... . 55 to 64 y e a r s .................................. . 64 years and over ........................ 7.1 2.8 4.3 18.6 3.9 3.0 0.9 6.7 3.0 3.7 21.1 5.6 4.3 1.3 9.8 3.9 5.9 22.0 6.3 5.0 1.3 10.9 4.4 6.6 23.3 5.7 4.6 1.1 . . . . Source: United States D epartm ent of Labor, E m p lo y m e n t a n d T ra in in g R e p o rt o f th e P re s id e n t (1976). many of these patterns to 1990, although the projected rates of change are slower than have occurred over the past quarter century. Thus, an increasing proportion of the labor force is composed of those demographic groups that his torically have experienced relatively higher rates of unemployment than adult males. Table 5 shows that despite changes in the composition of the labor force, the general structure of unemployment— i.e., the rela tive unemployment rates for different age and sex groups— has remained fairly stable over time. Thus, in all years the highest unemployment rates have occurred for teenagers of either sex. However, while the male teenage unemployment rate was the higher of the two through the 1950’s and 1960’s, the rate for fe males now appears somewhat greater. These higher unemployment rates for teenagers reflect in part their relatively lower levels of skill and experience; teen agers are more likely to be laid off. They also are more likely to be moving into and out of the labor force because of discouragement with respect to job pros pects and because of more probable movement into and out of school. Moreover, they may move among jobs as they search for a satisfactory position. In the adult categories, a consistent pattern appears. In the youngest age group, 20 to 24 years, and in the oldest age group, 55 and over, male unemployment rates are generally higher than female rates while in the middle ages, 25 to 54 years, fem ale unemployment rates are higher. This pattern probably reflects the typical discontinuous labor force participation of women who periodically withdraw from the labor force to engage in child care or because they have become discouraged about finding a job. They then experience additional difficulties in finding a job as reentrants whose job skills may have depreciated during their period of withdrawal from the labor force. In fact, it has been estimated that the “ high rate at which em ployed women leave the labor fo rc e ... is the main factor in the higher unemployment rates they experience” .7 Because of these changes in the composition of the labor force, it appears that “full employment”— how ever this is interpreted— for the American economy is likely to imply a higher level of total unemployment today than it would have some years ago.8 This does 7 See M arston [8 , pages 1 7 9 -8 2 ], 8 It is im portant to note that this discussion abstracts from the effect that liberal unem ploym ent com pensation may have in increasing the level and duration of unem ploym ent. C onsideration of this factor is beyond the scope of this analysis. FRBNY Quarterly Review/Winter 1976 29 of the labor force in the same direction may be expected to have similar effects on the average level of the overall unemployment rate under given eco nomic conditions. Table 5 Unemployment Rates by Sex and Age Sex and age group 1950 1955 1960 1965 1970 1975 5.1 4.2 5.4 4.0 4.4 7.9 12.5 15.5 16.1 10.8 15.0 12.4 7.7 8.9 6.3 3.3 4.8 3.0 3.1 3.8 2.6 3.2 4.1 2.5 4 .3 4.6 3.3 4.0 4.2 3.5 16.9 13.4 8.4 3.4 2.4 2.4 2.8 3.3 21.6 19.0 14.3 7.0 4.9 4.8 4.3 5.4 Total men, 16 years and over . . . 16 18 20 25 35 45 55 65 to 17 to 19 to 24 to 34 to 44 to 54 to 64 years y e a r s ............ y e a r s ............ y e a r s ............ y e a r s ............ y e a r s ............ y e a r s ............ y e a r s ............ and over . . . Total women, 16 years and over . . . 16 18 20 25 35 45 55 65 to 17 to 19 to 24 to 34 to 44 to 54 to 64 years y e a r s ............ y e a r s ............ y e a r s ............ y e a r s ............ y e a r s ............ y e a r s ............ y e a r s ............ and over . . . Bibliography 13.3 12.3 8.1 4.4 3.6 4.0 4.9 4.8 5.7 4.9 5.9 14.2 9.8 6.9 5.7 4.4 4.5 4.5 3.4 12.0 9.1 6.1 5.3 4.0 3.6 3.8 2.3 15.4 13.0 8.3 6.3 4.8 4.2 3.4 2.8 5.5 5.9 9.3 17.2 17.4 21.2 14.8 14.4 18.7 7.3 7.9 12.7 5.5 5.7 9.1 4.6 4.4 6.9 3.2 3.5 5.9 2.8 2.7 5.1 2.8 3.1 5.1 Source: United States D epartm ent of Labor, Em ploym ent and Training Report of the President (1976). [ 1] B ow en, W illiam G ., and Finegan, T. A ldrich. The E cono m ics of Labo r F o rce P artic ip a tio n (P rinceton, N.J.: P rinceton U niversity Press, 1969). [ 2] B ower, Leonard G. “ Labor Fo rce— C hanges in C om position A ffect U n e m p lo y m e n t” . Business R eview (F e d e ral R eserve Ba’nk of D allas, February 1973). [ 3] C ain, G len G. M a rrie d W om en in the Labo r Fo rce (C hicago: U niversity of C hic a g o Press, 1966). [ 4] Fu llerton, H .M ., Jr., and Byrne, J.J. “ Length of W orking Life for M en and W o m en, 1 97 0 ” . M on thly Labo r R eview (February 1976). [ 5] G astw irth, Joseph L. “ On the D ec lin e of M a le Labor Fo rce Par tic ip a tio n ” . M o n th ly Labor R eview (O c to b er 1972). [ 6] H ayghe, H ow ard. “ Fam ilies and the Rise of W orking W ives— an O v e rv ie w ” . M on thly Labo r R eview (M a y 1972). [ 7] Kreps, Juanita. S e x in the M a rk e tp la c e : A m erican W om en at W ork (B altim o re: Johns H opkins Press, 1971). [ 8] M arston, S tephen T. “ E m plo ym ent In stability and High U n em p loym ent R ate s ” . B rookings P apers on E conom ic A ctivity (1, 1976). [ 9] M in ce r, Jac o b . “ Labor Fo rce P articipation of M a rrie d W o m e n ” . Aspects of Labo r Econo m ics (P rinceton, N .J.: P rinceton U ni versity Press, 1962). not mean that presently high rates of unemployment are solely or even largely attributable to changing labor force participation. However, it is clear from Chart 5 (which shows actual unemployment rates and weighted unemployment rates for constant labor force composi tion quarterly from 1957 through the third quarter of 1976) that an increasing proportion of the unemploy ment rate is due to the changing composition of the labor force. The difference between the two measures of unemployment was rather small until the late 1960’s. It has now grown to almost 1 percentage point. In the third quarter of this year the weighted unemployment rate was 0.8 percentage point below the actual un employment rate. Further changes in the composition 30 FRBNY Quarterly Review/Winter 1976 [10] M in ce r, Jaco b, and P o lac h e k , S olom on. “ Fam ily Investm ents in Hum an C ap ital: Earnings of W o m e n ” . J o u rn a l of P o litic a l E conom y (82, Pt. 2, Supp. M arc h -A p ril 1974). [11] R ees, A lbert. The Econo m ics H arp e r and Row, 1973). of W ork a nd Pay (N ew Y ork: [12] U nited S tates D ep artm e n t of Labor, Bureau of Labor Statistics. “ T h e U.S. Labor F o rce in 1990: N ew P ro je c tio n s ” , N ew s (S e p tem b er 1 5 ,1 9 7 6 ). [13] U nited S tates D ep artm ent of Labor, E m plo ym ent and Training A dm inistration . E m plo ym ent a n d Training R ep ort of the P resi d ent. Transm itted to the C ongress 1976 (W ashington, D .C.: U nited S tates G o vernm ent Printing O ffice, 1976). [14] U nited States D ep artm e n t of Labor, M a n p o w e r A dm inistration . M a n p o w e r R ep o rt of the P resident. T ransm itted to the C ongress A pril 1975 (W ashington, D .C .: U nited S tates G o vernm ent P rint ing O ffice, 1975). The financial markets Current developments C hart 1 Recent Changes in Interest Rates Percent 4 s n 1111 I I I I I I I I I I I I I I I I I I I I t I I I I I I I I I I I I I I I I I l 111 I O N Sources: Federal R eserve Bank of New York, Board of Governors of the Federal R eserve System, and M oody’s investors Service, Inc. The broad decline in interest rates which began early in the summer extended into the fall. Growth in economic activity has remained modest in recent months and, under these circumstances, the Federal Reserve ac commodated a further easing in interest rates without fundamentally altering the basic thrust of monetary policy. While the debt markets were somewhat hesitant in October, perhaps because of uncertainty associated with the outcome of the election, interest rates across the maturity spectrum moved down after the voting. Long- and intermediate-term yields declined to their lowest levels in more than two years despite both exceptionally heavy new issue activity in the municipal bond market and continuation of the Treasury effort to lengthen the maturity of its outstanding debt. Short term market rates of interest, too, dropped further and, at the end of November, reached their lowest levels since late 1972. The Federal Reserve discount rate was reduced late in November by V\ percentage point. The change to 5 1/4 percent was the first lowering of this rate since January. The action was taken to bring the dis count rate into better alignment with short-term rates generally. The persistent decline in most long-term interest rates through the summer and fall (see Chart 1) may have come as something of a surprise. Earlier, con siderable pessimism had been expressed about the outlook for long-term yields. The view that such rates would rise over the balance of the year apparently was premised on the strong first-quarter perfor mance of the economy and the spring bulge in the monetary aggregates. With the prolonged sluggishness in economic growth over the second and third quar ters, however, concern that capacity problems would ^ soon lead to an acceleration in inflation diminished. Moreover, the relatively modest expansion in the mon etary aggregates, particularly M lf over the summer FRBNY Quarterly Review/Winter 1976 31 Chart 2 Growth in the Monetary Aggregates From tw elve months earlier Percent 14 M3 1975 Source: 1976 Board of Governors of the Federal R eserve System. helped to allay fears of another inflationary burst. The prolonged drop in intermediate- and longer term yields came as the Treasury was in the process of lengthening the maturity of its marketable interestbearing debt outstanding. Indeed, the average ma turity of privately held debt, which stood at slightly over five years in mid-1967, fell consistently to a low of twenty-nine months at the end of 1975. It then held at about this level until the spring of this year, when it started to rise. By the end of November, the T rea sury had succeeded in raising the average maturity to about three years. This increase was accomplished through heavy reliance on coupon offerings, especially intermediate-term issues, and a concomitant reduction in the use of Treasury bill auctions as a vehicle for raising new cash. In the first three refunding operations of the year, for example, the Treasury sold intermediateterm issues at par on a subscription basis. Demand for these issues proved in general to be far stronger than anticipated, with the Treasury ultimately selling con siderably more of the securities than it had originally planned. Overall, through the first eleven months of this year, the Treasury raised $49 billion of new cash through coupon offerings but less than $6 billion in the bill market. In recent months, the slower rate of economic ex pansion has continued. At the same time, evidence has accumulated suggesting that business loans at large weekly reporting commercial banks finally may have bottomed out. Over the thirteen-week period 32FRASER FRBNY Quarterly Review/Winter 1976 Digitized for ended December 1, business loans at these banks, including loan sales to affiliates, rose $4.4 billion, whereas they had fallen by more than $21 billion from their peak at the end of 1974 to August of this year. W hile some of the latest increase reflects bank purchases of bankers’ acceptances, there nevertheless has been some growth in business loans exclusive of acceptances. The pickup appears to be. concentrated in major money center institutions, where such loans previously had been particularly weak. It should also be noted that, despite recent signs of some firming, overall business demand for short-term credit has still been unusually soft thus far in the economic recovery. And, with short-term market interest rates continuing to move lower, a few commercial banks reduced their prime lending rate 1A percentage point to 6 1/4 percent in late November, following a 1A percentage point reduction which became general early in the month. The complete absence of a normal cyclical rise in short-term interest rates at this stage in the business cycle has preserved the competitiveness of time and savings deposits at commercial banks and thrift insti tutions at a point when such deposits might typically be feeling the effects of Regulation Q ceilings.1 This factor, together with legal and institutional changes such as NOW accounts, corporate and local government savings accounts, and telephone transfers of funds from savings to checking accounts, has enhanced the attractiveness of savings relative to demand deposits and has contributed to divergent growth in the mone tary aggregates over much of the year.2 Indeed, over the first eleven months of the year, growth of M 2 generally was running about 4-5 percentage points above that of M 1( and the gap between the expansion of M 3 and of M x was even wider (see Chart 2). In testi mony before the Congress in November, Federal Re serve Board Chairman Burns indicated that the longrun objectives for growth in the monetary aggregates had been modified to take these factors into account. The upper boundary of the desired growth-rate range for M x was reduced V2 percentage point, with the range set at AV2 to QV2 percent for the period extend ing from the third quarter of 1976 through the third quarter of 1977. In contrast, the growth path ceilings for the broader M 2 and M 3 measures were raised V2 percentage point, establishing new ranges of IV 2 to 10 percent and 9 to 11V2 percent, respectively. 1 For an explanation of the recent behavior of short-term interest rates, see the article on pages 3 3-3 9 of this R eview. 1 For further discussion of these developm ents, see Laurence H. Meyer, "A lternative Definitions of the M oney Stock and the Dem and for M oney” , M o n th ly R evie w (Federal Reserve Bank of New York, O ctober 1976), pages 266-74. Interest rate behavior in the current economic recovery by John P. Judd Nominal interest rates, and especially short-term rates, are clearly behaving atypically when compared with previous postwar economic recoveries in the United States. The conventional wisdom is that yields can be expected to move in a roughly procyclical pattern in response to rising demands for money and credit during economic upturns and reductions in these demands in downturns, During the present recovery, however, rates have not exhibited the expected up ward movement and, in fact, are now lower across the maturity spectrum than they were at the onset of the recovery in March 1975. This decline has gener ally been more pronounced in short-term than in long term rates, following the usual pattern of greater cyclical fluctuation in yields at the short end of the term structure. This article focuses on short-term yields and sug gests several factors which may have contributed sig nificantly to their decline over the first year and a half of the 1975-76 upswing. Emphasis is placed upon the highly probable reduction in inflationary expecta tions associated both with the lessening of the actual rate of inflation in the recovery and with the elimi nation of some highly visible supply side difficulties, such as the oil embargo and certain crop failures. There was, in addition, relatively little upward pres sure on interest rates stemming from the corporate sector, as several factors apparently contributed to atypical cyclical changes in the demand for and supply of short-term credit by nonfinancial cor porations. These included a pronounced increase in the demand for liquidity and an unusually slow pickup in business spending (particularly on inventories), cou pled with a strong rise in corporate cash flow and equity market financing. Finally, there is the possi bility that a shift in the public’s demand for money balances played a role in depressing short-term inter est rates. In any event, the factors which produced the atypical cyclical decline in short-term rates helped the United States Treasury conduct extensive debt financing without encountering increases in short-term rates. Equally important, the Federal Reserve was able to follow a policy of growth in the monetary aggregates which was widely regarded as moderate within a framework of declining short-term yields. This article is divided into five sections. The first section contrasts the current situation with past cycli cal behavior of interest rates in the United States. This is followed by sections analyzing how the inflation premium, the restructuring of corporate balance sheets, and the possible shift in the demand for money af fected recent short-term interest rate movements. Some comments on the relative importance of these factors are contained in the final section. Recent movements in interest rates Until the beginning of the 1970’s, interest rates across the maturity spectrum in the United States gen erally exhibited lagging procyclical movements.1 This pattern is reflected in the four- to six-month prime commercial paper rate in the recoveries beginning in 1954, 1958, and 1961 (see Chart 1). This representative short-term rate reached a trough several months after the trough in economic activity and then increased fairly steadily through at least the first eighteen months of recovery. By this point in these three upturns, the yield on commercial paper was 79 percent higher on average than it was at the respective troughs. This pattern was not followed, however, in the two most recent recoveries: by eighteen months after the Noi See C agan [ 2 ] . FRBNY Quarterly Review/Winter 1976 33 of the impact of Phase One and also Phase Two (with its Committee on Interest and Dividends) on price and interest rate expectations is uncertain. Movements in most other short-term market rates and also in most medium- and long-term rates over the business cycles under discussion paralleled those of the commercial paper rate. The size of fluctuations, however, was generally smaller the longer the term of the security. For example, the average increase over the first eighteen months of the recoveries beginning in 1954, 1958, and 1961 was 157 percent for the yield on three-month Treasury bills and 79 percent for the four- to six-month prime commercial paper rate. At the long end of the term structure, yields on constant maturity long-term Government securities rose by only 17 percent on average and Moody’s Aaa corporate bond rate increased by 12 percent. Similarly, interest rates during the 1975-76 recovery also have exhibited larger movements at the short end of the term structure (see Chart 2). By Septem ber 1976 the three-month vember 1970 trough the commercial paper rate had fallen from 6.30 percent to 4.51 percent, a 29 percent decline, whereas in the current upturn this rate has fallen from 6.06 percent to 5.45 percent, a decline of 10 percent. It is difficult to interpret interest rate movements during the 1970-72 recovery because of the announce ment and implementation of Phases One and Two of the wage and price controls in the summer and fall of 1971. The commercial paper rate behaved in its usual fashion from the business-cycle trough in No vember 1970 until shortly after the enactment of Phase One in August 1971 (see Chart 1). It then de clined sharply. This has been attributed to suddenly reduced inflationary expectations following the an nouncement of the w age-price freeze.2 It seems appro priate, however, to exclude this episode from the analysis because the precise magnitude and timing J S e e C agan [2 , page 5 0 ]. Chart 1 Short-term Interest Rates in the First Eighteen Months after Cyclical Troughs Four- to six-month prime com mercial paper rate Percent Percent 5 .0 0 3 195 4 -5 5 4 .0 0 --------------------------------- 3 .0 0 P ercent 5 .0 0 1 9 5 8 -5 9 4 .0 0 4 .0 0 3 .0 0 3 .0 0 2.00 2 .0 0 W S M 1961-62 2 .0 0 r m 1.001I May 1954 I I I I I I I I I I I I I I I I I Nov 1955 1.00 I I I ! I I I I I I I I Apr 1958 Percent 1970 I I 1 I 1 Oct 1959 Percent 8 .0 0 I 1971 1972 3 .0 0 M ar 1975 1.00 .1 Feb 1961 I II I I I I i II 1975-76 I I I I I I I I I I I I Sep 1976 Note: Trough dates are those defined by the National Bureau of Economic Research except for the latest trough, which is tentatively judged to have ended in M arch 1975. Source: Board of Governors of the Federal R eserve System. 34FRASER FRBNY Quarterly Review/Winter 1976 Digitized for I I I I I I Aug 1962 C hart 2 Yields on Representative Short-term and Long-term Securities 1973 1974 1975 1976 Note: Shaded a re a rep re s e n ts a period of econom ic recession. The initial month is defined bv the N ational Bureau of Economic R esearch to be N ovem ber 1973. The final month is tentatively ju d g e d to be M arch 1975. Sources: Board of G overnors of the Federal R eserve System and M oody’s Investors Service, Inc. Treasury bill rate and the commercial paper rate had fallen to 93 percent and 90 percent of their March 1975 levels, respectively. Yields on both long-term United States Government securities and seasoned Aaa-rated corporate bonds, however, fell to only 97 percent of their trough levels. Hence, while interest rates have generally fallen during this recovery, the term structure of rates has behaved qualitatively the same as in previous cycles; long rates moved in the same direction but to a lesser extent than short rates. In view of this, the rem ainder of this paper will focus primarily on short-term yields. to expect higher future inflation, implying a decline in the anticipated purchasing power of debt maturing in the future. Under this so-called “ Fisher” or “ price expectations” effect, lenders will demand and bor rowers will be willing to provide compensation in the form of higher nominal interest rates. Within a highly simplified setting, a fully anticipated 3 percentage point increase in the rate of inflation requires that (all else being equal) the nominal rate of interest rise by 3 percentage points to equate the demand and supply of credit.3 In addition to being an important elem ent in the secular increase in nominal yields since the m id-1960’s, the rate of inflation can be expected to play a role in the cyclical behavior of interest rates as well. For this role to be substantial, there must be a fairly short lag between changes in actual inflation rates and the associated expectations a n d /o r changes in actual rates must be large. There is substantial evidence that prior to the 1960’s both short-run and long-run infla tionary expectations adapted to actual inflation in completely and with a long lag, but that since then the adjustment has been fairly rapid and more com plete.4 In addition, there is evidence that increasing actual inflation rates were the dominant factor in changes in the nominal Aaa bond yield from 1961 to 1971, whereas other factors were most important from 1954 to I9 6 0 .5 The increased role of inflation in the determination of nominal interest rates since the mid-1960’s can be traced substantially to the widely different behavior of inflation in the two periods (see Chart 3). First, from 1953 through 1964 the average annual inflation rate (as measured by the percentage change in the consumer price index) was 1.3 percent, whereas in the period from 1965 through Septem ber 1976 this average jumped to 5.2 percent. In addition, the cyclical swings in these rates have been larger in the latter period, and the trend in inflation has been upward, unlike the earlier period. All in all, it would appear that the cost of not closely considering future infla tion in economic decisions has risen significantly since 1964, providing a greater incentive for economic agents to observe carefully and react quickly to price The inflation premium An important characteristic of short-term interest rates during the first eighteen months of postwar upturns is that, while they rose in the first three episodes and fell in the latter two, rate levels were generally lower in the earlier recoveries (see Chart 1). This situation reflects the secular increase in interest rates over the period usually attributed to the rapid runup in the rate of inflation beginning in the mid-1960’s (see Chart 3). Higher rates of inflation may cause market participants 3 This on e-to-one relationship between changes in anticipated inflation and nom inal interest rates cannot, in fact, be expected to hold precisely. For exam ple, progressive incom e taxation (all else being equal) im plies that nominal rates will rise by more than the increase in anticipated inflation. For a theoretical and em pirical discussion of the inflation premium and nominal interest rates, see LeRoy [ 6 ] . < C ag a n [ 2 ] , Turnovsky [ 7 ] , and Y ohe and Karnosky [ 8 ] are among those w hose research supports this position. s See Feldstein and C ham berlain [ 4 ] , FRBNY Quarterly Review/Winter 1976 35 changes. Moreover, even if reaction time has not in creased materially since the mid-1960’s, the greater size of cyclical price swings would have by itself in creased the role of actual inflation rates in nominal interest rate movements. W hile inflation may in general have become a more important determinant of interest rates in recent years, there is another reason, which is peculiar to the 1975-76 episode, for the rapid incor poration of decreases in the rate of inflation into expectations. It is widely held that the large price increases in 1973-74 were greatly affected by cer tain special factors not related to aggregate demand, such as the oil embargo and various crop failures. It was, therefore, reasonable for many participants to expect a diminution of inflation when these supply difficulties were resolved. Hence, the recently ob served decline in the rate of inflation most likely confirmed these expectations and was translated quickly into a decline in nominal short-term interest rates. Since these expectations related to phenom ena widely regarded as temporary, short-term rates should have been affected to a greater extent than long-term yields. The data are consistent with this explanation, since three-month Treasury bill rates declined from 8.96 percent at their August 1974 peak to 5.08 percent in Septem ber 1976, while long term Government bond yields dropped from 8.60 per cent to only 7.78 percent over the same period. It should be noted, however, that this movement in relative yields is also consistent with the typical cycli cal pattern described previously. It is, of course, difficult to determ ine the exact quantitative relationship between the rate of infla tion and a nominal rate of interest. The following rather crude calculation may be useful, however, in putting recent experience in perspective. If the com mercial paper rate had increased during the first eighteen months of the 1975-76 recovery by the same percentage that occurred on average in the upturns beginning in 1954, 1958, and 1961, it would have attained a level of about 11 percent in September C hart 3 R a t e s o f I n f l a t i o n in t h e P o s t w a r P e r i o d Percentage change in the consum er price index from one y ea r earlier Percent 12.0 195C3-64 _ ? n In l ill i l ln 1953 1111iln 111 n l i i 1i i l n 1954 1955 t.l.L.t ! i ! ! ; . : i ! i 1! ! 1! 11 ! ! I ! I I I ! I I I i i 1i i l l i 1ii _n 1i . i l n i i i i i i a l i i i i ! _Lll 111 11II I i ] 111 11 LI J l i k i i n k i J 1956 1957 1958 1959 1960 1961 1962 1963 1964 14.U 196'5-76 n 1111111n 111 n 111111111 i , i ! 1! 1 1965 1966 1967 Source: 11i II 1J 111., 11111111111 I i ! I I i II I I i 11111111111 11111111111 11111111111 1111i i i ! 11 11 11 1I I I I 1968 1969 1970 1971 1972 1973 1974 1975 United States Departm ent of Labor, Bureau of Labor Statistics. * 36FRASER FRBNY Quarterly Review/Winter 1976 Digitized for ii 1111111i i 1 1976 1976. The level reached was in fact 5.45 percent, leav ing a difference of about 5V2 percentage points. The rate of inflation, as measured by the percentage changes in the consumer and wholesale price indexes, declined over the same period by 4.8 percentage points and 8.7 percentage points, respectively. Hence, a large part of the atypical behavior of short-term interest rates probably can be attributed to the diminu tion of the inflation premium.6 Corporate balance sheets Another important element in the cyclical pattern of interest rates is the behavior of the demand for credit by nonfinancial corporations. The typical pattern of increased credit demands in the early stages of re coveries is related to increases in business spending during these periods. These increases have been, how ever, unusually small in the current upturn. During the first five quarters of the recoveries beginning in 1954, 1958, and 1961, the book value of inventories increased by roughly 3 1/2 to 5 percent, while the percentage in crease over a comparable period in the current upturn was only a little over 1 percent. This modest advance was probably related to the unusually high ratio of in ventories to sales attained in the 1974 downturn and to the conservative approach to inventory spending taken by business in the wake of that experience.7 Moreover, during the first five quarters of the three previous up turns considered here, nominal business fixed invest ment rose by roughly 12.5 to 18 percent, but it was up only by 7 percent in the current episode. This situation may have been caused, in part, by the somewhat lower levels of capacity utilization reached in the 1974 re cession than those in previous downturns. In light of these developments, it would seem that part of the rea son that the credit market activities of the Treasury did not induce increases in interest rates is that business sector demand for credit has been unusually weak. Even if business spending had increased in propor tions similar to previous upturns, several aspects of the financial activities of nonfinancial corporations would have, by themselves, contributed to declines in short term interest rates. These factors can be divided into three categories: corporate cash flow, equity market * It should be noted that the im portant role of the inflation premium in nom inal interest rate m ovem ents raises a question as to w hether rates will exhibit a typical cyclical pattern of any kind in the future. This will, of course, depend heavily upon w h eth er or not inflation rates resum e the roughly procyclical pattern which has been less pronounced during the 1 97 0 ’s than in the prior postwar period. 7 Inventory investm ent m ay also have been sluggish in part because the anticipated rate of inflation declin ed , m aking the holding of physical assets less advantageous. financing, and the demand for liquidity.8 As the partial result of inflation and the tax cuts of 1975, increases in nonfinancial corporate cash flow less inventory profits in the current recovery have been larger than in any of. the three previous recoveries being considered. During the first five quarters of recovery, this measure in creased by 26 percent in 1954-55, 241/2 percent in 1958-59, and 24 percent in 1961-62, but by 45 percent in 1975-76. This recent increase is especially telling when compared with the rather modest growth in capital expenditures (nominal business fixed invest ment plus changes in the book value of inventories) over the same period. In addition, equity market financ ing by corporations was substantially larger in the current recovery as compared with previous ones. Over the first four quarters of recovery, net funds raised through stock sales equaled about $1.0 billion in 1954-55, $2.1 billion in 1958-59, and $1.5 billion in 1961-62 but equaled $9.8 billion in 1975-76. These factors have contributed to unusual weakness in growth of the demand for credit, and especially short term credit, in the current recovery. Another financial factor which has been important in reducing short-term nominal yields is the improve ment in corporate liquidity since late 1974. Through the 1960’s and the early 1970’s, there was a secular dete rioration in the liquidity position of nonfinancial corpo rations as measured by certain standard ratios. This phenomenon may have been related to the almost un interrupted business-cycle upswing during that period. The vulnerability of corporations to sudden changes in credit market conditions was not really demonstrated until the events of the most recent downturn in 1973-75. Toward the end of that recession, nonfinancial corporations suddenly altered their previous behavior in favor of increased liquidity. This situation is evident in movements in the ratio of liquid assets to current liabilities and in the ratio of short-term debt to bonds (see Chart 4). The former ratio declined steadily from a peak in 1959-111 of 55 percent to a low of 29 percent in 1974-IV but has increased markedly since then. The latter ratio reached a trough in 1958-111 of 36 percent, then increased to 67 percent in 1974-IV, but subse quently has fallen substantially. Hence, the pattern since late 1974 has been one of lengthening the matu rity structure of debt and placing greater emphasis on liquid assets.9 Both of these factors have served to put downward pressure on short-term interest rates. 8 These points are discussed in detail by Harris [ 5 ] (also see [ 1 ] in connection with the dem and for business loans but a pply equally well to recent short-term interest rate m ovem ents. * T h e additional liquid assets have been m ainly in the form of United States Treasury bills. FRBNY Quarterly Review/Winter 1976 37 C hart 4 Selected Liquidity Measures for Nonfinancial Corporations 1953 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 Note: Shaded a re a s represent periods of recession as defined by the National Bureau of Econom ic R esearch except for the latest recession, which is tentatively judged to have ended in M arch 1975. Source: Board of Governors of the Federal R eserve System. The demand for money The preceding discussion has attempted to explain the unusual decline of short-term interest rates in the current recovery by analyzing the behavior of variables which normally would be expected to explain fluctuations in nominal interest rates. It may be, how ever, that recently observed interest rate behavior stems in part from a shift in the public’s demand for money relative to that for other assets. This possi bility has been raised by recent difficulties with econometrically estimated money demand equations. Some equations for M x have overestimated the demand for money to a progressively greater extent since the middle of 1974.10 These results at least raise the possibility of a yet unexplained and undefined change in the relationship between the demand for money and its explanatory variables. Such a change would be important for interest rate movements in the current upturn. If money demand has shifted inward, this would most likely imply simultaneous outward shifts in the sup ply of short-term credit. If the public demands less money at any given interest rate level than formerly was the case, it will presumably want to hold greater quantities of other liquid assets such as Treasury 10 A recent paper by Enzler, Johnson, and Paulus [ 3 ] discusses these difficulties and the authors’ numerous attem pts to correct for them, none of which were particularly successful. FRBNY Quarterly Review/Winter 1976 Digitized for38 FRASER bills, commercial paper, and deposits at nonbank thrift institutions. As demand shifts in favor of these other assets, short-term interest rates tend to fall. Conclusion This article has traced the unexpected behavior of short-term interest rates in the current economic re covery principally to changes in the inflation premium and to other factors affecting demand and supply in the market for short-term credit. Because it is difficult to evaluate the precise size of these effects and indeed even their relative importance, conclusions necessarily must be tentative. Nevertheless, even if allowance is made for fairly long lags in the response of inflationary expectations to actual inflation rates, a decline in the inflation premium since early 1975 would seem capable of explaining much of the recent decline in rates. This factor alone, however, should leave borrowers and lenders in about the same posi tion as prior to the change in inflationary expectations, and should not affect the quantity of short-term credit. Since nonfinancial commercial paper plus business loans outstanding at all commercial banks declined at an average annual rate of 3.7 percent from March 1975 through September 1976, it seems likely that fac tors other than the inflation premium have had an effect. Among those proposed above, some have con tributed to an increase in the supply of credit and others have produced a decrease in the demand for it. Both effects result in lower interest rates, but only the demand elements cause the quantity of short-term credit to fall as well. This suggests that the factors reducing credit demand— weak growth in business spending relative to avattabfe-mternal funds, emphasis on equity market financing, and the lengthening of the maturity of the debt of nonfinancial corporations— have played a somewhat greater role than the factors in creasing the supply of credit— greater demand for liquid assets by nonfinancial corporations and a possi ble contraction in the demand for money balances. [2] Cagan, Phillip. “The Recent Cyclical Movements of Interest Rates in Historical Perspective". Business Economics (January 1972), pp. 43-52. [3] Enzler, Jared; Johnson, Lewis; and Paulus, John. “Some Prob lems of Money Demand”. Brookings Papers on Economic Activ ity (1976:1), pp. 261-82. [4] Feldstein, Martin, and Chamberlain, Gary. “Multimarket Ex pectations and the Rate of Interest”. Journal of Money, Credit and Banking (November 1973), pp. 873-902. [5] Harris, Maury N. “The Weakness of Business Loans in the Current Recovery”. Monthly Review (Federal Reserve Bank of New York, August 1976), pp. 201-14. [6] LeRoy, Stephen F. “ Interest Rates and the Inflation Premium”. Monthly Review (Federal Reserve Bank of Kansas City, May 1973), pp. 11-18. Literature cited [7] Turnovsky, S. J., "Empirical Evidence on the Formation of Price Expectations”. Journal of the American Statistical Asso ciation (December 1970), pp. 1441-53. [1] Board of Governors of the Federal Reserve System. “Recent Shifts in Corporate Financing Patterns”. Federal Reserve Bul letin (September 1976), pp. 733-40. [8] Yohe, W. P., and Karnosky, D. S. “ Interest Rates and Price Level Changes, 1952-69”. Review (Federal Reserve Bank of St. Louis, December 1969), pp. 18-36. FRBNY Quarterly Review/Winter 1976 39 August-October 1976, Interim Report Treasury and Federal Reserve Foreign Exchange Operations by Alan R. Holmes and Scott E. Pardee* During the August-October period under review, foreign exchange market activity reflected the large disparities that persisted in actual and expected price performance and in balance-of-payments positions of major Euro pean countries. Market participants were quick to react to new events and to rumors or official statements which reinforced their expectations of a rise or a fall in a particular currency. In this atmosphere, markets for several currencies were unsettled by large-scale shifts in professional trading positions as well as in commercial leads and lags. Among those European currencies floating indepen dently vis-a-vis the dollar, the pound was driven down 11 percent during the period, the Italian lira declined a net of 3 percent and the French franc slipped a net of 2 percent. Meanwhile, within the group of currencies joined together in the European Community (EC) “snake” , speculative pressures had reemerged late in July on expectations of an early upward adjustment for the German mark against the other participating currencies. Tensions within this arrangement continued to build through the October 3 election in Germany, and member central banks again intervened massively while taking a variety of other measures— including in some cases a sharp tightening of monetary policy— to maintain their currencies within the limits of the snake. After an October 17 meeting in Frankfurt, the partici pating governments announced an agreement by which the mark’s parity was adjusted upward by 2 to 6 per cent against its partner currencies. After some initial hesitancy in the market, a substantial unwinding of dealers’ positions and reversal of commercial leads and lags was in progress by the month end. As in previous episodes of market stress, the dollar, as the main vehicle currency in the market, was in evitably caught up in the cross fire, rising against some currencies and falling against others. Against the German mark, however, the dollar began to lose some of its earlier resiliency to the heavy shifts into marks which developed each time market participants sought to switch out of other EC snake currencies or out of currencies, like sterling, which were weakening generally. This reduced buoyancy for the dollar in part reflected market concern over the pause in the Table 1 Federal Reserve System Drawings and Repayments under Reciprocal Currency Arrangements In millions of dollars equivalent Transactions with * Mr. Holm es is the Executive Vice President in charge of the Foreign Function of the Federal Reserve Bank of New York and M anager, System Open M arket Account. Mr. Pardee is Vice President in the Foreign Function and Deputy M anager for Foreign O perations of the System Open M arket Account. The Bank acts as agent for both the Treasury and the Federal Reserve System in the conduct of foreign exchange operations. 40 FRBNY Quarterly Review/Winter 1976 N ational Bank of Belgium ............................. Swiss N ational Bank . . . System swap com m itments, July 31, 1976 Drawings ( + ) or repay ments ( — ) August 1 through O ctober 31, 1976 System swap com m it ments, O ctober 31, 1976 82.4 1,147.2 55.0 - 1 ,1 4 7 . 2 27.4 -0 - 1,229.6 - 1 ,2 0 2 . 2 27.4 lt«s Federal Reserve System Drawings and Repayments under Special Swap Arrangement with the Swiss In m illio n s o f d o lla rs e q u iv a le n t T ra n s a c tio n s w ith S ystem sw ap c o m m itm e nts, J u ly 31, 1976 Sw iss N a tio n a l B ank . -0 - Tota l -0- ............................... D ra w in g s ( - f ) o r re pa ym e n ts ( — ) A u g u st 1 th ro u g h O c to b e r 31, 1976 System sw ap c o m m itm e n ts, O c to b e r 31, 1976 + 1,147.2 + 1,147.2 ------------------------ 1,147.2 1,147.2 United States economic recovery, the relative decline in interest rates here, and the further widening of our trade deficit. Uncertainties surrounding the United States elections also tended to weigh on market senti ment toward the dollar. In this atmosphere the dollar declined by a net 6 to 7 percent against the mark and other European currencies linked to it. For the most part, this decline was orderly. The occasionally sharp drops in dollar rates were mainly confined to the European trading day, at which times the German Bundesbank supplemented its intervention in other snake currencies with small to moderate pur chases of dollars. On a few days, however, the bid ding for marks spilled into the New York market and unsettled trading conditions here. On August 16-17, when speculation over possible rate adjustments within the EC snake triggered more generalized bid ding for marks, the Federal Reserve intervened in New York, selling $15.9 million equivalent of marks from balances. Again, in September and early October, amidst uncertainties surrounding the general election in Germany, the Federal Reserve operated on four days (September 16 and 24, October 5 and 6) to sell a total of $37.2 million of marks. Toward the end of October, when the continued volatility in sterling kept the markets generally unsettled, the dollar was again ad versely affected at times and the Federal Reserve sold another $16.3 million of marks in operations on Octo ber 19 and 26, also from balances. In summary, the Federal Reserve sold a total of $69.4 million equivalent of marks from existing bal ances during the three-month period. These sales were largely offset, however, by purchases of $63.4 million equivalent of marks, principally from corre spondents. In other operations, as part of its program to repay swap debt outstanding since August 1971, the Fed eral Reserve acquired sufficient Belgian francs in the market and from correspondents to cover the remain ing $82.4 million of its swap drawings on the National Bank of Belgium. Of this, the System had repaid $55 million by the end of October and had purchased in the forward market francs sufficient for repayment of the remainder in early November. Moreover, in October, the Federal Reserve and United States Treasury reached agreement with the Swiss National Bank on an orderly procedure for re paying over three years the Swiss franc indebtedness remaining from August 1971. This included $1,147.2 million equivalent of drawings under the Federal Reserve swap line, as well as the $1,599.3 million equivalent of United States Treasury Swiss francdenominated notes. In this connection, the Federal Reserve’s drawings on the original swap arrangement with the National Bank were repaid on October 29, using Swiss francs drawn under a newly established special swap facility which, in turn, will be reduced as the swap is repaid over the three-year period. In September, the Bank of England drew a further $100 million each from the Federal Reserve and the United States Treasury, raising total drawings in both cases to $300 million under the standby facility es tablished in June 1976. These drawings were in pro portion to drawings on other countries participating in the $5.3 billion package that terminates on Decem ber 9. In connection with the repayment of drawings under this agreement, the United Kingdom authorities initiated in October an application for a $3.9 billion drawing on the International Monetary Fund (IMF). On August 31, following persistent pressures on the Mexican peso through much of the year, the Mexican authorities announced that they would no longer sup- T a b le 3 ■■MM Drawings and Repayments by Foreign Central Banks and the Bank for International Settlements under Reciprocal Currency Arrangements In m illio n s o f d o lla rs — ----------D ra w in g s on Federal R eserve System o u ts ta n d in g J u ly 31, 1976 B anks d ra w in g on Federal Reserve System B ank o f E n g la n d B ank o f M e x ic o . 200.0 ... ------------------------------- 5600 D ra w in g s { + ) o r re pa ym e nts ( — ) August 1 th ro u g h O c to b e r 31, 1976 D ra w in g s on Federal Reserve System o u ts ta n d in g O c to b e r 31, 1976 + 100.0 -3 6 0 .0 300.0 -0 - c + 1 0 0 .0 1 -3 6 0 .0 300.0 f i i s i i i i m i i ii i ii i i FRBNY Quarterly Review/Winter 1976 41 port the previous fixed rate of $0.08, and over subse quent days the peso depreciated by almost 39 percent. After some recovery, official intervention was resumed to help steady the rate around $0.0505. By that time, Mexico had applied for substantial medium-term assist ance from the IMF. In that connection, on September 20, the United States Treasury and the Federal Reserve agreed to a special arrangement with the Bank of Mexico, making available up to $600 million of interim financing to Mexico. On this basis, the Bank of Mexico drew $365 million on the United States Treasury in early October and repaid that amount out of proceeds of its first IMF drawing in early November. The Bank of Mexico also repaid in early October the $360 million of swap drawings on the Federal Reserve outstanding for six months. In the market, however, selling pressure against the peso remained heavy, and in late October the authorities permitted the peso rate to depreciate by a further 25 percent. Swap network operations, 1962-76 As a supplement to this interim report, tables are presented providing historical data on Federal Re serve swap operations over the entire 1962-76 period in which the reciprocal currency arrangements have been in existence. These summaries have been pre pared in response to a number of requests from both the academic and financial communities for data on System operations. Table I shows the changes in the amounts available under each of the reciprocal cur rency arrangements. Table II presents Federal Reserve drawings and repayments by quarter on those swap lines for which there were operations, and Table III gives drawings and repayments by others. FRBNY Quarterly Review/Winter 1976 Digitized for42 FRASER Table I Federal Reserve Reciprocal Currency Arrangements In m illio n s o f d o lla rs ; y e a rly in c re a s e s ( + ) a nd d e cre a se s ( — ) A m ount of fa c ility O rig in a l fa c ility D ate A m o u n t 1 2 /3 1 /6 2 In s titu tio n A u s tria n N a tio n a l B a n k ........................ N a tio n a l B ank o f B e lg i u m ................... B ank o f C an a d a ...................................... B ank o f D e n m a r k .................................... B ank o f E n g la n d ...................................... B a n k o f F r a n c e ......................................... G e rm a n Fed e ra l B a n k .......................... B a n k o f I t a l y .............................................. B a n k o f J a p a n ......................................... B ank o f M e x ic o ......................................... N e th e rla n d s B a n k .................................. ............ ............ 1 0 /2 5 /6 2 6 /2 0 /6 2 ............ 8 / 2 /6 2 ............ 1 0 /2 9 /6 3 ............ 6 /1 3 /6 2 B a n k fo r In te rn a tio n a l S e ttle m e n ts : S w iss f r a n c s - d o lla r s .......................... O th e r a u th o riz e d E urop e a n c u r r e n c ie s - d o lla r s ............................... 50.0 50.0 250.0 100.0 50.0 50.0 5 0.0 5 0.0 150.0 130.0 50.0 100.0 50.0 100.0 50.0 50.0 250 .0 -0 50.0 50.0 50.0 150.0* -0 -0 50.0 -0 -0 100.0 100.0 100.0 150.0 -0 900.0 1966 1967 1968 — — — + + + 50.0 50.0 250.0 — — — — +250.Q > — — — — — + 2 0 0 .0 — + 100.0 + + + + + 600.0 — 150.0 150.0 200 .0 1963 — — — 1965 1964 — + + + 450.0 50.0 200.0 100.0 1 5 0 .0 f + 50.0 — — + 50.0 + + 5 0 .0 f 50.0 — — — — + + 50.0 5 0.0 + + 75.0 250.0 1 0 0 .0 f 150.0 — 350.0 150.0 300.0 130.O f 75.0 1 0 0 .0 f 100.0 200.0 + 50.0 — — + 50.0 + + 50.0 + + 50.0 — 1 5 0 .0 f + 1,150.0 + 3 0 0 .0 + 450.0 + 1,700.0 + + + + + + + + + + + + 250.0 —500.0 900.0 250.0 250.0 250.0 — + + 175.0 — 50.0 200.0 200.0 + 200 .0 400.0 + 400.0 + 2 ,5 8 0 .0 + + 3 ,4 2 5 .0 * F a c ility in c re a s e d $10 0 .0 m illio n on D e c e m b e r 8 ,1 9 6 2 . f N ew fa c ility . T a b le I (c o n tin u e d ) In s titu tio n A u s tria n N a tio n a l B a n k ...................................... N a tio n a l B ank o f B e lg i u m .................................... B ank o f C an a d a ..................................................... B a n k o f D e n m a r k ..................................................... B a n k o f E n g la n d ..................................................... B ank o f F r a n c e ....................................................... G e rm a n Federal B a n k ......................................... B a n k o f I t a l y .............................................................. B ank o f J a pa n .......................................................... B a n k o f M e x ic o ...................................... .................. N e th e rla n d s B a n k ..................................................... B ank o f N orw ay ....................................................... B ank o f Sw eden ....................................................... S w iss N a tio n a l B a n k ................................................ B a n k fo r In te rn a tio n a l S e ttle m e n ts: S w iss f r a n c s - d o lla r s ........................................... O th e r a u th o riz e d E u rop e a n currencies-dollars .............................................. Total ............................................................................... ................. ................. ................. ........ ........ ........ ........ ........ ......... ................. ................. ........ ......... ......... 1969 1970 + 1 0 0 .0 + 2 7 5 .0 — — — — — 1971 1972 + 100.0 — — — — — — — — ■ — — — + 250.0 __ —— — — — — — -1 0 0 .0 — — + 1 0 0 .0 — — — — — + 400,0 __ — — — — — — — — — — — — — — — — C+ 5 7 5 .0 — — — — — — + 250.0 + 5 0 0 .0 1973 1974 __ 50.0 + — 400.0 + — + 1 ,000.0 — 50.0 + .— + 1 000.0 — + 1,000.0 — + 1,000.0 750.0 + 1 000.0 + — + " ,000.0 — 50.0 + — 200.0 + — 50.0 + — 50.0 + — 400.0 + — + 250.0 -0- + 6 ,2 5 0 .0 1 /1 /7 6 to 1975 1 0 /3 1 /7 6 __ __ — — — — — *— — + 180.0 — — .— — __ __ — — — — — — — — — — — — A m ount of fa c ility 1 0 /3 1 /7 6 250.0 1,000.0 2,000.0 250.0 3,000.0 2,000.0 2,000.0 3,000.0 2,000.0 360.0 500.0 250.0 300.0 1,400.0 — — — — — — 1,250.0 + 1 8 0 .0 -0 - 20,160.0 + 2 ,0 0 0 .0 600.0 FRBNY Quarterly Review/Winter 1976 43 Table II Federal Reserve System Drawings and Repayments under Reciprocal Currency Arrangements M a rch 1962 th ro u g h O c to b e r 1976; in m illio n s o f d o lla rs e q u iv a le n t; d ra w in g s ( + ) o r re p a y m e n ts ( — ) A u s tria n N a tio n a l B ank P eriod 1962: N a tio n a l Bank of B e lg iu m B ank o f C anada Bank of E n g la n d Bank of Fra n ce G e rm a n F ederal Bank 50.0 I.. II . . + 50.0 III . . — 50.0 + + O u ts ta n d in g I .. - -5 0 .0 It.. \ + \— 20.0 (+ 1 - 5.0 5.0 0- - ;+ l- 0- + IV . . 1964: 15.0 0- - I ............... 15.0 - 0- 25.0 25.0 + 10.0 50.0 10.0 50.0 ( +20.0 (+ 1 0 .0 I -20.0 | — 10.0 - 0- - + 12.5 — 113.0 ( + 9.0 I -1 2 .5 9.0 f + 136.0 |- 1 1 3 .0 60.0 9 0 yu \ + 550 {-1 1 5 .0 0- — 15.0 - I 1965: -0 - + 37.5 ( + 107.5 {-1 0 0 .0 45.0 + I .. ■- + II . . (+ IV . . 1966: 5+ 1 - 0- - -0 - ; + i5 . o I — 60.0 10.0 - 5.0 0- 0- - - - - 0- + 140.0 140.0 37.5 10.0 97.5 10.0 + 76.2 — 85.4 105.8 + — + — III . . IV . . - 0- I.. II . . - 0- - + 100.0 - (+ { - - 0- 112.1 - - 0- f + 3 2 5 .0 I — 225.0 85.0 15.0 - 15.0 311L0 - - 0- FRBNY Quarterly Review/Winter 1976 Digitized for 44 FRASER - 0- - 0- 0- 100.0 -0 - 150.0 20.0 - (+ 65.0 C+ )- 10.0 \— 20.0 — — 35.0 - 35.0 + - 0- 112.1 55.0 55.0 - 15.0 + 100.0 — 40.0 ] j \+ I— i+ \+ 0- - 0- 75.0 5.0 55.0 15.0 + 15.0 185.0 28.0 33.0 42.0 127.0 25.0 250.0 - - 040.0 - 40.0 -0- ( + 300.0 |-1 7 0 .0 130.0 75.0 — 280.0 100.0 45.0 95.0 {+ I - 200.0 55.0 145.0 - 0- 75.0 + 185.0 + 15.0 ;+ 2 8 5 .0 i — 85.0 400.0 - 55.0 65.0 + 75.0 -345.0 III . . + 5.0 145.0 100.0 II . . IV . . 0- _ 1q n n 1300 -0 - +112.1 0- I.. O u ts ta n d in g 25.0 100.0 -1 8 9 .0 - { — 25.0 -175:0 - 3000 50 0 - 0- ; + i5 .o [ - 120.0 88.8 + - f + 100.0 • 40.0 170.0 - 45.5 12.0 + 130.0 l + 54.0 1 -1 2 4 .1 - 48.0 500.0 ( + 300.0 (-3 5 0 .0 9.5 25.0 + 400.0 53.1 80.0 5.0 75.0 - - 60.0 350.0 1+ 15.0 55.0 70.0 + 350.0 0- IV . . 1969: — 50.0 + 100.0 111 .. O u ts ta n d in g 50.0 - 0- + 5.0 +100.0 0- 30 0 30.0 50.0 100.0 - I 50.0 95.0 ( + 150.0 ) - 82.0 {-1 6 8 .0 a g a in s t B e lg ia n fra n c s :+ 2o.o 20.0 -0 - 10.0 0- l + 60.0 I — 10.0 80.0 + J + 10 0 .0 - 50.0 — 55.0 50.0 — 140.0 II . . 1968: -0 - I.. O u ts ta n d in g 50.0 - 50.0 — 3 5.0 ' III 1967: -0 - 55.0 10.0 30.0 35.0 0- - I .. II . . IV . . O u ts ta n d in g + + + \ — 40.0 f + 75.0 \ 80.0 III . . O u ts ta n d in g 10.0 — 25.0 V O u ts ta n d in g . . . . - 0- I I ............... II I a g a in s t S w iss fra n c s + £ + 40.0 ' — 50.0 + 60.0 - S w iss N a tio n a l Bank 10.0 40.0 50.0 50.0 + 150.0 III . . O u ts ta n d in g 0- - N e th e rla n d s Bank \+ l- 50.0 IV . . 1963: Bank of Ita ly 0 Table II (continued) Austrian National Bank Period 1970: I ................. I I II I I V O u ts ta n d in g .......... 1971: -0 - I ................. I I ................. I l l ................. I V ................. O u ts ta n d in g .......... 1972: -0 - I ................. I I ................. I V ................. ( + 335.0 7 -1 2 5 .0 j + 1 2 5 .0 |- 2 0 5 .0 + 260.0 -1 4 5 .0 455.0 -0 - I ................. 1973: - f 50.0 f + 45.0 | -1 3 0 .0 + 135.0 \ + 165.0 | — 110.0 210.0 \+ ) — c+ ) - I l l ................. O u ts ta n d in g .......... National Bank of Belgium 20.0 10.2 10.2 35.0 55.0 415.0 - 25.0 f+ 6.0 52.0 - 82.2 Bank of C anada Bank of England German Federal Bank Bank of France B ankof Italy Swiss National Bank N etherlands Bank against Swiss francs BIS against Belgian francs 145.0 — 130.0 + + 270.0 + -0 - -0 - -0 - -0 - + -0- + 7 5 0 .0 — 35.0 715.0 - -0- -0 - 200.0 + 300.0 1f + 130.0 | -3 0 0 .0 (+ 1 2 0 .0 i[ - 2 5 0 . 0 60.0 10.0 50.0 3 0.0 -0 - -0 - + 250.0 + 750.0 + 6 0 0 .0 + 35.0 1,000.0 600.0 35.0 300.0 50.0 .-0 - -0 - -0 - 150.0 450.0 -0 - -0 - f+ I - — - 300.0 300.0 -0 - 52.0 -6 6 3 .0 200.0 -0 - f + 104.6 ) -1 0 4 .6 - -3 5 .0 130.0 570.0 -0 - 600.0 -0 - 600.0 -0 - 600.0 -0 - 600.0 -0 - 5.0 I I II I I V ................. O u ts ta n d in g .......... 1974: -0 - 261.8 ( + 4 7 .0 | — 47.0 -0 - -0 - -0 - \ } f | I ................. I I ................. (+ ) (+ I l l ................. I V ................. * O u ts ta n d in g .......... 1975: -0 - I ................. II 1.7 1.7 13.2 13.2 261.8 + 16.7 (+ 13.1 29.8 I V ................. f+ (— 5 4.0 * 18.1 297.6 1975: -0 - I ................. I I ................. I l l ................. O c t o b e r ................. O u ts ta n d in g .......... -0 - -0 - 21A i\ + 2.9 [— 2.9 -0 - + 2 5 5 .0 3.7 + 130.4 — 122.8 -0 - f + 3 0 1 .5 82.8 218.7 f + 4 5 .6 ) - 5.1 -4 0 .5 f + 644.1 ) — 25.0 ( + 63.4 J -4 8 7 .7 -4 1 3 .5 -0 - 1[ + 7.6 I 7.6 [ + 38.0 [ — 34.8 3.2 + 49.0 J; + ] - 47.3 90.6 8.8 565.0 - 193.8 (+ 1 - 13.3 5.9 378.5 + -0 - -0 - -0 - -0 - -0- -0 - -0 - -0 - -0 i + I - f + 133.9 } — 26.4 — 107.5 -0 - 19.6 19.6 -0 - 152.1 159 4 + -0 - 86.5 — 83.7 -1 0 0 .0 -0 - -0 - -2 5 8 .8 I I I ................. O u ts ta n d in g .......... f + 4 3 5 .6 ) -2 7 8 .9 f + 21.0 ( — 177.7 -0 - 1 96.Of 567.2 1+ l - 6 0 0 .0 i 20.0 - 1 ,147.2§ -0 - — 600 0 t -0 - -0 - * Amount by which the do llar countervalue of the Federal R eserve’s pre-August 1971 Belgian franc com m itm ents, adjusted for the B elgian franc revaluation of 1971, was increased to reflect the two United States dollar devaluations of 1971 and 1973. f Amount by which the do llar countervalue of the Federal Reserve's pre-August 1971 Swiss franc com m itm ents was increased to take account of the two United States dollar devaluations of 1971 and 1973. This increase is reflected entirely in the System ’s position with the Swiss National Bank because of a transfer of Swiss franc com mitments from the Bank for International Settlem ents to the Swiss National Bank sufficient to keep Federal Reserve com m itm ents to the BIS within the $600 million swap facility. t C onsolidation of Swiss franc swap debt. § The Federal Reserve repaid the outstanding $1,147.2 million equivalent of its pre-August 1971 Swiss franc swap indebtedness and took down the sam e am ount on the newly created special swap line designed to refund the short-term obligation into a m edium -term obligation, which will be reduced as drawings are repaid over the next three years. FRBNY Quarterly Review/Winter 1976 45 Table III Drawings and Repayments by Foreign Central Banks and the Bank for International Settlements (BIS) under Reciprocal Currency Arrangements M arch 1962 through O ctober 1976; in millions of dollars; drawings ( + ) or repaym ents ( — )___________________________________ ___ Austrian National Bank Period I..., II . . . III . . . IV . . . Outstanding National Bank of Belgium Bank of Canada National Bank of Denm ark Bank of England Bank of Bank of Bank of Bank of France Italy Japan M exico Netherlands Bank BIS against G erm an marks 1962: + 250.0 -2 5 0 .0 0- - (+ 1 1+ ) (+ ) - 1963: II III . . . IV . . . Outstanding 1964: - 0- - 0- - 25.0 12.5 10.0 12.5 10.0 5.0 15.0 -0 - 0- 0- - 0- - 0- 0- 0- - 0- - - 0(+ ) (+ ) (+ ) f+ IV . . . Outstanding - 50.0 50.0 - 1 5 0 .0 15.0 85.0 65.0 J + 1 .2 7 0 .0 | — 1,105.0 1965: 0- - 0- - 0- 0- - 0- 0- - 0- 0- - 0- - 0- - 0- - - 0- - - 0- - + 50.0 ( + 3 0 .0 ]-3 0 .0 -5 0 .0 200.0 - 0- - 0- 605.0 485.0 610.0 570.0 475.0 85.0 75.0 350.0 475.0 - 0- - 0- 0- - — 475.0 4 “ 175.0 450.0 (+ 225.0 1 - 1966: IV . . . Outstanding - 0- - 0- + 17.6 - 17.6 - - 0- I - 0- - 0- - 0- I... + 250.0 II... -1 2 5 .0 + 30.0 20.0 + 180.5 -1 8 3 .0 7.5 III . . . IV . . . Outstanding I + 50.0 III . . . -50.0 350.0 + 225.0 + 425.0 -1 2 5 .0 - 0- 600.0 1,050.0 + 50.0 + + 545.0 645.0 600.0 - - 200.0 25.0 25.0 + - -0 - -0 ( + 25.0 { - 25.0 ( + 100.0 { -1 0 0 .0 + 74.0 58.5 + 195.0 -1 0 4 .0 + 244.0 -1 5 4 .0 -0 - { -0 - 850.0 100.0 1,150.0 50.0 |+ i+ 0- - 465.0 540.0 330.0 255.0 - 0- - 0- 0- - -0 - 46 FRBNY Quarterly Review/Winter 1976 -0 - 650.0 - 0- - 0- ( + 43.0 { -2 4 3 .0 ( + 182.0 { - 39.0 ( + 191.0 ) -3 3 4 .0 (+ 4 2 1 .0 75.0 346.0 0- - 10.0 200.0 0- - ;+ +100.0 (+ 3 9 0 .0 40.0 + 275.0 -2 9 5 .0 430.0 + 54.7 - 24.9 - 0- - 0- - 0- 29.8 - 0- + -4 6 1 .0 J+ -1 0 9 .7 -3 0 0 .0 0- - 0- 82.2 J + 109.7 82.2 65.0 + 300.0 65.0 - 66.0 -4 12 .0 ’ + 306.0 -195.0 1 + 1 4 5 .0 -2 56 .0 1 + 1 2 6 .0 46.0 80.0 ;+ ( + 225.0 { - 1 9 4 .0 450.0 -2 0 4 .0 IV . . . Outstanding — 75.0 75.0 (+210.0 50.0 {+1,000.0 IV . . . Outstanding (+ ) - 350.0 III . . . 1969: - + (+ - 0- - +100.0 IV . . . 1968: 0- - 25.0 + 0- - III . . . 1967; 0- 25.0 I... II . . . Outstanding - + - 0- - 0- - 0- 51.0 -131.0 ' + 25.0 25.0 + 4.0 4.0 ' + 62.0 62.0 - 0- Table III (continued) A u s tria n N a tio n a l N a tio n a l B a n k o f B a n k B e lg iu m P eriod 1970: B a n k of C an a d a N a tio n a l Bank of D e n m a rk B a n k of E n g la n d — I ................. 650.0 B ank o f B a n k o f B a n k o f Fra n ce Ita ly Japan + 100.0 -1 0 0 .0 N e th e rla n d s B ank + 800.0 + 200.0 -6 0 0 .0 I I ................. ■ I l l ................. I V ................. . O u ts ta n d in g .......... 1971: B a n k of M e x ic o -0 - -0 - -0 - + 400.0 - 400.0 -0 - -0 - -4 0 0 .0 -0 - -0 - -0 - -0 - -0 - BIS a g a in s t G e rm a n m arks \ + 136.0 [-1 3 6 .0 | + 77.0 I - 77.0 l + 77.0 I - 77.0 ' + 4 4.0 l - 44.0 -0 - I ................... I I II I I V O u ts ta n d in g ............ 1972: -0 - - 0- - 0- - 0- - 0- (+ )~ (+ )~ I I II I I V O u ts ta n d in g ............ 1973: 8.0 8.0 6.0 6.0 1.0 1.0 4.0 4.0 (+ I ................... 0 -0 - - 0- - 0- - 0- - 0- - 0- - 0- - 0- - 0- l- I ................... I I II I I V O u ts ta n d in g ............ 1974: -0 - - 0- - 0- (+ \ — j+ | — (+ 26.0 26.0 76.0 76.0 65.0 65.0 j + 129.0 ( —-129.0 I ................... I I ................... II I I + 180.0 -1 8 0 .0 V O u ts ta n d in g ............ -0 - - 0- - 0- - 0- - 0- - 0- - 0- - -0- 0- " .............. ....................................................................................................................................................................j II I ... I V O u ts ta n d in g ............ 1976: .. + 1 8 0 .0 -0 - -0 - -0 - ( + 130.0 1 -3 6 0 .0 -0 - -0 - -0 - -0 - -0 - -0 - I : 1 - 19.0 19.0 -0 - i+ I i+ I - 14.0 14.0 37.0 37.0 -0 - + 500.0 I ................... I I ................... + 200.0 I l l ................... + 100.0 O c t o b e r ................... O u ts ta n d in g ............ 1.0 { —l i i 0 -0 - -0 - -0 - -0 - 300.0 + 3 6 0 .0 — 500.0 -0 - -0- -0 - -3 6 0 .0 -0 - -0 - -0 - FRBNY Quarterly Review/Winter 1976 47 This issue introduces the Bank’s Quarterly Review. (The Monthly Review was discontinued after the October issue.) The new publication is designed for in-depth analysis of a range of domestic and international economic and financial developments. All Monthly Review subscribers will automatically receive the Quarterly Review. We hope that you will be pleased with the new publication. FRBNY Quarterly Review/Winter 1976 Federal Reserve Bank of New York 33 Liberty Street New York, N.Y. 10045 Return Postage Guaranteed