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FEDERAL RESERVE BANK OF RICHMOND

MONTHLY
REVIEW
Structure of the
Residential Mortgage Market
Government Finance in the Nation s
Capital
Business Cycles, Growth Cycles, and
The Current Expansion

V o lu m e 58
Num ber 9



S E P T E M B E R

1972

Structure of the
RESIDENTIAL MORTGAGE MARKET
Introduction
W idespread hom e ow nership has
long been regarded in this country as a source of
social and economic stability as well as an indicator
of a relatively high standard of living. Accordingly,
the Federal government has made a substantial ef­
fort to encourage the building of privately owned
homes by the nation’s populace. Mortgage financing
is typically used in the purchase of a home because
the requisite cash outlay would be far beyond the
means of most buyers. T o make home ownership
widely available, the Federal government has tried
both to increase and to stabilize the flow of funds
into mortgages and to ease the terms under which
mortgages are available.
During the Great Depression of the 1930’s, the
Federal government undertook a number of actions
to rebuild the struggling mortgage market. These
measures led to the creation of various government
operated agencies and to the encouragement of pri­
vate financial institutions specializing in residential
mortgages. On various occasions since the 1930’s,
particularly when the availability of credit has been
limited and interest rates have been high, further
government participation in the mortgage market
has occurred. By m id-1972, a highly complex array
of private, governmental, and semigovernmental in­
stitutions comprised the residential mortgage market.
This article clarifies the structure of the mortgage
market by describing the activities of the institutions
channeling savings into mortgages.
The F low of Funds T o shed som e light on the
structure of the residential mortgage market, a flow
diagram, depicting the various institutional channels
a dollar of savings might travel on its way into a
mortgage loan, has been developed. The supply of
savings on the left side of the diagram represents only
that portion of total savings (income minus con­
sumption) that has been attracted into the resi­
dential mortgage market instead of the market for
numerous other forms of financial and real invest­
ments also competing for the total supply of savings.
The solid arrows indicate the flow of savings into
mortgage loans rather than the movement of mort­
gage securities from originators of loans to possible
secondary holders. Dashed arrows refer to insured

The institutions listed in the first column issue
primary securities to savers and then use the funds
to purchase mortgages originated by other lenders.
Three of these agencies, the Federal Home Loan
Mortgage Corporation (F H L M C or Freddie M ac),
the Government National Mortgage Association
(G N M A or Ginnie M ae), and the Federal National
Mortgage Association (F N M A or Fannie M ae), are
at least partially government sponsored. The fourth
agency, the M G IC Mortgage Corporation (M G IC
or Maggie M ae), is a completely private purchaser
of mortgages in the secondary market.
The next column represents the depository and
contractual savings institutions that engage in nu­
merous mortgage lending activities. The depository
institutions originate both conventional and govern­
ment guaranteed mortgage loans and buy and sell
mortgages in the secondary market. Life insurance
companies, however, restrict their portfolio of mort­
gages to those acquired in the secondary market.
Mortgage companies do not hold a permanent
portfolio of mortgage loans but instead resell nearly
all of the mortgages they originate. Thus, in the dia­
gram they are directly linked to mortgage borrowers
but only indirectly linked to savers.
The most conspicuous form of Federal govern­
ment participation in housing finance is shown at
the bottom of the diagram. Using funds directly
acquired from the U. S. Treasury, the Department
of Housing and Urban Development— via the Fed­
eral Housing Administration and G N M A — subsi­
dizes certain types of residential housing. Through
a variety of projects, H U D and the F H A have com ­
bined to further slum clearance and make home
ownership available to the urban poor.
The D ep ository Institutions A lth ou gh the three
types of depository institutions shown in the diagram
are privately owned and operated, they are subject
to certain Federal and state regulations. Savings and
loan associations, for example, are restricted in that
they must invest almost exclusively in mortgages.
T o enhance their ability to compete with commercial
banks for savings deposits, savings and loan associa­
tions are allowed to pay a higher interest rate than
banks on such deposits. Partially as a result of this

or guaranteed arrangements in conjunction with

regulation, total savings deposits at savings and loan

flows of funds.

associations are currently about 85% as large as

2



M O N TH LY REVIEW, SEPTEMBER 1972

total savings deposits at commercial banks, even
though there are less than half as many savings and
loan associations. Fulfilling the role assigned them,
savings and loan associations have regularly invested
about 95% of their deposits in residential mort­
gages. O f the more than $160 billion in residential
mortgage loans held by savings and loan associations
at the end of 1971 (see Table I ) , nearly 88 % were
conventional loans.
The remainder were either
guaranteed by the Veterans Administration or in­
sured by the Federal Housing Administration. A
small number of these government-backed mortgages
held by savings and loan associations were acquired
through mortgage companies that had originated the
loans. Each of these relationships is indicated by the
appropriate arrows in the diagram.
Mutual savings banks, most of which are located
in Northeastern states, also engage heavily in resi­
dential mortgage lending. They are not, however,
as restricted in their investment policies as are sav­
ings and loan associations, even though they have
been given the same interest rate differential. Thus,
only about 70% of their savings deposits have been
invested in mortgages in recent years. Also, more
than half of their mortgage portfolio consists of F H A
and V A backed loans, reflecting the fairly large
volume of mortgages purchased from mortgage com ­
panies. In recent years, nearly one-third of all resi­
dential mortgages held by mutual savings banks have
been originated by mortgage companies.
Commercial banks have not traditionally been as
active in the housing market as have nonbank thrift

Ta b le

I

RESIDENTIAL MORTGAGE LOANS
($ b illio n s )
Decem ber 1970

D ecem ber

O u t­
s ta n d in g
Tota l
S a vings a n d Loan
A ssocia tio n s
M u tu a l S avings
Banks
C om m e rcial Banks
Life Insurance
C om panies
FN M A
O thers

Source:

Percent

$338.2

1971

O u t­
sta n d in g

Percent

100.0

$374.7

100.0

138.8

41.0

159.7

42.6

49.9
45.6

14.8
13.5

53.0
52.0

14.1
13.9

42.7
15.5
45.7

12.6
4.6
13.5

41.4
17.8
50.8

11.0
4.8
13.6

Federal Reserve B u lle tin , June 1972.

institutions. Instead, commercial banks have en­
gaged primarily in commercial and consumer lend­
ing.
Substantial increases in time deposits since
1960, however, have allowed banks to make more
mortgage loans, especially during periods of easy
money and low interest rates. Normally, most mort­
gages issued by banks have a lower loan to value
ratio and a shorter maturity than those issued by
nonbank thrift institutions. Only a little more than
20 % of time and savings deposits at banks have
found their way into residential mortgages. About
75% of these loans have been of the conventional
type in recent years.
Life insurance companies participate in the resi­
dential mortgage market almost exclusively through

STRUCTURE OF THE RESIDENTIAL MORTGAGE MARKET
FHLMC

M G IC
S avings a n d Loan Assocs.

M

O

L

M u tu a l S avings Banks

FHA

R

• •»

T

VA

C om m e rcial Banks

G
A
G

Life Insurance C om panies

E

GNMA

L

M o rtg a g e

O

C om panies
FN M A




A

T

N
S

m mm
m
HUD

m m m m m mmm
m m

FHA
GNMA

^

Ta b le II

DISTRIBUTION OF VA AND FHA LOANS
D ecem ber 1971
(e stim a te d )
($ b illio n s )
FHA
S a vin g s a n d Loan
$13.8
A ssocia tio n s
M u tu a l Savings
Banks
16.1
C om m e rcial Banks
8.3
Life Insurance
C om panies
10.8
FN M A
12.7
O thers
19.5
T otal
S ource:

$81.2

Percent

VA

Percent

17.0

$10.8

27.3

19.8
10.7

12.1
3.0

30.6
7.6

13.3
15.6
24.0

5.0
5.0
3.6

12.7
12.7
9.1

100.0

$39.5

100.0

Federal Reserve B u lle tin , June 1972.

the secondary market, relying largely on mortgage
companies to originate the loans. Although both the
yield and maturity of mortgages are attractive to life
insurance companies, the process of originating them
would require operational activities ill-suited to in­
surance companies.
Recently, life insurance com ­
panies have been investing somewhat less than they
once did, but they still hold over 20 % of their total
assets in residential mortgages, with about one-third
of these backed by the F H A and V A .

the loan, is paid by the borrower. In case of default,
the lender may receive either cash or F H A deben­
tures in exchange for the property. The debentures
are fully guaranteed by the U. S. Treasury but carry
a slightly higher yield than comparable Treasury
securities.
During periods of tight credit and high interest
rates, ceiling levels on F H A mortgages are usually
below conventional mortgage rates. In this instance,
most lenders are willing to engage in F H A financing
only at a discount from the face value of the loan,
thus raising the effective yield. Since 1961, the F H A
has subsidized a variety of loans in addition to in­
suring them. Many of these programs call for the
F H A to pay the difference between the reduced
house payment a low income individual can afford
and the fair market payment. This type of program
has expanded considerably in recent years.
The V A operates under many of the same con­
ditions as the F H A , except that its programs are
restricted to qualified veterans. Also, loan to value
ratios are usually about 98% but may run as high
as 100%. On defaulted loans, the V A pays cash
for a portion of the loan and exchanges its debentures
for the remainder. The borrower pays no fee as in
the case of an F H A loan. Most V A programs
merely guarantee loans, although funds are available
in some instances.

Government Guarantees and Insurance U ntil the
mid-1960’s, most of the Federal government’s overt
efforts to improve housing finance were conducted
through the Federal Housing Administration and
the Veterans’ Administration. T o reverse the wide­
spread foreclosures on mortgages during the Great
Depression, the F H A was conceived in 1934 for the
purpose of insuring residential mortgages made to
individuals of modest economic circumstances. In­
surable loans currently are limited to a maximum
of $33,000 with down payments graduated from
3-15% , depending on the size of the loan. The
property also must be appraised and approved by the
F H A . In the 1960’s, F H A programs to provide
funds in the form of subsidies, as well as insurance,
were introduced .1 Typically, an F H A insured loan
has an interest rate somewhat lower than rates on
comparable conventional loans. The lower rate is ac­
ceptable to most mortgage lenders because of the re­
duced risk and better marketability of the loan, as
can be seen from the wide ownership of such loans
indicated in Table II. The cost of the insurance,
one-half of one percent of the outstanding value of

Mortgage Companies O ne im portant group of
participants in the mortgage market often goes un­
noticed, because its members do not hold a permanent
portfolio of mortgages. These are mortgage banks
or mortgage companies. The volume of mortgage
activity conducted by these institutions is shown in
Table III. Mortgage companies utilize short-term
funds borrowed from commercial banks to originate
and close mortgage loans that they eventually sell to
other financial institutions, a process indicated by
the relationships shown in the diagram. During most
of the 1960’s, mortgage companies sold to life in­
surance companies and mutual savings banks about
60-70% of the loans they originated. About 90%
of the residential mortgages originated by mortgage
companies are F H A insured or V A guaranteed,
which enhances the marketability of the loans. A l­
though the Federal National Mortgage Association
bought a number of loans made by mortgage com ­
panies in the latter 1960’s, this trend was substantially
reversed in 1971 and, so far, in 1972.

1 See “ FHA Mortgage Insurance and Subsidies,” Business Con­
ditions, Federal Reserve Bank of Chicago (March 1972), pp. 8-15
and John H. Hand, “ Government Lending Agencies,” Financial In­
stitutions and Markets, ed. Murray E. Polakoff (Boston: Houghton
Mifflin Co., 1970), pp. 230-236.
The Hand article also describes
V A , FNM A, and GNMA.

Government Agencies and the Secondary Market
In the latter half of the 1960’s, rapid economic ex­
pansion laid the groundwork for substantial housing
demand. More people were earning higher incomes

4




M O N TH LY REVIEW, SEPTEMBER 1972

and aspiring to higher standards of living, including
ownership of attractive homes. In addition, greater
attention was given by the government to the housing
problems of the urban poor. This growing demand
for housing created a strong demand for mortgage
funds at a time when other participants in the
capital market were also aggressively seeking funds.
These factors, in conjunction with various economic
and stabilization policy forces, eventually produced
historically high interest rates and a limited avail­
ability of credit, which severely reduced the flow of
funds into mortgages. One of the reasons that the
mortgage market was unable to attract its customary
share of funds was the relatively underdeveloped
state of the secondary market for mortgages. Many
suppliers of funds to the capital markets had avoided
investing in mortgages because these instruments
limit portfolio flexibility. Most mortgage loans are
characterized by such features as appraisal standards,
loan to value ratio, and certain local variations, all of
which reduce the marketability of mortgage securities.
Given the high social and political priority ac­
corded housing in this country, the Federal govern­
ment has moved to strengthen the secondary mort­
gage market. In 1968, legislation was enacted con­
verting the Federal National Mortgage Association
into a government-sponsored private agency, whose
primary function was to purchase F H A and V A
mortgages from originators of loans. A s a semi­
private agency, F N M A ’s operations are not financed
through the Federal budget. Thus, F N M A now has
a much greater freedom to borrow in the capital
markets and to purchase mortgages.

Since 1968,

F N M A has rapidly increased its purchases, raising
its holdings over $10 billion by the end of 1971,
as shown in Table IV .

F N M A obtains the funds

used to purchase mortgages by selling securities di­
rectly to the public as shown in the diagram. Be­
cause these securities are explicitly not guaranteed
by the U. S. Treasury, they are traded in the market

Table III

ACTIVITY OF MORTGAGE COMPANIES
($ b illio n s )
R esidential M o rtg a g e s
Loans Closed
1965
1966
1967
1968
1969
1970

Source:

$10.9
9.3
9.7
10.4
11.6
13.0

M o rtg a g e B a n kin g 1970.




Loans Sei
$47.9
51.1
54.4
58.4
63.0
68.5

Ta b le IV

FNMA ACTIVITY
($ b illio n s )

Year

Purchases

1968
1969
1970
1971

$1.9
4.1
5.1
3.1

Source:

Year-End
Loan P o rtfo lio

Sales
$ ........

.3

$ 7.2
10.9
15.5
17.8

Savings a n d Loan Fact Book, 1972.

for government agency securities. “ Agencies” are
regarded as having a slightly greater degree of risk
than Treasury backed securities and consequently
carry a slightly higher yield.
A s a private corporation, F N M A is profit oriented
as well as an official supporter of the secondary
mortgage market. Beyond normal expenses, the size
of its profit margin depends on the spread between
yields earned on mortgages purchased and the in­
terest costs of borrowing. W hen interest rates are
generally high the spread narrows, and when they
are low it widens. F N M A ’s debt is primarily shortand intermediate-term as opposed to the long-term
nature of its mortgage holdings. Thus, the return
on F N M A ’s assets remains fairly stable, while its
interest costs fluctuate in step with the movement of
interest rates in general. A s interest rates have re­
treated during the last two to three years from his­
torical highs, F N M A has lengthened its debt struc­
ture in preparation for future tight money periods.
The greatest need for extensive purchases of mort­
gages by F N M A of course comes when interest
rates are high, which is also the time when its
profit margin is being squeezed.
In 1968, F N M A began acquiring mortgages via
the auction procedure. A s it now stands, biweekly
auctions are held on Mondays at the F N M A head­
quarters in Washington. One week F N M A buys
only V A and F H A backed loans and in the next
only conventional loans.2 Actually, existing mort­
gages do not directly enter into the auction process.
Instead, F N M A offers a four month commitment to
purchase a given volume of mortgages at a stated
price. After all bids have been received, F N M A
accepts a quantity of commitments whose yield is
commensurate with current market conditions. The
bidder pays a nonrefundable fee of one-quarter of
one percent of the value of the loan. The bidder,
however, is not required to honor the commitment.
If interest rates fall, and the value of the mortgages
2 In 1970, Congress authorized FN M A to purchase conventional, as
well as FHA and V A backed, mortgage loans.

FEDERAL RESERVE B AN K OF R IC HM O ND

5

Table V

ESTIMATED OWNERSHIP
OF G N M A PASS-THROUGH SECURITIES
FEBRUARY 1972
($ b illio n s )
O u ts ta n d in g
Total
S avings a n d Loan A ssocia tio n s
M u tu a l S avings Banks
C om m e rcial Banks
Insurance C om p a n ie s
C o rp o ra tio n s a n d P artn e rship s
Pension Funds
M o rtg a g e C o m p a n ie s*
C re d it U nions
In d iv id u a ls

Percent

$3.7
1.7
.7
.1

100.0
46.9
19.2
4.0

.3
.2
.3
.2

9.2
5.7
8.6
5.7
.6

*H e ld fo r fu tu re sale.
* * $ 2 2 m illio n .
S ource:

W e e kly Bond B uyer, M arch 27, 1972, p. 6.

rises, he is free to sell them elsewhere. Almost all
of the loans purchased by F N M A in the auction
process come from mortgage companies.
Part of F N M A ’s mortgage holdings in recent years
has come from a source other than the weekly auc­
tions. F N M A ’s charter requires it to buy a reason­
able amount of subsidized loans made to low-and
moderate-income families.
So F N M A has pro­
vided a substantial volume of funds to support a
number of the H U D programs, as indicated by the
arrow from F N M A to H U D in the diagram.
T o provide savings and loan associations with
their own secondary outlet for mortgages, Congress
created the Federal Home Loan Mortgage Corpora­
tion in 1970. This agency sells securities to the public
and uses the proceeds to purchase mortgages from
Federally insured savings and loan associations.
Specifically, F H L M C engages in purchases and
sales of F H A and V A backed loans, participates
in conventional loans, and purchases conventional
loans outright. These operations, like those of
F N M A , are conducted on a forward commitment
basis. Another objective of F H L M C is to stan­
dardize loan documents, appraisals, and other asspects of the mortgage lending process in order to
enhance the marketability of the typical mortgage
security. Since 1970, F H L M C has obtained enough
funds in the capital markets to purchase over $1
billion of mortgages in 1971.

T o allow F N M A to operate freely as a semiprivate
organization, G N M A was given its special assistance
fund and its management and liquidation fund.
These two funds mostly contain loans made prior
to 1954 or loans made on a one-time basis to serve
a specialized need.
G N M A ’s major function has
emerged in two other areas, which are delineated in
the diagram. First, it subsidizes and underwrites
many of the programs run by H U D . Second, it has
participated in the development of a new mortgage
security, known as a pass-through.
The pass-through program was initiated in 1970.
Any mortgage lender authorized to make F H A
loans may put together a package of F H A and V A
backed loans. Once the contents of the package or
pool have been approved by G N M A , it guarantees
them, pledging the full faith and credit of the govern­
ment to insure the timely payment of both principal
and interest.
Pass-throughs apparently have been quite at­
tractive to a large bloc of investors, as shown in
Table V , and may now be purchased in amounts as
small as $25,000.
The return on a pass-through
takes the form of a monthly payment consisting of
both interest and principal.
A private organization that performs a function
similar to that of F N M A and F H L M C is the M G IC
Mortgage Corporation, which is a subsidiary of the
privately-owned M G IC Investment Corporation, a
long-time insurer of mortgages. M G IC, which began
doing business in March 1972, intends to establish
a secondary market for the mortgages it insures. It
is especially interested in the new 95% conventional
loans that savings and loan associations have been
allowed to make since August 1971. A s shown in
the diagram, M G IC sells securities to the public to
provide capital for mortgage purposes.
Conclusion The com m on characteristic am ong
these organizations (F N M A , G N M A , F H L M C ,
M G IC ) is that they have provided a more effective
channel between the typical mortgage loan and the
highly competitive capital markets than existed in
the past, especially during tight money periods. For
years, the traditional mortgage loan, with all of its
unstandardized features, has had great difficulty
competing for funds whenever credit conditions
tightened. Although the institutional structure of

The other government agency actively participating

the mortgage market has grown to be extremely com ­

in the residential mortgage market, the Government

plex, largely as a result of Federal government par­

National Mortgage Association, engages in a much

ticipation, the development of an effective secondary

wider variety of programs than does either F N M A

market has helped to channel more funds into resi­

or F H L M C . G N M A was created in 1968 to assume

dential mortgages than ever before.

several functions previously performed by F N M A .

6




M O N TH LY REVIEW, SEPTEMBER 1972

Philip H . Davidson

GOVERNMENT FINANCE IN THE
NATION'S CAPITAL
Unlike any other municipality in the country, the
nation’s capital is unique in the area of government
finance. Whereas other political subdivisions in the
U. S. can make final determinations regarding the
methods of acquiring and dispensing revenue, in
Washington, D. C., such decisions are made not only
by the local administration but also by the Office of
the President and Congress. Moreover, because of
its unique relationship to the National Government,
the District receives annually a Federal payment to
supplement revenue from its own sources. A n an­
nual contribution by the Federal Government, this
payment, which has been made sporadically since
1790, is not based on the District’s own tax re­
sources or its expenditures, but, rather, upon the
discretion of Congress. Although no agreement has
been reached regarding the size of the payment, which
has jumped from $6 million in 1939 to $139.0 million
in 1971, policymakers have agreed that the cost of
governing the District of Columbia should not be
borne by District taxpayers alone and that this na­
tional contribution is indispensable. W ith expendi­
tures doubling at less than ten-year intervals, howr
to meet the growing revenue needs of the city remains
one of the District’s most urgent problems.

prises an area of only 67 square miles. This rela­
tively small area, coupled with a declining popula­
tion, greatly limits available sources of revenue. Also,
the District is restricted geographically by the states
of Maryland and Virginia, which further places it
under confining economic restraints. For example,
the large number of commuters who live in the
adjacent states but are employed by the Federal Gov­
ernment and work in the District are not taxed di­
rectly by the city, which loses substantial revenue as
a result. The move to the suburbs, which is taking

Special Fiscal Problems The very presence of the
Federal Government places extra and unusual strain
on the city’s finances. For instance, the city picks
up the tab whenever the President honors foreign
visitors with welcoming ceremonies, or when a group
of protestors demonstrates for a particular cause.
The city’s 120-odd foreign embassies and chanceries
require constant police protection. Moreover, every
four years when a President is inaugurated the cost
of additional traffic control, visitors’ protection, etc.
becomes the responsibility of the city. Not only does
the Federal presence place additional costs on the

GENERAL REVENUE

place in most large cities, is especially troublesome
for Washington, since its suburban areas are in other
states.

Although the District has the tax programs

and in many cases the tax rates, it lacks taxpayers.
Revenue

From fiscal year 1960 to 1970, general

revenue, i.e., revenue from both the Federal Govern­
ment and the District’s own sources, almost tripled,
rising from $256.3 million to $720.9 million (Chart
1). In 1970, revenue from the Federal Government,

C h a rt 1

Fiscal Years

I9 6 0
Total
1970

From
Federal
G o v 't.

city, offset to some extent by revenue from tourists,
but it also imposes special restraints on the District’s
taxing freedom.

The Federal Government is the

From
Own
Sources

Taxes

jC h a rg e s a n d Misc.

________ u _________________
Taxes

! C harges a n d Misc.

J___I

city’s major employer and chief property ow ner; but
because the National Government cannot be taxed,

200

the city is denied a large potential source of revenue.

400

600

800

$ M illio n s

Geographical restrictions also affect the financial
status of the city.

For instance, the District com ­




Source: U. S. D e p a rtm e n t o f C om m erce, B ureau o f th e Census.

FEDERAL RESERVE B A N K OF R IC H M O N D

7

which includes the annual Federal payment and
various Federal grants, totaled $271.5 million, while
revenue from the city’s own sources accounted for
$449.4 million. The proportion of revenue con­
tributed by the Federal Government increased from
24.0% in 1960 to around 38.0% in 1970, while the
ratio of funds from the District’s own sources de­
clined from about 76.0% to 62.0% . Yet, even with
the rapid rate of growth in revenue from the Federal
Government, well over half of total revenue in 1970
came from the District’s own sources, primarily from
taxes (Chart 2 ).
Although property taxes remained the largest single
source of tax revenue in 1970, such taxes accounted
for only around one-third of total tax revenue and
slightly less than one-fifth of total revenue. The rela­
tive importance of the property tax is conspicuously
smaller in the District of Columbia than in other
cities of similar size.

For example, in Dallas and

Cleveland the ratio of property tax revenue to total
tax revenue was 68.5%

and 58.8%, respectively,

while the proportion for the District was only 32.7% .
The property tax produces relatively little revenue
in the District, because a proportionately large share
of real property is not taxable and the effective tax
rate is comparatively low.

For fiscal year 1971, the

fixed minimum rate was $3.20 per $100 of assessed

C h a rt 2

REVENUE FROM TAXES
Fiscal Years
$ M illion s
140

120
100

80

value, but property in the District is assessed at only
54.3% of market value.
In these terms, the ef­
fective assessment rate in fiscal year 1971 was $1.74
per $100, below the average of $2.50 per $100 of
market value for the 25 largest cities. Only three of
the 25 largest cities had effective rates lower than
that of the District.
City income taxes accounted for around 27.0% of
tax revenue in 1970. From 1960 to 1970, revenue
from personal income taxes rose from $35.6 million
to $103.5 million. The District initiated personal in­
come taxation in 1939 and has increased rates six
times in the last 20 years. Current rates range from
2 .0 % on the first $ 1,000 of taxable income to 10 .0 %
on amounts of $25,000 and over, with exemptions
of $ 1,000 for single persons, $ 2,000 for married
couples, and $500 for each dependent. A comparison
between the District and the 40 states that levied an
income tax in 1971 indicates that the nation’s capital
ranked well above the average. Based on taxes paid
by a family of four with incomes of $5,000, $10,000,
and $25,000, the District ranked 18th, 1 1 th, and 8th,
respectively. Also, individual income tax collections
as a percent of total personal income in the District
stood at 2.23% , considerably above the national
average of 1.15% in 1970. Considering the relatively
high rate of income taxation and the large number of
people working in the District, revenue produced
from this tax is not as large as might be expected.
The major reason for this situation is that non­
residents, that is, people who earn income in the Dis­
trict but live elsewhere, are exempted from the tax.
Another source of District tax revenue is the sales
tax. General and selective sales taxes accounted for
around 34.0% of total tax revenue or $133.3 million
in 1970. First imposed in 1949, the general sales tax
was the city’s fastest growing source of revenue
during the 1960’s. Revenue from the general sales
tax increased from $22.5 million in 1960 to $71.3
million in 1970, an average annual rate of increase
of 12.0%
The District sales tax rate as of Sep­
tember 1971 was 4.0% , slightly above the 3.7%
average of the 45 states that levy sales taxes but

6 0

-

i

—

below the 4.7% average rate of the 25 largest cities.
The District taxes food at a relatively low rate of

40

1.0% and exempts all drugs.

Sales taxes have two

advantages for the D istrict: (1 ) the tax is easy to
20

administer because it is collected by the merchant
Property G eneral
Sales

Selective
Sales

Income

JJ

i

A ll
Licenses

l
A ll
O the r

Source: U. S. D epartm ent o f Commerce, Bureau o f the Census.

and ( 2 ) the tax affects tourists and nonresidents who
otherwise contribute little to the support of local
government.
Other sources of tax revenue in the District are
taxes from licenses and certain miscellaneous taxes.

8




M O N TH LY REVIEW, SEPTEMBER 1972

C h a rt 3

GENERAL EXPENDITURES BY FUNCTION
Fiscal Years

TOTAL

Education

Highways

Public Welfare

Health and
Hospitals

Police and
Fire

Sewage and
Sanitation

Interest
on Debt

All Other

Source: U. S. Department of Commerce, Bureau of the Census.

Revenues from both these sources increased sub­
stantially from 1960 to 1970, but such levies still ac­
count for only a small proportion of total tax revenue.
In fiscal 1970, revenue from licenses accounted for
$18.1 million, while revenue from other miscellaneous
sources was $ 8.2 million.
A review of the tax structure indicates that the

E xpenditures Between fiscal years 1960 and 1970,
total general expenditures grew at an average annual
rate of around 11.0%, rising from $269.2 million in
1960 to $761.7 million in 1970 (Chart 3 ). Total per
capita expenditures, which also grew at an average
annual rate of 11.0%, rose from $353.28 to $1,006.87.
Education accounted for the largest single expendi­

District has a relatively low property tax, a rela­

ture in 1970, $197.6 million.

tively high individual income tax, and a sales tax

trict students grew approximately 13.5% per year

that is about average.

during the 1960’s, accounting for some 26.0% of

The total tax burden of Dis­

Expenditures for Dis­

trict residents appears to be much the same as the

total expenditures by 1970.

average burden shouldered by residents of the na­

expenditures more than tripled, rising from $73.10 to

tion’s 25 largest cities.

$261.22.

In fiscal 1971, total taxes as

Per capita educational

A particularly sharp increase in expendi­

a percent of family income for the District family

tures for higher education occurred during the latter

earning $5,000 was 6.5% , while the 25 city average

part of the 1960’s. Such expenditures rose from $1.3

was 8.0% .

million in 1960 to $37.9 million in 1970.

In the $25,000 income classification, the

Most of

ratio of total taxes to family income in Washington

the growth in higher education took place after the

was 8 .6 % ; the 25 city average was 7.7% .

passage of the Public Higher Education A ct of 1967,




FEDERAL RESERVE B A N K OF R IC H M O N D

9

percent of total expenditures rose from 7.8% in 1960
to 12.7% in 1970. Rapid growth was also reflected
in public welfare expenditures per person, which more
than quadrupled, jumping from $27.43 to $127.66.
Although all expenditure categories rose in absolute
terms during the period, spending for highways and
sanitation and sewage facilities fell as a proportion
of total expenditures. The proportion of revenue
spent for highways dropped from 13.7% in 1960 to
7.9% in 1970, while the ratio of sanitation and
sewage expenditures to total expenditures declined
from 6 .8 % to 4.6% .

which provided for the creation of the Federal City
College and the Washington Technical Institute.
Expenditures for health and hospitals also in­
creased substantially, rising at a rate of 11.4% per
year. Around 15.0% of total expenditures, or $114.2
million, went for health care for local residents in
1970.
Expenditures for police and fire protection
also rose, climbing at a 9.8% average annual rate.
The most rapidly growing expenditure item during
the decade of the 1960’s was public welfare. From
1960 to 1970, welfare expenditures grew at an
average annual rate of 16.5%, increasing from $20.9
million to $96.6 million. Welfare expenditures as a

0



D ebt Expenditures exceeded general revenue in
every year except 1968 (Chart 4 ). In order to meet
the rising costs of conducting its affairs, the city in­
creased its outstanding debt. The District borrows
directly from the U. S. Treasury, rather than on
the open market as do other municipalities. Until
November 1967, District borrowing was at a flat
rate prescribed by Congress, but in that year Public
Law 90-120, which greatly expanded the amount
the District could borrow, was passed by Congress.
The debt limit was changed so it could not exceed
6.0% of the average general fund revenues. Con­
gress, however, still maintained project-by-project
approval of all borrowing. Because of this change in
the amount that could be borrowed, debt rose much
more rapidly between 1968 and 1970 than in the
previous years of the decade. Debt outstanding in­
creased nearly $200 million from 1968 to 1970, just
slightly less than the total increase from 1960 to
1967. In 1960, debt outstanding for the District was
$147.5 million; by 1970, it totaled $596.5 million.
C onclusion G overnm ent finance in the nation’s
capital is unlike that of any other municipality be­
cause of Washington’s unique political status. Tw o
characteristics of government finance that the Dis­
trict unfortunately shares with other urban areas,
however, are rising costs and expanding needs. In
this respect, Washington is much like other American
cities that are seeking new ways of acquiring revenue
in order to satisfy the growing demands of their
residents.
Carla R. Gregory

M O N TH LY REVIEW, SEPTEMBER 1972

BUSINESS CYCLES, GROWTH CYCLES, AND
THE CURRENT EXPANSION
N ow that over a year and a half has passed since
the beginning of the current economic expansion in
November 1970, sufficient economic data are avail­
able to allow a meaningful comparison of the current
business cycle with those of the recent past. This
article discusses the current economic expansion in
terms of the traditional business cycle and compares
the current cycle with an average cycle representative
of the three most recent business cycles in the U. S.
Some of the distinguishing noncyclical features of the
current cycle are also examined. Finally, there is a
short discussion of a recently proposed alternative
approach to cyclical economic analysis, the growth
cycle.

Although the recurring ups and downs in the level
of business activity constitute the common element
of the business cycle, each cycle is also accompanied
by its own distinctive economic, political, social, and
institutional phenomena.
The most obvious dis­
tinguishing features of the current business cycle, the
beginning of which is taken by the N B E R as the
November 1969 peak, include the automobile strike
of late 1970, an unusually persistent high rate of in­
flation and the consequent institution of a wageprice control system. Less obvious, but equally im­
portant, are the noncyclical changes in the labor
market, which have had a significant impact on the
behavior of unemployment in the current cycle.

THE BUSINESS CYCLE

THE CURRENT CYCLE AND THOSE OF THE PAST

Traditionally, the term business cycle has been
used to denote the recurring sequence of economic
contraction, trough, economic expansion, and peak.
Analysis of these cycles, which are characteristic of
economic activity in the United States, can be con­
ducted on different levels. Since the term business
cycle is meant to apply to generally widespread
fluctuations in economic activity, the behavior of com ­
prehensive aggregate economic indicators should be
one important consideration in any analysis of the
business cycle. A number of such indicators have
been selected from the National Bureau of Economic
Research (N B E R ) list of coincident economic in­
dicators : nominal G N P, real GN P, industrial pro­
duction, non-agricultural payroll employment, and the
rate of unemployment. These indicators generally
reflect changes in the overall level of economic ac­
tivity at approximately the time such changes occur
and will be used to examine cyclical behavior in
this article.
Since W orld W ar II, two significant changes in
the nature of the business cycle have been reflected
in the behavior of these economic indicators.
In
terms of the amplitude of their expansions and con­
tractions, the severity of the post-W orld W ar II
cycles has declined relative to that of pre-W orld W ar
II cycles. Also, the length of the contraction phase
of the cycle has declined in the post-W orld W ar II
period. Both of these changes are also apparent in
the behavior of the current business cycle.

D uration T h e duration o f cyclical contractions
in the U nited States since W o rld W a r II appears
to be declining. Based upon cyclical turning points
established by the N B E R , the average duration of
the seven business contractions that occurred be­
tween the two W orld W ars was 16 months. The
average length of the post-W orld W ar II recessions
was 11 months. On the basis of a tentatively es­
tablished November 1970 trough date, the contrac­
tion prior to the current expansion lasted 12 months .1
The average length of the interwar expansions lasted
approximately 35 months. During the post-W ar
periods, the expansions averaged about 49 months.
The increase in average duration of expansions is
due entirely to the 103 month expansion from 1961
to 1969.




The C oincident E con om ic Indicators Th e cyclical
behavior of the chosen indicators for the current cycle
and for a representative post-W ar cycle is presented
in Chart 1. The representative cycle is computed as
the average of the given economic series for the
three business cycles having their troughs in August
1954, April 1958, and February 1961. The behavior
of both the current and the average cycle is depicted
over the period beginning with the fourth quarter
1 If the 1970 automobile strike had been averted, it seems likely that
the contraction would have ended no later than August 1970, thus
lasting only nine months. This possibility is suggested by Solomon
Fabricant in Recent Economic Changes and the Agenda of BusinessCyclt Research, National Bureau Report 8, Supplement (New York:
National Bureau of Economic Research, May 1971).

FEDERAL RESERVE B A N K OF R IC H M O N D

H

prior to the trough and ending with the fifth quarter
after the trough.
The post-W ar contractions have been characterized
by relatively mild fluctuations in aggregate economic
activity. During the average post-W ar contraction,
total spending, as measured by the annual rate of
Gross National Product (G N P ), fell by less than
1.0% as shown in Chart la. During the 1970 con­
traction, G N P actually rose by over 4.0% , reflecting
an unusually high rate of inflation for a contraction
period.
Economic recovery following these mild
contractions has likewise been characterized by rela­

tively mild G N P growth. During the first five
quarters of recovery in the average cycle, G N P rose
by about 11.0%. The rate of G N P growth during
the first five quarters of the current expansion was
slightly less than 12 .0 % .
Real G N P (G N P corrected for inflation) is the
most comprehensive indicator of real economic ac­
tivity. Chart lb shows that in the average post-W ar
contraction real G N P declined by slightly more than
2.0% . There was an approximate 1.3% real G N P
decline during the contractionary phase of the cur­
rent cycle. In the first five quarters of the current

Chart 1

C O INCIDENT E C O N O M IC INDICATORS

% of Trough

Quarters from Trough

(b) REAL G N P

Quarters from Trough

(d) N O N A G R IC U L T U R E PAYROLL EM PLO Y M EN T

(c) IN D U ST R IA L P R O D U C T IO N IN D E X

% of Trough

% of Trough

(e) U N E M P L O Y M EN T RATE
Percent

100

-1 0

-5

0
5
10
Months from Trough




15

Trough
_
0 L _ I_______ I_______ L______ I_______ I_______ L.
-1 0
-5
0
5
10
15
Months from Trough

-1 0

Source: U. S. Department of Commerce, Business Conditions Digest, various issues.

-5

0
5
10
Months from Trough

15

expansion, real G N P rose by about 6.0% , compared
to an increase of about 9.0% for the average post­
w a r cycle.
Industrial production is a less comprehensive,
though somewhat more volatile, indicator of real
economic activity. Chart lc indicates that the average
decline in industrial production for the three previous
business contractions was slightly less than 15.0% ;
during the 1970 contraction, industrial production de­
clined by less than 8.0% . Industrial production rose
by almost 7.0% during the first five quarters of the
current expansion, compared to an approximate
16.0% rate of increase for the corresponding ex­
pansionary period of the average cycle.
The cyclical behavior of employment is presented in
Chart Id. In comparison with the experience of the
average post-W ar cycle, the current cycle has been
characterized by a relatively mild fluctuation in em­
ployment.
Nonagricultural payroll employment,
which declined by about 3.0% during the average
post-W ar contraction, fell by only about 1.0% in the
contraction phase of the current cycle. Employment
in the current expansion increased by a little less
than 3.0% , compared to an approximate 5.0% in­
crease during the first five quarters of the average
expansion.
The most atypical cyclical indicator observed dur­
ing the current business cycle was the unemployment
rate, which is shown in Chart le. The unemploy­
ment rate rose by 2.4 points during the contractionary
phase of the current cycle, and by 3.0 percentage
points during the average contraction. But where
the unemployment rate declined by 1.8 points during
the first five quarters of average cyclical expansion,
it remained relatively stable during the current ex­
pansion, fluctuating for the most part near the 5.9%
level, which it reached at the time of the November
1970 trough.

NONCYCLICAL INFLUENCES
A proper understanding of the cyclical nature of
economic activity requires an awareness of those im­
portant noncyclical forces that might be affecting the
economy.

Such forces may act either to exaggerate

or dampen cyclical economic forces.

Consequently,

they may provide an insight into what might appear
to be anomalous behavior on the part of economic
indicators.
Inflation and W a g e-P rice Controls

C h a rt 2

GNP IMPLICIT PRICE DEFLATOR
% o f T ro u gh

Q u a rte rs fro m T ro u gh

Source: U. S. D e p a rtm e n t o f C om m erce, B ureau o f th e Census.

nom ic contraction. This persistent inflation is re­
flected in the previously m entioned divergence
between the grow th rates of nom inal and real
G N P during the current business cycle. T h e b e ­
havior of the im plicit G N P deflator, one indicator
o f price perform ance, is shown in Chart 2.
D u rin g periods o f inflation, fiscal and m onetary
p olicy measures are intended to act on excess
aggregate demand, the source of so-called demand
pull inflation. D u rin g 1969, such policies were
effective in dissipating the excess demand that
had developed from 1966 to 1968. But in spite of
the recession that began in late 1969, prices co n ­
tinued to rise substantially over the current cycle,
with relatively little decline in their rate o f in­
crease.

Subsequent application of expansionary

policies to stim ulate econ om ic recovery was co m ­
Perhaps the

plicated

by

the possibility

that

such

policies

m ost conspicuous feature of the current business

m ight exacerbate the inflationary problem .

cycle has been the relative insensitivity of the

apparent failure of prices to respond to cyclical

unusually high rate of inflation to cyclical eco-

contraction was attributed by many to the strong




FEDERAL RESERVE B A N K OF R IC H M O N D

T he

13

inflationary expectations that had been generated
from 1966 to 1968. This inflationary p sy ch olog y
presum ably contributed to increasingly higher
w age demands b y w orkers trying to offset the
effects o f past and expected future inflation on
their incom e. W a g e settlements in 1970 and 1971
reflected the so-called cost push variety of in­
flation, which is relatively insensitive to the usual
econ om ic policies designed for demand pull in ­
flation. T he w age-price control system instituted
in A u gu st 1971 was intended to eliminate the pre­
vailing inflationary p sy ch olog y and thereby co n ­
tribute to a slow in g in the rate of price increase.
T ypica lly, such controls have been instituted in
response to demand pull inflation occu rrin g dur­
ing periods of econ om ic expansion.
In those
situations, controls often lead to inefficient re­
source allocation, quality deterioration, and per­
haps shortages for some products. Im position of
a control system during a period of slack e co ­
nom ic conditions, how ever, suggested the p o s ­
sibility that such problem s w ould be avoided.
E con om ic recovery could occur w ithout placing
an immediate strain on production capacity.
Moreover, increased productivity typical of cyclical
recovery would have a moderating effect on infla­
tionary pressures through its downward impact on
unit labor costs. The goal of the control system is
to eliminate inflationary expectations and their ef­
fects on prices before the economy again becomes
subject to the demand pull pressures of a strong
cyclical expansion.
Once inflationary expectations
are eliminated, it should be possible to rely on coun­
tercyclical monetary and fiscal policies to achieve
relative price stability.
Strike A ctiv ity T h e autom obile strike o f 1970
and the threatened steel strike of 1971 provide im­
portant examples of the interrelations between the
traditional business cycle and noncyclical factors that
affect overall business activity. Although many eco­
nomic indicators did reach a trough in November
1970 (or the fourth quarter for quarterly data), it is
possible that the late 1970 automobile strike retarded
the emergence of expansionary forces which had
begun to appear earlier in 1970. Moreover, the sub­
sequent resurgence in economic activity that occurred
in the first quarter of 1971 in large part reflected a
normal post-strike reaction rather than a funda­
mentally strong cyclical upturn in economic activity.
Thus, the strong rebound in the automobile industry
may have obscured strike induced weaknesses in
other sectors of the economy.

The problem of de­

termining the actual cyclical turning point is further

14




complicated by the steel inventory buildup of early
1971, which occurred in anticipation of a possible
August 1971 steel strike.
If the cyclical reversal
occurred subsequent to the early 1971 automobile re­
bound, it would provide one possible explanation for
the sluggish nature of the 1971 cyclical recovery.
L abor M arket Changes N on cyclical forces also
had an important effect on the cyclical behavior of
employment and unemployment in the current busi­
ness cycle. Contributing to the somewhat slow re­
covery growth in payroll employment was an actual
decline in manufacturing employment during 1971.
Much of this decline has been attributed to reduced
defense expenditures and the resulting employment
effect in industries producing ordnance, aircraft, and
communications equipment. A t the same time, a
relatively high rate of labor force growth has
characterized the current expansion, tending to offset
downward cyclical pressures on the unemployment
rate. During the five quarter post trough period of
the current cycle, the civilian labor force increased
by almost 3.5% ; the corresponding rate of increase
in the representative cycle was only 1 .8 % .
The declining U. S. role in Southeast Asia has also
contributed in a more direct manner to the employ­
ment situation. A s the size of the armed forces de­
clines, returning veterans contribute to the growing
civilian labor force. Moreover, these veterans are
usually young and inexperienced and consequently
tend to have a higher than average rate of unemploy­
ment (6.9 % in 1970 and 8 .8 % in 1971). A s a result,
there is further upward pressure on the unemploy­
ment rate to oppose the downward pressure of
cyclical expansion.
There is much additional information concerning
noncyclical factors that might facilitate an under­
standing of economic behavior in the current business
cycle. For example, balance of payments problems,
the international monetary crisis, and the consequent
devaluation of the dollar are undoubtedly important
considerations in the analysis of recent economic
fluctuations. The foregoing is sufficient, however, to
illustrate the difficulty involved in analyzing cyclical
economic activity.

GROWTH CYCLES
Fluctuations in economic activity are characteristic
of all modern industrialized states. In some, how­
ever, especially Japan and the countries of Western
Europe, these fluctuations differ in one respect from
the traditional business cycle that has been typical of
the post-W orld W ar II U. S. economy. In these
countries, the fluctuations in the rate of economic

M O N TH LY REVIEW, SEPTEMBER 1972

growth are seldom so great that the growth rate be­
comes negative. Consequently, the actual level of
economic activity seldom declines as it does during
the contraction phase of the traditional business cycle.
In order to provide a more suitable framework for
the analysis of such fluctuations, and also to give a
means of comparing U . S. economic activity with
that of other countries, the concept of a growth cycle
has been developed by N B E R analysts as an alter­
native approach for investigating economic fluctua­
tions .2
A growth cycle consists of a high growth phase
and a low growth phase. The high growth phase
can be defined as a period in which the actual rate
of economic growth exceeds the normal rate and the
low growth phase as a period of less than normal
economic growth. The normal rate is simply the
long-run rate of economic growth .3 The transitions
from low growth to high growth and from high
growth to low growth are termed the upturn and
downturn, respectively. In Chart 3, the growth cycle
is compared graphically to the traditional business
cycle. The growth cycle concept of turning points
can be applied to the traditional cycle by finding
those points where the rate of economic growth dur­
ing the traditional cycle (slope of the curve) equals
the trend rate of growth (slope of the trend line),
that is, at points D and U in Chart 3. In terms of
the traditional cycle, a reduction in the rate of eco­
nomic growth must occur before the level of eco­
nomic activity actually declines, so that the down­
turn of the business cycle precedes its peak. In a
similar manner, the shift from low growth to high
growth occurs after the trough of the business cycle,
since higher than trend growth can occur only after
the growth rate (slope of curve) has changed from
negative to positive. Consequently, the high growth
phase will be shorter, and the low growth phase
longer, than the business cycle counterparts.
A s in the case of business cycle analysis, growth
cycle turning points are determined by a large number
of economic indicators. Based on these indicators,
growth cycle studies conducted by the N B E R in­
dicate that a low growth phase took place from the
third quarter of 1966 to the fourth quarter of 1967.
This low growth phase is reflected in the behavior of
real GN P. During the low growth phase, real G N P
2 For a further discussion of growth cycles, see Use Mintz, “ Dating
American Growth Cycles,” Business Cycle Today, ed. Victor
Zarnowitz (New York: National Bureau of Economic Research,
1972).
3 This approach is open to the criticism that the long-run rate is
dependent upon the time period over which the long-run rate is
computed.
An alternative approach is to establish growth cycles
such that each high (low) growth phase is greater (less) than the
average rate for the two low (high) growth phases immediately
preceding and following. In practice, the two approaches yield very
similar turning points.




C h a rt 3

ECONOMIC ACTIVITY UNDER ALTERNATIVE
CONCEPTS OF CYCLICAL BEHAVIOR
ion

Expansion

BUSINESS CYCLE

— High Growth

Low
Growth

«. I«— High —
Growth

GROW TH CYCLE

--------------------------------— * . Tim e --------------------------------------►

The peaks a n d tro u g h s o f th e tr a d itio n a l business cycle
a re d en o te d b y th e le tte rs P a n d T re spe ctive ly. G ro w th
cycle tu rn in g p o in ts , d e n o te d b y the le tte rs U a n d D, re ­
s p ective ly, o ccur w h e n the a c tu a l ra te o f econom ic g ro w th
changes fro m g re a te r th a n to less th a n (d o w n tu rn ), o r fro m
less th a n to g re a te r th a n (u p tu rn ), th e tre n d ra te o f g ro w th .
In a lg e b ra ic term s, these tra n s itio n s o ccur a t th e p o in ts
w h e re th e slope o f the curves is e q u a l to th e slope o f the
tre n d lin e . Thus, u p tu rn s a n d d o w n tu rn s can be d e te rm in e d
fo r b o th typ e s o f cycle.

grew at an annual rate of 2.9% , compared with the
normal rate of approximately 4.0% for the 10-year
period from 1960 to 1969. Real G N P grew by ap­
proximately 5.5% in the preceding high growth
period from the second quarter of 1964 to the second
quarter of 1966. During the high growth period
from the first quarter of 1968 to the first quarter of
1969, real G N P grew by about 4.1% .

The 1966-

1967 low growth phase could have conceivably de­
veloped into an actual contraction.

The fact that it

did not can probably be attributed in part to easing

FEDERAL RESERVE B A N K OF R IC H M O N D

15

monetary policy actions in late 1966 and early 1967
and to expansive fiscal actions later in 1967.
Some economists believe that the frequency of
actual contractions in U. S. business activity will
decline and that future economic fluctuations will be
better characterized as growth cycles. This trend
can be attributed to a number of factors. The applica­
tion of monetary and fiscal stabilization policies has
already been mentioned as a moderating influence on
cyclical swings .4 There are also institutional ar­
rangements, such as the income tax structure and
unemployment compensation programs, that con ­
tribute to stability in the level of aggregate demand
by offsetting cyclical fluctuations in income.
The changing structure of the U. S. economy, in
particular the relative growth in the size of the
service sector and the government sector, provide
further stabilizing influences on economic activity.
Services, unlike tangible goods produced in the in­
dustrial sector, cannot be stored by the producer or
the consumer. Since the consumer cannot generally
stockpile services but must purchase them at the time
they are needed, there is less fluctuation in the de­
mand for consumer services than for consumer goods.
Moreover, since production of a service must occur
simultaneously with

its consumption, the service

sector is relatively free from the effects of procyclical
' This is not a universally accepted view of course.
There are
many economists, most notably Milton Friedman, who argue that
monetary and fiscal policy actions do indeed contribute to economic
fluctuations.

inventory investment, which occurs in the industrial
sector. Relative to the industrial sector, the service
sector is also characterized by a large number of selfemployed persons and white collar workers whose
jobs are somewhat less sensitive to cyclical fluctua­
tions in the level of business activity. The size of the
government sector also exerts a considerable stabiliz­
ing influence on economic activity. Decisions con­
cerning the provision of many public services (and
goods) are generally not related to fluctuations in
the level of economic activity, though the timing of
many government expenditures can be used as a tool
of stabilization policy. Together with the stabilizing
effects of monetary and fiscal policies and institutional
arrangements, the structural shift towards a more
service-oriented economy should continue to moderate
the magnitude of cyclical swings in the level of
economic activity.

CONCLUSION
In the heady economic atmosphere of the booming
1960’s, it was not hard to find economists willing to
argue that cyclical economic analysis had become an
anachronism. Moreover, there were numerous econo­
mists willing to concede the obsolescence of the busi­
ness cycle as a useful mode of economic analysis.
Undesirable though it may have been, recent ex­
perience has served as a reminder that cyclical forces
are still operating in the economy.
Glenn Picou and M arjorie S. Hale

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A rticles m ay be reproduced if source is given. Please provide the Bank’s Research D epartm ent with
a copy of any publication in which an article is used.

16




M O N TH LY REVIEW, SEPTEMBER 1972


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