Full text of Economic Review (Federal Reserve Bank of Atlanta) : July/August 1978, Volume 63, Number 4

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ECONOMIC
REVIEW

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tlanta, Georgia 30303

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FEATURES:
Southeastern Inflation:
19 7 1-7 7
67
Cost-of-living increases have
been slightly more volatile in the
Southeast than nationwide in re­
cent years.
Usury: The Recent Tennessee
Exp e rie n ce ........................................ 69
Tennessee's seven-month ex­
perience with a binding usury
ceiling on consumer loan rates fit
the predictions of conventional
economic theory almost to the
letter. Lenders sought alternative
sources of earnings, rationed con­
sumer credit with stiffer contract
terms and customer standards, or
stopped lending. Borrowers turned
to retailers, credit cards, and
out-of-state lenders or slowed
their repayments as credit became
difficult to get.
W orking Paper Abstracts
• Southern Banks and
the Confederate Monetary
E x p a n s io n
80
• Of Money and Prices: Some
Historical Perspectives . . .8 1

Economic Review , Vol. LXIII, No. 4. Free Subscription and
additional copies available upon request to the Research
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Please, provide this Bank’s Research Department with a copy
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Banking Note: Increasing
Liq u id ity Pressures ..............82
District banks have had to step
up their borrowing in recent
months as the aging of the
business upswing brought an ac­
celeration of credit demands and
a slowdown in core deposit
growth. We probably won't see a
replay of 1974's intense liquidity
pressures this year, however.
Labor Force Participation
and Jo b O p p ortunities___ 84
This study confirms that Job
seekers' success attracts new
hopefuls into the labor market;
their failure discourages labor
force participation. With such
movements into and out of the
labor force, unemployment rates
cannot accurately reflect the
health of labor markets.
Flue-Cured Tobacco: Output
Dow n, Prices U p ........................89
While last year's drought and
smaller acreage allotments held
down national output of fluecured tobacco and boosted auc­
tion prices to a new record, Dis­
trict growers reaped the benefits
of both good yields and high
prices.

Director of Research: Harry Brandt
Editing: Patricia Faulkinberry
Editing Assistance: A dolpha Jordan
Production and Graphics:
Susan F. Taylor and Eddie W. Lee, Jr.

SOUTHEASTERN
INFLATION: 1371-77
by W illiam N. Cox
How much has inflation eroded my
spending power? Has my paycheck kept
up with inflation? Has inflation hit me
harder than people in other parts of the
country? People in other income brackets?
We can find a fairly good set of data
with which to answer these questions
by looking at the Bureau of Labor
Statistics "cost-of-living data" from
w hich we calculated the inflation rates
on the next page.1 The BLS starts with
three mythical four-person families with
different econom ic standards of living—
lower, interm ediate, and higher budgets—
whose 1977 spending levels are shown
in Table I. Then BLS researchers use
surveys and interviews to estimate the
annual cost of maintaining each living
standard in various locations around
the country. These estimates are better
suited for regional comparisons of

cost-of-living changes than are the C o n­
sumer Price Indexes, as we have pointed
out previously in this Review.2
The BLS provides these inflation
estimates for four Sixth District cities—
Atlanta, Baton Rouge, Nashville, and
O rlando—and for a sample of smaller
towns in the South. For each of the
three budget levels, the accompanying
tables compare regional inflation estimates
with the U.S. "u rb a n " average (which
also includes small towns). We show the
effects of inflation on family budgets
in two ways: including and excluding
all taxes.
These estimates of inflation, expressed
as average annual rates, span two threeyear periods: autumn 1971 to autumn 1974
and autumn 1974 to autumn 1977. (Autumn
1971 marked the beginning of the wageprice freeze; President Ford took office

’ Statistics and documentation are available from the Bureau of Labor
Statistics, Suite 540, 1371 Peachtree Street, N.E., Atlanta, Georgia 30309.

2James T. Fergus, "Cost-of-Living Com parisons: Oasis or M irage?/' this
Review , July-August 1977.

TABLE 1
SPENDING LEV ELS NECESSARY TO MAINTAIN
THREE ECONOMIC LIVING STANDARDS, AUTUMN 1977
(for families of four)

Lower Budget
Excluding
Including
Taxes
Taxes
Urban U.S.
Atlanta
Baton Rouge
Nashville
Orlando
Nonmetropolitan South

$10,481
9,594
9,572
9,413
9,661
9,202

$8,657
8,125
8,125
8,065
8,240
7,825

Intermediate Budget
Including
Excluding
Taxes
Taxes

Higher Budget
Including
Excluding
Taxes
Taxes

$17,106
15,483
15,283
15,290
14,910
14,471

$25,202
22,584
22,695
22,206
21,832
20,584

Source: Annual releases of the Bureau of Labor Statistics, 1977, "A Guide to Living Costs."




$13,039
12,066
12,074
12,218
11,953
11,395

$17,948
16,499
17,015
16,922
16,663
15,284

TA BLE 2

COST-OF-LIVING INCREASES, EXCLUDING TAXES
(annual percentage rates)

Lower Budget
1971-74 1974-77 1971-77
Urban U.S.
Atlanta
Baton Rouge
Nashville
Orlando
Nonmetropolitan South

7.8%
8.2
7.7
8.0
8.6
8.9

5.8%
5.2
6.2
5.5
4.8
5.5

Intermediate Budget
1971-74 1974-77 1971-77

6.8%
6.7
7.0
6.8
6.7
7.2

8.1%
8.9
8.4
8.3
8.8
9.3

6.2%
6.1
6.2
6.2
5.9
6.2

7.1%
7.5
7.3
7.2
7.4
7.7

Higher Budget
1971-74 1974-77 1971-77
6.2%
8.7
8.3
8.1
8.6
9.2

7.4%
6.1
6.1
6.0
6.1
6.2

6.8%
7.4
7.2
7.1
7.4
7.7

TABLE 3
COST-OF-LIVING INCREASES, INCLUDING TAXES
(annual percentage rates)

Lower Budget
1971-74 1974-77 1971-77
Urban U.S.
Atlanta
Baton Rouge
Nashville
Orlando
Nonmetropolitan South

8.4%
8.8
8.1
8.5
9.1
9.4

4.4%
3.7
4.8
3.9
3.2
3.9

6.4%
6.2
6.4
6.1
6.1
6.6

Intermediate Budget
1971-74 1974-77 1971-77
9.3%
10.1
9.4
9.2
9.7
10.3

6.1%
5.7
5.7
5.6
5.3
5.6

7.7%
7.9
7.3
7.4
7.4
7.9

Higher Budget
1971-74 1974-77 1971-77
9.3%
10.7
9.3
9.2
9.7
10.5

6.6%
6.3
6.0
6.0
5.9
6.2

8.0%
8.4
7.7
7.6
7.8
8.3

Source: Annual releases of the Bureau of Labor Statistics, 1971-77, containing cost-of-living estimates for selected urban areas in the autumn of
each year. The 1975, 1976, and 1977 releases are entitled “A Guide to Living Costs."

in August 1974 in the middle of the
1974-75 recession.)
What do the comparisons show?
They suggest four things. First, over the
entire 1971-77 period, the effect of
inflation on southeastern families was not
significantly different from that which
their counterparts experienced else­
where, regardless of budget level.
Second, both nationally and in the
Southeast, the impact of inflation
diminished significantly from 1971-74
to 1974-77 in all budget categories.
Third, when the inflation rate was high
nationally, it was even higher in the
Southeast, and when the inflation rate
fell across the nation, it dropped even
further in the Southeast. In almost
every case, including or excluding taxes,
the southeastern inflation readings
were higher than the nation's in 1971-74
but lower than the nation's in 1974-77.
We cannot tell from the data we




have whether this is typical or unusual
for the Southeast. Recessions hold
down prices, however, and we do know
that the 1974-75 recession hit the South­
east later and harder than the rest of
the country, which is unusual in the light
of historical experience.
Fourth and finally, the BLS data suggest
that the 1971-77 inflation hit intermediate
and higher budget families harder than
low budget fam ilies, particularly when
taxes are considered. The tax part could
be expected because inflation boosts
families into higher income tax brackets.
But the results are somewhat surprising,
since a number of studies have suggested
the opposite—that lower income
families have been hit harder by post­
war inflation.3B

3See, for exam ple, J.G. W illiam son, " 'Strategic' Wage Goods, Prices, and
Inequality," Am erican Economic Review , March 1977, pp. 29-41.

USURY: THE RECENT
TENNESSEE EXPERIENCE
by Robert E. K eleher and B. Frank King
In March 1978, the Tennessee electorate
voted to remove a 10-percent usury
ceiling from the state constitution. This
usury vote was apparently a response both
to events which took place in the state
during the period of high interest rates
in 1974 and to an important judicial
decision made in August 1977 pertaining
to interest rates on consumer loans.
Empirical studies have examined the
effects of the Tennessee usury ceiling in
1974, but documentation of tne more
recent consum er lending experience has
been minimal at best.1 Tnis article reports
on a study of that experience.
Historical Background. Prior to March
1978, the state constitution limited
interest rates on most loans made by
Tennessee lenders to Tennessee borrowers
to 10 percent. W hereas most states have
adopted numerous exemptions to their
usury statutes, Tennessee's ceiling was
comparatively com prehensive ana
difficult to amend. Consequently, when
short-term market interest rates exceeded
10 percent between April and November
of 1974, its usury ceiling applied to a
wide spectrum of credit transactions.
O ther studies have demonstrated that
during this period, the usury ceiling
significantly disrupted credit flows in
Tennessee and propagated the use of
nonprice credit rationing.2
As a response to these events in
Tennessee (as well as in two other states),
the Congress of the United States passed,
and President Ford signed into law, the

1 For an examination of the 1974 Tennessee experience, see R.E. Keleher,
"State Usury Laws: A Survey and Application to the Tennessee Experience,”
W orking Paper Series, Federal Reserve Bank of Atlanta, January 1978.
2 See Keleher, op. cit.




M ansfield-Albert Bill (Public Law 93-501)
at the end of September 1974. This bill
allowed most financial institutions in
the state to charge interest rates higher
than those allowed by the Tennessee
(or any other state) Constitution. It
thus relieved the financial disruption
in Tennessee. In early 1975, while this law
was still in force, short-term interest
rates fell below the 10-percent level.
In mid-1977, the M ansfield-Albert Law
expired, so that if interest rates regained
double-digit levels, Tennessee would
again be susceptible to credit disrup­
tions arising from the usury ceiling.
During tnis entire period, consumer
lending in Tennessee was generally
unaffected by the usury ceiling. A
number of statutes which effectively
granted exceptions to a simple 10-percent
interest ceiling had been enacted over
the years by tne state legislature. In
particular, the Industrial Loan and Thrift
Act permitted various add-ons, discounts,
and fees w hich, in effect, exempted
direct consumer lending by finance
companies from a strict 10-percent annual
percentage rate usury ceiling. Provisions
in other acts gave banks and credit unions
similar latitude in rates charged on their
direct consumer loans. M oreover, the
Retail Instalment Credit Act allowed finance
charges on retail credit purchases which
permitted effective rates to exceed 10
ercent. This latter law was construed
y the courts to give legal support to the
"tim e-price differential" doctrine
whereby the difference between a cash
price and a time price was not considered
to be interest and, thus, not subject to the
constitutional usury ceiling. The timeprice differential was said by the courts

to apply to credit cards, merchantoriginated credit (like store credit ac­
counts), and conditional sales contracts. In
addition, subsequent purchases of such
receivables were not covered by the usury
ceiling. These laws and the courts'
interpretations of them effectively
insulated most forms of consumer lending
from the 10-percent usury ceiling.
On August 22, 1977, however, these
circumstances were changed when the
Tennessee Supreme Court invalidated that
part of the Industrial Loan and Thrift
Act which had permitted finance com ­
panies to charge effective rates in excess
of 10 percent. The court's interpretation
was that interest could not exceed a
10-percent annual percentage rate
on direct consumer loans. Technically,
the court decision did not apply to laws
other than the Industrial Loan and Thrift
A ct; however, the statutes covering
commercial banks and credit unions were
clearly vulnerable to similar interpretation.
Thus, most banks and credit unions
interpreted the decision to apply to their
direct consumer lending. In general,
however, the decision was not considered
to apply to forms of lending covered
by the Retail Instalment Credit Act.
W hen the court decision was rendered,
a constitutional convention was consider­
ing an amendment to change the usury
ceiling as well as other amendments to the
state constitution. The convention
subsequently recommended an am end­
ment removing the usury ceiling. This
amendment was endorsed in the March
referendum . As a result of this vote, the
interest rate provisions of the Industrial
Loan and Thrift Act were reinstated as of
March 31—the election certification
date. Thus, between the Supreme Court's
usury decision in August 1977 and the effec­
tive date of the constitutional amendment,
a binding usury ceiling on direct consumer
lending was in effect in Tennessee.
This seven-month period has several
earmarks of a laboratory experim ent on
the results of an effective usury ceiling.
M arket rates on consumer instalment
loans were above 10 percent prior to the
August 1977 decision. The court's imposi­
tion of a strict 10-percent annual percent­
age rate ceiling was rather sudden
and not entirely expected. Lenders and




borrowers had made few prior adjust­
ments. The decision left several different
alternatives for lenders and borrowers;
thus, a variety of reactions could be
observed. In addition, the ceiling was
lifted after a tim e, allowing observation
of market participants' readjustment
to a freer environm ent.
Tennessee's unintended experim ent has
provided an opportunity to see if the
effects of a binding usury ceiling coincide
with a rather fully developed body of
econom ic principles and evidence about
such ceilings. To examine these effects,
we conducted a series of interviews
with persons who were knowledgeable
about lenders' and borrowers' reactions
to the ceiling and analyzed the available
data. We found that w nile the ceiling
was binding, less credit was available.
Borrowers and lenders sought credit
alternatives that were not covered by
the usury ceiling. Some lenders stopped
lending almost entirely; others used non­
price rationing techniques to reduce
lending that was covered by the ceiling.
Some borrowers could not get credit;
many of those who could get credit
borrowed at rates above the ceiling. Those
who had the most difficulty in borrowing
had low incomes, wanted to borrow
small amounts, and did not have wellestablished credit. The usury ceiling
protected these borrowers from high
credit costs only to the extent that it made
credit unavailable to them at any cost.
All of our findings are consistent
with orthodox econom ic principles that
have been articulated often ana for many
years. In addition, the findings parallel
those of most other studies of actual
experiences with effective usury ceilings.
These facts add further to the confidence
that one can have in both the theory
and the evidence concerning the effects
of usury laws. In the rest of this article, we
proceed first with an outline of the
econom ic principles that relate to the
effect of usury ceilings. Following that, we
present an account of the Tennessee
evidence and then a statement of
conclusions.
THE THEORY
W hen market interest rates exceed
the usury ceiling, some credit market

distortions can be anticipated. Interest
rates subject to the usury ceiling are
prevented from perform ing their credit
rationing function— borrowers demand
more credit than lenders are willing to
supply at the legal interest ceiling. This
situation is normally referred to as an
excess demand for credit. The portfolio
adjustments made by lenders and bor­
rowers in response to this excess demand
will largely determ ine the impact of the
usury ceiling on various sectors of
the state econom y. These responses may
take the form of shifts in the supply and
demand for credit, as well as a more
extensive use of nonprice credit rationing.
Shifts in Supply and Demand. When
market interest rates are above usury
ceilings, lenders are prohibited from
earning market-determined returns on
credit instruments subject to usury.
Lenders observe that assets not subject
to usury ceilings (either local instru­
ments not covered by the ceiling or outof-state instruments) offer more attractive
returns and that safer (lower risk) instru­
ments can be acquired at rates equivalent
to the ceiling. Consequently, lenders
may shift funds into tnese substitute
assets in order to obtain a better riskreturn mix in their portfolios.3 In so
doing, lenders affect the allocation of
credit within the state as well as between
states.
Certain financial institutions such as
finance companies, however, may be
limited by regulation or convention to
very specialized portfolios and thereby
may be prevented from shifting into
alternative assets. M oreover, if the cost
of funds to these specialized institutions
is market-determined (and, consequently,
at high levels during a period when the
ceiling is effective), they may be forced
to reduce the size of both sides of their
balance sheet by paying off liabilities
as well as by extending fewer loans.
These portfolio adjustments have
implications for the supply of credit
subject to the usury ceiling. Specifically,
as the interest rates on credit instruments
not subject to usury rise relative to the

3 First, however, lenders will normally accommodate prior loan
commitments and lines of credit.




usury ceiling, the supply of loans covered
by the ceiling will dim inish. Since credit
is highly mobile, particularly in an
integrated national credit market, the
speed of these supply shifts may be
quite rapid. The more open the state
economy and the larger the set of allow ­
able exemptions in the usury statute the
greater will be the degree of contraction
of the usury-covered credit supply.
In addition to reducing the supply
of credit which is subject to usury,
effective usury ceilings will increase the
demand for tnat credit. Borrowers within
and outside of the state will attempt
to shift out of the higher priced marketregulated credit and into the lower
priced credit covered by the ceiling. As
a consequence, the demand for credit
instruments subject to usury will be
greater than it would have been in the
absence of the ceiling. These shifts in
both demand and supply will work to
expand the excess demand created by the
effective usury ceiling.
Portfolio changes made by lenders and
borrowers in response to effective
usury ceilings will have several important
consequences. First, to the extent that
lenders shift out of loans subject to usury
ceilings and into out-of-state instruments,
credit will leave the state economy.
Borrowers in the area will have access to
less credit, and to the extent that expendi­
tures are credit-financed, expenditures
and income will be lower.
Second, financial institutions which
have narrow, specialized portfolios and
sources of funds with costs that are
market-determined will be forced by
lower earnings to diminish (or cease)
lending. On the other hand, lenders
which nave diversified portfolios and
are able to quickly (and inexpensively)
adjust by shifting into credit instruments
not covered by the ceiling will not be
adversely affected to any substantial
degree. Borrowers using the specific type
of credit covered by the ceiling will find
less accom m odation, particularly if
they do not have access to alternative
sources of credit not subject to the
ceiling. Borrowers with access to alter­
native sources will be able to obtain
credit but at market rates above the usury
ceiling. In sum, if the portfolio adjustments

described here were the only responses
of lenders, then it could be anticipated
that specialized financial institutions,
borrowers with access to few alternatives,
and certain credit-dependent sectors of
the state economy would be more
adversely affectea than would diversified
lenders and borrowers.
Contract-Related Forms of Nonprice
Credit Rationing. Shifting into higher
yielding assets not covered by usury
ceilings, however, is not the only option
available to lenders. Given the excess
demand created by the usury ceiling,
lenders may attempt to continue to make
some loans covered by the ceiling. If some
loans are still profitable at the usury rate,
lenders w ill use nonprice rationing devices
based on the characteristics of the loan
customer or contract to choose profitable
loans and weed out unprofitable ones.
Nonprice rationing methods are
intended to increase the profitability
of loans that remain subject to an effective
usury ceiling. Profitability can be improved
by (a) lowering costs, (b) reducing risk,
or (c) increasing the effective (as opposed
to nominal) interest rate. Forms of
contract-related nonprice credit rationing
normally employed by lenders are adapta­
tions of these three possibilities. They
include, for exam ple, the fo llo w in g :4
1. increases in collateral (lower risk
and lower investigative and m onitor­
ing costs);
2. increases in the compensating
balances required (increase effective
return);
3. alterations in maturity structure
or repayment schedules (lower risk
and increase effective yield );
4. increases in fees, such as service
charges, commitment fees, insurance
charges, down payments, etc.
(increase effective yield); and
5. increases in the size of the loan
(lower cost).
Although use of these indirect forms
of paying interest may not perform the
rationing function so efficiently as direct
interest charges, lenders and borrowers
may nonetheless be able to avoid some

4 For more detailed explanations as to the rationale for these nonprice
rationing devices, see Keleher. op. cit.




of the effects of a usury ceiling by adopting
them. The use of these nonprice rationing
devices will cause more credit to be
supplied and less to be demanded at the
ceiling rate. That is, at a given contract
interest rate, lenders are willing to
offer more loans if collateral is higher,
compensating balances are higher, or
various charges and/or fees are higher;
conversely, borrowers will dem and
few er loans. The effects of the usury
ceiling on credit supply and demand are
thus mitigated.
This form of nonprice rationing has
some important implications for certain
sectors of the state econom y as well as
for financial institutions. First, ceilingconstrained credit sectors of the economy
are not so adversely affected as when
financial institutions exclusively shift
funds into assets not covered oy the
ceiling. Credit is still available in these
sectors, albeit at an effective price
higher than the usury ceiling; more
consumers dependent upon credit can
still obtain funds. Second, the earnings
of financial institutions, particularly those
with specialized portfolios, will not be
so adversely affected, since nonprice
rationing devices merely substitute for
higher interest charges.
Although nonprice forms of rationing
are generally less efficient than price
rationing (higher transactions and inform a­
tion costs are involved), they do function
as substitutes for direct price changes.
If these methods are easily and extensively
em ployed, there does not appear to be
much reason to have a usury law, since
the law will only be circum vented with a
less efficient form of rationing.
Customer-Related Forms of Nonprice
Credit Rationing. Borrower character­
istics may also be employed as nonprice
rationing criteria. These characteristics
relate both to the risks of lending to
a particular borrower for specific purposes
and to the desirability of accommodating
those borrowers who have maintained a
continuing and profitable relationship
with the financial institution. The most
extensively used customer attributes
are those that relate to the quality of the
individual's credit—wealth, income,
stability, and indebtedness. In addition,
the length and profitability of the

customer's relationship to the lender
may be used as an inaex of both risk and
future profitability.
If financial institutions respond by
employing these customer-related non­
price rationing criteria, unique effects
on borrowers, the state economy, and
state financial institutions will result.
First, since low risk borrowers will most
likely receive credit at the usury ceiling—
at rates below those determined in the
market— they may benefit from the
ceiling. However, borrowers with lower
incomes and asset sizes who have not estab­
lished long-term customer relationships
will find credit more difficult to obtain.
M oreover, such borrowers are less likely
to have access to alternative types of
credit not covered by the ceiling. Even if
they have such access, however, they will
pay interest rates above the usury ceiling.
In short, effective usury ceilings may
result in the price of credit being lower
only for low risk, well-establishea bor­
rowers. For riskier borrowers without
established customer relationships,
credit may either be unavailable at any
price or available only at rates above the
usury ceiling.
Second, if financial institutions continue
to accommodate a large number of long­
term customers at the usury ceiling,
profits of these institutions will be lower
than they otherwise would have been.
This is particularly true if lenders accom ­
modate these well-established customers
with money purchased at market rates.
Under these conditions, lenders will
eventually shift funds into assets not
covered oy the ceiling or begin to apply
contract-related forms of nonprice credit
rationing more intensively.
Three general categories of lender
response to an effective usury ceiling
have been review ed; namely, shifts into
alternative credit instruments and the use
of contract- and customer-related
forms of nonprice credit rationing. The
initial response of borrowers would be to
seek more credit at the usury ceiling
rate. Finding it available only under
nonprice rationing schemes or unavailable,
borrowers would try to meet the nonprice
rationing criteria and to find alternative
sources of credit. Failing that, some
borrowers may not borrow at all.




Each of these responses has unique
implications for particular sectors of the
state economy as well as for the financial
institutions themselves. Although it is
likely that these three reactions will be
simultaneous, to some extent their impact
may be felt in different time frames.
For example, the longer the usury law
remains effective the more likely that
financial institutions will shift into assets
not subject to usury and adopt contractrelated forms of nonprice credit rationing,
even if it means a de-emphasis of accom­
modating their best, well-established
customers. In view of these three possibil­
ities, if it is observed that loan volume
has been significantly affected by an
effective usury ceiling, then it can be
concluded that either the contractrelated nonprice rationing measures were
not employed, customer relationships
were o t minor im portance, or that these
effects were offset by shifts of funds
into market-regulated instruments. If it is
observed that loan volum e was not
significantly influenced by an effective
usury ceiling, then either nonprice
rationing was employed or long-term
customer relationships were of substan­
tial importance.
THE TENNESSEE EVIDENCE
In order to determ ine the influences of
the August 1977 usury decision on bor­
rowers and lenders in Tennessee, we talked
to a group of people whom we expected to
be familiar with both borrower and lender
reactions. This group included finance
company and commercial bank lenders,
consum er representatives, and one state
regulator of finance companies. All were
located in the Chattanooga and Nashville
areas. We chose them because we thought
they would have information useful to
us and because they were accessible.
The group was not a scientifically repre­
sentative sample, but the seven finance
companies included large and small,
local and national concerns, and the
six banks included large and small
institutions, with Federal Reserve members
predominating. We also drew information
from several statistical reports that we
felt were relevant. Inform ation gathered
from all sources was remarkably consistent.
Immediate Lender Adjustments. The
pattern of reactions that showed up in

our interviews and our statistics corre­
sponded generally to what we expected
on the basis of the theory expounded
above. We concentrated our attention
on banks and finance companies because
these lenders made most of the loans
affected directly or indirectly by the
August decision. Each reacted within the
context of its legal powers and the
types of customers that it served. Finance
companies were the more seriously
affected.
Finance Companies. Prior to August 1977,
the finance companies from which we got
inform ation had been making loans at
well above the annual percentage rate of
10 percent imposed by the courts. These
loans were prim arily to individual con­
sumers, but two larger companies did
substantial financing of equipment
and inventories for small businessmen.
G enerally, the finance companies that we
interviewed stopped making new loans
in Tennessee after August 22. The very
few new loans that they reported were
loans to established customers who
had em ergencies or loans already
committed before August 22. These
finance companies let most of their
existing loans run off during the sevenmonth period from August 1977 through
March 1978. Those with loans that they had
expected to be refinanced when they
made them generally accepted a partial
payment ana extended the balance at the
10-percent ceiling rate, and those that
got applications for extensions from
customers who could not pay generally
honored these requests.
The finance companies ceased making
loans because they felt that they could
not raise money, administer loans,
take risks, and make a profit at the 10percent rate plus the state's maximum
service charges. They pointed out that
they operated on borrowed funds, could
spread fixed costs of originating and
administrating loans only over smalldenom ination loans, ana made loans with
a relatively high default risk. The default
risk associated with their loans varied;
two reported that many of their customers
also had bank credit cards, and two others
reported that most of their customers
could not get a card. Nevertheless, all




companies reported that they were
unable to make a profit at the 10-percent
rate.
We got a general impression that these
finance companies were somewhat less
aggressive in their collection policies
wnile the usury ceiling was binding.
They reported that they had "c a rrie d "
quite a few customers with problems,
although they might not have under other
circumstances. Their softer policies
seemed to arise from their impression
that customers were being squeezed by a
credit shortage, had few alternatives
for borrowing to pay or consolidate
loans, and were likely to take personal
bankruptcy if pushed to make payment.
These companies also treated tne usury
roblem as temporary and were thus
esitant to jeopardize long-term seasoned
relationships tnat might provide profitable
business after the crisis was over. Banks
reported the same thing. Further, this
tendency toward ease on collections was
confirm ed by one local consum er credit
counseling service that reported a large
decline in the number of new clients
between August 1977 and February 1978
and a jum p toward previously normal
levels in March of tnis year after the
constitutional amendment passed.
The finance companies with offices
outside Tennessee made some referrals
to those offices and forwarded credit
information on referred borrowers. O ne
company purchased an out-of-state office
prim arily for referrals; another attempted
to unsuccessfully. Customers that they
referred were generally those with the
least risk and requests for the largest
loans. A large proportion were small
businesses at tne two companies that
served this group. The finance companies'
Tennessee regulator reported that loans
from out of state were not more prev­
alent because Tennessee had long had a
rule that the physical presence of an
out-of-state lender or his agent in the
state to collect a loan caused its interest
rate to revert to the 10-percent usury
ceiling, retroactive to the date the loan
was extended.
Despite some extensions of new loans,
some refinancing, and a less aggressive
collection policy, each finance company

that we talked to reported a substantial
decline in loans outstanding from August
1977 through March 1978. Their estimates
of the drop ranged from 20 to 35 percent
and are consistent with those of tneir
regulator, who estimated a 30-percent
reduction in outstandings for all Tennessee
companies during the period. This repre­
sents a decline in outstandings of about
$150 million.
The finance companies used funds gen­
erated by this decline in several ways
which were much influenced by the
individual situations of the companies.
The funds generally went to pay off
various sorts of debts, usually commercial
paper or bank lines. Those companies
with out-of-state offices allocated some
funds to them — probably to handle
Tennessee business, at least in part. Two
companies attempted to expand their
purchases of conditional sales contracts
from merchants. In doing this, they could
acquire consumer loans that had been
exempt from the usury ceiling by the
tim e-price differential interpretation
discussed above. One succeeded, but the
other met stiff competition from banks
and captive finance companies such as
G M A C and had little success. Both of the
finance companies were affiliated with
bank holding companies which have
bank subsidiaries in their market areas.
The independent companies that we
interviewed did not expand lending of this
sort—commonly called indirect lending—
because their managements felt that they
could not survive in the indirect market
alone. They wanted as few encumbrances
as possible to closing shop if the usury
ceiling were not increased.
Banks. Com m ercial banks depended
much less on consumer lending and had
a larger proportion of low risk consumer
loan customers than finance companies.
Those that we talked to planned to stay
in the consumer lending business whether
or not the usury ceiling was raised, but
they intended to make substantial changes
in tneir approach if the usury amendment
failed. They tended to make a broader
range of adjustments and to go further
toward the positions they would have
adopted if tne ceiling had been set
permanently at 10 percent. In contrast to




the finance companies, which generally
stopped lending, the banks made many
of the partial adjustments described in our
discussion of usury.
Five of the six banks we talked to
shifted funds from types of loans that were
covered by the 10-percent ceiling to those
that were not. Under Tennessee law, the
types of consumer loans that were not
covered were instalment loans that fell
under a tim e-price differential concept.
They included loans made directly by a
merchant for merchandise and then
discounted to the bank. Credit card
purchases also fell under this concept.
Two banks made no attempt to divert
funds from loans subject to the 10percent ceiling to consumer loans that
were not covered. They simply reduced
their consumer loans. O ne of these was
trying to lower its loan-deposit ratio
anyway. The other was a small bank
that had no base of dealer discount
business to start with and only a small
credit card business. It allocated funds
to other assets such as business loans.
The most general bank reaction was to
increase indirect automobile and equipm ent
lending by discounting dealer paper on
this merchandise. The banks that tried
to maintain consumer lending made
some moves to increase their indirect
lending. Two of the larger ones were
particularly aggressive, bringing on new
dealerships and expanding programs with
existing dealers. From comments by
banks and finance companies, it is evident
that captive finance companies also
increased their efforts at indirect lending,
apparently seeing an unexploited market
made more attractive by the lower usury
ceiling.
Two of the banks that expanded indirect
lending quite aggressively also successfully
channeled requests for smaller consumer
instalment loans into credit card advances
and preauthorized personal lines of
credit, feeling that tne costs of making and
administering these loans were lower.
They selectively raised credit limits on
credit cards and notified their customers
of new or increased personal credit lines.
They stepped up their efforts to market
this type of credit.

T A B LE I
AVERAGE YEAR-TO-YEAR CHANGE IN MONTHLY EXTEN SIONS
OF INSTALMENT CRED IT, SEP TEM B ER 1977-MARCH 1978,
REPORTED BY SM ALL SA M PLES OF BANKS IN EACH STA TE
Tennessee

Percent Change
Alabama

Georgia

Automobile Loans
Purchased Paper
Direct Loans
Total

39
-29
7

34
19
24

64
12
29

Credit Cards
Retail Purchases
Cash Advances
Total

21
89
30

22
39
23

26
10
25

Other Instalment
Loans for Personal Expenses

-31

21

12

Other Consumer Loans

-18

44

- 8

Total Instalment Credit

1

23

21

/■t'v'V.

At best, the banks we interviewed held
consumer lending steady by replacing
declining direct consumer loans with
indirect loans, credit cards, preauthorized
overdrafts, and personal lines of credit.
None reported gains in overall consumer
lending; some were unable to keep
total consumer loans constant. O ne of
their problems, in addition to stiff com ­
petition in indirect lending, may have been
the public's belief that consumer credit
was not available. A couple of the bankers
admitted (dolefully) that their own state­
ments may have helped to promote this
misconception.
Data on consumer lending by Tennessee
banks are sparse but quite consistent
with the statements made by the bankers in
our interviews. The Federal Reserve Bank
of Atlanta collects detailed instalment
lending data from banks in its District as
part of a national sample. Seven of these
banks are in Tennessee. We compared
the monthly reports of these banks with
those of control groups of nine banks in
Alabama and eleven in Georgia. The
groups are dominated by larger banks
and are not necessarily representative of
their states, but statistics on their behavior
conform very closely to the results that
both our theory and interviews lead us




to expect. The details are reported
in Table 1.
During the period when the usury ceiling
was binding on consum er loans in
Tennessee, direct automobile loans at our
group of Tennessee banks declined
sharply; these loans rose sharply at
the banks in Alabama and Georgia. Indirect
automobile loans rose in all three states,
as Tennessee banks apparently transferred
auto lending business from direct to
indirect loans. The Alabama and Georgia
banks outdistanced those in Tennessee
in growth of total automobile loans.
In addition, the use of credit cards,
particularly of cash advances, grew more
rapidly in Tennessee. Extensions of other
consum er instalment loans, most of which
were covered by the 10-percent ceiling,
fell off sharply; this contrasts with the
gains of Alabama and Georgia banks. O verall,
tne seven Tennessee banks barely
increased their consumer loan extensions
during the period, while at banks sampled
in the other two states, these extensions
grew by more than 20 percent.
Besides diverting funds to other
instruments, bankers also modified their
contracts on loans affected by the ceiling.
They changed credit contracts in two
ways. All raised the minimum size of

consumer loans made under the 10-percent
ceiling in order to spread fixed costs
of administering and originating each
loan over larger loans. Tne data on bank
consumer lending, described above,
show no greater increase in the average
size of consum er loans at the Tennessee
banks than at those in Alabama and
Georgia during the August 1977-March
1978 period, indicating that the Tennessee
banks may have been making few loans
at the minimum size to begin with.
Most banks decreased the maturity of
their consum er loans. Two that had been
making direct auto loans with a four-year
maturity cut back to three years; another
put a two-year maximum on all direct
consum er lending. Regarding the usury
problem as probably temporary, some
banks shifted from their normal equal
instalment loans to 18-month or 12-month
balloon notes—that is, notes with a large
final payment. They hoped to refinance
the large final payments at a higher rate
when tney came due. O ther banks made
few or no balloon notes because they
felt that the expense of making a new loan
for the balloon portion was likely to be
more than the gain from a higher rate.
Two characteristics dominated the banks'
customer-related responses—risk and
relationship. Each bank reported tightening
its credit risk standards in order to
reduce the cost of loans made under the
10-percent ceiling. However, none
reported asking for more pledged
security on their loans. Tightening of
credit standards is confirm ed by a sub­
stantial volume of complaints to the state
overnm ent from bank customers who
ad previously been eligible for loans
but who were refused on the grounds of
credit risk shortly after the August 1977
decision.
In addition to tightening credit
standards, each bank also promulgated
rules that no loans would be made to
customers who had no prior deposit
relationship. Interestingly, the smaller
banks reported that they interpreted
these rules flexibly and made loans in some
cases if a customer would shift his deposit
from another bank. The larger banks'
rules seemed to have been considerably
less flexible.




The banks' reactions underscore the
effect of the usury ceiling on profits from
a particular type of lending. Tney con­
tinued lending to much the same group
of customers by way of instruments not
affected by the 10-percent ceiling or
in ways that were less costly to administer.
They sought to lower the unit costs of
lending by raising the minimum size of
loans, serving customers they already
knew, and cutting out the most risky
borrowers. They also sought to ensure
future profits by taking care of existing
customers.
Anticipated Long-Run Lender Adjust­
ments. Actions of both types of lenders
that we interviewed were influenced by
the possibility that the August decision
would be in effect only tem porarily.
Despite the sharp decline in lending
volum e, no finance company that we
visited closed offices because of a lower
usury ceiling. (Many offices were closed
by other firms, usually large national
companies.) These firms maintained
offices in order to keep a vital staff
intact, to have a convenient place to
collect payments, and to maintain a
presence in a familiar location (and to
satisfy lease requirem ents in some cases).
However, each reported cutting its staff
by 30 percent or more. Each banl< reported
that it tried to keep its staff intact, pri­
marily through reassignments.
We asked tne lenders what they planned
to do if the March constitutional amend­
ment failed. Each finance company
planned to stop making new loans, to
close offices, and eventually to leave the
business in Tennessee. The largest firm
that we talked to described rather elabo­
rate plans to consolidate its Tennessee
offices by stages before closing up
entirely. Banks spoke of some staff
reductions and a small num ber of branch
closings; they indicated that more
shifts toward alternative types of consumer
credit might have been made.
Such anticipated moves are similar to
those actually made by Arkansas financial
institutions under a 10-percent usury
ceiling that is even more com prehensive
than tnat of Tennessee. Studies of the
Arkansas experience indicate that a
permanent effective usury ceiling is

accompanied by increased use of security
requirem ents, service fees, insurance
charges in credit contracts, a reduction
of credit availability within the state,
and the disappearance of finance
companies from the state's consumer
lending business5.
Borrower Reactions. Borrowers reacted
to the lower usury ceiling by conform ing
to lenders' requirements, by seeking
alternatives of various sorts, by stretching
existing credit, by reducing additions to
savings deposits, and by postponing
purchases. That commercial banks
continued to make loans under the 10ercent ceiling indicates that some
orrowers adapted to the ceiling by meet­
ing the requirements of larger loan
size, better risk, close relationship,
and shorter maturity. That banks were
unable to maintain direct lending volume
and finance companies virtually stopped
making new loans show that not all
borrowers were able to adapt in these
ways.
In states bordering Tennessee, some
borrowers were able to get loans from
commercial banks and finance com ­
panies that were not subject to a usury
ceiling of 10 percent. As mentioned above,
some Tennessee finance companies
referred some customers to tneir out-ofstate offices, usually customers who
were better credit risks and wanted to
borrow relatively large amounts. In
explaining this, the persons that we
interviewed noted that borrowers of small
amounts were generally reluctant to
travel far for loans. More important,
however, was the state rule that required
out-of-state lenders who entered the
state to collect a loan to bring the loan
into conform ity with Tennessee usury
standards.
Borrowers who were referred to out-ofstate offices were joined by many who
crossed state lines without referral.
Managers at two finance companies and
one bank across the Georgia state line
from Chattanooga reported numerous
inquiries from potential customers in
Tennessee during the six weeks follow ing
the August 22 decision. The Georgia

C

5 See, for example, K.J. Burns, R. Daigler, and L.S. Scruggs, “ The Impact of
Restrictive Interest Rates on Consumer C re d it,” October 1977, and the several
references therein to research on the Arkansas case by Lynch.




banker complained that Chattanooga
banks served the best customers from
both states at 10 percent and all of the
rejects came to him. (He reported that
many became his rejects also.) The
Georgia finance company that served
Tennessee's small loan customers
doubled its outstandings in seven months
and reported that all finance companies
in the area were very busy during the
period.
In areas both near to and far from the
state lines, borrowers sought other
alternative means of borrowing. Banks'
ability to expand their indirect lending
for cars and equipment and the aggressive
moves of captive finance companies
in this type of lending indicate that
consumers who purchased large durable
goods increased their direct borrowing
for merchandise on notes that were
then discounted to financial institutions.
This alternative may have worked well for
purchasers of larger consum er durable
goods, but it had limited use in financing
other purchases.
A more generally applicable type of
credit for smaller purchases and small cash
loans was the credit card. Several banks
reported heavier bank credit card volume
during the period. O ne had more requests
for increased borrowing limits than usual,
and another raised limits on many of
its card accounts of its own accord.
Further, two of the finance companies
reported that a greater-than-usual
proportion of their business during the
period immediately after the ceiling
was lifted involved loans to refinance
credit card outstandings that had reached
credit limits.
The consumer credit data reported in
Table 1 indicate greater increases in
extensions of credit card credit in the
Tennessee banks than in the Alabama and
Georgia banks. The increases were
particularly great in cash advances. In
Tennessee, cash advances had generally
carried a 10-percent rate even before the
August 1977 decision, but they were
available at least to some credit card
customers. Those customers apparently
increased their use of this available credit
in the face of loss of other types.
In addition to bank cards, retail stores'
credit programs seem to have gotten more

use. Two bankers and one finance
company manager who were fam iliar with
the business reported that the larger
retail stores did a larger-than-usual credit
business while the 10-percent ceiling
was effective.
Like indirect borrowing, however, use
of credit cards had its limits. Some
finance company managers doubted that
many of their customers could have used
the credit card alternative to any great
extent. These customers' incomes and
assets were too low and their credit
was insufficiently established to make them
eligible for credit cards. Customers in
these categories who could get cards
generally had low credit limits.
A further credit-related alternative
used by some borrowers was limiting
payments on outstanding credit. O nly
one institution that we talked to reported
that consum er loan delinquencies were
less than usual; that was a bank which
had changed its collection system during
the early summer of 1977. Generally,
the arrival of Christmas and w inter, with
its higher utility bills, touched off a
greater-than-usual increase in delinquen­
cies. We reported above that lenders,
knowing alternative sources of credit were
scarce, tended to carry more borrowers
for longer than usual. Thus, they allowed
borrowers to use outstanding credit
as a substitute for new extensions.
Some of the persons that we interviewed
speculated that some consumers had
drawn down savings deposits and other
liquid assets in order to continue spending.
O ne reported hearing talk of “ too much
cash" from some automobile dealerships.
Data on net time and savings deposit
changes at Tennessee banks and savings
and loan associations are consistent
with such behavior. Although it remained
positive, the growth rate of these deposits
in Tennessee declined relative to that
of similar deposits in Alabama and Georgia
during the six months following the August
usury decision.
All of the credit alternatives used by
borrowers were apparently inadequate to
maintain spending. Existence of these
credit alternatives, coincidence of other
spending influences, and the probable
diffuseness of the usury ceiling's spending
impact make the magnitude of this




TABLE 2

N

CHANGE IN ESTIM A TED R ETA IL S A L E S
BEFO RE AND A FTER USURY DECISION*
(average monthly percent change,
seasonally adjusted data)

State
Alabama
Georgia
Tennessee

March 1977July 1977

September 1977January 1978

2.5
1.2
1.4

0.5
0.8
- 2 .2

'Estim ate s are based on s ales tax collections

negative spending influence difficult to
measure. Analyzing the influence from
the lender's side, we found that the banks
we talked to were able at most to maintain
their overall volum e of consumer credit,
that the finance companies virtually
ceased to make new loans, and that
access to out-of-state lending was
generally limited to residents of border
areas wno were less risky borrowers of
larger amounts. O ne doubts that expanded
retail credit, delinquencies, and other
alternatives overcome this dim inution.
Analyzing from the borrower's side, the
increase in delinquencies and the surge of
new borrowing since the ceiling was
raised on March 31 indicate that at
least some borrowers were strapped for
credit and put off spending until credit was
available to them.
Changes in retail sales in Tennessee
during the five months after the August
usury decisions are consistent with some
negative effect on consum er spending.
The average monthly change in sales
during the five months prior to the
decision was a positive 1.4 percent; during
the five months after, a negative 2.2
percent. Average growth in the neighbor­
ing states of Georgia and Alabama also
dropped in the September 1977-January
1978 period, but the drop was not so
severe and gains continued (see Table 2).
The bankers that we interviewed were
split on whether businesses that they
normally made loans to had experienced
severe ill effects. About half saw little
appreciable impact; the others felt
tnat small retailers without credit plans,
particularly sellers of furniture, appliances,
and used cars, had been adversely
affected in a serious way.

Borrowers, then, like lenders, sought
and used available alternative sources
of credit. These included out-of-state
lenders, dealers who could discount
credit they granted directly for m erchan­
dise, both bank and retail consumer
credit card programs, and extensions of
existing credit either through formal
arrangements or delays in repayment.
There is some indication that tne alterna­
tives failed to completely make up for
the sharp decline in direct credit and
that total spending in the state was lower
than it otherwise would have been, but
estimates of the amount of this impact
are difficult.
Apparently, borrowers of small amounts,
with lower incom es, without established
credit, and with needs for nondurable
goods or services were most often unable to
get credit as a result of the 10-percent
ceiling. The least risky customers of banks
were generally able to get bank loans
either directly under the 10-percent

ceiling or through dealer paper. Durable
goods buyers with established credit
generally found financing available at the
dealer; those with credit cards could
use these up to their assigned credit
limits, and less risky borrowers of large
amounts in border areas could find outof-state sources.
The Theory and Our Evidence. O ur
interviews and the available data are
generally consistent with the predictions
of econom ic theory about the effects of
the August 1977 usury decision. That
theory—and its predictions— is by no
means novel. Indeed, economists have
often (and almost unanimously) indicated
that effective usury ceilings will redirect
credit flows, will make credit more
difficult to get, and will fail to produce
their intended effect—to allow small
borrowers credit at low rates. The
Tennessee experience, then, constitutes
additional support for these contentions.H

WORKING PAPER ABSTRACTS
The following articles summarize staff analyses that may interest those in the economics and
banking professions as well as others. They are more technical than the typical Economic
Review article. The analyses and conclusions are those of the authors. Studies of this kind do
not necessarily reflect the views of the Federal Reserve Bank. Each complete study is available
as part of a series of Federal Reserve Bank of Atlanta Working Papers. Single copies of these and
other studies are available upon request to the Research Department, Federal Reserve Bank of
Atlanta, Atlanta, Georgia 30303.

SOUTHERN BANKS AND THE
CONFEDERATE MONETARY EXPANSION
by John M . Godfrey
In the past, the role of southern banks
in the Confederate monetary expansion
was never adequately explained because
researchers had not assembled the rele­
vant data in a com prehensive and logical
way. New and revised data, which fill in
missing information and correct m isinfor­
mation, have been compiled from U.S.
Treasury reports, state documents, and




surviving bank reports and records. An
analysis of the new data reveals that
banks contributed much less to the
monetary expansion than has generally
been reported. Even when bank notes and
deposits were advancing most rapidly,
the growth contributed only m oderately to
the Confederate monetary expansion.
And after early 1862, the increase in bank

money had only a minor impact on
aggregate monetary growth. However,
earlier studies by jonn Christopher Schwab
and Eugene Lerner generally m isrepre­
sented the role of southern banks and the
impact of bank money on overall money
supply growth. A particular fault was
their failure to take into consideration
banks' holdings of currency and other
cash, which resulted in a double-counting
of a portion of the money supply.
Based upon these new and revised data,
this W orking Paper examines the changes
in bank-created money and bank-held
money from 1860 through 1864 and
investigates the reasons for these changes.
The basic banking data are described, and
the banking terms used are defined.

The historical discussion is divided into
three periods. Bank money in the South
declined during 1860 because of develop­
ing political uncertainties but posted
a strong advance the follow ing year as a
result of relatively rapid growth in
war-related bank credit. From early 1862
through early 1864, smaller increases in
bank credit and larger bank acquisitions of
interest-bearing Treasury currency
reduced the rate of bank money growth.
W hen the Confederate government
enacted a major currency reformation in
February 1864, there was an immediate
and massive impact on banks. Bank
deposits dropped sharply, and a large
portion of outstanding bank loans was
repaid. ■

OF MONEY AND PRICES:
SOME HISTORICAL PERSPECTIVES
by Robert E. Keleher
Recently, a number of economists have
developed a "n e w " approach to analyzing
the balance of payments and exchange
rates. This approach emphasizes the
importance of the demand and supply of
money in determ ining the balance of
payments and exchange rates. Accordingly,
this view has come to be known as the
monetary approach to the balance of
payments ana exchange rates. Elaborations
of this view have established that in
examining the causal relationship between
money and prices, different models must
be applied to the small, open economy
(SOE) and the closed world aggregate.
M oreover, in examining the relationship
between money and prices in the indi­
vidual small, open economy, the case
of fixed exchange rates should be analyzed
differently than the case of flexible
exchanges. Thus, the monetary approach
indicates that in exam ining the moneyprice causal relationship, tnree funda­
mental cases exist that must be clearly
distinguished from one another, namely,
the closed econom y, the SOE under
fixed exchange rates, and the SOE under




flexible exchange rates. In this study, the
relationship between money and prices
in each of these three cases is briefly
outlined. It is then demonstrated that all
three of the above fram eworks, as well
as their implications for money and prices,
were well recognized by earlier gen­
erations of economists.
O f the three fram eworks, the fixed
exchange rate model of the SOE fre­
quently has been misrepresented and
misunderstood. M oreover, its historical
developm ent has not been adequately
docum ented. Consequently, this paper
gives particular emphasis to this model.
In discussing the developm ent of these
models, attention is generally given to
major monetary writers in English thought
beginning with Hume. In addition to
Hume, the contributions of Smith, Ricardo,
Tooke (and the Banking School), J. S.
M ill, W icksell, and Laughlin are discussed.
Finally, some reasons are suggested for
the demise of the SOE fixecfexchange
rate model before its recent revival in the
modern monetary approach. ■

SIXTH DISTRICT BANKING NOTES
INCREASING LIQ U ID ITY
PRESSURES
In recent months, the District's 32 largest
banks have found it increasingly necessary
to borrow funds to meet rising loan
demands. This need to borrow typically
develops in the latter stages of an
econom ic expansion when the combined
demand for consum er, business, and real
estate credit is most intense and the
large banks find it most difficult to attract
funds from traditional deposit sources.
However, the liquidity pressures that the
large District banks have experienced in
recent months are not nearly as severe
as those that developed during 1974, and
they have had no problems finding
buyers for money market CDs or purchas­
ing Federal funds.
During the early stages of a business
expansion, loan growtn is generally
moderate and inflows of banks' "c o re "
deposits— net demand deposits and
savings and time deposits (except for
those issued in denominations of $100,000
and over)—are sufficient to fund the
new loans. For example, in the 12 months
ended in September 1977, loans at the
large banks advanced nearly $1.3 billion
(about 11 percent) and "c o re " deposit
gains totaled $1.4 billion. As a result,
the banks' collective net borrowings
were less than $100 m illion.
Since last fall, the large banks have
moved into a new stage. Conditions
changed and brought pressure on the
large banks to acquire funds in the
financial markets. Between September
1977 and May 1978, loans grew $1.3 billion,
an annual rate of 14 percent, with business
loans accounting for nearly one-half
of the gain and consumer instalment
and real estate loans making up the
rem ainder. But growth in "c o re " deposits
slowed to only a $100-million increase.
When interest rates are rising, large city
banks generally face stronger competition
for "c o re " deposits than do suburban
and rural banks, so the recent weaker
"c o re " deposit gains were in line with past
experiences. In the face of this develop­
ment, the large banks aggressively stepped
up their use of managed liabilities by $1.1
billion. Sales of negotiable CDs and other
time deposits issued in denominations




of $100,000 and over rose more than $600
m illion, with most of the remaining
funds coming from greater use of the over­
night Federal funds market.
The traditional measures of liquidity
such as the loan-to-deposit ratio (L/D )
point out the increased liquidity pressures
of the large banks. In May, the large
banks collectively had an L/D of 87, up
from a low of 81 in early 1977. However,
the loan-to-deposit ratio more appropriate
to the large banks includes only "c o re "
deposits (i.e., net of large-denomination
time deposits), expressed as L/D *. The
L/D * for the large banks stood at 121 in
May, up from 112 in September and an
early 1977 low of 109. Tne bigger increase
in tne L/D * clearly points out the need
of these banks to borrow more heavily
to support the strong loan growth. The
May L/D * for small- and medium-size
District banks was only about 74 but was
nearly 180 for large New York City banks.
Despite the recent advance in tne L/D *
and even though the total volum e of
borrowed funds is approaching the mid1974 level, liquidity pressures have not been

lending have been more manageable.
Also, changes in most banks' borrowing
costs have oeen more readily reflected in
changes in interest rates on loans, so
that banks' net interest margins (interest
revenue less interest expenses) have not
been severely saueezed. In 1974, some
banks faced undue strains because they
used interest-sensitive short-term liabil­
ities (at high rates) to fund fixed-rate,
longer term loans (made at low rates).
With loan rates moving with borrowing
costs, banks are better able to pay the
higher market rate for borrowed funds
if the need arises.
The need to rely on borrowed funds
may not become nearly as critical in 1978
as in 1974. Since late in 1974, banks have
had more flexibility in the interest rates
they can pay for state and local government




deposits. The new six-month maturity
time deposits with interest rates tied to
the six-month Treasury bill rate should
enable many large banks to broaden their
deposit bases by attracting interestsensitive deposits of $10,000 and over.
Also, banks may pay higher rates to draw
longer term consum er deposits.
W hile the large banks have been using
borrowed funds in about the same
absolute quantity as in 1974, there have
been some qualitative improvements in
the structure of the liabilities. Banks have
significantly extended the maturity of
their large-denomination negotiable CDs.
The average maturity of outstanding
large CDs this spring was 3.3 months,
with nearly 40 percent maturing in over 3
months. In mid-1974, however, the average
maturity was 2.2 months and only 20
percent matured in more than 3 months.
The longer the maturity of liabilities the
less the need for banks to roll over matur­
ing CDs.
Banks also have a much larger secondary
source of liquidity in their securities
ortfolios. U. S. Governm ent securities
oldings recently totaled over $2.3 billion,
up from slightly under $1.0 billion in late
1974. The shortest maturity Treasury bills
and notes, amounting to nearly $900
m illion, could be easily sold or allowed to
mature in order to obtain funds. (Some
of these securities, of course, may not
be readily available because they are
pledged tor public deposits; or they may
already be a source of funds because
they have been sold under short-term
repurchase agreements.) In 1974, holdings
of short maturity Governm ents were
about $250 m illion, with Treasury bills
comprising less than $40 m illion.
The recent strength in loan demand
has caused the District's larger banks to
rely increasingly on borrowed funds.
Even though managed liability usage is up,
the banks have not been experiencing
significant liquidity pressures. The large
District banks can be expected to manage
a continued rise in lending by making
further use of borrowed funds. However,
if these banks find it necessary to borrow
substantially more w hile interest rates
are rising, they will likely see pressures
developing that are sim ilar but less severe
than those of mid-1974.

John M . Godfrey

LABOR FORCE PARTICIPATION
AND JOB OPPORTUNITIES
by Charlie Carter
An important influence on the decision to
seek work is the prospect that search
efforts will be successful. One good in ­
dicator of job prospects is the success of
those currently seeking em ploym ent. O ur
evidence shows that when a larger fraction
of the working-age population is success­
ful, people who would not otherwise seek
work are encouraged to enter the labor
force. The reverse occurs when job seekers
are generally unsuccessful.
Two Theories of Cyclical Labor Force
Responses. Findings of earlier empirical
studies suggest that labor force participa­
tion rates are positively related to shortrun swings in the pace of econom ic
activity.1 O n the one hand is the
"discouraged-worker hypothesis." It argues
that increases in the demand for labor
not only provide employment opportun­
ities for tnose currently seeking em ploy­
ment but swell the labor force with others
who withdrew or held back when job pros­
pects were unfavorable. These individuals
are w illing to work at existing wage rates
but have failed to participate in the labor
force because job opportunities were
scarce. To the extent that persons leave
the labor force during cyclical declines—
i.e., lose their jobs and do not seek
others—the reauction in employment will
exceed the increase in unemployment.

'See, for exam ple, Thomas Dernburg and Kenneth Strand, "C yclical Variation
in Civilian Labor Force Participation," The Review of Economics and
Statistics, November 1964, pp. 378-91; Peter S. Barth, "U nem ploym ent and
Labor Force Participation," Southern Economic Journal, January 1968, pp. 37583; Joseph M. Bonnin and W illiam Y. Davis, "Labor Force Responsiveness
to Short-Run Variations in Economic O pportunity," Southern Economic
lo u rn al, O ctober 1971, pp. 161-72; and Alfred Telia, "T h e Relations of Labor
Force to Em ploym ent," Industrial and Labor Relations Review , XVII (April
1964), pp. 454-69. For the most recent treatment, see George C. Perry,
"Potential Output and Productivity," Brooking Papers on Econom ic Activity,
1:1977, pp. 11-47, and Michael L. W achter, "Interm ediate Swings in Labor
Force Participation," Brookings Papers on Economic A ctivity, 2:1977, pp. 545-74.




On the other hand, individuals may
decide not to enter the labor market,
even if prospects are favorable. Returns
from working may not be significantly
higher than returns from not working.
Rising benefits from public assistance pro­
grams, broader industry coverage under
unem ploym ent insurance programs,
and the relative value of leisure dis­
courage labor force participation.
Opposing the discouraged-worker effect
is the "add itio nal-w o rker" effect. An
initial drop in employment results
in large-scale discouragement and, later,
withdrawal from the labor force. How­
ever, the additional-worker hypothesis
maintains that subsequent declines
in employment are met with smaller
reductions in labor force participation.
As the period of econom ic slack con­
tinues, downward pressures on family
incomes and living standards force
additional family members to enter the
labor force. By reducing real income,
inflation reinforces the added-worker
effect. Therefore, the additional-worker
effect may partially offset the negative
impact of the discouraged-worker effect
on labor force participation.
O f course, the net impact of cyclical
changes in activity on labor force partici­
pation depends on the relative importance
of the two effects. If the discouragedw orker effect dominates, the net in­
fluence on labor force participation will
be negative. The change would be posi­
tive if the additional-worker effect
dominates and zero in the case where
the two effects are of equal strength.
Problems in Testing for Labor Force
Responses. Interest in the cyclical
sensitivity of labor force participation
began in the mid-1960s, with seminal
works by Dernburg-Strand (D-S) and Telia

who used the employment-to-population
ratio to predict labor force responses.
Since then, many other studies have
examined this issue.
Empirical findings have generally
attached greater significance to the
discouraged-worker effect. Therefore, dur­
ing cyclical declines in econom ic activity,
labor force participation shrinks and labor
force growth slows. By not counting
those who withdraw from the labor
force because they think they cannot
find w ork, reported unemployment
statistics understate the "tru e " magnitude
of unem ploym ent. Also, labor force
data used to estimate productive capacity
understate the potential labor supply,
which leads to underestimates of the
output potential of the economy.
Substantial employm ent growth without
significant reductions in unemployment
during the earlier part of the current
econom ic expansion and renewed em pha­
sis on potential output have stimulated
interest in the subject. Besides over­
looking "hidden unem ploym ent" during
downturns, the unem ploym ent rate gives
little recognition to employment growth
during upswings. Thus, if the discouragedw orker effect dominates, the unem ploy­
ment rate will portray labor market
conditions as being better than they are
in bad times and worse than they are
in good times.
Since cyclical changes in labor force
participation interfere with the job­
less rate's ability to represent labor
market conditions, many economists have
begun to consider alternative measures.
Indexes of help-wanted advertising, the
duration of unem ploym ent, quit rates, and
unem ploym ent rates of prime age males
and other demographic groups are most
often used. A measure receiving in­
creasing attention by labor market analysts
is the proportion o t the working-age
population that is em ployed.2 By focus­
ing on em ployment and population
instead of unem ploym ent and labor force,

JSee Geoffrey M oore, "H o w Full is Full Employment?" (Washington,
American Enterprise Institute, 1973); Geoffrey M oore, “ The Numbers Aren’t
Everything/' New York Times, October 2, 1975, Op-Ed pages; Christopher
Green, "The Employment Ratio As an Indication of Aggregate Demand
Pressures," Monthly Labor Review, April 1977, pp. 25-32; and Julius Shiskin,
"Employment and Unem ploym ent: The Doughnut or the H ole?,” Monthly
Labor Review, February 1976. pp. 3-20.




this measure is more cyclical than un­
employment rates and gives greater at­
tention to job growth. Also, because it
uses em ployment rather than unem ploy­
ment, the measure more closely re­
flects aggregate demand pressures on
labor markets. The working-age population
may also be considered a better measure
of the number of individuals who want a
job than the labor force, which measures
w orking and "active ly " searching for work.
O ur Test of Labor Force Responses.
If the national labor force expands
and contracts with cyclical swings in the
level of econom ic activity, a cyclical
pattern is likely to be found in subnational
labor markets. M oreover, labor force
participation in regions (or states) could
be expected to be even more volatile
due to interregional and interstate
migrations of labor. On a national scale,
individuals respond to cyclical fluctu ­
ations in job opportunities by participating
or not participating in the labor force.
Except for choosing new occupations,
no other alternative is available. However,
when cyclical changes in employment
opportunities are not uniform across
the nation, the options are not limited to
participation or nonparticipation but
are broadened to include relocation in
regions or states w here job prospects are
more promising. Therefore, studies of
cyclical changes in labor force partici­
pation that are national in scope overlook
the effects of a possible redistribution of
labor among regions due to regional
differences in labor market conditions. For
that reason, we chose to test for labor
force responses on the state and
District level.
The Model. Using a simultaneous
equation approach developed by D-S
and widely used elsewhere, we tested
labor force responses with seasonally
adjusted monthly data for the state of
Florida from January 1970 to December
1977. The dependent variable was the
civilian labor force participation rate—
the proportion of the working-age popu­
lation seeking or holding employment.
Since no state measures of aggregate
economic activity, such as output, industrial
production, or capacity utilization were
available, the em ploym ent ratio described
above was used to measure cyclical

variation in job opportunities. We hypothe­
sized that since a reduction in this
ratio represents a deterioration of
job prospects, the discouraged-worker
effect should create a positive relation­
ship between the employment ratio
ana labor force participation.
To detect additional-worker effects, we
added the "expiration ratio," or the
num ber of new monthly expirations of
unem ploym ent insurance benefits relative
to the working-age population, to the
equation. Eligibility for benefits from
state and Federal unemployment in ­
surance programs requires labor force
participation by the recipient. However,
when the primary w orker expects his
benefits to expire, other family members

(spouses and teen-agers) may be forced
to enter or be deterred from leaving; the
labor force. W e, therefore, expected a
positive relationship between labor
force participation and the expiration
ratio.3 Since labor force participation
will expand before the actual expiration
of unem ploym ent insurance benefits, this
variable entered the equation with a
lead of two months, as in the D-S model.
Also, to capture the secular effects of
changing legal and social attitudes
toward working females, rising oppor­
tunity costs of nom ework relative to
3To be sure, the expiration ratio accounts for only some of the additionalw orker effect. Since unemployment insurance benefits do not completely
make up for lost earnings, some added workers may enter the labor force
in response to extended unem ploym ent of the head of the household.

PPENDIX_________________________________________
The final form of the D-S estimating equation used here was
(1) LFPRj. ~aQ + a-jERj. ”^a2^^t + 2

*~t'

where LFPR is the civilian labor force participation rate; ER is the em ploym ent ratio;
XR is the expiration ratio; and TN D, the trend term , is the reciprocal of the workingage population. The initial estimation with ordinary least squares showed evidence
of serial correlation. The Hildreth-LU technique for eliminating serial correlation
was used and produced the following estimates, with t-statistics in parentheses:
LFPR t = .11106 + ,8275ERt + ,0121XRt + 2 - 183.6TN D t ,
(6.371)
(18.918)
(12.120)
(-4.456)
R2 = .8245

D -W

= 1.984

SE = .0034.

Coefficients on both the employment and expiration ratios assumed their expected
signs and are highly significant, as is the trend term. The Durbin-Watson statistic
shows an absence of serial correlation. The independent variables explain more
than three-fourths of the monthly swings in labor force participation. Therefore, the
estimated equation documents both discouraged-worker and additional-worker
effects in Florida's labor market.
Equation (1) alone is not sufficient to determ ine the relative strengths of the two
effects because the employm ent ratio and the expiration ratio are interrelated.
M onthly expirations of unem ploym ent insurance benefits are inversely related to
previous levels of employment. Estimating the net effect of job opportunities on
labor force participation, then, required a simultaneous estimation of their effect on
the expiration ratio. The specific form of the expiration ratio equation used was
(2) X R j = bg + b-jER^_-j + t ^ X R t —1 + e^,

where all variables are as described in equation (1).
The following coefficients were estimated for equation (2):




X R t = .832 - 1.5079ERt_ i
(.864)
(-1.82)
R 2 = .948

+ .9568XRt n
(28.9)

D - W = 1.74

SE = .168.

market w ork, the decline in fertility rates
and the trend toward smaller families,
rising Social Security payments, and the
tendency of adult men to remain in school
longer, a trend term was entered into the
equation.
The Findings. The coefficients and
statistics we estimated for this equation
confirm ed that both the discouragedw orker and additional-worker effects
significantly influence Florida's labor
market participation in the ways we
expected. But, since employment levels
partly determ ined the number of un­
employm ent insurance expirations
in a later period, we had to quantify
that effect in order to estimate the net
effect of the em ployment ratio on labor
force participation. The Appendix de­
scribes the technique used and presents

the estimated coefficients and sum­
mary statistics.4
W hen both direct and indirect effects
are considered, we estimated that a
cyclical decline in em ploym ent in
Florida of 100 resulted in a withdrawal
of 41 workers from the labor force during
the test period. Thus, reported un­
employment statistics which show a rise
in unem ploym ent of only 59 understate
the "tru e " magnitude of unemployment
in Florida by 41.
Other Areas. For the remaining Sixth
District states, the participation data are
annual averages and the analysis is only
exploratory at this point. Tables 1 and 2
4Since j = f + f by definition, simultaneity could bias the coefficient of
£ toward unity. However, the extent of this bias cannot be determ ined.
Disaggregation by age-sex groups was desirable, but such data were not
available.

\

Then, to solve for the net effect of cyclical changes in job prospects on labor force
participation, equations (1) and (2) should be considered in their stationary states. A
close approximation of such a solution was obtained by assuming that the em ploy­
ment and expiration ratios are constant over time, i.e.,
ERt = ERt_-j = ER, and XRt = X R t_] = XR.
Under those assumptions, equations (1) and (2) were restated as follow :
(1a) LFPRt = aQ + a-|ER + a 2 XR + a 3 TN D t + et, and
(2a) XR =

b°
1 -

+

b2

bl

ER.

1 - b2

Substituting equation (2a) into equation (1a) and simplifying provide an equation
that specifies the net effect of an instantaneous change in the em ploym ent ratio on
labor force participation:
(3a) LFPR{ = Aq + A-]ER + a 3 TND^ + ej,
an 0 - b?) + a?bo

where A n - _ _______ _________ , and
U
1 - b2
3-j (1

b 2 ) -I- 3 ^ b

Plugging the parameters estimated for equations (1) and (2) into equation (3a), we
calculated that A-j = .4051.




J

TA B LE 1
LABOR FO R C E PARTICIPATION R A TES, U.S. AND
SIXTH D ISTR IC T ST A T ES , 1970-77
(percent)

Alabama
Florida
Georgia
Louisiana
Mississippi
Tennessee
District
U.S.

1970

1971

1972

1973

1974

1975

1976

1977

59.1
56.1
62.8
55.4
53.8
61.0
58.3
61.3

61.6
54.9
63.3
55.4
53.5
60.3
58.2
61.0

58.0
54.0
63.6
54.8
56.0
61.0
57.6
61.0

57.1
55.1
64.1
55.1
57.4
60.8
58.1
61.4

57.3
56.0
63.6
54.5
58.6
61.9
58.2
61.8

56.9
56.2
63.1
56.1
58.3
60.4
58.3
61.8

57.0
55.3
63.9
56.2
58.8
59.9
58.2
62.1

58.2
55.3
63.9
57.7
58.9
60.8
58.7
62.8

S o u rce s: Population figures derived from Current Population Reports: Population Estimates and Projections, "Estim ates of the Population
of States: B y Age, April 1970-July 1, 1977." Labor force data are annual averages obtained from each state, bench marked
estim ates of labor force levels, em ploym ent levels, and unem ploym ent levels, 1970 to 1977 (unpublished).

TA B LE 2
EXPLOYM ENT-TO-POPULATION RATIOS, U.S. AND
SIXTH D ISTR ICT ST A T ES , 1970-77
(percent)

Alabama
Florida
Georgia
Louisiana
Mississippi
Tennessee
District
U.S.

1970

1971

1972

1973

1974

1975

1976

1977

55.6
53.7
60.3
51.8
51.0
58.4
55.4
57.4

58.2
52.3
60.8
51.3
50.7
57.5
55.2
56.6

54.4
51.2
61.0
50.6
53.6
58.7
54.9
57.0

54.6
52.8
61.6
51.4
55.2
58.4
55.5
57.8

53.9
52.5
60.3
49.9
55.9
58.8
55.1
57.2

52.5
50.2
57.6
52.0
53.5
55.4
53.1
56.0

53.2
50.4
58.7
53.4
55.0
56.3
53.8
56.8

53.9
50.8
59.4
53.7
54.5
57.0
54.4
57.9

Sources: Population figures derived from Currant Population Reports: Population Estimate* and Projections, "Estim ates of the Population
of States: By Age, April 1970-July 1, 1977." Employment data are annual averages obtained from each state, bench m arked
estimates of labor force levels, employment levels, and unemployment levels, 1970 to 1977 (unpublished).

give 1970-77 labor force participation
rates and em ployment-to-population
ratios, respectively, for both the U.S.
and Sixth District states. The cyclical
behavior of labor force participation
is evident in each Sixth District state.
Although the timing and magnitudes
differ, labor force participation declined
in all District states during the last
recession, reflecting the dominance of
the discouraged-worker effect. The cyclical
decrease in participation was greatest in
Tennessee, from a high of 61.9 percent
in 1974 to 59.9 percent in 1976. In
Alabama, labor force participation
dropped a full percentage point as well.
(Comparisons among the other Sixth
District states and the nation are left
to the reader.)




Summary. O ur purpose here has been
to determ ine the presence and relative
importance of the discouraged-worker and
adaitional-worker effects on labor force
participation in the Sixth District states.
A detailed statistical analysis of Florida
labor markets provided evidence of both
influences and of the dom inance of the
discouraged-worker effect. The patterns of
labor force participation rates ana employ­
ment ratios over the last recession suggest
that discouragement was not limited to
Florida but was a Districtwide phenomenon.
And, to the extent that cyclical changes in
opportunities discourage (encourage) labor
force participation, conventional measures
understate (overstate) the "true" magnitude
of unem ploym ent, f l

FLUE-CURED TOBACCO:
OUTPUT DOWN, PRICES UP
by Yvonne F. Davies
Drought-reduced yields, smaller allot­
ments, and record high auction prices
characterized the 1977 U.S. flue-cured
tobacco cro p.1 Although production in
the Sixth District states was less affected
by drought than in other producing areas,
the District crop rode the coattails of
a high price associated with low output
nationally. In drought-stricken areas,
lower yields increased farmers' unit
costs and squeezed net returns, but in the
Sixth District, growers' net returns
improved considerably.
The National Scene. Flue-cured tobacco,
the leading cigarette and export tobacco,
is produced in only six states— North
Carolina, South Carolina, Georgia,
Virginia, Florida, and Alabama. The crop
has been grown under acreage-poundage
marketing quotas since 1965, with
allotments enforced by the U.S. Depart­
ment of Agriculture. Price support is made
available to eligible producers.2 In
1977, the 1,127-million pound flue-cured
crop accounted for 58 percent of the
U.S. tobacco crop (see Chart 1). The
flue-cured crop was 14 percent smaller
than the 1976 crop and 20 percent
below 1975's production. Tne small crop
resulted from a 12-percent reduction in
acreage allotments by the USDA to
bring supplies in line with use and a
3-percent drop in yields due to dry
weather.

'Flue-cured tobacco acquired its name from the curing method formerly
in use. Tobacco leaves were strung and stored in barns w here heat was
forced in through flues. During the curing process, the tobacco
became milder and acquired an aroma. Now, bulk barns have largely
replaced this labor-intensive method. Bulk curing involves the passage
of conditioned air through tightly packed tobacco.
-The 1977 support level was $1,138 per pound. The tobacco price
support program provides for annual adjustment in the support price
using a formula which takes into account increases in prices paid by
farmers for goods and services.




CHART 1
FLUE-CURED TOBACCO, THE LEADING
CIGARETTE AND EXPORT TOBACCO,
CONSTITUTES THE MAJORITY OF THE U.S.
TOBACCO CROP
(Percentages are based on 1977 output)

Flue-Cured
Air Cured

Cigar Types

Fire-Cured

3.0%
S O U R C E : U SD A, 1977 data.

The demand for flue-cured tobacco
depends almost entirely on its use in cig­
arettes to give them certain flavor and
smoking characteristics. Domestic cigarette
blends are composed mainly of fluecured tobacco, with most of the re­
mainder being burley tobacco. In 1977,
a little more tnan half of the flue-cured
supply was used dom estically; the rest was
exported (see table). Since 1973, flue-cured
exports have decreased, as competing
foreign tobaccos have been in more ample

r

FLU E-C U RED TO BA C CO PRODUCTION AND UTILIZATION, 1975-77
Unit

1975

1976

1977

District States:
Production*
Yield per Acre
Acres Harvested
Gross Sales*
Average Auction Price
Value of Sales

mil. lbs.
pounds
acres
mil. lbs.
cts./lb.
mil. $

180.0
2,018
89,200
190
100.1
191

155.2
1,877
82,640
163
110.2
180

161.0
2,062
78,080
169
115.8
196

United States:
Production*
Yield per Acre
Acres Harvested
Gross Sales*
Average Auction Price
Value of Sales

mil. lbs.
pounds
acres
mil. lbs.
cts./lb.
mil. $

1,415.0
1,973
717,200
1,469
100.0
1,469

1,316.3
1,974
666,640
1,370
110.6
1,515

1,127.3
1,910
590,080
1,186
117.9
1,398

Total Utilization:*
Domestic Use
Exports

mil. lbs.
mil. lbs.
mil. lbs.

1,193
671
522

1,148
634
514

1,125
625
500

'Annual data for production, sales, and utilization of flue-cured tobacco differ because of the nature of the crop. Growers sell 95 percent of their
leaf tobacco at auctions; the rest is sold at the farm directly to tobacco manufacturers. Before it can be processed into consumer products,
tobacco must be stored so aging can take place. A year’s supply consists of production during the year plus the carryover of government
loan stocks and stocks held by manufacturers and dealers.
Sources. Crop Production, 1977 Annual Summary, 1-16-78; Tobacco Markat News, weekly reports from 7-16-77 to 10-7-77; and Tobacco
Situation, March 1978.

supply and relatively less costly. Domestic
use has declined also, but only since 1975,
reflecting the slowdown in per capita
cigarette consumption.
Publicity about smoking's health
dangers, plus price increases, has resulted
in a downtrend in per capita use since
1963, when it peaked at 217 packs. Last
year's decline in the smoking rate
was about one percent, from 205 packs
(4,092 cigarettes) in 1976 to 203 packs
(4,064 cigarettes) per capita. But gains
in adult population have caused total
cigarette consumption and sales to
rise, although more slowly, each year
(see Chart 2). In 1977, a record 620
billion cigarettes were smoked.
Although total tobacco acreage is
a negligible proportion of total crop
acreage, the crop is an important source
of both farm ana nonfarm income,
particularly in producing areas. In 1977,
consumers spent $17.1 billion on tobacco
products, with $15.8 billion of the total
for cigarettes. Sale of these tobacco
products generated $6.2 billion in govern­
mental revenues ($2.5 billion in Federal,




$3.6 billion in state, and $0.1 billion
in local). National cash receipts from
tobacco farming in 1977 represented only
2 percent of all farm receipts; however, in
North Carolina, where flue-cured tobacco
production is centered, tobacco receipts
accounted for 33 percent of the total.
In the Sixth District states, tobacco
provided 3 percent of farm receipts. The
78,080 acres of flue-cured tobacco
harvested in the District required ex­
penditures of $113 million for equipm ent,
supplies, and labor last year. The cutback
in plantings from 1975 to 1977 reduced
outlays by $4 m illion. Such reductions
are econom ically significant to tobaccoproducing communities.
A Closer Look at the Sixth District.
Flue-cured tobacco is grown in only
three of the Sixth District states— Georeia,
Florida, and Alabama— referred to as tne
Georgia-Florida Belt. These states pro­
duced 161 m illion pounds in 1977,
14 percent of the U.S. flue-cured crop
(see table). Production in the GeorgiaFlorida Belt is centered in Georgia's
southeastern counties, where 135 million

CH A RT 3

CHART 2
U.S. C IG A R ET T E CONSUMPTION 1960-77

FLUE-CURED TOBACCO: CO STS AND
RETURNS IN THE SIXTH DISTRICT
STA TES, 1972-77
CEN TS PER
POUND

120
Auction Price

Per Capita

Returns to Land,
Management and " •
Allotment

60

Production Cost*

S O U R C E : U SO A.

1972

pounds were harvested in 1977. Florida's
north central counties produced 25 million
pounds and south central Alabama,
1 m illion pounds. Despite reduced acreage
allotments in 1977, the District's im­
proved yields provided a 1977 crop that
exceeded the 1976 crop (see Chart 3).
In most producing areas, unfavorable
weather conditions (the dry weather
in May) cut yields and hurt crop quality.
However, Florida was the only District
state to show a reduced yield from 1976
levels.
Auction sales of the District's 1977
flue-cured crop lasted 50 days—from
July 13 to O ctober 6. Early season
auction prices averaged below those in
1975 and 1976. The lower prices were
due to changed grade standards that
permitted discounts for excess sand on
the lower tobacco leaves that ripen
first. Further into the season, prices moved
up to record levels and, for the season,
averaged $1.16 per pound in the District
and $1.18 per pound nationwide. The
higher auction prices and larger sales
volum e in 1977 produced $196 million in




1974

•Production co sts presum e bulk barn harvest. C o sts appearing in the
U S D A ’s Tobacco Situation were revised to reflect actual yields
using the method described by Verner G rise in the Septem ber 1977
issue. A 2-percent decrease in yield w as assum ed to result in a
1-percent reduction in harvest fuel, electricity, and labor use.
Marketing charges were adjusted in equal proportion to decreases
in yield. All other costs were assum ed to rem ain the sam e. C harges
for land, management, and leasing of tobacco allotm ents were not
included in the calculation of net returns.

ross sales for District producers, the
ighest value since 1974's $203 m illion.
This contrasts with the nation, where a
drop in quantity sold offset the price rise,
decreasing gross sales 8 percent to
$1,398 million.
Returns to flue-cured tobacco growers
in the District improved considerably
in 1977 (see Chart 3). The average
auction price of $1.16 per pound less
production costs of 70 cents per pound
provided “ net” returns3 of 46 cents per
pound. The 1977 spread between market
JThese net returns should not be construed as profit, since production
costs do not include charges for land, management, and leasing of
tobacco allotments. These expenses vary markedly from one tobacco
grower to another but are roughly estimated to range from 25 to
35 cents a pound.

price and production costs exceeded the
slim returns in 1975 and 1976 and compared
favorably to returns of the 1972-74
period. Producers outside the District
did not fare quite so well. With yields
off sharply in 1977, their production
costs per pound climbed. Record auction
rices tempered the cost increases,
owever, and "n e t" returns of producers
outside the District edged up from 42 cents
a pound in 1976 to 43 cents a pound in 1977.
Outlook. The 1978 U.S. flue-cured
crop is projected by the USDA at 1,125
m illion pounds, about the same as last
season. Although this year's national
poundage marketing quota for flue-cured
tobacco is only 1 percent below the 1977
quota, the quota for the Georgia-Florida
Belt is down 9 percent. The larger cutback
in this Belt is due to its 1977 crop being
larger than norm al; the 9-percent
reduction brings the area back in line
with its historical share of national
production. In response to the poundage
quota, tobacco growers throughout
tne nation announced their intentions to
plant 579,520 acres in flue-cured tobacco
(a 2-percent reduction from 1977). District
growers, when surveyed as to their
intentions, indicated they will set 71,520
acres, 8 percent less than the 78,080
acres in 1977. The 1978 crop should be of
higher quality than in previous years as
a result of a change in the tobacco
program. Growers who agree not to harvest
the four lower leaves can plant up to
120 percent of their acreage allotment.
This change should reduce the surplus
of lower stalk, lower quality tobacco.
If 1978 yields are close to their
historical averages, production costs

should rise about 5 percent (about three
cents a pound) over 1977. The increase
is due to higher wage rates. Since the
price support for tobacco will be raised
6.3 percent in 1978, the higher pro­
duction costs should be more than
offset. With normal yields, growers of
flue-cured tobacco could realize gains
over 1977 returns of four to five cents
a pound.
A longer run consideration is that anti­
smoking publicity and legislation
continue to expand. Thirty-one states now
have laws either prohibiting smoking
in public places or segregating smokers
from nonsmokers. In January, the pace
of antismoking efforts picked up when
a major campaign was launched by
the Department of Health, Education,
and W elfare to discourage cigarette use.
Another factor that may affect cigarette
consumption is rising cigarette taxes.
In 1977, four states raised taxes on
cigarettes. By year-end, state cigarette
tax rates averaged almost 13 cents a pack
and ranged from 2 cents a pack in North
Carolina to 21 cents a pack in C onnecti­
cut, Florida, and Massachusetts. Tbe
Federal excise tax, unchanged since 1951,
is 8 cents a pack. The long-run impact
of higher taxes and antismoking efforts
on total smoking and, hence, on fluecured tobacco demand is uncertain. To
date, the major effects have been a
decrease in the rate of growth in annual
cigarette sales since 1973 and the intro­
duction of low tar, low nicotine cigarettes.
If the antismoking campaign proves
successful in reducing total cigarette
consum ption, continuing reductions in
acreage planted in tobacco seem lik e ly .B

NEW PUBLICATIONS
INSIDE THE FEDERAL OPEN MARKET COMMITTEE
Excerpts from an address by Monroe Kimbrel, President,
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RESEARCH PAPER
SERIES

Convenience and Needs: Holding Company Claims and
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by Joseph E. Rossman, Jr., and B. Frank King

WORKING PAPER
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An Empirical Test of the Linked Oligopoly Theory: An
Analysis of Florida Holding Companies
by David D. Whitehead

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