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IN
THI S
I S S U E
Another Look A t Bank
C a sh M a n a g e m e n t
. . 2
The Tightening
Labor M a rke t . . . .
FEDERAL
RESERVE
BANK
OF
14
CLEVELAND
E C O N O M IC REVIEW
ANOTHER LOOK AT
BANK CASH MANAGEMENT
In June 1962, the Federal Reserve Bank of
In order to provide a standard for com
Cleveland introduced a system of "daily re
parison, it was necessary to'utilize a control
porting" for member banks in the Fourth
group of member banks located in an area
Federal Reserve District. Under daily report
where daily reporting was not in use for a
ing, District member banks each day report
specified period of time. In other words,
figures on deposits, vault cash, and related
characteristics of banks in the control group
items to the Federal Reserve Bank of C leve
were compared with characteristics of se
land. By so doing, and with the information
lected Fourth District banks. Specifically, the
on maintained reserves and required reserves
two groups of banks were (1) those Fourth
provided by this Bank in return, member
District member banks located in the Cleve
banks are afforded the opportunity to manage
land territory (the portion of Ohio served by
cash
particularly
this Bank's main office), and (2) member banks
through the minimization of cash reserves in
located in the portion of Indiana served by the
excess of legal requirements. This article
Federal Reserve Bank of C hicago.2 These
presents the results of a research project de
areas are shown by the shaded parts of the
signed to find out whether District member
accompanying map.
assets
more
efficiently,
banks did in fact manage their cash assets
The findings of this study, while perhaps
more tightly; by so doing, the article evaluates
not conclusive, strongly suggest that a notice
the influence that daily reporting had on the
able im p r o v e m e n t did n o t o ccu r in the cash
cash management practices of District banks.1
1 As background for this article, the reader may wish
to consult other articles on cash management that ap
peared in previous issues of the Economic Review.
See "Bank Management of Cash Assets," ''Management
of Cash Assets at Reserve City and Country Member
Banks," and "Management of Cash Assets at Fourth
District Reserve City and Country Member Banks,"
Federal Reserve Bank of Cleveland, Cleveland, Ohio,
April, July, and December 1965. The first article provides
a general discussion of the cash management function.
2
2 Considerations of data availability made it desirable
to limit the study to member banks located in the area
covered by this Bank's Cleveland office. Member banks
located in that part of Indiana served by the Federal
Reserve Bank of Chicago were chosen as a control group
because "daily reporting" is not in effect in the Seventh
Federal Reserve District and because of Indiana's simi
larities and proximity to Ohio.
The Research Department of the Federal Reserve
Bank of Cleveland acknowledges the cooperation of its
Chicago counterpart in supplying data and technical
advice.
AUGUST 1966
banks (14 days). In the case of loan demand,
a proxy measure derived from Call Report
data was used—the ratio of loans (net) to de
posits. The data on loan demand, in contrast
to the data on reserves, were as of a certain
date (the date of the Call Report).
Because bank size significantly influences
the performance of cash management, banks
in each group were distributed in seven size
classes. The total of gross demand and time
deposits—averaged for three selected periods
—was used to measure bank size. The ranges
management performance of Ohio banks
of the size classes and the number of member
(compared with Indiana banks) in th e p e r io d
banks in each class are shown in Table I.
follow in g th e sta rt o f daily rep o rtin g . That
Because the relative distributions (Column 5)
is to say, and as will becom e more evident later,
left Indiana poorly represented by very small
daily reporting in the Fourth District did not
banks (size class 1) and, more importantly, by
widen the performance differential between
very large banks (size class 7), all-bank aggre
Ohio and Indiana banks that had already ex
gates would easily be misleading. This situ
isted at the time daily reporting was introduced.
ation strengthened the decision to focus on
Nevertheless, as a by-product of the consid
individual size classes. It should be noted that
eration of daily reporting, the study did yield
all banks in size classes 1 through 6 are
some interesting findings of a broader nature,
Country member banks, whose legal reserve
which becom e the major emphasis of this
calculation periods cover two-week intervals.
Member banks in class 7, on the other hand,
article. In capsule form, the findings show
that member banks in Ohio, in the time period
studied, managed their cash balances more
aggressively than member banks in Indiana.
TABLE I
Size Classes and Number of Banks
Selected Banks in O h io and In dian a
More aggressive performance of the cash
management function in turn reflected the
influences of deposit composition, deposit
instability, and the intensity of loan demand.
CHARACTERISTICS OF THE DATA
The data used in this study are for the years
1961-63, inclusive. Except for measures of
(1)
(2)
Size
Class Gross Deposit Ranges
1
Less than $1 million
2
$ 1 -$ 5 million
(3)
(4)
(5)
Number o f Banks
(4) as a
O hio Indiana
Percent o f (3)
6
2
101
66
65
67
33%
3
$5-$ 10 million
55
37
4
$ 1 0 -$ 2 5 million
52
32
62
5
$ 2 5 -$ 5 0 million
18
10
56
6
$5 0-$ 100 million
9
6
67
7
$1 00 million and over
11
3
27
loan demand, the data are reserve period
averages of daily figures, with the reserve
period in all cases that for Country member
252
1 56
Sources: Federal Reserve Bank o f Cleveland and Federal Reserve
Bank o f Chicago
3
CASH RATIOS for SELECTED BANKS in OHIO and INDIANA
Size Class 3
M A IN T A IN E D RESERVES
TOTAL DEPOSITS
________
IN DIA N A
REQUIRED RESERVES
TOTAL DEPOSITS
_____ ________ ^
s
--------------- -— s
OHIO
T ^
IN D IA N A
OHIO
VAULT CASH
TOTAL DEPOSITS
OHIO
IN DIA NA
CORRESPONDENT BALANC ES
1/26/61
S o u r c e s of data:
June 1962
Daily Reporting
Federal
Reserve
Bank
of Clev elan d
and Federal
Reserve
Bank
of C h i c a g o
12/12/63
lb.
CASH RATIOS for SELECTED BANKS in OHIO and INDIANA
Size Class 7
M A N A G E D CASH
M A IN T A IN E D RESERVES
—
—
REQUIRED RESERVES
VAULT CASH
CORRESPONDENT BALANCES
2/2/61
Digitized
S o u r c e s o for
f daFRASER
ta:
Federal Reserve B ank
June 1 9 6 2
D a i l y R e p o rt in g
of C l e v e l a n d
and
Federal
Reserve
Bank
of C h i c a g o
12/19/63
E C O N O M IC REVIEW
are all Reserve City banks (Country banks in
classed Indiana banks. For example, during
Ohio with over $100 million in deposits were
the three-year period, 1961-63, the managed
excluded), whose legal reserve positions must
cash ratio averaged 13.31 percent for Indiana
be adjusted over a, seven-day period. For
banks in size class 3 compared with 8.74 per
banks in the latter size class, each observation
cent for Ohio banks in that size category. In
was computed from daily averages covering
the case of the largest size banks, those in
two reserve calculation periods.
Indiana operated with managed cash ratios
averaging 7.21 percent compared with 3.59
percent for Ohio banks.
CASH M ANAGEM ENT PERFORMANCE
Table II also presents average values of the
Since performance variation among the
component ratios (with the appropriate com
size classes is largely in the details, and the
putational sign of each) that enter into the
basic essentials of performance are reason
measurement of the managed cash ratio. The
ably consistent throughout all size classes,
first three component ratios (Columns 2, 3,
the graphic presentation is limited to only
and 4) are more easily and effectively con
two size classes. Thus, data for member banks
sidered when combined into the ratio of ex
in size classes 3 and 7 are used to illustrate
cess reserves (maintained reserves -f- vault
differences in cash management performance
cash — required reserves) to total deposits
between member banks in the two groups
(Column 5). The existence of excess reserves
(see Charts la and lb ). From the charts, it is
causes banks to forego income that could be
clear that Ohio bankers were more aggressive
earned if such reserves were loaned out or
than their counterparts in Indiana in manag
invested; bank management therefore prefers
ing discretionary (managed) cash assets.3
to keep such balances to the minumum con
This is evidenced by the substantially higher
sistent with various operating considerations.
proportions of managed cash to total deposits
As Table II reveals, in the period under re
held by both relatively small (size class 3) and
view all classes of Indiana banks showed ex
very large (size class 7) Indiana banks.4
cess reserve ratios that were larger (between
As shown by the values of the managed
47 percent in the case of class 2 banks, and
cash ratios in Table II (Column 1), Ohio banks,
143 percent in the case of class 7 banks) than
in every size class, outperformed similarly
the ratios of similar size banks in Ohio. In all
3 See the articles referred to in footnote 1. Discretionary,
larger proportions of total deposits as demand
cases, Indiana banks also kept substantially
or managed, cash assets are defined as the sum of cor
respondent balances plus excess reserves, with the
latter calculated as the difference between the total of
balances maintained at the regional Federal Reserve
bank plus vault cash and the volume of required reserves.
4 The start of daily reporting in June 1962 did not widen
the differential in favor of Ohio banks— particularly
smaller banks— as can be seen from the charts.
6
balances at correspondent banks (Column 6).
Thus, the pattern prevailing in the case of the
managed cash ratio was also clearly evident
in the two major component ratios.
At this point, it is appropriate to ask the
seemingly obvious question, why? That is to
say, what reasons can be found to explain the
AUGUST 19 66
TABLE II
M anaged Cash and Component Ratios
Selected Banks in O h io and Indiana
(M e a n V a lu e s o f Reserve Period A v e ra g e s, 1 9 6 1 -6 3 )
(1)
M a n a g e d Cash-rTotal Deposits
=
(2)
(4)
(3)
Maintained
Reserves-;Total Deposits +
Vault Cash-rTotal Deposits
Required
Reserves -fTotal Deposits
(5)
Excess
Reserves-TTotal Deposits +
( 6)
Correspondent
Balances-H
Total Deposits
( 2 + 3 — 4)
Size Class 1
Ohio
11.91
6.26
Indiana
22.29
12.37
+
+
3.11
3.94
5.43
6.48
2.51
5.01
9.87
12.42
Size Class 2
Ohio
10.30
6.54
Indiana
13.95
9.45
+
+
2.15
4.75
3.94
6.35
2.18
5.83
5.80
8.14
+
+
2.17
5.04
3.17
5.58
2.13
5.90
5.36
7.94
2.33
4.88
2.91
5.85
2.42
5.51
5.59
6.05
Size Class 3
O hio
Indiana
8.74
6.04
13.31
9.13
Size Class 4
Ohio
Indiana
8.76
5.46
11.65
8.68
+
+
Size Class 5
Ohio
Indiana
7.59
5.51
12.21
8.41
8.24
5.07
12.61
8.06
+
+
2.25
5.02
2.74
4.85
2.48
5.56
5.33
6.87
+
+
2.60
4.93
2.74
6.04
2.11
5.71
4.46
8.13
+
+
1.32
8.61
1.36
2.23
1.64
9.45
3.30
3.91
Size Class 6
Ohio
Indiana
Size Class 7
O hio
3.59
8.65
Indiana
7.21
11.11
Sources: Federal Reserve Bank o f Cleveland and Federal Reserve Bank of Chicago
more aggressive cash management perfor
2, time and savings deposits held by all size
mance of member banks in Ohio. (The criterion
classes of Ohio banks comprised considerably
for "m ore aggressive," it should be reiterated,
larger proportions of total deposit liabilities
is that lower ratios indicate less income fore
than in the case of Indiana banks. The con
gone.)
sistency in the differential between the pro
portions during the 1961-63 period suggests
DEPOSIT COMPOSITION
that structural factors played an instrumental
A marked difference in the deposit mix of
role. W hile there does not seem to be a com
banks in the two groups would appear to be of
plete explanation for the (locational) differ
particular importance in explaining the better
ence in deposit composition, one known in
performance of Ohio banks. As seen in Chart
fluence does offer some possibility and merits
7
2.
TIME DEPOSITS as a PERCENT of TOTAL DEPOSITS
for SELECTED BANKS in OHIO and INDIANA
1/26/61
60
12/12/63
S iz e C la s s 3
_______________________
.
50
OHIO
40
IN D IA N A
30
1/26/61
12/12/63
S ize C la s s 4
60
___________________________________________________ ________________
50
^
—
_______
40
OHIO
—
IN D IA N A
30
1/26/61
Si ze C la s s 5
60
50
OHIO
40
IN D IA N A
30
S o u r c e s for
o f dFRASER
ata:
Federal Reserve B an t
Digitized
12/12/63
_____________ ._________ _
of C l e v e l a n d
and
Federal
Reserve
Bank
of C h i c a g o
AUGUST 1966
TABLE III
Growth of Time and Savings Deposits, 1961-63
TABLE IV
Growth of Gross Demand Deposits
Selected Banks in O h io and Indiana
Selected Banks in O h io and Indiana
(in thousands o f dollars)
(in thousands o f dollars)
Size
Class
Ohio
Indiana
Size
Class
Indiana
Ohio
1
T i= $ 4 0 8 . 5 + $ 2 . 1 t
T i'= $ 2 9 3 . 2 + $ 0 . 7 t
1
T i= $ 3 4 0 . 7 + $ 1 . 0 t
T V = $502.1 + $ 0 .5 t
2
T2= 1 ,5 2 6 .0 + 5 .8t
T2'= l , 0 2 6 . 9 + 3 . 8 t
2
T2= 1,167.2 + 3.3t
T2' = 1,592.1 + 4 . 6 t
3
T3= 3 , 5 2 7 .0 + 1 6.5t
T3' = 2,570.1 + 7 . 8 t
3
T3= 3 ,2 1 8 . 9 + 7 . 9 t
Ts ' = 3,945.1 + 8 . 9 t
4
T4= 6 ,8 9 1 .8 + 3 2 .6 t
T4' = 5 , 5 6 1 .3 + 2 1 .Ot
4
T4= 6,593.8 + 15.0t
T4' = 7 , 3 7 5 .6 + 2 6.7t
5
T5= l 5,028.1+ 7 8 .3 t
T5' = 1 3 ,6 0 7 .6 + 3 3 .1 1
5
T5= 1 4 ,0 2 9 .4 + 4 4 . 3 t
T5'= 2 0 , 8 5 8 . 6 + 4 6 . 9 t
6
T6= 2 8 ,2 7 0 .8 + 1 1 1.8t
V = 2 4 ,2 2 9 .6 + 6 6 .2 t
6
T6= 33,057.1 + 4 1 . 9t
T6'= 3 8 , 7 0 6 . 7 + 5 0 . 7 t
7
T7= 306,3 3 8 .9 + 1 ,9 1 1.8t
T7' = 17 7 ,8 8 3 .2 + 3 5 3 .3 t
7
T7= 4 8 3 , 8 9 2 .5 + 5 3 7 .6 t
T7'= 5 4 4 , 6 9 2 .0 + 3 3 6 . 6 t
Sources: Federal Reserve Bank of Cleveland and Federal Reserve
Bank o f Chicago
Sources: Federal Reserve Bank of Cleveland and Federal Reserve
Bank o f Chicago
comment. The lesser importance to Indiana
interval (the duration of a Country bank's re
banks of time and savings deposits partly re
serve adjustment period) increased, on aver
flects the regulation by the State of Indiana—
age, by about $21 thousand. The $5,561.3
affecting all commercial banks in the State—
thousand figure in the equation is a constant
that sets (what have turned out to be compara
that represents an estimate of the amount of
tively low) maximum interest rates payable on
time and savings deposits as of the base period
time and savings deposits. Thus, until Jan-
(January 1961).
uary 1, 1964, the maximum rate payable on
The numbers reveal two important points.
passbook (savings) accounts was 3 percent;
First, for each size class, Ohio banks began
since that date, the maximum rate has been
the year 1961 with more time and savings
raised to 3 % percent. The maximum rate on
deposits than did Indiana banks of similar
time deposits (including negotiable certifi
size. Second, member banks in Ohio achieved
cates of deposit) with maturities of 90 days or
larger additions to time and savings deposit
more has been fixed at 4 % percent since
liabilities than did Indiana banks. (For ex
December 29, 1964, while a 4 percent ceiling
ample, class 5 banks in Ohio experienced
is in effect for shorter maturities.
average reserve period gains of $78.3 thou
The consequences of this situation, as well
as the influence of other factors, are suggested
sand compared with $33.1 thousand for Indi
ana banks in the same class.)
in Table III. The data presented in the table
Similar equations for gross demand de
are estimates of the average dollar increase
posits are presented in Table IV. As can be
in total time and savings deposits (T* and T /)
seen quickly, there is not the same consistency
for the range of size classes 1 through 7 dur
of behavior as revealed by time and savings
ing the 1961-63 period. For Indiana banks in
deposits.
size class 4, for example, the equation indi
Identification of the relative prominence of
cates that during the period under review
time and savings deposits in the liability struc
time and savings deposits in each two-week
ture of Ohio banks is the first step in explain
9
EC O N O M IC REVIEW
ing differences in cash management perfor
mance between member banks in that State
requirements.
But it also would seem that deposit mix in
and those in Indiana. It will be recalled that
fluences cash management performance in
the required reserve ratios of Indiana banks
ways other than through the required re
exceeded those of O hio banks of similar size
serve route. As a general matter, and assum
in the period under review. Since reserve
ing all other things do not change, positive
requirements against demand deposits and
relationships may be asserted to exist between
against time and savings deposits were the
the ratio of demand to total deposits and the
same for all member banks of the Federal
ratios of maintained reserves and corre
Reserve System during the period studied,
spondent balances to total deposits. Consider
the higher required reserve ratios of Indiana
first the deposits a member bank keeps with
member banks reflected the greater propor
its correspondent bank. These balances com
tions of demand deposits in the total deposit
pensate the correspondent for the various
mix of those banks. This is the case because
services the latter provides. Probably the
legal reserve ratios set against demand d e
single most used service is that of check
posits (presently, 12 and 16}^ percent for
clearance. In part, then, the demand bal
Country and Reserve City member banks,
ances a bank may keep at its city correspon
respectively) are substantially higher than
dents compensate for the costs incurred by
the legal reserve ratio applied to time and
the latter and, closely related, provide the
savings deposits (in the period studied, 4 per
correspondent with ready cash to settle n eg
cent) .
ative clearing balances on the bank it is ser
vicing. Because checks are written against
If deposit composition influenced only the
demand deposits, only correspondent bal
required reserve ratio, and if in all other
ances will tend to increase with the proportion
respects member banks in the two states were
of demand to total deposits.
alike, the managed cash ratios of Indiana
banks, by definition, would be lower than
Deposits at the Federal Reserve bank, on
those of O hio banks of similar size (the re
the other hand, serve both a regulatory func
quired reserve ratio is a deduction item in the
tion and a check-clearing function generally
computation of the managed cash ratio).
similar to that served by correspondent bal
However, deposit composition also influences,
ances (the Federal Reserve System operates
both directly and indirectly, the other com
check-clearing facilities that both complement
ponents of the managed cash ratio. To some
and supplement those offered by the corres
extent, the higher effective required reserve
pondent network). A member bank's main
ratios of Indiana banks explain their higher
tained reserves, like its correspondent bal
maintained reserve ratios, since it is the de
ances, act somewhat like a sponge—absorb
posit of cash at the regional Federal Reserve
ing net clearing surpluses on some days and
Bank, plus the holding of vault cash, that
providing immediate liquidity needed
allows member banks to meet legal reserve
other days to meet unforeseen deficits.
10
on
AUGUST 1 9 6 6
TABLE V
Estimates of Gross Deposit Instability
Selected Banks in Ohio and Indiana
(Coefficient of Variation)
( l)
(2)
Size Class
Ohio
Indiana
1
3 .3 4 %
4 .1 7 %
matter, the estimates of deposit instability
(measured by the magnitude of the coefficient
of variation) shown in Table V, suggest that
short-term (reserve calculation period) fluctu
(3)
(2) as a Percent o f (1)
period under review than for Ohio banks.
125%
2
1.97
2.03
103
3
1.36
1.83
135
4
1.26
1.68
133
ations were larger for Indiana banks in the
With the exception of size classes 2 and 6
(where differences were slight), the deposit
instability of Indiana banks exceeded that of
5
1.31
1.59
121
6
1.49
1.55
104
Ohio banks of similar size by between 21 per
7
1.26
2.18
173
cent (class 5) and 73 percent (class 7).
Note: As implied, the coefficient o f variation (V) is a measure of
relative dispersion— in this instance, a measure o f short-run
deposit-level instability. In making the estimates, the following
procedure was used:
(1) Trend was eliminated from each deposit series;
(2) For each series, the standard deviation (0) of the residuals
about the trend line was estimated;
(3) Because, even within a size class, a ve ra g e size o f bank
differs between the two states (see the following table),
V instead o f 0 w as selected as the more meaningful
statistic for comparison purposes. For with everything
else the same, the larger a bank’s deposits, the more
absolute volatility in its levels is to be expected. A
relative measure o f variation (V) was calculated for
each series, as well as for each size class and state, by
dividing the ave rag e deposit magnitude into 0.
1
of time and savings deposit levels. This situ
ation coupled with the greater relative im
portance of time and savings deposits in total
deposits of Ohio banks explains the lesser d e
posit volatility for Ohio banks (see Table V).
The data in Table VI are interesting in two
for demand deposit volatility to decline sharply
Ohio
$
stability of demand deposit levels, as shown
in Table VI, is substantially greater than that
additional respects. First, there is a tendency
A verage Size of Bank
(in thousands of dollars)
Size Class
The influence of deposit volatility is not
independent of deposit mix. Short-term in
867
Indiana
$
with the first increases in bank size (as well
842
2
3,045
2,941
3
7,686
7,158
4
15,318
14,772
5
33,777
37,546
6
67,245
67,434
7
884,536
749,123
TABLE VI
Estimates of (a) Demand Deposit and
(b) Time and Savings Deposit Volatility
Selected Banks in Ohio and Indiana
(Coefficient of Variation)
Sources: Federal Reserve Bank of Cleveland and Federal Reserve
Bank o f Chicago
DEPOSIT INSTABILITY
Deposit instability, that is, fluctuations in
deposit levels, also influences the size of a
bank's managed cash ratio. The more a bank's
deposits fluctuate day-to-day and week-toweek, the more cash it must hold to meet
sudden net deposit withdrawals. As a general
Demand Deposits
Size Class
Time and
Savings Deposits
Ohio
Indiana
1
6 .1 9 %
7 .0 2 %
2 .4 9 %
1 .1 5 %
2
4.37
3.43
0.88
0.41
0.52
Ohio
Indiana
3
3.22
3.06
1.17
4
2.94
2.92
0.85
1.20
5
2.87
2.77
1.54
0.74
6
2.68
2.62
2.17
1.57
7
2.53
2.93
1.61
0.77
Sources: Federal Reserve Bank o f Cleveland and Federal Reserve
Bank o f Chicago
1 1
EC O N O M IC REVIEW
as for time and savings deposits), and for
these declines to continue, though more
gradually, as bank size increases. The con
siderably greater deposit instability observed
TABLE VII
Net Loans as a Percent of
Total Deposits— June 30, 1962
Selected Banks in O h io and Indiana
at the smallest banks (in both groups) is, per
haps, explained by the lack of diversification
in deposit ownership and by the dependence
of small banks in rural areas upon agricultural
activities.
Second, except for member banks in size
class 4, member banks in O hio experienced
greater instability of time and savings deposit
levels than like size institutions in Indiana.
(1)
(2)
Size Class
Ohio
Indiana
(3)
(1) as a Percent
1
5 3 .9 %
2 1 .7 %
2
51.5
43.5
118
3
54.1
39.7
136
4
54.2
44.1
123
5
53.1
47.0
113
6
48.5
43.7
111
7
49.3
50.6
97
248%
Sources: Federal Reserve Bank o f Cleveland and Federal Reserve
Bank o f Chicago
Only for one size class (6) was the volatility
sidered by most observers to be a bank's most
of time and savings deposits at Indiana banks
profitable, and most socially desirable, use
more than one-half of what it was at Ohio
of acquired funds; or (2) as some indication
banks; conversely, for all other classes the
of the circumstances or conditions surround
coefficients of variation of time and savings
ing loan demand, for example, the intensity
deposits at O hio banks were more than double
or lack of intensity of loan demand. For pres
what they were at Indiana banks of com pa
ent purposes, the latter interpretation is given
rable size. Possibly, the relatively low rates
more weight, particularly because there is no
paid on time and savings deposits by Indiana
reason to expect managerial com petence to
banks discouraged corporate money man
vary among states (bank size has already been
agers and other holders of temporarily idle
isolated out).
funds who are sensitive to interest rate dif
It is clear from the data in Table VII that,
ferentials from holding time deposits (partic
with the exception of member banks in size
ularly certificates of deposit) in banks in that
class 7, net loan to deposit ratios were higher
State.
for Ohio banks. It can also be noted that the
differences tend to narrow with increases in
LOAN DEM AND
bank size, becom ing relatively insignificant
Differences in cash management perfor
in the case of the very largest banks. Thus,
mance between member banks in Ohio and
the net loan to deposit ratio maintained by
Indiana may also be a consequence of dif
Ohio banks in size class 1 exceeded that of
ferences in loan demand. Table VII presents
similarly classed Indiana banks by about 150
the average net loan to deposit ratio for each
percent, while in the case of class 6 banks the
size class of bank, as of June 30, 1962. The
differential was only 11 percent. The 3 per
ratio may be interpreted in at least two ways:
cent differential in favor of Indiana banks in
(1) as reflecting bank management's aggres
size class 7 can perhaps be best interpreted,
siveness in making loans—a function con-
in the absence of other information, as sug
Digitized for12
FRASER
AUGUST 1966
article,5 that the way to maximize total profits
gesting no significant difference among the
largest institutions with respect to loan de
is to maximize each income element and to
mand. In the case of small banks, where loan
minimize each cost element.
demand is more or less confined to the sur
As businessmen, bankers obviously like to
rounding locale, community characteristics,
make profits. That they seek to maximize
for example, industrial-agricultural mix, may
profits, at least in some short-run sense, is
account for the lower loan ratios observed
quite another matter and considerably less
for relatively small banks in Indiana. Local
certain than the first statement. Like everyone
factors are less dominant in the case of the
else, bankers have various objectives and
larger banks, and in the case of the largest
goals, all of which may not be mutually com
banks virtually completely give way in im
patible. Moreover, like everyone else, bankers
portance to national econom ic circumstances
are creatures of habit, to say nothing of in
and conditions.
ertia. In short, it should hardly be surprising
With the making of loans viewed as the
if bankers, viewing the making of loans as the
"first" business of commercial banking, it is
basic banking function, were to reveal some
to be expected that, unless and until consid
slackness in managing their bank's cash
erations of liquidity and solvency demand
position, and were to exercise more success
otherwise, higher loan demand will result in
ful management only under the pressure of
compression of the managed cash and invest
intense loan demand.6
ment ratios. Banks might, of course, always
seek to maximize profits by placing any and
all idle balances into liquid, interest-bear-
5 See "Management of Cash Assets at Reserve City and
Country Member Banks," Economic Review, July
1965, pp. cit.
ing assets, for example, U. S. Treasury bills
and Federal funds. But this assumes both that
the maximization of profits is the goal of bank
management and, as pointed out in an earlier
6 Thus, it may not be surprising that daily reporting was
not found to have the type of results, with respect to
improved cash management by Country bankers, that
some individuals suspected it would have.
13
EC O N O M IC REVIEW
THE TIGHTENING LABOR MARKET
During the first five years of the current
business expansion—from the first quarter
of 1961 to the first quarter of 1966—total
employment in the U. S. rose from 66.8 mil
TABLE I
Employment and Unemployment, U. S.
First Quarter Averages, Selected Years
Seasonally Adjusted
lion to 73.6 million persons, and unemploy
In Millions o f Persons
ment declined from 4.9 million to 2.9 million
persons.
Total
Employment
Payroll employment in nonagri-
cultural industries over the same time span
Nonfarm
Payroll
Employment
Unemployment
1961
66.8
53.5
4.9
rose by an even larger amount than total em
1964
69.8
57.5
4.0
ployment, or from 53.5 million to 62.5 million
1965
71.4
59.6
3.6
1966
73.6
62.5
2.9
persons. Expressed as annual averages, total
employment increased by almost 1.4 million
Y ear-to-year change
19 61-6 6 (avg.)
+
1.4
+
1.8
— 0.4
persons per year (an annual growth rate of
1 9 61-6 4 (avg.)
+
1.0
+
1.3
— 0.3
2.0 percent), nonfarm payroll employment
1 9 64-6 5
+
1.6
+
2.1
— 0.4
19 65-6 6
+
2.2
+
2.9
— 0.7
increased by 1.8 million persons (3.1 percent
Source: U. S. Department o f Labor
growth rate), and unemployment declined by
nearly 0.4 million persons.
increase in total employment was substan
The changes in total and nonfarm employ
tially larger than that of the entire five-year
ment over the five-year period were not evenly
period. Similarly, the gain from the first
distributed, the averages nothwithstanding.
quarter of 1965 to the first quarter of 1966
For example, as shown in Table I, during the
amounted to 2.2 million persons, a gain ex
most recent two years the annual average
ceeded only once before (between the first
quarters of 1955 and 1956), and was more
Note: Employment and labor force data for the second
quarter of 1966 that have become available since
this article was prepared do not completely fit the
pattern prevailing through the first quarter. For
example, while the labor force continued to grow
at a slackened pace, the increase, for the first
time since 1964, was larger than the increase in
employment (employment increased by an un
usually small amount in the second quarter). While
these developments do not invalidate the retro
spective analysis presented in this article, they
could influence prospective developments, de
pending of course on whether the second quarter
was a temporary departure or a turning point.
Digitized for
14FRASER
them double the annual average increase
during 1961- 64. The decline in unemployment
during the 1965-66 period amounted to 0.7
million persons, or considerably more than
the earlier annual averages shown in Table I.
The accelerated pace of employment growth
in the four-quarter period under review was
accom panied by a noticeable tightening of
the labor market, which at this time shows
little sign of abating. It is the purpose of this
article to examine some aspects of that tight-
AUGUST 1966
l.
business recession.
CIVILIAN LABOR FORCE, EMPLOYMENT,
The effect of public policy measures (for
and UNEMPLOYMENT
example, reductions in income taxes) intro
M i l l i o n s of p e r s o n s
M illio n s of p e rs o n s
tivity, which in turn would stimulate employ
NU M BE R of U N E M P L O Y E D
__
duced after 1963 to stimulate econom ic a c
ment growth and reduce unemployment, is
Scale
evident from the chart. As the chart shows,
employment gains exceeded labor force ex
pansion in each quarter beginning in 1964,
|- A N N U A I CHANGES
and the level of unemployment declined cor
respondingly.1Interestingly, the recent widen
Q U A RTERLY CH/I NGES
J k lfll l l ,
( ^—E M P L O Y 1A ENT
> 1
ICIVILIAN L AB0R FORCE
Hi i
ing of the margin between employment gains
1
and labor force growth did not result from a
SEASONAL LY ADJUSTED
IQ 2Q 30 40 10 20 30 40 IQ 20 30 40 IQ 20 30 40
1963
S o u rce of d a t a :
1964
1965
1966
rising pace of employment increases but from
a slowing down in labor force growth. Thus,
employment gains remained fairly steady
throughout the last five quarters shown in the
U .S . D e p a r t m e n t o f L a b o r
chart—between 500,000 and 600,000 per
ening and to explore some of the implications
sons per quarter—in contrast to a progres
for the economy, both in retrospect and in
sive reduction in civilian labor force expansion
prospect.
from nearly 500,000 in the first quarter of
CHANGES IN THE LABOR MARKET
1965 to 300,000 in the first quarter of 1966.
The degree of labor market tightness re
(See also Table II.)
The quarterly increases in the labor force
flects the amount of balance—or lack of bal
in 1965, when combined, more than met the
a n ce—between the supply of and demand for
goal of a 1.5 million average annual rise pro
manpower. Expansion of the civilian labor
jected by the U. S. Department of Labor for
force (labor supply) and gains in total civilian
the second half of this decade, but the annual
employment (reflecting, although not directly
ized increase in the first quarter of 1966 fell
measuring, labor demand) are shown in
considerably short of the mark.2 The shortfall,
Chart 1 for the period since 1963. Employ
of course, may be made up by the expected
ment gains fell short of labor force expansion
during 1963, so that the number of unemploy
ed (shown in the upper portion of the chart)
failed to decline. In fact,
unemployment
moved slightly higher, lending some support
1 There was a net gain in employment in the third
quarter of 1964 despite the unusual appearance of the
data plotted in the chart. The phenomenon reflected the
late occurrence of the survey week in relation to the end
of the school year, which shifted normal third-quarter
employment increases into the second quarter.
to the then widely held view that unemploy
ment would continue to settle on a progres
sively higher plateau after each
postwar
2 In the second quarter of 1966, the gain in the civilian
labor force was even smaller than in the first quarter.
15
E C O N O M IC REVIEW
TABLE II
Civilian Labor Force and Employment, U. S.
Q u a rte rly C h an ge s, 1 9 6 4 - 1 9 6 6
S e a so n a lly Adjusted
In Thousands of Persons
Adult Men
Adult W om en
Teenagers
All Groups
Labor Force Employment
Labor Force Employment
Labor Force Employment
Labor Force Employment
1st Q
+ 138
+243
+ 136
+ 108
+ 116
+ 158
+390
2nd Q
+ 161
+253
+ 330
+ 388
+ 100
+
44
+591
+685
3rd Q
+
69
+ 103
— 159
—
98
—
40
+
23
— 130
+
4th Q
+
24
+
73
+ 163
+ 177
+
74
+
46
+261
+ 296
5
+
+509
28
1st Q
+246
+318
+226
+ 255
+
7
+477
+580
2nd Q
+
+ 102
+ 103
+ 130
+296
+278
+431
+510
3rd Q
— 157
—
63
+248
+298
+302
+336
+393
+571
4th Q
— 191
—
29
+ 151
+ 188
+402
+ 379
+362
+538
1st Q
+ 193
+268
+
+ 178
+
+ 138
+ 308
+584
32
64
51
Source: U. S. Department o f Labor
large influx of young people into the labor
and older, increased retirement from work
force after mid-1966. On the other hand, the
resulted in reduced labor force participation,
shortfall may also be a warning signal that
while a decline in the 35-44 year labor force
the labor force is losing its elasticity in sup
group followed steady shrinkage of that age
plying the manpower needs of the economy.
group in the population. Normal growth of the
If the latter were the case, it would be a re
remaining portion of the adult male labor
versal of the situation prior to 1964 when
force was too small to offset the com bined
labor force expansion, although much below
losses in the three age groups that showed
the recent rate, was too fast for employment to
declines.
keep abreast.
The recent slowdown in growth of the civil
In contrast, labor force participation of
adult women has continued to rise, and,
ian labor force can be traced to one specific
coupled with rapid growth in the number and
component group—adult men. For example,
labor force participation of teenagers (in re
a decline for that group occurred in the third
sponse to more job opportunities suitable for
and fourth quarters of 1965, instead of normal
that group), has produced the overall increase
expansion in line with population growth
in the labor force shown in the table. Thus,
(see Table II). The decline mainly involved
while a decline in the adult male labor force
three age brackets within the adult male
did not halt total labor force growth between
group. In the 20-24 year group, it reflected
the first quarters of 1965 and 1966, it did
increased manpower demands of the armed
necessitate adjustments on the part of em
forces as well as shifts from part-time to full
ployers to a supply of additional manpower
time student status. Among males 65 years
that was largely teenagers (70 percent).
Digitized for
16FRASER
AUGUST 1966
2
cially in the prime age groups where labor
EMPLOYMENT
Change
fro m
F ir s t Q u a r t e r 1 9 6 5
to F i r s t Q u a r t e r 1 9 6 6
M il l io n s of P e rs o n s
*,»■.
force participation is 95 percent or higher.
The steep rise in teenagers' share of total
new employment—from less than one-tenth
a year earlier to one-half in the 1965-66 peri
+2 . 0 -
od (first quarters) — underscores the comingof-age of the record baby crop of the mid1940's. It also points to the importance of
+1. 5 -
young people as a source of additional man
power in the next several years. The large
rise in employment between 1965 and 1966
+1. 0 -
would not have com e about except for the
availability of young people, since the gain
in adult employment in that period was less
+0 . 5 -
than the gain in the same time span a year
earlier. In percentage terms, during 1965-66
0-
(first quarters)
SEASONALLY ADJUSTED
S o u rce of d a t a :
U . S . D e p a r t m e n t of L a b o r
teenage
employment rose
much more than adult employment, while
adult males recorded a smaller gain than
adult women.
Composition of Employment Gains. Shifts
Chart 2 further indicates that two out of
within the labor force left their mark on the
every three adult women and more than nine
composition of the employment gain from
out of every ten young people constituting the
1965 to 1966 (first quarters), as Chart 2
shows. Teenagers, representing about 9 per
employment gain during 1965-66 reflected
net additions to the labor force. The remaining
cent of the labor force, accounted for one-
portion in each group consisted of persons
half of total new employment, while adult men
—roughly 60 percent of the labor force—
previously unemployed.3 In contrast, the en
tire net increase in employment among adult
contributed only one-eighth of the gain. The
men was accounted for by the unemployed,
latter represented a sharp drop in the share of
including an additional number of persons
new employment that had been accounted
for by men in previous years (40-45 percent).
It also meant that for the second year in a row
the contribution by men was smaller than
that by adult women. For one thing, this situ
ation reflects the relative depletion of the
supply of suitable male workers among the
unemployed; it also indicates that few un
tapped sources of male labor are left, espe
3 These numbers show that the predicted midyear in
vasion of the labor market by teenagers, which in the
spring of last year was viewed with alarm by most ob
servers, was harmlessly channeled into employment
without damage to the unemployment rate. There were
even a few jobs to spare for reducing teenage unemploy
ment over the year. It must be remembered, however,
that many of the new teenage workers found employ
ment in Neighborhood Youth Corps and similar Gov
ernment-financed projects
assist young people.
designed
specifically
to
17
EC O N O M IC REVIEW
needed to offset the decline in the male labor
force mentioned earlier.
About 45 percent of additional employ
TABLE III
Employment Change by Occupation
First Quarter Averages, 1965-1966
ment during 1965-66 went to white-collar
In Thousands
o f Persons
occupations, while a slightly smaller per
centage filled blue-collar jobs. The balance
White-collar workers
Percent
+ 2 .9 %
+921
Professional and technical
+ 164
+ 1.8
M an age rs, proprietors
—
64
— 0.9
represented additional employment in service
Clerical
+588
+ 5 .4
occupations. The largest relative gains o c
Sales
+233
of the gain, reduced by the loss in farm jobs,
curred among clerical, sales, service, and
Blue-collar workers
+ 5 .2
+ 3 .4
+851
semiskilled blue-collar workers, with each
Craftsmen, foremen
+254
O peratives
+714
+ 5 .5
registering employment gains of over 5 per
Nonfarm laborers
— 117
— 3.4
cent between the first quarter of 1965 and the
first quarter of 1966 (see Table III).
M anpow er Needs in 1966. In order for the
Service workers
+ 5 .2
+471
+ 5 .8
+397
Service exd. household
Farm workers
+ 2 .9
— 196
+ 2 ,0 4 7
economy to expand in 1966 at the same pace
TOTAL
as in 1965 and to attain currently estimated
Source: U. S. Department o f Labor
— 5.5
+ 2 .9 %
levels of total output, it will be necessary to
As Chart 2 indicates, unemployment con
have an increase in total labor input that
tributed about one-third of the employment
matches the combination of last year's rates
g a in d u r in g 1 9 6 5 -6 6 , i n c l u d i n g a b o u t
of growth in manhours and in productivity.
Stated differently, econom ic growth could be
400,000 adult men, 200,000 adult women,
and less than 100,000 teenagers. Consider
retarded and production could fail to reach
ing only the numbers involved, it should be
estimated goals if one or all of the ingredients
possible to shift about one-fourth of the
of total labor input should slacken, or if an
present approximately three million unem
insufficient increase in one is not offset. If
ployed persons into employment this year,
labor productivity, or output per manhour,
thereby reducing the unemployment rate to
continues to advance at last year's rate—a
about 3 percent, assuming continuation of
rather bold assumption, perhaps, in light of
current labor force trends.4 Given the com
some of the observations discussed later in
position of the unemployed pool, however,
this article—the manhours variable (number
potential difficulties becom e readily appar
employed times hours worked per employee)
ent. Unlike the labor force, the unemployed
will be the other key factor in assuring that
this year's output goals will be met. Specifi
cally, achieving the number of manhours
needed will require a net addition of at least
two million employed persons this year, who
would com e either from the unemployed or
from persons outside the labor force.
Digitized for 18
FRASER
4 A reduction of the unemployment rate below 3 per
cent, or very close to the absolute minimum, was antici
pated in May by the chairman of the President's Council
of Economic Advisers, if output were to continue to
advance at recent rates. The Secretary of Labor two
months earlier had associated "full employment" with
an unemployment rate of "about 2.5 percent."
AUGUST 1966
TABLE IV
Percent Distribution of Unemployed Persons
First Quarter Averages, 19>65 and 1 9 6 6
Seasonally Adjusted
1965
1966
By a g e and sex:
p e rce n ta g e of short-term unem ploym ent
(under five weeks) increased during 1965-66.
The decline in duration, coupled with the
very low levels to which unemployment rates
of specific age or occupation groups have
Men, 20 years and over
43%
40%
dropped, suggests that unemployment in at
Women, 20 years and over
30
30
least some segments of the labor force is ap
Both sexes, 14 -19 years
27
30
proaching the frictional level, and represents
Less than 5 weeks
48%
53%
5 to 14 weeks
29
26
unemployment rates are far from a frictional
15 to 26 weeks
12
11
11
10
level for such groups of workers as nonwhite
27 weeks and over
By duration o f unemployment:
Source: U. S. Department of Labor
pool is not a self-replenishing source of man
to a large degree labor turnover. In contrast,
or young people, although a ''frictional"
level for teenagers should probably be pegged
higher than for other workers in view of the
power. W hen the level of the pool declines in
known propensity of young workers for fre
response to strong demand, its composition
quent job changing. Secondary worker cate
is apt to change, with primary workers—
gories—those lacking in training, educational
particularly adult males with previous work
attainment, or significant work experience—
experience in a skilled or semiskilled o ccu
are likely places where additional manpower
pation—in greater demand and likely to be
may be found, especially if further efforts are
withdrawn sooner than secondary workers.
made to bridge the gap between job require
As shown in Table IV, the total number un
ments and qualifications of available persons
employed in the first quarter of this year in
cluded proportionally more persons under
by redesigning jobs and by training workers.
It should not be overlooked, however, that
20 years of age and fewer adult men than
reduced productivity and upward pressure
was the case one year earlier. Compared
on unit labor costs are likely consequences of
with the age-sex composition of the labor
employing workers who lack experience or
skill.
force—six adult men, three adult women, and
one person under 20 in every ten persons—
Further difficulty in culling the manpower
the unemployed group for the first quarter
needed this year from the unutilized labor
was distorted in that it included three teen
supply stems from the gap between occu
agers and only four adult men in every ten
pational skills available among the unemploy
persons.5
The decline in total unemployment has also
ed and skills needed to fill new jobs. This is
illustrated by a comparison of the distribution
affected the length of time individuals are un
of the present three million unemployed (by
employed (see Table IV). For example, the
reported occupation of last job) with the o c
5 In the second quarter, the proportions moved still
cupations represented by the two million
closer toward equality: 33 percent teenagers and 36
additional jobs created during 1965-66 (see
percent adult men.
Table V). It would appear that demands in
19
E C O N O M IC REVIEW
TABLE V
Unemployment and Changes in Employment,
by Occupation
First Q u a rte r A v e ra g e s, 1 9 6 5 and 1 9 6 6
White-collar workers
710
percent appears to leave some room for fur
ther expansion, considering that as much as
63 percent participation was achieved in
1944 (with over 11 million persons in the
In Thousands of Persons
Unemployed
1966*
total labor force participation of about 57
Employment
Change
19 65-1 966
+921
armed services). Such a high level of partici
pation, however, is likely to be reached only
in a period of emergency, if at all. Thus, for
Professional, technical
110
+164
1966, an amount of labor force expansion
M anagers, proprietors
100
—
close to the projected rate of 1.9 percent is
Clerical
34 0
+588
Sales
160
+233
possible although by no means assured, in
64
+851
view of the rather slow gain during the first
Craftsmen, foremen
410
+254
half of this year and the uncertain contri
Operatives
720
+714
Nonfarm laborers
35 0
— 117
bution of the adult male segment of the labor
Blue-collar workers
1,480
Service workers
470
Service exd. households
380
Farm workers
N o previous work experience
+397
100
400
TOTAL
+471
— 196
—
3,160
+ 2 ,0 4 7
*Calculated from percent distribution of total number unemployed.
Source: U. S. Department o f Labor
force due to its vulnerability to fluctuating
military demands.
Longer Workweek. The scarcity of skilled
labor in general, as well as shortages of work
ers in specific occupations, cannot be quickly
remedied by even the most elastic labor force.
Such stringencies can be removed only
through training of new workers and, pos
few (if any) of the categories shown could be
sibly, more efficient utilization of present
substantially met from the unemployed, es
work forces, including a lengthening of the
pecially if it is remembered that a portion of
workweek
the unemployed in each group are merely
workers from retirement. Chart 3 presents
changing jobs and thus are not really avail
average weekly hours of production workers
able to fill new jobs. Resort to untapped
in manufacturing industries, a group that
and possibly recall
of skilled
sources of supply, as well as to more training,
accounts for about one-fifth of total employ
particularly for occupations in short supply,
ment and whose behavior is considered as a
again appears to be an inescapable condition
reliable indicator of the general trend in
for meeting this year's manpower demand.
employment. The chart shows that a longer
Since the unemployed pool is slowly dry
workweek has indeed been resorted to in
ing up and is becom ing an increasingly un
order to find a partial substitute for unavail
certain source of additional manpower, the
able skilled workers. Total weekly hours (as
labor force assumes more importance as a
well as overtime hours) have risen almost
source of supply, both through natural growth
without interruption since 1963, with the
in numbers and through increased partici
pace picking up in the middle of 1965, notably
pation of specific groups. The present rate of
in the durable goods industries.
20
AUGUST 1966
—during the Korean War and W orld War II
— shows that weekly hours in both durable
AVERAGE WORKWEEK in MANUFACTURING
T otal w e e k ly hours
and nondurable goods in the first quarter of
this year6 had already surpassed the highest
level of hours attained in any month of the
K orean p eriod . H ow ever, they w ere still
below peak levels recorded during 19431945, when the workweek climbed as high
as 47 hours in the durable goods sector, and
above 43 hours in the nondurable goods sector.
A further expansion in weekly hours would
thus not seem impossible. There are serious
doubts, however, as to whether such a devel
opment would be advisable or desirable in
view of the fatigue effect of sustained overtime
work on labor productivity, as well as the in
S o u r c e of d a t a :
U .S . D e p a r t m e n t of L a b o r
direct effect on labor cost and the direct cost
pressure due to premium pay for overtime
hours. There is the further question as to how
W hile the rise in hours per week in manu
long an extended workweek can be main
facturing since 1963 may not appear exces
tained before leisure time begins to look more
sive, the aggregate tends to conceal substan
attractive to employees than a fatter pay en
tially larger increases in individual industries
velope.
that have been faced with rising production
Rising Compensation. In addition to the up
requirements and an insufficient supply of
ward pressure on labor costs due to increased
labor. In the machinery industry, for example,
overtime work and employment of workers
the increase in hours is twice as large as for
possessing only marginal productivity, there
all of manufacturing. An even larger rise has
is a tendency in periods of tight labor supply
occurred in the metalworking machinery sub
for wage and salary levels to rise generally.
section of that group, where the average work
A recent study by the U. S. Department of
week has been as high as 46 hours and indi
Labor shows that, between 1954 and 1965,
vidual plant schedules have run as high as
average negotiated wage rate adjustments
50 hours per week.
tended to change inversely with changes in
How much higher is the workweek likely
to be pushed in an effort to raise total manhours in general or in specific labor-starved
industries in particular? A comparison of the
current level of weekly hours with the work
week in previous periods of labor stringencies
6 A slight easing of weekly hours, as well as overtime
hours, in manufacturing was reported in the second
quarter of 1966. The reduction, part of which reflected
curtailed work schedules in the auto industry, does not
alter the comparison of the length of the workweek
between the current and previous periods of short
labor supply.
21
E C O N O M IC REVIEW
the unemployment rate.7 Thus, negotiated
wage settlements in the first quarter of 1965
resulted in larger percent increases both for
TABLE VI
Average Hourly Earnings
in Selected Industries*
the first contract year and over the entire life
Earnings
of the contract than in the corresponding
periods of 1964 and 1963.
1965
1966
$2.59
$2.67
2.77
2.86
Percentage Increase
1 9 65-6 6
(First
Quarters)
1960-64
(Annual
A verages)
An appraisal of the outcome of wage n e
gotiations in the early part of 1966, under
taken by a private research organization,
found that the average increase in wage rates
negotiated from January through March 1966
was larger than gains negotiated during last
year's first quarter. O f a somewhat larger
Manufacturing
Durable goods
3 .3 %
2 .9 %
3.3
2.9
2.7
Primary metals
3.16
3.24
2.6
Machinery
2.92
3.04
4.0
3.1
Electrical equipment
2.55
2.62
2.7
2.5
Transportation
equipment
3.18
3.29
3.5
3.2
Nondurable goods
2.33
2.41
3.3
2.9
2.7
Printing and
publishing
3.02
3.11
3.0
Chemicals
2.85
2.93
2.8
3.0
of 1965 and 1966, hourly earnings in manu
Rubber
2.59
2.64
2.1
2.4
facturing industries rose by 0.4 percentage
Construction
3.65
3.79
3.8
3.8
Communication
2.80
2.90
3.5
4.0
4.1
order of magnitude, between the first quarters
points more than the annual average increase
Electric utilities
3.17
3.29
3.7
W holesale trade
2.57
2.67
3.9
3.1
Banking
2.10
2.18
4.0
3.3
Laundries and
dry cleaning
1.47
1.55
5.4
4.0
remainder of the year, with organized labor
Hotels and motels
1.34
1.40
4.5
4.6
pressing for sizable raises by pointing to in
creases in profits and living costs. Moreover,
*Production or nonsupervisory workers only.
between 1960 and 1964.8 (See Table VI.)
The trend toward more expensive wage
settlements is likely to continue during the
Source: U. S. Department o f Labor
the pressure for higher rates of pay will not be
confined to large unionized industries, but
IMPLICATIONS FOR THE ECONOMY
will likely affect smaller industries and non-
The developments in labor markets just
unionized plants as well, as has already been
reviewed have an important bearing on cur
the case for some nonmanufacturing indus
rent problems of containing inflation. The
tries. Finally, individual wage and salary rates
tightening of labor markets and the bidding
can be expected to go up as employers com
up of wage rates move in the direction of in
pete with each other for their share of the
creasing labor costs, thereby adding fuel to
limited supply of workers.
the inflationary problem. It should be recog
nized that increasing labor costs are not the
7 "Major Collective Bargaining Settlements, 1965,”
April 1966, p. 372.
only source of inflationary pressure, and that
M o n t h l y L a b o r R e v ie w ,
the magnitudes involved in the problem are
8 During the second quarter of this year, average hourly
earnings in manufacturing were three cents higher than
important to retain a sense of correct pro
sometimes unintentionally exaggerated. It is
in the first quarter; the increase amounted to 4.5 per
cent on an annual basis.
Digitized for 22
FRASER
portion in dealing with the matter, and to con
sider the evidence in its proper perspective.
AUGUST 1966
Labor costs make up one element, and an
important one, in price determination. Labor
costs are not the same thing as wage rates.
Interrelations of wage rates, labor costs, and
4.
COMPENSATION and OUTPUT PER MANHOUR
and UNIT LABOR COST
IN D EX 1 9 5 7 - 5 9 = 1 0 0
prices are not mechanical or rigid. To what
extent increases in labor compensation may
be absorbed or counteracted without raising
prices, or without dangerously depressing
profits, is a question of strategic econom ic
importance. The relevant measure of offset to
rising wage rates is increased output per manhour ("productivity"), although that measure
reflects the influence of modernized equipment
as well as labor and management efficiency.
Output Per Manhour. In recent years, and
S o u r c e s of d a t a :
U. S. D e p a r t m e n t of C o m m e r c e ;
apparently right up to the present, the record
U. S. D e p a r t m e n t of L a b o r ;
of achievement in increasing output per man-
B o a r d of G o v e r n o r s of th e
F e d e r a l R e s e r v e System
hour is quite remarkable. Annual changes in
output per manhour in manufacturing since
ment under mounting demand pressures, as
1957, expressed on an index-number basis,
well as loss of the initial advantage of a sharp
are shown in Chart 4. The continued rise is
rate of increase in volume—are again being
clear, although the gain of 3.6 percent for the
advanced under 1966 conditions of even
year 1965 was somewhat less than the 4.5
percent gain in 1964. An annual gain of 3.6
tighter pressures. This time, the outcome m a y
be different, but again it may not.
percent during an advanced stage of busi
Unit Labor Costs. The gains in output per
ness expansion is highly unusual; in most
manhour in manufacturing during 1961-65
previous expansions a marked tapering off
slightly more than offset the rise in labor com
or even decline in output per manhour o c
pensation, as indicated in Chart 4. The result
curred in the mid-stages or late stages of the ex
was that labor cost p e r u n it o f o u tp u t reg
pansion. Indeed, many analysts had expected
istered a slight decline over those years.9
that a serious slackening or decline would
occur in 1964 or 1965, but it did not.
Thus, for a protracted period the econom y
has seemed to some observers to be on the
verge (as it has turned out, a "moving verge")
of a deterioration in productivity gains. The
same factors that were previously advanced
as heralding a slackening in productivity
gains—resort to less efficient labor and equip
9 It is generally recognized that the favorable showing
of unit labor costs in manufacturing during recent years
played a highly significant role in making possible the
relative stability of prices as well as maintenance or
increase in corporate profits. Neither the price nor the
profit picture is under direct consideration in this article.
It may be noted, however, that the industrial component
of the Wholesale Price Index, although showing a re
newed tendency to rise in late 1965, scored an average
increase for the year of only 1.3 percent.
23
AUGUST 1966
Labor costs make up one element, and an
important one, in price determination. Labor
costs are not the same thing as wage rates.
Interrelations of wage rates, labor costs, and
4.
COMPENSATION and OUTPUT PER MANHOUR
and UNIT LABOR COST
IN D E X 1 9 5 7 - 5 9 = 1 0 0
prices are not mechanical or rigid. To what
extent increases in labor compensation may
be absorbed or counteracted without raising
prices, or without dangerously depressing
profits, is a question of strategic econom ic
importance. The relevant measure of offset to
rising wage rates is increased output per manhour ("productivity"), although that measure
reflects the influence of modernized equipment
as well as labor and management efficiency.
Output Per Manhour. In recent years, and
S o u r c e s of d a t a :
U. S. D e p a r t m e n t of C o m m e r c e ;
apparently right up to the present, the record
U. S. D e p a r t m e n t of L a b o r ;
of achievement in increasing output per man-
B o a r d of G o v e r n o r s of th e
F e d e r a l R e s e r v e System
hour is quite remarkable. Annual changes in
output per manhour in manufacturing since
ment under mounting demand pressures, as
1957, expressed on an index-number basis,
well as loss of the initial advantage of a sharp
are shown in Chart 4. The continued rise is
rate of increase in volume—are again being
clear, although the gain of 3.6 percent for the
advanced under 1966 conditions of even
year 1965 was somewhat less than the 4.5
percent gain in 1964. An annual gain of 3.6
tighter pressures. This time, the outcome m a y
be different, but again it may not.
percent during an advanced stage of busi
Unit Labor Costs. The gains in output per
ness expansion is highly unusual; in most
manhour in manufacturing during 1961-65
previous expansions a marked tapering off
slightly more than offset the rise in labor com
or even decline in output per manhour o c
pensation, as indicated in Chart 4. The result
curred in the mid-stages or late stages of the ex
was that labor cost p er u n it o f o u tp u t reg
pansion. Indeed, many analysts had expected
istered a slight decline over those years.9
that a serious slackening or decline would
occur in 1964 or 1965, but it did not.
Thus, for a protracted period the econom y
has seemed to some observers to be on the
verge (as it has turned out, a "moving verge")
of a deterioration in productivity gains. The
same factors that were previously advanced
as heralding a slackening in productivity
gains—resort to less efficient labor and equip
9 It is generally recognized that the favorable showing
of unit labor costs in manufacturing during recent years
played a highly significant role in making possible the
relative stability of prices as well as maintenance or
increase in corporate profits. Neither the price nor the
profit picture is under direct consideration in this article.
It may be noted, however, that the industrial component
of the Wholesale Price Index, although showing a re
newed tendency to rise in late 1965, scored an average
increase for the year of only 1.3 percent.
23
EC O N O M IC REVIEW
TABLE VII
Employee Compensation and Output Per
Manhour and Unit Labor Cost— Manufacturing
Monthly, 1964-1966
Index 1957-59 = 100, Seasonally Adjusted
including fringes, per manhour is divided by
physical output per manhour, yielding a
figure for labor cost per unit of output.
The question now arises as to whether a
continuation of the favorable record is occu r
Employee
Compensation
Per Manhour*
Output Per
Manhour
Unit
Labor
Cost
ring when recent monthly figures are ex
1964-J
123.8
124.3
99.6
some changes are in process, but that they
F
123.0
123.4
99.7
M
123.6
124.3
99.5
have not appreciably altered the picture.
A
124.5
125.4
99.2
Data for recent months appear to indicate the
following. The series on compensation per
amined. The data in Table VII indicate that
M
125.5
126.6
99.1
J
126.0
126.5
99.6
J
126.1
127.4
99.0
manhour is rising at a slightly faster pace than
A
126.7
127.5
99.4
previously, which is in accord with the dis
S
127.9
127.2
100.6
O
128.0
126.3
101.4
N
127.4
127.5
99.9
time, output per manhour, despite forebod
D
127.8
128.7
99.3
99.2
ings, has continued to rise at a rate only
1965-J
cussion earlier in this article. At the same
127.5
128.5
F
128.1
128.7
99.5
slightly less than last year's general experi
M
128.5
129.4
99.3
ence. Introduction of modernized equipment,
98.9
A
128.9
130.4
M
129.1
130.6
98.9
made possible by the large capital spending
J
129.2
130.9
98.8
of recent years, has been an important factor
J
129.4
131.6
98.4
A
130.0
131.8
98.6
in this performance. Nevertheless, the com bi
S
130.2
131.0
99.4
nation of compensation and output per man-
O
130.3
131.2
99.3
hour has resulted in a slight rise in labor cost
N
130.5
131.0
99.6
D
130.3
132.0
98.7
1966-J
131.7
132.5
99.4
F
132.3
132.5
99.9
per unit of output thus far this year, in con
trast to a decline in the year-earlier period.
M
132.7
133.4
99.4
A
133.6
133.9
99.7
M
134.0
134.7
99.5
rising unit labor costs in manufacturing marks
J
134.1
135.0
99.3
a new trend is an important question for the
Whether or not this short experience with
* W a g e s and salaries plus supplements.
outlook. Some qualified observers feel that a
Note: Figures in the third column (unit labor cost) are close to, but
not identical with those shown by Series No. 62 published
monthly in Business Cycle Developments, U. S. Department
o f Commerce.
new trend is definitely in the making, and
Minor differences are traceable to alternative methods o f
seasonal adjustment of the constituent series.
Sources: U. S. Department o f Commerce; U. S. Department of
La bor; Board of Governors of the Federa I Reserve System
that it is based b o th on rising compensation,
on the one hand, and a slackening in the rate
of gain in output per manhour, on the other.
It is important to remember that these three
variables are connected in such a way that an
(See lower portion of Chart 4.) Arithmetically,
outright decline in output per manhour is not
the relationship of the three lines in Chart 4
required to produce an increase in labor cost
may be identified as follows: compensation,
per unit of output.
24
AUGUST 1966
Relation to Broader Measures. Beyond the
downward. The broader fact that last year's
impact on manufacturing, a question may be
increase in real output resulted in about equal
raised as to repercussions of recent labor
proportions from gains in manhours worked
market developments upon the economy,
and in productivity is also unusual, reflecting
more broadly measured. This subject could
especially the large employment gains of last
be raised in various forms, but, for the pur
year. The general tendency for a considerable
pose at hand, one question may be stated this
number of years, including even some of the
way: What proportion of last year's real gain
early 1960's, was for a larger part of the gain
in output of the econom y may be traced to
in real output to be ascribed to productivity
gains in employment and the increase in
than to employment increases.
hours worked (described earlier), and what
The outline of the 1965 performance, with
proportion may be ascribed to improvement
respect to the relative roles of productivity
in productivity? What can be said about the
gains and manhour gains in facilitating out
prospects for this year, in the same terms?
For this type of measurement, the most
put growth, helps to shape the nature of the
problem being faced in 1966. If the gains in
practical unit of coverage is the total "private
total manhours worked and in productivity
econom y," that is, Gross National Product
turn out to be about the same as experienced
deflated for price changes and less the gov
last year,11 the total real gain in output might
ernment accounts. The starting point is the
also be very close to last year's gain of 6.2
fact that the real output of the private econom y
percent for the private economy, or 5.9 per
("G ross Private Product") is estimated to have
cent for GNP. But if at the same time the rise
increased last year at a rate of 6.2 percent.
in GNP, in current dollars, should be as much
(Total real GNP rose by 5.9 percent.)
Of the 6.2 percent gain last year in real
as 8.5 or 9.0 percent, to an annual total of
$740 billion or more,12 as many (although not
output of the private economy, about half is
all) business analysts have suggested as fore,
estimated as due to the increase in manhours
casts, it is obvious that such an outcome im
worked, while the other half stemmed from
plies that the accompanying rise in the price
the increase in output per manhour. The 3.1
level will be considerably larger than last
percent gain ascribable to increase in man-
year's rise of 1.8 percent in the GNP deflator.
hours worked, in turn, may be broken down
The central point is that the possibility of an
as follows: 2.6 percent was due to the increase
unusually large increase in GNP, b o th in
in numbers of people employed, while 0.5
percent may be ascribed to the net rise in
weekly hours worked.10 The increase in
weekly hours worked was quite marked in
1965, as described earlier, and ran counter
to the recognized long-run trend, which is
10 Source of these estimates is the U. S. Bureau of Labor
Statistics.
11 Such an assumption resolves a number of doubts on
the favorable side. Average working hours, for example,
are certainly not expected to rise as much as they did
last year, and may even decline in accordance with the
more customary showing of recent years.
12 A figure of $740 billion or more would be roughly
equivalent to the $735 billion forecast which was com
mon before the July revisions in the GNP accounts.
25
E C O N O M IC REVIEW
dollar terms and real terms, is open to some
pressure on resources and reemergence of
doubt in view of the labor market develop
the inflationary problem, public policy has
shifted toward holding down the expansion
ments discussed earlier.
TOWARDS IMPROVEMENT OF LABOR
FORCE A N D LABOR MARKETS
of aggregate demand. Unemployment, how
ever, is not completely vanquished as a prob
lem, especially for some of the well-known
O ne of the goals of public and private
disadvantaged groups. Therefore, the relative
policy for many years has been a general
importance of the structural approach is
improvement in the quality of the labor force
coming to the fore. As events have unfolded,
and the functioning of labor markets, includ
it would seem that the basic distinction be
ing such targets as the upgrading of qualities
tween the two approaches does not turn on
and skills of the labor supply, enhancement
which one is better, but rather on which one
of the mobility of labor, and a more efficient
came first in terms of emphasis.
matching of people and jobs.
2. A second converging set of considera
As a consequence of the recent tightening
tions stems from the pressing need of employ
of the labor market, such a set of endeavors
ers for a better qualified and more mobile
has taken on certain new angles and new
labor supply. These are management angles,
emphases. Outstanding is the marked accent
but they point in the same direction, in terms
on the acknowledged desirability of stepping
of needs and goals, as the first set of social
up such efforts. Three sets of considerations
policy considerations. So far as a better quali
converge toward this end. They may be out
fied labor supply is concerned, the desires of
lined as follows.
employers are clear and uncontested. In re
1.
Efforts to reach the goal of full employ spect to mobility as a desideratum, there may
ment have necessarily involved a relative
be crosscurrents from management's point of
shift in emphasis from the "aggregate d e
view, insofar as one employer's need to hold
mand" approach to the "structural" approach.
his workers may offset another's stake in
During the 1960's until this year, the aggre
greater mobility. But the general desirability
gate demand approach (accompanied by con
of an efficient matching of people with jobs,
siderable debate)
which implies mobility, commands a consider
was favored in
public
policy over the structural approach, although
able degree of agreement.
the latter was presumably not to be altogether
3. A third set of considerations, pointing
neglected. In retrospect, it can be seen that
in the same direction as the other two, lies in
the advocates of aggregate demand have
the relationship between the quality of labor
much in the record to support the validity of
markets and the central problem of stability
their contentions of the early 1960's, insofar
versus inflation. To the extent that production
as unemployment has, in fact, been dramati
bottlenecks can be broken by improvements
cally reduced, largely by methods involving
in labor markets, and to the extent that pro
the expansion of aggregate demand. Now,
du ctivity gains ca n b e m aintained or in
however, with the em ergence of increased
creased under conditions of a better qualified
26
AUGUST 1966
labor force, inflationary pressures are less
lations that tend to limit the earnings of retired
ened to that degree. Although no miracles
persons. Suggested changes would be aimed
may be expected from this approach, and
at providing incentive for job retention or
although the realization of gains in this di
possible job resumption by skilled older
rection may be hard to measure, it is none
workers. A few years ago, when unemploy
theless true that even small advances in a
ment was a major problem, the social advan
many-sided approach to the containing of in
tage of early retirement programs was given
flation are helpful. Any appreciable gains in
much stress. Now that shortages of skilled
this direction would relieve some of the bur
labor have come to the fore, attitudes toward
dens of more rigorous anti-inflationary mea
the relative desirability of early and late re
sures such as tighter monetary policy or tax
tirement are undergoing a marked change,
increases.
for obvious reasons.
In the light of the foregoing considerations,
3. Under the Manpower Development and
much greater attention (and in some cases a
Training Act of 1962, as amended in 1963
different kind of attention) is being paid to a
and 1965, the Federal Government has under
number of interrelated specific measures,
way a number of pilot projects for financially
both public and private. A few of them are
assisting the relocation of workers in econom i
mentioned here for illustrative purposes, with
cally distressed areas. This type of program,
no attempt at a comprehensive listing or an
involving efforts to move the worker to the
order of priority.
1. On-the-job training of employees is now
job, rather than bringing the job to the worker,
is a new-style version of attempts to promote
a matter of recognized importance. Under the
mobility of the labor force in the process of
gun of necessity, numerous employers have
broken new ground in this direction; much
dealing with pockets of unemployment. So far,
the scale of operations has been small. Ex
ingenuity has been exercised, and more will
perience in other countries, especially Great
be needed. Also, the Federal Government
Britain and Sweden, indicates that solid re
has a program of providing assistance to em
sults of such programs can be achieved.
ployers in setting up such training facilities,
4. From numerous quarters has com e ad
both on the arrangements side and on the
vocacy of programs for the vesting of pen
finance side, while the control of the operation
sions, or the adoption of transferable pensions,
remains with the employer. Although still
to facilitate labor mobility. It has been argued
relatively small in extent, the Federal pro
that when there are serious shortages of
gram shows signs of gathering momentum,
skilled construction workers in upstate New
especially since a turn has been made toward
York, for example, accompanied by surpluses
industry-wide frameworks of cooperation be
in New York City, it is undesirable to have
tween the Government and a number of
pension considerations interfere with mobility.
national trade associations.
As mentioned previously, there may be cross
2. Numerous suggestions have been made
currents in management's view of this type of
for altering the present Social Security regu
question. Costs of such programs may be
27
E C O N O M IC REVIEW
large, and management often feels that its
measures or programs may be involved in the
past investment in pensions entitles it to the
current approach to improvements in the
full benefits of retention of existing employees.
labor force and the functioning of labor mar
At least, however, the pension question is
kets. Indicative of the enlarged attention paid
getting a new look under the newer circum
to such matters at levels of national policy
stances.
making is the fact that the Council of Eco
5.
Improved statistical information about nomic Advisers, which had devoted only
job needs and personnel availability con
about one page to such matters in each of the
tinues to be a recognized goal. But here also
1962 and 1963 annual reports, gave ten
efforts are being made in new directions. A
pages of attention to the subject in its 1965
vigorous attempt by both public and private
Annual Report (under the heading of "Toward
agencies to improve statistical data on specific
a More Productive Use of Our Labor Force"),
job vacancies is one such instance.
and in the 1966 Annual Report devoted an
In addition to the five sets of illustrations
just mentioned, numerous other types of
28
entire chapter of 22 pages to the subject of
"Strengthening Human Resources."
Additional copies of the E C O N O M IC REVIEW may
be obtained from the Research Department, Federal
Reserve Bank of Cleveland, P.O. Box 6387, Cleveland,
Ohio 44101. Permission is granted to reproduce any
material in this publication.
@FedFRASER