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O C T O B E R 1967

THIS

I SSUE

Financial Flows:
Recent Patterns
and Problems . . . .

Trends and Recent
Relationships in Yields
on U .S. Government
Securities
........................ 18

FEDERAL

RESERVE

BANK

CLEVELAND

Additional copies of the EC O N O M IC REVIEW may
be obtained from the Research Department, Federal
Reserve Bank of Cleveland, P.O . Box 6 3 8 7 , Cleveland,
Ohio 4 41 01 . Permission is granted to reproduce any
material in this publication.

OCTOBER 1 9 6 7

FINANCIAL FLOWS:
RECENT PATTERNS AND PROBLEMS

II is widely accepted that the adjustment
in economic activity has been largely com
pleted, and that the economy is now moving
forward at a relatively brisk pace. This inter
pretation is confirmed by the general strength
of most major economic time series: indus
trial production, nonfarm employment, manu
facturers' backlogs, retail sales, and housing
starts, among others. The expected behavior
of these areas, a s well as that of the major
spending sectors, such as the government
sector, adds a favorable tone to most eco
nomic forecasts.
While there are alw ays major uncertain
ties in forecasting the economic outlook (at
the present time, the uncertain length and
extent of the automobile strike a s well as
the uncertain dimensions and timing of the
proposed surtax), many observers believe
that the economy may be on a path that could
lead to substantial, and possibly excessive,
increases in economic activity. Following a
nominal increase in Gross National Product
in the first quarter of 1967, there was moderate
improvement in the second quarter ($8.8 bil
lion), and acceleration in the third quarter
($15.0 billion). According to the majority of

forecasts, the pace of GNP could quicken
further in the current quarter, with the pace
carrying over into the first half of 1968.
It is precisely the anticipated quickening
of GNP that provides the rationale for impo
sition of a surtax, a s recommended by the
Administration. It is felt in many quarters
that the failure to impose an appropriate
surtax would allow excessive aggregate
demand to intensify inflationary pressures in
the economy, which in effect would super
impose demand-pull pressures on the costpush pressures already apparent in recent
widespread cost and price increases. In the
absence of an appropriate surtax — both in
terms of timing and magnitude — it is not
inconceivable that the burden of restraining
the economy in the period ahead could be
forced on monetary policy, a s in 1966. If this
were the case, it would not be unlikely that
economic events could once again lead to
the types of problems and pressures that
characterized the economy in 1966, in par
ticular, uneven and distorted flows of funds
through financial markets and financial insti
tutions. This article discusses financial flows
in recent years, with emphasis on the period
3

ECONOMIC REVIEW

since 1965 when unusually wide swings in
demands for and supplies of funds occurred.

FL O WS o f F U N D S in C R E DI T M A R K E T S
Net changes in b illio n s of d o lla rs

DEMANDS FOR FUNDS

As shown in ihe upper left-hand portion of
Chart 1, the volume of funds raised annually
in credit markets increased steadily from
1962 to a record high in 1965, and then de
clined very slightly in 1966. During this fiveyear period, the volume of funds raised by
the various levels of government in the na
tion remained relatively steady, and thus
accounted for a decreasing proportion of ihe
total. Consumer borrowings were noticeably
large in 1964 and 1965, but fell back in 1966,
to slightly less than the amount raised in
1963. In contrast, business demands for funds
increased steadily, and substantially, as the
period progressed.
Developments in 1966-1967 can be best
evaluated by the use of quarterly data. As
shown in the upper right-hand portion of
Chart 1, in ihe first quarter of 1966, demands
for funds peaked at an all-time high of $84
billion. However, after being virtually un
changed in the second quarter, ihe total vol
ume of funds raised was reduced markedly
in the second half of 1966, due in large part
to declines in the supply of funds available
to potential borrowers. In the first quarter of
1967, borrowings once again increased sub
stantially, reflecting some easing in the sup
ply situation a s well a s a large increase in
the Federal Government's demands for funds.
In contrast, in the second quarter of 1967
total borrowings were ihe smallest in several
years, a s a result of Treasury debt repay
ments and the general slowing in economic
activity.
Digitized 4
for FRASER

FUNDS RAISED

I I I

-GOVERNMENT

ANNUAL TOTALS

-SEASONALLY ADJUSTED ANNUAL RATE

FUNDS SUPPLIED
+100
+75

l l u
ANNUAL TOTALS
-25
1962 '64

'66

QUARTERLY-SEASONALLY ADJUSTED ANNUAL RATE
2

1966

1 2

1967

1968

Source of data: Board of Governors of the Federal Reserve System

Demands for funds by the three major sec
tors of the economy also changed markedly
after midyear 1966. As shown in the upper
right-hand portion of Chart 1, there were
large fluctuations in ihe volume of funds
raised by governments and businesses, with
more moderate shifts by the consumer sector.
An examination of ihe demands for funds by
each major sector provides some indication
of the factors responsible for changes in
demands.
CONSUMER SECTOR

On balance, the consumer sector is a net
supplier of funds to the economy. At times,
consumers supply a large portion of their
savings directly to financial markets, a s in
the fourth quarter of 1966; usually, however,
a greater proportion of consumer savings
flows through financial intermediaries, as in

OCTOBER 1 9 6 7

ihe second quarter of 1967 and in mosi years
shown in the left-hand portion of the bottom
panel of Chart 2.
Nevertheless, ihe consumer sector includes
many individual borrowers who obtain funds
primarily in the form of long-term mortgage
credit and short-term consumer credit. As
shown in the lop panel of Chart 2, the volume
of consumer borrowing declined from peak
levels during the first three quarters of 1966,
and stabilized around quarterly increases at
an annual rate of $18 billion. Chart 2 also
shows that successively larger annual in
creases in mortgage credit were recorded
from 1962 through 1964. In 1965, the increase
in mortgage indebtedness w as about the
sam e as in 1964; however, in 1966, the in
crease in mortgage indebtedness returned
to about the 1962 volume. (For these and
Chart 2.

C ON S U M E R B O R R O W IN G and S AV IN G
B illio n s of d o lla rs

NET INCREASE
- i n LIAB ILITIES— +50
+40
+30
+20

ANNUAL TOTALS

+10
0
-10

-*1-4 FAM ILY MORTGAGES
QUARTERLY-SEASONALLY ADJUSTED ANNUAL RATE

3ET INCREASE in
-INANCiAL ASS
+50
+40
+30
^SAVINGS ACCOUNTS

+20

+10
0
ANNUAL TOTALS
1962 '64

-10

QUARTERLY-SEASONALLY ADJUSTED ANNUAL RATE
2

1966

1967

* Through Credit M arket Instrum ents.
Source of data: Board of Governors of the Federal Reserve System

1968

other similar data, see Table I.) The peak in
mortgage borrowing was reached in late
1965, and then successive quarterly declines
occurred until a recent low was recorded in
the first quarter of 1967.
The impact of the change in monetary pol
icy in 1966 on mortgage credit, which normal
ly accounts for considerably more than half
of consumer borrowing, is well known. Bui,
a s the year progressed, the credit squeeze
also had some impact on consumer credit.
The net effect was that by the first quarter of
1967 consumer borrowing accounted for the
smallest proportion of total funds raised in
several years.
The rapid increase in consumer liquidity
beginning in late 1966 was reflected in sub
stantial gains in financial assets (see bottom
panel of Chart 2). The extent to which the re
building of consumer liquidity will have an
impact on consumer spending is still unclear
at this time. For one thing, in the consumer
sector a s well a s elsewhere, the savers are
not necessarily the borrowers. Moreover, con
sumer spending and consumer demands for
funds are heavily dependent upon overall
income and decisions about savings. Al
though retail sales and homebuying have
been increasing recently, there is little evi
dence at this time of a major consumer spend
ing boom, particularly in real terms, that is,
after adustments for higher prices. Moreover,
lightening residential mortgage terms, rising
prices for consumer goods and services, and
uncertainties associated with the auto strike
may dampen consumer buying plans, at least
temporarily. In any event, rebuilt consumer
liquidity does provide a foundation for pos
sible strength in consumer spending.
5

ECONOMIC REVIEW
TABLE I
Funds Raised Through Credit Market Instruments
By Sectors
(billions of dollars)
Seasonally Adjusted Annual Rates
Annually

1966

1967

Category

1962

1963

1964

1966

Corporate profits

+ 4 .4

+ 6 .7

9.1

+ 6 .4

+ 10.0

— 1.6

—0—

— 2.0

— 18.8

+ 2 .8

Minus: Taxes

+ 1.1

+ 2.0

+ 1.4

3.3

+ 2.7

4.4

— 0.4

-0 -

— 0.4

— 8.4

+ 0 .8

After tax profits

+ 3.4

+ 2.3

+ 5 .2

5.9

+ 3.7

5.6

— 1.2

-0 -

— 1.6

— 10.4

+ 2 .0

Minus: Dividends

+ 1.2

+ 1.5

+ 0 .7

1.9

+ 1.6

1.6

0.4

—0 —

— 1.6

4.0

+ 3 .6

Plus: Depreciation
Allowances

+ 3 .7

+ 1.7

+ 1.9

2.6

+ 2 .4

1.6

2.0

+ 2 .0

2.0

+ 2 .8

Net change in
internal funds

+ 5 .9

+ 2 .4

+ 6.6

6.5

+ 4 .5

5.6

-0 -

2.0

+ 2 .4

— 12.8

+ 1.2

Net change in
external funds

+ 2.5

+ 0 .1

— 1.7

+ 11.9

+ 7 .1

5.5

+ 15.9

— 25.0

+ 2.0

— 6.1

+ 8.0

1965

Sources: U. S. Department of Commerce and Securities and Exchange Commission

ECONOMIC REVIEW

than in several previous years. The greater
volume of public offerings of bonds has at
times produced market congestion and has
had an appreciable effect on interest rates.
INTEREST RATES

The recent wide swings in demands for
funds have resulted in some atypical interest
rate movements, which are illustrated by the
behavior of short- and long-term yields on
U.S. Government securities. While long rates
were fairly stable throughout 1964 and the
first half of 1965, short rates were rising grad
ually (see Chart 7). In mid-1965, greater in
volvement in Vietnam on the part of the
United States altered expectations of investors
and borrowers and increased credit demands,
which in turn were reflected in sharply rising

long- and short-term rates. The rapid rise in
interest rates was temporarily interrupted
during the first half of 1966, but the upward
movement was resumed around midyear as
a restrictive monetary policy became effec
tive. Interest rales subsequently reached the
highest levels in over 40 years.
In the latter months of 1966, rates began to
ease from their highs a s the economy showed
signs of weakening. The Federal Reserve
System quickly recognized these signs and
changed from a restrictive policy to a policy
that provided substantial reserve growth. In
terest rates declined further in response to
the increased reserve growth. After dropping
to a low early in 1967, long-term rates began
to move up again a s strong demands for

OCTOBER 1 96 7

still considerably above rates prevailing in
mid-1965. Long-term rates subsequently edged
upward, and by late summer-early fall had
either approached or surpassed 1966 highs.
The recent rise in long-term rates mainly re
flects the pressures in the capital markets due
to huge credit demands of corporations and
state and local governments, a s well a s of the
Federal Government. While business credit
demands represent an attempt on the part of
corporations to rebuild liquidity positions
a s well a s to maintain a high, if not rising,
level of capital spending, it is perhaps even
more significant that borrowers have been
concerned with a possible repetition of the
1966 credit squeeze. This concern is prompted
largely by the feeling that heavy Federal
Government demands for funds could be
Chart 8.

CAPITAL M A R K E T RATES

funds were reinforced by fears in some quar
ters of a return to a restrictive monetary
policy. By June, yields on long-term securi
ties had surpassed their 1966 high; long-term
yields rose further after June. While the
Treasury bill rate continued to decline
through June, it has moved up sharply since
then.1
As shown in Chart 8, selected long-term
interest rates rapidly fell from their AugustSeptember 1966 highs and reached lows in
January-February of 1967. The January- Feb
ruary lows in long-term rates, however, were

1 For a more detailed discussion of the level of interest
rates and the relationship of short- and long-term rates,
see "Trends and Recent Relationships in Yields on U.S.
Government Securities," Economic Review, October 1967.

Per cent

FHA MORTGAGES
( M a r k e t Yi e l d) —
6

NEW CORPORATE
ISSUES ( A n a ) *

! /

ijT

PR,Mt RA ' V

____ _________________
4
U. S. BONDS *
( Long- t er m)
3

/
s '"

J \

MUNI CI PALS ( A a a ) *

------v

19 64

’ 65

’66

’67

MONTHLY

’6 8

* Monthly averages.
Source of data: Board of Governors of the Federal Reserve System

ECONOMIC REVIEW

superimposed on the credit demands gener
ated by the resumption of strong economic
activity. This sentiment co n ceivably per
suaded some borrowers to enter ihe market
in anticipation of future needs. As a result,
despite the large-scale availability of funds,
all credit demands thus far in 1967 could not
be satisfied at prevailing interest rates, and
conseguenlly, rates moved upward. The up
ward drift in other long-term rates was trans
mitted to mortgage yields, which have grad
ually moved upward since May.
As suggested in Chari 9, short-term rales
were perhaps much more responsive to eco
nomic conditions and ihe change in monetary
policy in late 1966. The rate on new issues
of 3-month Treasury bills fell almost 2 per
centage points from a peak in October 1966
to June 1967; bill rales subsequently turned
up sharply after June. Although other short
term rates exhibited similar patterns, these
rates did not turn up a s sharply a s did ihe
bill rate, or did not increase at all. The re
sponse of short-term rales to monetary ease
in late 1966 and early 1967 was reflected in
and reinforced by the attempt of financial
and nonfinancial institutions to restore liquid
ity positions. The growth in deposits and
share capital of deposit-type financial insti
tutions was utilized to a large extent to ac
quire short-term investments and to pay off
debts, thereby exerting downward pressure
on short-term rates. At the sam e time, loan
demand at banks continued relatively weak,
partly a s a result of reduced inventory ac
cumulation. Nonfinancial corporations, on the
other hand, sought to clear their credit lines
at banks, while corporations also attempted
to assure themselves of an adequate supply

of funds by issuing commercial paper and
long-term securities.
FUNDS SUPPLIED

For 1966 as a whole, ihe total flow of funds
into credit markets was slightly less than in
1965, but substantially exceeded ihe 1964
flow (see Chart 10). During 1966, as discussed
earlier, flows of funds decreased from an
annual rate of $84 billion in the first quarter
to $54 billion in ihe fourth quarier. In response
to the change in monetary policy, total funds
supplied increased sharply in ihe first quarter
of 1967. However, in ihe second quarter, total
funds supplied again declined. As indicated
earlier, the second quarter slowdown in
funds raised and funds supplied was centered
almost entirely in ihe Federal Government
sector, where accelerated corporate profit

OCTOBER 1 9 6 7
Chart 10.

F U N DS SUPPLIED to CREDIT M A R K E TS
Bi l l i ons of dol l a r s
Q U A R T E R L Y -S E A S O N A L L Y A D JU STED ANN UAL RATE

ANNUAL TO TA LS

80
ALL OTHER
70

NONBANK

FIN A N C IA L
I N S T IT U T IO N S

3
1968

* Commercial Bank plus N onfinancial Institution Lending exceeded Total Lending in second q uarter 1967 as
A ll Other Lending Institutions were net users of funds.
Source of data: Board of Governors of the Federal Reserve System

tax payments coupled with a run-off of cash
balances permitted the Government to retire
debt at a nearly $22 billion annual rate.
In addition to changes in the contour of
total funds supplied, there were significant
changes in the composition of funds supplied.
Funds supplied by deposit-type financial in
stitutions for 1966 a s a whole were only 60
percent of the amount supplied in 1965, due
to ihe fact that flows were severely reduced
in the second half of the year. As shown in
Chart 10, funds supplied by commercial
banks declined from an annual rale of $28
billion in the first half of 1966 to $9 billion in
the second half; funds supplied by nonbank
deposit-type financial institutions declined
from an annual rate of $13.5 billion in the first

quarter to an average of slightly more than
$6 billion during the next three quarters. As
a result, deposit-type financial institutions
(bank and nonbank) suffered a substantial
reduction in their share of total funds sup
plied.
Funds supplied by insurance companies
and pension funds, a s shown in Chart 10,
were fairly stable during 1966, and in fact
actually increased for the year a s a whole.
A significant change occurred in the "all
other" category, however. For 1966 a s a
whole, this category supplied almost twice
the amount of funds a s in each of the previous
two years. The major sources of funds in the
"all other” category were the Federal Gov
ernment and domestic nonfinancial sources
13

ECONOMIC REVIEW

— households, businesses, and stale and lo
cal governments. While each of these sources
increased the supply of funds to credit mar
kets in 1966, the major change in the domestic
nonfinancial category occurred in the house
hold sector.
Households, influenced by high interest
rates, bypassed deposit-type financial insti
tutions and invested funds directly in finan
cial markets—acquiring substantial amounts
of U.S. Government and municipal securities
— in what came to be known as "disinterme
diation.'' Thus, while total flows of funds on
the supply side were not significantly less
in 1966 than in 1965, both the intrayear pat
tern and ihe composition of flows were sub
stantially altered. In the first half of 1967, a
semblance of normality on the supply side
was restored, a s consumers saved a greater
proportion of current income, liquidated se
curity holdings, and transferred substantial
funds to deposit-type institutions.

during ihe first half of 1966 more than com
pensated for the drop in savings inflows that
occurred in the second quarter. By late
August, however, market rates of interest had
risen above maximum permissible offering
rates on CDs and banks experienced a sizable
run-off, which amounted to approximately $3
billion by mid-December. Thus, a significant
deterioration in deposit growth at commer
cial banks did not materialize until ihe third
and fourth quarters. With individuals with
holding funds from deposit-type institutions
and investing directly in higher-yielding mar
ket investments, the pressure on deposit-type
institutions led to a marked drop in mortgage
credit.

Chart 11.

N E T I N F L O W of T I M E a n d S A V I N G S D E P O S I T S
C u m u l a t i v e Cha nge f r o m End of Y e a r
Bi l l i ons of d o l l a r s
10

DEPOSIT-TYPE FINANCIAL
INSTITUTIONS

The shortfall of deposit inflows at all de
posit-type institutions in 1966 is revealed in
Chari 11. Savings and loan associations ex
perienced a slowdown in net inflows in both
ihe second and third quarters. In the fourth
quarter, while inflows increased, the gain
was not large enough to compensate for the
earlier shortfall. By the end of 1966, cumula
tive net inflows at savings and loan associa
tions were less than half of the 1965 inflows.
Net deposit inflows at mutual savings banks
were approximately one-third less in 1966
than in 1965. At commercial banks, accele
rated growth of certificates of deposit (CDs)

_ SA\ I NGS a nd L 0 A I

8
6

AS! OCI A T I O N
1967
1965

____-

2
0
1967

M U T U A L S A V I N GS
BANKS 1

4
2
0

1965

CO AMER CI AL BAN) S

1965

16
14
12

----

1967

1966

8
6
4
2

SEASO N A L n

n
J

Source of data: Board of Governors of the Federal Reserve System

A D Jl STED

OCTOBER 1 96 7

The situation shifted in 1967, and net in
flows of lime and savings deposits and share
capital have expanded considerably, with
the expansion even greater than in 1965 (see
Chari 11). The improvement of deposit in
flows, however, did not immediately result
in increased mortgage or other lending. For
example, savings and loan associations uti
lized a substantial proportion of the enlarged
deposit inflow to retire indebtedness to the
Federal Home Loan Bank. During the first
half of 1967, for example, savings and loan
associations reduced such indebtedness at
an annual rate of nearly $4.5 billion. In addi
tion, savings and loan associations have
attempted to rebuild liquidity positions by
purchasing U.S. Government securities. Thus,
although mortgage financing by savings and
loan associations picked up rapidly, the
amount of mortgage credit extended has re
mained below 1965 levels. The situation was
somewhat similar at mutual savings banks,
which became substantial purchasers of cor
porate bonds (at an annual rate of nearly $3
billion in the first half of 1967).
Time and savings deposit inflows into com
mercial banks were also considerable during
the first half of 1967. Much of the initial in
crease in time and savings deposits reflected
the growth of CDs, a s short-term market rates
of interest fell below CD offering rates. During
the second quarter, however, there was vir
tually no growth in CDs. In the third quarter,
CDs at large commercial banks again in
creased. The recent strength of time and sav
ings deposit inflows at commercial banks has
been supported by the growth of other time
deposits, particularly savings accounts, which
earlier this year had shown little increase.

COM M ERCIAL BANK CREDIT

The uses of deposit inflows in 1967 by com
mercial banks reflect the attempt to rebuild
liquidity positions as well a s the influence of
the sluggish performance of the economy in
the first half of the year. In the first quarter
of 1967, total loans and investments grew
substantially in response to sharply accele
rated reserve expansion, although most of
the growth represented the acquisition of U.S.
Government securities and state and local
obligations (see Chart 12). The inventory ad
justment, the decline of plant and equipment
expenditures, and increased corporate use
of the open market were important influences
on the moderate growth of total loans (includ
ing business loans). In the second quarter,
bank credit growth was more restrained as
total loan growth eased even further. Banks
continued, however, to acquire state and
local obligations even though maturing tax
anticipation bills resulted in a sharp decline
in holdings of U.S. Government securities.
Thus, the portfolios of commercial banks
were clearly influenced by the attempt to re
build liquidity a s well a s by moderate loan
demand. In the third quarter, bank credit
expansion virtually exploded, being larger
than in the first quarter, a s banks continued
to add to investment portfolios while accom
modating stronger total loan demand (busi
ness loan demand, however, hardly in
creased).
The sharp expansion of bank credit thus far
in 1967 was made possible by the rapid
growth of bank reserves after the change in
monetary policy last fall. The buildup of non
borrowed reserves during the first quarter of
1967 was one of the greatest on record (see
15

ECONOMIC REVIEW

196 4

1965

1966

1967

Q U A R T E R LY -S E A S O N A LLY ADJUSTED ANNUAL RATE

+50
+40
+30
+20
+1 0

fl
1 F

- 10
1

of data: Board of Governors of the Federal Reserve System

MEASURES

3
196 7

1966

of M O N E T A R Y POLICY

Bi l l i ons of dol l a r s

Source of data: Board of Governors of the Federal Reserve System

OCTOBER 1 96 7

Chari 13). While growlh moderated some
what in Ihe April-June period, it again accele
rated in the third quarter. Chart 13 shows that
not all of the growth in nonborrowed reserves
was transferred into total reserve growth,
however, a s member banks reduced their in
debtedness to the Federal Reserve System
(particularly during the first half of the year).
The expansionary posture of monetary policy
is clearly indicated by the much more rapid
growth of nonborrowed reserves relative to
required reserves.

CO N CLU D IN G COMMENTS

Financial developments similar to those
in 1966 could reoccur in the period ahead if
the economy does not have the benefit of
an appropriate public policy. As things de
veloped, public policy — both fiscal and
monetary policy — certainly deserves much

credit for aiding the economy to weather ihe
inventory adjustment during the first half of
1967 with only "minimum hurt." Nevertheless,
expansionary public policy has enabled the
economy to restock its liquidity to a degree
that may make the economy vulnerable in
the period ahead, particularly in view of the
business expansion that is now underway.
Conceivably, the proposed surcharge on
personal and corporate income taxes could
provide sufficient restraint on the economy
so that monetary policy could continue to
provide moderate reserve growth, which is
necessary to achieve balanced and orderly
economic expansion. However, if the expan
sion were to become excessively vigorous or
if the surcharge were too small, or not passed
at all, then monetary policy might be faced
with a situation that could regenerate the
types of financial pressures and problems
that characterized the second half of 1966.

ECONOMIC REVIEW

TRENDS AND RECENT
RELATIONSHIPS IN YIELDS ON
U.S. GOVERNMENT SECURITIES
The economic expansion lhal began in
early 1961 has been characterized by a trend
marked by irregularly rising yields on U.S.
Government securities. This trend reached
what appeared at the time to be a peak dur
ing August-September 1966, when interest
rates on U.S. Government securities were
at their highest levels since before the Great
Depression. After September, interest rates
began to decline and continued on a down
ward course into 1967. Long-term interest
rates turned upward in February followed by
intermediate-term rates in May and short
term rates in July. By early fall, short- and
intermediate-term interest rates had moved
considerably above previous lows and long
term rates had surpassed 1966 peak levels.
This article describes the recent behavior
of yields on U.S. Government securities
against the background of major factors de
termining the levels and patterns of interest
rates during any given period. There are at
least two considerations in an analysis of
interest rate relationships: (1) ihe trend over
Digitized for
18FRASER

time in absolute levels of interest rates in
various maturity sectors; and (2) the term
structure of interest rates — the relationship
between rates in one maturity sector against
those prevailing in other maturity sectors.1
YIELD CH AN GES FROM 1961 TO 1966

The trend in interest rates from 1961 to
1966 for issues in three representative matu
rity classifications is shown in Table I.
Although yields in all three categories reg
istered gains during this period, the increases
were not uniform. The market yield on 3month Treasury bills, for example, increased
1 U. S. Government securities are usually classified a s
short-, intermediate-, and long-term, although within each
category there are issu es with widely varying original
maturities. 'The short-term sector, for exam ple, contains
issu es with original maturities varying from three months
to one year. In general, however, securities maturing
within one y ear are referred to a s short-term, with the
3-monih Treasury bill the best known issue in this class.
Issues that mature between one and five y ears are des
ignated a s intermediate-term, while issu es with maturi
ties of more than five y ears are in the long-term category.

OCTOBER 1 9 6 7

nearly 250 basis points — from an annual
average of 2.36 percent in 1961 to 4.85 per
cent in 1966. In comparison, the increases in
yields on intermediate- and long-term securi
ties were more moderate. The former in
creased 156 basis points — from 3.60 percent
in 1961 to 5.16 percent in 1966 — while the
latter increased only 76 basis points — from
3.90 percent to 4.66 percent — over the sam e
period. As a result, ihe interest rate differen
tial or spread between short- and longer-term
issues decreased steadily during the 19611966 period. In fact, during 1966 the average
yield on 3-month Treasury bills w as moder
ately higher than that on long-term issues,
while the average yield on intermediateterm issues was substantially higher.2
It is significant that, during the first five
years of the current expansion, the updrift
in interest rates was relatively moderate. In
late 1965 and 1966, however, interest rates
rose markedly (see Table I and Chart 1),
reflecting increased supply-demand pres
sures in the real and financial sectors of
the economy.
THE EVIDENCE FROM YIELD CURVES

Although time series data are helpful
for analyzing trends in the absolute levels
of interest rates, the yield curve is the most
2 The yield spread between short- and longer-term issues
w as of considerable concern to monetary policy particu
larly in the earlier y ears of the current expansion. The
concern arose primarily because of efforts to improve
the United States balance of payments position without
inhibiting domestic economic growth. It w as believed
that by keeping short-term rales high relative to long
term rates, short-term capital outflows from the United
States would be reduced without depressing the level
of domestic investment.

useful device for examining yield relation
ships at a given lime between securities with
various maturities. Yield curves are defined
a s graphical statements of the term structure
of interest rates a s of a particular point in
time. The time period can vary from an in
stant to one year or more. In other words, a
yield curve can be drawn from closing quota
tions at the end of the trading day, or from
daily, weekly, monthly, or annual averages.
Changes in the shape of the yield curve
are not alw ays gradual. A curve may change
shape markedly several times during the
course of a year, reflecting frequent price
changes when market forces are given free
expression. Yield curves become immune to
change only when security yields are rigidly
controlled. Empirical evidence points to the
existence of four basic types of yield curves,
which are shown in Chart 2; the curves are
drawn on the basis of average annual yields
on U.S. Government securities with terms
to maturity varying from three months to
20 years.
The most frequently occurring curve — at
least since 1945 — exhibits relatively low
yields on short-term maturities with gradu
ally rising yields a s the term to maturity in
creases. The yield curve for 1961 in Chart 2
is an approximation of such an "ascending"
curve. Two other types — which rarely oc
cur — include a "flat" curve where yields for
all maturity issues are approximately equal;
and a "humped" curve in which intermedi
ate-term yields are above both short- and
long-term yields. The yield curves for 1965
and 1966 in Chart 2 conform reasonably well
to the flat and humped types. A descending
yield curve (sometimes called a "reverse"
19

ECONOMIC REVIEW
TABLE I
Yields on U.S. Government Securities
(Percent)
3-Month
Bills

Y ear
1961
1962
1963
1964

Annual
Average

Change
During
Year

Change
During
Y ear

Annual
Average

+ 0 .4 1

3.57

— 0.03

+ 0 .3 9
+ 0 .3 8

3.72
4.06

Rate Spread Between:
3-5 Yrs.
and O ver
10-Yrs.

Change
During
Year

Bills &
3-5 Yrs.
1.24

1.54

0.30

3.95

+ 0 .0 5

0.80

1.18

0.38

+ 0 .1 5

4.00

+ 0 .0 5

0.56

0.84

0.28

+ 0 .3 4

4.15

+ 0 .1 5

0.52

0.61

0.09

Annual
Average

3.60

2.36
2.77
3.16

Bonds
O ver 10 Years

3-5 Years

3.90

1965

3.54
3.95

+ 0 .4 1

4.22

+ 0 .1 6

4.21

+ 0 .0 6

0.2 7

1966

4.85

+ 0 .9 0

5.16

+ 0 .9 4

4.66

+ 0 .4 5

0.31

Average
for Period

3.44

4.15

4.06

Bills &
O ver 10
Yrs.

0.26

— 0.01*
— 0 .5 0 *

— 0.19*

0.62

0.71

0.09

*Minus signs indicate differentials in favor of shorter-term issues.
Source: Board of Governors of the Federal Reserve System

curve) such a s Ihe one dated October 1966 in
Chart 3 is another basic, but less commonly
observed, curve. The changing term structure
of interest rates during the 1961-1966 period
is illustrated by the yield c u r v e s in Chari 2.

lion and increased capacity for future pro
duction is likely to result in enlarged demands
for loanable funds. The supply of loanable
Chart 1.

Y I E L D S on U. S. G O V E R N M E N T S E C UR I T I E S

FACTORS DETERMINING

Percent

INTEREST RATES

The behavior of interest rates over time, as
shown in Chart 1, suggests that interest rates
along the entire maturity spectrum generally
tend to move together. That is, in periods
when long-term rates are "high” in absolute
terms, short- and intermediate-term rates also
are likely to be "high.” There is little contro
versy about the causes of high or low abso
lute levels of interest rates. In the absence of
any actions by the monetary authorities, the
absolute levels of interest rates are estab
lished basically by market conditions reflect
ing supply and demand relationships for loan
able funds. In periods of expanding economic
activity, the need to finance current produc
20

BONDS OVER 10 YEARS

( 3- M0 NTH)
MARKET YIELD

MONTHLY A VERA GES OF DA ILY FIG U RES

Ii
1961
Source of data:

’63

I
’65

I
’67

Board of Governors of the Federal Reserve System

ECONOMIC REVIEW
TABLE I
Yields on U.S. Government Securities
(Percent)
3-Month
Bills

Bonds
O ver 1 0 Years

3-5 Years

Change
Durinq
Year

Annual
Average

Change
During
Year

Annual
A verage

Rate Spread Between:

Change
During
Year

Bills &
3-5 Yrs.

Bills &
O ver 10
Yrs.

3-5 Yrs.
and Over
1 0-Yrs.

Year

Annual
Average

1961
1962

1.24

1.54

2.77

+ 0 .4 1

3.57

— 0.03

3.95

+ 0 .0 5

0.80

1.18

0.38

1963

3.16

3.72

+ 0 .1 5

4.00

+ 0.05

0.56

0.84

0.28

3.60

2.36

3.90

1964

3.54

+ 0 .3 9
+ 0 .3 8

4.06

+ 0 .3 4

4.15

+ 0 .1 5

0.52

0.61

1965

3.95

+ 0 .4 1

4.22

+ 0.16

4.21

+ 0.06

0.27

0.26

1966

4.85

+ 0.90

5.16

+ 0 .9 4

4.66

+ 0 .4 5

0.31

— 0.19*

Average
for Period

3.44

0.62

0.71

4.06

4.15

0.30

0.09
— 0.01*
— 0.5 0 *
0.09

*Minus signs indicate differentials in favor of shorter-term issues.
Source: Board of Governors of the Federal Reserve System

curve) such a s the one daied Ociober 1966 in
Chari 3 is another basic, but less commonlyobserved, curve. The changing term structure
of interest rates during the 1961-1966 period
is illustrated by the yield curves in Chart 2.

tion and increased capacity for future pro
duction is likely to result in enlarged demands
for loanable funds. The supply of loanable
Chart 1.

Y I E L D S on U.S. G O V E R N M E N T S EC U R I T I E S

FACTORS DETERMINING

Percent
6

INTEREST RATES

The behavior of interest rates over time, as
shown in Chart 1, suggests that interest rates
along the entire maturity spectrum generally
tend to move together. That is, in periods
when long-term rates are "high” in absolute
terms, short- and intermediate-term rates also
are likely to be "high." There is little contro
versy about the causes of high or low abso
lute levels of interest rates. In the absence of
any actions by the monetary authorities, the
absolute levels of interest rates are estab
lished basically by market conditions reflect
ing supply and demand relationships for loan
able funds. In periods of expanding economic
activity, the need to finance current produc

TREASURY BILLS
(3-MONTH)
MARKET YIELD

MONTHLY A VERA G ES OF D A ILY FIG U RES

1961
Source of data:

’63

' 65

’67

Board of Governors of the Federal Reserve System

OCTOBER 1 96 7

funds, on the olher hand, is primarily a func
tion of saving habils and the level of current
income. Monetary policy also influences the
supply of loanable funds through the extent
to which the Federal Reserve System is will
ing to provide reserves to commercial banks
to expand the volume of money and credit.
Thus, actions on the part of borrowers, savers,
lenders, and monetary authorities determine
the level of interest rates that will emerge
during a period of time.
Despite intensive research in recent years,
there are still widely divergent views regard
ing the determination of relative, a s opposed
to absolute, levels of interest rates. Although
yields in the various maturity categories tend
to move in the sam e direction over the long
run, not all of these yields move by the sam e

magnitude. On the other hand, when the time
span is short, yields in different maturity
sectors may move in opposite directions. To
explain this rather complex behavior, several
theories have been advanced in the past 40
years. The discussion that follows attempts
to summarize these theories.
Supply and Demand Conditions. It would
appear that supply and demand conditions
for securities of a particular maturity deter
mine yields in that maturity category. For
example, all things being equal, if the de
mand for long-term funds increased while
the demand for short-term funds decreased,
long-term interest rates would be expected
to rise and short-term rates to fall, thereby
altering the relationship between short- and
long-term yields (until market conditions
21

ECONOMIC REVIEW

changed). This outcome, however, presup
poses that short- and long-term securities
are essentially two different goods and that
ihe change in the price of one does not affect
the price of the other. If, on the other hand,
short- and long-term securities were perfect
substitutes, increased yields on long-term
securities would induce investors to with
draw funds from short-term securities to in
vest in long-term securities. The net result of
the switch, which is in effect a change in
demand, would be to raise rates on short-term
securities and lower long-term rates, thus re
storing the original relationship between
short- and long-term yields. Therefore, the
influence of supply and demand changes in
the various maturity sectors on the term struc
ture of interest rates depends to an important
extent upon whether or not securities with
different maturity dates are considered sub
stitutes by investors and borrowers.
The Role of Institutions. Because of institu
tional considerations and constraints, some
observers have concluded that the securities
market is "segm ented" and that each differ
ent investor group concentrates its transac
tions in a particular maturity sector of the
market, rather than along the whole maturity
range. Insurance companies, for example, in
vest a large part of their assets in long-term
securities, because the nature of their liabil
ities enables them to predict the size of their
future payments. By investing in long-term
issues, insurance companies avoid ihe cost
and fluctuation in yields thai would arise
from continuous reinvestment in shori-ierm
securities. In contrast, commercial banks,
whose liabilities are subject to wide and
frequent fluctuations, and business firms, with

a large amount of "temporary" funds, usu
ally prefer to invest in short-term securities.
If the segmented market approach is correct,
the term structure of interest rates would be
mainly determined by supply and demand
conditions within each segment of the mar
ket, and yield changes in one market sector
would not necessarily induce similar changes
in another.
The Role of Expectations. Expectations
about the future levels of rates are also be
lieved to influence the term structure of
interest rates. In its "purest" form, the "ex
pectations theory" of the term structure of
interest rates3 views short- and long-term
securities a s perfect substitutes. Institutional
constraints are not overlooked, but specula
tion and arbitrage in ihe securities markets
are assum ed to be strong enough to overcome
institutional preferences for specific maturity
categories.4 Under the expectations theory,
longer-term rates of interest are conceived to
be averages of current short-term rates and
3 Besides several journal articles, three books on this
subject have received attention recently: David Meiselman. The Term Structure of Interest R ales (Englewood
Cliffs: Prentice-Hall, 1962); Reuben Kessel, The Cyclical
Behavior of the Term Structure of Interest Rates, O cca
sional Paper 91 (New York: National Bureau of Economic
Research, 1965); and Burton G. Malkiel, The Term Struc
ture of Interest Rates: Expectations and Behavior Patterns
(Princeton: Princeton University Press, 1966).
4 For exam ple, if certain financial institutions by heavy
purchases could force down short-term rates without
altering long-term rates, professional traders and other
specialists would react by selling short-term securities
and buying long-term until the original relationship be
tween short- and long-term yields would be largely
restored. Therefore, any lasting changes in interest rate
relationships could not be explained by supply and de
mand in particular market sectors, but by changes in
expectations about future rates.

OCTOBER 1 9 6 7

those expected in the future. Thus, changes
in expectations about future short-term in
terest rates will tend to change the whole
structure of interest rates.
To illustrate, assume that yields on secur
ities with maturities of one and two years
are approximately 4.00 and 4.50 percent, re
spectively. The relationship implies that the
expected yield on one-year securities will be
approximately 5.00 percent one year in the
future. Thus, if $100 were invested in a twoyear security, interest for the period would be
$9.00 ($4.50 -f- $4.50). The same amount would
be realized if $100 were invested in a oneyear security at 4.00 percent and at the end
of the year reinvested for another year at
5.00 percent. In this example, the "long-term"
rate (4.50 percent for two-year securities) is
the average of the present one-year rate
(4.00 percent) and the expected one-year rate
(5.00 percent).
If developments caused an upward revi
sion in the expected future one-year rate,
for example, to 5.50 percent instead of 5.00
percent, the two-year rate (according to the
expectations theory) would then move to
4.75 percent (the average of the present 4.00
percent plus the expected 5.50 percent oneyear rate). The relationship in the yield curve
between the one- and two-year rates would
then change from 4.00 percent and 4.50 per
cent to 4.00 percent and 4.75 percent. As a
result, the yield curve would become steeper
in the intermediate-maturity area.
Generally, when interest rates are expect
ed to rise, investors are likely to refrain from
buying long-term securities, in order to avoid
future capital losses (due to a decline in
securities prices). Long-term borrowers, on

the other hand, faced with the possibility of
higher rates in the future, would probably
decide to issue long-term bonds before rates
rose. The combination of decreased demand
for long-term securities and increased supply
of long-term securities would lend to produce
higher long-term rates relative to short-term
rates, and thus the slope of the yield curve
would increase.
If market expectations point toward lower
interest rates in ihe future, the flow of funds
would tend to reverse course. Lenders would
switch to the long-term sector, hoping to real
ize capital gains, while borrowers would post
pone long-term borrowing in anticipation of
lower interest costs in the future. The com
bined actions of lenders and borrowers would
tend to depress ihe long-term sector of the
yield curve.5
5 The empirical evidence regarding ihe validity of the
expectations hypothesis is mixed. W. Braddock Hickman,
in The Term Structure of Interest R ates: An Exploratory
A n alysis (New York: National Bureau of Economic Re
search, November 16, 1942, unpublished), found very
little correspondence between the expected rates implied
by the expectations theory and the actual rates that
m aterialized a year later. J. M. Culbertson in "The Term
Structure of Interest Rates,'' Quarterly Journal of Eco
nomics,, 71 (November 1957), pp. 485-517, also found the
expectations theory unsatisfactory on the b asis of empir
ical evidence indicating that, contrary to the expecta
tions hypothesis, realized yields for bonds and bills dur
ing the sam ple holding period were not equal. Meiselman,
op. cit., on the other hand, by utilizing a mathematical
model asserting that expectations are revised when pre
viously held expectations turn out to be erroneous, found
the theory consistent with annual interest rate d ata of
the 1900-1954 period. M eiselman's results and conclusions
have been partially questioned and in some c ase s sub se
quently modified, among others, by Kessel, op. cit.. Malkiel, op. cit., and J. H. Wood, "Expectations, Errors, and
the Term Structure of Interest R ates," Journal of Political
Economy, 71 (April 1963), pp. 160-171.

Liquidity Considerations. Because prices on
long-term securities fluctuate more than
prices on short-term securities, given the
sam e interest rate change in both maturity
areas, any potential capital loss is greater
for the long-term investor. In other words,
short-term securities are more liquid (or closer
to money) than long-term securities; there
fore, in order to compensate the purchaser of
a long-term security for loss of liquidity and
risk of capital loss, the long-term interest rate
would have to be higher than the short-term
rate.6 Thus, when liquidity is considered,
most long-term rates should be higher than
short-term rates. Under these circumstances,
the yield curve generally would have a
slightly ascending slope. In exceptional situ
ations, when current short-term rates are
believed to be "too high" and are expected
to fall sharply in the future, the yield curve
would have a descending slope. Finally,
when short-term rates are expected to fall
only slightly, the yield curve would appear
flat.
Policy Factors. The levels and maturity re
lationships of interest rates can also be influ
enced by Federal Reserve and U.S. Treasury
policies and actions. For example, if the secu
rities market were actually ''segmented," the
Treasury could affect the yield curve by
changing the maturity composition of the
public debt. As an illustration, if the Treasury
refinanced maturing short-term issues with
long-term securities and thereby increased

the supply of long-term relative to short-term
debt, the yield relationship would be changed
toward higher long-term and lower short-term
yields. Similarly, through open market oper
ations, the Federal Reserve System can
change relative supplies of short- and long
term debt. Open market purchases that re
duce the outstanding supply in a particular
maturity sector would lend to lower yields
in that seclor. In the case of open market
sales, the reverse would occur.
If the expectations theory were correct,
the ability of both the Treasury and the Fed
eral Reserve to influence the term structure
of interest rates would be questionable. Since,
according to that theory, the relationship be
tween short- and long-term rates is deter
mined mainly by expectations regarding
future levels of short-term rates, changes in
relative supplies of securities brought about
by debt management or monetary policy
would only have a transitory effect on the
term structure of interest rates. In fact, how
ever, open market operations of Treasury
financing operations often cause the market
to revise previously held expectations about
future rates, so that the term structure of in
terest rates does change. In other words, as
long as the monetary or Treasury authorities
can influence market expectations about fu
ture rates, they are also able to have some
influence over the term structure of interest
rates.
RECENT INTEREST RATE PATTERNS

This argument also assum es that most investors are
risk-averters rather than risk-takers. The holder of a long
term bond not only takes the risk of capital loss, but the
chance for capital gains a s well. If most lenders were
risk-takers, there would be no reason to p ay them a
higher rate for investing in long-term securities.

Digitized for24
FRASER

Since the beginning of 1966, yields in three
maturity categories of U.S. Government
securities have fluctuated over a wide range.
Data regarding the behavior of interest rates
during 1966-1967 are presented in Table II.

TABLE II
Yields on U.S. Government Securities
Monthly Average of Daily Figures
(Percent)

3-Month Bills

3-5 Years

Bonds O ver 10 Years

Month

1966

1967

Change

1966

1967

Change

1966

1967

January

4.58

4.72

+ 0.14

4.89

4.71

— 0.18

4.43

4.40

— 0.03

February

4.65

4.56

— 0.09

5.02

4.73

4.61
4.63

4.47

— 0.14

Change

March

4.58

4.26

— 0.32

4.94

4.52

— 0.29
— 0.42

4.45

— 0.18

April

4.61

3.84

— 0.77

4.86

4.46

— 0.40

4.55

4.51

— 0.04

M ay

4.63

3.60

— 1.03

4 94

4.68

— 0.26

4 .5 7

4.7 6

June

4.50

3.53

— 0.97

5.01

4.93

— 0.08

4.63

4.86

+ 0 .1 9
+ 0 .2 3

July

4.72

4.20

— 0.52

5.22

5.17

— 0.05

4.74

4.86

+ 0 .1 2

August

4.94

4.26

— 0.68

5.57

5.28

— 0.29

4.80

4.95

+ 0 .1 5

September

5.36

4.42

— 0.94

5.62

4.79

—

4.9 9
—

+ 0.20

5.33

5.40
—

— 0.22

October

5.38

4.70

November

5.31

—

5.43

—

4.74

—

December

4.96

—

5.07

—

4.65

—

Average

4.85

4.15*

— 0.70

5.16

4.88*

— 0.28

4.66

4.69*

+ 0 .0 3

High

5.36

4.72

— 0.64

5.62

5.40

— 0.22

4.79

4.99

+ 0 .2 0

Low

4.50

3.53

— 0 .9 7

4.86

4.46

— 0.40

4.43

4.40

— 0.03

*For the first nine months.
Source: Board of Governors of the Federal Reserve System

Generally, yeilds during the first nine
months of 1967 were on average lower than
for 1966 a s a whole. But that situation con
ceals some relatively wide movements that
have occurred in interest rates during 19661967. After reaching a peak of 5.36 percent in
September 1966, yields on 3-month Treasury
bills declined steadily through June 1967 to
a level of 3.53 percent. A reversal in the
downward trend occurred in ihe last week
of June, and by September the average yield
had risen to 4.42 percent.
Rales on 3-5 year issues began to rise
in May 1967, somewhat earlier than Treasury
bills, and by September the average yield had
climbed to 5.40 percent. The spread between
yields on 3-month and 3-5 year maturities
widened consistently during the first half of
1967. As shown in Table II, there was only
one basis point difference in the average
yields of the two maturity classes in January.

In June, however, ihe average yield on 3-5
year maturities was 140 basis points higher
than that on 3-month bills. The spread nar
rowed somewhat in July, and then remained
about the sam e in August.
Long-term yields set a record high of 4.99
percent during September 1967. The previous
high (4.87 percent) had been established in
the week ended September 2, 1966. During
the early months of 1967, the average yield
on 3-month issues was higher than that on
long-term issues. As bill rates declined and
long-term yields rose, the differential was first
reduced and then reversed when yields on
long-term issues moved above those on short
term issues. The subsequent rise in bill rates
during the summer months narrowed the
spread between short- and long-term issues.
Recent changes in interest rate relation
ships are shown by the yield curves in Chart
3. Generally, over the months from October
25

ECONOMIC REVIEW

SELE CT ED Y I E L D C U R V ES f o r U. S. G O V E R N M E N T S EC U R I TI E S
Per cent

Ye a r s to Ma t u r i t y
NOTE: Yield curves based on one day figures.
Source of data:

Salomon Brothers & Hutzler

1966 lo August 1967, ihe yield curve changed
from a descending type in October 1966, to
a relatively flat curve in February 1967, to a
rapidly ascending type in June, and to a more
gradually ascending curve in August. This
pattern is certainly not unusual in light of
the marked changes in financial and business
conditions during the period. During most of
1966, the goal of monetary policy w as to
restrain aggregate demand and inflationary
pressures that had developed in the economy
as a result of increased activity in the private
and public sectors. Interest rates reached rec
ord levels during ihai summer; but a s loan
demand slackened in the fall, interest rates
began to decline. Historically, yield curves
of the type shown for October 1966 in Chart
3 tend to emerge during periods of a rela
tively high level of economic activity when

the general feeling in financial markets is
that interest rates are too high relative to
their likely future levels.
From October 1966 through February 1967,
interest rates — especially for short- and
intermediate-maturities — fell co n sid erab ly
and, as shown in the curve for February 1967,
ihe yield differential between short- and long
term securities virtually disappeared. Several
factors could have contributed to this devel
opment. For one thing, there was a slowdown
in the pace of economic activity. In addition,
ihe change io an expansionary monetary
policy in November 1966 helped to remove
reserve pressures from commercial banks, a s
the Federal Reserve System supplied re
serves to ihe banks rather liberally, which
in turn had a moderating influence on interest

OCTOBER 1 96 7

rates. Reduced demand for business loans
had a similar influence. At the sam e time, ihe
heavy demand for liquidity, that is, the de
mand for short-term investments by individ
uals and institutions, that developed late in
1966 may explain in part the larger decline
in short-term relative to long-term yields.
The President's m essage to Congress in Jan
uary 1967, with its reference to plans for a
lax increase because of an anticipated surge
in economic activity later in the year, and
the subsequent apprehension expressed by
certain Congressional leaders about the ad
visability of the proposed tax plans may have
had a mixed influence on investors' attitudes
about future prospects for interest rates.
During March and April, short- and inter
mediate-term interest rates fell further, while
long-term rates turned upward. Among the
factors that brought about this development
were the continuation of monetary ease by
ihe Federal Reserve, ihe strong demand for
short-ierm assets (liquidity), and expectations
of higher rates in the months ahead, a s re
flected, for example, in the surge of borrow
ing in the long-term market. It also became
increasingly clear during this period that the
size of the deficit in the Federal budget would
be larger than that announced in the January
budget m essage and that the fear of a reces
sion (in view of the evidence in the first
quarter's GNP data released in April) may
have been exaggerated. At least to investors
and borrowers, these seemed to be signs sug
gesting higher interest rates in the future;
consequently, many investors decided to
invest temporarily in short-ierm securities
and many borrowers attempted io obtain
long-term funds at whai seemed to be favor

able rates. A factor that may have prevented
long-term rates from moving higher w as the
decision by the Federal Open Market Com
mittee during the spring of 1967 to acquire
coupon issues, when appropriate, to provide
additional reserves to member banks.
As shown in Chart 3, the yield curve for
June indicated that intermediate- and long
term yields had moved appreciably higher
than in February (intermediate-term yields
on average had turned up in May). In addi
tion to expectations of higher interest rates,
this change probably can be attributed in
part to the record volume of security offerings
by business corporations, a s well as by state
and local governments, that continued into
the summer at an unabated pace.
Typically, however, and a s an example of
the rapidly changing nature of yield curves,
the curve for June 1967 proved to be short
lived. Treasury bill rates increased sharply
in late June and early July. In part, an impetus
to this rise was provided by the announce
ment that the Treasury had made plans to
auction over $4 billion of lax anticipation bills
early in July for the purpose of raising addi
tional cash for the current fiscal year. During
ihe rest of July and in August, yields on shortand iniermediate-ierm securities on balance
gradually worked higher, while yields on
long-term issues edged above levels reached
in June. As a result, ihe yield curve for August
took on the shape depicted in Chart 3.
With interest rates continuing to move
higher in September, and with short- and in
termediate-term rates increasing more than
long-term rates, the yield curve for September
w as generally both higher and flatter than
the yield curve for August.
27

Fourth Federal

Reserve District