The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
July - August The Deficit Dilemma -Another View . . . . The Market for Farm Mortgage Credit . . . . Current Statistics . . . . . . . page 1963 3 . . . . page 10 . . . page 16 FEDERAL RESERVE BANK OF KANSAS UITY Subscriptions to the MONTHLY REVIEW are available to the public without charge. Additional copies of any issue may be obtained from the Research Department, Federal Reserve Bank of Kansas City, Kansas City 6, Missouri. Permission is granted to reproduce any material in this publication. The Deficit Dilemma he plethora of writing on the U. S. balance of payments has ranged far and wide over various dimensions of the Nation's international financial straits. Nonetheless, several reasons seem to justify further efforts on this question. First, the importance of the issues is sufficient motive for continued and expanding exposure before the general public. Second, a great deal of con fusion and uncertainty sti11 seems to cxi 't with regard to terminology as well as to the mechanics and interpretation of the balance-of-payment data. For that reason, this article wilJ pay particular attention to the basic fundamentals which underlie the balanceof-payments system of accounting, as well as the practical meaning of the balance of payments itself. Finally, in order to place current U. S. payments difficulties in their proper perspective, they will be viewed in the framework of the "classical" payments deficit to determine whether a fundamental disequilibrium-or imbalance-exists. T WHAT DOES IT ALL MEAN? The public has become aroused and anxious over the persistent and sizable deficits on the U. S. balance of payments. While some anxiety is certainly justified, any judgments on that subject should be based upon an understanding of the factors involved. Table 1 presents an analysis of official balance-of-payments data for 1961 and 1962. While the table may appear to be unduly complex at first, the balance of payments actually is fairly easy to comprehend, both in terms of its various basic accounts and the accounting principles governing the entries. The balance of payments is an accounting record which lists the dollar totals of the various international economic transactions beMonthly Review • July-August 1963 -- An other View tween the United States and the rest of the world over a given period. It is a record of the amount of dollars or receipts that the United States accumulates as a result of foreign spending, investing, lending, and the remittance of gifts by foreigners, in comparison with the amount of dollars which the United States pays out to foreigners because of similar U. S. activities abroad. As with any typical accounting statement, there are two sides to the balance of payments- one for credit entries and the other for offsetting debit entries. Credit entries indicate dollar receipts by the United States, while debits denote U. S. payments to foreigners. Anyone familiar with rudimentary accounting procedures will recognize this as a doubleentry bookkeeping system. This means that for each transaction recorded, every debit entry is offset by a credit entry or entries in the same amount. The practical effect of this is that, insofar as the over-all balance of payments is concerned, total debits must necessarily equal total credits and, therefore, the balance of payments always "balances." This being the case, any reference to a "deficit" in the balance of payments implies a somewhat different meaning of the term than is customary. As commonly understood, the term "deficit" refers to a shortfall in receipts or income relative to payments or expenditures. Since this cannot be the case in a double-entry system of bookkeeping, it may be asked, "What is meant by a deficit on balance of payments?" Note in Table 1 that the balance of payments is made up of a number of different accounts, such as goods and services, remittances, and private and government investments. Although it is true that the algebraic sum of all the debit and credit entries must be equal to zero, this need 3 The Deficit Dilemma Table 1 ANALYSIS OF U. S. BALANCE OF PAYMENTS, EXCLUDING MILITARY GRANT AID Millions of Dollars DEBITS U. S. payments recorded* Imports: Merchandise Military expenditures Other services Remittances and pensions Government grants and capital outflows Transactions involving no immediate dollar outflow from the United States Dollar payments to foreign countries and international institutions U. S. private capital Direct investments Long-term portfolio Short-term 1961 31,778 1962 33,254 14,497 2,934 5,436 705 4,056 16,145 3,028 5,791 736 4,281 2,940 3,211 1,116 4,150 1,598 1,011 1,541 1,070 3,273 1,557 1,209 507 CREDITS U. S. receipts recorded* Exports: Merchandise Financed by Government grants and capital Military sales In come on investments, private Income on investments, Government Miscellaneous services Repayments on U. S. Government loans: Scheduled Nonscheduled Foreign capital other than liquid funds : Private Iiabi Ii ties Government li abiliti es Excess of recorded receipts (credits) [ +] or payments (debits) [ - ] On goods, services, remittances, and pensions On Government grants and capital assets On Government nonliquid liabilities On private direct and long-term portfolio investment On private short-term investments Unrecorded transactions (net)* Total net receipts(+) or payments(-) equals changes in official monetary assets and in liquid liabilities (increase in net liquid assets +, decrease -) Changes in gold and convertible currency holdings of U. S. monetary authorities and in liquid liabilities Gold (sales +, purchases -) Convertibl e currencies (sales +, purchases - ) Liquid liabilities, total (increase + , decrease - ) 19 1 - 1,465 +4,739 - 2,782 + 85 - 2,143 - 1,364 -905 - 1,161 +4,090 - 2,998 +865 - 2,495 - -623 -1,025 -2,370 -2,1 86 +2,370 +857 - 116 + 1,629 +2,186 +890 1961 30,313 1962 32,093 19,913 20,479 2,237 402 3,464 380 4,152 2,345 660 3,850 472 4,329 606 668 617 666 643 85 1J5 865 19-62_ + 17 + 1,279 * Transactions other than changes In official monetary as set s and in liquid liabilities . SOURCE : U. S. Department of Commerce , Office of Business Economics . not, and in most instances will not, be the case insofar as any one particular account or group of accounts on the balance of payments is concerned. Thus, the volume of foreign goods and services which U. S. citizens purchase can exceed or fall short of the amount which foreigners buy here. Similarly, capital outflows, gifts, and gold movements from the United States need not be equal to the volume of these items received from abroad. Consequently, a deficit or a surplus can exist for any accoun t or group of accounts, a fact easily verified by Table 1. During 1962, for example, if transactions involving official U . S. monetary assets, convertible currencies, and liquid liabilities of the 4 United States are excluded, th remaining transactions resulted in an excess of payments over receipts-total net payments-by the United States of $2,186 million. This was the magnitude of the deficit for 1962. Notice, however, that this deficit was matched exactly by the volume of changes in gold and convertible currency holdings of the U. S. monetary authorities, and in liquid liabilities, so that the over-all balance was eq ual to zero. A better grasp of the existence of a deficit on balance of payments may be gained , perhaps, if a "stock-flow" approach is used. Assume that at the beginning of the accounting period, the United States has a given stock of -Another View official monetary assets as well as a given level of international claims against her. As a result of transactions during the period, receipts generated by U. S. exports, investment income, etc., flow into the United States from abroad. Conversely, U. S. imports, dividend payments to foreigners, Government grants or loans, etc., occasion payments which result in an outflow of funds from the United States. If the two flows are of equal volume, there is no net accretion to or drawing-down from the U. S. stock of monetary assets, nor is there any net change in the international claims positionneither a "surplu " nor a "deficit" exists. But if, as in th e case of the United States in recent yea rs, th e stock of monetary asse ts i drawn down, or the total of intern ational claim aga in st the United States increases in order to finance a shortfall in U. S. receipts, a "deficit" situation exists, measured by the decrease in U . S. monetary assets and the increase in the amount of international claims against the United States. DISEQUILIBRIA AND THE "CLASSICAL" DEFICIT To most people, a balance-of-payments defi cit probably implies a fa ilure on th e part of a country to export as much as it imports. However, this is only a part of the picture and in no way determines whether or not some fundamental disequilibrium exists in the deficit country. That is to say, the existence of a deficit on one or another of the balance-of-payments accounts is not in itself a sufficient condition for determining the existence of a fundamental disequilibrium. Table 2 views the U. S. balance of payments somewhat differently than does Table 1. Current Accou nt consists largely of merchandise exports and imports and , to a lesser extent, services such as those associated with transportation and tourism ; investment income both here and abroad; and military outlays made by the United States as well as those of its allies. Monthly Review • July-August 1963 The merchandise component of the Current Account is commonly known as the "balance of trade," and it is this single element that many people refer to in discussions which purport to deal with the balance-of-payments deficit in its entirety. If merchandise imports exceed the dollar amount of exports, a "negative" or "unfavora ble" or "adverse" balance of trade is said to exist. This would be reflected by an excess of debi ts over credits for this particular item, a situ ation which does not hold for the United States in 1962, or for that matter throughout the entire postwar period. Table 2 AN ALTERNATIVE VIEW OF U. S. PAYMENTS POSITION FOR 1962 Millions of Dollars Debit( - ) Credit(+ ) I. Current Account Merc hand ise Services Investment income Mil itary outlays Net on current account, excluding transfers under military grants II. Unilateral Transfers Pr ivate U. S. Government (except military grant aid) Net, excluding military transfers Ill. Capital Account U. S. private Short-term Long-term Net U. S. Government Long-term Repayments Foreign currency holdings and short-term claims, net (increase - ) Net Foreign (increase in U. S. liabilities +l Long-term Short-term and U. S. Government Increase in foreign holdings of liquid dollar assets Net IV. Gold and Convertible Currencies Gold (sa les by monetary authorities l Convertible currencies (purchases - ) Net V. Errors and Omissions Net 16,145 20,479 4,796 995 4,329 3,028 4,322 660 4,826 491 2,148 2,639 507 2,766 3,273 2,1 33 1,283 245 1,095 271 749 1,279 2,299 + 890 17 907 1,025 SOURCE : U. S. Department of Commerce, Offi ce of Business Economics. 5 The Deficit Dilemma During 1962, the United States recorded a trade surplus of approximately $4. 3 billion, while income from U. S. investments abroad exceeded outpayments to foreign investors by $3.3 billion. These two elements of strength in the balance of payments were offset somewhat by net debits of $467 million on services and approximately $2.4 billion for military outlays. Nevertheless, the Current Account as a whole was a positive element in the balance-of-payments picture to the tune of nearly $5 billion. Unilateral Transfers represent private or public gifts and, as the debit balance indicates, they have moved outward from the United States. This has been the case for the entire postwar period. In 1962, private remittance accounted for approximately one fifth of the net outflow, with Government nonmilitary grants and payments to pensioners living abroad accounting for the remainder. Note that the effect of the debit balance on this account serves to offset, by more than half, the level of excess receipts on Current Account. The Capital Account records changes in international claims against the United States, as well as in the level of claims which the United States holds against the rest of the world. It reflects changes in the international debtor-creditor status of a country and denotes capital inflows by credit entries, and capital outflows by debits. As Table 2 shows, these claims may be private or public, and they may be long- or short-term. The private short-term claims consist primarily of demand deposits held abroad by Americans or in the United States by foreigners. Long-term claims involve securities such as stocks and bonds"portfolio" investment-while long-term "direct'' investment takes the form of outlays on actual physical plant and equipment abroad , or acquisition of controlling interest in foreign corporations. Consider the U . S. private capital account on Table 2. For 1962, there was net debit balance of $3,273 million, consisting of long6 and short-term capital movements. That is to say, there was an export, or an outflow, of capital from the United States. Ignore for the moment the funds which left the United States and focus upon the movement of the claims instead. In exchange for the funds received, foreigners gave U. S. citizens international claims in the form of demand deposits in foreign banks, short-term notes, or stocks and bonds. As a result of this capital outflow, U.S. claims against the rest of the world increased or, conversely, the rest of the world's claims against the United States decreased . The fund s flowed from the United States- they were exported- but the claim flowed into the United tatcs- they w re imported- and it is by regarding the import of th claim , rath r th an the export of the fund , that on can a ociate the debit entry with capital outflow . It should be clear, however, that from the point of view of the foreign country which receives the capital funds from the United States, the entire analysis is reversed. That is, the receipt of funds results in an "export" of an 1.0.U. to the United States, and this would be reported as a credit, acknowledging the outmovement of the claim. This capital accounting procedure may be illustrated by the example of a U. S. citizen who buys a foreign bond and pays for it by writing a check, in dollar , to the seller. Thi s would be recorded on the U. S. balance of payments in the following manner: The purchase of the bond increases the amount of U. S. claims against the rest of the world but results in a capital outflow which is recorded by a debit on long-term capital. The receipt of the check by the foreigner, which is subsequently deposited in his bank, increa es foreign dollar demand deposits, thereby increasing the rest of the world's claims again t the United States and is therefore record d as a credit on short-term capital. Thus, the offsetting capital entries are consistent with the double-entry system of accounting. -Another View Gold and Convertible Currencies are media of international payment in addition to dollars, of course. They are treated in the balance of payments in the same manner as the Current Account items, but because of their significance as international media of exchange, they have been separated from the other items. As Table 2 shows, in 1962 the United States sold $890 million worth of gold. This sale was similar to any other merchandise sale or export in that it generated receipts for the United States and therefore was recorded by a credit in the gold account. The sale of convertible currencies similarly generated receipts for the United States, much as a merchandise export would, and was therefore recorded as a credit on convertible currencies. The final account in Table 2 is Errors and Omissions. In some balance-of-payments presentations, it is referred to as Unrecorded Transactions. It is a balancing account and owes its existence to the fact that balance-ofpayments data originate in many separate agencies which utilize varying standards and principles. Thus, it is possible that some transactions may not be accounted for on both sides of the balance of payments in the same amounts at the same time. In addition, it is possible for some types of transactions to go unrecorded altogether- particularly, according to some observers, short-term capital movements. In order to provide the missing debits or credits, so as to make the over-all balance of payments balance, it becomes necessary to have an Errors and Omissions or Unrecorded Transactions account. Having spent some time on the actual meaning of, and the mechanics involved in, the balance of payments, the relationship between deficits and disequilibria may now be considered. As stated earlier, the most commonly held view of a deficit is one which involves an unfavorable balance of trade. However, as has been pointed out, such a deficit need not imply a fundamental disequilibrium. Because a fundMonthly Review • July-August 1963 amental disequilibrium is characterized by a distortion in the basic cost-price relationships between the deficit country and the rest of the world, its effects are felt mainly on the merchandise component of Current Account. Thus, an adverse trade balance is a necessary, but not a sufficient condition for the existence of such a disequilibrium. In the case of the United States, not only has a "favorable" balance of trade been maintained during the entire postwar period, but a surplus has existed for the entire Current Account. Even if a country should experience a trade deficit, this is not in and of itself an unhealthy situation. During the latter half of the 19th century, the United States was in this position. This coincided with the wave of railroad construction which entailed considerable imports from Europe, but which was financed to a large degree by longterm capital inflows from abroad. Similarly, England for many years in this century recorded trade deficits which were offset by income from investments made years earlier. Thus, one cannot view the deficit alone to determine the existence of a fundamental disequilibrium; rather it is the manner in which the deficit is being offset or financed which makes this determination. U. S. DEFICIT - CLASSICAL OR OTHERWISE? Because so much importance has been attached to U. S. balance-of-payments deficits in recent years, one might suspect that they represent a new phenomenon for the United States; In point of fact, such deficits have occurred annually since 1950, the sole exception being 1957 when a small surplus was recorded in connection with increased levels of activity engendered by the earlier Suez crisis. The U. S. net position on balance of payments for the entire postwar period is included in Table 3. The reasons for the more recent heightened concern over the deficit problem become obvious when the pre-1957 figures are contrasted with those for the period since 1958. 7 The Deficit Dilemma Table 3 NET BALANCE ON MAJOR ACCOUNTS Net Current Account, excluding transfers under military grants Net Unilateral (except military grant aid) Net Capital Net Private Net U. S. Government Net Foreign (increase in U. S. liabilities +l Gold and Convertible Currencies Gold (sales + l Convertible Currencies (purchases -l Errors and Omissions Net Surplus* (+) or Net Deficit** (-) Net Current Account, excluding transfers under military grants Net Unilateral (except military grant aid) Net Caiital Net rivate Net U. S. Government Net Foreign (increase in U.S. liabilities +l Gold and Convertible Currencies Gold (sales +l Convertible Currencies (purchases -) Errors and Omissions Net Surplus* (+) or Net Deficit** (-) Millions of Dollars 1948 1949 1950 1951 1952 1953 1954 +6,149 -5,627 +1,779 - 4,007 +3,671 -3,492 +2,226 - 2,505 +386 - 2,454 +1,828 -2,262 -906 - 1,024 -553 -652 -1,265 -156 -1,048 - 156 -1,160 -420 - 383 - 218 -1,622 +93 -1,792 -2,850 -2,850 +352 - 1,530 -1,530 +72 -164 -164 + 1,927 +1,743 +1,743 +601 - 53 -53 + 1,637 - 379 -379 +1,169 + 1,161 + 1,161 +936 + 1,179 + 1,492 +298 +298 + 173 -3,580 -305 1959 1946 __IBL +7,744 -2,899 +11,529 -2,612 +6,440 -4,511 -413 - 3,019 - 987 - 4,224 - 985 -623 - 623 +195 - + 1,261 +4,567 + 1,005 1955 1956 1957 +775 +175 1958 +2,009 - 2,486 +3,967 - 2,398 +5,729 - 2,318 +2,206 - 2,338 - 1,255 - 310 - 3,071 - 629 - 3,577 - 958 +1,498 +41 +41 t 503 +1,894 -306 -306 +765 -798 -798 +543 + 1,157 - ,145 -935 +520 -21 +477 t 601 +339 ,046 -2,152 1960 1961 1962 +134 - 2,424 +3,769 - 2,336 +5,444 - 2,559 +4,826 - 2,639 - 2,936 - 971 - 2,375 - 353 - 3,892 - 1,105 - 4,150 - 928 - 3,273 - 1,095 +1,276 +2,275 +2,275 +3,875 +731 +731 +2,545 + 1,702 + 1,702 +2,357 +741 +857 -116 -905 +2,299 +907 +890 +17 - 1,025 -2,370 -2,186 - t.488 ,529 +412 -3,743 -683 -3,881 - 1,550 (Debits - and Credits +); *Defined as the reduction In U. S. liquid liabiliti es and / or increase in U. S. gold holdings; **Defined as the Increase in U. S. liquid liabilities and / or reduction In U. S. gold holdings. SOURCE : U. S. Department of Commerce, Office of Business Economics . From 1950 through 1957, the United States experienced a cumulative deficit of some $10.2 billion, including a net outflow of gold of about $1. 7 billion, with the remainder accounted for by an increase of about $8.5 billion in short-term and liquid liabilities held by foreigners. From 1958 through 1962, the overall balance-of-payments deficit approximated $15. 7 billion, while the net gold outflow reached nearly $6.5 billion. In other words, in the past 5 years, the size of the cumulative deficit has increased by almost 50 per cent, while the outflow of gold has exceeded that of earlier levels by almost four times. Merely pointing out the up and downs in balance-of-payments deficits during the postwar period accomplishe little if anything toward determining whether these figures indicate either a fundamental weakness in the economy or an economy which is living"beyond its means." 8 During the entire postwar period, the United States has experienced continuous and, for the most part, substantial "favorable" balances on its trade account--even if one excludes that portion of the export surplus which is associated with U. S. Government aid or financing, such as under Public Law 480 or the Mutual Security Program. 1 This should not imply, however, that there are grounds for complacency, since any additional improvement in the trade balance will enable the Nation to more 1 For the years 1955 through 1962, excluding 1959, the U. S. trade surplus averaged more than $2.6 billion annually after subtracting P. L. 480 shipment and M.S.P. nonmilitary aid. The year 1959 hows an "adver e" trade balance if one subtracts these items from the over-all surp lus. A noted below, this i largely explained by a harp increase in imports associated with a cyclical ri e in the level of economic activity in the United States, rather than with a decline in the level of exports. - A nother View easily accommodate the burden on the other balance-of-payment accounts. The absence of an " adverse" balance of trade, though , is a key indication th at the U. S. payments deficit is not of the "classical" variety. Without a deficit on balance of trade, it is difficult to argue th at the United State has experienced any sort of fundamental di sequilibrium . Table 3 verifies thi point. At no time durin g the entire postwar period has the United States incurred a deficit on Current Acco unt. T he smalle t net surpluses on Current Account were in 1953-when U . S. imports remained relatively unchanged from a y a r arlier whil e xports fell by nea rly $ I billion- and in 1959, when exports r main d constant while imports rose by n ·1rly $2.4 billi n vcr year-earl ier lev Is as a res ult of a harp upswing in dome ti econom ic a tivity. A further indication of a lack of the existence of a fundamental disequilibrium may be noted by observing that, wi th the sole exception of the gold account, the remaining accounts in each instance carry an opposite sign than that which would imply the presence of a fundam ental disequilibrium. For exa mple, on Unilateral T ran fers, the tring of net debit ba lances indicate that th e United State has been a net donor, rath r th an a recipient of gifts. Simil arly, the capital account shows net capital outflows ( debit ) on both private and Government accounts for each of the postwar years, th e sole exception being a small inflow on Government acco unt in 1954. Thus, the United States has provided both long-term investment funds and short-term liquid funds to foreigners rather than the converse. CONCLUSIONS appear to be of a rather special variety, stemming from strength rath er than weakness.2 Such a view, however, is not inconsi tent with the notion that the U. S. bala nce of payment is not in equilibrium. The absence of a fundamental di sequilibrium does not imply that the payments deficit do not have erious implications . Such an interpretation would be naive in the extreme. It i important, however, to be fully aware of the varied dim ensions of the balanceof-p aymen ts problem in taking step s to cure it. The pre-1 95 8 de ficits were ge nerally regarded as desirable in the se n e th at they provided th e world with badly needed liquidity for purposes o f co ndu cting th e smooth fl ow o f in terna ti ona l com mer ·e, without undul y threatning th e U. S. international r ·serve position . H wever, 5 co ns cutive yea rs of sub tanti al pay ments defici ts entailing signifi ca nt capital and gold outflows have re ulted in an agonizing reappraisal of not only the strength of the U. S. international financial position , but the state of the dom estic economy as well. It may seem paradoxical to question the competitive strength of an economy which has shown that it can generate sizable export surplu ses year in and yea r out in pite of increasing rivalry from all over th e globe. Neve rthe less, in the face of ubstanti al U. S. military and economic commitm ents ove r mu ch of the world, th e ov r-a ll ca pabilitie of th e economy can no longer be taken for gra nted or con idered in i olation, but must be viewed in relation to the demands being made on it- demands which in many cases are not predicated upon economic criteria, but rather upon political, humane, or national defense considerations. Seen in this light, U. S. p ayments deficits, though "noncla ical" in na ture, non th cles repre cnt a dil mma. Eviden e presented o fa r leads to the conclu ion th at U. S. payments dcfi its h ave bee n in no sense "classical" and , furthermore, that th y are not indicative of a fundamental di sequilibrium. Except for th e gold outflow , which is associated with cla ical deficits, the deficits :! A la rge meas ure of th e gold outflow m ay be traced to th e prac ti ce followed by m a ny foreign central banks of m ai nta ining a fi xed ratio of go ld rese rve to dollar holdin g . Specul a tive go ld move me nt , on the oth er ha nd , have dimini hed considerably in th e rece nt p as t a th e probability of deva lua tion of the doll a r has lesse ned. Monthly Review • July-August 1963 9 The Ma rket for Farm Mortgage Credit have not been in general agreement concerning the degree of influence that interest rates have on the supply and demand for credit. Some say there is virtually no change in the quantity of credit demanded or supplied wh n interest rates and other economic forces change. Others say there is considerable response. The response undoubtedly varies among different markets for credit-that is, for various industries and for different maturities. Relatively little research has been done to estimate the responsiveness of supply and demand in various credit markets. This article summarizes a study designed to measure responsiveness to interest rates and other factor~ in one credit market - the market for farm mortgage credit. The research on which the article is based was sponsored jointly by the U. S. Department of Agriculture and Purdue University. The article will discuss the economic model, or the theoretical considerations upon which the study was based. It will then present statistical estimates of the responsiveness of suppliers and users of farm mortgage credit to changes in the various economic factors in the model. Finally, it will discuss some of the implications of the estimated relationships. One of at least three concepts could be used in studying the market for farm mortgage credit: ( 1) the stock of debt outstanding at some point during the year; (2) farm mortgage loans closed during the year, a gross flow concept; or ( 3) farm mortgage loans closed less repayments, a net flow concept. The con- E 10 CONOMISTS cept used in this study was the annual gross flow of farm real-estate mortgage loans. As shown in Chart 1, the volume of farm mortgage debt outstanding in the United States has fluctuated over the years, but the annual volume of farm mortgage loan issued- the fl ow of credit- has been even more erratic. hart 2 indicat s that the rate of interest also has fluctuated, though not so much as yields on preferred stocks, a nonfarm alternative. AN ECONOMIC MODEL The economic model for a study of this type contains the economic factors that are thought to influence the demand for and supply of credit. Demand fo r Credit. The amount of farm mortgage credit demanded during a given p'eriod will tend to be inver ely related to the Chart 1 OUTSTANDING FARM REAL-ESTATE DEBT ON JANUARY 1, AND ANNUAL GROSS FLOW OF FARM REAL-EST ATE CREDIT Billions of Dollars Billions of Dollars 4 16 3 12 Debt Outstond i n9 ✓ (Ltft Scolt) 8 2 4 Flow of Credit (Ri9hl Scale) o._,_._..__.__._.___..__._.__._.__._._._._._,_._~..___._,._._..-L.L.,._._~_..............._~ o 1920 '30 '40 SOURCE: U. S. Department of Agriculture . '50 '60 Farm Mortgage Credit Chart 2 AVERAG E RATE OF INTEREST ON CURRENTLY NEGOTIATED FARM MORTGAGE LOANS AND YIELDS ON PREFERRED STOCKS Per Cent 8 Per Cent 8 Farm Mortgage Rate 6 6 // 4 4 Stock Yields 2 0 1920 2 LLJ c 1 1 LI, ' 0 1 1 l I I I 11 l I '40 I I I I J l I, l, '50 1 J 1J I J L 0 '60 SOURCE : Purduo University ; USDA; and Standard and Poor's Security Prlco I ndox Record. average rate of interest on farm mortgage loans closed during the period. With a higher average rate, a smaller volume of loans would be closed, other things being equal. The question is how much smaller. An estimate of this comes later in the article. The rationale for expecting a negative relationship rests on the proposition that with a lower rate of interest farmers will invest more in their businesses, if other conditions are unchanged. The amount of internal funds available to farmers will al o influence the amount of credit demanded. If the amount of investment in such farm items as new equipment and buildings is relatively stable, or largely independent of short-run changes in farm income, then a negative relationship should be expected between the supply of internal funds within agriculture and the quantity of credit demanded. An increase in agriculture's internal funds brought about, say, by an increase in farm income, would be expected to decrease the demand for er dit. Thi a sumes that farmers do not us for living expenses all of the increase in income and that at least part of the saving is invested in agriculture rather than in nonfarm alternatives. Monthly Review • July-August 1963 Economic logic suggests two additional variables likely to influence the demand for farm mortgage credit. First, changes in farm wage rates probably change the demand for credit. As farm wage rates rise, other things being equal, capital equipment will be substituted for labor and this will probably increase the demand for credit. Second, changes in technology may change the demand for capital resources and the derived demand for credit. Supply of Credit. The supply of long-term credit to agriculture is postulated to be positively related to the farm mortgage rate of interest, relative to the nonfarm rate. Other things being equal, increasing quantities of agricultural cred it per unit of time will be supplied at succ sively higher relative rates of interest, and vice versa. Operationally, a problem arises as to how to measure the average nonfarm rate of interest. The ideal would be a weighted average of the rates or yields on all alternatives in the economy, but this is not available. The practical solution is to use the return on an immediate alternative to farm mortgage loans-such as Government bond yields, corporate bond yields, or the yield on corporate equities-to represent the nonfarm rate. Government bonds are an entirely different category of risk for lenders than farm mortgage loan . Standard and Poor's index of yields on preferred stocks was used in the statistical analysis since, in many respects, preferred stocks represent a degree of investor risk similar to farm mortgage loans. The supply of loanable funds in the economy is partly a function of the rate of saving and changes in the money supply. The supply of credit, or loanable funds, to a major industry of an economy would be influenced by these same variables, although different industries may be affected differently. It would be expected that the supply of credit to agriculture would be increased with an increase in the rate of national saving and with an increase in the supply of money. 11 Farm Mortgage Credit The supply of credit offered to agriculture is postulated to be a function of lenders' expectations concerning the ability of farmers to rep ay . It is not known how lenders formulate expectations. Perhaps they consider "real" prices of farm products as an indicator. The hypothesis is tested using the ratio of the index of prices received by farmers for all farm products to th e index of prices p aid for items used in production as a meas ure of rea l farm prices. It was also hypothesized that lenders consider th e value of agriculture's assets in deciding how much credit to extend to the industry. T he value of total farm assets is included as a variable in th supply relation. The influ nee of eac h o f th variab les on the supp ly and demand for farm mortgage ere lit was estim ated in a m odel which permits estimating th e separa te influence of each variable, taking into account the simultaneous influence of all the other variables being considered. Estimates were computed by using annual data for the period 1921 to 1959. ECONOMIC IMPLICATIONS OF THE STATISTICAL RESULTS Statistical studies of credit m arkets generate useful knowledge about important causal factors and their direction of influence, as well as estimates of the degree of responsiveness of both suppl iers and use rs of credit to changes in different economic forces. Such knowledge has implications for policy formulation. Estimates of the degree of responsiveness of suppliers and users are called elasticities. In the study being reported, the estimated elasticities of the variables, together with the observed fluctuations or changes in the variables over time, provide a basis for unde r tanding shifts in th e upply and dema nd for fa rm mortgage credit. This gives insight into the important economic forces at work, and shows the manner in which the farm mortgage m arket is related to both the agricultural sector and the nonfarm sectors of the economy. 12 The estimated elasticities of the economic variables in the model are presented in Table 1. The elasticity of demand with respect to the interest rate, minus 2.29, indicates that if all other variables are constant a 1 per cent change in the interest rate would cause an opposite change of 2.29 per cent in the quantity of farm mortgage credit demanded. More specifically, a 5 per cent dec rease in the farm mortgage interest rate, say from 5.00 to 4.75 per cent, would be associated with an 11 per cent increase in the volume of credit demanded. The same interpretation is applied to changes in th e other vari ables. For instance, a 1 per c nt increase in the farm wage rate would be as ·o ·iatcd with a I .49 per cent increase in th e demand ror farm mortgage cred it. he stati sti cal results suggest that short-run flu ctu ations in the volume of farm mortgage credit stem more from dem and forces than from changes in supply. This is in contrast to Klaman's finding in the residential mortgage market. H e shows rather convincingly that supply rather than demand has determined volume and price of residential mortgage credit. 1 Two fac tors are probably important in explaining thi s difference. F irst, capital form ation in ag ri cul ture is la rgely financed internally from gro s fa rm income, with les dependence on ex ternal capital or cred it. Second, th e role of the intern al fund s variable is important in understanding why flu ctu atio ns in the farm mortgage credit market are largely initiated by demand. The results indicate that the demand for farm mortgage credit is relatively responsive to changes in internal funds. (An elasticity larger than one lmplies th at ch anges in internal funds prompt a greater th an proportional chan ge in th e volume of credit demanded.) ln addition , int rn al fund are th e m ost volatile of th e demand hifters in th e short-run, with 7 .5 1 S. B. Kl a m a n, The Postwar Residential M ort[!,age Market , Princeton University Press , Princeton , New Jersey, 1961. Farm Mortgage Credit Table 1 ELASTICITIES AND FLUCTUATIONS OF DEMAND AND SUPPLY VARIABLES Average Annu al Short-Run Perce ntage Variable Elasticity Fluctuation Demand Interest rate - 2.29 +2 .2 Internal funds - 1.37 +7.5 Technology - 1.96 +5.4 Farm wage rate +1.49 + 5.9 Supply Interest rate +1.51 +1.8 Yield differential +0.14 +10.0 National saving +0.20 +19.4 Change in the money su pply 23.0* +0.16 Farm pri ces +0.22 +5.5 Farm assets I 0.23 -! 5.6 '1111 Is an averag • of Ilic pcrccnlag, of 1he s co ne! dill rcnce, sin e' the varIalllc I~ thr first d1ffc rcn c (change) of the mon y supply . NOT : Demand elasticities and flul tuatIon s wer• estimated with data from 1921 to 1959 , upply, from 1935 to 1959. Te chnology wa s measured by an unpublished revIsIon of the index published in graphi c form tn T. T. Stout and V. W. Ruttan, "Regio nal Pattern s of Technologi ca l Change in American Agriculture," Journal of Farm Economics , May 1958. per cent average annual fluctuation. Coupled with the high elasticity, this suggests that fluctu ations in internal funds are a main cau e of fluctuation in the quantity of mortgage credit sought by farmers. The concJu ion th a t short-run fluctuations in internal fund s arc negatively related to the quantity of credit suggests th at with a decrease in int rnal fund gross inv strncnt tend to be maintained by using more credit. The volatility of farm income and the relative shortrun stability of investment then explain much of th e fluctu atio n in the market for far m mortgage credit. These relationships also go a long way in explaining the prevalance of "internal credit rationing" among farm people, or the tendency for many farmers to use les credit than i available to th em . 1f gross invc tmcnt and con umpti n by farmer tend to be relatively stable in the hort run , and farm income tends to be comparatively volatile, th en credit demand of farmer tend to be a residual source of fund s that fluctuate in the opposite direction from Monthly Review • July-August 1963 internal funds. 1n other words, farmers do not borrow as much at a given point in time as would seem to be economically rational so that they may have borrowing power to draw on when incomes temporarily decline. In this way, they can maintain investment and con umption pattern s bas d on longer-run considerations. The stimated ela ticitic for both the farm wage rate and tcchn logy provide in ight into the substitution process within th e agricultural industry. The demand for farm mortgage credit is relatively responsive to ch anges in the farm wage ra te, and it i rel ated po itively. This sugges ts that capital equipm ent, with a derived demand for credit , t nds t be substituted for labor with rise s in wag rates, and vice versa. Fluct ua tion s in th e rea l farm wage rate hav been co nsidcrabl , with sizab le dec rea ses during th e depres ion and increa s during World War 11. lf efforts to increase the rate of economic growth a re successful, and if wage rates rise with growth, the elasticity suggests additional substitution of capital for labor and, in turn, an increase in the demand for credit to finance it. Changes in technology have also been a contributing factor to changes in the quantity of credit demanded. The output-increa sing effects of technical change are such that increases in tec hnology in agriculture lead to decreases in the agg r ga te demand for long-term credit. The estimated ela ticity refl ects th general need to tra nsfer re ourccs out of agriculture as the level of technology increases. It suggests that technology is substituted for capital as well as for labor; that is, that technology in agriculture has tended to be both capital-saving and laborsaving. A classic example of an increase in technology in agriculture is the development of hyb rid corn , which ha s made pos ible significant increases in output per unit of input. Jt now takes le s land , labor, and capital to produce a given quantity of corn . This concept of technology differs from the less precise but perhaps more widely held idea that Jinks increased 13 Farm Mortgage Credit mechanization with increased technology. In the framework of this study, increased mechanization is considered either an addition to capital equipment or a substitution of capital for labor, not an increase in technology as such. This difference in definition must be understood in interpreting the elasticity for technology, because it i the former concept of technology that the index used in this study purports to measure. The statistical results suggest that the demand for long-term farm credit is interest elastic, or very responsive to changes in the interest rate. However, average annual fluctuation in the farm mortgag rate f interest have be n small historically, even th ugh f r m y ar the hang wa ub tantial. In g neral , then , fluctuations in the quantity of credit demanded have stemmed largely from causes other than changes in the rate of interest. In interpreting the elasticity of demand with respect to the rate of interest, it is necessary to keep in mind that the quantity variable is the gross volume of farm mortgage loans issued, including loans to refinance existing debt. During periods when interest rates were lower than they had been previously, some farmers may have refinanced at the new lower rates. This would tend to increa e the volume of farm mortgage loans closed during the period without changing the volume of outstanding debt. The result is that the elasticity implied from using the gross flow as a measure of the volume of credit could be expected to be larger than an elasticity obtained from using net changes in the stock of outstanding debt. In addition, the "price" of farm mortgage credit manifests itself in more than one dimension. Besides the rate of interest, factors such as the term of the loan and size of downpayment are subject to market determination. In this study, the rate of interest was the only price factor considered. To the extent that the various price factors move together, the rate of interest may serve as an indicator for all of them. 14 The analysis, however, probably overstates the true price effect of the interest rate on both credit demand and supply. The statistical results suggest that supplies of farm mortgage money are also relatively responsive to changes in the farm mortgage rate of interest. However, they indicate a much smaller re ponse to nonfarm interest rates, as mea ured by differences in the yield between farm mortgage loans and preferred stocks. Nevertheless, the average annual percentage fluctuation of the differential- 10 per cent-is sufficiently large that shifts in the quantity of mortgage money supplied in respon e to changing r lativ intere t rat s d occur, v n though th lasti ity may be low. Analysis of thi s variabl is limit d by l w tati tical signifi ance f r its coefficient, however, and inferences hould be drawn with caution. The impact that national saving and changes in the stock of money have on the supply of farm mortgage credit is of interest to policymakers . While national saving is not directly subject to willful control, a certain amount of control does exist over the economy's money supply. The statistical results indicate that the supply of farm mortgage credit is not very responsive with respect to both national saving and chang s in the money supply. The relatively large average annual percentage fluctuations in these variables, however, indicate that noticeable hift in supply conditions do result from these factors. CONCLUDING COMMENTS Persons concerned with supplies of credit may be interested in estimated future amounts of farm mortgage loans closed per year and estimated interest rates. Are significant changes likely over the n xt several year ? The elasticities, or degrees of respon ivene to economic forces , indicated by this study may be used to estimate the effects of projected changes in the economy. For instance, if farm wage rates continue to increase at an average annual rate farm Mortgage Credit about as they have during the recent past, what effect will this have on the annual vomme of loans closed and on farm mortgage interest rates? In addition to wage rates, agricultural technology and the rate of national saving would each be expected to increase over time with normal growth of the economy. However, little, if any, logical reason exists for expecting either pronounced increase or decreases over a long period for the rest of the economic forces considered in this study. One basis for estimating the effects might be to assume th at farm wage rate , agricultural technology, and the rate of national saving will ca h continue to increase, on the average, at the am annual rate that they did during a recent period. The other factors will be assumed to be constant for estimating purposes. While they will certainly continue to fluctuate from year to year, and therefore will cause fluctuations in the annual volume of credit and interest rates, these other factors, taken separately, will probably average out over several years without creating a trend in volume or interest rates. During the 1950's, the real farm wage rate increased an average of 2.5 per cent per year, agricultural technology by 1. 7 per cent, and real national saving by 2.25 per cent per year. Estimates of future farm mortgage credit requirements and interest rates are made by pro- Table 2 ESTIMATED AVERAGE ANNUAL CHANGE IN FUTURE VOLUME OF FARM MORTGAGE LOANS CLOSED AND AVERAGE FARM MORTGAGE RATE OF INTEREST Total Annual Change Annual Change Resulting from Increases in: Tech- National Wage nology Saving olume (in millions of 1954 dollars) Interest rate (per cent) +9.7 +37.o 0 + 0.07 Monthly Review • July-August 1963 - 32.B -0.06 +s.s -0.01 jecting into the future these same average annual rates of change and by using the estimated elasticities ot this study. A 2.5 per cent increase in farm wage rates would be associated with a $37 million increase in the annual volume of farm mortgage loans closed and with an increase of 7 basis points (. 07 per cent) in the average farm mortgage rate of interest. At the same time, an increase of 1. 7 per cent in technology would be associated with a $32.8 million decrease in loans closed, and so on. The cumulative effects of the indicated changes in wage, technology, and saving would be an estimated annual increase of $9.7 million in farm mortgage loans clo cd and no change in the farm mortgage rate of interest. The c timat d avcrag annual in r ment in loans clo ed - $9.7 million- i about one half of 1 per cent of the average annual volume of the 1950's, which was $1,871 million in terms of 1954 dollars. Recognizing that credit and capital are not synonymous, this estimate is at least compatible with Tostlebe's prediction that, although the ratios of capital to labor and capital per farm will rise, growth of farm capital in the aggregate will occur " ... at an average rate that is likely to be substantially less than 1 per cent per annum. " 2 The assumption that technology will continue to increase at the same rate it did during the 1950's may not be realistic. That decade was one of exceptionally rapid increases in technology in agriculture. With a slower rate 9f technological change, the increase in the volume of farm mortgage credit would be greater. The estimates are in terms of a constant price level. To the extent that inflation or deflation is anticipated the estimates should be adjusted. 2 Alvin S. Tostlebe, Capital in Agriculture: Its Formatidn and Financing Since 1870, National Bureau of Economic Research, Princeton University Press, Princeton, New Jersey, 1957, p. 19. 15 BANKING IN THE TENTH DISTRICT Reserve City Member Banks District and Country Member Banks Reserve City Member Banks Country Mem ber Ban ks Reserve City Member Banks Reserve City Member Banks Country Member Banks -May 1963 Percentage Change From June 1963 Percentage Change From States Deposits Loans Deposits Loans Country Member Banks May June May June May June May June Apr. May Apr. May Apr. May Apr. May 1963 1962 1963 1962 1963 1962 1963 1962 1963 1962 1963 1962 1963 1962 1963 1962 Tenth F. R. Dist. Colorado Kansas Missouri * N bras ka New Mex ico * Ok la homa * Wyoming + 3 +9 +2 +4 +12 +3 ** + 3 ** 2 - 1 +2 H13 t + 1 ** ** + 3 + 4 + 10 + 2 ** ** + 1 * Tenth District portion only . +13 +5 +16 + 3 ** +12 +9 +7 + 14 + 3 ** -J 13 6 + 13 ** +12 +6 +8 ** +2 +2 ** 11 ** +3 + 8 +3 + 13 +4 +6 6 +1 t -5 -j 2 8 - 5 + 11 t +6 ** No reserve citi es in this state . t +2 ** - 1 + 1 ** - 1 ** +9 +9 ** 2 + 12 ** +14 ** +1 +2 - 1 +1 -1- 2 13 +2 +3 +13 +16 + 13 + 12 H 13 I 15 + 13 H- 12 - 2 - 1 ** - 2 1 ** - 2 ** +4 +5 ** + 1 -j 1 ** 8 ** -- - 1 +6 1 +10 2 +5 1 +6 4 3 - 1 12 1 8 t tL ess than 0.5 per cent. +5 -- PRICE INDEXES, UNITED STATES Index June 1963 May 1963 Apr. 1963 June 1962 May 1962 Consumer Price Index (1957-59 = 100). ___ ___ ____ _ Wholesale Price Index (1957-59 = 100). ___ ________ Prices Received by Farmers (1910-14 = 100) .... Prices Paid by Farmers (1910-14 = 100). ________ 106.6 100.3 241 311 106.2 100.0r 240 311 106.2 99.7 242 311 105.3 100.0 239 306r 105.2 100.2 241r 307r r R vi sed . -- -- TENTH DISTRICT BUSINESS INDICATORS Value of Check Payments District Percentage change from prev ious year Metropolitan Areas June 1963 Tenth Federal Reserve District__ _____ _ Denver ___________ ___ _________ __________________ Wichita ____ ____ ___ ________________________ _____ Kansas City ______ _________ __ _______ ______ ____ Omaha ______ _________ _______ ____ _______________ - 2 0 - 5 0 - 6 - 1 - 9 Oklahoma City ___________ ___ ____________ __ _ 16 --Valu e of Department Store Sales and Principal Tulsa -- --- -- --- - -- ---- - - -. -- -- - -- ------ --- --- -- - - May 1963 +4 +7 - 3 +4 +5 +11 - 2 Six Months 1963 +2 +3 - 3 +3 +4 +7 - 5 June 1963 May 1963 Six Months 1963 +5 +2 +7 +12 +5 +3 +5 +2 +6 - 5 +5 - 3 +2 +2 +4 +4 0 +7 +2 +4 +6 -- -- --
@FedFRASER