Full text of Economic Review (Federal Reserve Bank of San Francisco) : November/December 1973

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Monetary Policy: A Letter
... Chairman Burns examines the
record of monetary policy, in
a letter to Senator Proxmire.

Weakening Boom?
... The Western boom showed signs
of weakness even before the
onset of the energy crisis.

Fueling Bank-Loan Growth
... Third-quarter Joan upsurge
helped by sell-off of securities
and by expansion of CD funds.

Business Review is edited by William Burke, with the assistance of
Karen Rusk (editorial) and Janis Wilson (graphics).
Copies of this and other Federal Reserve publications are available from
the Administrative Services Department, Federal Reserve Bank of San
Francisco, P.O. Box 7702, San Francisco, California 94120.

2

The role of the money supply
in the conduct of monetary
policy was discussed in detail
in a recent letter from Arthur F.
Burns, Chairman of the Board
of Governors of the Federal
Reserve System, to Senator
William Proxmire of Wisconsin.
The text of the letter follows.

November 6,1973
The Honorable William Proxmire
United States Senate
Washington, D. C.
Dear Senator Proxmire:
I am writing in further response
to your letter of September 17,
1973, which requested comments
on certain criticisms of monetary
policy over the past year.
As stated in your letter, the
criticisms are: (1) "that there was
too much variation from time to
time in the rate of inctease in the
money supply, that monetary
policy was too erratic, too much
characterized by stops and
starts"; and (2) "that the money
supply had increased much too
much last year, in fact that the
increase would have been too
much even if we had been in the
depths of a recession instead of
enjoying a fairly vigorous economic expansion."

These criticisms involve basic
issues with regard to the role of
money in the economy, and the
role that the money supply
should play in the formulation
and execution of monetary
policy. These issues, along with
the specific points you raise,
require careful examination.
Criticism of Our Public Policies
During the past two years the
American economy has experienced a substantial measureof
prosperity. Real output has
increased sharply, jobs have
been created for millions of
additional workers, and total
personal income-both in dollars
and in terms of real purchasing
power-has risen to the highest
levels ever reached.

Yet the prosperity has been a
troubled one. Price increases
have been large and widespread.
For a time, the unemployment
rate remained unduly high.
Interest rates have risen sharply
since the spring of 1972. Mortgage money has recently become
difficult to obtain in many
communities. And confidence in
the dollar at home and abroad
has at times wavered.
Many observers have blamed
these difficulties on the management of public economic
policies. Certainly, the Federal
budget-despite vigorous efforts

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1,1

to hold expenditures downcontinued in substantial deficit.
There has also been an enormous
growth in the activities of Federally-sponsored agencies which,
although technically outside the
budget, must still be financed.
The results of efforts to control
wages and prices during the past
year have been disappointing.
Partial decontrol in early 1973
and the subsequent freeze failed
to bring the results that were
hoped for.
Monetary policy has been
criticized on somewhat contradictory counts-for being
inflationary, or for permitting too
high a level of interest rates, or
for failing to bring the economy
back to full employment, or for
permitting excessive short-term
variations in the growth of the
money supply, and so on.

at all indicative, the public
policies on which we have relied
are being widely questioned.
Many members of the above
group, in fact, went on record for
a significant change in fiscal
policy. In response to a question
whether they favored a variable
investment tax credit, 46.5 percent said "yes", 40 percent said
"no" and 13.5 percent
expressed "no opinion."
Let me now turn to the questions
raised in your letter and in some
other recent discussions about
monetary policy. I shall discuss,
in particular, the role of money
supply in the conduct of
monetary policy; the extent and
significance of variability in the
growth of the money supply;
and the actual behavior of the
money supply during 1972-73.
Role of Money Supply

One indication of dissatisfaction
with our public policies was
provided by a report, to which
you refer in your letter, on a
questionnaire survey conducted
by the National Association of
Business Economists. Of the
responents, 38 percent rated
fiscal policy "over the past year"
as "poor"; 41 percent rated
monetary policy "over the past
year" as "poor"; and only 14 percent felt that the wage-price
controls under Phase IV were
"about right." If this sampling is
4

For many years economists have
debated the role of the money
supply in the performance of
economic systems. One school
of thought, often termed "monetarist," claims that changes in the
money supply influence very
importantly, perhaps even
decisively, the pace of economic
activity and the level of prices.

Monetarists contend that the
monetary authorities should pay
principal attention to the money
supply, rather than to other
financial variables such as
interest rates, in the conduct of
monetary policy. They also
contend that fiscal policy has
only a small independent impact
on the economy.
Another school of thought places
less emphasis on the money
supply and assigns more importance to the expenditure and
tax policies of the Federal
Government as factors influencing real economic activity and
the level of prices. This school
emphasizes the need for
monetary policy to be concerned
with interest rates and with
conditions in the money and
capital markets. Some economic
activities, particularly residential
building and State and local
government construction,
depend heavily on borrowed
funds, and are therefore influenced greatly by changes in the
cost and availability of credit. In
other categories of spendingsuch as business investment in
fixed capital and inventories, and
consumer purchases of durable
goods-credit conditions playa
less decisive role, but they are
nonetheless important.

Monetarists recognize that
monetary policy affects private
spending in part through its
impact on interest rates and other
credit terms. But they believe
that primary attention to the
growth of the money supply will
result in a more appropriate
monetary policy than would
attention to conditions in the
credit markets.
Needless to say, monetary policy
is-and has long been-a controversial subject. Even the
monetarists do not speak with
one voice on monetary policy.
Some influential monetarists
believe that monetary policy
should aim strictly at maintaining
a constant rate of growth of the
money supply. However, what
that constant should be, or how
broadly the money supply should
be defined, are matters on which
monetarists still differ. And there
are also monetarists who would
allow some-but infrequentchanges in the rate of growth of
the money supply, in accordance
with changing economic
conditions.
It seems self-evident that
adherence to a rigid growth rate
rule, or even one that is changed
infrequently, would practically
prevent monetary policy from
playing an active role in economic stabilization. Monetarists
recognize this. They believe that

most economic disturbances
tend to be self-correcting, and
they therefore argue that a
constant or nearly constant rate
of growth of the money supply
would result in reasonably
satisfactory economic performance.
But neither historical evidence,
nor the thrust of explorations in
business-cycle theory over a long
century, give support to the

notion that our economy is
inherently stable. On the
contrary, experience has demonstrated repeatedly that blind
reliance on the self-correcting
properties of our economic
system can lead to serious
trouble. Discretionary economic
policy, while it has at times led
to mistakes, has more often
proved reasonably successful.
The disappearance of business
depressions, which in earlier
5

times spelled mass unemployment for workers and mass
bankruptcies for businessmen, is
largely attributable to the
stabilization policies of the last
thirty years.
The fact is that the internal
workings of a market economy
tend of themselves to generate
business fluctuations, and most
modern economists recognize
this. For example, improved
prospects for profits often spur
unsustainable bursts of investment spending. The flow of
personal income in an age of
affluence allows ample latitude
for changes in discretionary
expenditures and in savings rates.
During a business-cycle
expansion various imbalances
tend to develop within the
economy-between aggregate
inventories and sales, or between
aggregate business investment in
fixed capital and consumer
outlays, or between average unit
costs of production and prices.
Such imbalances give rise to
cyclical movements in the
economy. Flexible fiscal and
monetary policies, therefore, are
often needed to cope with
undesirable economic developments, and this need is not
diminished by the fact that our
available tools of economic
stabilization leave something to
be desired.
6

There is general agreement
among economists that, as a rule,
the effects of stabilization
policies occur gradually over
time, and that economic
forecasts are an essential tool of
policy making. However, no
economist-or school of
economics-has a monopoly on
accurate forecasting. At times,
forecasts based largely on the
money supply have turned out
to be satisfactory. At other times,
such forecasts have been quite
poor, mainly because of unanticipated changes in the
intensity with which the existing
money stock is used by business
firms and consumers.
Changes in the rate of turnover
of money have historically played
a large role in economic
fluctuations, and they continue
to do so. For example, the
narrowly-defined money stockthat is, demand deposits plus
currency in public circulationgrew by 5.7 percent between
the fourth quarter of 1969 and
the fourth quarter of 1970. But
the turnover of money declined
during that year, and the dollar
value of GNP rose only 4.5 percent. In the following year, the
growth rate of the money supply
increased to 6.9 percent, but
the turnover of money picked
up briskly and the dollar value
of GNP accelerated to 9.3 percent. The movement out of

recession in 1970 into recovery
in 1971 was thus closely related
to the greater intensity in the use
of money. Occurrences such as
this are very common because
the willingness to use the existing
stock of money, expressed in its
rate of turnover, is a highly
dynamic force in economic life.
For this as well as other reasons,
the Federal Reserve uses a blend
of forecasting techniques. The
behavior of the money supply
and other financial variables is
accorded careful attention. So
are the results of the most recent
surveys on plant and equipment
spending, consumer attitudes,
and inventory plans. Recent
trends in key producing and
spending sectors are analyzed.
The opinions of businessmen
and outside economic analysts
are canvassed, in part through
the nationwide contacts of Federal Reserve Banks. And an assessment is made of the probable
course of fiscal policy, also of
labor-market and agricultural
policies, and their effects on the
economy.
Evidence from all these sources is
weighed. Efforts are also made to
assess economic developments
through the use of large-scale

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econometric models. An eclectic
approach is thus taken by the
Federal Reserve, in recognition
of the fact that the state of
economic knowledge does not
justify reliance on any single
forecasting technique. As
economic research has cumulated, it has become increasingly
clear that money does indeed
matter. But other financial
variables also matter.
In recent years, the Federal
Reserve has placed somewhat
more emphasis on achieving
desired growth rates of the
monetary aggregates, including
the narrowly-defined money
supply, in its conduct of
monetary policy. But we have
continued to give careful
attention to other financial
indicators, among them the level
of interest rates on mortgages
and other loans and the liquidity
position of financial institutions
and the general public. This is
necessary because the economic
implications of any given
monetary growth rate depend on
the state of liquidity, the attitudes
of businessmen, investors, and
consumers toward liquidity, the
cost and availability of borro\Ned
funds, and other factors. Also,
as the nation's central bank, the
Federal Reserve can never lose
sight of its role as a lender of last
resort, so that financial crises and
panics will be averted.

I recognize that one advantage
of maintaining a relatively stable
growth rate of the money supply
is that a partial offset is thereby
provided to unexpected and
undesired shifts in the aggregate
demand for goods and services.
There is always some uncertainty
as to the emerging strength of
aggregate demand. If money
growth is maintained at a rather
stable rate, and aggregate
demand turns out to be weaker
than is consistent with the
nation's economic objectives,
interest rates will tend to decline
and the easing of credit markets
should help to moderate the
undesired weakness in demand.
Similarly, if the demand for
goods and services threatens to
outrun productive capacity, a
rather stable rate of monetary
growth will provide a restraining
influence on the supply of credit
and thus tend to restrain
excessive spending.
However, it would be unwise for
monetary policy to aim at all
times at a constant or nearly
constant rate of growth of money
balances. The money growth
rate that can contribute most to
national objectives will vary with
economic conditions. For
example, if the aggregate
demand for goods and services
is unusually weak, or if the
demand for liquidity is unusually
strong, a rate of increase in the

money supply well above the
desirable long-term trend may
be needed for a time. Again,
when the economy is experiencing severe cost-push inflation, a
monetary growth rate that is
relatively high by a historical
yardstick may have to be
tolerated for a time. If money
growth were severely constrained
in order to combat the element
of inflation resulting from such a
cause, it might well have
seriously adverse effects on
production and employment. In
short, what growth rate of the
money supply is appropriate at
any given time cannot be
determined simply by extrapolating past trends or by some
preconceived arithmetical
standard.
Moreover, for purposes of
conducting monetary policy, it is
never safe to rely on just one
concept of money-even if that
concept happens to be fashionable. A variety of plausible
concepts merit careful attention,
because a number of financial
assets serve as a convenient,
safe, and liquid store of
purchasing power.

7

I

The Federal Reserve publishes
data corresponding to three
definitions of money, and takes
all of them into account in
determining policy. The three
measures are: (a) the narrowlydefined money stock (M 1 ), which
encompasses currency and
demand deposits held by the
nonbank public; (b) a more
broadly-defined money stock
(M 2 ), which also includes time
and savings deposits at commercial banks (other than large
negotiable time certificates of
deposit); (c) a still broader
definition (M 3 ), which includes
savings deposits at mutual
savings banks and savings and
loan associations. A definition
embracing other liquid assets
could also be justified-for
example, one that would
include large-denomination
negotiable time certificates of
deposit, U.s. savings bonds and
Treasury bills, commercial
8

paper, and other short-term
money market instruments.
There are many assets closely
related to cash, and the public
can switch readily among these
assets. However money may be
defined, the task of determining
the amount of money needed to
maintain high employment and
reasonable stability of the general
price level is complicated by
shifting preferences of the
public for cash and other
financial assets.

Variability of
Money Supply Growth
In the short run, the rate of
change in the observed money
supply is quite erratic, and
cannot be trusted as an indicator
of the course of monetary
policy. This would be so even
if there were no errors of
measurement.

The record of hearings held by
the Joint Economic Committee
on June 27,1973 includes a
memorandum which I submitted on problems encountered
in controlling the money supply.
As indicated there, week-toweek, month-to-month, and
even quarter-to-quarter
fluctuations in the rate of change
of money balances are frequently
influenced by international
flows of funds, changes in the
level of U.S. Government
deposits, and sudden changes
in the public's attitude towards
liquidity. Some of these variations appear to be essentially
random-a product of the
enormous ebb and flow of funds
in our modern economy.
Because the demands of the
public for money are subject to
rather wide short-term variations,
efforts by the Federal Reserve to
maintain a constant growth rate
of the money supply could lead
to sharp short-run swings in
interest rates and risk damage to
financial markets and the economy. Uncertainties about
financing costs could reduce
the fluidity of markets and increase the costs of financing to
borrowers. In addition, wide and
erratic movements of interest
rates and financial conditions
could have undesirable effects
on business and consumer

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spending. These adverse effects
may not be of major dimensions,
but it is better to avoid them.
In any event, for a variety of
reasons explained in the
memorandum for the Joint
Economic Committee, to which I
have previously referred, the
Federal Reserve does not have
precise control over the money
supply. To give one example, a
significant part of the money
supply consists of deposits
lodged in nonmember banks that
are not subject to the reserve
requirements set by the Federal
Reserve. As a result there is some
slippage in monetary control.
Furthermore, since deposits at
nonmember banks have been
reported for only two to four
days in a year, in contrast to
daily statistics for member banks,
the data on the money supplywhich we regularly present on a
weekly, monthly, and quarterly
basis-are estimates rather than
precise measurements. When the
infrequent reports from nonmember banks become available,
they often necessitate considerable revisions of the money
supply figures. In the past two
years, the revisions were upward,
and this may happen again
this year.

Some indication of the extent of
short-term variations in the recorded money supply is provided
below. Table 1 shows the average
and maximum deviations (without regard to sign) of M I from
its average annual growth rate
over a three and a half year
period. As would be expected, the
degree of variation diminishes as
the time unit lengthens; it is
much larger for monthly than for
quarterly data, and is also larger
for quarterly than for semiannual data.
Table 1
DEVIATIONS IN M I FROM ITS
AVERAGE RATE OF GROWTH
1970 THRU MID-1973

Form of Data

Monthly
Quarterly
Semi-annual

Annual Rates of Change
in percent
Average
Maximum
Deviation Deviation

3.8

8.8

2.4

5.5

1.8

4.1

In our judgment, there need be
little reason for concern about
the short-run variations that
occur in the rate of change in the
money stock. Such variations
have minimal effects on the real
economy. For one thing, the
outstanding supply of money is
very large. It is also quite stable,
even when the short-run rate of
change is unstable. This October
the average outstanding supply
of MIl seasonally adjusted, was
about $264 billion. On this base,

a monthly rise or fall in the
money stock of even $2112 billion
would amount to only a 1 percent change. But when such a
temporary change is expressed
as an annual rate, as is now
commonly done, it comes out as
about 12 percent and attracts
attention far beyond its real
significance.
The Federal Reserve research
staff has investigated carefully
the economic implications of
variability in M I growth. The experience of the past two decades
suggests that even an abnormally large or abnormally
small rate of growth of the
money stock over a period up to
six months or so has a negligible
influence on the course of the
economy-provided it is subsequently offset. Such short-run
variations in the rate of change in
money supply may not at all
reflect Federal Reserve policy,
and they do not justify the attention they often receive from
financial analysts.
The thrust of monetary policy and
its probable effects on economic
activity can only be determined
by observing the course of the
money supply and of other monetary aggregates over periods
lasting six months or so. Even
then, care must be taken to
measure the growth of money
balances in ways that temper the
9

influence of short-term variations. For example, the growth of
money balances over a quarter
can be measured from the
amount outstanding in the last
month of the preceding quarter
to the last month of the current
quarter, or from the average
amount outstanding during the
preceding quarter to the average
in the current quarter. The first
measure captures the latest
tendencies in the money supply,
but may be distorted by random
changes that have no lasting
significance. The second measure
tends to average out temporary
fluctuations and is comparable to
the data provided on a wide
range of non-monetary economic
variables, such as the gross
national product and related
measures.
A comparison of these two ways
of measuring the rate of growth
in M 1 is shown in Table 2 for
successive quarters in 1972 and
1973. The first column, labeled
M, shows annual rates calculated
from end-months of quarters;
the second column, labeled Q,
shows annual rates calculated
from quarterly averages.

Table 2
GROWTH RATES OF MONEY
SUPPLY ON TWO BASES
Annual Rate of Change,
in percent

M

1973

Q

9.2
6.1

5.3
8.4

8.2
8.6

8.0

N

1972

I
II
III

1.7
10.3
0.3

I
II
III

7.1
4.7

6.9
5.1

As may be seen, the quarterly
averages disclose much more
clearly the developing trend of
monetary restraint-which, in
fact, began in the second quarter
of 1972. Also, the growth of M l1
which on a month-end basis
appears very erratic in the first
three quarters of 1973, is much
more stable on a quarterly
average basis. For example,
wh i1e the level of M 1 did not
expand significantly between
june and September, the
quarterly average figures indicate
further sizable growth in the
third quarter. For purposes of
economic analysis, it is an
advantage to recognize that the
money available for use was
appreciably larger in the third
quarter than in the second
quarter.

Experience of 1972-73
During 1972, it was the responsibility of the Federal Reserve
to encourage a rate of economic
expansion adequate to reduce
unemployment to acceptable
levels. At the same time, despite
the dampening effects of the
wage-price control program,
inflationary pressures were
gathering. Monetary policy,
therefore, had to balance the
twin objectives of containing
inflationary pressures and
encouraging economic growth.
These objectives were to some
extent conflicting, and monetary
policy alone could not be
expected to cope with both
problems. Continuation of an
effective wage-price program
and a firmer policy offiscal
restraint were urgently needed.

The narrowly-defined money
stock increased 7.4 percent
during 1972 (measured from the
fourth quarter of 1971 to the
fourth quarter of 1972.) Between
the third quarter of 1972 and the
third quarter of 1973, the growth
rate was 6.1 percent. By the
first half of 1973, the annual
growth rate had declined to 5.8
percent, and a further slowing
occurred in the third quarter.

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Evaluation of the appropriateness
of these growth rates would
require full analysis of the
economic and financial objectives, conditions, and policies
during the past two years, if not
longer. Such an analysis cannot
be undertaken here. Some
perspective on monetary developments during 1972-73 may be
gained, however, from comparisons with the experience of
other industrial countries, and
by recalling briefly how domestic
economic conditions evolved
during this period.
Table 3 compares the growth of
M , in the United States with that
of other industrial countries in
1972 and the first half of 1973.
The definitions of M , differ
somewhat from country to
country, but are as nearly
comparable as statistical sources
permit. It goes without saying
that each country faced its own
set of economic conditions and
problems. Yet it is useful to note
that monetary growth in the
United States was much lower
than in other major industrial
countries, and that it also was
steadier than in the other
countries.

Table 3
ANNUAL PERCENT RATES OF
GROWTH IN MONEY SUPPLY
1971.4

1972.4

to 1972.4 to 1973.2

United States
United Kingdom
Germany
France
Japan

7.4
14.1
14.3
15.4
23.1

5.8
10.0
4.2
8.7
28.2

The next table shows, in summary fashion, the rates of
change in the money supply
of the United States, in its total
production, and in the consumer
price level during 1972 and 1973.
The table is based on the latest
data. It may be noted, in passing,
that, according to data available
as late as January 1973, the rate
of growth of M , during 1972 was
7.2%, not 7.4%; and that the
rate of increase in real GNP was
7.7%, not 7.0%. In other words,
on the basis of the data available
during 1972, the rate of growth
of M , was below the rate of
growth of the physical volume of
over-all production.

The table indicates that growth
in M , during 1972 and 1973
approximately matched the
growth of real output, but was far
below the expansion in the dollar
value of the nation's output.
Although monetary policy
limited the availability of money
relative to the growth of
transactions demands, it still
encouraged a substantial
expansion in economic activity;
real output rose by about 7 percent in 1972. Even so, unemployment remained unsatisfactorily
high throughout the greater part
of the year. It was not until
November that the unemployment rate dropped below 5.5
percent. For the year as a whole,
the unemployment rate averaged
5.6 percent. It may be of interest
to recall that unemployment
averaged5.5 pe rcent in 1954 and
1960, which are commonly
regarded as recession years.
Since the expansion of M 1 in
1972 was low relative to the
demands for money and credit, it
was accompanied by rising shortterm interest rates. Long-term
interest rates showed little net
change last year, as credit
demands were satisfied mainly in
the short-term markets.

11

Table 4

MONEY SUPPLY, GNP, AND PRICES IN THE U.S.
(Percent change at annual rates)

Money supply (M 1 )

1971.4 to 1972.4
7.4

1972.4 to
1973.2
1973.3
5.8
5.6

Gross National Product
Current dollars
Constant dollars

10.6
7.0

12.1
5.4

11.7
4.8

3.4
3.0

7.1
4.0

7.8
4.1

Prices
Consumer price index (CPI)
CPI excluding food

In 1973, the growth of M 1
moderated while the transactions
demands for cash and the
turnover of money accelerated.
GNP in current dollars rose at a
12 percent annual rate as prices
rose more rapidly. In credit
markets short-term interest rates
rose sharply further, while longterm interest rates also moved
up, though by substantially less
than short-term rates.
The extraordinary upsurge of the
price level this year reflects a
variety of special influences. First,
there has been a world-wide
economic boom superimposed
on the boom in the United States.
Second, we have encountered
critical shortages of basic

materials. The expansion in
industrial capacity needed to
produce these materials had not
been put in place earlier because
of the abnormally low level of
profits between 1966 and 1971
and also because of numerous
impediments to new investment
on ecological grounds. Third,
farm product prices escalated
sharply as a result of crop failures
in many countries last year.
Fourth, fuel prices spurted
upward, reflecting the developing shortages in the energy field.
And fifth, the depreciation of the
dollar in foreign exchange
markets has served to boost
prices of imported goods and to
add to the demands pressing on
our productive resources.

In view of these powerful special
factors, and the cyclical
expansion of our economy, a
sharp advance in our price level
would have been practically
inevitable in 1973. The upsurge
of the price level this year hardly
represents either the basic trend
of prices or the response of
prices to previous monetary or
fiscal policies-whatever their
shortcomings may have been. In
particular, as the above tables
show, the explosion of food
prices that occurred this year is
in large part responsible for the
accelerated rise in the over-all
consumer price level.
The severe rate of inflation that
we have experienced in 1973
cannot responsibly be attributed
to monetary management or to
public policies more generally.
In retrospect, it may well be that
monetary policy should have
been a little less expansive in
1972. But a markedly more
restrictive policy would have led
to a still sharper rise in interest
rates and risked a premature
ending of the business
expansion, without limiting to
any significant degree this year's
upsurge of the price level.

Concluding Observations
The present inflation is the most
serious economic problem facing
our country, and it poses great
12

difficulties for economic stabilization policies. We must
recognize, I believe, that it will
take some time for the forces of
inflation, which now engulf our
economy and others around the
world, to burn themselves out. In
today's environment, controls
on wages and prices cannot be
expected to yield the benefits
they did in 1971 and 1972, when
economic conditions were much
different. Primary reliance in
dealing with inflation-both in
the near future and over the
longer term-will have to be
placed on fiscal and monetary
policies.
The prospects for regaining price
stability would be enhanced by
improvements in our monetary
and fiscal instruments. The
conduct of monetary policy
could be improved if steps were
taken to increase the precision
with which the money supply can
be controlled by the Federal
Reserve. Part of the present
control problem stems from
statistical inadequacies-chiefly
the paucity of data on deposits
at nonmember banks. Also,
however, control overthe money
supply and other monetary
aggregates is less precise than it
can or should be because nonmember banks are not subject to
the same reserve requirements as
are Federal Reserve members.

I hope that the Congress will
support efforts to rectify these
deficiencies. For its part, the
Federal Reserve Board is even
now carrying on discussions with
the Federal Deposit Insurance
Corporation about the need for
better statistics on the nation's
money supply. The Board also
expects shortly to recommend to
the Congress legislation that will
put demand deposits at commercial banks on a uniform basis
from the standpoint of reserve
requirements.
Improvements in our fiscal
policies are also needed. It is
important for the Congress to put
an end to fragmented consideration of expenditures, to place a
firm ceiling on total Federal
expenditures, and to relate these
expenditures to prospective
revenues and the nation's
economic needs. Fortunately,
there is now Widespread
recognition by members of the
Congress of the need to reform
budgetary procedures along
these broad lines.

It also is high time for fiscal
policy to become a more
versatile tool of economic
stabilization. Particularlyappropriate would be fiscal
instruments that could be
adapted quickly, under special
legislative rules, to changing
economic conditions-such as a
variable tax credit for business
investment in fixed capital. Once
again I would urge the Congress
to give serious consideration to
this urgently needed reform.
We must strive also for better
understanding of the effects of
economic stabilization policies
on economic activity and prices.
Our knowledge in this area is
greater now than it was five or ten
years ago, thanks to extensive
research undertaken by economists in academic institutions,
at the Federal Reserve, and
elsewhere. The keen interest of
the Joint Economic Committee in
improving economic stabilization
policies has, I believe, been an
influence of great importance in
stimulating this widespread
research effort.
I look forward to continued
cooperation with the Committee
in an effort to achieve the kind
of economic performance our
citizens expect and deserve.
Sincerely yours,

Arthur F. Burns

The Western boom continued
during the summer and early
fall months, helped along by the
upsurge in the farm sector and
in the export trade. At the same
time, production became seriously strained by shortages of
fuels and other basic materials. A
slowdown in employment growth
reflected some of these supply
difficulties, but it probably signified also a weakening of demand
in certain sectors of the regional
economy. Then, as the fuel
shortage worsened in late fall,
many observers began to revise
downward their forecasts for
regional business in 1974.
Civilian employment increased at
less than a 2-percent annual rate
during the third quarter, extending a deceleration which first appeared during the spring period.
Jobs continued to expand in most
industries, but sluggishness was
apparent in several fields, such
as non-aerospace manufacturing. Not surprisingly, the unemployment rate remained rather
high, averaging 5.5 percent during the third quarter, just as it
had for most of the earlier part
of the year. In view of a slowerthan-national rise in employment,
the regional jobless rate remained
above the national rate during
the quarter, and this situation
continued in October as the
national rate fell from 4.8 to

Consumer buying generally held
at a high level, despite the first
signs of weakness in durablegoods sales and a deceleration in
instalment-credit growth. Yet
with prices soaring, real gains
moderated in most sectors,
especially food.
Business firms continued to spend
substantial sums for new plant
and equipment, in an attempt to
keep up with heavy boom-level
demands. Public utilities, trading
firms and durable-goods manufacturers relied heavily on bank
term loans for their capital-goods
financing. In short-term financing,
bank-credit demand slackened
towards the end of summer as
firms rechanneled much of their
business to the commercial-paper
market, following a decline in
paper rates below the banks'
prime-loan rate. But retailers and
some manufacturing firms, especially in machinery and transportation equipment, maintained a
heavy demand for bank credit.
State and local governments
remained in a relatively easy fiscal
position, helped by boomgenerated tax revenues and
further infusions of Federal
revenue-sharing funds. At the
same time, municipal-bond
financing continued stronger than
in 1972; for the year to date, new
issues have totalled about $2.2

Percentage Change (1972.3-1973.3)

o

40

80

120

160

EGGS

WHEAT
TURKEY
BEEF CATTLE
COTTON

Western farmers and ranchers benefit from soaring prices,
with wheat being only the most conspicuous example
year-ago pace. During the third
quarter, local governments in
California and Arizona, and state
agencies in Alaska and Oregon,
went to market with sizable
issues.

Farming: banner year
Western farmers this fall began
closing their books on a banner
year. Total cash receipts may
approach $11.0 billion in 1973,
about 24 percent above last
year's record, and net farm income cou Id rise even faster to a
record $3.3 billion, despite falling
government payments and rapidly rising production expenses.
Sharply higher field-crop prices
and expanded fruit and vegetable
production are contributing to a
record gain in crop receipts, offset only partly by a droughtinduced 17-percent cutback in
the Pacific Northwest's wheat
crop. Similarly, record price increases are boosting returns to

livestock producers substantially,
more than offsetting a moderate
decline in the volume of
marketings.

last summer's price freeze. Livestock production has been running below year-earlier levels,
with cattle and calf slaughter
during the January-September
period falling about 6 percent
below the comparable 1972
figure. Prospects for livestock
production now look more promising, however, in view of the
lifting of beef price ceilings and
the availability of bumper feed
crops. The number of cattle and
calves on feed this fall was about
2 percent higher in California,
and 4 percent higher in Arizona,
than a year ago.

Aerospace: stronger
The sharp price rises underlying
the Western farm prosperity reflect to some extent the boom in
farm exports. In fiscal 1973, Western farm exports jumped to an
all-time high of $1.5 billion. The
sharpest gains were registered
by Pacific Northwest farmers,
with the area's wheat exports
alone far more than doubling in
a single year's time. Moreover,
export demand for farm products
remains strong, especially for
wheat, cotton and rice.
For livestock producers, 1973
remains a difficult year despite
soaring prices and incomes. They
have had to contend with soaring
feed costs, along with the market
uncertainties arising from last
spring's consumer boycott and

The Western aerospace industry
remained a positive force on the
regional employment scene,
adding 13,200 workers to its payrolls between June and October.
Total employment in the industry
now stands at S80,SOO-about
1S percent above the mid-1971
low but still about 2S percent
below the late-1967 peak. Both
California and Washington
shared in the gain, which was
centered in electronic equipment
and aircraft and reflected the
strength of the commercial
market for those products. A
highlight of the Washington aerospace market was the strong pace
of orders for the Boeing 747. As
of September, the Company had
received a total of 29 orders for
the wide-bodied plane, compared

with only 7 for the comparable
period a year ago.
While the civilian sector has
been responsible for most of the
recent strength in aerospace
employment, the ability of the
industry to sustain employment
growth next year may well depend upon the emerging strength
of the defense market. The ArabIsraeli war may provide additional thrust to an already evident
uptrend in military spending. The
Pentagon has submitted a $2.2billion supplemental budget
request, mostly to replace war
material furnished to Israel, and
it may ask for more funds to buy
transport planes and expand its
inventory of sophisticated
missiles.
A slowdown in commercialaircraft orders seems all but
inevitable, on the other hand, in
light of the poor traffic and earnings reports emanating from the
nation's major airlines, plus the
cutbacks in scheduled flights
necessitated by the current fuel
shortage. lockheed has announced plans to layoff 1,500
workers by January, because of
the decision of one of its major
airline customers to postpone
delivery of nine l-1011 jetliners,
and the profits outlook for this
and other aerospace manufacturers has become somewhat
clouded.
16

Construction: mixed
The pace of construction activity
increased during the third quarter, with construction awards
rising about 9 percent to a $15.4
billion annual rate. The increase
centered largely in the nonresidential sector: as a result, this
District contributed more than its
share to the nation's fixed-investment boom. Non-residential
construction surged to new highs
in virtually every state of the region, with awards rising substantially for commercial, educational
and (especially) manufacturing
facilities. Heavy construction
activity also advanced during the
quarter, largely in response to
increased demand for watersupply and waste-disposal
systems.
In the residential sector, activity
continued to recede from the
early-1973 peak, with a sharperthan-national decline. The number of Western housing starts
declined to a 422,000-unit annual
rate, some 21 percent below the
1972 pace. (The decline in dollar
terms was less, reflecting the
continued upsurge in construction costs.) Mobile-home sales
meanwhile trailed last year's pace
in most District states.

The early-1973 downturn reflected a general weakening of
housing demand, and thus preceded the late-spring run-up in
interest rates. The more recent
decline, in contrast, reflected a
growing stringency on supplies
of available funds and an attendant rise in borrowing costs.
Western S&l's experienced a net
outflow of savings, because of the
strong competition from inceasingly attractive money-market
instruments. (The bellwether
Treasury-bill rate rose from 7 percent in June to over 9 percent in
mid-September-a full percentage point above the early-1970
tight-money peak). New savings
actually exceeded the year-ago
inflow by almost 30 percent, but
a doubling of withdrawals resulted in an overall net outflow of
$165 million. California S&l's
accounted for all of the loss, however; most other District states
recorded continued (albeit reduced) savings inflows. For their
part, large District banks posted
a net inflow of $313 millionseveral times the previous quarter's inflow-as a substantial
increase in consumer-type certificate accounts more than offset
a large loss in passbook savings.
The mortgage-lending pace remained at a fairly high level even
in the face of this overall slowdown in savings flows. District

S&L's increased their mortgage
portfolios by $1.1 billion during
the third quarter, partly by reducing their cash and liquid investments, and partly by drawing on
advances from the Federal Home
Loan Banks and other borrowings.
District banks increased their
mortgage loans by $1.2 billion,
with roughly three-quarters of the
total in residential mortgages.
Some individual banks became
less willing to make mortgage
commitments, especially for
multi-family units, but banks generally did not curtail their lending.
Mortgage borrowing costs rose
substantially during the summer
quarter, reflecting both the contraction in savings inflows and
the rising cost of funds associated
with the mid-year increase in
rate ceilings payable on savings.
The average rate on conventional
loans rose from about 8 percent
in early June to almost 9% percent in late September, even
exceeding the rate increase reported nationwide. In October,
however, a number of lenders
began paring their lending rates
-in some cases to 8% percent
on prime-quality homes-in
response to a decline in moneymarket rates and an improvement
in bank and S&L savings inflows.

Materials: short

Thousands

Strong demand and upward price
pressures characterized the markets for most Western-produced
basic materials this summer and
fall. The one major exception
was forest products, and even
there a shift is now in the wind.
Lumber prices had advanced
almost without interruption for
2% years until last spring, but
were already dropping from record levels when the 60-day freeze
was imposed in mid-June, so
that the Cost of Living Council
felt safe in exempting the industry
from Phase IV wage-and-price
controls.
By October, wholesale prices for
softwood lumber were almost
4 percent below their May peak,
while softwood plywood prices
were almost 37 percent lower.
The turnaround was triggered by
governmental actions to increase
supply, and the price decline
continued as housing activity
slowed. However, the closure of
six Oregon plywood mills in midOctober, due to a shortage of
glues and fuels, touched off a
wave of scare buying, and initiated a 30-percent surge in prices
for key items within a month's
time.

Housing Permits

100

O~-'-"""L...I""""""'..L-IL-L."""...L-L­

'60

'65

'70

'73

Regional housing activity shows
decline, measured on any basis
Nonferrous-metals producers
were prevented by price controls
from raising their prices during
this period, despite the worldwide boom in demand which
sent foreign prices soaring well
above u.s. producer quotations.
The outflow of metal to overseas
markets combined with production problems to create serious
shortages, which in one case
(zinc) forced a major steel producer to discontinue galvanizing

operations. Fearful that supplementary supplies from the government stockpile would soon
run out, producers asked Congress to authorize the release of
additional stockpile metal, but
passage of such legislation
seemed remote because of
national-security considerations.
Pacific Northwest aluminum producers were hard-pressed to
meet customers' heavy demands
because of a shortage of hydroelectric power. This droughtcaused shortage forced a cutback
in operations to 75 percent of
capacity by mid-July. During the
summer months, the domestic
industry relied on government
stockpile metal to meet 20 percent of customers' total requirements, but by November all of
the aluminum authorized for sale
had been withdrawn, pointing to
even more serious supply problems in future months.
The Western steel industry experienced the highest thirdquarter production levels in its
history, as output surpassed the
year-ago mark by 10 percent.
The industry benefited not only
from the strong demand for steel
for non-residential construction,
but also from a slowdown in the
flow of foreign imports. Steel
imports tapered off in response
to the devaluation of the dollar
and strong overseas demand,
18

_

which induced Japanese producers to turn to other markets.
Despite its improved balance
sheet, the domestic steel industry was one of the first to receive
permission to boost its prices
after the freeze was lifted this
summer. The Cost of Living
Council supported industry arguments that a 4.8-percent increase
in prices for sheet and strip items
was justified on the basis of
higher costs, as well as necessary
to finance the new capacity required to prevent a future "steel
crunch."
Western oil refineries boosted
their operations to near-capacity
levels during the summer and
early fall, and thereby recorded a
7-percent year-to-year increase
in output. Foreign crude flowed
in at an increased rate after midApril, when the Administration
suspended oil-import quotas and
removed existing tariffs on crude
and products. These imports more
than made up for the continued
decline in domestically-produced
crude.
Western refinery activity is
bound to decline as a result of the
Arab embargo on oil shipments
to this country and related cutbacks in their shipments to other
nations. Prior to the embargo,
Arab states were supplying over
one-third of the crude oil imported into the Pacific region, but

__l1lil1lil1li111· • • ·•• 1• •·
[1I-1II
lI

supplies from Canada-another
large exporter-also will be
affected by the Arab moves.
The West thus will be confronted with severe problems
because of the petroleum crisis,
but it could also playa major role
in the long-term solution of the
crisis. On the consumption side,
heating-oil problems could be
less severe than elsewhere, at
least partly because of the milder
temperatures on the Pacific rim,
where most of the region's people
live. Gasoline maybe a different
matter, not only because Westerners rely almost completely on
the private auto as a means of
transportation, but also because
Western driving involves much
longer distances than driving
elsewhere. On the production
side, the crisis has already hastened Congressional acceptance
of the Alaska pipeline, and it may
also hasten the exploitation of
Rocky Mountain coal and shaleoil resources, which up to now
have lain idle because of both
economic and environmental
considerations.
Verle Johnston, Yvonne Levy
and Dean Chen

· ...•
[.111111

•

.it

•·•

Commercial banks, regionally as
well as nationally, continued to
meet heavy boom-level loan
demands during the third quarter
of the year. Money-market rates
increased steadily, pushing bank
costs for funds to record highs
and posing problems of disintermediation. Banks also had to
meet higher reserve requirements
against demand deposits, as well
as newly imposed marginal
reserve requirements on certain
oftheir deposit and non-deposit
sources of funds. To counter these
developments, banks made
numerous increases in their prime
business-loan rate, to a record 10
percent, and bid aggressively for
large-denomination time certificates (CD's), and also for fouryear certificates during the
relatively brief period in which
rate ceilings were removed on
these deposit instruments.
In late September and October,
however, there was evidence of
some slackening in bank-credit
demand. Money-market rates
moved down from their record
highs; also, banks bid less aggressively for funds and (in October)
lowered their prime rate generally to 9% percent.

Loans at Western banks rose by
$2.5 billion in the July-September
period. This increase represented
a 15-percent annual growth rate,
slightly higher than in the previous three-month period but
only half as large as the spectacular first-quarter gain. The
regional loan expansion lagged
somewhat behind the national
pace during the summer period,
reflecting a slowdown in business-loan growth which actually
began as early as last May. On the
other hand, mortgage lending in
the West accelerated from an
already rapid pace and contributed nearly half of the total thirdquarter loan increase.
To accommodate these heavy
loan demands, District banks reduced their holdings ofTreasury
securities by $800 million, but
partially offset this reduction by
adding $350 million in taxexempt and Federal-agency
securities. Banks also increased
their borrowings from the Federal Reserve Bank and through
repurchase agreements with corporations and public agencies.
But the major source of funds for
the third-quarter credit expansion
came from a $2.1 billion increase
in time deposits, mainly in largedenomination CD's.

19

Billions of Dollars

Deposits mixed
Total deposits at District member
banks increased by $1.9 billion
in the third quarter. This 11percent annual growth rate was
low only in relation to the exceptionally high rates recorded during the first two quarters of the
year. Incidentally, it was somewhat greater than the thirdquarter gain reported by banks
elsewhere in the nation.

Ratio Scale

20

Security Holdings

16

Business loons

8

Not seasonallyadiusted
4

1971

1972

Business loans finally level off at Western banks ...
security holdings increase, and CD upsurge tapers off

1973

A decrease in the demanddeposit component was due to a
large decline in U.S. Government
deposits, as the Treasury ran
down its balances to unseasonally
low levels. As monetary pressures
mounted, private demand deposits slowed to a 3-percent
expansion rate, down from the
high 12-percent rate of the
January-june period. Even the
time-deposit rise, at an 18percent rate, represented some
reduction from the first-half pace
as banks began to feel the effects
of disintermediation.
Individual deposit components
moved in divergent directions, as
is evident from an examination of
unadjusted data for large District
banks. By July and August, disintermediation at these banks
was seen in a sharply higher outflow of passbook savings. Their
third-quarter decrease amounted
to $573 million, or several times
larger than the normal seasonal

20

decline reported during the preceding quarter. However, attrition at banks was relatively small
compared with the withdrawal
rate of savings-and-Ioan associations.
The more favorable bank experience was surprising, since many
major banks retained a 41/2percent rate on savings instead of
moving to the 5-percent ceiling
permitted under Federal Reserve
Regulation Q as of mid-year.
However, most District banks increased rates on other consumertype deposits to their higher
ceilings, so that these time deposits rose $886 million in the
quarter. Of this amount, over
$200 million was in certificates
with 4-year maturities-the "wild
cards" which were freed from
rate ceilings onJuly 1.
The volume of "wild card" deposits doubled, but this percentage gain was only one-fourth as
large as the increase reported by
banks elsewhere, perhaps reflecting the less-active bidding for
such deposits on the part of
Western banks. But these longerterm deposit instruments are now
likely to become a less-important
source of bank funds, in view of
the 7% -percent rate ceiling that
was reimposed on November 1.
During October, however, they
grew rapidly in response to offering rates as high as 71/2 percent.

The most significant change,
however, was the $2.6-billion
increase in large-denomination
negotiable CD's. Last spring's
removal of rate ceilings on such
deposits permitted banks to bid
competitively for corporate and
other funds, in contrast to the
situation in 1969 and early 1970,
when severe attrition occurred
because ceilings did not permit
CD rates to rise as high as the
rates offered on other moneymarket instruments.
Western banks were particularly
aggressive in bidding for CD
money during the July-September
period; outstandings rose 28 percent in this period alone, substantially above the increase
reported by large banks nationally. (But at the end of the quarter,
CD's accounted for only onefourth of time-and-savings deposits at District banks, compared
with a one-third share nationally.)
Some of the funds acquired
through issuance of CD's served
to offset the large $855-million
decrease in deposits of states and
political subdivisions-a somewhat greater-than-seasonal
decline.
Record rates

Reserve discount rate went to a
record 71/2 percent in midAugust, and the Fed-funds rate
and CD offering rates reached
101/2 percent or more at their
September highs. Banks thereupon took a number of actions in
the third quarter to increase their
return on earning assets.
They made nine increases, of 1/4
percentage points each, in the
prime rate for large business
borrowers, bringing this rate to a
record 10 percent in mid-September. However, in line with the
rate guidelines ofthe Committee
on Interest and Dividends, banks
made smaller adjustments in rates
charged to smaller business customers. Fewer and smaller adjustments also were made in
mortgage-loan rates and rates on
consumer loans.
For many banks, their most important cost decision was a negative one-not to increase the
rate paid on passbook savings to
the 5-percent ceiling permitted
under the revised Regulation Q.
The cost reduction obtainable
from maintaining a 41/2 -percent
rate was quite substantial, since
savings deposits at District banks
exceed $21 billion.

Rising interest rates this summer
presented banks with serious cost
problems in the face of continued
strong loan demand and a restrictive monetary policy. The Federal
21

The higher loan rates that were
applied to the expanded loan
volume produced increases in
income for most Western banks,
both before and after adjustment
for securities transactions. But the
wide variation in individual bank
performance, already noticeable
early in the year, was very marked
during the third-quarter. During
that period, some major banks
recorded lower earnings, either
because of special circumstances
or because of large borrowings
and heavy reliance on high-cost
CD's.
Higher required reserves

Required reserves of District
member banks rose by $219 million in the third quarter, to $5.7
billion, at least partly because of
an increase of about $2.0 billion
in deposits subject to reserves. In
addition, reserve requirements
against net demand deposits
were raised by 1;'2 percentage
point in mid-july. Also, marginal
reserve requirements (over a midMay base) were imposed in june
and early july on large-denomination CD's, as well as on funds
obtained from sales of finance
bills and funds obtained through
issuance of holding-company
commercial paper. A further increase in marginal reserve requirements became effective in
early October.

22

As monetary policy became more
restrictive, banks borrowed more
heavily at the discount window to
meet their reserve requirements.
Borrowings from the San Francisco Federal Reserve Bank rose
from $174 million in the second
to $195 million in the third quarter. On the other hand, major
District banks reduced their net
purchases of Federal funds by
about one-fourth to $275 million.
(But these aggregate figures do
not reveal the continued heavy
reliance by some banks on the
Fed-funds market as a source of
borrowed funds.) Repurchase
agreements with corporations
and public agencies provided
banks with their largest source of
borrowed funds-over $2.3 billion, for a one-third increase over
the prior quarter. (Data on reserves and borrowings are on a
daily average basis.)

More favorable setting?

As the economy showed signs
this fall of gearing down to a more
sustainable rate of growth, loan
pressure on banks abated somewhat, although pressure on
reserves continued restrictive. It
should be noted, however, that
some of the recent slackness in
business-loan expansion was due
to the diversion of lendingto the
commercial-paper market which
followed the drop in the paper
rate below the banks' prime rate.
In addition, some easing in term
lending began to occur in the
wake of heavier corporate borrowing in the capital markets.
With business-loan volume declining and money-market rates
falling, banks lowered their prime
rate from 10 to 9% percent in late
October, and some even went as
low as 91;'2 percent.
Mortgage rates at some Western
banks dropped from 9112 to 91/4
percent this fall. Although realestate loans have continued to
expand at a relatively rapid rate,
a slowdown is expected as residential construction stays on its
downtrend. Meanwhile, the high
ratio of consumer debt to income

apparently is being reflected in a
reduced expansion rate in instalment credit. As overall loan demand eases, banks should be able
to replenish their holdings of
securities and improve the collateral-shortage problems that
have been plaguing some of them
in recent months.

Percent

11

10

Federal Funds

9

District banks borrowed less from
the San Francisco Reserve Bank in
October, but they continued
under reserve pressure with the
Fed-funds rate holding around
9% to 10 percent. The threat of
disintermediation lessened, and
banks showed a small gain in
passbook savings as well as continued expansion in consumer-type time deposits. In
this situation, banks bid less
aggressively for negotiable CD's,
running off over $800 million in
these deposit instruments. Banks'
earnings prospects improved in
October as the cost of CD money
fell, but the picture clouded again
during November's energy/
financial crisis, which saw moneymarket rates stiffening again.
Ruth Wilson

8

7

Prevailing Prime Rate

6

'\

5

4
1971

1972

1973

Bank borrowing costs decline (at least temporarily)
in early fall, permitting drop in prime business-loan rate

23